UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2004 or

For the transition period from _____________ to _____________

Commission File Number: 000-50245

NARA BANCORP, INC.

(213) 639-1700

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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

     As of July 31, 2004, there were 23,208,838 outstanding shares of the issuer’s Common Stock, $0.001 par value.

Table of Contents

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

NARA BANCORP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)

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See notes to condensed consolidated financial statements

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CONDENSED CONSOLIDATED STATEMENTS OF INCOME

For the three and six months ended June 30, 2004 and 2003
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

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See accompanying notes to condensed consolidated financial statements

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Notes to unaudited Consolidated Financial Statements

1. Nara Bancorp, Inc.

     Nara Bancorp, Inc. (“Nara Bancorp”, on a parent-only basis, and “we” or “our” on a consolidated basis), incorporated under the laws of the State of Delaware in 2000, is a bank holding company, headquartered in Los Angeles, California, offering a full range of commercial banking and consumer financial services through its wholly owned subsidiary, Nara Bank, N.A., a national bank (“Nara Bank”) with branches in California and New York as well as Loan Production Offices in California, Washington, Colorado, Georgia, Illinois, New Jersey, and Virginia.

2. Basis of Presentation

     Our condensed consolidated financial statements included herein have been prepared without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures, normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such SEC rules and regulations.

     The condensed consolidated financial statements include the accounts of Nara Bancorp and its wholly owned subsidiaries, principally Nara Bank, N. A. (the “Bank”). All intercompany transactions and balances have been eliminated in consolidation.

     Nara Bancorp also has five special-purpose subsidiaries that were formed for capital-raising transactions: Nara Capital Trust I, Nara Statutory Trust II, Nara Capital Trust III, Nara Statutory Trust IV, and Nara Statutory Trust V. With the adoption of FASB Interpretation No. 46 (“FIN 46”) Nara Bancorp deconsolidated the five grantor trusts as of December 31, 2003. As a result, the junior subordinated debentures issued by Bancorp to the grantor trusts, totaling $39.3 million, are reflected in our consolidated balance sheet in the liabilities section at June 30, 2004 and December 31, 2003, under the caption as “junior subordinated debentures.” We also recorded $2.1 million in other assets in the consolidated statement of financial condition at June 30, 2004 and December 31, 2003 for the common capital securities issued by the issuer trusts.

     We also believe that we have made all adjustments necessary to fairly present our financial position and the results of our operations for the interim period ended June 30, 2004. Certain reclassifications have been made to prior period figures in order to conform to the June 30, 2004 presentation. The results of operations for the interim period are not necessarily indicative of results for the full year.

     These condensed consolidated financial statements should be read along with the audited consolidated financial statements and accompanying notes included in our 2003 Annual Report on Form 10-K/A.

3. Stock-Based Compensation

     Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employees compensation plans at fair value. We have elected to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair value of our stock at the date of grant over the grant price.

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     We have adopted the disclosure only provisions of SFAS No. 123. Had compensation cost for our stock-based compensation plans been determined based on the fair value at the grant date for awards consistent with the provisions of SFAS No. 123, our net income would have been reduced to the pro forma amounts as follows:

     No options were granted during the second quarter of 2004. The weighted-average fair value of options granted during the second quarter of 2003 was $4.81. The fair value of options granted under our stock option plans during the second quarter of 2003 was estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions used: 0.5% dividends yield, volatility of 35.10% with risk-free interest rate of 2.3% and expected lives of three to five years. The weighted-average fair value of options granted during the six months of 2004 was $12.46. The fair value of options granted under our stock option plans during the first six months of 2004 was estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions used: 0.67% dividend yield, volatility of 38.68%, risk-free interest rate of 3.5% and expected lives of six years.

4. Dividends

     On May 17, 2004, we declared a $0.0275 per share cash dividend paid on July 14, 2004 to stockholders of record at the close of business on June 30, 2004. On March 11, 2004, we declared a $0.025 per share cash dividend paid on April 12, 2004 to stockholders of record at the close of business on March 31, 2004.

