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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2004 or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _______________________________________ to
000-50914
_______________________
(Commission File Number)
BRIDGE CAPITAL HOLDINGS
______________________________________________________
(Exact name of registrant as specified in its charter)
CALIFORNIA 80-0123855
_______________________________ _______________________________________
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
55 ALMADEN BOULEVARD, SAN JOSE, CA 95113
____________________________________________________________
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 423-8500
Securities registered pursuant to Section 12 (b) of the Act:
Name of each exchange
Title of each class on which registered
___________________ _____________________
None None
Securities registered pursuant to Section 12 (g) of the Act:
Title of each class
__________________________
Common Stock, no par value
Bridge Capital Holdings (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 and (2) has been subject to such filing requirements for the past 90
days. Yes [ ] No [X] .
Indicate by checkmark 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 checkmark whether registrant is an accelerated filer (as
defined by in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the voting stock held by non-affiliates of
Bridge Bank, N.A., the registrant's predecessor, was $68,620,970 as of June 30,
2004.
As of January 21, 2005, Bridge Bank, N.A. had 6,097,697, shares of common
stock outstanding.
Documents incorporated by reference: The Bank's Proxy Statement for its
2005 Annual Meeting of Shareholders is incorporated herein by reference in Part
III, Items 10 through 14.
1
FORWARD-LOOKING STATEMENTS
IN ADDITION TO THE HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS CERTAIN
FORWARD-LOOKING INFORMATION 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, AND WHICH ARE SUBJECT TO THE "SAFE HARBOR" CREATED BY THOSE
SECTIONS. THE READER OF THIS ANNUAL REPORT SHOULD UNDERSTAND THAT ALL SUCH
FORWARD-LOOKING STATEMENTS ARE SUBJECT TO VARIOUS UNCERTAINTIES AND RISKS THAT
COULD AFFECT THEIR OUTCOME. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE SUGGESTED BY SUCH FORWARD-LOOKING STATEMENTS. SUCH RISKS AND
UNCERTAINTIES INCLUDE, AMONG OTHERS, (1) COMPETITIVE PRESSURE IN THE BANKING
INDUSTRY INCREASES SIGNIFICANTLY; (2) CHANGES IN THE INTEREST RATE ENVIRONMENT
REDUCES MARGINS; (3) GENERAL ECONOMIC CONDITIONS, EITHER NATIONALLY OR
REGIONALLY, ARE LESS FAVORABLE THAN EXPECTED, RESULTING IN, AMONG OTHER THINGS,
A DETERIORATION IN CREDIT QUALITY; (4) CHANGES IN THE REGULATORY ENVIRONMENT;
(5) CHANGES IN BUSINESS CONDITIONS AND INFLATION; (6) COSTS AND EXPENSES OF
COMPLYING WITH THE INTERNAL CONTROL PROVISIONS OF THE SARBANES-OXLEY ACT AND OUR
DEGREE OF SUCCESS IN ACHIEVING COMPLIANCE; (7) CHANGES IN SECURITIES MARKETS,
(8) FUTURE CREDIT LOSS EXPERIENCE; (9) CIVIL DISTURBANCES OR TERRORIST THREATS
OR ACTS, OR APPREHENSION ABOUT POSSIBLE FUTURE OCCURANCES OF ACTS OF THIS TYPE;
AND (10) THE INVOLVEMENT OF THE UNITED STATES IN WAR OR OTHER HOSTILITIES.
THEREFORE, THE INFORMATION IN THIS ANNUAL REPORT SHOULD BE CAREFULLY CONSIDERED
WHEN EVALUATING THE BUSINESS PROSPECTS OF THE COMPANY.
FORWARD-LOOKING STATEMENTS ARE GENERALLY IDENTIFIABLE BY THE USE OF TERMS SUCH
AS "BELIEVE", "EXPECT", "INTEND", "ANTICIPATE", "ESTIMATE", "PROJECT", "ASSUME,"
"PLAN," "PREDICT," "FORECAST," "IN MANAGEMENT'S OPINION," "MANAGEMENT CONSIDERS"
OR SIMILAR EXPRESSIONS. WHEREVER SUCH PHRASES ARE USED, SUCH STATEMENTS ARE AS
OF AND BASED UPON THE KNOWLEDGE OF MANAGEMENT, AT THE TIME MADE AND ARE SUBJECT
TO CHANGE BY THE PASSAGE OF TIME AND/OR SUBSEQUENT EVENTS, AND ACCORDINGLY SUCH
STATEMENTS ARE SUBJECT TO THE SAME RISKS AND UNCERTAINTIES NOTED ABOVE WITH
RESPECT TO FORWARD-LOOKING STATEMENTS.
ALL OF THE COMPANY'S OPERATIONS AND MOST OF ITS CUSTOMERS ARE LOCATED IN
CALIFORNIA. OTHER EVENTS, INCLUDING THOSE OF SEPTEMBER 11, 2001, HAVE INCREASED
THE UNCERTAINTY RELATED TO THE NATIONAL AND CALIFORNIA ECONOMIC OUTLOOK AND
COULD HAVE AN EFFECT ON THE FUTURE OPERATIONS OF THE COMPANY OR ITS CUSTOMERS,
INCLUDING BORROWERS. THE COMPANY DOES NOT UNDERTAKE, AND SPECIFICALLY DISCLAIMS
ANY OBLIGATION, TO UPDATE ANY FORWARD-LOOKING STATEMENTS TO REFLECT OCCURRENCES
OR UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH STATEMENTS.
2
PART 1
ITEM 1. BUSINESS
GENERAL
On July 26, 2000 an Application to Obtain a National Banking Charter
and Federal Deposit Insurance was filed with the Comptroller of the Currency
(the "Comptroller") and with the Federal Deposit Insurance Corporation (the
"FDIC"). The Comptroller approved the Application on November 17, 2000 and the
FDIC approved the Bank's Application for Federal Deposit Insurance. On December
6, 2000, the Bank's Articles of Association and Organizers' Certificate were
adopted by the Bank's organizers, which established the Bank's corporate
existence. There are no predecessors to the Bank.
The Bank commenced operations on May 14, 2001. The Bank engages in
general commercial banking business, and accepts checking and savings deposits,
makes commercial, real estate, auto and other installment and term loans, and
provides other customary banking services. The Bank attracts the majority of its
loan and deposit business from the residents and numerous small and middle
market businesses and professional firms located in Santa Clara County. Its
headquarters office is located at 55 Almaden Boulevard, San Jose, California
95113.
In 2002, the Bank opened a full-service branch office in Palo Alto and
established a U.S. Small Business Administration Lending Group that includes a
regional loan production office in Sacramento county. Also, it launched Bridge
Capital Finance Group, a factoring and asset-based lending division with a loan
production office in Santa Clara. During the year ended December 31, 2003, the
Bank opened an office in downtown San Jose and established a U.S. Small business
Administration regional loan production office in San Diego county.
On October 1, 2004, Bridge Bank, National Association (the "bank")
announced completion of a bank holding company structure which was approved by
shareholders at the Bank's annual shareholders' meeting held on May 20, 2004.
The bank holding company, formed as a California corporation, is named Bridge
Capital Holdings (the "company"). Information in this report dated prior to
September 30, 2004 is for Bridge Bank, N.A.
Bridge Capital Holdings was formed for the purpose of serving as the
holding company for Bridge Bank and is supervised by the Board of Governors of
the Federal Reserve System. Effective October 1, 2004, Bridge Capital Holdings
acquired 100% of the voting shares of Bridge Bank, National Association. As a
result of the transaction, the former shareholders of Bridge Bank received one
share of common stock of Bridge Capital Holdings for every one share of common
stock of Bridge Bank owned.
Prior to the share exchange, the common stock of the Bank had been
registered with the Office of Comptroller of the Currency. As a result of the
share exchange, common stock of Bridge Capital Holdings is now considered
registered with the Securities and Exchange Commission. Future filings will be
made with the SEC rather than the Office of the Comptroller of the Currency and
will be available on the SEC's website, HTTP://WWW.SEC.GOV as well as on the
Company's website http://www.bridgebank.com.
The Bank provides the local business and professional community with
banking services tailored to the unique needs of the Silicon Valley. The Bank
does not intend to offer trust services initially or for the foreseeable future,
but it will attempt to make such services available to the Bank's customers
through correspondent institutions. The deposits of the Bank are insured by the
FDIC, up to applicable limits, and the Bank is a member of the Federal Reserve
System.
In addition, the Bank provides some specialized services to its
customers. These services include courier deposit services to key locations or
customers throughout the Bank's service area, Small Business Administration
(SBA) loans, factoring and asset-based loans and Internet banking. The Bank
3
reserves the right to change its business plan at any time and no assurance can
be given that, if the Bank's proposed business plan is followed, it will prove
successful.
At December 31, 2004, the Bank had total assets of approximately $402
million, total gross loans of $295 million and total deposits of approximately
$352 million. At December 31, 2004, the Company had 80 full-time equivalent
employees.
DEPOSITS
The Bank offers a wide range of deposit accounts designed to attract
small and medium size commercial businesses as well as business professionals
and retail customers, including a complete line of checking and savings
products, including passbook savings, "Money Market Deposit" accounts which
require minimum balances and frequency of withdrawal limitations, NOW accounts,
and bundled accounts. Other accounts offered by the Bank include term
certificates of deposit.
Other deposit services include a full complement of convenience
oriented services, including direct payroll and social security deposit,
post-paid bank-by-mail, and Internet banking, including on-line access to
account information. However, at this time, the Bank does not open accounts
through the Internet. Any plans to offer online account opening must be approved
in advance by the Comptroller. No assurance can be given that, if applied for,
such approval will be obtained.
As the Bank has no automated teller machines, the Bank may refund all
or portion of transaction charges incurred by its customers for their use of
another bank's ATM. The majority of the Bank's deposits are obtained from
businesses located in the Bank's primary service area.
LENDING ACTIVITIES
The Bank engages in a full range of lending products designed to meet
the specialized needs of its customers, including commercial lines of credit and
term loans, constructions loans, equipment loans, and mortgage loans.
Additionally, the Bank extends accounts receivable, factoring and inventory
financing to qualified customers. Loans are also offered through the Small
Business Administration guarantee loan programs, both the 7(a) and 504 programs
(described below under "Item7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--FINANCIAL CONDITION AND EARNING
ASSETS--Loan Portfolio").
The Bank finances real estate construction projects, primarily for the
construction of owner occupied and 1 to 4 unit residential developments and
commercial buildings under $3 million in loan size.
