UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
445 Pine Avenue, Goleta, California 93117
(Address of principal executive offices) (Zip code)
(805) 692-5821
(Registrant's telephone number, including area code)
SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:
COMMON STOCK, NO PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained, and will not be contained, to the best of
the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes[_] No [X]
As of March 24, 2005, 5,745,014 shares of the registrant's common stock were
outstanding. The aggregate market value of common stock, held by non-affiliates
of the registrant as of March 24, 2005, was $50,092,258 based on a closing price
of $12.10 for the common stock, as reported on the Nasdaq Stock Market. For
purposes of the foregoing computation, all executive officers, directors and 5
percent beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed to be an admission that such executive
officers, directors or 5 percent beneficial owners are, in fact, affiliates of
the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A in connection with
the 2005 Annual Meeting are incorporated by reference into Part III of this
Report. The proxy statement will be filed with the Securities and Exchange
Commission not later than 120 days after the registrant's fiscal year ended
December 31, 2004.
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COMMUNITY WEST BANCSHARES
FORM 10-K
INDEX
PART I PAGE
ITEM 1. Description of Business 3
ITEM 2. Description of Property 5
ITEM 3. Legal Proceedings 5
ITEM 4. Submission of Matters to a Vote of Security Holders 5
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Shareholder Matters 6
ITEM 6. Selected Financial Data 7
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 8
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk 42
ITEM 8. Consolidated Financial Statements and Supplementary Data 42
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 65
ITEM 9A. Controls and Procedures 65
ITEM 9B. Other Information 65
PART III
ITEM 10. Directors and Executive Officers 65
ITEM 11. Executive Compensation 65
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 65
ITEM 13. Certain Relationships and Related Transactions 65
ITEM 14. Principal Accountant Fees and Services 65
PART IV
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 65
SIGNATURES 68
CERTIFICATIONS 69
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
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Community West Bancshares ("CWBC") was incorporated in the State of California
on November 26, 1996, for the purpose of forming a bank holding company. On
December 31, 1997, CWBC acquired a 100% interest in Community West Bank,
National Association ("CWB") (formerly known as Goleta National Bank).
Effective that date, shareholders of CWB became shareholders of CWBC in a
one-for-one exchange. The acquisition was accounted at historical cost in a
manner similar to pooling-of-interests. CWBC and CWB are referred to herein as
"the Company."
Community West Bancshares is a bank holding company. During the fiscal year,
CWB was the sole bank subsidiary of CWBC. CWBC provides management and
shareholder services to CWB.
CWB offers a range of commercial and retail financial services to professionals,
small to mid-sized businesses and individual households. These services include
various loan options as well as deposit products. CWB also offers other
financial services.
Relationship Banking - Relationship banking is conducted at the community level
through two full-service branches, in Goleta and Ventura, California, with a
third scheduled to open in Santa Maria, California in April 2005. Until that
time, the Bank will continue to maintain a loan production office in Santa
Maria. The primary customers are small to mid-sized businesses in these
communities and their owners and managers. CWB's goal is to provide the highest
quality service and the most diverse products to meet the varying needs of this
highly sought customer base.
CWB offers a range of commercial and retail financial services, including the
acceptance of demand, savings and time deposits, and the origination of
commercial, real estate, construction, home improvement and other installment
and term loans. Its customers are also provided with the choice of a range of
cash management services, remittance banking, merchant credit card processing,
courier service and online banking. Through strategic alliances, customers have
access to other services such as equipment leasing programs and international
banking services.
In addition to the traditional financial services offered, CWB offers internet
banking, automated clearinghouse origination, electronic data interchange, and
check imaging.
One of CWB's key strengths and a fundamental difference that enables it to stand
apart from the competition is the depth of experience of personnel in combining
commercial lending and business development skills. These individuals develop
business, structure and underwrite the credit and manage the relationship. This
provides a competitive advantage as CWB's competitors for the most part, have a
centralized lending function where developing business, underwriting credit and
managing the relationship is split up between multiple individuals.
The financial service's industry as a whole offers a broad range of products and
services. Few companies today can effectively offer all of them. Accordingly,
CWB continues to investigate products and services that it believes address the
needs of its customers and help it attain a competitive advantage over others in
the industry. The Company continues to analyze its local markets for potential
expansion opportunities.
Small Business Association Lending - CWB has been an approved lender/servicer of
loans guaranteed by the Small Business Association ("SBA") since 1990. The
Company originates SBA loans which are frequently sold into the secondary
market. The Company continues to service these loans after sale and is required
under the SBA programs to retain specified amounts. The two primary SBA loan
programs that CWB offers are the basic 7(a) Loan Guaranty and the Certified
Development Company ("CDC"), a Section 504 ("504") program. The 7(a) serves as
the SBA's primary business loan program to help qualified small businesses
obtain financing when they might not be eligible for business loans through
normal lending channels. Loan proceeds under this program can be used for most
business purposes including working capital, machinery and equipment, furniture
and fixtures, land and building (including purchase, renovation and new
construction), leasehold improvements and debt refinancing. Loan maturity is
generally up to 10 years for working capital and up to 25 years for fixed
assets. The 7(a) loan is approved and funded by a qualified lender, guaranteed
by the SBA and subject to applicable regulations. The SBA typically guarantees
75%, and up to 85% of the loan amount, depending on the loan size.
Periodically, the Company may sell some of the unguaranteed portion of select
7(a) program loans into the secondary market. The Company is required by the
SBA to retain a contractual minimum of 5% on all SBA 7(a) loans. The SBA 7(a)
loans are all variable interest rate loans. The servicing spread is a minimum
of 1% on all loans. Income recognized by the Company on the sales of the
guaranteed portion of these loans and the ongoing servicing income received have
in the past been significant revenue sources for the Company.
-3-
CWB has been offering 504 loans since 1991, but was fairly inactive in this loan
product through 2002. Beginning in 2003, upon acquisition of a group of
experienced 504 lenders in the Sacramento area, CWB increased its 504 loan
origination volume. The 504 program is an economic development-financing
program providing long-term, low down payment loans to expanding businesses.
Typically, a 504 project includes a loan secured from a private-sector lender
with a senior lien, a loan secured from a CDC (funded by a 100% SBA-guaranteed
debenture) with a junior lien covering up to 40% of the total cost, and a
contribution of at least 10% equity from the borrower. The maximum SBA
debenture generally is $1 million for regular 504 loans and $1.3 million for
those 504 loans that meet a public policy goal. As of December 8, 2004, those
limits were raised to $1.5 million and $2 million, respectively.
In 2001, the CWB began offering Business & Industry ("B & I") loans. These
loans are similar to the SBA product, except they are guaranteed by the U.S.
Department of Agriculture. The guaranteed amount is generally 80%. B&I loans
are made to businesses in designated rural areas and are generally larger loans
to larger businesses than the 7(a) loans. Similar to the SBA 7(a) product, they
can be sold into the secondary market.
CWB originates SBA loans in the states of California, Alabama, Colorado,
Florida, Georgia, North Carolina, Oregon, South Carolina, Tennessee and
Washington. Beginning in 1995, the SBA designated CWB as a "Preferred Lender."
As a Preferred Lender, CWB has been delegated the loan approval, closing and
most servicing and liquidation authority responsibility from the SBA. CWB
currently has SBA Preferred Lender status in the California districts of Los
Angeles, Fresno, Sacramento, San Francisco, San Diego and Santa Ana, as well as
the states of Alabama, Colorado, Florida, Georgia, North Carolina, South
Carolina and Tennessee. CWB also has Preferred Lender status in the cities of
Seattle and Spokane, Washington and Portland, Oregon. Due to CWB's Preferred
Lender status in so many states and districts, CWB has achieved competitive
advantage in this product and has been able to increase its loan volume in
recent years.
Mortgage Lending - In 1995, CWB established a Wholesale and Retail Mortgage Loan
Center. The Mortgage Loan Division originates residential real estate loans
primarily in the California counties of Santa Barbara, Ventura and San Luis
Obispo. Some retail loans not fitting CWB's wholesale lending criteria are
brokered to other lenders. After wholesale origination, the real estate loans
are sold into the secondary market.
In 1998, CWB established a financing program for manufactured housing to provide
affordable home ownership to low to moderate-income families that are purchasing
or refinancing their manufactured house generally in CWB's primary lending areas
of Santa Barbara, Ventura and San Luis Obispo counties. In the last year, the
Company has expanded this program into Los Angeles, Orange and San Diego
counties. The manufactured housing loans are retained in CWB's loan portfolio.
As of December 31, 2004, CWB held $66.4 million of manufactured housing loans in
its portfolio. CWB has not incurred any loan losses on this product.
COMPANY HISTORY
From December 1998 until August 2001, the Company owned a 100% interest in
Palomar Community Bank ("Palomar"). In August of 2001, the Company sold Palomar
Community Bank. From October 1997 to November 1999, the Company owned a 70%
interest in Electronic Paycheck, LLC. In November 1999, Electronic Paycheck,
LLC merged with ePacific.com Incorporated and the Company's interest was reduced
to 10%. In October 2002, the Company sold its remaining interest in
ePacific.com Incorporated.
COMPETITION AND SERVICE AREA
The financial services industry is highly competitive with respect to both loans
and deposits. Overall, the industry is dominated by a relatively small number
of major banks with many offices operating over a wide geographic area. In the
markets where the Company's banking branches are present, several de novo banks
have increased competition. Some of the major commercial banks operating in the
Company's service areas offer types of services that are not offered directly by
the Company. Some of these services include leasing, trust and investment
services and international banking. The Company has taken several approaches to
minimize the impact of competitor's numerous branch offices and varied products.
First, the Company through CWB provides courier services to business clients,
thus discounting the need for multiple branches in one market. Second, through
strategic alliances and correspondents, the Company provides a full compliment
of competitive services. Finally, one of CWB's strategic initiatives is to
establish loan production offices in areas where there is a high demand for its
lending products. In addition to loans and deposit services offered by the
CWB's two branches located in Goleta and Ventura, California, a loan production
office currently exists in the city of Santa Maria, California. The Company
also maintains SBA loan production offices in the California areas of Roseville,
San Francisco bay area, Los Angeles and San Diego as well as the states of
Colorado, Florida, Georgia, North Carolina, South Carolina and Washington.
-4-
Competition may adversely affect the Company's performance. The financial
service's business in the Company's markets is highly competitive and becoming
increasingly more so due to changing regulations, technology and strategic
consolidations amongst other financial service providers. Other banks and
specialty financial services companies may have more capital than the Company
and can offer trust services, leasing and other financial products to the
Company's customer base. When new competitors seek to enter one of the
Company's markets, or when existing market participants seek to increase their
market share, they sometimes undercut the pricing or credit terms prevalent in
that market. Increasing levels of competition in the banking and financial
services businesses may reduce our market share or cause the prices to fall for
which the Company can charge for products and services.
GOVERNMENT POLICIES
The Company's operations are affected by various state and federal legislative
changes and by policies of various regulatory authorities, including those of
the states in which it operates and the U.S. government. These policies
include, for example, statutory maximum legal lending rates, domestic monetary
policies by the Board of Governors of the Federal Reserve System, U.S. fiscal
policy, U.S. Patriot Act and capital adequacy and liquidity constraints imposed
by bank regulatory agencies. Changes in these laws, regulations and policies
greatly affect our operations. See"Item 7, Management's Discussion and Analysis
of Financial Conditions and Results of Operations - Supervision and Regulation."
EMPLOYEES
As of December 31, 2004, the Company had 130 full-time and 10 part-time
employees. The Company's employees are not represented by a union or covered by
a collective bargaining agreement. Management of the Company believes that, in
general, its employee relations are good.
ITEM 2. DESCRIPTION OF PROPERTY
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The Company owns the property on which the CWB full-service branch office is
located in Goleta, California.
All other property is leased by the Company, including the principal executive
office in Goleta. This facility houses the Company's corporate offices,
comprised of various departments, including compliance, data processing,
electronic business services, finance, human resources, loan operations, SBA
administration, special assets and the mortgage loan division.
The Company continually evaluates the suitability and adequacy of the Company's
offices and has a program of relocating or remodeling them as necessary to
maintain efficient and attractive facilities. Management believes that its
existing facilities are adequate for its present purposes.
ITEM 3. LEGAL PROCEEDINGS
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The Company is involved in various litigation of a routine nature that is being
handled and defended in the ordinary course of the Company's business. In the
opinion of management, based in part on consultation with legal counsel, the
resolution of these litigation matters will not have a material impact on the
Company's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
- ------- ------------------------------------------------------------
None.
-5-
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
- ------ -----------------------------------------------------------------
MATTERS
-------
Market Information, Holders and Dividends
The Company's common stock is traded on the Nasdaq Stock Market ("Nasdaq") under
the symbol CWBC. The following table sets forth the high and low sales prices
on a per share basis for the Company's common stock as reported by Nasdaq for
the period indicated:
2004 Quarters 2003 Quarters
-------------------------------- --------------------------------
Fourth Third Second First Fourth Third Second First
------- ------ ------- ------ ------- ------ ------- ------
Stock Price Range:
High $ 13.47 $10.74 $ 9.75 $ 9.38 $ 9.25 $ 7.34 $ 6.50 $ 5.45
Low 10.55 8.15 8.23 8.19 6.85 5.90 5.00 4.58
Cash Dividends
Declared $ .04 $ .04 $ .04 $ - $ - $ - $ - $ -
As of March 24, 2005, the year to date high and low stock sales prices were
$15.30 and $11.00, respectively. As of March 24, 2005, the last reported sale
price per share for the Company's common stock was $12.10.
As of March 24, 2005, the Company had 403 stockholders of record of its common
stock.
Cash dividends of $686,000 ($0.12 per share) were paid in 2004. The Company
resumed declaring dividends to its shareholders in the second quarter of 2004.
It is the Company's intention to declare and pay dividends quarterly. The
primary source of funds for dividends paid to shareholders is dividends received
from the subsidiary bank, CWB. CWB's ability to pay dividends to the Company is
limited by California law and federal banking law. As of December 31, 2004, CWB
had $4.2 million available for dividends.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table summarizes the securities authorized for issuance as of
December 31, 2004:
- ------------------------------------------------------------------------------------------------------------
Number of
securities to be Number of securities
issued upon Weighted-average remaining available for future
exercise of exercise price of issuance under equity
outstanding outstanding compensation plans
options, warrants options, warrants (excluding securities
Plan Category and rights and rights reflected in column (a)
- ------------------------------------------------------------------------------------------------------------
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------
Plans approved by shareholders 543,307 $ 6.77 372,451
- ------------------------------------------------------------------------------------------------------------
Plans not approved by shareholders - N/A -
- ------------------------------------------------------------------------------------------------------------
Total 543,307 372,451
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-6-
ITEM 6. SELECTED FINANCIAL DATA
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The following selected financial data have been derived from the Company's
consolidated financial condition and results of operations, as of and for the
years ended December 31, 2004, 2003, 2002, 2001 and 2000, and should be read in
conjunction with the consolidated financial statements and the related notes
included elsewhere in this report.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
INCOME STATEMENT: (IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest income $ 21,845 $ 20,383 $ 29,976 $ 40,794 $ 51,864
Interest expense 7,845 9,342 13,466 20,338 26,337
----------- ----------- ----------- ----------- -----------
Net interest income 14,000 11,041 16,510 20,456 25,527
Provision for loan losses 418 1,669 4,899 11,880 6,794
----------- ----------- ----------- ----------- -----------
Net interest income after provision for loan 13,582 9,372 11,611 8,576 18,733
losses
Non-interest income 10,462 10,675 11,398 22,171 16,481
Non-interest expenses 17,521 16,736 24,931 32,006 29,978
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 6,523 3,311 (1,922) (1,259) 5,236
Provision (benefit) for income taxes 2,688 1,128 (652) (1,281) 2,539
----------- ----------- ----------- ----------- -----------
NET INCOME (LOSS) $ 3,835 $ 2,183 $ (1,270) $ 22 $ 2,697
========== =========== ============ =========== ===========
PER SHARE DATA:
Income (loss) per common share - Basic $ 0.67 $ 0.38 $ (0.22) $ 0.00 $ 0.44
Weighted average shares used in income (loss)
per share calculation - Basic 5,717,813 5,693,807 5,690,224 5,947,658 6,017,216
Income (loss) per common share - Diluted $ 0.65 $ 0.38 $ (0.22) $ 0.00 $ 0.43
Weighted average shares used in income (loss)
per share calculation - Diluted 5,867,236 5,758,200 5,690,224 5,998,003 6,233,245
Book value per share $ 6.56 $ 6.02 $ 5.64 $ 5.86 $ 5.90
BALANCE SHEET:
Net loans $ 290,506 $ 244,274 $ 245,856 $ 260,955 $ 329,265
Total assets 365,203 304,250 307,210 323,863 405,255
Total deposits 284,568 224,855 219,083 196,166 228,720
Total liabilities 327,634 269,919 275,123 290,506 369,221
Total stockholders' equity 37,569 34,331 32,087 33,357 36,035
OPERATING AND CAPITAL RATIOS:
Return on average equity 10.60% 6.65% (3.99)% 0.07% 7.35%
Return on average assets 1.15% 0.73% (0.42)% 0.01% 0.61%
Dividend payout ratio 17.91% - - - -
Equity to assets ratio 10.29% 11.28% 10.48% 10.30% 8.89%
Tier 1 leverage ratio 10.41% 11.15% 10.48% 9.07% 7.25%
Tier 1 risk-based capital ratio 12.51% 14.05% 12.66% 11.75% 9.11%
Total risk-based capital ratio 13.76% 15.31% 13.92% 13.02% 11.04%
Selected data for the year ended December 31, 2000 include Palomar. The income
statement for 2001 includes 8.5 months of Palomar operating results.
-7-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------- ---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
The following discussion is designed to provide insight into management's
assessment of significant trends related to Community West Bancshares ("CWBC" or
"Company") and its wholly-owned subsidiary Community West Bank's (formerly known
as Goleta National Bank) ("CWB") consolidated financial condition, results of
operations, liquidity, capital resources and interest rate risk. Unless
otherwise stated, "Company" refers to CWBC and CWB as a consolidated entity. It
should be read in conjunction with the consolidated financial statements and
notes thereto and the other financial information appearing elsewhere in this
report.
Forward-Looking Statements
This 2004 Annual Report on Form 10-K contains statements that constitute
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Those forward-looking statements include statements regarding the
intent, belief or current expectations of the Company and its management. Any
such forward-looking statements are not guarantees of future performance and
involve risks and uncertainties, and actual results may differ materially from
those projected in the forward-looking statements. Such risks and uncertainties
include:
- changes in the interest rate environment affecting interest rate
margins and/or interest rate risk
- reduction in our earnings by losses on loans
- deterioration in general economic conditions
- the regulation of the banking industry
- dependence on real estate
- risks of natural disasters
- increased competitive pressure among financial services companies
- operational risks
- legislative or regulatory changes adversely affecting the
business in which the Company engages
- the availability of sources of liquidity at a reasonable cost
- other risks and uncertainties that may be detailed herein
OVERVIEW OF EARNINGS PERFORMANCE
- -----------------------------------
In 2004, the net income of the Company was $3.8 million, or $0.67, per basic and
$0.65 per diluted share. This represents a $1.7 million increase in net income
over 2003. The significant factors impacting net income for 2004 compared to
2003 were:
- net loan portfolio growth of $46.2 million, or 18.9%, primarily
in commercial, commercial real estate, manufactured housing and SBA
loans;
- stabilization of delinquencies and continued prepayments of the
securitized loans and related bonds impacting interest income,
interest expense and provision for loan losses;
- a 125 basis point increase in the Federal Reserve Board's target
interest rate from 1.0% to 2.25%, positively impacting net interest
income;
- reduction in mortgage refinancings, that negatively impacted loan
fees and gain on loan sales.
