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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 0-18630

Cathay Bancorp, Inc.

Registrant’s telephone number, including area code:

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

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

      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 þ          No o

      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. þ

      Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Act).     Yes þ          No o

      The aggregate market value of the voting stock held by non-affiliates of Registrant as of February 3, 2003 was $558,605,248 (computed on the basis of $37.75 per share, which was the closing price of our Common Stock reported by the Nasdaq National Market on February 3, 2003).*

      The aggregate market value of the voting stock held by non-affiliates of the Registrant, computed by reference to the price at which the common equity was last sold as of the last business day of the Registrant’s most recently completed second fiscal quarter (June 28, 2002) was $603,555,500

      The number of shares outstanding as of February 3, 2003: Common Stock, $.01 par value — 18,015,315 shares.

	•	Portions of Registrant’s definitive proxy statement relating to Registrant’s 2003 Annual Meeting of Stockholders to be held April 21, 2003, as filed, are incorporated by reference into Part I and Part III.

*	Estimated solely for the purposes of this cover page. The market value of shares held by Registrant’s directors, executive officers, and Employee Stock Ownership Plan have been excluded.

CATHAY BANCORP, INC.

2002 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

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      In this annual report on Form 10-K, “Bancorp” refers to Cathay Bancorp, Inc. and the “Bank” refers to Cathay Bank. The terms “Company,” “we,” “us,” and “our” refer to Bancorp and the Bank collectively. The statements in this report include forward-looking statements regarding management’s beliefs, projections, and assumptions concerning future results and events. These forward-looking statements may, but do not necessarily, also include words such as “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,” “may,” “will,” “should,” “could,” “predicts,” “potential,” “continue” or similar expressions. Forward-looking statements are not guarantees. They involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, adverse developments, or conditions related to or arising from:

	•	our expansion into new market areas;
	•	fluctuations in interest rates;
	•	demographic changes;
	•	increases in competition;
	•	deterioration in asset or credit quality;
	•	changes in the availability of capital;
	•	adverse regulatory developments;
	•	changes in business strategy, including the formation of a real estate investment trust and the application to the Securities and Exchange Commission for deregistration of the registered investment company;
	•	general economic or business conditions; and
	•	other factors discussed in Part II — Item 7 — “Factors that May Affect Future Results.”

      Actual results in any future period may also vary from the past results discussed in this report. Given these risks and uncertainties, we caution readers not to place undue reliance on any forward-looking statements, which speak as of the date of this report. We have no intention and undertake no obligation to update any forward-looking statement or to publicly announce the results of any revision of any forward-looking statement to reflect future developments or events.

PART I

Items 1.     Business

      Cathay Bancorp, Inc. is a business corporation organized under the laws of the State of Delaware on March 1, 1990. Our only office, and our principal place of business, is located at the main office of Cathay Bank at 777 North Broadway, Los Angeles, California 90012. Our telephone number is (213) 625-4700.

      We are the holding company of Cathay Bank, a California state-chartered commercial bank. Our sole current business activity is to hold all of the outstanding stock of Cathay Bank. In the future, we may become an operating company or acquire savings institutions, banks, or companies engaged in bank-related activities and may engage in or acquire such other businesses, or activities as may be permitted by applicable law.

      We invite you to visit us at our Web site at www.cathaybank.com, to access free of charge our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, all of which are made available as soon as reasonably practicable after we electronically file such material with or furnish it to the Securities and Exchange Commission. In addition, you can write to us to obtain a free copy of any of those reports at Cathay Bancorp Inc., 777 North Broadway, Los Angeles, California 90012, Attn: Investor Relations.

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      Our primary business is the business of the Bank. Therefore, the competitive conditions to be faced by us are expected to include those faced by the Bank. See “Business of the Bank — Competition.” In addition, many banks and financial institutions have formed holding companies. It is likely that these holding companies will attempt to acquire other banks, thrift institutions, or companies engaged in bank-related activities. Thus, we may face increased competition in undertaking acquisitions of such institutions and in operating after any such acquisition.

      Due to the limited nature of our activities, Bancorp currently does not employ any persons other than our management, which includes the President, the Chief Financial Officer, Secretary, Assistant Secretary, and the General Counsel. In the future, if we acquire other financial institutions or pursue other lines of business, we may hire additional employees. See “Business of the Bank — Employees.”