The Bank directs its commercial lending principally toward businesses
whose demands for credit fall within the Bank's lending limit. In the event
there are customers whose commercial loan demands exceed the Bank's lending
limits, the Bank seeks to arrange for such loans on a participation basis with
other financial institutions.
The Bank also extends lines of credit to individual borrowers, and
provides homeowner equity loans, home improvement loans, auto financing, credit
and debit cards and overdraft/cash reserve accounts.
BUSINESS HOURS
In order to attract loan and deposit business, the Bank maintains lobby
hours currently between 9:00 a.m. and 5:00 p.m. Monday through Friday.
For additional information concerning the Bank, see Selected Financial
Data under Item 6 on page 11.
4
COMPETITION
The banking business in Santa Clara County, as it is elsewhere in
California, is highly competitive, and each of the major branch banking
institutions has one or more offices in the Bank's service area. The Bank
competes in the marketplace for deposits and loans, principally against these
banks, independent community banks, savings and loan associations, thrift and
loan companies, credit unions, mortgage banking companies, and non-bank
institutions such as mutual fund companies and investment brokerage firms that
claim a portion of the market.
Larger banks may have a competitive advantage because of higher lending
limits and major advertising and marketing campaigns. They also perform
services, such as trust services, international banking, discount brokerage and
insurance services, which the Bank is not authorized or prepared to offer
currently. The Bank has made arrangements with its correspondent banks and with
others to provide such services for its customers. For borrowers requiring loans
in excess of the Bank's legal lending limit, the Bank has offered, and intends
to offer in the future, such loans on a participating basis with its
correspondent banks and with other independent banks, retaining the portion of
such loans which is within its lending limit. As of December 31, 2004, the
Bank's unsecured legal lending limit to a single borrower and such borrower's
related parties was $7,080,000 based on regulatory capital of $43,058,000.
However, for risk management purposes, the Bank has established internal
policies, which at present provide lending limits that are less than the Bank's
legal lending limit.
The Bank's business is concentrated in its service area, which
primarily encompasses Santa Clara County, and also includes, to a lesser extent,
the contiguous areas of Alameda, San Mateo and Santa Cruz counties. During 2002,
the Bank established an SBA loan production office in Sacramento county and
during 2003, a SBA loan production office in San Diego county.
In order to compete with major financial institutions in its primary
service area, the Bank uses to the fullest extent possible the flexibility that
is accorded by its independent status. This includes an emphasis on specialized
services, local promotional activity, and personal contacts by the Bank's
officers, directors and employees. The Bank also seeks to provide special
services and programs for individuals in its primary service area who are
employed in the agricultural, professional and business fields, such as loans
for equipment, furniture, and tools of the trade or expansion of practices or
businesses.
Banking is a business that depends on interest rate differentials. In
general, the difference between the interest rate paid by the Bank to obtain its
deposits and its other borrowings and the interest rate received by the Bank on
loans extended to its customers and on securities held in the Bank's portfolio
comprises the major portion of the Bank's earnings.
Commercial banks compete with savings and loan associations, credit
unions, other financial institutions and other entities for funds. For instance,
yields on corporate and government debt securities and other commercial paper
affect the ability of commercial banks to attract and hold deposits. Commercial
banks also compete for loans with savings and loan associations, credit unions,
consumer finance companies, mortgage companies and other lending institutions.
The interest rate differentials of the Bank, and therefore its
earnings, are affected not only by general economic conditions, both domestic
and foreign, but also by the monetary and fiscal policies of the United States
as set by statutes and as implemented by federal agencies, particularly the
Federal Reserve Board. This agency can and does implement national monetary
policy, such as seeking to curb inflation and combat recession, by its open
market operations in United States government securities, adjustments in the
amount of interest free reserves that banks and other financial institutions are
required to maintain, and adjustments to the discount rates applicable to
borrowing by banks from the Federal Reserve Board. These activities influence
the growth of bank loans, investments and deposits and also affect interest
rates charged on loans and paid on deposits.
5
SUPERVISION AND REGULATION
INTERSTATE BANKING
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Interstate Banking Act") regulates the interstate activities of banks and
bank holding companies and establishes a framework for nationwide interstate
banking and branching. Since June 1, 1997, a bank in one state has generally
been permitted to merge with a bank in another state without the need for
explicit state law authorization. However, states were given the ability to
prohibit interstate mergers with banks in their own state by "opting-out"
(enacting state legislation applying to all out-of-state banks prohibiting such
mergers) prior to June 1, 1997.
Since 1995, adequately capitalized and managed bank holding companies
have been permitted to acquire banks located in any state, subject to two
exceptions: first, a state may still prohibit bank holding companies from
acquiring a bank which is less than five years old; and second, no interstate
acquisition can be consummated by a bank holding company if the acquiror would
control more than 10% of the deposits held by insured depository institutions
nationwide or 30% or more of the deposits held by insured depository
institutions in any state in which the target bank has branches.
A bank may also establish and operate de novo branches in any state in
which the bank does not maintain a branch if that state has enacted legislation
to expressly permit all out-of-state banks to establish branches in that state.
Among other things, the Interstate Banking Act amended the Community
Reinvestment Act to require that in the event a bank has interstate branches,
the appropriate federal banking regulatory agency must prepare for that
institution a written evaluation of (i) the bank's record of CRA performance and
(ii) the bank's CRA performance in each applicable state. Interstate branches
are now prohibited from being used as deposit production offices. Also, a
foreign bank is permitted to establish branches in any state other than its home
state to the same extent that a bank chartered by the foreign bank's home state
may establish such branches.
The Caldera, Weggeland, and Killea California Interstate Banking and
Branching Act of 1995 (the "Caldera Weggeland Act") implemented important
provisions of the Interstate Banking Act discussed above and repealed
California's previous interstate banking laws, which were largely preempted by
the Interstate Banking Act. (Prior California law prohibited, among other
things, an out-of-state bank holding company from establishing a de novo
California bank except for the purpose of taking over the deposits of a closed
bank. This restriction has been eliminated.)
As indicated above, the Interstate Banking Act generally permits a bank
in one state to merge with a bank in another state without the need for explicit
state law authorization. However, the Caldera Weggeland Act expressly prohibits
a foreign (other state) bank which does not already have a California branch
office from (i) purchasing a branch office of a California bank (as opposed to
purchasing the entire bank) and thereby establishing a California branch office
or (ii) establishing a California branch on a de novo basis.
The Interstate Banking Act also requires, among other things, approval
of the state bank supervisor of the target bank's home state for interstate
acquisitions of banks by bank holding companies. The Caldera Weggeland Act
authorizes the Commissioner to approve such an interstate acquisition if the
Commissioner finds that the transaction is consistent with certain criteria
specified by law.
The changes effected by Interstate Banking Act and Caldera Weggeland
Act are expected to continue to increase competition in the environment in which
the Bank will operate to the extent that out-of-state financial institutions may
6
directly or indirectly enter the Bank's market areas. It appears that the
Interstate Banking Act has contributed to the accelerated consolidation of the
banking industry in that a number of the largest bank holding companies are
expanding into different parts of the country that were previously restricted.
While some large out-of-state banks have already entered the California market
as a result of this legislation, it is not possible to predict the precise
impact of this legislation on the Bank and the competitive environment in which
it operates.
REGULATION W
The Federal Reserve has adopted Regulation W to comprehensively
implement sections 23A and 23B of the Federal Reserve Act.
Sections 23A and 23B and Regulation W limit the risks to a bank from
transactions between the bank and its affiliates and limit the ability of a bank
to transfer to its affiliates the benefits arising from the bank's access to
insured deposits, the payment system and the discount window and other benefits
of the Federal Reserve system. The statute and rule impose quantitative and
qualitative limits on the ability of a bank to extend credit to, or engage in
certain other transactions with, an affiliate (and a nonaffiliate if an
affiliate benefits from the transaction). However, certain transactions that
generally do not expose a bank to undue risk or abuse the safety net are
exempted from coverage under Regulation W.
Historically, a subsidiary of a bank was not considered an affiliate
for purposes of Sections 23A and 23B, since their activities were limited to
activities permissible for the bank itself. The Gramm-Leach-Bliley Act
authorized "financial subsidiaries" that may engage in activities not
permissible for a bank. These financial subsidiaries are now considered
affiliates. Certain transactions between a financial subsidiary and another
affiliate of a bank are also covered by sections 23A and 23B under Regulation W.
Regulation W has certain exemptions, including:
o For state-chartered banks, an exemption for subsidiaries lawfully
conducting nonbank activities before issuance of the final rule.
o An exemption for extensions of credit by a bank under a general
purpose credit card where the borrower uses the credit to purchase
goods or services from an affiliate of the bank, so long as less than
25% of the aggregate amount of purchases with the card are purchases
from an affiliate of the bank (a bank that does not have nonfinancial
affiliates is exempt from the 25% test).
o An exemption for loans by a bank to a third party secured by
securities issued by a mutual fund affiliate of the bank (subject to a
number of conditions).
o Subject to a number of conditions, an exemption that would permit a
banking organization to engage more expeditiously in internal
reorganization transactions involving a bank's purchase of assets from
an affiliate.
The final rule contains new valuation rules for a bank's investments in, and
acquisitions of, affiliates.
The Federal Reserve expects examiners and other supervisory staff to
review intercompany transactions closely for compliance with the statutes and
Regulation W and to resolve any violations or potential violations quickly.
TYING ARRANGEMENTS AND TRANSACTIONS WITH AFFILIATED PERSONS
A bank is prohibited from tie-in arrangements in connection with any
extension of credit, sale or lease of property or furnishing of services. For
example, with some exceptions, a bank may not condition an extension of credit
on a promise by its customer to obtain other services provided by it, its
7
holding company or other subsidiaries (if any), or on a promise by its customer
not to obtain other services from a competitor.
Directors, officers and principal shareholders of the Bank, and the
companies with which they are associated, may have banking transactions with the
Bank in the ordinary course of business. Any loans and commitments to loan
included in these transactions must be made in compliance with the requirements
of applicable law, on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons of similar creditworthiness, and on terms not involving more than
the normal risk of collectibility or presenting other unfavorable features.