The impact to the Company from these items, and others of both a positive and
negative nature, will be discussed in more detail as they pertain to the
Company's performance for 2004 throughout the analysis sections of this report.
2003 earnings were $2.2 million compared to a net loss of $1.3 million for 2002.
That increase was due to CWB exit in 2002 from higher risk lending products
combined with increased prepayment of the securitized loan portfolio and
increased expense control.
CRITICAL ACCOUNTING POLICIES
- ------------------------------
The Company's accounting policies are more fully described in Note 1 of the
Consolidated Financial Statements. As disclosed in Note 1, the preparation of
financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and assumptions about
future events that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ significantly from those
estimates. The Company believes that the following discussion addresses the
Company's most critical accounting policies, which are those that are most
important to the portrayal of the Company's financial condition and results of
operations and require management's most difficult, subjective and complex
judgments.
-8-
PROVISION AND ALLOWANCE FOR LOAN LOSSES - The Company maintains a detailed,
systematic analysis and procedural discipline to determine the amount of the
allowance for loan losses ("ALL"). The ALL is based on estimates and is
intended to be adequate to provide for probable losses inherent in the loan
portfolio. This process involves deriving probable loss estimates that are
based on individual loan loss estimation, migration analysis/historical loss
rates and management's judgment.
The Company employs several methodologies for estimating probable losses.
Methodologies are determined based on a number of factors, including type of
asset, risk rating, concentrations, collateral value and the input of the
Special Assets group, functioning as a workout unit.
The ALL calculation for the different major loan types is as follows:
- SBA - All loans are reviewed and classified loans are assigned a
specific allowance. Those not classified are assigned a pass rating. A
migration analysis and various portfolio specific factors are used to
calculate the required allowance on those pass loans.
- Relationship Banking - Includes commercial, commercial real
estate and consumer loans. Classified loans are assigned a specific
allowance. A migration analysis and various portfolio specific factors
are used to calculate the required allowance on the remaining pass
loans.
- Manufactured Housing - An allowance is calculated on the basis of
risk rating, which is a combination of delinquency, value of
collateral on classified loans and perceived risk in the product line.
- Securitized Loans - The Company considers this a homogeneous
portfolio and calculates the allowance based on statistical
information provided by the servicer. Charge-off history is calculated
based on three methodologies; a 3-month and a 12-month historical
trend and by delinquency information. The highest requirement of the
three methods is used.
The Company calculates the required ALL on a monthly basis. Any difference
between estimated and actual observed losses from the prior month are reflected
in the current period required ALL calculation and adjusted as deemed necessary.
The review of the adequacy of the allowance takes into consideration such
factors as concentrations of credit, changes in the growth, size and composition
of the loan portfolio, overall and individual portfolio quality, review of
specific problem loans, collateral, guarantees and economic conditions that may
affect the borrowers' ability to pay and and/or the value of the underlying
collateral. Additional factors considered include: geographic location of
borrowers, changes in the Company's product-specific credit policy and lending
staff experience. These estimates depend on the outcome of future events and,
therefore, contain inherent uncertainties.
The Company's ALL is maintained at a level believed adequate by management to
absorb known and inherent probable losses on existing loans. A provision for
loan losses is charged to expense. The allowance is charged for losses when
management believes that full recovery on the loan is unlikely. Generally, the
Company charges off any loan classified as a "loss"; portions of loans which are
deemed to be uncollectible; overdrafts which have been outstanding for more than
30 days; and, all other unsecured loans past due 120 or more days. Subsequent
recoveries, if any, are credited to the ALL.
INTEREST ONLY STRIPS AND SERVICING RIGHTS - The guaranteed portion of certain
SBA loans can be sold into the secondary market. Servicing rights are
recognized as separate assets when loans are sold with servicing retained.
Servicing rights are amortized in proportion to, and over the period of,
estimated future net servicing income. Also, at the time of the loan sale, it
is the Company's policy to recognize the related gain on the loan sale in
accordance with GAAP. The Company uses industry prepayment statistics and its
own prepayment experience in estimating the expected life of the loans.
Management periodically evaluates servicing rights for impairment. Servicing
rights are evaluated for impairment based upon the fair value of the rights as
compared to amortized cost on a loan-by-loan basis. Fair value is determined
using discounted future cash flows calculated on a loan-by-loan basis and
aggregated to the total asset level. Impairment to the asset is recorded if the
aggregate fair value calculation drops below the net book value of the asset.
The initial servicing rights and resulting gain on sale are calculated based on
the difference between the best actual par and premium bids on an individual
loan basis. Additionally, on certain SBA loan sales that occurred prior to
2003, the Company retained interest only strips ("I/O Strips"), which represent
the present value of excess net cash flows generated by the difference between
(a) interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors and (ii) contractual
servicing fees. The I/O strips are classified as trading securities.
Accordingly, the Company records the I/O strips at fair value with the resulting
increase or decrease in fair value being recorded through operations in the
current period. Quarterly, the Company verifies the reasonableness of its
valuation estimates by comparison to the results of an independent third party
valuation analysis.
-9-
SECURITIZED LOANS AND BONDS PAYABLE - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
trusts ("Trusts"). The transfers have been accounted for as secured borrowings
and, accordingly, the mortgage loans and related bonds issued are included in
the Company's consolidated balance sheets. Such loans are accounted for in the
same manner as loans held to maturity. Deferred debt issuance costs and bond
discount related to the bonds are amortized on a method that approximates the
level yield method over the estimated life of the bonds.
OTHER REAL ESTATE OWNED - Other real estate owned ("OREO") is real estate
acquired through foreclosure on the collateral property and is recorded at fair
value at the time of foreclosure less estimated costs to sell. Any excess of
loan balance over the fair value of the OREO is charged-off against the ALL.
Subsequent to foreclosure, management periodically performs a new valuation and
the asset is carried at the lower of carrying amount or fair value. Operating
expenses or income, and gains or losses on disposition of such properties, are
charged or credited to current operations.
STOCK-BASED COMPENSATION - GAAP permits the Company to use either of two
methodologies to account for compensation cost in connection with employee stock
options. The first method requires issuers to record compensation expense over
the period the options are expected to be outstanding prior to exercise,
expiration or cancellation. The amount of compensation expense to be recognized
over this term is the "fair value" of the options at the time of the grant as
determined by the Black-Scholes valuation model. Black-Scholes computes fair
value of the options based on the length of their term, the volatility of the
stock price in past periods and other factors. Under this method, the issuer
recognizes compensation expense regardless of whether or not the employee
eventually exercises the options.
Under the second methodology, if options are granted at an exercise price equal
to the market value of the stock at the time of the grant, no compensation
expense is recognized. The Company believes that this method better reflects
the motivation for its issuance of stock options, as they are intended as
incentives for future performance rather than compensation for past performance.
GAAP requires that issuers electing the second method must present pro forma
disclosure of net income (loss) and earnings per share as if the first method
had been elected. See "Recent Accounting Pronouncement" below.
Under the terms of the Company's stock option plan, full-time salaried employees
may be granted qualified stock options or incentive stock options and directors
may be granted nonqualified stock options. Options may be granted at a price not
less than 100% of the market value of the stock on the date of grant. Qualified
options are generally exercisable in cumulative 20% installments. All options
expire no later than ten years from the date of grant.
RECENT ACCOUNTING PRONOUNCEMENT - On December 16, 2004, the Financial Accounting
Standards Board ("FASB") issued FASB Statement No. 123 (revised 2004),
Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting
for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and amends FASB Statement No. 95,
Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar
to the approach described in Statement 123. However, Statement 123(R) requires
all share-based payments to employees, including grants of employee stock
options, to be recognized in the income statement based on their fair values.
Pro forma disclosure is no longer an alternative. Statement 123(R) must be
adopted no later than July 1, 2005. Early adoption will be permitted in periods
in which financial statements have not yet been issued. The Company expects to
adopt Statement 123(R) as of July 1, 2005.
Statement 123(R) permits public companies to adopt its requirements using one of
two methods: 1) A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the requirements of
Statement 123(R) for all share-based payments granted after the effective date
and (b) based on the requirements of Statement 123 for all awards granted to
employees prior to the effective date of Statement 123(R) that remain unvested
on the effective date. 2) A "modified retrospective" method which includes the
requirements of the modified prospective method described above, but also
permits entities to restate based on the amounts previously recognized under
Statement 123 for purposes of pro forma disclosures either (a) all prior periods
presented or (b) prior interim periods of the year of adoption. The Company
plans to adopt Statement 123 using the modified-prospective method.
As permitted by Statement 123, the Company currently accounts for share-based
payments to employees using Opinion 25's intrinsic value method and, as such,
generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method will have an
insignificant impact on our result of operations and our overall financial
position. The precise impact of adoption of Statement 123(R) will depend on
levels of share-based payments granted in the future. Had we adopted Statement
123(R) in prior periods, the impact of that standard would have approximated the
impact of Statement 123 as described in the disclosure of pro forma net income
and earnings per share in Note 9 to our consolidated financial statements.
Statement 123(R)
-10-
also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce net operating cash flows and increase net financing cash flows in periods
after adoption. While the Company cannot estimate what those amounts will be in
the future (because they depend on, among other things, when employees exercise
stock options) there were no operating cash flows recognized in prior periods
for such excess tax deductions.
EXTERNAL FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
- ---------------------------------------------------------------------
Economic Conditions
Nationally, the banking industry and the Company have been affected by the
continued growth in the economy and the actions of the Federal Reserve Board to
manage inflationary pressures through measured increases to the Federal discount
rate. From June 2004 to December 2004, the Federal Reserve Board raised the
discount rate five times from 1.0% to 2.25%, a rate increase of 1.25%. While
inflation remains largely in check, these increases have served to enhance net
interest margin for many asset-sensitive financial institutions. Recent reports
by the Federal Reserve Board also suggest modestly higher commercial and
industrial lending tempered by slower residential mortgage lending.
The Company serves three primary regions. The Tri-Counties region which
consists of San Luis Obispo, Santa Barbara and Ventura counties in the state of
California, the SBA Western Region where CWB originates SBA loans (California,
Washington, Oregon and Colorado) and the SBA Southeast Region (Georgia, Florida,
Tennessee, Alabama, North Carolina and South Carolina). The forecast for the
Tri-Counties area is generally positive for the coming years, as is the overall
outlook for California and the nation as a whole. In many sections of the
country, consumer spending and tourism are on the rise and manufacturing
activity has strengthened. In the Southeast, consumer loan demand remained
strong while commercial demand improved marginally while remaining at low
levels.
Regulatory Considerations
The financial services industry is heavily regulated. The Company is subject to
federal and state regulation designed to protect the deposits of consumers, not
to benefit shareholders. These regulations include the following:
- the amount of capital the Company must maintain
- the types of activities in which it can engage
- the types and amounts of investments it can make
- the locations of its offices
- insurance of the Company's deposits and the premiums paid
for this insurance
- how much cash the Company must set aside as reserves for
deposits
The regulations impose significant limitations on operations and may be changed
at any time, possibly causing future results to vary significantly from past
results. Government policy and regulation, particularly as implemented through
the Federal Reserve System, significantly affects credit conditions. See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations - Supervision and Regulation."
Bank Regulations Could Discourage Changes in the Company's Ownership
Bank regulations could delay or discourage a potential acquirer who might have
been willing to pay a premium price to acquire a large block of common stock.
That possibility could decrease the value of the Company's common stock and the
price that a stockholder will receive if shares are sold in the future. Before
anyone can buy enough voting stock to exercise control over a bank holding
company like CWBC, bank regulators must approve the acquisition. A stockholder
must apply for regulatory approval to own 10 percent or more of the Company's
common stock, unless the stockholder can show that they will not actually exert
control over the Company. Regardless, no stockholder can own more than 25
percent of the Company's common stock without applying for regulatory approval.
The Price of the Company's Common Stock May Change Rapidly and Significantly
The market price of the Company's common stock could change rapidly and
significantly at any time. The market price of the Company's common stock has
fluctuated in recent years. Between January 1, 2003 and December 31, 2004, the
market price of its common stock ranged from a low of $4.58 per share to a high
of $13.47 per share. Fluctuations may occur, among other reasons, in response
to:
- short-term or long-term operating results
- legislative/regulatory action or adverse publicity
- perceived value of the Company's loan portfolio
-11-
- trends in the Company's nonperforming assets
- announcements by competitors
- economic changes
- general market conditions
- perceived strength of the banking industry in general
- the Company's relatively low float and thinly-traded stock
The trading price of the Company's common stock may continue to be subject to
wide fluctuations in response to the factors set forth above and other factors,
many of which are beyond the Company's control. The stock market can experience
extreme price and trading volume fluctuations that often are unrelated or
disproportionate to the operating performance of individual companies. The
Company believes that investors should consider the likelihood of these market
fluctuations before investing in the Company's common stock.
Dependence on Real Estate
Approximately 45% of the loan portfolio of the Company is secured by various
forms of real estate, including residential and commercial real estate. A
decline in current economic conditions or rising interest rates could have an
adverse effect on the demand for new loans, the ability of borrowers to repay
outstanding loans and the value of real estate and other collateral securing
loans. The real estate securing the Company's loan portfolio is concentrated in
California. If real estate values decline significantly, especially in
California, the change could harm the financial condition of the Company's
borrowers, the collateral for its loans will provide less security and the
Company would be more likely to suffer losses on defaulted loans.
Curtailment of Government Guaranteed Loan Programs Could Affect a Segment of the
Company's Business
A major segment of the Company's business consists of originating and selling
government guaranteed loans, in particular those guaranteed by the SBA. From
time to time, the government agencies that guarantee these loans reach their
internal limits and cease to guarantee loans. In addition, these agencies may
change their rules for loans or Congress may adopt legislation that would have
the effect of discontinuing or changing the programs. Non-governmental programs
could replace government programs for some borrowers, but the terms might not be
equally acceptable. Therefore, if these changes occur, the volume of loans to
small business, industrial and agricultural borrowers of the types that now
qualify for government guaranteed loans could decline. Also, the profitability
of these loans could decline. In late 2004, the SBA eliminated the piggy-back
program, in which a conventional real estate loan is made and a SBA 7(a)
guaranteed second trust deed is subordinate to the conventional first trust
deed. As the funding and sale of the guaranteed portion of 7(a) loans is a
significant portion of the Company's business, the long-term resolution to the
funding for the 7(a) loan program may have an unfavorable impact on the
Company's future performance and results of operations.
Environmental Laws Could Force the Company to Pay for Environmental Problems
When a borrower defaults on a loan secured by real property, the Company
generally purchases the property in foreclosure or accepts a deed to the
property surrendered by the borrower. The Company may also take over the
management of commercial properties when owners have defaulted on loans. While
CWB has guidelines intended to exclude properties with an unreasonable risk of
contamination, hazardous substances may exist on some of the properties that it
owns, manages or occupies. The Company faces the risk that environmental laws
could force it to clean up the properties at the Company's expense. It may cost
much more to clean a property than the property is worth. The Company could
also be liable for pollution generated by a borrower's operations if the Company
took a role in managing those operations after default. Resale of contaminated
properties may also be difficult.
Competition
The banking industry is highly competitive. The Company faces competition not
only from other financial institutions within the markets it serves, but
deregulation has resulted in competition from companies not typically associated
with financial services as well as companies accessed through the internet. As
a community bank, the Company attempts to combat this increased competition by
developing and offering new products and increased quality of services.
EARNINGS PERFORMANCE
- ---------------------
In 2004, the net income of the Company was $3.8 million, or $0.67, per basic
share and $0.65 per diluted share compared to $2.2 million, or $0.38, per basic
and diluted share for 2003. Return on average assets and average equity both
increased to 1.15% and 10.6%, respectively, for 2004, compared with 0.73% and
6.65%, respectively, for 2003. Interest income increased by $1.5 million
primarily due to the Company's loan growth, while interest expense declined by
$1.5 million for the comparable period.
-12-
In addition, the Company's provision for loan losses decreased by $1.3 million
from $1.7 million for 2003 to $418,000 for 2004 resulting in an increase in net
interest income after provision for loan losses of 44.9%, or $4.2 million, to
$13.6 million for the year ended December 31, 2004 from $9.4 million for 2003.
The Company's net income increased $3.5 million from 2002 to 2003. The increase
primarily resulted from cost control efforts and changes to business lines as
well as a reduction in the provision for loan losses.
Changes in Interest Income and Interest Expense
Net interest income is the difference between the interest and fees earned on
loans and investments and the interest expense paid on deposits and other
liabilities. The amount by which interest income will exceed interest expense
depends on the volume or balance of earning assets compared to the volume or
balance of interest-bearing deposits and liabilities and the interest rate
earned on those interest-earning assets compared to the interest rate paid on
those interest-bearing liabilities.
Net interest margin is net interest income expressed as a percentage of average
earning assets. It is used to measure the difference between the average rate
of interest earned on assets and the average rate of interest that is paid on
liabilities used to fund those assets. To maintain its net interest margin, the
Company must manage the relationship between interest earned and paid. The
following table sets forth, for the period indicated, the increase or decrease
of certain items in the consolidated income statements of the Company as
compared to the prior periods:
YEAR ENDED DECEMBER 31,
---------------------------------------------------
2004 VS. 2003 2003 VS. 2002
------------------------- ------------------------
AMOUNT OF PERCENT OF AMOUNT OF PERCENT OF
INCREASE INCREASE INCREASE INCREASE
(DECREASE) (DECREASE) (DECREASE) (DECREASE)
----------- ------------ ----------- -----------
INTEREST INCOME (DOLLARS IN THOUSANDS)
Loans $ 907 4.6% $ (9,648) (32.9)%
Investment securities 490 100.2% 287 142.1%
Other 65 27.5% (232) (49.6)%
----------- ------------ ----------- -----------
Total interest income 1,462 7.2% (9,593) (32.0)%
----------- ------------ ----------- -----------
INTEREST EXPENSE
Deposits 395 8.5% (924) (16.7)%
Bonds payable and other borrowings (1,892) (40.1)% (3,200) (40.4)%
----------- ------------ ----------- -----------
Total interest expense (1,497) (16.0)% (4,124) (30.6)%
----------- ------------ ----------- -----------
NET INTEREST INCOME 2,959 26.8% (5,469) (33.1)%
Provision for loan losses (1,251) (75.0)% (3,230) (65.9)%
----------- ------------ ----------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 4,210 44.9% (2,239) (19.3)%
NON-INTEREST INCOME
Gains from loan sales, net (879) (18.1)% 72 1.5%
Other loan fees 853 29.2% (465) (13.7)%
Loan servicing fees, net 152 12.0% 183 16.9%
Document processing fees, net (120) (12.8)% (467) (33.3)%
Service charges 5 1.3% (64) (14.5)%
Other (224) (71.1)% 18 6.1%
----------- ------------ ----------- -----------
Total non-interest income (213) (2.0)% (723) (6.3)%
----------- ------------ ----------- -----------
NON-INTEREST EXPENSES
Salaries and employee benefits 435 3.8% (2,180) (16.0)%
Occupancy and equipment expenses (95) (5.6)% (428) (20.2)%
Professional services 304 47.8% (939) (59.6)%
Depreciation (49) (8.4)% (190) (24.6)%
Loan servicing and collection (213) (48.6)% (434) (49.8)%
Impairment of I/O strips and servicing rights - - (1,788) (100.0)%
Lower of cost or market provision on loans held for sale - - (1,381) (100.0)%
Other 403 20.4% (855) (30.2)%
----------- ------------ ----------- -----------
Total non-interest expenses 785 4.7% (8,195) (32.9)%
----------- ------------ ----------- -----------
Income before provision for income taxes 3,212 5,233
Provision for income taxes 1,560 1,780
----------- -----------
NET INCOME $ 1,652 $ 3,453
=========== ===========
-13-
Total interest income increased 7.2% from $20.4 million in 2003 to $21.8 million
in 2004. Total interest expense decreased 16.0% from $9.3 million in 2003 to
$7.8 million in 2004. The Company experienced a $907,000, or 4.6%, increase in
interest income from loans in 2004 over 2003. The increase resulted from the
growth in loans primarily related to manufactured housing, commercial real
estate, commercial and SBA of $27.4 million, $14.3 million, $6.3 million and
$4.6 million, respectively. This loan growth contributed to increases in
interest income on loans from manufactured housing of $1.7 million, or 51.6%,
commercial real estate of $1.5 million, or 48.2%, commercial of $600,000, or
43.7%, and SBA of $331,000, or 9.1%. Reduction in the securitized loan
portfolio of $13.9 million, or 37.2%, primarily due to payments of loan
balances, partially offset this increase in interest income with a decrease in
interest income of $2.5 million, or 41.3%, from 2003 compared to 2004. Mortgage
loan interest income also declined by $535,000, or 77%. The decrease in the
securitized loan portfolio also indirectly accounted for a $2.2 million decline
in interest expense as the related bonds paid down by $12.2 million. This
decrease in interest expense was partially offset by increases in interest paid
on deposits and other borrowings of $395,000 and $304,000, respectively.