Business of the Bank

      The Bank was incorporated under the laws of the State of California on August 22, 1961, and was licensed by the Department of Financial Institutions (previously known as the California State Banking Department), and commenced operations as a California state-chartered bank on April 19, 1962. Cathay Bank is an insured bank under the Federal Deposit Insurance Act but, like most state-chartered banks of similar size in California, it is not a member of the Federal Reserve System.

      The Bank’s main office is located in the Chinatown area of Los Angeles, at 777 North Broadway, Los Angeles, California 90012.

      In addition, the Bank has the following branch offices:

	•	Southern California — Eleven branches located in the cities of:

	•	Alhambra (2 locations)
	•	Cerritos
	•	City of Industry (2 locations)
	•	Diamond Bar
	•	Irvine
	•	Monterey Park
	•	San Gabriel
	•	Torrance
	•	Westminster

	•	Northern California — Eight branches, located in the cities of:

	•	Cupertino
	•	Millbrae
	•	Milpitas
	•	Oakland
	•	Richmond
	•	Sacramento
	•	San Jose
	•	Union City

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	•	New York — Three branches, located in the cities of:

	•	Brooklyn
	•	Flushing
	•	New York City (Located in the Chinatown area)

	•	Texas — One branch located in the city of Houston
	•	Hong Kong — One representative office
	•	Shanghai, China — One representative office

      Our primary market area is defined by the Community Reinvestment Act delineation, which includes the contiguous areas surrounding each of the Bank’s branch offices. It is the Bank’s policy to reach out and actively offer services to low and moderate income groups in the delineated branch service areas. Many of the Bank’s employees speak both English and one or more Chinese dialects or Vietnamese, and are thus able to serve the Bank’s Chinese, Vietnamese, and English speaking customers.

      The Bank conducts substantially the same business operations as a typical commercial bank. It accepts checking, savings, and time deposits, and makes commercial, real estate, personal, home improvement, automobile, and other installment and term loans. From time to time, the Bank invests available funds in other interest-earning assets, such as U.S. Treasury securities, U.S. government agencies securities, state and municipal securities, mortgage-backed securities, asset-backed securities, corporate bonds, and venture capital investments.

      The Bank’s services also include:

	•	letters of credit
	•	wire transfers
	•	forward currency, spot and forward contracts
	•	traveler’s checks
	•	safe deposit
	•	night deposit
	•	Social Security payment deposit
	•	collection
	•	bank-by-mail
	•	drive-up and walk-up windows
	•	automatic teller machines (“ATM”)
	•	Internet banking services
	•	other customary bank services

      To accommodate those customers who cannot conduct banking business during normal banking hours, the Bank has extended its banking hours to include Saturday hours for most branches and Sunday hours at its New York branches. In addition, the operations of the drive-up and walk-up facilities are extended past normal banking hours.

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      Since its inception, the Bank’s policy has been to attract business from, and to focus its primary services for the benefit of, individuals, professionals, and small to medium-sized businesses in the local markets in which its branches are located. The three general areas to which the Bank has directed its lendable assets are:

	•	residential mortgage loans, commercial mortgage loans, construction loans, mortgage warehousing loans, home equity lines loans;
	•	commercial loans, trade financing loans, Small Business Administration (“SBA”) loans; and
	•	installment loans to individuals for automobile, household, and other consumer expenditures.

      The Bank offers a program called Cathay Global Investment Services, which allows its customers to trade stocks online and to purchase mutual funds, annuities, equities, bonds, and short-term money market instruments, through UVest Financial Services Group, Inc.

Securities

      The Bank’s securities portfolio is managed by the First Vice President and Manager and the Company’s Investment Committee, in accordance with a comprehensive written Investment Policy which addresses strategies, types, and levels of allowable investments, and which is reviewed and approved by our Board of Directors of the Company.

      Our investment portfolio is managed to meet our liquidity needs through proceeds from scheduled maturities and is also utilized for pledging requirements for deposits of state and local subdivisions, securities sold under repurchase agreements, and Federal Home Loan Bank (“FHLB”) advances. The portfolio is comprised of U.S. government agency securities, mortgage-backed securities, collateralized mortgage obligations, obligations of states and political subdivisions, corporate debt instruments and equity securities. At December 31, 2002, the aggregate investment securities portfolio, with a carrying value of $707.73 million, was classified as investment grade securities, except for our $4.06 million of non-rated venture capital investments. We do not include federal funds sold and certain other short-term securities as investment securities. These other investments are included in cash and cash equivalents.