BANK HOLDING COMPANY ACT
The Company is registered as a bank holding company under the Bank
Holding Company Act of 1956, as amended ("BHCA"). As a bank holding company,
Capital Corp is subject to examination by the FRB. Pursuant to the BHCA, Capital
Corp is also subject to limitations on the kinds of businesses in which it can
engage directly or through subsidiaries. It may, of course, manage or control
banks. Generally, however, it is prohibited, with certain exceptions, from
acquiring direct or indirect ownership or control of more than five percent of
any class of voting shares of an entity engaged in nonbanking activities, unless
the FRB finds such activities to be "so closely related to banking" as to be
deemed "a proper incident thereto" within the meaning of the BHCA. As a bank
holding company, the Company may not acquire more than five percent of the
voting shares of any domestic bank without the prior approval of (or, for "well
managed" companies, prior written notice to) the FRB.
The BHCA includes minimum capital requirements for bank holding
companies. See section titled "Regulation and Supervision - Regulatory Capital
Requirements". Regulations and policies of the FRB also require a bank holding
company to serve as a source of financial and managerial strength to its
subsidiary banks. It is the FRB's policy that a bank holding company should
stand ready to use available resources to provide adequate capital funds to a
subsidiary bank during periods of financial stress or adversity and that it
should maintain the financial flexibility and capital-raising capacity needed to
obtain additional resources for assisting the subsidiary bank. Under certain
conditions, the FRB may conclude that certain actions of a bank holding company,
such as the payment of a cash dividend, would constitute an unsafe and unsound
banking practice.
"SOURCE OF STRENGTH" POLICY
According to FRB policy, bank holding companies are expected to act as
a source of financial strength to each subsidiary bank and to commit resources
to support such subsidiary.
SECURITIES AND EXCHANGE COMMISSION FILINGS
Under Section 13 of the Securities Exchange Act of 1934 ("Exchange
Act") and the SEC's rules, the Company must electronically file periodic and
current reports as well as proxy statements with the Securities and Exchange
Commission (the "SEC"). The Company electronically files the following reports
with the SEC: Form 10-K (Annual Report), Form 10-Q (Quarterly Report), and Form
8-K (Current Report). The Company may prepare additional filings as required.
The SEC maintains an Internet site, http://www.sec.gov, at which all forms filed
electronically may be accessed. Our SEC filings are also available on our
website at http://www.bridgebank.com.
REGULATION OF THE BANK
The Bank is regulated and supervised by the Comptroller of the Currency
and is subject to periodic examination by the Comptroller. Deposits of the
Bank's customers are insured by the FDIC up to the maximum limit of $100,000,
and, as an insured bank, the Bank is subject to certain regulations of the FDIC.
8
As a national bank, the Bank is a member of the Federal Reserve System and is
also subject to the regulations of the Federal Reserve Board (the "FRB").
The regulations of those federal bank regulatory agencies govern most
aspects of the Bank's business and operations, including but not limited to,
requiring the maintenance of non-interest bearing reserves on deposits, limiting
the nature and amount of investments and loans which may be made, regulating the
issuance of securities, restricting the payment of dividends and regulating bank
expansion and bank activities. The Bank also is subject to the requirements and
restrictions of various consumer laws and regulations.
Statutes, regulations and policies affecting the banking industry are
frequently under review by Congress and by the federal and charged with
supervisory and examination authority over banking institutions. Changes in the
banking and financial services industry are likely to occur in the future. Some
of the changes may create opportunities for the Bank 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 insured depository institutions such as the Bank. Changes in
the statutes, regulations, or policies that affect the Bank cannot necessarily
be predicted and may have a material effect on the Bank's business and earnings.
In addition, the regulatory agencies which have jurisdiction over the Bank have
broad discretion in exercising their supervisory powers.
The OCC can pursue an enforcement action against the Bank for unsafe
and unsound practices in conducting its business, or for violations of any law,
rule or regulation or provision, any consent order with any agency, any
condition imposed in writing by the agency, or any written agreement with the
agency. Enforcement actions may include the imposition of a conservator or
receiver, cease-and-desist orders and written agreements, the termination of
insurance of deposits, the imposition of civil money penalties and removal and
prohibition orders against institution-affiliated parties.
In addition to the regulation and supervision outlined above, banks
must be prepared for judicial scrutiny of their lending and collection
practices. For example, some banks have been found liable for exercising
remedies which their loan documents authorized upon the borrower's default. This
has occurred in cases where the exercise of those remedies was determined to be
inconsistent with the previous course of dealing between the bank and the
borrower. As a result, banks must exercise caution, incur expense and face
exposure to liability when dealing with delinquent loans.
The following description of selected statutory and regulatory
provisions and proposals is not intended to be a complete description of these
provisions or of the many laws and regulations to which the Bank is subject, and
is qualified in its entirety by reference to the particular statutory or
regulatory provisions discussed.
A. Effect of State Law
The laws of the State of California also affect the Bank's business and
operations. For example, under 12 U.S.C. 36, as amended by the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994, state laws regarding
community reinvestment, consumer protection, fair lending and establishment of
intrastate branches may affect the operations of national banks in states other
than their home states. On a similar basis, 12 U.S.C. 85 provides that state
law, in most circumstances, determines the maximum rate of interest which a
national bank may charge on a loan. As California law exempts all
state-chartered and national banks from the application of its usury laws,
national banks are also provided such an exemption by 12 U.S.C. 85.
B. Interstate Banking
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Interstate Banking Act") regulates the interstate activities of banks and
bank holding companies and establishes a framework for nationwide interstate
banking and branching. Since June 1, 1997, a bank in one state has generally
9
been permitted to merge with a bank in another state without the need for
explicit state law authorization. However, states were given the ability to
prohibit interstate mergers with banks in their own state by "opting-out"
(enacting state legislation applying to all out-of-state banks prohibiting such
mergers) prior to June 1, 1997.
Since 1995, adequately capitalized and managed bank holding companies
have been permitted to acquire banks located in any state, subject to two
exceptions: first, a state may still prohibit bank holding companies from
acquiring a bank which is less than five years old; and second, no interstate
acquisition can be consummated by a bank holding company if the acquiror would
control more than 10% of the deposits held by insured depository institutions
nationwide or 30% or more of the deposits held by insured depository
institutions in any state in which the target bank has branches.
A bank may also establish and operate de novo branches in any state in
which the bank does not maintain a branch if that state has enacted legislation
to expressly permit all out-of-state banks to establish branches in that state.
Among other things, the Interstate Banking Act amended the Community
Reinvestment Act to require that in the event a bank has interstate branches,
the appropriate federal banking regulatory agency must prepare for that
institution a written evaluation of (i) the bank's record of CRA performance and
(ii) the bank's CRA performance in each applicable state. Interstate branches
are now prohibited from being used as deposit production offices. Also, a
foreign bank is permitted to establish branches in any state other than its home
state to the same extent that a bank chartered by the foreign bank's home state
may establish such branches.
The Caldera, Weggeland, and Killea California Interstate Banking and
Branching Act of 1995 (the "Caldera Weggeland Act") implemented important
provisions of the Interstate Banking Act discussed above and repealed
California's previous interstate banking laws, which were largely preempted by
the Interstate Banking Act. (Prior California law prohibited, among other
things, an out-of-state bank holding company from establishing a de novo
California bank except for the purpose of taking over the deposits of a closed
bank. This restriction has been eliminated.)
As indicated above, the Interstate Banking Act generally permits a bank
in one state to merge with a bank in another state without the need for explicit
state law authorization. However, the Caldera Weggeland Act expressly prohibits
a foreign (other state) bank which does not already have a California branch
office from (i) purchasing a branch office of a California bank (as opposed to
purchasing the entire bank) and thereby establishing a California branch office
or (ii) establishing a California branch on a de novo basis.
The Interstate Banking Act also requires, among other things, approval
of the state bank supervisor of the target bank's home state for interstate
acquisitions of banks by bank holding companies. The Caldera Weggeland Act
authorizes the Commissioner to approve such an interstate acquisition if the
Commissioner finds that the transaction is consistent with certain criteria
specified by law.
10
The changes effected by Interstate Banking Act and Caldera Weggeland
Act are expected to continue to increase competition in the environment in which
the Bank will operate to the extent that out-of-state financial institutions may
directly or indirectly enter the Bank's market areas. It appears that the
Interstate Banking Act has contributed to the accelerated consolidation of the
banking industry in that a number of the largest bank holding companies are
expanding into different parts of the country that were previously restricted.
While some large out-of-state banks have already entered the California market
as a result of this legislation, it is not possible to predict the precise
impact of this legislation on the Bank and the competitive environment in which
it operates.
C. Change in Bank Control
The Bank Holding Company Act of 1956, as amended, and the Change in
Bank Control Act of 1978, as amended, together with regulations of the FRB and
the Comptroller, require that, depending on the particular circumstances, either
FRB approval must be obtained or notice must be furnished to the Comptroller and
not disapproved prior to any person or company acquiring "control" of a national
bank, such as the Bank, subject to exemptions for some transactions. Control is
conclusively presumed to exist if an individual or company (i) acquires 25% or
more of any class of voting securities of the bank or (ii) has the direct or
indirect power to direct or cause the direction of the management and policies
of the Bank, whether through ownership of voting securities, by contract or
otherwise; provided that no individual will be deemed to control the Bank solely
on accord of being director, officer or employee of the Bank. Control is
rebuttably presumed to exist if a person acquires 10% or more but less than 25%
of any class of voting securities and either the company has registered
securities under Section 12 of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), or no other person will own a greater percentage of that
class of voting securities immediately after the transaction.
D. Regulation W
The Federal Reserve has adopted Regulation W to comprehensively
implement sections 23A and 23B of the Federal Reserve Act.
Sections 23A and 23B and Regulation W limit the risks to a bank from
transactions between the bank and its affiliates and limit the ability of a bank
to transfer to its affiliates the benefits arising from the bank's access to
insured deposits, the payment system and the discount window and other benefits
of the Federal Reserve system. The statute and rule impose quantitative and
qualitative limits on the ability of a bank to extend credit to, or engage in
certain other transactions with, an affiliate (and a nonaffiliate if an
affiliate benefits from the transaction). However, certain transactions that
generally do not expose a bank to undue risk or abuse the safety net are
exempted from coverage under Regulation W.
Historically, a subsidiary of a bank was not considered an affiliate
for purposes of Sections 23A and 23B, since their activities were limited to
activities permissible for the bank itself. The Gramm-Leach-Bliley Act
authorized "financial subsidiaries" that may engage in activities not
permissible for a bank. These financial subsidiaries are now considered
affiliates. Certain transactions between a financial subsidiary and another
affiliate of a bank are also covered by sections 23A and 23B under Regulation W.