5. Stock Splits

     On May 17, 2004, Nara Bancorp announced that its Board of Directors approved a two-for-one stock split of its common stock, effected in the form of a 100% stock dividend, which was distributed on June 15, 2004 to stockholders of record on close of business on May 31, 2004. The effect of this dividend is that stockholders received one additional share of Nara Bancorp common stock for each share owned. All share and per share information have been restated to reflect the stock split.

6. Earnings Per Share (“EPS”)

     Basic EPS excludes dilution and is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted to common stock that would then share in our earnings.

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     The following table shows how we computed basic and diluted EPS for the periods ended June 30, 2004 and 2003.

For the six months ended June 30,

For the three months ended June 30,

7. SBA

     Certain Small Business Administration (“SBA”) loans that we have the intent to sell prior to maturity have been designated as held for sale at origination and are recorded at the lower of cost or market value on an aggregate basis. A valuation allowance is established if the aggregate market value of such loans is lower than their cost and operations are charged or credited for valuation adjustments. A portion of the premium on sale of SBA loans is recognized as gain on sale of loans at the time of the sale. The remaining portion of the premium (relating to the portion of the loan retained) is deferred and amortized over the remaining life of the loan as an adjustment to yield. Servicing assets are recognized when loans are sold with servicing retained. Servicing assets are recorded based on the present value of the contractually specified servicing fee, net of servicing costs, over the estimated life of the loan, using a discount rate based on the related note rate, plus 1 to 2%. Servicing assets are amortized in proportion to and over the period of estimated future net servicing income.

     We periodically evaluate servicing assets for impairment. At June 30, 2004, the fair value of servicing assets was determined using a weighted-average discount rate of 6.8% and a prepayment speed of 11.5%. At December 31, 2003, the fair value of servicing assets was determined using a weighted-average discount rate of 6.9% and a prepayment speed of 11.4%. For purposes of measuring impairment, servicing assets are stratified by

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loan type. An impairment is recognized if the carrying value of servicing assets exceeds the fair value of the stratum. The fair values of servicing assets exceeded the carrying amounts and were $3,784,000 and $3,376,000 at June 30, 2004 and December 31, 2003, respectively.

     An interest-only strip is recorded based on the present value of the excess of the total future income from serviced loans over the contractually specified servicing fee, calculated using the same assumptions as used to value the related servicing assets. Such interest-only strip is accounted for at estimated fair value, with unrealized gain or loss, net of tax, recorded as a component of accumulated other comprehensive income (loss).

8. Goodwill and Other Intangible Assets

     In July 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations completed after June 30, 2001 and also specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill and those acquired intangible assets that are required to be included in goodwill. SFAS No. 142 requires that goodwill no longer be amortized, but instead be tested for impairment at least annually. Additionally, SFAS No. 142 requires recognized intangible assets to be amortized over their respective estimated useful lives and reviewed for impairment. We adopted SFAS No. 142 on January 1, 2002.

     We tested goodwill for impairment as of December 31, 2003, noting no impairment in recorded goodwill of $1.9 million. No conditions indicated any impairment as of June 30, 2004. There were no changes in goodwill for the three and six months ended June 30, 2004 and 2003.

     We also tested intangible assets for impairment as of December 31, 2003, noting no impairment. We will continue to amortize intangible assets, representing core deposit intangibles, over their original estimated useful lives of seven years. There were no additions to core deposits intangibles during the three and six months ended June 30, 2004 and 2003.

     As of June 30, 2004, intangible assets subject to amortization include core deposit intangibles of $4,439,659 (net of $1,165,247 accumulated amortization) and servicing assets of $ 3,068,200. Amortization expenses for such intangible assets were $324,544 and $651,128 for the three and six months ended June 30, 2004, respectively. Estimated amortization expense for intangible assets for the remainder of 2004 and the five succeeding fiscal years follows:

9. Recent Accounting Pronouncements

     In January 2003, the FASB issued Interpretation No. 46 — “Consolidation of Variable Interest Entities” (“FIN 46”). In December 2003, the FASB revised FIN 46 and codified certain FASB Staff Positions previously issued for FIN 46 (“FIN 46R). The objective of FIN 46 as originally issued, and as revised by FIN 46R, was to improve financial reporting by companies involved with variable interest entities. Prior to the effectiveness of FIN 46, we generally included another entity in our consolidated financial statements only if we controlled the entity through voting interests. FIN 46 changed that standard by requiring a variable interest entity to be consolidated if we were subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both.