Interest income on investments also increased in 2004 over 2003 by $555,000, or
76.6%, due to increased activity in investment securities.
Total interest income decreased 32.0% from $30 million in 2002 to $20.4 million
in 2003. Total interest expense decreased 30.6% from $13.5 million in 2002 to
$9.3 million in 2003. The Company experienced a $9.6 million, or 32.9%, decline
in interest income from loans in 2003 over 2002. This decline was primarily the
result of the exit from certain business lines. Also contributing to the
decrease in loan interest income was a reduction of $3.8 million, or 38%, in
interest income received on the securitized loan portfolio. The decrease in
loan interest from the securitized portfolio is a result of the $28.8 million
net decrease in the portfolio during 2003. This 43.5% decrease in the
securitized loan portfolio also indirectly accounted for 80% of the $4.1 million
decline in interest expense as the related bonds paid down by $24.4 million, or
48.3%.
The following table sets forth the changes in interest income and expense
attributable to changes in rate and volume:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
2004 VERSUS 2003 2003 VERSUS 2002
--------------------------- ---------------------------
CHANGE DUE TO CHANGE DUE TO
TOTAL ---------------- TOTAL ------------------
CHANGE RATE VOLUME CHANGE RATE VOLUME
-------- ------ -------- -------- -------- --------
(IN THOUSANDS)
Interest earning deposits in other financial $ 116 $ 3 $ 113 $ (37) $ (14) $ (23)
institutions (including time deposits)
Federal funds sold (51) 35 (86) (195) (132) (63)
Investment securities 490 58 432 287 (29) 316
Loans, net 3,428 (6) 3,434 (5,856) (7,044) 1,188
Securitized loans (2,521) 164 (2,685) (3,792) 299 (4,091)
-------- ------ -------- -------- -------- --------
Total interest-earning assets 1,462 254 1,208 (9,593) (6,920) (2,673)
-------- ------ -------- -------- -------- --------
Interest-bearing demand 450 256 194 (229) (255) 26
Savings 25 (6) 31 (89) (106) 17
Time certificates of deposit (80) (355) 275 (606) (679) 73
Bonds payable (2,196) 193 (2,389) (3,284) 301 (3,585)
Other borrowings 304 35 269 84 - 84
-------- ------ -------- -------- -------- --------
Total interest-bearing liabilities (1,497) 123 (1,620) (4,124) (739) (3,385)
-------- ------ -------- -------- -------- --------
Net interest income $ 2,959 $ 131 $ 2,828 $(5,469) $(6,181) $ 712
======== ====== ======== ======== ======== ========
The Company primarily earns income from the management of its financial assets
and liabilities and from charging fees for services it provides. The Company's
income from managing assets consists of the difference between the interest
income received from its loan portfolio and investments and the interest expense
paid on its liabilities, primarily interest paid on deposits. This difference
or spread is net interest income. Net interest income, when expressed as a
percentage of average total interest-earning assets, is referred to as net
interest margin on interest-earning assets. The Company's net interest income
is affected by the change in the level and the mix of interest-earning assets
and interest-bearing liabilities, referred to as volume changes. The Company's
net yield on interest-earning assets is also affected by changes in the yields
earned on assets and rates paid on liabilities, referred to as rate changes.
Interest rates charged on the Company's loans are affected principally by the
demand for such loans, the supply of money available for lending purposes,
competitive factors and general economic conditions such as federal economic
policies, legislative tax policies and governmental budgetary matters.
The following table presents the net interest income and net interest margin for
the three years indicated:
-14-
YEAR ENDED DECEMBER 31,
----------------------------
2004 2003 2002
-------- -------- --------
(DOLLARS IN THOUSANDS)
Interest income $21,845 $20,383 $29,976
Interest expense 7,845 9,342 13,466
-------- -------- --------
Net interest income $14,000 $11,041 $16,510
======== ======== ========
Net interest margin 4.41% 3.93% 5.87%
NON-INTEREST INCOME
The following table summarizes the Company's non-interest income for the three
years indicated:
YEAR ENDED DECEMBER 31,
-------------------------
NON-INTEREST INCOME 2004 2003 2002
------- ------- -------
(IN THOUSANDS)
Gains from loan sales, net: $ 3,981 $ 4,860 $ 4,788
Other loan fees 3,776 2,923 3,388
Loan servicing fees, net 1,416 1,264 1,081
Document processing fees, net: 817 937 1,404
Service charges 381 376 440
Other 91 315 297
------- ------- -------
Total non-interest income $10,462 $10,675 $11,398
======= ======= =======
Total non-interest income for the Company declined by $213,000, or 2%, from 2003
to 2004. This decline was primarily due to the drop in total mortgage loan
originations of $114.9 million or 35.5%, from $323.7 million in 2003 to $208.8
million in 2004 which resulted in declines of $662,000 in gains on loan sales,
$680,000 in other loan fees and $374,000 in document processing fees. Net gains
on loan sales for the SBA division also declined slightly by $217,000, or 5.9%,
due to management's decision to sell less 7(a) guaranteed loans in 2004 than
2003. It is the Company's intention to continue to decrease the pace of 7(a)
loan sales in the future to help grow the SBA loan portfolio. During the year
the Company increased activity in SBA 504 loan originations and referrals which
resulted in increases in other SBA loan fees and document processing fees of
$1.5 million and $182,000, respectively. Other non-interest income decreased in
2004 compared to 2003 primarily due to the change in the sales of OREO
properties for the two periods.
The following table summarizes these changes:
YEAR ENDED DECEMBER 31,
------------------------
2004 2003 CHANGE
------ ------ --------
(IN THOUSANDS)
Gains from loan sales, net
SBA $3,481 $3,698 $ (217)
Mortgage 500 1,162 (662)
------ ------ --------
Total $3,981 $4,860 $ (879)
====== ====== ========
Other loan fees
SBA $1,522 $ - $ 1,522
Mortgage 2,243 2,923 (680)
Other 4 - 4
------ ------ --------
Total $3,776 $2,923 $ 846
====== ====== ========
Document processing fees, net
SBA $ 182 $ - $ 182
Mortgage 563 937 (374)
Other 72 - 72
------ ------ --------
Total $ 817 $ 937 $ (120)
====== ====== ========
Other
Gain on sale of OREO $ 4 $ 157 $ (153)
Gain on sale of assets 1 33 (32)
Other 86 125 (39)
------ ------ --------
Total $ 91 $ 315 $ (224)
====== ====== ========
-15-
Total non-interest income for the Company declined by $723,000, or 6.3%, from
2002 to 2003. Despite the increased refinance activity experienced in the
mortgage industry during 2003, the mortgage division experienced a decline in
total loan originations from 2002 to 2003 of $44.2 million, or 12.6%. The exit
from HLTV in 2002 was responsible for $1.9 million of the decline in
non-interest income from 2002 to 2003. This decline was partially offset by an
increase in gains on loans sales for the mortgage and SBA divisions in 2003 over
2002 and a small increase in document processing fees for the mortgage division
in 2003. During 2003, the Company also received higher premiums on SBA loan
sales. The mortgage division activity slowed down in the 2003 fourth quarter.
NON-INTEREST EXPENSES
The following table summarizes the Company's non-interest expenses for the three
years indicated:
YEAR ENDED DECEMBER 31,
-------------------------
NON-INTEREST EXPENSES 2004 2003 2002
------- ------- -------
(IN THOUSANDS)
Salaries and employee benefits $11,851 $11,416 $13,596
Occupancy and equipment expenses 1,596 1,691 2,119
Professional services 940 636 1,575
Depreciation 532 581 771
Loan servicing and collection 225 438 872
Impairment of SBA interest only strips and servicing assets - - 1,788
Lower of cost or market provision on loans held for sale - - 1,381
Other 2,377 1,974 2,829
------- ------- -------
Total non-interest expenses $17,521 $16,736 $24,931
======= ======= =======
Non-interest expenses increased $785,000 in 2004 compared to 2003. Increases in
salaries and employee benefits, professional services and other expenses of
$435,000, $304,000 and $403,000, respectively, were partly offset by declines in
occupancy, depreciation and loan servicing and collection of $95,000, $49,000
and $213,000. The increase in salaries and employee benefits was primarily due
to increased cost of living and decreased availability of qualified resources.
The increase in professional fees was primarily due to increases in accounting
and audit fees, legal fees and other consulting services of $112,000, $94,000
and $91,000, respectively. The increase in other expense was primarily due to a
$402,000 charge relating to sub-lease costs incurred in connection with a former
lending relationship.
Non-interest expense declined $8.2 million, or 33%, from 2002 to 2003.
Financial asset write-downs of $3.2 million in 2002 as well as changes in
business lines contributed to the difference between 2002 and 2003, as did the
Company's continuing efforts to control expenses. The following table compares
the various elements of non-interest expenses as a percentage of average assets:
TOTAL SALARIES AND OCCUPANCY AND
AVERAGE NON-INTEREST EMPLOYEE DEPRECIATION
YEAR ENDED DECEMBER 31, ASSETS EXPENSES BENEFITS EXPENSES
- ------------------------ -------- ------------- -------------- -------------
(DOLLARS IN THOUSANDS)
2004 $333,230 5.26% 3.56% 0.64%
2003 $299,661 5.58% 3.81% 0.76%
2002 $301,962 8.25% 4.50% 0.95%
INCOME TAXES
Income tax provision (benefit) was $2,688,000 in 2004, $1,128,000 in 2003, and
$(652,000) in 2002. The effective income tax (benefit) rate was 41.2%, 34.1%,
and (33.9%) for 2004, 2003 and 2002, respectively. See footnote 10, "Income
Taxes", in the notes to the Consolidated Financial Statements.
CAPITAL RESOURCES
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") contains
rules as to the legal and regulatory environment for insured depository
institutions, including reductions in insurance coverage for certain kinds of
deposits, increased supervision by the federal regulatory agencies, increased
reporting requirements for insured institutions and new regulations concerning
internal controls, accounting and operations.
-16-
The prompt corrective action regulations of FDICIA define specific capital
categories based on the institutions' capital ratios. The capital categories,
in declining order, are "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized" and "critically
undercapitalized". To be considered "well capitalized", an institution must
have a core capital ratio of at least 5% and a total risk-based capital ratio of
at least 10%. Additionally, FDICIA imposed in 1994 a new Tier I risk-based
capital ratio of at least 6% to be considered "well capitalized". Tier I
risk-based capital is, primarily, common stock and retained earnings, net of
goodwill and other intangible assets.
To be categorized as "adequately capitalized" or "well capitalized", CWB must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
and values as set forth in the tables below:
(DOLLARS IN THOUSANDS) RISK- ADJUSTED TOTAL TIER 1 TIER 1
TOTAL TIER 1 WEIGHTED AVERAGE CAPITAL CAPITAL LEVERAGE
CAPITAL CAPITAL ASSETS ASSETS RATIO RATIO RATIO
-------- --------- --------- -------- -------- -------- ---------
DECEMBER 31, 2004
CWBC (Consolidated) $ 41,047 $ 37,315 $ 298,359 $358,623 13.76% 12.51% 10.41%
CWB 38,550 34,819 298,309 354,889 12.92 11.67 9.81
DECEMBER 31, 2003
CWBC (Consolidated) 37,150 34,096 242,730 305,666 15.31% 14.05% 11.15%
CWB 34,695 31,648 242,170 301,024 14.33 13.07 10.51
Well capitalized ratios 10.00 6.00 5.00
Minimum capital ratios 8.00 4.00 4.00
The Company does not anticipate any material changes in its capital resources.
CWBC has common equity only and does not have any off-balance sheet financing
arrangements. The Company has not reissued any treasury stock nor does it have
any immediate plans or programs to do so.
-17-
SCHEDULE OF AVERAGE ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY
As of the dates indicated below, the following schedule shows the average
balances of the Company's assets, liabilities and stockholders' equity accounts
as a percentage of average total assets:
DECEMBER 31,
------------------------------------------------------
2004 2003 2002
----------------- ----------------- ---------------
AMOUNT % AMOUNT % AMOUNT %
--------- ------ --------- ------ -------- ------
ASSETS (DOLLARS IN THOUSANDS)
Cash and due from banks $ 5,364 1.6% $ 6,431 2.1% $ 6,684 2.2%
Interest-earning deposits in other financial institutions 6,919 2.1% 1,359 0.5% - -
Federal funds sold 8,684 2.6% 15,462 5.1% 22,903 7.6%
Time deposits in other financial institutions 577 .2% 1,542 0.5% 3,929 1.3%
Federal Reserve Bank & Federal Home Loan Bank stock 1,902 .6% 812 0.3% 780 0.3%
Investment securities available-for-sale 21,220 6.4% 8,910 3.0% - -
Investment securities held-to-maturity 3,493 1.0% 5,036 1.7% 4,264 1.4%
Interest only strips, at fair value 3,214 1.0% 4,054 1.3% 6,104 2.0%
Loans held for sale, net 44,037 13.2% 45,445 15.2% 27,699 9.2%
Loans held for investment, net 197,622 59.3% 147,351 49.2% 132,061 43.7%
Securitized loans, net 28,661 8.6% 50,173 16.7% 83,876 27.8%
Servicing rights 3,002 0.9% 2,062 0.7% 2,213 0.7%
Other real estate owned, net 88 - 677 0.2% 554 0.2%
Premises and equipment, net 1,655 0.5% 1,805 0.6% 2,338 0.8%
Other assets 6,792 2.0% 8,542 2.9% 8,557 2.8%
--------- ------ --------- ------ -------- ------
TOTAL ASSETS $333,230 100.0% $299,661 100.0% $301,962 100.0%
========= ====== ========= ====== ======== ======
LIABILITIES
Deposits:
Non-interest-bearing demand $ 38,761 11.6% $ 34,400 11.5% $ 31,388 10.4%
Interest-bearing demand 50,785 15.2% 35,768 11.9% 27,439 9.1%
Savings 17,810 5.3% 15,480 5.2% 13,270 4.4%
Time certificates of $100,000 or more 31,851 9.6% 21,076 7.0% 42,970 14.2%
Other time certificates 109,456 32.9% 109,828 36.7% 85,137 28.2%
--------- ------ --------- ------ -------- ------
Total deposits 248,663 74.6% 216,552 72.3% 200,204 66.3%
Other borrowings 22,699 6.8% 6,518 2.2% - -
Bonds payable in connection with securitized loans 19,676 5.9% 39,000 13.0% 69,251 22.9%
Other liabilities 5,992 1.8% 4,746 1.5% 689 0.2%
--------- ------ --------- ------ -------- ------
Total liabilities 297,030 89.1% 266,816 89.0% 270,144 89.4%
--------- ------ --------- ------ -------- ------
STOCKHOLDERS' EQUITY
Common stock 29,940 9.0% 29,812 10.0% 29,797 9.9%
Retained earnings 6,275 1.9% 3,037 1.0% 2,021 0.7%
Accumulated other comprehensive (loss) (15) - (4) - - -
--------- ------ --------- ------ -------- ------
Total stockholders' equity 36,200 10.9% 32,845 11.0% 31,818 10.6%
--------- ------ --------- ------ -------- ------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $333,230 100.0% $299,661 100.0% $301,962 100.0%
========= ====== ========= ====== ======== ======
-18-
INTEREST RATES AND DIFFERENTIALS
- -----------------------------------
The following table illustrates average yields on interest-earning assets and
average rates on interest-bearing liabilities for the years indicated. These
average yields and rates are derived by dividing interest income by the average
balances of interest-earning assets and by dividing interest expense by the
average balances of interest-bearing liabilities for the years indicated.
Amounts outstanding are averages of daily balances during the period.
YEAR ENDED DECEMBER 31,
-------------------------------
INTEREST-EARNING ASSETS: 2004 2003 2002
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Interest earning deposits in other financial institutions:
Average outstanding $ 6,919 $ 1,359 $ -
Interest income 170 31 -
Average yield 2.46% 2.28% -
Time deposits in other financial institutions:
Average outstanding 577 1,542 3,929
Interest income 13 36 104
Average yield 2.25% 2.33% 2.65%
Federal funds sold:
Average outstanding 8,684 15,462 22,903
Interest income 118 169 364
Average yield 1.36% 1.09% 1.59%
Investment securities:
Average outstanding 26,615 14,758 5,044
Interest income 979 489 202
Average yield 3.68% 3.31% 4.00%
Gross loans, excluding securitized:
Average outstanding 244,492 195,648 164,301
Interest income 16,982 13,554 19,410
Average yield 6.95% 6.93% 11.81%
Securitized loans:
Average outstanding 30,098 52,359 85,134
Interest income 3,583 6,104 9,896
Average yield 11.91% 11.66% 11.62%
Total interest-earning assets:
Average outstanding 317,385 281,128 281,311
Interest income 21,845 20,383 29,976
Average yield 6.88% 7.25% 10.66%
-19-
YEAR ENDED DECEMBER 31,
-------------------------------
INTEREST-BEARING LIABILITIES: 2004 2003 2002
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Interest-bearing demand deposits:
Average outstanding $ 50,785 $ 35,768 $ 27,438
Interest expense 820 371 600
Average effective rate 1.61% 1.04% 2.19%
Savings deposits:
Average outstanding 17,810 15,480 13,270
Interest expense 241 215 304
Average effective rate 1.35% 1.39% 2.29%
Time certificates of deposit:
Average outstanding 141,308 130,904 128,107
Interest expense 3,955 4,035 4,641
Average effective rate 2.80% 3.08% 3.62%
Bonds payable:
Average outstanding 19,676 39,000 69,251
Interest expense 2,441 4,637 7,921
Average effective rate 12.41% 11.89% 11.44%
Other borrowings:
Average outstanding 22,699 6,518 -
Interest expense 388 84 22
Average effective rate 1.71% 1.29% -
Total interest-bearing liabilities:
Average outstanding 252,278 227,670 238,088
Interest expense 7,845 9,342 13,466
Average effective rate 3.11% 4.10% 5.66%
NET INTEREST INCOME 14,000 11,041 16,510
NET INTEREST SPREAD 3.77% 3.15% 5.00%
AVERAGE NET MARGIN 4.41% 3.93% 5.87%
Nonaccrual loans are included in the average balance of loans outstanding.