Regulation W has certain exemptions, including:
o For state-chartered banks, an exemption for subsidiaries lawfully
conducting nonbank activities before issuance of the final rule.
o An exemption for extensions of credit by a bank under a general
purpose credit card where the borrower uses the credit to purchase
goods or services from an affiliate of the bank, so long as less than
25% of the aggregate amount of purchases with the card are purchases
from an affiliate of the bank (a bank that does not have nonfinancial
affiliates is exempt from the 25% test).
11
o An exemption for loans by a bank to a third party secured by
securities issued by a mutual fund affiliate of the bank (subject to a
number of conditions).
o Subject to a number of conditions, an exemption that would permit a
banking organization to engage more expeditiously in internal
reorganization transactions involving a bank's purchase of assets from
an affiliate.
The final rule contains new valuation rules for a bank's investments in, and
acquisitions of, affiliates.
The Federal Reserve expects examiners and other supervisory staff to
review intercompany transactions closely for compliance with the statutes and
Regulation W and to resolve any violations or potential violations quickly.
E. Tying Arrangements and Transactions with Affiliated Persons
A bank is prohibited from tie-in arrangements in connection with any
extension of credit, sale or lease of property or furnishing of services. For
example, with some exceptions, a bank may not condition an extension of credit
on a promise by its customer to obtain other services provided by it, its
holding company or other subsidiaries (if any), or on a promise by its customer
not to obtain other services from a competitor.
Directors, officers and principal shareholders of the Bank, and the
companies with which they are associated, may have banking transactions with the
Bank in the ordinary course of business. Any loans and commitments to loan
included in these transactions must be made in compliance with the requirements
of applicable law, on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons of similar creditworthiness, and on terms not involving more than
the normal risk of collectibility or presenting other unfavorable features.
F. Capital Adequacy Requirements
The Bank is subject to the Comptroller 's capital guidelines and
regulations governing capital adequacy for national banks. Additional capital
requirements may be imposed on banks based on market risk. The FDIC requires a
Tier 1 capital1/ ratio to total assets ratio of 8% for new banks during the
first three years of operation.
After the first three years of operations, the Comptroller requires a
minimum leverage ratio of 3% of Tier 1 capital to total assets for national
banks that have received the highest composite regulatory rating (a regulatory
measurement of capital, assets, management, earnings, liquidity and sensitivity
to risk) and that are not anticipating or experiencing any significant growth.
All other institutions will be required to maintain a leverage ratio of at least
100 to 200 basis points above the 3% minimum.
The Comptroller's regulations also require national banks to maintain a
minimum ratio of qualifying total capital to risk-weighted assets of 8.00%.
Risk-based capital ratios are calculated with reference to risk-weighted assets,
including both on and off-balance sheet exposures, which are multiplied by
certain risk weights assigned by the Comptroller to those assets. At least
one-half of the qualifying capital must be in the form of Tier 1 capital.
The risk-based capital ratio focuses principally on broad categories of
credit risk, and may not take into account many other factors that can affect a
bank's financial condition. These factors include overall interest rate risk
exposure; liquidity, funding and market risks; the quality and level of
earnings; concentrations of credit risk; certain risks arising from
__________________
1/ Tier 1 capital is generally defined as the sum of the core capital elements
less goodwill and certain intangibles. The following items are defined as core
capital elements: (i) common stockholders' equity; (ii) qualifying noncumulative
perpetual preferred stock and related surplus; and (iii) minority interests in
the equity accounts of consolidated subsidiaries.
12
nontraditional activities; the quality of loans and investments; the
effectiveness of loan and investment policies; and management's overall ability
to monitor and control financial and operating risks, including the risk
presented by concentrations of credit and nontraditional activities. The
Comptroller has addressed many of these areas in related rule-making proposals.
In addition to evaluating capital ratios, an overall assessment of capital
adequacy must take account of each of these other factors including, in
particular, the level and severity of problem and adversely classified assets.
For this reason, the final supervisory judgment on a bank's capital adequacy may
differ significantly from the conclusions that might be drawn solely from the
absolute level of the bank's risk-based capital ratio. The Comptroller has
stated that banks generally are expected to operate above the minimum risk-based
capital ratio. Banks contemplating significant expansion plans, as well as those
institutions with high or inordinate levels of risk, should hold capital
consistent with the level and nature of the risks to which they are exposed.
Further, the banking agencies have adopted modifications to the
risk-based capital regulations to include standards for interest rate risk
exposures. Interest rate risk is the exposure of a bank's current and future
earnings and equity capital arising from movements in interest rates. While
interest rate risk is inherent in a bank's role as a financial intermediary, it
introduces volatility to bank earnings and to the economic value of the bank.
The banking agencies have addressed this problem by implementing changes to the
capital standards to include a bank's exposure to declines in the economic value
of its capital due to changes in interest rates as a factor that the banking
agencies consider in evaluating an institution's capital adequacy. Bank
examiners consider a bank's historical financial performance and its earnings
exposure to interest rate movements as well as qualitative factors such as the
adequacy of a bank's internal interest rate risk management.
Finally, institutions with significant trading activities must measure
and hold capital for exposure to general market risk arising from fluctuations
in interest rates, equity prices, foreign exchange rates and commodity prices
and exposure to specific risk associated with debt and equity positions in the
trading portfolio. General market risk refers to changes in the market value of
on-balance-sheet assets and off-balance-sheet items resulting from broad market
movements. Specific market risk refers to changes in the market value of
individual positions due to factors other than broad market movements and
includes such risks as the credit risk of an instrument's issuer. The additional
capital requirements apply to institutions with trading assets and liabilities
equal to 10% or more of total assets or trading activity of $1 billion or more.
The federal banking agencies may apply the market risk regulations on a case by
case basis to institutions not meeting the eligibility criteria if necessary for
safety and soundness reasons.
The federal banking agencies will evaluate an institution in its
periodic examination on the degree to which changes in interest rates, foreign
exchange rates, commodity prices or equity prices can affect a financial
institution's earnings or capital. In addition, the agencies focus in the
examination on an institution's ability to monitor and manage its market risk,
and will provide management with a clearer and more focused indication of
supervisory concerns in this area.
Under certain circumstances, the Comptroller may determine that the
capital ratios for a national bank must be maintained at levels which are higher
than the minimum levels required by the guidelines. A national bank which does
not achieve and maintain required capital levels may be subject to supervisory
action by the Comptroller through the issuance of a capital directive to ensure
the maintenance of required capital levels. In addition, the Bank is required to
meet certain guidelines of the Comptroller concerning the maintenance of an
adequate allowance for loan and lease losses.
The federal banking agencies, including the OCC, have adopted
regulations implementing a system of prompt corrective action under the Federal
Deposit Insurance Corporation Improvement Act ("FDICIA"). The regulations
establish five capital categories with the following characteristics: (1) "Well
capitalized," consisting of institutions with a total risk-based capital ratio
of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a
leverage ratio of 5% or greater and which are not operating under an order,
written agreement, capital directive or prompt corrective action directive; (2)
"Adequately capitalized," consisting of institutions with a total risk-based
13
capital ratio of 8% or greater, a Tier 1 risk-based capital of 4% or greater and
a leverage ratio of 4% or greater and which do not meet the definition of a
"well capitalized" institution; (3) "Undercapitalized," consisting of
institutions with a total risk-based capital ratio of less than 8%, a Tier 1
risk-based capital ratio of less than 4%, or a leverage ratio of less than 4%;
(4) "Significantly undercapitalized," consisting of institutions with a total
risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of
less than 3%, or a leverage ratio of less than 3%; and (5) "Critically
undercapitalized," consisting of institutions with a ratio of tangible equity to
total assets that is equal to or less than 2%.
The regulations establish procedures for the classification of
financial institutions within the capital categories, for filing and reviewing
capital restoration plans required under the regulations, and for the issuance
of directives by the appropriate regulatory agency, among other matters. See
"SUPERVISION AND REGULATION -- Prompt Corrective Action."
The appropriate federal banking agency, after notice and an opportunity
for a hearing, is authorized to treat a well capitalized, adequately capitalized
or undercapitalized insured depository institution as if it had a lower
capital-based classification if it is in an unsafe and unsound condition or
engaging in an unsafe and unsound practice. Thus, an adequately capitalized
institution can be subjected to the restrictions (described below) that are
imposed on undercapitalized institutions (provided that a capital restoration
plan cannot be required of the institution), and an undercapitalized institution
can be subjected to the restrictions (also described below) applicable to
significantly undercapitalized institutions. See "SUPERVISION AND REGULATION --
Prompt Corrective Action."
An insured depository institution cannot make a capital distribution
(as broadly defined to include, among other things, dividends, redemptions and
other repurchases of stock), or pay management fees to any person or persons
that control the institution, if it would be undercapitalized following the
distribution. However, a federal banking agency may (after consultation with the
FDIC) permit an insured depository institution to repurchase, redeem, retire or
otherwise acquire its shares if (i) the action is taken in connection with the
issuance of additional shares or obligations in at least an equivalent amount
and (ii) the action will reduce the institution's financial obligations or
otherwise improve its financial condition. An undercapitalized institution is
generally prohibited from increasing its average total assets, and is also
generally prohibited from making acquisitions, establishing new branches, or
engaging in any new line of business except under an accepted capital
restoration plan or with the approval of the FDIC. In addition, a federal
banking agency has authority with respect to undercapitalized depository
institutions to take any of the actions it is required to or may take with
respect to a significantly undercapitalized institution (as described below) if
it determines "that those actions are necessary to carry out the purpose" of
FDICIA.
The federal banking agencies have adopted a joint agency policy
statement to provide guidance on managing interest rate risk. The statement
indicates that the adequacy and effectiveness of a bank's interest rate risk
management process and the level of its interest rate exposures are critical
factors in the agencies' evaluation of the bank's capital adequacy. If a bank
has material weaknesses in its risk management process or high levels of
exposure relative to its capital, the agencies will direct it to take corrective
action. These directives may include recommendations or directions to raise
additional capital, strengthen management expertise, improve management
information and measurement systems, or reduce levels of exposure, or to
undertake some combination of these actions.
The federal banking agencies have also issued an interagency policy
statement that, among other things, establishes benchmark ratios of loan loss
reserves to specified classified assets. The benchmark established by the policy
statement is the sum of (a) 100% of assets classified loss; (b) 50% of assets
classified doubtful; (c) 15% of assets classified substandard; and (d) estimated
credit losses on other assets over the upcoming 12 months. This amount is
neither a "floor" nor a "safe harbor" level for an institution's allowance for
loan losses.
At December 31, 2004, the Bank is in compliance with the Comptroller's
risk-based and leverage ratios. See Footnote 14 to the Bank's Financial
Statements included under Item 8. of this Annual Report.