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The consolidation requirements of FIN 46 applied immediately to variable interest entities created after January 31, 2003. The consolidation requirements applied to older entities in the first fiscal year or interim period beginning after June 15, 2003. The provisions of FIN 46R are required to be adopted prior to the first reporting period that ends after March 15, 2004. The adoption of FIN 46 and FIN46R did not have a significant impact on our financial position, results of operations, or cash flows.

     In December 2003, the Accounting Standards Executive Committee of the AICPA issued Statement of Position No. 03-3 (“SOP 03-3”), Accounting for Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 addresses the accounting for differences between the contractual cash flows and the cash flows expected to be collected from purchased loans or debt securities if those differences are attributable, in part, to credit quality. SOP 03-3 requires purchased loans and debt securities to be recorded initially at fair value based on the present value of the cash flows expected to be collected with no carryover of any valuation allowance previously recognized by the seller. Interest income should be recognized based on the effective yield from the cash flows expected to be collected. To the extent that the purchased loans or debt securities experience subsequent deterioration in credit quality, a valuation allowance would be established for any additional cash flows that are not expected to be received. However, if more cash flows subsequently are expected to be received than originally estimated, the effective yield would be adjusted on a prospective basis. SOP 03-3 will be effective for loans and debt securities acquired after December 31, 2004. Although we anticipate that the implementation of SOP 03-3 will require significant loan system and operational changes to track credit related losses on loans purchased starting in 2005, we do not expect to have a significant effect on the consolidated financial statements.

     In March 2004, the Emerging Issues Task Force (EITF) reached consensus on the guidance provided in EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (EITF 03-1) as applicable to debt and equity securities that are within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and equity securities that are accounted for using the cost method specified in Accounting Policy Board Opinion No. 18 The Equity Method of Accounting for Investments in Common Stock. An investment is impaired if the fair value of the investment is less than its cost. EITF 03-1 outlines that an impairment would be considered other-than-temporary unless: a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment, and b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. Although not presumptive, a pattern of selling investments prior to the forecasted recovery of fair value may call into question the investor’s intent. In addition, the severity and duration of the impairment should also be considered in determining whether the impairment is other-than-temporary. This new guidance for determining whether impairment is other-than-temporary is effective for reporting periods beginning after June 15, 2004. Adoption of this standard may cause us to recognize impairment losses in the consolidated statements of income which would not have been recognized under the current guidance or to recognize such losses in earlier periods, especially those due to increases in interest rates. Since fluctuations in the fair value for available-for-sale securities are already recorded in accumulated other comprehensive Income, adoption of this standard is not expected to have a significant impact on stockholders’ equity.

10. Commitments and Contingencies

     We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Our exposure to credit loss in the event of nonperformance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for extending loan facilities to customers. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; and income-producing properties.

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Commitments at June 30, 2004 are summarized as follows:

     In the normal course of business, we are involved in various legal claims. We have reviewed all legal claims against us with counsel and have taken into consideration the views of such counsel as to the outcome of the claims. In our opinion, the final disposition of all such claims will not have a material adverse effect on our financial position and results of operations.

11. Derivative Financial Instruments and Hedging Activities

     As part of our asset and liability management strategy, we may engage in derivative financial instruments, such as interest rate swaps, with the overall goal of minimizing the impact of interest rate fluctuations on our net interest margin. During the second and fourth quarters of 2002, we entered into various interest rate swap agreements as summarized in the table below. Our objective for the interest rate swaps is to manage asset and liability positions in connection with our overall strategy of minimizing the impact of interest rate fluctuations on our interest rate margin. As part of our overall risk management, our Asset Liability Committee monitors and measures the interest rate risk and the sensitivity of our assets and liabilities to interest rate changes, including the impact of the interest rate swaps.