LOAN PORTFOLIO
- ---------------
The Company's largest categories of loans held in the portfolio are commercial
loans, real estate loans, SBA loans, installment loans (including manufactured
housing) and second mortgage loans. Loans are carried at face amount, net of
payments collected, the allowance for loan losses, deferred loan fees/costs and
discounts on loans purchased. Interest on all loans is accrued daily, primarily
on a simple interest basis. It is the Company's policy to place a loan on
nonaccrual status when the loan is 90 days past due. Thereafter, previously
recorded interest is reversed and interest income is typically recognized on a
cash basis.
The rates charged on variable rate loans are set at specific increments. These
increments vary in relation to the Company's published prime lending rate or
other appropriate indices. At December 31, 2004, approximately 62% of the
Company's loan portfolio was comprised of variable interest rate loans. At
December 31, 2003 and 2002, variable rate loans comprised approximately 63% and
56%, respectively, of the Company's loan portfolio. Management monitors the
maturity of loans and the sensitivity of loans to changes in interest rates.
The following table sets forth, as of the dates indicated, the amount of gross
loans outstanding based on the remaining scheduled repayments of principal,
which could either be repriced or remain fixed until maturity, classified by
years until maturity:
-20-
DECEMBER 31,
------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------------------------------------------------------------------------------------------------
IN YEARS (IN THOUSANDS)
------------------------------------------------------------------------------------------------------
FIXED VARIABLE FIXED VARIABLE FIXED VARIABLE FIXED VARIABLE FIXED VARIABLE
-------- --------- ------- --------- -------- --------- -------- --------- -------- ---------
Less than One $ 3,877 $ 44,896 $ 2,382 $ 34,108 $ 2,604 $ 8,188 $ 10,346 $ 26,532 $ 1,058 $ 100,717
One to Five 12,922 29,567 4,128 13,576 3,615 16,224 3,975 6,195 8,250 5,403
Over Five (1) 94,567 108,571 85,390 109,366 105,491 116,322 164,748 58,761 219,213 642
------------------------------------------------------------------------------------------------------
Total $111,366 $ 183,034 $91,900 $ 157,050 $111,710 $ 140,734 $179,069 $ 91,488 $228,521 $ 106,762
======================================================================================================
(1) Approximately $23.5 million of the fixed rate loans at December 31, 2004 are
in the Company's securitized loan portfolio, which was originally funded by
bonds payable, approximately $13.9 million balance of which remains outstanding
at December 31, 2004.
Distribution of Loans
The distribution of the Company's total loans by type of loan, as of the dates
indicated, is shown in the following table:
DECEMBER 31,
------------------------------------------------------------------------------
2004 2003 2002 2001 2000
-------------- -------------- -------------- -------------- --------------
(DOLLARS IN THOUSANDS)
LOAN BALANCE LOAN BALANCE LOAN BALANCE LOAN BALANCE LOAN BALANCE
-------------- -------------- -------------- -------------- --------------
Commercial $ 30,893 $ 24,592 $ 19,302 $ 26,411 $ 36,188
Real estate 85,357 71,010 47,456 44,602 55,083
SBA 35,265 30,698 40,961 31,889 30,888
Manufactured housing 66,423 39,073 28,199 24,135 16,892
Other installment 8,645 5,770 7,047 4,088 6,006
Securitized 23,474 37,386 66,195 108,584 153,031
Held for sale 45,988 42,038 43,284 30,848 37,195
-------------- -------------- -------------- -------------- --------------
Gross Loans 296,045 250,567 252,444 270,557 335,283
Less:
Allowance for loan losses 3,894 4,675 5,950 8,275 6,746
Deferred fees/costs (103) 69 (318) 222 (2,710)
Discount on SBA loans 1,748 1,549 956 1,105 1,982
-------------- -------------- -------------- -------------- --------------
Net Loans $ 290,506 $ 244,274 $ 245,856 $ 260,955 $ 329,265
============== ============= =============== ============== ==============
Percentage to Gross Loans:
Commercial 10.5% 9.8% 7.6% 9.8% 10.8%
Real estate 28.8% 28.3% 18.8% 16.5% 16.4%
SBA 11.9% 12.3% 16.3% 11.8% 9.2%
Manufactured housing 22.5% 15.6% 11.2% 8.9% 5.0%
Other installment 2.9% 2.3% 2.8% 1.5% 1.8%
Securitized 7.9% 14.9% 26.2% 40.1% 45.7%
Held for sale 15.5% 16.8% 17.1% 11.4% 11.1%
-------------- -------------- -------------- -------------- --------------
100.0% 100.0% 100.0% 100.0% 100.0%
============== ============= =============== ============== ==============
Commercial Loans
In addition to traditional term commercial loans made to business customers, CWB
grants revolving business lines of credit. Under the terms of the revolving
lines of credit, CWB grants a maximum loan amount, which remains available to
the business during the loan term. Generally, as part of the loan requirements,
the business agrees to maintain its primary banking relationship with CWB. CWB
does not extend material loans of this type in excess of two years.
Commercial Real Estate and Construction Loans
Commercial real estate loans are primarily made for the purpose of purchasing,
improving or constructing single-family residences, commercial or industrial
properties.
-21-
A substantial portion of the Company's real estate construction loans are first
and second trust deeds on the construction of owner-occupied single family
dwellings. The Company also makes real estate construction loans on commercial
properties. These consist of first and second trust deeds collateralized by the
related real property. Construction loans are generally written with terms of
six to eighteen months and usually do not exceed a loan to appraised value of
80%.
Commercial and industrial real estate loans are secured by nonresidential
property. Office buildings or other commercial property primarily secure these
loans. Loan to appraised value ratios on nonresidential real estate loans are
generally restricted to 80% of appraised value of the underlying real property
if occupied by the owner or owner's business; otherwise, these loans are
generally restricted to 75% of appraised value of the underlying real property.
SBA Loans
The SBA loans consist of 7(a), 504 and B&I loans. The 7(a) loan proceeds are
used for working capital, machinery and equipment purchases, land and building
purposes, leasehold improvements and debt refinancing. The SBA guarantees up to
85% of the loan amount depending on loan size. Under the SBA 7(a) loan program,
the Company is required to retain a minimum of 5% of the gross originated
principal amount of each loan it originates and sells into the secondary market
The 504 loans are made in conjunction with Certified Development Companies.
These loans are granted to purchase or construct real estate or acquire
machinery and equipment. The loan is structured with a conventional first trust
deed provided by a private lender and a second trust deed which is funded
through the sale of debentures. The predominant structure is terms of 10% down
payment, 50% conventional first loan and 40% debenture.
B&I loans are guaranteed by the U.S. Department of Agriculture. The guaranteed
amount is generally 80%. B&I loans are similar to the 7(a) loans but are made
to businesses in designated rural areas. These loans can also be sold into the
secondary market.
Real Estate Loan
The mortgage loan division originates first and second mortgage loans secured by
trust deeds on one to four family homes. The loans are made to borrowers for
the purpose of purchasing a home or refinancing an existing home for purposes
such as interest rate reduction, home improvement, and debt consolidation.
These loans are underwritten to specific investor guidelines and are committed
for sale to that investor. A majority of these loans are sold servicing
released into the secondary market.
Manufactured Housing Loans
The mortgage loan division originates loans secured by manufactured homes
primarily located in mobile home parks along the Central Coast of California.
At December 31, 2004, the Bank had $66.4 million in its portfolio. The loans
are serviced internally and are generally fixed rate written for terms of 10 to
30 years with balloon payments ranging from 10 to 15 years.
Other Installment Loans
Installment loans consist of automobile, small home equity lines of credit and
general-purpose loans made to individuals. These loans are primarily fixed
rate.
Second Mortgage Loans
The Company originated second mortgage loans with loan to value ratios as high
as 125%. In 1998 and 1999, the Company transferred $81 million and $122 million
of these loans, respectively, to the Trusts. The Trusts then sold bonds to
third party investors, which were secured by the transferred loans. The bonds
are held in a trust independent of the Company, the trustee of which oversees
the distribution to the bondholders. The mortgage loans are serviced by a third
party ("Servicer"), who receives a stated servicing fee. There is an insurance
policy on the subordinate bonds that guarantees the payment of the bonds.
As part of the securitization agreements, the Company received an option to
repurchase the bonds when the aggregate principal balance of the mortgage loans
sold declined to 10% or less of the original balance of mortgage loans
securitized. Because the Company has a call option to reacquire the loans
transferred and did not retain the servicing rights, the Company was deemed to
not have surrendered effective control over the loans transferred. Therefore,
the securitizations are accounted for as secured borrowings with a pledge of
collateral. Accordingly, the
-22-
Company consolidates the Trusts and the financial statements of the Company
include the loans transferred and the related bonds issued. The securitized
loans are classified as held for investment.
Loan Commitments Outstanding
The Company's loan commitments outstanding at the dates indicated are summarized
below:
DECEMBER 31,
-------------------------------------------
2004 2003 2002 2001 2000
------- ------- ------- ------- -------
(IN THOUSANDS)
Commercial $19,010 $13,867 $11,370 $ 7,450 $ 9,776
Real estate 7,618 11,676 7,664 6,370 8,323
SBA 6,107 9,531 8,675 4,712 4,545
Installment loans 8,966 5,112 2,402 13,339 2,260
Standby letters of credit 403 522 380 438 913
------- ------- ------- ------- -------
Total commitments $42,104 $40,708 $30,491 $32,309 $25,817
======= ======= ======= ======= =======
The Company makes loans to borrowers in a number of different industries. Other
than Manufactured Housing, no single concentration comprises 10% or more of the
Company's loan portfolio. At December 31, 2004, Manufactured Housing comprised
22.5% of the Company's loan portfolio. Commercial real estate loans and SBA
loans comprised over 10% of the Company's loan portfolio as of December 31, 2003
and 2004, but consisted of diverse borrowers. Although the Company does not
have significant concentrations in its loan portfolio, the ability of the
Company's customers to honor their loan agreements is dependent upon, among
other things, the general economy of the Company's market areas.
-23-
Allowance for Loan Losses
The following table summarizes the activity in the Company's allowance for loan
losses for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
(IN THOUSANDS)
Average gross loans, held for investment, $230,533 $202,563 $218,317 $267,402 $297,574
including Securitized loans
Gross loans at end of year, held for 248,412 206,912 208,522 237,989 302,476
investment, including Securitized loans
Allowance for loan losses, beginning of year $ 4,676 $ 5,950 $ 8,275 $ 6,746 $ 5,529
Loans charged off:
Commercial 185 445 1 614 410
Real estate 274 471 2,474 3,129 1,216
Installment - 3 - - 446
Short-term consumer - 902 3,162 2,478 2
Securitized 1,356 2,512 4,012 4,358 3,674
--------- --------- --------- --------- ---------
Total 1,815 4,333 9,649 10,580 5,748
--------- --------- --------- --------- ---------
Recoveries of loans previously charged off
Commercial 31 88 71 40 154
Real estate 44 42 396 171 17
Short-term consumer - 672 1,392 400 -
Securitized 540 588 566 378 1
--------- --------- --------- --------- ---------
Total 615 1,390 2,425 990 171
--------- --------- --------- --------- ---------
Net loans charged off 1,200 2,943 7,224 9,590 5,577
Provision for loan losses 418 1,669 4,899 11,881 6,794
Adjustments due to Palomar purchase/sale - - - (762) -
--------- --------- --------- --------- ---------
Allowance for loan losses, end of year $ 3,894 $ 4,676 $ 5,950 $ 8,275 $ 6,746
========= ========= ========= ========= =========
Ratios:
Net loan charge-offs to average loans 0.5% 1.5% 3.3% 3.6% 1.9%
Net loan charge-offs to loans at end of period 0.5% 1.4% 3.5% 4.0% 1.8%
Allowance for loan losses to loans held for investment at end of period 1.6% 2.3% 2.9% 3.5% 2.2%
Net loan charge-offs to allowance for loan losses at beginning of period 25.7% 49.5% 87.3% 142.2% 100.9%
Net loan charge-offs to provision for loan losses 287.1% 176.3% 147.5% 80.7% 82.1%
The following table summarizes the allowance for loan losses:
DECEMBER 31,
--------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
PERCENT PERCENT PERCENT PERCENT PERCENT
OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
IN EACH IN EACH IN EACH IN EACH IN EACH
BALANCE AT CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY
END OF PERIOD TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL
APPLICABLE TO: AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
- -------------------- ------- --------- ------- --------- ------- --------- ------- --------- ------- ---------
SBA $ 1,388 35.7% $ 1,550 27.0% $ 1,874 26.6% $ 1,752 18.8% $ * 12.5%
Manufactured housing 465 11.9% 372 15.6% 272 11.2% 291 8.9% * 5.0%
Securitized 1,109 28.5% 2,024 14.9% 2,571 26.2% 4,189 40.1% 4,042 45.6%
All other loans 932 23.9% 730 42.5% 1,233 36.0% 2,043 32.2% 2,704 36.9%
--------------------------------------------------------------------------------------------------
TOTAL $ 3,894 100% $ 4,676 100% $ 5,950 100% $ 8,275 100% $ 6,746 100%
==================================================================================================
* The detailed information for 2000 is not readily available.
-24-
Total allowance for loan losses ("ALL") decreased $782,000, or 16.7%, from $4.7
million at December 31, 2003 to $3.9 million at December 31, 2004. The majority
of the decline in the allowance related to a decrease of $915,000 in the
allowance for securitized loans. The securitized loan loss allowance changed
primarily due to the significant principal balance payments in 2004 of $13.9
million, or 37.2%, and a 57.6% decrease in net charge-offs from 2003 compared to
2004. This decrease in allowance was partially offset by increases in the
allowance for other loans due to loan growth.
Loans charged-off, net of recoveries, were $1.2 million in 2004, $2.9 million in
2003 and $7.2 million in 2002. The primary reason for the decline in net
charge-offs in 2004 was the significant paydown in the securitized loan
portfolio. The Company has also experienced continued increases in the SBA
portfolio credit quality. Management believes its continued strong underwriting
standards have influenced the decline in problem loans in the SBA portfolio.
In management's opinion, the balance of the allowance for loan losses was
sufficient to absorb known and inherent probable losses in the loan portfolio as
of December31, 2004.
The Company recorded $418,000 as a provision for loan losses in 2004, $1.7
million in 2003 and $4.9 million in 2002. The primary reasons for the decrease
in provision expense are the pay-down in the securitized loan portfolio and the
Company's change in portfolio mix to perceived less risky loans.
Nonaccrual, Past Due and Restructured Loans
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest under the contractual terms of the loan agreement.
Factors considered by management in determining impairment include payment
status, collateral value and the probability of collecting scheduled principal
and interest payments. Loans that experience insignificant payment delays or
payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis. When determining the possibility of impairment, management
considers the circumstances surrounding the loan and the borrower, including the
length of the delay, the reasons for the delay, the borrower's prior payment
record and the amount of the shortfall in relation to the principal and interest
owed. For collateral-dependent loans, the Company uses the fair value of
collateral method to measure impairment. All other loans, except for
securitized, are measured for impairment based on the present value of future
cash flows. Impairment is measured on a loan-by-loan basis for all loans in the
portfolio except for the securitized loans, which are evaluated for impairment
on a collective basis.
The recorded investment in loans that are considered to be impaired is as
follows:
YEAR ENDED DECEMBER 31,
----------------------------------------------
2004 2003 2002 2001 2000
------- ------- -------- -------- --------
(IN THOUSANDS)
Impaired loans without specific valuation allowances $ 49 $ 235 $ 422 $ - $ 565
Impaired loans with specific valuation allowances 3,926 6,843 7,971 6,587 3,531
Specific valuation allowance related to impaired loans (425) (640) (1,127) (1,669) (1,207)
------- ------- -------- -------- --------
Impaired loans, net $3,550 $6,438 $ 7,266 $ 4,918 $ 2,889
======= ======= ======== ======== ========
Average investment in impaired loans $5,137 $6,584 $ 7,565 $ 5,047 $ 4,677
======= ======= ======== ======== ========
The following schedule reflects recorded investment at the dates indicated in
certain types of loans:
YEAR ENDED DECEMBER 31,
------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
(IN THOUSANDS)
Nonaccrual loans $ 8,350 $ 7,174 $13,965 $11,413 $ 4,893
SBA guaranteed portion of loans included above (5,287) (4,106) (8,143) (7,825) (2,748)
-------- -------- -------- -------- --------
Nonaccrual loans, net $ 3,063 $ 3,068 $ 5,822 $ 3,588 $ 2,235
======== ======== ======== ======== ========
-25-
Troubled debt restructured loans $ 124 $ 193 $ 829 $ 1,093 $ 615
Loans 30 through 90 days past due with interest accruing 1,804 3,907 5,122 2,607 4,277
Interest income recognized on impaired loans $ 103 $ 277 $ 190 $ 1,443 $ 387
Interest foregone on nonaccrual loans and
troubled debt restructured loans outstanding 208 216 1,263 1,146 592
-------- -------- -------- -------- --------
Gross interest income on impaired loans $ 311 $ 493 $ 1,453 $ 2,589 $ 979
======== ======== ======== ======== ========
The accrual of interest is discontinued when substantial doubt exists as to
collectibility of the loan; generally at the time the loan is 90 days
delinquent. Any unpaid but accrued interest is reversed at that time.
Thereafter, interest income is no longer recognized on the loan. As such,
interest income may be recognized on impaired loans to the extent they are not
past due by 90 days. Interest on nonaccrual loans is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual.
Loans are returned to accrual status when all of the principal and interest
amounts contractually due are brought current and future payments are reasonably
assured. All of the nonaccrual loans are impaired. Although net nonaccrual
loans decreased slightly during 2004, total nonaccrual loans increased by $1.2
million. This increase was due to an increase in SBA guaranteed loans
repurchased from investors on behalf of the SBA of $1.1 million. These loan
balances represent no credit risk to CWB as they are guaranteed by the SBA.
Total impaired loans decreased by $3.1 million, or 43.8%, in 2004. The specific
valuation allowances allocated to impaired loans also decreased by $215,000, or
33.6%. The majority of this decrease relates to payoffs received from borrowers
of $2.8 million with specific reserves of $132,000 and one loan for $197,000
with a specific valuation allowance of $129,000 which was converted to OREO
during 2004. Also contributing to the change were $395,000 of regular loan
payments received from borrowers and $144,000 of loans upgraded during the year.
These declines were partially offset by $527,000 in new impaired loans with
$155,000 of specific valuation allowance allocated to them.