14
G. Payment of Dividends
The ability of the Company to make dividend payments is subject to
statutory and regulatory restrictions. FDIC policies generally preclude dividend
payments during the first three years of operation, allow cash dividends to be
paid only from net operating income, and do not permit dividends to be paid
until an appropriate allowance for loans and lease losses has been established
and overall capital is adequate. The FDIC requires that a depository institution
maintain a Tier 1 capital to assets ratio of not less than 8% during the first
three years of operation. See "SUPERVISION AND REGULATION - Capital Adequacy
Requirements."
After the first three years of operations, the Board of Directors of a
national bank may declare the payment of dividends depending upon the earnings,
financial condition and cash needs of the bank and general business conditions.
A national bank may not pay dividends from its capital. All dividends must be
paid out of net profits then on hand, after deducting losses and bad debts. A
national bank is further prohibited from declaring a dividend on its shares of
common stock until its surplus fund equals the amount of capital stock or until
10% of the bank's net profits of the preceding half year in the case of
quarterly or semiannual dividends, or the preceding two consecutive half-year
periods in the case of an annual dividend, are transferred to the surplus fund.
The approval of the Comptroller is required for the payment of dividends if the
total of all dividends declared by the bank in any calendar year would exceed
the total of its net profits of that year combined with its retained net profits
of the two preceding years, less any required transfers to surplus or a fund for
the retirement of any preferred stock.
In addition to the above requirements, guidelines adopted by the
Comptroller set forth factors which are to be considered by a national bank in
determining the payment of dividends. A national bank, in assessing the payment
of dividends, is to evaluate the bank's capital position, its maintenance of an
adequate allowance for loan and lease losses, and the need to revise or develop
a comprehensive capital plan.
The Comptroller also has broad authority to prohibit a national bank
from engaging in banking practices which it considers to be unsafe or unsound.
It is possible, depending upon the financial condition of the national bank in
question and other factors, that the Comptroller may assert that the payment of
dividends or other payments by a bank is considered an unsafe or unsound banking
practice and therefore, implement corrective action to address such a practice.
Accordingly, the future payment of cash dividends by the Company will
not only depend upon the Bank's earnings during any fiscal period but will also
depend upon the assessment of its Board of Directors of capital requirements and
other factors, including dividend guidelines and the maintenance of an adequate
allowance for loan and lease losses.
H. Community Reinvestment Act
Under the Community Reinvestment Act ("CRA") regulations, the federal
banking agencies determine a bank's CRA rating by evaluating its performance on
lending, service and investment tests, with the lending test being the most
important. The tests are applied in an "assessment context" that is developed by
the agency for the particular institution. The assessment context takes into
account demographic data about the community, the community's characteristics
and needs, the institution's capacities and constraints, the institution's
product offerings and business strategy, the institution's prior performance,
and data on similarly situated lenders. Since the assessment context for each
bank is developed by the bank regulatory agencies, a particular bank does not
know until it is examined whether its CRA programs and efforts have been
sufficient.
Institutions, like the Bank, with $250 million or more in assets are
required to compile and report data on their lending activities to measure the
performance of their loan portfolio. Some of this data is already required under
other laws, such as the Equal Credit Opportunity Act. Institutions have the
option of being evaluated for CRA purposes in relation to their own pre-approved
strategic plan. A strategic plan must be submitted to the institution's
15
regulator three months before its effective date and must be published for
public comment.
I. Audit Requirements
Depository institutions are required to have an annual examination of
their financial records. Depository institutions with assets greater than $500
million are required to have annual, independent audits and to prepare all
financial statements in compliance with generally accepted accounting
principles. Depository institutions are also required to have an independent
audit committee comprised entirely of outside directors, independent of the
institution's management.
The Bank's accounting and reporting policies conform with generally
accepted accounting principles and the practices prevalent in the banking
industry.
J. Insurance Premiums and Assessments
The FDIC has authority to impose a special assessment on members of the
Bank Insurance Fund (the "BIF") to insure that there will be sufficient
assessment income for repayment of BIF obligations and for any other purpose
which it deems necessary. The FDIC is authorized to set semi-annual assessment
rates for BIF members at levels sufficient to maintain the BIF's reserve ratio
to a designated level of 1.25% of insured deposits. Congress has considered
various proposals to merge the BIF with the Savings Association Insurance Fund
or otherwise to require banks to contribute to the insurance funds for savings
associations. Adoption of any of these proposals might increase the cost of
deposit insurance for all banks, including the Bank.
Under FDICIA, the FDIC has developed a risk-based assessment system,
which provides that the assessment rate for an insured depository institution
will vary according to the level of risk incurred in its activities. An
institution's risk category is based upon whether the institution is well
capitalized, adequately capitalized or less than adequately capitalized. Each
insured depository institution is also to be assigned to one of three
"supervisory subgroups": Subgroup A institutions are financially sound
institutions with a few minor weaknesses; Subgroup B institutions are
institutions that demonstrate weaknesses which, if not corrected, could result
in significant deterioration; and Subgroup C institutions are institutions for
which there is a substantial probability that the FDIC will suffer a loss in
connection with the institution unless effective action is taken to correct the
areas of weakness. The FDIC assigns each BIF member institution an annual FDIC
assessment rate on BIF insured deposits.
K. Prompt Corrective Action
The FDIC has authority: (a) to request that an institution's primary
regulatory agency (in the case of the Bank, the OCC) take enforcement action
against it based upon an examination by the FDIC or the agency, (b) if no action
is taken within 60 days and the FDIC determines that the institution is in an
unsafe and unsound condition or that failure to take the action will result in
continuance of unsafe and unsound practices, to order that action be taken
against the institution, and (c) to exercise this enforcement authority under
"exigent circumstances" merely upon notification to the institution's primary
regulatory agency. This authority gives the FDIC the same enforcement powers
with respect to any institution and its subsidiaries and affiliates as the
primary regulatory agency has with respect to those entities.
An undercapitalized institution is required to submit an acceptable
capital restoration plan to its primary federal bank regulatory agency. The plan
must specify (a) the steps the institution will take to become adequately
capitalized, (b) the capital levels to be attained each year, (c) how the
institution will comply with any regulatory sanctions then in effect against the
institution and (d) the types and levels of activities in which the institution
will engage. The banking agency may not accept a capital restoration plan unless
16
the agency determines, among other things, that the plan "is based on realistic
assumptions, and is likely to succeed in restoring the institution's capital"
and "would not appreciably increase the risk . . . to which the institution is
exposed." A requisite element of an acceptable capital restoration plan for an
undercapitalized institution is a guaranty by its parent holding company that
the institution will comply with the capital restoration plan. Liability with
respect to this guaranty is limited to the lesser of (i) 5% of the institution's
assets at the time when it becomes undercapitalized and (ii) the amount
necessary to bring the institution into capital compliance with applicable
capital standards as of the time when the institution fails to comply with the
plan. The guaranty liability is limited to companies controlling the
undercapitalized institution and does not affect other affiliates. In the event
of a bank holding company's bankruptcy, any commitment by the bank holding
company to a federal bank regulatory agency to maintain the capital of a
subsidiary bank will be assumed by the bankruptcy trustee and entitled to
priority of payment over the claims of other creditors, including the holders of
the company's long-term debt.
FDICIA provides that the appropriate federal regulatory agency must
require an insured depository institution that is significantly
undercapitalized, or that is undercapitalized and either fails to submit an
acceptable capital restoration plan within the time period allowed by regulation
or fails in any material respect to implement a capital restoration plan
accepted by the appropriate federal banking agency, to take one or more of the
following actions: (a) sell enough shares, including voting shares, to become
adequately capitalized; (b) merge with (or be sold to) another institution (or
holding company), but only if grounds exist for appointing a conservator or
receiver; (c) restrict specified transactions with banking affiliates as if the
"sister bank" exception to the requirements of Section 23A of the Federal
Reserve Act did not exist; (d) otherwise restrict transactions with bank or
nonbank affiliates; (e) restrict interest rates that the institution pays on
deposits to "prevailing rates" in the institution's "region"; (f) restrict asset
growth or reduce total assets; (g) alter, reduce or terminate activities; (h)
hold a new election of directors; (i) dismiss any director or senior executive
officer who held office for more than 180 days immediately before the
institution became undercapitalized, provided that in requiring dismissal of a
director or senior executive officer, the agency must comply with procedural
requirements, including the opportunity for an appeal in which the director or
officer will have the burden of proving his or her value to the institution; (j)
employ "qualified" senior executive officers; (k) cease accepting deposits from
correspondent depository institutions; (l) divest nondepository affiliates which
pose a danger to the institution; (m) be divested by a parent holding company;
and (n) take any other action which the agency determines would better carry out
the purposes of the prompt corrective action provisions.
In addition to the foregoing sanctions, without the prior approval of
the appropriate federal banking agency, a significantly undercapitalized
institution may not pay any bonus to any senior executive officer or increase
the rate of compensation for a senior executive officer without regulatory
approval. If an undercapitalized institution has failed to submit or implement
an acceptable capital restoration plan the appropriate federal banking agency is
not permitted to approve the payment of a bonus to a senior executive officer.
Not later than 90 days after an institution becomes critically
undercapitalized, the institution's primary federal bank regulatory agency must
appoint a receiver or a conservator, unless the agency, with the concurrence of
the FDIC, determines that the purposes of the prompt corrective action
provisions would be better served by another course of action. Any alternative
determination must be documented by the agency and reassessed on a periodic
basis. Notwithstanding the foregoing, a receiver must be appointed after 270
days unless the FDIC determines that the institution has positive net worth, is
in compliance with a capital plan, is profitable or has a sustainable upward
trend in earnings, and is reducing its ratio of non-performing loans to total
loans, and unless the head of the appropriate federal banking agency and the
chairperson of the FDIC certify that the institution is viable and not expected
to fail.
The FDIC is required, by regulation or order, to restrict the
activities of critically undercapitalized institutions. The restrictions must
include prohibitions on the institution's doing any of the following without
prior FDIC approval: entering into any material transactions not in the usual
course of business, extending credit for any highly leveraged transaction;
engaging in any "covered transaction" (as defined in Section 23A of the Federal
17
Reserve Act) with an affiliate; paying "excessive compensation or bonuses"; and
paying interest on "new or renewed liabilities" that would increase the
institution's average cost of funds to a level significantly exceeding
prevailing rates in the market.