      Information concerning the carrying value and the maturity distribution and yield analysis of the Company’s securities available-for-sale and securities held-to-maturity portfolios is included in Part II — Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in “Note 3 to the Consolidated Financial Statements.” A summary of the amortized cost and estimated fair value of the Bank’s securities by contractual maturity is included in Part II — Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in “Note 3 to the Consolidated Financial Statements.”

Loans

      Our Board of Directors and senior management establish the basic lending policy for the Bank. Each loan is generally considered in terms of, among other things, character, repayment ability, financial condition of the borrower, secondary repayment source, collateral, capital, leverage capacity of the borrower, market conditions for the borrower’s business or project, and prevailing economic trends and conditions. In the case of mortgage loans, our lending policy requires an independent appraisal on real estate property in accordance with applicable regulatory guidelines. Loan originations are obtained by a variety of sources, including existing customers, walk-in customers, referrals from brokers or existing customers, and advertising. In its present marketing efforts, the Bank emphasizes its community ties, customized personal service, competitive rates, and an efficient underwriting and approval process, with loan applications taken at all of the Bank’s branch offices. The Bank’s centralized documentation department supervises the obtaining of credit reports, appraisals, and other documentation involved with a loan.

      Commercial Mortgage Loans. These loans are typically secured by first deeds of trust on commercial properties, including primarily commercial retail properties, shopping centers and owner-occupied industrial facilities, and secondarily office buildings, multiple-unit apartments, and multi-tenanted industrial properties.

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      Commercial Loans. The Bank provides personalized financial services to diverse commercial and professional businesses in its market areas. Commercial loans consist primarily of short-term loans (normally with a maturity of up to one year) to support general business purposes, or to provide working capital to businesses in the form of lines of credit to finance trade-finance loans. The Bank continues to focus primarily on commercial lending to small-to-medium size businesses, within the Company’s geographic market area. Commercial loan pricing is generally at a rate tied to the prime rate, as quoted in the Wall Street Journal, or the Banks’ reference rate.

      Small Business Administration Loans. The Bank originates SBA loans in California, under the “preferred lender” status. Preferred lender status is granted to a lender which has made a certain number of SBA loans and which, in the opinion of the SBA, has staff who are qualified and experienced in this area. As a preferred lender, the Bank’s SBA Lending Group has the authority to make, on behalf of the SBA, the SBA guaranty on loans under the 7(a) program. This can represent a substantial savings in loan processing time to the customer. Under this program, the SBA delegates loan underwriting, closing, and most servicing and liquidation authority and responsibility to carefully selected lenders.

      The Bank utilizes both the 504 program, which is focused toward long-term financing of buildings and other long-term fixed assets, and the 7(a) program, which is the SBA’s primary loan program, and which can be used for financing of a variety of general business purposes such as acquisition of land and buildings, equipment, inventory and working capital needs of eligible businesses generally over a 5- to 25-year term. The collateral position in the SBA loans is enhanced by the SBA guaranty in the case of 7(a) loans, and by lower loan-to-value ratios under the 504 program. During 2002, the Bank sold the guaranteed portion of certain of its SBA 7(a) loans in the secondary market. SBA loan pricing is generally at a rate tied to the prime rate, as quoted in the Wall Street Journal.

      Residential Mortgage Loans. The Bank originates single-family-residential mortgage loans, and home equity lines of credit. The single-family-residential mortgage loans are comprised of conforming, non-conforming, and jumbo residential mortgage loans, and are secured by first and subordinate liens on single (one-to-four units) family residential properties. The Bank’s products include a fixed-rate residential mortgage loan, an adjustable-rate residential mortgage loan, and a variable-rate home equity line of credit loan. The pricing on our variable-rate home equity line of credit is generally at a rate tied to the prime rate, as quoted in the Wall Street Journal, or the Banks’ reference rate. These mortgage loans are underwritten in accordance with the Bank’s guidelines, on the basis of the borrower’s financial strength, historical loan quality, and other qualifications. The Bank’s highest concentration of residential mortgage loans relates to properties in California.