Financial difficulties encountered by certain borrowers may cause the Company to
restructure the terms of their loan to facilitate loan repayment. A troubled
debt restructured loan ("TDR") would generally be considered impaired. The
balance of impaired loans disclosed above includes all TDRs that, as of December
31, 2004, 2003 and 2002, are considered impaired. Total TDRs decreased by
35.8%, or $69,000, from $193,000 to $124,000 as of December 31, 2003 and 2004,
respectively.
INVESTMENT PORTFOLIO
- ---------------------
The following table summarizes the carrying values of the Company's investment
securities for the years indicated:
YEAR ENDED DECEMBER 31,
------------------------
2004 2003 2002
------- ------- ------
Available-for-sale securities (IN THOUSANDS)
- -----------------------------
U.S. Government and agency $15,221 $ 7,024 $ -
Other (1) 7,037 8,408
------- ------- ------
Total held-to-maturity securities $22,258 $15,432 $ -
======= ======= ======
Held-to-maturity securities
- ---------------------------
U.S. Government and agency $ 200 $ 200 $ 707
Other (1) 5,894 4,836 5,305
------- ------- ------
Total available-for-sale securities $ 6,094 $ 5,036 $6,012
======= ======= ======
At December 31, 2004, $200,000 at carrying value of the above held-to-maturity
securities were pledged as collateral to the U.S. Treasury for CWB's treasury,
tax and loan account and $14 million at carrying value were pledged under
repurchase agreements, which are treated as collateralized financing
transactions. Additionally, $14.1 million, at carrying value, were pledged to
the Federal Home Loan Bank, San Francisco, as collateral for current and future
advances.
-26-
The following tables summarize the maturity period and weighted average yields
of the Company's investment securities at December 31, 2004.
LESS THAN ONE ONE TO FIVE FIVE TO TEN
TOTAL AMOUNT YEAR YEARS YEARS OVER TEN YEARS
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
(DOLLARS IN THOUSANDS)
Available-for-sale securities
- -----------------------------
U. S. Government
and agency $15,221 3.0% $ - - $11,257 3.0% $ 3,964 3.0% $ - -
Other (1) 7,037 4.0% - 7,037 4.0% - - - -
------- ------- ------- ------- -------
Total HTM $22,258 3.3% $ - - $18,294 3.4% $ 3,964 3.0% $ - -
======= ======= ======= ======= =======
Held-to-maturity securities
- ---------------------------
U.S. Government
and agency $ 200 3.7% $ 200 3.7% $ - - $ - - $ - -
Other (1) 5,894 4.8% - - 4,852 4.6% - - 1,042 5.5%
------- ------- ------- ------- -------
Total AFS $ 6,094 4.7% $ 200 3.7% $ 4,852 4.6% $ - - $ 1,042 5.5%
======= ======= ======= ======= =======
(1) Consists of pass-through mortgage backed securities and collateralized
mortgage obligations.
Mortgage-backed securities and collateralized mortgage obligations are
distributed in total based on average expected maturities.
Interest-Only Strips and Servicing Rights
As of December 31, 2004 and 2003, the Company held interest-only strips in the
amount of $2.7 million and $3.6 million, respectively. These interest-only
strips represent the present value of the right to the estimated net cash flows
generated by SBA loans sold. Net cash flows consist of the difference between
(a) interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors and (ii) contractual
servicing fees. The Company also held servicing rights related to SBA loans
sales of $3.3 million and $2.5 million at December 31, 2004 and 2003,
respectively. For loans sold subsequent to March 31, 2002, the initial
servicing rights and resulting gain on sale were calculated based on the
difference between the best actual par and premium bids on an individual loan
basis. The servicing right balances are subsequently amortized over the
estimated life of the loans using industry prepayment statistics and the
Company's own experience. Quarterly, the servicing right and I/O strip assets
are analyzed for impairment. In 2002, the Company recorded a $1.8 million
impairment charge related to the valuation of the servicing rights and I/O
strips. The interest-only strips are accounted for as investments in debt
securities classified as trading securities. Accordingly, the Company marks
them to fair value with the resulting increase or decrease recorded through
operations in the current period. At December 31, 2004 and 2003, all of the
servicing rights are related to SBA loan sales.
LIQUIDITY MANAGEMENT
- ---------------------
The Company has established policies as well as analytical tools to manage
liquidity. Proper liquidity management ensures that sufficient funds are
available to meet normal operating demands in addition to unexpected customer
demand for funds, such as high levels of deposit withdrawals or increased loan
demand, in a timely and cost effective manner. The most important factor in the
preservation of liquidity is maintaining public confidence that facilitates the
retention and growth of core deposits. Ultimately, public confidence is gained
through profitable operations, sound credit quality and a strong capital
position. The Company's liquidity management is viewed from both a long-term
and short-term perspective as well as from an asset and liability perspective.
Management monitors liquidity through regular reviews of maturity profiles,
funding sources and loan and deposit forecasts to minimize funding risk. The
Company has asset/liability committees ("ALCO") at the Board and Bank management
level to review asset/liability management and liquidity issues. The Company
maintains strategic liquidity and contingency plans. Periodically, the Company
has significantly used short-term time certificates from other financial
institutions to meet projected liquidity needs. The Company has invested
resources in the purchase of government-guaranteed investment securities and
obtained a financing arrangement, repurchase agreements ("Repos") that allow it
to pledge these securities as collateral for short-term borrowing in case of
increased liquidity needs. As of December 31, 2004, the Company had $13.7
million of outstanding Repos, with interest rates of 1.40% to 2.35%, all of
which mature within one year.
-27-
In 2004, CWB was approved for membership in the Federal Home Loan Bank ("FHLB").
As a member of the FHLB, the bank has established a credit line under which the
borrowing capacity is determined subject to "delivery" status of qualifying
collateral. Generally, this collateral includes certain mortgages or deeds of
trust and securities and notes of the U.S. Government and its agencies. As of
December 31, 2004, CWB had $33.8 million of loans and $14.1 million of
securities pledged as collateral for FHLB borrowings. CWB has borrowed $10.5
million with interest rates between 1.77% and 3.28% on advances maturing within
three years. CWB had $18.8 million in remaining borrowing capacity with FHLB at
December 31, 2004. Repos provided the Company improved flexibility in managing
its liquidity resources. However, the Company intends to let them mature in
2005, transfer the collateral to the FHLB, and use FHLB for future advances.
The FHLB provides more flexibility as to terms.
The Company also maintains two federal funds purchased lines for a total
borrowing capacity of $13.5 million.
The Company, through the Bank, also has the ability as a member of the Federal
Reserve System, to borrow at the discount window up to 50% of what is pledged at
the Federal Reserve Bank. In January 2003, the Reserve Bank replaced the
existing discount window program with new primary and secondary credit programs.
CWB qualifies for primary credit as it has been deemed to be in sound financial
condition. The rate on primary credit will be 50 basis points less than the
secondary credit rate and will generally be granted on a "no questions asked
basis" at a rate that initially will be at 100 basis points above the Federal
Open Market Committee's (FOMC) target federal funds rate. As the rate is
currently not attractive, it is unlikely it will be used as a regular source of
funding, but is noted as available as an alternative funding source.
The Company has not experienced disintermediation and does not believe this is a
potentially probable occurrence. CWB's core deposits (excluding certificates of
deposit) grew by approximately $56.1 million during 2004. The liquidity ratio of
the Company has steadily increased and was 25%, 26% and 27% at December 31, 2002
and 2003 and 2004, respectively. The liquidity ratio consists of cash and due
from banks, deposits in other financial institutions, available for sale
investments, federal funds sold and loans held for sale, divided by total
assets.
CWBC's routine funding requirements primarily consist of certain operating
expenses. Normally, CWBC obtains funding to meet its obligations from dividends
collected from its subsidiary and has the capability to issue debt securities.
Federal banking laws regulate the amount of dividends that may be paid by
banking subsidiaries without prior approval.
Interest Rate Risk
The Company is exposed to different types of interest rate risks. These risks
include: lag, repricing, basis and prepayment risk.
- Lag Risk- lag risk results from the inherent timing difference
between the repricing of the Company's adjustable rate assets and
liabilities. For instance, certain loans tied to the prime rate index
may only reprice on a quarterly basis. However, at a community bank
such as CWB, when rates are rising, funding sources tend to reprice
more slowly than the loans. Therefore, for CWB, the effect of this
timing difference is generally favorable during a period of rising
interest rates and unfavorable during a period of declining interest
rates. This lag can produce some short-term volatility, particularly
in times of numerous prime rate changes.
- Repricing Risk - repricing risk is caused by the mismatch in the
maturities / repricing periods between interest-earning assets and
interest-bearing liabilities. If CWB was perfectly matched, the net
interest margin would expand during rising rate periods and contract
during falling rate periods. This is so since loans tend to reprice
more quickly than do funding sources. Typically, since CWB is somewhat
asset sensitive, this would also tend to expand the net interest
margin during times of interest rate increases.
- Basis Risk - item pricing tied to different indices may tend to
react differently, however, all CWB's variable products are priced off
the prime rate.
- Prepayment Risk - prepayment risk results from borrowers paying
down / off their loans prior to maturity. Prepayments on fixed-rate
products increase in falling interest rate environments and decrease
in rising interest rate environments. Since a majority of CWB's loan
originations are adjustable rate and set based on prime, and there is
little lag time on the reset, CWB does not experience significant
prepayments. However, CWB does have more prepayment risk on its
securitized and manufactured housing loans and its mortgage-backed
investment securities. Offsetting the prepayment risk on the
securitized loans are the related bonds payable, which were issued at
a fixed rate. When the bonds payable prepay, given the current
-28-
interest rate environment, this reduces CWB's interest expense as
a higher, fixed rate is, in effect, traded for a lower, variable rate
funding source.
Management of Interest Rate Risk
To mitigate the impact of changes in market interest rates on the Company's
interest-earning assets and interest-bearing liabilities, the amounts and
maturities are actively managed. Short-term, adjustable-rate assets are
generally retained as they have similar repricing characteristics as our funding
sources. CWB sells mortgage products and a portion of its SBA loan
originations. While the Company has some interest rate exposure in excess of
five years, it has internal policy limits designed to minimize risk should
interest rates rise. Currently, the Company does not use derivative instruments
to help manage risk, but will consider such instruments in the future if the
perceived need should arise.
Loan sales- The Company's ability to originate, purchase and sell loans is also
significantly impacted by changes in interest rates. Increases in interest
rates may also reduce the amount of loan and commitment fees received by CWB. A
significant decline in interest rates could also decrease the size of the CWB's
servicing portfolio and the related servicing income by increasing the level of
prepayments.
Operational Risk
Operational risk represents the risk of loss resulting from the Company's
operations, including but not limited to, the risk of fraud by employees or
persons outside the Company, the execution of unauthorized transactions by
employees, transaction processing errors and breaches of internal control system
and compliance requirements. This risk of loss also includes the potential
legal actions that could arise as a result of an operational deficiency or as a
result of noncompliance with applicable regulatory standards, adverse business
decisions or their implementation and customer attrition due to potential
negative publicity.
Operational risk is inherent in all business activities and the management of
this risk is important to the achievement of the Company's objectives. In the
event of a breakdown in the internal control system, improper operation of
systems or improper employee actions, the Company could suffer financial loss,
face regulatory action and suffer damage to its reputation. The Company manages
operational risk through a risk management framework and its internal control
processes. The framework involves business units, corporate risk management
personnel and executive management. Under this framework, the business units
have direct and primary responsibility and accountability for identifying,
controlling and monitoring operational risk. Business unit managers maintain a
system of controls with the objective of providing proper transaction
authorization and execution, proper system operations, safeguarding of assets
from misuse or theft and ensuring the reliability of financial and other data.
Business unit managers ensure that the controls are appropriate and are
implemented as designed. Business continuation and disaster recovery planning
is also critical to effectively manage operational risks. The Company's
internal audit function (currently outsourced to a third party) validates the
system of internal controls through risk-based regular and ongoing audit
procedures and reports on the effectiveness of internal controls to executive
management and the Audit Committee of the Board.
While the Company believes that it has designed effective methods to minimize
operational risks, there is no absolute assurance that business disruption or
operational losses would not occur in the event of disaster.
DEPOSITS
- --------
The following table shows the Company's average deposits for each of the periods
indicated below:
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2004 2003 2002
------------------- ------------------- -------------------
AVERAGE PERCENT AVERAGE PERCENT AVERAGE PERCENT
BALANCE OF TOTAL BALANCE OF TOTAL BALANCE OF TOTAL
-------- --------- -------- --------- -------- ---------
(DOLLARS IN THOUSANDS)
Noninterest-bearing demand $ 38,761 15.6% $ 34,400 15.9% $ 31,560 15.6%
Interest-bearing demand 50,785 20.4% 35,768 16.5% 29,347 14.5%
Savings 17,810 7.2% 15,480 7.2% 13,270 6.6%
TCD's of $100,000 or more 31,851 12.8% 21,076 9.7% 42,970 21.2%
Other TCD's 109,456 44.0% 109,828 50.7% 85,137 42.1%
-------- --------- -------- --------- -------- ---------
Total Deposits $248,663 100.0% $216,552 100.0% $202,284 100.0%
======== ========= ======== ========= ======== =========
-29-
The maturities of time certificates of deposit ("TCD's") were as follows:
DECEMBER 31,
-------------------------------------------
2004 2003
-------------------- ---------------------
TCD'S OVER OTHER TCD'S OVER OTHER
$100,000 TCD'S $100,000 TCD'S
----------- ------- ----------- --------
(IN THOUSANDS)
Less than three months $ 8,002 $16,237 $ 7,376 $ 18,824
Over three months through six months 7,062 20,809 5,071 25,209
Over six months through twelve months 9,877 15,843 5,315 43,743
Over twelve months through five years 15,452 39,137 1,911 21,315
----------- ------- ----------- --------
Total $ 40,393 $92,026 $ 19,673 $109,091
=========== ======= =========== ========
The deposits of the Company may fluctuate up and down with local and national
economic conditions. However, management does not believe that deposit levels
are significantly influenced by seasonal factors.
The Company manages its money desk in accordance with its liquidity and
strategic planning. Such deposits increased by $20.7 million during 2004 as the
Company's general funding needs increased due to the increase in loan
originations. The Company can use the money desk to obtain funds when necessary
in a short timeframe; however, these funds are more expensive as there is
substantial competition for these deposits.
CONTRACTUAL OBLIGATIONS
- -----------------------
The Company has contractual obligations that include long-term debt, deposits,
operating leases and purchase obligations for service providers. The following
table is summary of those obligations at December 31, 2004:
OVER 5
TOTAL < 1 YEAR 1-3 YEARS 3-5 YEARS YEARS
-------- --------- ---------- ---------- -------
(IN THOUSANDS)
Bonds payable in connection with securitized loans $ 14,511 $ 257 $ 582 $ 687 $12,985
FHLB borrowing 10,500 3,500 7,000 - -
Time certificates of deposits 132,419 77,830 36,900 17,689 -
Operating lease obligations 2,372 760 1,157 239 216
Purchase obligations for service providers 463 194 206 63 -
-------- --------- ---------- ---------- -------
Total $160,265 $ 82,541 $ 45,845 $ 18,678 $13,201
======== ========= ========== ========== =======
SUPERVISION AND REGULATION OF THE COMPANY
The following discussion of statutes and regulations affecting banks and their
holding companies is only a summary, does not purport to be complete and is
qualified in its entirety by reference to the actual statutes and regulations.
No assurance can be given that the statutes and regulations will not change in
the future. Moreover, any changes may have a material adverse effect on our
business.
GENERAL
The Company, as a bank holding company registered under the Bank Holding Company
Act of 1956, as amended ("BHCA"), and is subject to regulation by the Board of
Governors of the Federal Reserve System ("FRB"). Under FRB regulations, the
Company is expected to act as a source of managerial and financial strength for
its bank subsidiary. It cannot conduct operations in an unsafe or unsound
manner and must commit resources to support its banking subsidiary in
circumstances where the Company might not otherwise do so. Under the BHCA, the
Company and its banking subsidiary are subject to periodic examination by the
FRB. The Company is also required to file periodic reports of its operations
and any additional information regarding its activities and those of its
subsidiaries with the FRB, as may be required.
The Company is also a bank holding company within the meaning of Section 3700 of
the California Financial Code. As such, the Company and its subsidiaries are
subject to examination by, and may be required to file reports with, the
Commissioner of the California Department of Financial Institutions ("DFI").
Regulations have not yet been proposed or adopted or steps otherwise taken to
implement the DFI's powers under this statute.
-30-
The Company has a class of securities registered with the Securities Exchange
Commission ("SEC") under Section 12 of the Securities Exchange Act of 1934
("1934 Act") and has its common stock listed on the National Association of
Securities Dealers ("Nasdaq"). Consequently, the Company is subject to
supervision and regulation of the SEC and compliance with the listing
requirements of the Nasdaq.
RECENT LEGISLATION
THE SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act of 2002 ("SOX") became effective in July 2002 for all
public companies. SOX is designed to protect investors in capital markets by
improving the accuracy and reliability of corporate disclosures of public
companies. It is designed to address weaknesses in the audit process, financial
reporting systems and controls and broker-dealer networks surrounding companies
that have a class of securities registered under Section 12 of the 1934 Act or
are otherwise reporting to the SEC pursuant to Section 15(d) of the 1934 Act
(collectively, "public companies"). It is intended that by addressing these
weaknesses, public companies will be able to avoid the problems previously
encountered by many notable public companies.
The provisions of SOX and regulations issued by the SEC and the National
Association of Securities Dealers have a direct and significant impact on banks
and bank holding companies that are public companies. SOX has resulted in the
following:
Enhanced Financial Disclosure and Reports
- Certification of financial statements
- Disclosure of material information
Enhanced Accounting Oversight, Board Independence and Conflicts of Interest
Rules
- Public Accounting Oversight Board
- Auditor independence
- Independent Audit Committees
- Code of ethics
- Independent Board of Directors
- Independent Nominating and Compensation Committees
- Director and executive officer loans
- Stock option plans
- Attorney conduct
Enhanced Enforcement Powers and Penalties
- Document destruction
- Forfeiture for restated financial statements
- No discharge in bankruptcy
- Power to freeze funds
- Whistleblower protection
- Securities fraud felony
- Extended statue of limitation
On March 2, 2005, the SEC further extended the compliance dates for
non-accelerated filers such as the Company. These extensions of the compliance
dates require that the Company must begin to comply with the internal control
over financial reporting requirements for the fiscal year ending after July 15,
2006, which means calendar year 2006 for the Company.
Compliance with SOX is expected to continue to result in additional expenditures
by the Company in auditors' fees, directors' fees, attorneys' fees, outside
advisor fees, increased errors and omissions premium costs and other costs to
satisfy the new requirements for corporate governance imposed by the rules and
regulations of SOX.
THE CALIFORNIA CORPORATE DISCLOSURE ACT
On January 1, 2003, the California Corporate Disclosure Act ("CCD") became
effective. The new law requires that all "publicly traded companies" file with
the California Secretary of State a statement on an annual basis that includes
at least the following information:
-31-
- The name of the independent auditor for the publicly traded
company, a description of the services rendered by the auditor during
the previous 24 months, the date of the last audit and a copy of the
report
- The annual compensation paid to each director and executive
officer including options or shares granted to them that were not
available to other employees of the company
- A description of any loans made to any director at a preferential
loan rate during the previous 24 months including the amount and terms
- A statement indicating whether any bankruptcy has been filed by
the company's executive officers or directors during the past 10 years
- The statement indicating whether any member of the Board of
Directors or executive officer was convicted of fraud during the past
10 years
- A statement indicating whether the corporation has been
adjudicated as guilty of having violated any federal securities laws
or any banking or securities laws of California during the past 10
years which a judgment of over $10,000 was imposed
For purposes of the CCD, a "publicly traded company" is any company whose
securities are listed on a national or foreign exchange or which is the subject
of a two-way quotation system that is regularly published.