L. Potential Enforcement Actions; Supervisory Agreements
Under federal law, national banks and their institution-affiliated
parties may be the subject of potential enforcement actions by the OCC for
unsafe and unsound practices in conducting their businesses, or for violations
of any law, rule or regulation or provision, any consent order with any agency,
any condition imposed in writing by the agency or any written agreement with the
agency. Enforcement actions may include the imposition of a conservator or
receiver, cease-and-desist orders and written agreements, the termination of
insurance of deposits, the imposition of civil money penalties and removal and
prohibition orders against institution-affiliated parties.
M. Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002 implements legislative reforms intended
to address corporate and accounting fraud. In addition to the establishment an
accounting oversight board to enforce auditing, quality control and
independence standards, the bill restricts provision of both auditing and
consulting services by accounting firms. To ensure auditor independence, any
non-audit services being provided to an audit client require pre-approval by
the company's audit committee members. In addition, the audit partners must be
rotated. The Act requires chief executive officers and chief financial
officers, or their equivalent, to certify to the accuracy of periodic reports
filed with the SEC, subject to civil and criminal penalties if they knowingly
or willfully violate this certification requirement. In addition, under the
Act, legal counsel will be required to report evidence of a material violation
of the securities laws or a breach of fiduciary duty by a company to its chief
executive officer or its chief legal officer, and, if such officer does not
appropriately respond, to report such evidence to the audit committee or other
similar committee of the board of directors or the board itself.
Longer prison terms and increased penalties apply to corporate
executives who violate federal securities laws, the period during which certain
types of suits can be brought against a company or its officers is extended, and
bonuses issued to top executives prior to restatement of a company's financial
statements are subject to disgorgement if such restatement was due to corporate
misconduct. Executives are also prohibited from insider trading during
retirement plan "blackout" periods, and loans to company executives are
restricted. The Act accelerates the time frame for disclosures by public
companies, as they must immediately disclose any material changes in their
financial condition or operations. Directors and executive officers must also
provide information for most changes in ownership in a company's securities
within two business days of the change.
The Act also prohibits any officer or director of a company or any
other person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent public or certified
accountant engaged in the audit of the company's financial statements for the
purpose of rendering the financial statement's materially misleading. The Act
requires the SEC to prescribe rules requiring inclusion of an internal control
report and assessment by management in the annual report to stockholders. In
addition, the Act requires that each financial report required to be prepared in
accordance with (or reconciled to) accounting principles generally accepted in
the United States of America and filed with the SEC reflect all material
correcting adjustments that are identified by a "registered public accounting
firm" in accordance with accounting principles generally accepted in the United
States of America and the rules and regulations of the SEC.
A company's chief executive officer and chief financial officer are
each required to certify that the Company's quarterly and annual reports do not
contain any untrue statement of a material fact. The rules have several
requirements, including having these officers certify that: they are responsible
for establishing, maintaining and regularly evaluating the effectiveness of the
Bank's internal controls; they have made certain disclosures to the Bank's
18
auditors and the audit committee of the Board of Directors about the company's
internal controls; and they have included information in the Company's quarterly
and annual reports about their evaluation and whether there have been
significant changes in the Bank's internal controls or in other factors that
could significantly affect internal controls subsequent to the evaluation.
N. USA PATRIOT Act
In the wake of the tragic events of September 11th, on October 26,
2001, the President signed the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act
of 2001. Under the USA PATRIOT Act, financial institutions are subject to
prohibitions against specified financial transactions and account relationships
as well as enhanced due diligence and "know your customer" standards in their
dealings with foreign financial institutions and foreign customers. For example,
the enhanced due diligence policies, procedures, and controls generally require
financial institutions to take reasonable steps:
o To conduct enhanced scrutiny of account relationships to guard against
money laundering and report any suspicious transaction;
o To ascertain the identity of the nominal and beneficial owners of, and
the source of funds deposited into, each account as needed to guard
against money laundering and report any suspicious transactions;
o To ascertain for any foreign bank, the shares of which are not
publicly traded, the identity of the owners of the foreign bank, and
the nature and extent of the ownership interest of each such owner;
and
o To ascertain whether any foreign bank provides correspondent accounts
to other foreign banks and, if so, the identity of those foreign banks
and related due diligence information.
Under the USA PATRIOT Act, financial institutions were given 180 days
from enactment to establish anti-money laundering programs. The USA PATRIOT Act
sets forth minimum standards for these programs, including:
o The development of internal policies, procedures, and controls;
o The designation of a compliance officer;
o An ongoing employee training program; and
o An independent audit function to test the programs.
The Bank has adopted comprehensive policies and procedures to address
the requirements of the USA PATRIOT Act, and management believes that the Bank
is currently in compliance with the Act.
O. Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act eliminated many of the barriers that
separated the insurance, securities and banking industries since the Great
Depression. The Gramm-Leach-Bliley Act is the result of a decade of debate in
the Congress regarding a fundamental reformation of the nation's financial
system. The law is subdivided into seven titles, by functional area.
The major provisions of the Gramm-Leach-Bliley Act are:
FINANCIAL HOLDING COMPANIES AND FINANCIAL ACTIVITIES. Title I establishes a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial service providers by revising
and expanding the BHC Act framework to permit a holding company system to engage
in a full range of financial activities through qualification as a new entity
known as a financial holding company.
19
Activities permissible for financial subsidiaries of national banks include, but
are not limited to, the following: (a) Lending, exchanging, transferring,
investing for others, or safeguarding money or securities; (b) Insuring,
guaranteeing, or indemnifying against loss, harm, damage, illness, disability,
or death, or providing and issuing annuities, and acting as principal, agent, or
broker for purposes of the foregoing, in any State; (c) Providing financial,
investment, or economic advisory services, including advising an investment
company; (d) Issuing or selling instruments representing interests in pools of
assets permissible for a bank to hold directly; and (e) Underwriting, dealing
in, or making a market in securities.
SECURITIES ACTIVITIES. Title II narrows the exemptions from the securities laws
previously enjoyed by banks.
INSURANCE ACTIVITIES. Title III restates the proposition that the states are the
functional regulators for all insurance activities, including the insurance
activities of federally-chartered banks, and bars the states from prohibiting
insurance activities by depository institutions.
PRIVACY. Under Title V, federal banking regulators were required to adopt rules
that have limited the ability of banks and other financial institutions to
disclose non-public information about consumers to nonaffiliated third parties.
These limitations require disclosure of privacy policies to consumers and, in
some circumstances, allow consumers to prevent disclosure of certain personal
information to a nonaffiliated third party. Under the rules, financial
institutions must provide:
* initial notices to customers about their privacy policies, describing
the conditions under which they may disclose nonpublic personal
information to nonaffiliated third parties and affiliates;
* annual notices of their privacy policies to current customers; and
* a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
SAFEGUARDING CONFIDENTIAL CUSTOMER INFORMATION. Under Title V, federal banking
regulators were required to adopt rules requiring financial institutions to
implement a program to protect confidential customer information, and the
federal banking agencies have adopted guidelines requiring financial
institutions to establish an information security program.
The Bank implemented a security program appropriate to its size and
complexity and the nature and scope of its operations prior to the July 1, 2001
effective date of the regulatory guidelines, and since initial implementation
has, as necessary updated and improved that program.
COMMUNITY REINVESTMENT ACT SUNSHINE REQUIREMENTS. The federal banking agencies
have adopted regulations implementing Section 711 of Title VII, the CRA Sunshine
Requirements. The regulations require nongovernmental entities or persons and
insured depository institutions and affiliates that are parties to written
agreements made in connection with the fulfillment of the institution's CRA
obligations to make available to the public and the federal banking agencies a
copy of each agreement. The Bank is not a party to any agreement that would be
the subject of reporting pursuant to the CRA Sunshine Requirements.
The Bank intends to comply with all provisions of the
Gramm-Leach-Bliley Act and all implementing regulations as they become
effective.
M. Fair Credit Reporting
In 1970, the U. S. Congress the Fair Credit Reporting Act (the "FCRA")
in order to ensure the confidentiality, accuracy, relevancy and proper
utilization of consumer credit report information. Under the framework of the
FCRA, the United States has developed a highly advanced and efficient credit
reporting system. The information contained in that broad system is used by
financial institutions, retailers and other creditors of every size in making a
wide variety of decisions regarding financial transactions. Employers, and law
enforcement agencies have also made wide use of the information collected and
maintained in databases made possible by the FCRA. The FCRA affirmatively
20
preempts state law in a number of areas, including the ability of entities
affiliated by common ownership to share and exchange information freely, the
requirements on credit bureaus to reinvestigate the contents of reports in
response to consumer complaints, among others. By its terms, the preemption
provision of the FCRA will terminate as of December 31, 2003. Termination of the
preemption provisions could significantly impact the ability of the existing
credit bureau system to continue operating.
The Bank may incur additional costs, and be required to implement
additional costly procedures and systems in the event that the preemption
provisions of the FCRA terminate at the end of 2003, and California, or other
states, adopts legislation that would have the effect of prohibiting the
continued sharing of information such as that currently collected by credit
bureaus throughout the United States. The likelihood of the FCRA preemption
provisions terminating by their terms, and of the adoption of such restrictive
provisions by state legislatures, cannot be estimated at this time.
O. Consumer Laws and Regulations
In addition to the other laws and regulations discussed in this
Offering Circular, the Bank must also comply with consumer laws and regulations
that are designed to protect consumers in transactions with banks. While the
list is not exhaustive, these laws and regulations include the Truth in Lending
Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited
Funds Availability Act, the Equal Credit Opportunity Act, and the Fair Housing
Act, among others. These laws and regulations mandate disclosure requirements
and regulate the manner in which financial institutions must deal with customers
when taking deposits or making loans. The Bank must comply with the applicable
provisions of these consumer protection laws and regulations as part of its
ongoing regulatory compliance and customer relations efforts.
P. Exposure to and Management of Risk
The federal banking agencies examine banks and bank holding companies
with respect to their exposure to and management of different categories of
risk. Categories of risk identified by the agencies include legal risk,
operational risk, market risk, credit risk, interest rate risk, price risk,
foreign exchange risk, transaction risk, compliance risk, strategic risk, credit
risk, liquidity risk, and reputation risk. This examination approach causes bank
regulators to focus on risk management procedures, rather than simply examining
every asset and transaction. This approach supplements rather than replaces
existing rating systems based on the evaluation of an institution's capital,
assets, management, earnings and liquidity. It is not clear what effect, if any,
this examination approach will have on the Bank.