     Under the swap agreements, we receive a fixed rate and pay a variable rate based on H.15 Prime. The swaps qualify as cash flow hedges under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted, and are designated as hedges of the variability of cash flows we receive from certain of our Prime-indexed loans. In accordance with SFAS No. 133, these interest rate swap agreements are measured at fair value and reported as assets or liabilities on the consolidated statement of financial condition. The portion of the change in the fair value of the interest rate swaps that is deemed effective in hedging the cash flows of the designated assets are recorded in accumulated other comprehensive income (“OCI”), net of tax and reclassified into interest income when such cash flows occur in the future. Any ineffectiveness resulting from the hedges is recorded as a gain or loss in the consolidated statement of income as a part of non-interest income. As of June 30, 2004, the amounts in accumulated OCI associated with these cash flows totaled a loss of $686,084 (net of tax of $457,390), of which $105,447 is expected to be reclassified into interest income within the next 12 months. As of June 30, 2004, the maximum length of time over which we are hedging our exposure to the variability of future cash flow is approximately 8.5 years.

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Interest rate swap information at June 30, 2004 is summarized as follows:

1. Loss included in the consolidated statement of income for the six months ended June 30, 2004, representing hedge ineffectiveness. Hedge ineffectiveness was ($1,025,756), $280,067 and $427,924 for the three months ended June 30, 2004 and 2003 and six months ended June 30, 2003, respectively

2. Prime rate is based on Federal Reserve statistical release H.15

     During the second quarter of 2004 and 2003, interest income received from swap counterparties were $904,945 and $816,472, respectively. During the first six months of 2004 and 2003, interest income received from swap counterparties were $1.8 million and $1.6 million, respectively. At June 30, 2004 and 2003, we pledged as collateral to the interest rate swap counterparties agency securities with a book value of $2.0 million and real estate loans of $5.9 million.

12. Business Segments

     Our management utilizes an internal reporting system to measure the performance of our various operating segments. We have identified three principal operating segments for the purposes of management reporting: banking operation, trade finance (“TFS”), and small business administration (“SBA”). Information related to our remaining centralized functions and eliminations of intersegment amounts have been aggregated and included in banking operation. Although all three operating segments offer financial products and services, they are managed separately based on each segment’s strategic focus. The banking operation segment focuses primarily on commercial and consumer lending and deposit operations throughout our branch network. The TFS segment focuses primarily on allowing our import/export customers to handle their international transactions. Trade finance products include the issuance and collection of letters of credit, international collection, and import/export financing. The SBA segment provides our customers with the U.S. SBA guaranteed lending program.

     Operating segment results are based on our internal management reporting process, which reflects assignments and allocations of capital, certain operating and administrative costs and the provision for loan losses. Non-interest income and non-interest expense, including depreciation and amortization, directly attributable to a segment are assigned to that business. We allocate indirect costs, including overhead expense, to the various segments based on several factors, including, but not limited to, full-time equivalent employees, loan volume and deposit volume. We allocate the provision for loan losses based on the origination of new loans for the period. We evaluate the overall performance based on profit or loss from operations before income taxes excluding nonrecurring gains and losses. Future changes in our management structure or reporting methodologies may result in changes to the measurement of operating segment results.

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     The following tables present the operating results and other key financial measures for the individual operating segments for the three and six months ended June 30, 2004 and 2003.

For the Six Months Ended June 30
(Dollars in thousands)

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For the Three Months Ended June 30
(Dollars in thousands)

13. Other Comprehensive Income

     The following table shows the reclassification of other comprehensive income for the six months ended June 30, 2004 and 2003.

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14. Other Than Temporary Impairment

     For the six months ended June 30, 2004, we recorded pretax impairment charges of $1.8 million on floating rate agency preferred stocks as a result of decline in market value due to the interest rate environment.

15. Subsequent Event

     On July 27, 2004, Nara Bank and Interchange Bank, a subsidiary of Interchange Financial Services Corporation, agreed to terminate the Purchase and Assumption Agreement entered into on March 9, 2004 without consummating the proposed purchase of a branch of Interchange Bank by Nara as contemplated by such agreement.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following is management’s discussion and analysis of the major factors that influenced our consolidated results of operations and financial condition for the three and six months periods ended June 30, 2004 and June 30, 2003. This analysis should be read in conjunction with our Annual Report on Form 10-K/A for the year ended December 31, 2003 and with the unaudited consolidated financial statements and notes set forth in this report.

GENERAL

Selected Financial Data

     The following table sets forth certain selected financial data concerning the periods indicated:

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