BANK HOLDING COMPANY LIQUIDITY
The Company is a legal entity, separate and distinct from CWB. Although it has
the ability to raise capital on its own behalf or borrow from external sources,
the Company may also obtain additional funds through dividends paid by, and fees
for services provided to, CWB. However, regulatory constraints may restrict or
totally preclude CWB from paying dividends to the Company. See "- Limitations
on Dividend Payments."
The FRB's policy regarding dividends provides that a bank holding company should
not pay cash dividends exceeding its net income or that can only be funded in
ways, such as by borrowing, that weaken the bank holding company's financial
health or its ability to act as a source of financial strength to its subsidiary
banks. The FRB also possesses enforcement powers over bank holding companies
and their non-bank subsidiaries to prevent or remedy actions that represent
unsafe or unsound practices or violations of applicable statutes and
regulations.
TRANSACTIONS WITH AFFILIATES
The Company and any subsidiaries it may purchase or organize are deemed to be
affiliates of the bank subsidiary within the meaning of Sections 23A and 23B of
the Federal Reserve Act, herein referred to as the "FRA," as amended. Pursuant
thereto, loans by CWB to affiliates, investments by CWB in affiliates' stock and
taking affiliates' stock as collateral for loans to any borrower will be limited
to 10% of CWB's capital, in the case of any one affiliate, and will be limited
to 20% of CWB's capital in the case of all affiliates. In addition, such
transactions must be on terms and conditions that are consistent with safe and
sound banking practices. Specifically, a bank and its subsidiaries generally
may not purchase from an affiliate a low-quality asset, as defined in the FRA.
Such restrictions also prevent a bank holding company and its other affiliates
from borrowing from a banking subsidiary of the bank holding company unless the
loans are secured by marketable collateral of designated amounts. The Company
and CWB are also subject to certain restrictions with respect to engaging in the
underwriting, public sale and distribution of securities. See -"Supervision and
Regulation of the Bank Subsidiary - Significant Legislation."
LIMITATIONS ON BUSINESSES AND INVESTMENT ACTIVITIES
Under the BHCA, a bank holding company must obtain the FRB's approval before:
- directly or indirectly acquiring more than 5% ownership or
control of any voting shares of another bank or bank holding company
- acquiring all or substantially all of the assets of another bank
- merging or consolidating with another bank holding company
The FRB may allow a bank holding company to acquire banks located in any state
of the United States without regard to whether the acquisition is prohibited by
the law of the state in which the target bank is located. In approving
interstate acquisitions, however, the FRB must give effect to applicable state
laws limiting the aggregate amount of deposits that may be held by the acquiring
bank holding company and its insured depository institutions in the state in
which the target bank is located, provided that those limits do not discriminate
against out-of-state depository institutions or their holding companies, and
state laws which require that the target bank have been in existence for a
minimum period of time, not to exceed five years, before being acquired by an
out-of-state bank
-32-
holding company.
In general, the BHCA prohibits a bank holding company from acquiring direct or
indirect ownership or control of more than 5% of the voting securities of a
company that is not a bank or a bank holding company. However, with FRB
consent, a bank holding company may own subsidiaries engaged in certain
businesses that the FRB has determined to be "so closely related to banking as
to be a proper incident thereto". The Company, therefore, is permitted to
engage in a variety of banking-related businesses. Some of the activities that
the FRB has determined, pursuant to its Regulation Y, to be related to banking
are:
- making or acquiring loans or other extensions of credit for its
own account or for the account of others
- servicing loans and other extensions of credit
- operating a trust company in the manner authorized by federal or
state law under certain circumstances
- leasing personal and real property or acting as agent, broker, or
adviser in leasing such property in accordance with various
restrictions imposed by FRB regulations
- acting as investment or financial advisor
- providing management consulting advice under certain
circumstances
- providing support services, including courier services and
printing and selling MICR-encoded items
- acting as a principal, agent or broker for insurance under
certain circumstances
- making equity and debt investments in corporations or projects
designed primarily to promote community welfare or jobs for residents
- providing financial, banking or economic data processing and data
transmission services
- owning, controlling or operating a savings association under
certain circumstances
- selling money orders, travelers' checks and U.S. Savings
Bonds
- providing securities brokerage services, related securities
credit activities pursuant to Regulation T and other incidental
activities
- underwriting and dealing in obligations of the United States,
general obligations of states and their political subdivisions and
other obligations authorized for state member banks under federal law
Generally, the BHCA does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
Federal law prohibits a bank holding company and any subsidiary banks from
engaging in certain tie-in arrangements in connection with the extension of
credit. Thus, for example, CWB may not extend credit, lease or sell property,
or furnish any services, or fix or vary the consideration for any of the
foregoing on the condition that:
- the customer must obtain or provide some additional credit,
property or services from or to CWB other than a loan, discount,
deposit or trust service
- the customer must obtain or provide some additional credit,
property or service from or to the Company or CWB
- the customer may not obtain some other credit, property or
services from competitors, except reasonable requirements to assure
soundness of credit extended
In 1999, the Gramm-Leach-Bliley Act ("GLB") was enacted. GLB significantly
changed the regulatory structure and oversight of the financial services
industry. GLB permits banks and bank holding companies to engage in previously
prohibited activities under certain conditions. Also, under certain conditions,
banks and bank holding companies may affiliate with other financial service
providers such as insurance companies and securities firms. Consequently, a
qualifying bank holding company, called a financial holding company ("FHC"), can
engage in a full range of financial activities, including banking, insurance and
securities activities, as well as merchant banking and additional activities
that are beyond those traditionally permitted for bank holding companies.
Moreover, various non-bank financial service providers who were previously
prohibited from engaging in banking can now acquire banks while also offering
services such as securities underwriting and underwriting and brokering
insurance products. GLB also expands passive investment activities by FHCs,
permitting them to indirectly invest in any type of company, financial or
non-financial, through merchant banking activities and insurance company
affiliations. See "- Supervision and Regulation of the Bank Subsidiary -
Significant Legislation."
CAPITAL ADEQUACY
Bank holding companies must maintain minimum levels of capital under the FRB's
risk based capital adequacy guidelines. If capital falls below minimum
guideline levels, a bank holding company, among other things, may be
-33-
denied approval to acquire or establish additional banks or non-bank businesses.
The FRB's risk-based capital adequacy guidelines for bank holding companies and
state member banks, discussed in more detail below (see "- Supervision and
Regulation of the Bank Subsidiary - Risk-Based Capital Guidelines"), assign
various risk percentages to different categories of assets and capital is
measured as a percentage of those risk assets. Under the terms of the
guidelines, bank holding companies are expected to meet capital adequacy
guidelines based both on total risk assets and on total assets, without regard
to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will
be required if warranted by the particular circumstances or risk profiles of
individual organizations. For example, the FRB's capital guidelines contemplate
that additional capital may be required to take adequate account of, among other
things, interest rate risk, the risks posed by concentrations of credit or risks
associated with nontraditional banking activities or securities trading
activities. Moreover, any banking organization experiencing or anticipating
significant growth or expansion into new activities, particularly under the
expanded powers of GLB, may be expected to maintain capital ratios, including
tangible capital positions, well above the minimum levels.
LIMITATIONS ON DIVIDEND PAYMENTS
The Company is entitled to receive dividends when and as declared by CWB's
Board, out of funds legally available for dividends, as specified and limited by
the OCC's regulations. Pursuant to the OCC's regulations, funds available for a
national bank's dividends are restricted to the lesser of the bank's: (i)
retained earnings; or (ii) net income for the current and past two fiscal years
(less any dividends paid during that period), unless approved by the OCC.
Furthermore, if the OCC determines that a dividend would cause a bank's capital
to be impaired or that payment would cause it to be undercapitalized, the OCC
can prohibit payment of a dividend notwithstanding that funds are legally
available.
Since CWB is an FDIC insured institution, it is also possible, depending upon
its financial condition and other factors, that the FDIC could assert that the
payment of dividends or other payments might, under some circumstances,
constitute an unsafe or unsound practice and, thus, prohibit those payments.
As a California corporation, the Company's ability to pay dividends is subject
to the dividend limitations of the California Corporations Code ("CCC").
Section 500 of the CCC allows the Company to pay a dividend to its shareholders
only to the extent that the Company has retained earnings and, after the
dividend, the Company meets the following criteria:
- its assets (exclusive of goodwill and other intangible assets)
would be 1.25 times its liabilities (exclusive of deferred taxes,
deferred income and other deferred credits); and
- its current assets would be at least equal to its current
liabilities.
SUPERVISION AND REGULATION OF THE BANK SUBSIDIARY
GENERAL
Banking is a complex, highly regulated industry. The primary goals of the
regulatory scheme are to maintain a safe and sound banking system, protect
depositors and the FDIC's insurance fund and facilitate conduct of sound
monetary policy. In furtherance of these goals, Congress and the states have
created several largely autonomous regulatory agencies and enacted numerous laws
that govern banks, bank holding companies and financial services industry.
Consequently, CWB's growth and earnings performance can be affected not only by
management decisions and general economic conditions, but also by the
requirements of applicable state and federal statutes, regulations and the
policies of various governmental regulatory authorities, including the OCC, FDIC
and FRB.
The system of supervision and regulation applicable to CWB governs most aspects
of CWB's business, including:
- the scope of permissible business
- investments
- reserves that must be maintained against deposits
- capital levels that must be maintained
- the nature and amount of collateral that may be taken to secure
loans
- the establishment of new branches
- mergers and consolidations with other financial institutions
- the payment of dividends
-34-
CWB, as a national banking association is a member of the Federal Reserve
System, and is subject to regulation, supervision and regular examination by the
OCC, FDIC and FRB. CWB's deposits are insured by the FDIC up to the maximum
extent provided by law. The regulations of these agencies govern most aspects
of the CWB's business. California law exempts all banks from usury limitations
on interest rates.
The following summarizes the material elements of the regulatory framework that
applies to CWB. It does not describe all of the statutes, regulations and
regulatory policies that are applicable. Also, it does not restate all of the
requirements of the statutes, regulations and regulatory policies that are
described. Consequently, the following summary is qualified in its entirety by
reference to the applicable statutes, regulations and regulatory policies that
may have a material effect on CWB's business.
SIGNIFICANT LEGISLATION
In 1999, GLB was signed into law, significantly changing the regulatory
structure and oversight of the financial services industry. GLB repealed the
provisions of the Glass-Steagall Act that restricted banks and securities firms
from affiliating. It also revised the BHCA to permit an FHC to engage in a full
range of financial activities, including banking, insurance, securities and
merchant banking activities. It also permits FHCs to acquire many types of
financial firms without the FRB's prior approval.
GLB thus provides expanded financial affiliation opportunities for existing bank
holding companies and permits other financial service providers to acquire banks
and become bank holding companies without ceasing any existing financial
activities. Previously, a bank holding company could only engage in activities
that were "closely related to banking." This limitation no longer applies to
bank holding companies that qualify to be treated as FHC's. To qualify as an
FHC, a bank holding company's subsidiary depository institutions must be
"well-capitalized," "well-managed" and have at least a "satisfactory" Community
Reinvestment Act, herein referred to as "CRA," examination rating.
"Non-qualifying" bank holding companies are limited to activities that were
permissible under the BHCA as of November 11, 1999.
GLB changed the powers of national banks and their subsidiaries and made similar
changes in the powers of state-chartered banks and their subsidiaries. National
banks may now underwrite, deal in and purchase state and local revenue bonds.
Subsidiaries of national banks may now engage in financial activities that the
bank cannot itself engage in, except for general insurance underwriting and real
estate development and investment. For a subsidiary of a national bank to
engage in these new financial activities, the national bank and its depository
institution affiliates must be "well capitalized," have at least "satisfactory"
general, managerial and CRA examination ratings and meet other qualification
requirements relating to total assets, subordinated debt, capital, risk
management and affiliate transactions. Subsidiaries of state-chartered banks
can exercise the same powers as national bank subsidiaries if they satisfy the
same qualifying rules that apply to national banks, except that state-chartered
banks do not have to satisfy the managerial and debt rating requirements
applicable to national banks.
GLB also reformed the overall regulatory framework of the financial services
industry. To implement its underlying purposes, GLB preempted conflicting state
laws that would restrict the types of financial affiliations that are authorized
or permitted under GLB, subject to specified exceptions for state insurance laws
and regulations. With regard to securities laws, effective May 12, 2001, GLB
removed the current blanket exemption for banks from being considered brokers or
dealers under the Securities Exchange Act of 1934 and replaced it with a number
of more limited exemptions. Thus, previously exempted banks may become subject
to the broker-dealer registration and supervision requirements of the Securities
Exchange Act of 1934. The exemption that prevented bank holding companies and
banks that advised mutual funds from being considered investment advisers under
the Investment Advisers Act of 1940 was also eliminated.
Separately, GLB imposes customer privacy requirements on any company engaged in
financial activities. Under these requirements, a financial company is required
to protect the security and confidentiality of customer nonpublic personal
information. Also, for customers that obtain a financial product such as a loan
for personal, family or household purposes, a financial company is required to
disclose its privacy policy to the customer at the time the relationship is
established and annually thereafter, including its policies concerning the
sharing of the customer's nonpublic personal information with affiliates and
third parties. If an exemption is not available, a financial company must
provide consumers with a notice of its information sharing practices that allows
the consumer to reject the disclosure of its nonpublic personal information to
third parties. Third parties that receive such information are subject to the
same restrictions as the financial company on the reuse of the information. A
financial company is prohibited from disclosing an account number or similar
item to a third party for use in
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telemarketing, direct mail marketing or other marketing through electronic mail.
RISK-BASED CAPITAL GUIDELINES
General. The federal banking agencies have established minimum capital
- -------
standards known as risk-based capital guidelines. These guidelines are intended
to provide a measure of capital that reflects the degree of risk associated with
a bank's operations. The risk-based capital guidelines include both a
definition of capital and a framework for calculating the amount of capital that
must be maintained against a bank's assets and off-balance sheet items. The
amount of capital required to be maintained is based upon the credit risks
associated with the various types of a bank's assets and off-balance sheet
items. A bank's assets and off-balance sheet items are classified under several
risk categories, with each category assigned a particular risk weighting from 0%
to 100%. The bank's risk-based capital ratio is calculated by dividing its
qualifying capital (numerator) by the combined risk weights of its assets and
off-balance sheet items (denominator). A bank's total qualifying capital
consists of two types of capital components: "core capital elements," known as
Tier 1 capital, and "supplementary capital elements," known as Tier 2 capital.
The Tier 1 component of a bank's qualifying capital must represent at least 50%
of total qualifying capital and may consist of the following items that are
defined as core capital elements:
- common stockholders' equity and qualifying non-cumulative
perpetual preferred stock (including related surplus)
- minority interests in the equity accounts of consolidated
subsidiaries
The Tier 2 component of a bank's total qualifying capital may consist of the
following items:
- a portion of the allowance for loan and lease losses
- certain types of perpetual preferred stock and related surplus
- certain types of hybrid capital instruments and mandatory
convertible debt securities
- a portion of term subordinated debt and intermediate-term
preferred stock, including related surplus
Risk Weighted Assets and Off-Balance Sheet Items. Assets and credit equivalent
- --------------------------------------------------
amounts of off-balance sheet items are assigned to one of several broad risk
classifications, according to the obligor or, if relevant, the guarantor or the
nature of the collateral. The aggregate dollar value of the amount in each risk
classification is then multiplied by the risk weight associated with that
classification. The resulting weighted values from each of the risk
classifications are added together. This total is the bank's total risk
weighted assets.
A two-step process determines risk weights for off-balance sheet items, such as
unfunded loan commitments, letters of credit and recourse arrangements. First,
the "credit equivalent amount" of the off-balance sheet items is determined, in
most cases by multiplying the off-balance sheet item by a credit conversion
factor. Second, the credit equivalent amount is treated like any balance sheet
asset and is assigned to the appropriate risk category according to the obligor
or, if relevant, the guarantor or the nature of the collateral. This result is
added to the bank's risk-weighted assets and comprises the denominator of the
risk-based capital ratio.
Minimum Capital Standards. The supervisory standards set forth below specify
- ---------------------------
minimum capital ratios based primarily on broad risk considerations. The
risk-based ratios do not take explicit account of the quality of individual
asset portfolios or the range of other types of risks to which banks may be
exposed, such as interest rate, liquidity, market or operational risks. For
this reason, banks are generally expected to operate with capital positions
above the minimum ratios.
All banks are required to meet a minimum ratio of qualifying total capital to
risk weighted assets of 8%. At least 4% must be in the form of Tier 1 capital,
net of goodwill. The maximum amount of supplementary capital elements that
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of
goodwill. In addition, the combined maximum amount of term subordinated debt
and intermediate-term preferred stock that qualifies as Tier 2 capital for
risk-based capital purposes is limited to 50% of Tier 1 capital. The maximum
amount of the allowance for loan and lease losses that qualifies as Tier 2
capital is limited to 1.25% of gross risk weighted assets. The allowance for
loan and lease losses in excess of this limit may, of course, be maintained, but
would not be included in a bank's risk-based capital calculation.
The federal banking agencies also require all banks to maintain a minimum amount
of Tier 1 capital to total assets, referred to as the leverage ratio. For a
bank rated in the highest of the five categories used by regulators to rate
banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For
all banks not rated in the highest category, the minimum leverage ratio must be
at least 4% to 5%. These uniform risk-based capital guidelines and leverage
ratios apply across the industry. Regulators, however, have the discretion to
set minimum capital requirements for individual institutions, which may be
significantly above the minimum guidelines and ratios.
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OTHER FACTORS AFFECTING MINIMUM CAPITAL STANDARDS
The federal banking agencies have established certain benchmark ratios of loan
loss reserves to be held against classified assets. The benchmark by federal
banking agencies is the sum of:
- 100% of assets classified loss
- 50% of assets classified doubtful
- 15% of assets classified substandard and
- estimated credit losses on other assets over the upcoming 12
months
The federal risk-based capital rules adopted by banking agencies take into
account a bank's concentrations of credit and the risks of engaging in
non-traditional activities. Concentrations of credit refers to situations where
a lender has a relatively large proportion of loans involving a single borrower,
industry, geographic location, collateral or loan type. Non-traditional
activities are considered those that have not customarily been part of the
banking business, but are conducted by a bank as a result of developments in,
for example, technology, financial markets or other additional activities
permitted by law or regulation. The regulations require institutions with high
or inordinate levels of risk to operate with higher minimum capital standards.
The federal banking agencies also are authorized to review an institution's
management of concentrations of credit risk for adequacy and consistency with
safety and soundness standards regarding internal controls, credit underwriting
or other operational and managerial areas.
The federal banking agencies also limit the amount of deferred tax assets that
are allowable in computing a bank's regulatory capital. Deferred tax assets
that can be realized for taxes paid in prior carryback years and from future
reversals of existing taxable temporary differences are generally not limited.