Q. Money Laundering Control Act
The Money Laundering Control Act of 1986 provides sanctions for the
failure to report high levels of cash deposits to non-bank financial
institutions. Federal banking regulators possess the power to revoke the charter
or appoint a conservator for any institution convicted of money laundering.
Offending state-chartered banks could lose their federal deposit insurance, and
bank officers could face lifetime bans from working in financial institutions.
The Community Development Act, which includes a number of provisions that amend
the Bank Secrecy Act, allows the Secretary of the Treasury to exempt specified
currency transactions from reporting requirements and permits the federal bank
regulatory agencies to impose civil money penalties on banks for violations of
the currency transaction reporting requirements.
R. Safety and Soundness Standards
Federal banking regulators have adopted a Safety and Soundness Rule and
Interagency Guidelines Prescribing Standards for Safety and Soundness. The
guidelines create standards for a wide range of operational and managerial
matters including (a) internal controls, information systems, and internal audit
21
systems; (b) loan documentation; (c) credit underwriting; (d) interest rate
exposure; (e) asset growth; (f) compensation and benefits; and (g) asset quality
and earnings.
The Community Development Act required the federal bank regulatory
agencies to prescribe standards prohibiting as an unsafe and unsound practice
the payment of excessive compensation that could result in material financial
loss to an institution, and to specify when compensation, fees or benefits
become excessive. These guidelines characterize compensation as excessive if it
is unreasonable or disproportionate to the services actually performed by the
executive officer, employee, director or principal shareholder being
compensated.
Federal regulators have stated that the guidelines are meant to be
flexible and general enough to allow each institution to develop its own systems
for compliance. With the exception of the standards for compensation and
benefits, a failure to comply with the guidelines' standards does not
necessarily constitute an unsafe and unsound practice or condition. On the other
hand, an institution in conformance with the standards may still be found to be
engaged in an unsafe and unsound practice or to be in an unsafe and unsound
condition.
Although meant to be flexible, an institution that falls short of the
guidelines' standards may be requested to submit a compliance plan or be
subjected to regulatory enforcement actions. Generally, the federal banking
agencies will request a compliance plan if an institution's failure to meet one
or more of the standards is of sufficient severity to threaten the safe and
sound operation of the institution. An institution must file a compliance plan
within 30 days of request by its primary federal regulator, which is the OCC in
the case of the Bank. The guidelines provide for prior notice of and an
opportunity to respond to the agency's proposed order. An enforcement action may
be commenced if, after being notified that it is in violation of a safety and
soundness standard, the institution fails to submit an acceptable compliance
plan or fails in any material respect to implement an accepted plan. The Federal
Deposit Insurance Act provides the agencies with a wide range of enforcement
powers. An agency may, for example, obtain an enforceable cease and desist order
in the United States District Court, or may assess civil money penalties against
an institution or its affiliated parties.
S. Legislation and Proposed Changes
From time to time, legislation is enacted which has the effect of
increasing the cost of doing business, limiting or expanding permissible
activities or affecting the competitive balance between banks and other
financial institutions. Proposals to change the laws and regulations governing
the operations and taxation of banks, bank holding companies and other financial
institutions are frequently made in Congress and before various bank regulatory
agencies. For example, from time to time Congress has considered various
proposals to eliminate the federal thrift charter, create a uniform financial
institutions charter, conform holding company regulation, and abolish the Office
of Thrift Supervision. Typically, the intent of this type of legislation is to
strengthen the banking industry, even if it may on occasion prove to be a burden
on management's plans. No prediction can be made as to the likelihood of any
major changes or the impact that new laws or regulations might have on the Bank.
T. Impact of Government Monetary Policy
The earnings of the Bank are and will be affected by the policies of
regulatory authorities, including the Federal Reserve. An important function of
the Federal Reserve is to regulate the national supply of bank credit. Among the
instruments used to implement these objectives are open market operations in
U.S. Government securities, changes in reserve requirements against bank
deposits, and changes in the discount rate which banks pay on advances from the
Federal Reserve System. These instruments are used in varying combinations to
influence overall growth and distribution of bank loans, investments and
deposits, and their use may also affect interest rates on loans or interest
rates paid for deposits. The monetary policies of the FRB have had a significant
effect on the operating results of commercial banks in the past and are expected
to continue to do so in the future. The effect, if any, of such policies upon
the future business earnings of the Bank cannot be predicted.
22
U. Conclusions
It is impossible to predict with any certainty the competitive impact
the laws and regulations described above will have on commercial banking in
general and on the business of the Bank in particular, or to predict whether or
when any of the proposed legislation and regulations described above will be
adopted. It is anticipated that banking will continue to be a highly regulated
industry. Additionally, there has been a continued lessening of the historical
distinction between the services offered by financial institutions and other
businesses offering financial services, and the trend toward nationwide
interstate banking is expected to continue. As a result of these factors, it is
anticipated banks will experience increased competition for deposits and loans
and, possibly, further increases in their cost of doing business.
23
ITEM 2. PROPERTIES
At December 31, 2004, the Bank had three facilities located in Santa
Clara County, one facility located in Sacramento County and one facility in San
Diego county.
The first office, which is also the principal executive office of the
Bank, is located at 2120 El Camino Real, in the City of Santa Clara, County of
Santa Clara, State of California. The office is located in a freestanding,
two-story building, consisting of 5,430 square feet, located at the intersection
of El Camino Real and McCormick Drive. The building was previously a branch of
Washington Mutual Bank, and includes a vault and teller lines. The premises
include 42 parking spaces situated on a 35,719 square foot parcel. The premises
are sublet from Washington Mutual Bank. The sublease provides for a basic rent
of $13,582.50 per month from the commencement date until the first anniversary
of the sublease. On each anniversary date of the commencement of the sublease,
the basic rent will be increased by 4% of the amount of the basic rent during
the prior year. The Bank is also responsible for real estate taxes and insurance
costs. The sublease is for a period of ten (10) years, terminating on September
30, 2010. There is no option to extend the sublease beyond that date. Current
lease payments are $14,690.83 per month through the anniversary of the
commencement date. The foregoing description of the office is qualified by
reference to the lease agreement dated August 31, 2000 exhibit 10.4 to this
Report.
The second facility is a banking office located at 525 University
Avenue, City of Palo Alto, County of Santa Clara, State of California. The
office consists of approximately 2,975 square feet consisting of Suites 101 and
103 on the first floor of the building known as the Palo Alto Office Center. The
lease is for a term of 60 months commencing on December 1, 2001 and ending on
November 30, 2006. The Lease provides for a basic rent of $12,197.50 through the
first anniversary of the lease date. Effective with the first anniversary date
the lease payments will be adjusted by a factor that is tied to the Consumer
Price Index. Current lease payments are $16,147.39 per month through the 2004
anniversary of the commencement date The foregoing description is qualified by
reference to the lease agreement dated October 15, 2001 attached as exhibit
10.12 to this Report.
The third facility is an administrative office located at 55 Almaden
Boulevard, City of San Jose, County of Santa Clara, State of California. The
office consists of approximately 24,767 square feet on two floors of an
eight-story office building. The facility is being sublet from a prior tenant in
a sublease which commenced December 26, 2003 and terminates December 31, 2006.
The sublease provides for an initial base rent of $28,730 with annual
escalations to $45,819 in the final year of the sublease. The Bank has also
entered into a direct lease with the landlord, which will commence immediately
following the sublease term on January 1, 2007 for 120 months ending on December
31, 2016. The direct lease provides for an initial twelve-month period of
reduced rent followed by a base rent of $47,304.97 beginning on January 1, 2008
and increasing 3% on each anniversary date thereafter.
The fourth facility is a loan production office located at 3035
Prospect Park Drive, Suite 100, City of Rancho Cordova, County of Sacramento,
State of California. The office consists of approximately 1,964 square feet
consisting of Suite 100 in the real estate development known as "Prospect
Center". The lease is for a term of 36 months commencing on October 1, 2002 and
ending on September 30, 2005. The Lease provides for a basic rent of $1,865.80
through the first anniversary of the lease date. The basic rent will increase to
$1,940.43 effective with the first anniversary date and then increase to
$2,018.01 on the second anniversary date. The foregoing description is qualified
by reference to the lease agreement dated August 13, 2002 attached as exhibit
10.13 herein.
The fifth facility is a loan production office located at 7676 Hazard
Center Drive, Fifth Floor, City of San Diego, County of San Diego, State of
California. The office consists of approximately 905 square feet consisting of
offices No. 36a, 36b, 36c, 36d and 37 in the real estate development known as
"Barrister Executive Suites". The lease is for a term of 6 months commencing on
November 1, 2003 and ending on June 1, 2004. The lease provides for a basic rent
of $4,300.00 per month. The term of the lease will be automatically extended for
the same period of time as the initial term, upon the same terms and conditions,
24
unless either party notifies the other in writing to the contrary at least 90
days prior to the termination date.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a defendant in any pending legal proceedings and no
such proceedings are known to be contemplated. No director, officer, affiliate,
more than 5% shareholder of the Company or any associate of these persons is a
party adverse to the Company or has a material interest adverse to the Company
in any material legal proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year
covered by this Annual Report to a vote of security holders, through the
solicitation of proxies or otherwise.
25
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES.
There is limited trading in and no established public trading market
for the Company's Common Stock. On January 27, 2003, the Company's Common Stock
began trading on the Nasdaq Small Cap exchange under the symbol "BBNK".
Previously, it was traded on the Over-the-Counter Bulletin Board (OTCBB) under
the symbol "BBSV". Hoefer and Arnett, Incorporated, Knight Securities, LLP,
Schwab Capital Markets, and Baird Patrick & Co. make markets in the Company's
Common Stock.
The following table summarizes those trades of which the Company has
knowledge, setting forth the approximate high and low bid prices for the periods
indicated. The prices indicated below may not necessarily represent actual
transactions.
Bid Price of
Common stock (1)
Quarter ended Low High
__________________ _____ _____
March 31, 2003 5.25 7.25
June 30, 2003 6.00 8.75
September 30, 2003 8.00 12.50
December 31, 2003 10.25 13.50
March 31, 2004 12.00 13.24
June 30, 2004 11.06 12.95
September 30, 2004 10.75 13.76
December 31, 2004 13.07 17.65
(1) Prices represent the actual trading history on the Nasdaq Small Cap market.
Additionally, since trading in the Company's common stock is limited, the range
of prices stated is not necessarily representative of prices which would result
from a more active market.
The Company had 495 shareholders of record as of January 21, 2005.