      Real Estate Construction. The Bank’s real estate construction loan activity focuses on providing short-term loans, typically ranging between approximately $1.0 million and $5.0 million, to individuals and developers with whom the Bank has established relationships for the construction primarily of multi-unit projects. Residential real estate construction loans are typically secured by first deeds of trust and guarantees of the borrower. The economic viability of the projects, the borrower’s credit worthiness, and the borrower’s and contractor’s developmental experience are primary considerations in the loan underwriting decision. The Bank utilizes approved independent licensed appraisers. The Bank monitors projects during the construction phase through regular construction inspections and a disbursement program tied to the percentage of completion of each project. The Bank also occasionally makes unimproved property loans to borrowers who intend to construct a single-family-residence on the lot generally within twelve months. In addition, the Bank also makes commercial real estate construction loans to high net worth clients with adequate liquidity for construction of office and warehouse properties. Such loans are typically secured by first deeds of trust and guarantees of the borrower.

      Installment Loans. The Bank’s installment loan portfolio is divided between installment loans secured by automobiles and home improvement loans. Installment loans tend to be fixed rate and longer-term (one-to-

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      Distribution and Maturity of Loans. Information concerning loan type and mix, distribution of loans and maturity of loans is included in Part II — Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in “Note 4 to the Consolidated Financial Statements.”

      Non-performing Loans and Allowance for Loan Losses. Information concerning non-performing loans, allowance for loan losses, loans charged-off, loan recoveries, and other real estate owned is included in Part II — Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in “Notes 4 and 5 to the Consolidated Financial Statements.”

Asset Quality

      The Bank monitors its asset quality with lending and credit policies, which require the regular review of its loan portfolio. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of the loan agreements. Such loans are placed under closer supervision with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan losses, and (if appropriate) partial or full charge-off.

      The Bank’s policy is to place loans on a non-accrual status if interest and principal or either interest or principal is past due 90 days or more, or in cases where management deems the full collection of principal and interest unlikely. After a loan is placed on non-accrual status, any interest collected or accrued in the previous three months, is generally reversed against current income. Thereafter, any payment is generally first applied towards the principal balance. Depending on the circumstances, management may elect to continue the accrual of interest on certain past due loans if partial payment is received and/or the loan is well collateralized, and in the process of collection. The loan is generally returned to accrual status when the borrower has brought the past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled. Information concerning non-accrual, past due, and restructured loans is included in Part II — Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in “Note 4 to the Consolidated Financial Statements.”

Deposits

      The Bank attempts to price its deposits in order to promote deposit growth and offers a wide array of deposit products in order to satisfy its customers’ needs. The Bank’s current deposit products include passbook accounts, checking accounts, money market deposit accounts, certificates of deposit, individual retirement accounts, college certificates of deposit, and public funds deposits.

      The Bank’s deposits are generally obtained from residents within the Company’s geographic market area. The Bank utilizes traditional marketing methods to attract new customers and deposits, by offering a wide variety of products and services and utilizing various forms of advertising media. Information concerning types of deposit accounts, average deposits and rates, and maturity of time deposits of $100,000 or more is included in Part II — Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Borrowings

      Borrowings from time to time include securities sold under agreements to repurchase, the purchase of federal funds, and funds obtained as advances from the FHLB of San Francisco. Information concerning the types, amounts, and maturity of our borrowings is included in “Note 8 to the Consolidated Financial Statements.”

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Return on Equity and Assets

      Information concerning the return on average assets, return on average stockholders’ equity, the average equity to assets ratio and the dividend payout ratio is included in Part II — Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Interest Rates and Differentials

      Information concerning the interest-earning asset mix, average interest-earning assets, average interest-bearing liabilities and the yields on interest-earning assets and interest-bearing liabilities is included in Part II — Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Analysis of Changes in Net Interest Income

      An analysis of changes in net interest income due to changes in rate and volume is included in Part II — Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Commitments and Letters of Credit

      Information concerning the Bank’s outstanding loan commitments and letters of credit is included in “Note 11 to the Consolidated Financial Statements.”

Subsidiaries of Cathay Bank

      Cathay Investment Company. Cathay Investment Company is a wholly-owned subsidiary of the Bank that was formed in 1984 to invest in real property. In 1987, Cathay Investment Company opened an office in Taipei, Taiwan to promote Taiwanese real estate investments in Southern California. The office in Taipei is located at Sixth Floor, Suite 3, 146 Sung Chiang Road, Taipei, Taiwan.