However, deferred tax assets that can only be realized through future taxable
earnings are limited for regulatory capital purposes to the lesser of:
- the amount that can be realized within one year of the
quarter-end report date, or
- 10% of Tier 1 capital
The amount of any deferred tax in excess of this limit would be excluded from
Tier 1 capital, total assets and regulatory capital calculations.
The federal banking agencies have also adopted a joint agency policy statement
that provides that the adequacy and effectiveness of a bank's interest rate risk
management process and the level of its interest rate exposure is a critical
factor in the evaluation of the bank's capital adequacy. A bank with material
weaknesses in its interest rate risk management process or high levels of
interest rate exposure relative to its capital will be directed by the federal
banking agencies to take corrective actions. Financial institutions which have
significant amounts of their assets concentrated in high risk loans or
nontraditional banking activities, and who fail to adequately manage these
risks, may be required to set aside capital in excess of the regulatory
minimums.
PROMPT CORRECTIVE ACTION
The federal banking agencies possess broad powers to take prompt corrective
action ("PCA") to resolve the problems of insured banks. Each federal banking
agency has issued regulations defining five capital categories: "well
capitalized", "adequately capitalized", "undercapitalized", "significantly
undercapitalized" and "critically undercapitalized". Under the regulations, a
bank shall be deemed to be:
- "well capitalized" if it has a total risk-based capital ratio of
10% or more, has a Tier 1 risk-based capital ratio of 6% or more, has
a leverage capital ratio of 5% or more and is not subject to specified
requirements to meet and maintain a specific capital level for any
capital measure
- "adequately capitalized" if it has a total risk-based capital
ratio of 8% or more, a Tier 1 risk-based capital ratio of 4% or more
and a leverage capital ratio of 4% or more (3% under certain
circumstances) and does not meet the definition of "well capitalized"
- "undercapitalized" if it has a total risk-based capital ratio
that is less than 8%, a Tier 1 risk-based capital ratio that is less
than 4%, or a leverage capital ratio that is less than 4% (3% under
certain circumstances)
- "significantly undercapitalized" if it has a total risk-based
capital ratio that is less than 6%, a Tier 1 risk-based capital ratio
that is less than 3% or a leverage capital ratio that is less than 3%;
and
- "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2%
Banks are prohibited from paying dividends or management fees to controlling
persons or entities if, after making the payment, the bank would be
"undercapitalized," that is, the bank fails to meet the required minimum level
for
-37-
any relevant capital measure. Asset growth and branching restrictions apply to
"undercapitalized" banks. Banks classified as "undercapitalized" are required
to submit acceptable capital plans guaranteed by its holding company, if any.
Broad regulatory authority was granted with respect to "significantly
undercapitalized" banks, including forced mergers, growth restrictions, ordering
new elections for directors, forcing divestiture by its holding company, if any,
requiring management changes and prohibiting the payment of bonuses to senior
management. Even more severe restrictions are applicable to "critically
undercapitalized" banks, those with capital at or less than 2%. Restrictions
for these banks include the appointment of a receiver or conservator after 90
days, even if the bank is still solvent. All of the federal banking agencies
have promulgated substantially similar regulations to implement this system of
PCA.
A bank, based upon its capital levels, that is classified as "well capitalized,"
"adequately capitalized" or "undercapitalized" may be treated as though it were
in the next lower capital category if the appropriate federal banking agency,
after notice and opportunity for hearing, determines that an unsafe or unsound
condition, or an unsafe or unsound practice, warrants such treatment. At each
successive lower capital category, an insured bank is subject to more
restrictions. The federal banking agencies, however, may not treat an
institution as "critically undercapitalized" unless its capital ratios actually
warrant such treatment.
DEPOSIT INSURANCE ASSESSMENTS
The FDIC has implemented a risk-based assessment system in which the deposit
insurance premium relates to the probability that the deposit insurance fund
will incur a loss. The FDIC sets semi-annual assessments in an amount necessary
to maintain or increase the reserve ratio of the insurance fund to at least
1.25% of insured deposits or a higher percentage as determined to be justified
by the FDIC.
Under the risk-based assessment system adopted by the FDIC, banks are
categorized into one of three capital categories, "well capitalized",
"adequately capitalized" and "undercapitalized". Assignment of a bank into a
particular capital category is based on supervisory evaluations by its primary
federal regulator. After being assigned to a particular capital category, a
bank is classified into one of three supervisory categories. The three
supervisory categories are:
- Group A - financially sound with only a few minor weaknesses
- Group B - demonstrates weaknesses that could result in significant
deterioration
- Group C - poses a substantial probability of loss
The capital ratios used by the FDIC to define "well-capitalized", "adequately
capitalized" and "undercapitalized" are the same as in the prompt corrective
action regulations.
The assessment rates are summarized below, expressed in terms of cents per $100
in insured deposits:
Assessment Rates Supervisory Group
-------------------------------------
Capital Group Group A Group B Group C
- ------------- ---------- ----------- ------------
1-Well Capitalized 0 3 17
2-Adequately Capitalized 3 10 24
3-Undercapitalized 10 24 27
CWB is currently risk rated a 1A, which results in CWB being categorized as well
capitalized, group A.
INTERSTATE BANKING AND BRANCHING
Bank holding companies from any state may generally acquire banks and bank
holding companies located in any other state, subject in some cases to
nationwide and state-imposed deposit concentration limits and limits on the
acquisition of recently established banks. Banks also have the ability, subject
to specific restrictions, to acquire by acquisition or merger branches located
outside their home state. The establishment of interstate branches is also
possible in those states with laws that expressly permit it. Interstate
branches are subject to many of the laws of the states in which they are
located.
California law authorizes out-of-state banks to enter California by the
acquisition of, or merger with, a California bank that has been in existence for
at least five years, unless the California bank is in danger of failing or in
certain other emergency situations. Interstate branching into California is,
however, limited to the acquisition of an existing bank.
ENFORCEMENT POWERS
In addition to measures taken under the PCA provisions, insured banks may be
subject to potential enforcement actions by the federal regulators for unsafe or
unsound practices in conducting their businesses, or for violation of
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any law, rule, regulation or condition imposed in writing by the regulatory
agency or term of a written agreement with the regulatory agency. Enforcement
actions may include:
- the appointment of a conservator or receiver for the bank
- the issuance of a cease and desist order that can be judicially
enforced
- the termination of the bank's deposit insurance
- the imposition of civil monetary penalties;
- the issuance of directives to increase capital;
- the issuance of formal and informal agreements
- the issuance of removal and prohibition orders against officers,
directors and other institution-affiliated parties
- the enforcement of such actions through injunctions or
restraining orders based upon a judicial determination that the
deposit insurance fund or the bank would be harmed if such equitable
relief was not granted
SAFETY AND SOUNDNESS GUIDELINES
The federal banking agencies have adopted guidelines to assist in identifying
and addressing potential safety and soundness concerns before capital becomes
impaired. These guidelines establish operational and managerial standards
relating to:
- internal controls, information systems and internal audit systems
- loan documentation - credit underwriting
- asset growth
- compensation, fees and benefits
Additionally, the federal banking agencies have adopted safety and soundness
guidelines for asset quality and for evaluating and monitoring earnings to
ensure that earnings are sufficient for the maintenance of adequate capital and
reserves. If an institution fails to comply with a safety and soundness
standard, the appropriate federal banking agency may require the institution to
submit a compliance plan. Failure to submit a compliance plan or to implement
an accepted plan may result in a formal enforcement action.
The federal banking agencies have issued regulations prescribing uniform
guidelines for real estate lending. The regulations require insured depository
institutions to adopt written policies establishing standards, consistent with
such guidelines, for extensions of credit secured by real estate. The policies
must address loan portfolio management, underwriting standards and loan-to-value
limits that do not exceed the supervisory limits prescribed by the regulations.
MONEY LAUNDERING AND CURRENCY CONTROLS.
Various federal statutory and regulatory provisions are designed to enhance
recordkeeping and reporting of currency and foreign transactions. Pursuant to
the Bank Secrecy Act, financial institutions must report high levels of currency
transactions or face the imposition of civil monetary penalties for reporting
violations. The Money Laundering Control Act imposes sanctions, including
revocation of federal deposit insurance, for institutions convicted of money
laundering.
The International Money Laundering Abatement and Financial Anti-Terrorism Act of
2001 ("IMLAFATA"), a part of the USA Patriot Act, authorizes the Secretary of
the Treasury, in consultation with the heads of other government agencies, to
adopt special measures applicable to banks and other financial institutions to
enhance recordkeeping and reporting requirements for certain financial
transactions that are of primary money laundering concern. Among its other
provisions, IMLAFATA requires each financial institution to: (i) establish an
anti-money laundering program; (ii) establish due diligence policies, procedures
and controls with respect to its private banking accounts and correspondent
banking accounts involving individuals and certain foreign banks; and (iii)
avoid establishing, maintaining, administering, or managing correspondent
accounts in the Untied States for, or on behalf of, a foreign bank that does not
have a physical presence in any country. In addition, IMLAFATA contains a
provision encouraging cooperation among financial institutions, regulatory
authorities and law enforcement authorities with respect to individuals,
entities and organizations engaged in, or reasonably suspected of engaging in,
terrorist acts or money laundering activities.
On October 1, 2003, the Treasury Department adopted final regulations which
implemented IMLAFATA and mandated that federally-insured banks and other
financial institutions establish customer identification programs
-39-
designed to verify the identity of persons opening new accounts, to maintain the
records used for verification, and to determine whether the person appears on
any list of known or suspected terrorists or terrorist organizations.
CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are focusing greater attention on compliance with
consumer protection laws and their implementing regulations. Examination and
enforcement have become more intense in nature and insured institutions have
been advised to carefully monitor compliance with various consumer protection
laws and their implementing regulations. Banks are subject to many federal
consumer protection laws and their regulations, including:
- Community Reinvestment Act ("CRA")
- Truth in Lending Act ("TILA")
- Fair Housing Act ("FH Act")
- Equal Credit Opportunity Act ("ECOA")
- Home Mortgage Disclosure Act ("HMDA")
- Real Estate Settlement Procedures Act ("RESPA")
- Gramm-Leach-Bliley Act
CRA is intended to encourage insured depository institutions, while operating
safely and soundly, to help meet the credit needs of their communities. CRA
specifically directs the federal bank regulatory agencies, in examining insured
depository institutions, to assess their record of helping to meet the credit
needs of their entire community, including low- and moderate-income
neighborhoods, consistent with safe and sound banking practices. CRA further
requires the agencies to take a financial institution's record of meeting its
community credit needs into account when evaluating applications for, among
other things, domestic branches, consummating mergers or acquisitions or holding
company formations.
The federal banking agencies have adopted regulations that measure a bank's
compliance with its CRA obligations on a performance-based evaluation system.
This system bases CRA ratings on an institution's actual lending service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements. The ratings range from a high of "outstanding" to a
low of "substantial noncompliance".
ECOA prohibits discrimination in any credit transaction, whether for consumer or
business purposes, on the basis of race, color, religion, national origin, sex,
marital status, age (except in limited circumstances), receipt of income from
public assistance programs or good faith exercise of any rights under the
Consumer Credit Protection Act. The Federal Interagency Task Force on Fair
Lending issued a policy statement on discrimination in lending. The policy
statement describes the three methods that federal agencies will use to prove
discrimination:
- overt evidence of discrimination
- evidence of disparate treatment
- evidence of disparate impact
If a creditor's actions have had the effect of discriminating, the creditor may
be held liable even when there is no intent to discriminate.
FH Act regulates many practices, including making it unlawful for any lender to
discriminate against any person in its housing-related lending activities
because of race, color, religion, national origin, sex, handicap or familial
status. FH Act is broadly written and has been broadly interpreted by the
courts. A number of lending practices have been found to be, or may be
considered, illegal under FH Act, including some that are not specifically
mentioned in FH Act itself. Among those practices that have been found to be,
or may be considered, illegal under FH Act are:
- declining a loan for the purposes of racial discrimination
- making excessively low appraisals of property based on racial
considerations
- pressuring, discouraging or denying applications for credit on a
prohibited basis
- using excessively burdensome qualifications standards for the
purpose or with the effect of denying housing to minority applicants
- imposing on minority loan applicants more onerous interest rates
or other terms, conditions or requirements
- racial steering or deliberately guiding potential purchasers to
or away from certain areas because of race
-40-
TILA is designed to ensure that credit terms are disclosed in a meaningful way
so that consumers may compare credit terms more readily and knowledgeably. As a
result of TILA, all creditors must use the same credit terminology and
expressions of rates, the annual percentage rate, the finance charge, the amount
financed, the total payments and the payment schedule. HMDA grew out of public
concern over credit shortages in certain urban neighborhoods. One purpose of
HMDA is to provide public information that will help show whether financial
institutions are serving the housing credit needs of the neighborhoods and
communities in which they are located.
HMDA also includes a "fair lending" aspect that requires the collection and
disclosure of data about applicant and borrower characteristics as a way of
identifying possible discriminatory lending patterns and enforcing
anti-discrimination statutes. HMDA requires institutions to report data
regarding applications for one-to-four family real estate loans, home
improvement loans and multifamily loans, as well as information concerning
originations and purchases of those types of loans. Federal bank regulators
rely, in part, upon data provided under HMDA to determine whether depository
institutions engage in discriminatory lending practices.
RESPA requires lenders to provide borrowers with disclosures regarding the
nature and costs of real estate settlements. Also, RESPA prohibits certain
abusive practices, such as kickbacks, and places limitations on the amount of
escrow accounts.
GLB required disclosure of the bank's privacy policy at the time the customer
relationship is established and annually thereafter. Under the provisions of
GLB, financial institutions must put systems in place to safeguard the
non-public personal information of its customers.
Violations of these various consumer protection laws and regulations can result
in civil liability to the aggrieved party, regulatory enforcement including
civil money penalties and even punitive damages.
OTHER ASPECTS OF BANKING LAW
CWB is also subject to federal and state statutory and regulatory provisions
covering, among other things, security procedures, currency and foreign
transactions reporting, insider and affiliated party transactions, management
interlocks, electronic funds transfers, funds availability and truth-in-savings.
There are also a variety of federal statutes that regulate acquisitions of
control and the formation of bank holding companies.
IMPACT OF MONETARY POLICIES
Banking is a business that depends on rate differentials. In general, the
difference between the interest rate paid by a bank on its deposits and its
other borrowings and the interest rate earned on its loans, securities and other
interest-earning assets comprises the major source of CWB's earnings. These
rates are highly sensitive to many factors which are beyond CWB's control and,
accordingly, the earnings and growth of CWB are subject to the influence of
economic conditions generally, both domestic and foreign, including inflation,
recession and unemployment and also to the influence of monetary and fiscal
policies of the United States and its agencies, particularly the FRB. The FRB
implements national monetary policy, such as seeking to curb inflation and
combat recession, by:
- Open-market dealings in U.S. government securities
- Adjusting the required level of reserves for financial
institutions subject to reserve requirements
- Placing limitations upon savings and time deposit interest rates
- Adjusting the discount rate applicable to borrowings by banks
which are members of the FRB
The actions of the FRB in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates. From June 2004 to
December 2004, the FRB has increased the discount rate five times resulting in a
rate increase of 1.25% during the period. The FRB raised interest rates once in
March 2005 and additional increases are expected during the remainder of 2005.
The nature and timing of any future changes in the FRB's policies and their
impact on the Company and CWB cannot be predicted, however, depending on the
degree to which our interest-earning assets and interest-bearing liabilities are
rate sensitive, increases in rates would have a temporary effect of increasing
our net interest margin, while decreases in interest rates would have the
opposite effect. In addition, adverse economic conditions could make a higher
provision for loan losses a prudent course and could cause higher loan
charge-offs, thus adversely affecting our net income or other operating costs.
See Interest Rate Risk- page 28.
REGULATORY MATTERS
From October 2002 until October 2003, CWB was operating under a Consent Order
with the OCC. In addition, from March 2000 until November 2003, the Company was
operating under a Memorandum of Understanding with the FRB. Prior to
termination of agreements, both CWB and the Company were precluded from certain
activities.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- -------- ---------------------------------------------------------------
The Company's primary market risk is interest rate risk ("IRR"). To minimize
the volatility of net interest income at risk ("NII") and the impact on economic
value of equity ("EVE"), the Company manages its exposure to changes in interest
rates through asset and liability management activities within guidelines
established by the Board's ALCO. ALCO has the responsibility for approving and
ensuring compliance with asset/liability management policies, including IRR
exposure.
To mitigate the impact of changes in interest rates on the Company's
interest-earning assets and interest-bearing liabilities, the Company actively
manages the amounts and maturities. The Company generally retains short-term,
adjustable-rate assets as they have similar re-pricing characteristics as
funding sources. The Company sells substantially all of its mortgage products
and a portion of its SBA loan originations. While the Company has some assets
and liabilities in excess of five years, it has internal policy limits designed
to minimize risk should interest rates rise. Currently, the Company does not
use derivative instruments to help manage risk, but will consider such
instruments in the future if the perceived need should arise.
The Company uses software, combined with download detailed information from
various application programs, and assumptions regarding interest rates, lending
and deposit trends and other key factors to forecast/simulate the effects of
both higher and lower interest rates. The results detailed below indicate the
impact, in dollars and percentages, on NII and EVE of an increase in interest
rates of 200 basis points and a decline of 200 basis points compared to a flat
interest rate scenario.
- -------------------------------------------------------------------------------------
INTEREST RATE SENSITIVITY 200 BP INCREASE 200 BP DECREASE
--------------- ------------------
2004 2003 2004 2003
------- ------ -------- --------
(DOLLARS IN THOUSANDS)
Anticipated impact over the next twelve months:
Net interest income (NII) $1,230 $ 871 $(1,237) $(2,106)
8.2% 6.4% (8.3%) (15.4%)
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
Economic value of equity (EVE) $ (749) $ 260 $ 241 $ (88)
(1.6%) 0.7% 0.5% (.2%)
- -------------------------------------------------------------------------------------
For further discussion of interest rate risk, see Item 7.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
- -------
The Company's consolidated financial statements begin on page F-1.
-42-
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Community West Bancshares
We have audited the accompanying consolidated balance sheets of Community West
Bancshares (the Company) as of December 31, 2004 and 2003, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 2004. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an
audit of the Company's internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Community West
Bancshares at December 31, 2004 and 2003, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2004, in conformity with U.S. generally accepted accounting
principles.