The Company's shareholders are entitled to receive dividends when
and as declared by its Board of Directors, out of funds legally available
therefor, subject to statutory and regulatory restrictions. FDIC policies
generally preclude dividend payments during the first three years of operation,
allow cash dividends to be paid only from net operating income, and do not
permit dividends to be paid until an appropriate allowance for loans and lease
losses has been established and overall capital is adequate. The FDIC requires
that a depository institution maintain a Tier 1 capital to assets ratio of not
less than 8% during the first three years of operation. See "SUPERVISION AND
REGULATION - Capital Adequacy Requirements."
After the first three years of operations, the Board of Directors of
a national bank may declare the payment of dividends depending upon the
earnings, financial condition and cash needs of the bank and general business
conditions. A national bank may not pay dividends from its capital. All
dividends must be paid out of net profits then on hand, after deducting losses
and bad debts. A national bank is further prohibited from declaring a dividend
on its shares of common stock until its surplus fund equals the amount of
capital stock or until 10% of the bank's net profits of the preceding half year
in the case of quarterly or semiannual dividends, or the preceding two
consecutive half-year periods in the case of an annual dividend, are transferred
to the surplus fund. The approval of the Comptroller is required for the payment
of dividends if the total of all dividends declared by the bank in any calendar
year would exceed the total of its net profits of that year combined with its
26
retained net profits of the two preceding years, less any required transfers to
surplus or a fund for the retirement of any preferred stock.
In addition to the above requirements, guidelines adopted by the
Comptroller set forth factors, which are to be considered by a national bank in
determining the payment of dividends. A national bank, in assessing the payment
of dividends, is to evaluate the bank's capital position, its maintenance of an
adequate allowance for loan and lease losses, and the need to revise or develop
a comprehensive capital plan.
The Comptroller also has broad authority to prohibit a national bank
from engaging in banking practices which it considers to be unsafe or unsound.
It is possible, depending upon the financial condition of the national bank in
question and other factors, that the Comptroller may assert that the payment of
dividends or other payments by a bank is considered an unsafe or unsound banking
practice and therefore, implement corrective action to address such a practice.
The Company has not declared dividends since inception of the Bank's
existence. In the future, the Company may consider cash and stock dividends,
subject to the restrictions on the payment of cash dividends as described above,
depending upon the level of earnings, management's assessment of future capital
needs and other factors considered by the Board of Directors.
The following chart provides information as of December 31, 2004
concerning the Bank's Stock Option Plan, the Company's only equity compensation
plan:
Number of securities Weighted average Number of securities
to be issued upon exercise price of remaining available
exercise of outstanding options, for future issuance
outstanding options, warrents, and rights under equity
warrants, and rights compensation plans
(excluding securities
reflected in column (a)
(a) (b) (c)
----------------------- ---------------------- -------------------------
Equity compensation
plans approved by
security holders 1,255,974 $ 6.81 503,638
Equity compensation
plans not approved by
security holders - - -
----------------------- ---------------------- -------------------------
Total 1,255,974 $ 6.81 503,638
======================= ====================== =========================
27
ITEM 6. SELECTED FINANCIAL DATA
The following table presents certain consolidated financial information
concerning the business of the Company. This information should be read in
conjunction with the Financial Statements and the notes thereto, and
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained elsewhere herein.
For the period
from inception
Statement of Operations Data: May 14, 2001
(dollars in thousands, except per share data) As of and for the years ended through
December 31, December 31,
2004 2003 2002 2001
-------------------------------------------------------
Interest income $ 19,457 $ 12,133 $ 7,002 $ 1,573
Interest expense 2,896 2,235 1,192 419
-------------------------------------------------------
Net interest income 16,561 9,898 5,810 1,154
Provision for credit losses (1,671) (843) (1,424) (511)
Net interest income after provision
for credit losses 14,890 9,055 4,386 643
-------------------------------------------------------
Other income 3,855 2,664 1,460 18
Other expenses (13,596) (10,214) (8,530) (4,202)
-------------------------------------------------------
Income before income taxes 5,149 1,505 (2,684) (3,541)
Income taxes (2,112) 1,868 (1) -
-------------------------------------------------------
Net income (loss) $ 3,037 $ 3,373 $ (2,685) $ (3,541)
=======================================================
Per share Data:
Basic income (loss) per share $ 0.50 $ 0.56 $ (0.53) $ (0.92)
Diluted income (loss) per share 0.46 0.53 (0.53) (0.92)
Shareholders' equity per share 5.43 4.95 4.39 4.05
Cash dividend per common share - - - -
Balance Sheet Data:
Balance sheet totals-end of year:
Assets $402,037 $278,579 $181,188 $ 96,185
Loans, net 289,467 191,053 126,345 35,581
Deposits 352,456 246,394 153,359 80,100
Shareholders' equity 33,122 29,954 26,564 15,524
Average balance sheet amounts:
Assets $341,466 $222,454 $133,830 $ 38,857
Loans, net 240,465 156,587 86,892 10,151
Deposits 307,471 193,765 111,607 27,753
Shareholders' equity 30,768 27,075 21,126 10,847
Selected Ratios:
Return on average equity 9.87% 12.46% -12.71% -32.64%
Return on average assets 0.89% 1.52% -2.01% -9.11%
Efficiency ratio 66.59% 81.31% 117.33% 358.53%
Leverage capital ratio 9.70% 13.47% 19.85% 39.95%
Net chargeoffs (recoveries) to average loans 0.08% -0.05% 0.20% -
Allowance for loan losses to total loans 1.41% 1.38% 1.37% 1.42%
Average equity to average assets 9.01% 12.17% 15.79% 27.92%
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Certain matters discussed or incorporated by reference in this Annual
Report on Form 10-K are forward-looking statements that are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. Please see "Forward-Looking Statements" on page 1. Therefore, the
information set forth therein should be carefully considered when evaluating
business prospects of the Bank.
CRITICAL ACCOUNTING POLICIES
Our accounting policies are integral to understanding the results
reported. Accounting policies are described in detail in Note 1 to the
Consolidated Financial Statements. Our most complex accounting policies require
management's judgment to ascertain the valuation of assets, liabilities,
commitments and contingencies. We have established detailed policies and control
procedures that are intended to ensure valuation methods are well controlled and
applied consistently from period to period. In addition, the policies and
procedures are intended to ensure that the process for changing methodologies
occurs in an appropriate manner. The following is a brief description of our
current accounting policies involving significant management valuation
judgments.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents management's best estimate of losses
inherent in the existing loan portfolio. The allowance for loan losses is
increased by the provision for loan losses charged to expense and reduced by
loans charged off, net of recoveries. The provision for loan losses is
determined based on management's assessment of several factors: reviews and
evaluation of specific loans, changes in the nature and volume of the loan
portfolio, current economic conditions and the related impact on specific
borrowers and industry groups, historical loan loss experiences, the level of
classified and nonperforming loans and the results of regulatory examinations.
Loans are considered impaired if, based on current information and
events, it is probable that we will be unable to collect the scheduled payments
of principal or interest when due according to the contractual terms of the loan
agreement. The measurement of impaired loans is generally based on the present
value of expected future cash flows discounted at the historical effective
interest rate stipulated in the loan agreement, except that all
collateral-dependent loans are measured for impairment based on the fair value
of the collateral. In measuring the fair value of the collateral, management
uses assumptions and methodologies consistent with those that would be utilized
by unrelated third parties.
Changes in the financial condition of individual borrowers, in economic
conditions, in historical loss experience and in the condition of the various
markets in which collateral may be sold may all affect the required level of the
allowance for loan losses and the association provision for loan losses.
SALE OF SBA LOANS
In calculating gain on the sale of SBA loans, the Bank performs an
allocation based on the relative fair values of the sold portion and retained
portions of the loan. The company assumptions are validated by reference to
external market information.
AVAILABLE-FOR-SALE SECURITIES
The fair value of most securities classified as available-for-sale is based on
quoted market prices. If quoted market prices are not available, fair values are
extrapolated from the quoted prices of similar instruments.
29
DEFERRED TAX ASSETS
Our deferred tax assets are explained in the section below titled
"Income Tax" and in Note 8 to the Consolidated Financial Statements presented in
our 2004 10-K. We use an estimate of future earnings to support our position
that the benefit of our deferred tax assets will be realized. If future income
should prove non-existent or less than the amount of the deferred tax assets
within the tax years to which they may be applied, the asset will not be
realized and our net income will be reduced.
SECONDARY STOCK OFFERING
The Bank filed a Registration Statement on Form SB-2 on March 22, 2002
with respect to a proposed public offering of the Bank's Common stock for an
aggregate consideration of $12,000,001. The registration statement was declared
effective by the Comptroller on April 15, 2002. A second registration statement,
registering additional shares to cover over-subscriptions was filed with the
Comptroller on June 14, 2002, and became effective as of that date. The Bank
completed the offering of 2,215,384 shares of Common Stock, $2.50 par value, at
a price of $6.50 per share, for an aggregate consideration of $14,399,996 on
June 17, 2002.
OPERATING RESULTS
For the year ended December 31, 2004, the Company reported net income
of $3,037,000 or $0.50 basic and $0.46 diluted earnings per share, compared with
net income of $3,373,000 or $0.56 basic and $0.53 diluted earnings per share for
the year ended December 31, 2003 and a net loss of ($2,685,000) or ($0.53) basic
and diluted loss per share for the year ended December 31, 2002. Net income for
2004 represented a decrease of $336,000 compared to 2003 primarily due to a
one-time benefit of $1.9 million related to the recognition of deferred tax
assets in 2003. The impact was offset, in part, by an increase of $6.7 million
in interest income and an increase of $1.2 million in other income, offset, in
part, by an increase of $0.8 million in provision for credit losses and $3.4
million in other expense. See the specific sections below for details regarding
these changes.
Net income for the year ended December 31, 2003 of $3,373,000, or $0.56
basic and $0.53 diluted earnings per share, compared to net loss of $2,685,000
or ($0.53) basic and diluted earnings per share in 2002. The improvement in net
income of $6.1 million resulted from an increase of $4.1 million in net interest
income, $1.2 million in non-interest income and a decrease of $0.6 million in
the provision for credit losses, offset, in part by an increase of $1.7 million
in non-interest expenses and a one-time benefit of $1.9 million related to the
recognition of deferred tax assets.
30
NET INTEREST INCOME AND MARGIN
Net interest income is the principal source of the Company's operating
earnings. Net interest income is affected by changes in the nature and volume of
earning assets held during the year, the rates earned on such assets and the
rates paid on interest-bearing liabilities. The following table shows the
composition of average earning assets and average funding sources, average
yields and rates and