      Cathay Securities Fund, Inc. Cathay Securities Fund, Inc. is a registered investment company and a wholly-owned subsidiary of the Bank. It was formed in 2000 to engage in the business of investing in, owning, and holding loans and securities. Its office is located at 777 North Broadway, Los Angeles, California 90012. The Company has applied to the Securities and Exchange Commission to deregister this registered investment company. See discussion below in the section entitled “Factors That May Affect Future Results” of this Annual Report on Form 10-K.

Expansion

      Management of the Bank continues to look for opportunities to expand the Bank’s branch network by seeking new branch locations and/or by acquiring other financial institutions to diversify its customer base in order to compete for new deposits and loans, and to be able to serve its customers more effectively. On June 27, 2002, the Bank opened a new branch in Brooklyn, New York, and on September 9, 2002, the Bank opened a new branch in Sacramento, Northern California. In addition, with China’s accession into the World Trade Organization and its increasing importance in the world economy, the Bank opened a representative office in Shanghai, China, on April 20, 2002.

Competition

      The banking business in California, and specifically in the market areas served by most of the Bank’s branch offices, is highly competitive. The Bank competes for deposits and loans with other commercial banks, savings and thrift institutions, brokerage houses, insurance companies, mortgage companies, credit unions, credit card companies and other financial and non-financial institutions and entities. In addition, the Bank also competes with other entities (both governmental and private industry) that are seeking to raise capital through the issuance and sale of debt and equity securities. Many of these institutions and entities offer

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      The direction of federal legislation in recent years seems to favor increased competition between different types of financial institutions and to foster new entrants into the financial services market. Competitive conditions are expected to continue to intensify as legislation is enacted which has the effect of dissolving historical barriers that limit participation in certain markets, increasing the cost of doing business for banks, or affecting the competitive balance between banks and other financial and non-financial institutions and entities. Technological factors, such as on-line banking and brokerage services, and economic factors can also be expected to have an ongoing impact on increasingly competitive conditions.

      To compete with other financial institutions in its primary service areas, the Bank relies principally upon the following:

	•	local promotional activities
	•	personal contacts by its officers, directors, employees, and stockholders
	•	extended hours on weekdays, Saturday banking, and Sunday banking in certain locations
	•	Internet banking
	•	an Internet website, located at www.cathaybank.com
	•	certain other specialized services

      For customers whose loan demands exceed the Bank’s lending limit, the Bank has attempted in the past, and intends in the future, to arrange for such loans on a participation basis with correspondent banks. The Bank also assists customers requiring other services not offered by the Bank to obtain such services from its correspondent banks.

      In Southern California, at least three other Chinese-American banks of comparable size provide particular competition for loans and deposits with the Bank and at least two super-regional banks provide such competition for deposits. In Northern California, one of these Chinese-American banks provide particular competition for loans and deposits with the Bank and the same two super-regional banks provide such competition for deposits as well.

      In addition, there are many other Chinese-American banks in both Southern and Northern California. Banks from the Pacific Rim countries, such as Taiwan, Hong Kong, and China also continue to open branches in the Los Angeles area, thus increasing competition in the Bank’s primary markets.

Employees

      As of December 31, 2002, Bancorp and Bank (including subsidiaries) employed approximately 581 persons, including 131 officers. None of the employees are represented by a union. Management believes that its relations with employees are excellent.

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Executive Officers

      The table below sets forth the names, ages, and positions of all executive officers of the Company. See Part III, Item 10 — “Directors and Executive Officers of the Registrant,” below for further information regarding the executive officers of Bancorp and Cathay Bank.

Regulation

      As a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended and as revised by the Gramm-Leach-Bliley Act of 1999, Bancorp’s primary regulatory authority is the Federal Reserve System (the “Federal Reserve”). The Bank Holding Company Act requires Bancorp to file annual reports of its operations with the Federal Reserve. Bancorp is also subject to examination by the Federal Reserve.

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      The Bank, as a California state-chartered commercial bank, is regulated by the Federal Deposit Insurance Corporation (or FDIC), and by the California Department of Financial Institutions. The Bank’s deposits are insured up to the legal maximum by the FDIC. Although not a member of the Federal Reserve, the Bank is subject to Federal and State rules and regulations.

      Regulatory authorities review key operational areas of Bancorp and the Bank, including asset quality, capital adequacy, liquidity, management and administrative ability, compliance with consumer protection laws and security of confidential customer information. Applicable law and regulations also limit the business activities in which Bancorp, the Bank, and its subsidiaries may be engaged. See also, “Other Banking Regulations — Interstate Banking” and “Federal Limits on the Activities and Investments of State-Chartered Banks” below.

      Bancorp also files periodic reports, proxy statements, and other information with the Securities and Exchange Commission, and is subject to federal and state securities laws, including the Sarbanes-Oxley Act of 2002, which contains provisions dealing with corporate governance and management, disclosure, oversight of the accounting profession, and auditor independence.

      The following summary describes some of the more significant laws, regulations, and policies that affect our operations. It is not a complete listing of all laws that apply to Bancorp and the Bank. To the extent that the information in this Section, “Regulation of Bancorp, and the Bank,” describes statutory or regulatory provisions, it is qualified in its entirety by reference to such provisions.

      The banking and financial services industry is heavily regulated. Regulations, statutes, and policies affecting the industry are frequently under review by Congress, state legislatures, and the federal and state agencies charged with supervisory and examination authority over banking institutions. This regulatory framework is intended primarily to protect the Bank’s depositors, the federal deposit insurance fund, and the safety and soundness of the regulated financial institutions. Generally, the regulatory framework is not intended to protect our stockholders.

      We expect that changes in the banking and financial services industry will continue to occur in the future. Some of the changes may create opportunities for us to compete in financial markets with less regulation. However, these changes also may create new competitors in geographic and product markets which have historically been limited by law to banking institutions, such as the Bank. We cannot predict how changes in regulations, statutes, or policies will impact us. These changes may have a material adverse effect on our business and earnings.

      The operations of bank holding companies and their subsidiaries are affected by the fiscal and monetary policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the national supply of bank credit.

      The Federal Reserve uses the following instruments of monetary policy, among others, as a means to implement its objectives:

	•	open market purchases and sales of U.S. government securities;
	•	changes in the discount rate on bank borrowings; and
	•	changes in reserve requirements on bank deposits and borrowings by banks and their affiliates.

      The Federal Reserve uses these instruments of monetary policy in varying combinations to seek to influence the overall level of bank loans, investments and deposits; the interest rates charged on loans and paid for deposits; the price of the dollar in foreign exchange markets; and the level of inflation. The Federal Reserve’s fiscal and monetary policies will continue to have a significant effect on Bancorp and the Bank.

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     Bank Holding Company Regulation

      As a bank holding company, Bancorp is subject to regulation, supervision, and examination by the Federal Reserve. It is required to file reports with the Federal Reserve and furnish such other information as may be required by the Federal Reserve under the Bank Holding Company Act.

      The Federal Reserve has a policy that bank holding companies must serve as a source of financial and managerial strength to their subsidiary banks and may not conduct their operations in an unsafe or unsound manner. It is the Federal Reserve’s position that bank holding companies should stand ready to use their available resources to provide adequate capital to their subsidiary banks during periods of financial stress or adversity. Bank holding companies should also maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting their subsidiary banks. If a bank holding company fails in these requirements, the Federal Reserve will generally consider such failure to be an unsafe and unsound banking practice or a violation of the Federal Reserve’s regulations or both.

      The Federal Reserve also has the authority to regulate bank holding company debt, including the authority to impose interest rate ceilings and reserve requirements on such debt. Under certain circumstances, the Federal Reserve may require Bancorp to file written notice and obtain its approval prior to purchasing or redeeming Bancorp’s equity securities.

      Bancorp must also obtain the prior approval of the Federal Reserve if it acquires more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of a bank or bank holding company. The Federal Reserve must also give prior approval to any merger or consolidation with another bank holding company.

      In addition, under the Bank Holding Company Act, Bancorp cannot acquire direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company. It cannot engage directly or indirectly in activities other than banking, managing or controlling banks or furnishing services to its subsidiaries. However, there are some statutory exceptions. Subject to prior approval of the Federal Reserve, Bancorp can acquire shares of companies engaged in activities that the Federal Reserve deems to be closely related to banking or managing or controlling banks. In addition, as discussed below under “Financial Services Modernization Legislation,” if Bancorp becomes a “Financial Holding Company,” certain restrictions on acquiring ownership or control of certain non-banking companies will no longer apply.

      On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 (referred to in this report as the Modernization Act), which among other things revised the Bank Holding Company Act. Effective March 12, 2000, the Modernization Act repealed the two affiliation provisions of the Glass-Steagall Act that restricted banks and securities firms from affiliating.

      The Modernization Act repealed:

	•	Section 20 of the Glass-Steagall Act, which restricted the affiliation of Federal Reserve member banks with firms “engaged principally” in specified securities activities, and
	•	Section 33 of the Glass-Steagall Act, which restricted officer, director, or employee interlocks between a member bank and any company or person “primarily engaged” in specified securities activities.

      In addition, the Modernization Act expressly preempted any state law restricting the establishment of financial affiliations, primarily related to insurance. The law established a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers. The Modernization Act revised and expanded the Bank Holding Company Act framework and permitted a bank holding company to engage in additional types of financial activities provided that it became a “Financial Holding Company” under the Modernization Act.

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      Such financial activities include banking, insurance, securities activities, merchant banking, and additional activities incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

      To affiliate with other financial service providers, we would have to become a “Financial Holding Company.” We would have to file a declaration with the Federal Reserve, electing to engage in activities permissible for Financial Holding Companies and certify that we are eligible to do so because the Bank is “well-capitalized” and “well-managed.” The Federal Reserve must also determine that the Bank, as the insured depository institution subsidiary, has at least a “satisfactory” rating under the Community Reinvestment Act. We have not sought to become a Financial Holding Company. We will continue to monitor our strategic business plan, market conditions, and other factors to determine whether we will elect to become a Financial Holding Company and take advantage of the expanded powers provided in the Modernization Act.

      Under the Modernization Act, securities firms and insurance companies that become Financial Holding Companies may acquire banks and other financial institutions. No regulatory approval will be required for a Financial Holding Company to acquire a company (other than a bank holding company, bank or savings association) engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve. Prior Federal Reserve approval is required before a Financial Holding Company acquires the beneficial ownership or control of more than 5% of the voting shares of a bank holding company, bank or savings association. To the extent that the Modernization Act permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation.

      The Modernization Act also added a new section to the Federal Deposit Insurance Act. The new section allows subsidiaries of state banks to engage in “activities as principal that would only be permissible” for a national bank to conduct in a financial subsidiary. It expressly preserved a state bank’s right to retain all existing subsidiaries. California permits state-chartered commercial banks to engage in any activity permissible for national banks. Under the Modernization Act, a national bank subsidiary may engage in any financial activity which may be conducted through a Financial Holding Company subsidiary, except for insurance underwriting, insurance investments, real estate investment or development or merchant banking. Therefore, the Bank can form subsidiaries to engage in the activities authorized by the Modernization Act to the same extent as a national bank. To form a financial subsidiary, the Bank must be “well-capitalized” and meet other regulatory requirements. See “Other Banking Regulations — Federal Limits on the Activities and Investments of State-Chartered Banks” below.

      The Modernization Act may have the result of increasing the amount of competition that Bancorp and the Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than Bancorp and the Bank.

      Privacy. The Modernization Act provides consumers with new protections against the transfer and use of their nonpublic personal information by financial institutions. The Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of Thrift Supervision issued final rules on June 1, 2000.

      Under the rules, financial institutions must provide among other things:

	•	initial notices to customers about their privacy policies (including a description of the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates);
	•	annual notices of such privacy policies to current customers; and
	•	subject to certain exceptions, a reasonable method for customers to “opt out” of disclosure to nonaffiliated third parties.

      These federal privacy protections do not prohibit state governments from imposing more protective rules.

      Consumer Protection Rules — Sale of Insurance Products. On December 4, 2000, the federal bank and thrift regulatory agencies adopted consumer protection rules for the sale of insurance products by depository

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      The rule requires oral and written disclosure, before the completion of the sale of an insurance product or annuity, that such product:

	•	is not a deposit or other obligation of, or guaranteed by, the depository institution or its affiliate;
	•	is not insured by the FDIC or any other agency of the United States, the depository institution or its affiliates; and
	•	has certain risks of investment, including possible loss of value.

      Finally, the depository institution may not condition an extension of credit on the consumer’s purchase of an insurance product or annuity from the depository institution or from any of its affiliates; on the consumer’s agreement not to obtain an insurance product or annuity from an unaffiliated entity; or by prohibiting a consumer from obtaining an insurance product or annuity from an unaffiliated entity. The disclosure must be understandable and the customer must acknowledge receipt of such disclosure.

      In addition, to the extent practicable, a depository institution must keep insurance and annuity activities physically segregated from the areas where retail deposits are routinely accepted from the general public.

      Safeguarding Confidential Customer Information. In February 2001, the federal bank and thrift regulatory agencies published guidelines requiring financial institutions to establish an information security program to:

	•	identify and assess the risks that may threaten customer information;
	•	develop a written plan containing policies and procedures to manage and control these risks;
	•	implement and test the plan; and
	•	adjust the plan on a continuing basis to account for changes in technology, the sensitivity of customer information, and internal or external threats to information security.

      Each institution may implement a security program appropriate to its size and complexity and the nature and scope of its operations.

      The guidelines outline specific security measures that institutions should consider in implementing a security program. A financial institution must adopt those security measures determined to be appropriate. The guidelines require the Board of Directors to oversee an institution’s efforts to develop, implement, and maintain an effective information security program and approve written information security policies and programs. The guidelines became effective July 1, 2001.

      The precise impact of the Modernization Act on Bancorp and the Bank will not be fully known until the last of the Modernization Act’s phased effective dates occurs on November 12, 2004, and until regulatory agencies promulgate all the administrative regulations implementing many portions of the Act. It can be expected that state regulatory authorities and/or legislatures may act in response to the Modernization Act.

     USA Patriot Act

      On October 26, 2001, in response to the tragic events of September 11, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”). The Patriot Act is directed at the prevention, detection, and prosecution of international money laundering and financing of terrorism and, among other things, requires or will require financial institutions to do the following (i) establish an anti-money laundering program; (ii) establish due diligence policies, procedures, and controls with respect to private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks; and

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     Other Banking Regulations

      As a California state-chartered commercial bank, the Bank is subject to primary supervision, periodic examination, and regulation by the FDIC and by the California Department of Financial Institutions. The Bank’s deposits are insured by the FDIC up to the legal maximum and the Bank is subject to FDIC rules applicable to insured banks. Although not a member of the Federal Reserve, the Bank is subject to Federal and State rules and regulations.

      Capital Requirements. The Federal Reserve and the FDIC have established risk-based minimum capital guidelines that seek to ensure that banking organizations are appropriately capitalized. The guidelines are intended to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for transactions reported on the balance sheet as assets, and transactions which are recorded as off-balance sheet items, such as letters of credit or recourse arrangements. Under these guidelines, the nominal dollar amounts of assets and the credit equivalent amounts of off-balance sheet items are multiplied by one of several risk-adjusted percentages. The risk-adjusted percentages range from 0% for assets with low credit risk, such as U.S. Treasury securities, to 100% for assets with high credit risk, such as commercial loans.

      The federal regulators require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% (10% to be well capitalized) and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4% (6% to be well capitalized). In addition, the federal regulators require a minimum Tier 1 leverage ratio of 4% (5% to be well capitalized). The Company was well capitalized as of December 31, 2002, with a total risk-based capital ratio of 13.01%, a Tier 1 risk-based capital ratio of 11.93% and Tier 1 leverage ratio of 10.11%.

      The tables presenting our risk-based capital and leverage ratios as of December 31, 2002, are included in Note 10 to the Consolidated Financial Statements of Bancorp, which are included in this Annual Report on Form 10-K.

      Prompt Corrective Action. In December 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (or FDICIA) was enacted into law. FDICIA provided for the recapitalization of the Bank Insurance Fund and improved examinations of insured depository institutions. It required each federal banking regulatory agency to revise its risk-based capital standards and to specify levels at which regulated institutions are considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” It prescribes standards for safety and soundness of all insured depository institutions. FDICIA requires each federal banking agency and the FDIC to take “prompt corrective action” against those institutions that fail to satisfy their minimum capital requirements. As of December 31, 2002, the Bank was well capitalized for these regulatory purposes.

      An institution that, based on its capital levels, is classified as well capitalized, adequately capitalized or undercapitalized may be treated as though it were in the next lower capital category, if the appropriate federal banking agency determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. The affected institution must receive proper notice and have an opportunity for a hearing. At each successive lower capital category, an insured bank is subject to more restrictions, including restrictions on the bank’s activities, operational practices, and ability to pay dividends.

      In addition to measures taken under the prompt corrective action provision, commercial banking organizations may be subject to potential enforcement actions by federal regulators for, among other things, unsafe or unsound practices in conducting their businesses, or violations of any law, rule, regulation, or any condition imposed in writing by the relevant regulatory agency or any written agreement with a regulatory agency.