/s/ Ernst & Young LLP
Los Angeles, California
February 4, 2005
F-1
COMMUNITY WEST BANCSHARES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------
2004 2003
----------- ---------
(DOLLARS IN
THOUSANDS)
ASSETS
Cash and due from banks $ 8,769 $ 5,758
Interest-earning deposits in other financial institutions 9,700 5,031
Federal funds sold 11,736 11,267
----------- ---------
Cash and cash equivalents 30,205 22,056
Time deposits in other financial institutions 647 792
Investment securities available-for-sale, at fair value; amortized cost of 22,258 15,432
$22,380 at December 31, 2004 and $15,455 at December 31, 2003
Investment securities held-to-maturity, at amortized cost; fair value of 6,094 5,036
$6,122 at December 31, 2004 and $5,035 at December 31, 2003
Federal Home Loan Bank stock, at cost 1,200 -
Federal Reserve Bank stock, at cost 812 812
Interest only strips, at fair value 2,715 3,548
Loans:
Held for sale, at lower of cost or fair value 45,988 42,038
Held for investment, net of allowance for loan losses of $2,785 at December 31, 222,153 166,874
2004 and $2,652 at December 31, 2003
Securitized loans, net of allowance for loan losses of $1,109 at December 31, 2004 and
$2,024 at December 31, 2003 22,365 35,362
----------- ---------
Total loans 290,506 244,274
Servicing rights 3,258 2,499
Other real estate owned, net 13 527
Premises and equipment, net 1,763 1,632
Other assets 5,732 7,642
----------- ---------
TOTAL ASSETS $ 365,203 $304,250
=========== =========
LIABILITIES
Deposits:
Non-interest-bearing demand $ 44,384 $ 42,417
Interest-bearing demand 92,395 38,115
Savings 15,370 15,559
Time certificates of $100,000 or more 40,393 19,673
Other time certificates 92,026 109,091
----------- ---------
Total deposits 284,568 224,855
Securities sold under agreements to repurchase 13,672 14,394
Federal Home Loan Bank advances 10,500 -
Bonds payable in connection with securitized loans 13,910 26,100
Other liabilities 4,984 4,570
----------- ---------
Total liabilities 327,634 269,919
----------- ---------
Commitments and contingencies-See Note 15
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized; shares issued and outstanding, 30,020 29,874
5,729,869 at December 31, 2004 and 5,706,769 at December 31, 2003
Retained earnings 7,621 4,472
Accumulated other comprehensive loss (72) (15)
----------- ---------
Total stockholders' equity 37,569 34,331
----------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 365,203 $304,250
=========== =========
See accompanying notes.
F-2
COMMUNITY WEST BANCSHARES
CONSOLIDATED INCOME STATEMENTS
YEAR ENDED DECEMBER 31,
--------------------------
2004 2003 2002
------- ------- --------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
INTEREST INCOME
Loans $20,565 $19,658 $29,306
Investment securities 979 489 202
Other 301 236 468
------- ------- --------
Total interest income 21,845 20,383 29,976
------- ------- --------
INTEREST EXPENSE
Deposits 5,016 4,621 5,545
Bonds payable and other borrowings 2,829 4,721 7,921
------- ------- --------
Total interest expense 7,845 9,342 13,466
------- ------- --------
NET INTEREST INCOME 14,000 11,041 16,510
Provision for loan losses 418 1,669 4,899
------- ------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 13,582 9,372 11,611
NON-INTEREST INCOME
Gains from loan sales, net 3,981 4,860 4,788
Other loan fees 3,776 2,923 3,388
Loan servicing fees, net 1,416 1,264 1,081
Document processing fees, net 817 937 1,404
Service charges 381 376 440
Other 91 315 297
------- ------- --------
Total non-interest income 10,462 10,675 11,398
------- ------- --------
NON-INTEREST EXPENSES
Salaries and employee benefits 11,851 11,416 13,596
Occupancy and equipment expenses 1,596 1,691 2,119
Professional services 940 636 1,575
Depreciation 532 581 771
Loan servicing and collection 225 438 872
Impairment of SBA interest only strips and servicing assets - - 1,788
Lower of cost or market provision on loans held for sale - - 1,381
Other 2,377 1,974 2,829
------- ------- --------
Total non-interest expenses 17,521 16,736 24,931
------- ------- --------
Income (loss) before provision (benefit) for income taxes 6,523 3,311 (1,922)
Provision (benefit) for income taxes 2,688 1,128 (652)
------- ------- --------
NET INCOME (LOSS) $ 3,835 $ 2,183 $(1,270)
======= ======= ========
INCOME (LOSS) PER SHARE - BASIC $ 0.67 $ 0.38 $ (0.22)
INCOME (LOSS) PER SHARE - DILUTED $ 0.65 $ 0.38 $ (0.22)
See accompanying notes.
F-3
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED
OTHER TOTAL
COMMON STOCK RETAINED COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT EARNINGS INCOME (LOSS) EQUITY
------ -------- ---------- --------------- ---------------
(IN THOUSANDS)
BALANCES AT
JANUARY 1, 2002 5,690 $ 29,798 $ 3,559 $ - $ 33,357
Comprehensive income:
Net loss (1,270) - (1,270)
------ -------- ---------- --------------- ---------------
BALANCES AT
DECEMBER 31, 2002 5,690 29,798 2,289 - 32,087
Exercise of stock options 17 76 - - 76
Comprehensive income:
Net income 2,183 - 2,183
Change in unrealized losses on
securities available-for-sale, net (15) (15)
---------------
Comprehensive income 2,168
BALANCES AT
------ -------- ---------- --------------- ---------------
DECEMBER 31, 2003 5,707 29,874 4,472 (15) 34,331
Exercise of stock options 23 146 - - 146
Comprehensive income:
Net income 3,835 - 3,835
Change in unrealized losses on
securities available-for-sale, net (57) (57)
---------------
Comprehensive income 3,778
Cash dividends paid
($0.12 per share) (686) (686)
BALANCES AT
------ -------- ---------- --------------- ---------------
DECEMBER 31, 2004 5,730 $ 30,020 $ 7,621 $ (72) $ 37,569
====== ======== ========== =============== ===============
See accompanying notes.
F-4
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------
2004 2003 2002
--------- --------- ---------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 3,835 $ 2,183 $ (1,270)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Provision for loan losses 418 1,669 4,899
Provision for losses on real estate owned 1 25 86
Losses on sale of premises and equipment - - 132
Deferred income taxes (278) 474 1,219
Depreciation and amortization 1,270 1,589 3,031
Net amortization of discounts and premiums on securities 19 189 -
Gains on:
Sale of other real estate owned (2) (79) (14)
Sale of loans held for sale (3,981) (4,401) (4,788)
Changes in:
Fair value of interest only strips, net of accretion 833 1,000 3,385
Servicing rights, net of amortization (759) (602) 593
Other assets 1,562 4,068 108
Other liabilities 1,058 (1,062) 726
--------- --------- ---------
Net cash provided by operating activities 3,976 5,053 8,107
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities (3,179) (7,337) (11,904)
Purchase of available-for-sale securities (10,232) (24,197) -
Purchase of Federal Reserve Bank stock - - (37)
Purchase of Federal Home Loan Bank stock (1,200) - -
Principal paydowns and maturities of available-for-sale securities 3,314 8,670 -
Principal paydowns and maturities of held-to-maturity securities 2,095 8,219 6,010
Unrealized accumulated gains/losses on available for sale securities 99 - -
Additions to interest only strip assets - - (240)
Loan originations and principal collections, net (42,758) 2,744 14,049
Proceeds from sale of other real estate owned 529 1,718 399
Net decrease in time deposits in other financial institutions 145 1,485 3,661
Purchase of premises and equipment, net of sales (663) (254) (136)
--------- --------- ---------
Net cash (used in) provided by investing activities (51,850) (8,952) 11,802
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of stock options 146 76 -
Cash dividends paid to shareholders (686) - -
Net increase in demand deposits and savings accounts 56,058 9,847 16,043
Net increase (decrease) in time certificates of deposit 3,655 (4,075) 6,874
Proceeds from securities sold under agreements to repurchase 13,672 20,041 -
Repayments of securities sold under agreements to repurchase (14,394) (5,647) -
Proceeds from Federal Home Loan Bank advances 14,000 - -
Repayment of Federal Home Loan Bank advances (3,500) - -
Repayments of bonds payable in connection with securitized loans (12,928) (25,381) (41,138)
--------- --------- ---------
Net cash provided by (used in) financing activities 56,023 (5,139) (18,221)
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 8,149 (9,038) 1,688
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 22,056 31,094 29,406
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 30,205 $ 22,056 $ 31,094
========= ========= =========
See accompanying notes.
F-5
COMMUNITY WEST BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Community West Bancshares, a California
Corporation ("Company or CWBC"), and its wholly-owned subsidiary, Community West
Bank National Association ("CWB") (formerly known as Goleta National Bank), are
in accordance with accounting principles generally accepted in the United States
("GAAP") and general practices within the financial services industry. All
material intercompany transactions and accounts have been eliminated. The
following are descriptions of the most significant of those policies:
NATURE OF OPERATIONS - The Company's primary operations are related to
commercial banking and financial services through CWB which include the
acceptance of deposits and the lending and investing of money. The Company also
engages in electronic banking services. The Company's customers consist of
small to mid-sized businesses, as well as individuals. The Company also
originates and sells U. S. Small Business Administration ("SBA") and first and
second mortgage loans through its normal operations and loan production offices.
USE OF ESTIMATES - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities as well as disclosures of contingent assets and
liabilities at the date of the financial statements. These estimates and
assumptions also affect the reported amounts of revenues and expenses during the
reporting period. Although management believes these estimates to be reasonably
accurate, actual results may differ.
Certain amounts in the 2002 and 2003 financial statements have been reclassified
to be comparable with classifications in 2004.
BUSINESS SEGMENTS - Reportable business segments are determined using the
"management approach" and are intended to present reportable segments consistent
with how the chief operating decision maker organizes segments within the
company for making operating decisions and assessing performance. As of
December 31, 2004 and 2003, the Company had only one reportable business
segment.
RESERVE REQUIREMENTS - All depository institutions are required by law to
maintain reserves on transaction accounts and non-personal time deposits in the
form of cash balances at the Federal Reserve Bank ("FRB"). These reserve
requirements can be offset by cash balances held at CWB. At December 31, 2004
and 2003, CWB's cash balance was sufficient to offset the FRB requirement.
INVESTMENT SECURITIES - The Company currently holds securities classified as
both available-for-sale ("AFS") and held-to-maturity ("HTM"). Securities
classified as HTM are accounted for at amortized cost as the Company has the
positive intent and ability to hold them to maturity. Securities not classified
as HTM are considered AFS and are carried at fair value with unrealized gains or
losses reported as a separate component of accumulated other comprehensive
income (loss), net of any applicable income taxes. Realized gains or losses on
the sale of AFS securities, if any, are determined on a specific identification
basis. Purchase premiums and discounts are recognized in interest income using
the effective interest method over the terms of the related securities, or to
earlier call dates, if appropriate. Declines in the fair value of AFS or HTM
securities below their cost that are deemed to be other than temporary, if any,
are reflected in earnings as realized losses. There is no recognition of
unrealized gains or losses for HTM securities.
INTEREST ONLY STRIPS AND SERVICING RIGHTS - The guaranteed portion of certain
SBA loans can be sold into the secondary market. Servicing rights are
recognized at fair market value as separate assets when loans are sold with
servicing retained. Servicing rights are amortized in proportion to, and over
the period of, estimated future net servicing income. Also, at the time of the
loan sale, it is the Company's policy to recognize the related gain on the loan
sale in accordance with GAAP. The Company uses industry prepayment statistics
and its own prepayment experience in estimating the expected life of the loans.
Management periodically evaluates servicing rights for impairment. Servicing
rights are evaluated for impairment based upon the fair value of the rights as
compared to amortized cost on a loan-by-loan basis. Fair value is determined
using discounted future cash flows calculated on a loan-by-loan basis and
aggregated to the total asset level. Impairment to the asset is recorded if the
aggregate fair value calculation drops below the net book value of the asset.
The initial servicing rights and resulting gain on sale are calculated based on
the difference between the best actual par and premium bids on an individual
loan basis. Additionally, on certain SBA loan sales that occurred prior to
2003, the Company retained interest only strips ("I/O Strips"), which represent
the present value of excess net cash flows generated by the difference between
(a) interest at the stated rate paid by borrowers and (b) the sum of (i)
pass-through interest paid to third-party investors and (ii) contractual
servicing fees.
F-6
The I/O strips are classified as trading securities. Accordingly, the Company
records the I/O strips at fair value with the resulting increase or decrease in
fair value being recorded through operations in the current period.
Quarterly, the Company verifies the reasonableness of its valuation estimates by
comparison to the results of an independent third party valuation analysis.
LOANS HELD FOR SALE - Loans which are originated and intended for sale in the
secondary market are carried at the lower of cost or estimated fair value
determined on an aggregate basis. Valuation adjustments, if any, are recognized
through a valuation allowance by charges to lower of cost or market provision.
Loans held for sale are primarily comprised of SBA loans, second mortgage loans
and residential mortgage loans. The Company did not incur a lower of cost or
market valuation provision in the years ended December 31, 2004 and 2003.
LOANS HELD FOR INVESTMENT - Loans are recognized at the principal amount
outstanding, net of unearned income and amounts charged off. Unearned income
includes deferred loan origination fees reduced by loan origination costs.
Unearned income on loans is amortized to interest income over the life of the
related loan using the level yield method.
INTEREST INCOME ON LOANS - Interest on loans is accrued daily on a
simple-interest basis. The accrual of interest is discontinued when substantial
doubt exists as to collectibility of the loan, generally at the time the loan is
90 days delinquent, unless the credit is well secured and in process of
collection. Any unpaid but accrued interest is reversed at that time.
Thereafter, interest income is no longer recognized on the loan. Interest on
non-accrual loans is accounted for on the cash-basis or cost-recovery method,
until qualifying for return to accrual. Loans are returned to accrual status
when all of the principal and interest amounts contractually due are brought
current and future payments are reasonably assured. Impaired loans are
identified as impaired when it is probable that interest and principal will not
be collected according to the contractual terms of the loan agreement. All of
the Company's nonaccrual loans were also classified as impaired at December 31,
2004 and 2003.
REPURCHASE AGREEMENTS - Securities sold under repurchase agreements are treated
as collateralized financing transactions and carried at the amount at which the
securities will be subsequently repurchased.
SECURITIZED LOANS AND BONDS PAYABLE - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
trusts ("Trusts"). The transfers have been accounted for as secured borrowings
and, accordingly, the mortgage loans and related bonds issued are included in
the Company's consolidated balance sheets. Such loans are accounted for in the
same manner as loans held to maturity. Deferred debt issuance costs and bond
discount related to the bonds are amortized on a method that approximates the
level yield method over the estimated life of the bonds.
PROVISION AND ALLOWANCE FOR LOAN LOSSES - The Company maintains a detailed,
systematic analysis and procedural discipline to determine the amount of the
allowance for loan losses ("ALL"). The ALL is based on estimates and is
intended to be adequate to provide for probable losses inherent in the loan
portfolio. This process involves deriving probable loss estimates that are
based on individual loan loss estimation, migration analysis/historical loss
rates and management's judgment.
The Company employs several methodologies for estimating probable losses.
Methodologies are determined based on a number of factors, including type of
asset, risk rating, concentrations, collateral value and the input of the
Special Assets group, functioning as a workout unit.
The ALL calculation for the different major loan types is as follows:
- SBA - All loans are reviewed and classified loans are assigned a
specific allowance. Those not classified are assigned a pass rating. A
migration analysis and various portfolio specific factors are used to
calculate the required allowance on those pass loans.
- Relationship Banking - Includes commercial, commercial real
estate and consumer loans. Classified loans are assigned a specific
allowance. A migration analysis and various portfolio specific factors
are used to calculate the required allowance on the remaining pass
loans.
- Manufactured Housing - An allowance is calculated on the basis of
risk rating, which is a combination of delinquency, value of
collateral on classified loans and perceived risk in the product line.
- Securitized Loans - The Company considers this a homogeneous
portfolio and calculates the allowance based on statistical
information provided by the servicer. Charge-off history is calculated
based on three methodologies; a 3-month and a 12-month historical
trend and by delinquency information. The highest requirement of the
three methods is used.
The Company calculates the required ALL on a monthly basis. Any difference
between estimated and actual observed losses from the prior month are reflected
in the current period required ALL calculation and adjusted as deemed necessary.
The review of the adequacy of the allowance takes into consideration such
factors as
F-7
concentrations of credit, changes in the growth, size and composition of the
loan portfolio, overall and individual portfolio quality, review of specific
problem loans, collateral, guarantees and economic conditions that may affect
the borrowers' ability to pay and and/or the value of the underlying collateral.
Additional factors considered include: geographic location of borrowers, changes
in the Company's product-specific credit policy and lending staff experience.
These estimates depend on the outcome of future events and, therefore, contain
inherent uncertainties.
The Company's ALL is maintained at a level believed adequate by management to
absorb known and inherent probable losses on existing loans. A provision for
loan losses is charged to expense. The allowance is charged for losses when
management believes that full recovery on the loan is unlikely. Generally, the
Company charges off any loan classified as a "loss"; portions of loans which are
deemed to be uncollectible; overdrafts which have been outstanding for more than
30 days; and, all other unsecured loans past due 120 or more days. Subsequent
recoveries, if any, are credited to the ALL.
OTHER REAL ESTATE OWNED - Other real estate owned ("OREO") is real estate
acquired through foreclosure on the collateral property and is recorded at fair
value at the time of foreclosure less estimated costs to sell. Any excess of
loan balance over the fair value of the OREO is charged-off against the
allowance for loan losses. Subsequent to foreclosure, management periodically
performs a new valuation and the asset is carried at the lower of carrying
amount or fair value. Operating expenses or income, and gains or losses on
disposition of such properties, are charged to current operations.
PREMISES AND EQUIPMENT - Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the terms of the leases or the estimated useful
lives of the improvements, whichever is shorter. Generally, the estimated
useful lives of other items of premises and equipment are as follows:
Building and improvements 31.5 years
Furniture and equipment 5 - 10 years
Electronic equipment and software 2 - 5 years
INCOME TAXES - The Company uses the accrual method of accounting for financial
reporting purposes as well as for tax reporting. Due to tax regulations,
certain items of income and expense are recognized in different periods for tax
return purposes than for financial statement reporting. These items represent
"temporary differences." Deferred income taxes are recognized for the tax
effect of temporary differences between the tax basis of assets and liabilities
and their financial reporting amounts at each period end based on enacted tax
laws and statutory tax rates applicable to the periods in which the differences
are expected to affect taxable income. A valuation allowance is established for
deferred tax assets if, based on weight of available evidence, it is more likely
than not that some portion or all of the deferred tax assets may not be
realized.
INCOME (LOSS) PER SHARE - Basic income (loss) per share is computed based on the
weighted average number of shares outstanding during each year divided into net
income (loss). Diluted income per share is computed based on the weighted
average number of shares outstanding during each year plus the dilutive effect,
if any, of outstanding options divided into net income (loss).
STATEMENT OF CASH FLOWS - For purposes of reporting cash flows, cash and cash
equivalents include cash, due from banks, interest-earning deposits in other
financial institutions and federal funds sold. Federal funds sold are one-day
transactions with CWB's funds being returned the following business day.
STOCK-BASED COMPENSATION - GAAP permits the Company to use either of two
methodologies to account for compensation cost in connection with employee stock
options. The first method requires issuers to record compensation expense over
the period the options are expected to be outstanding prior to exercise,
expiration or cancellation. The amount of compensation expense to be recognized
over this term is the "fair value" of the options at the time of the grant as
determined by the Black-Scholes valuation model. Black-Scholes computes fair
value of the options based on the length of their term, the volatility of the
stock price in past periods and other factors. Under this method, the issuer
recognizes compensation expense regardless of whether or not the employee
eventually exercises the options.
Under the second methodology, if options are granted at an exercise price equal
to the market value of the stock at the time of the grant, no compensation
expense is recognized. The Company believes that this method better reflects
the motivation for its issuance of stock options, as they are intended as
incentives for future performance rather than compensation for past performance.
GAAP requires that issuers electing the second method must present pro forma
disclosure of net income (loss) and earnings per share as if the first method
had been elected. Under the terms of the Company's stock option plan, full-time
salaried employees may be granted qualified stock options or incentive stock
options and directors may be granted nonqualified stock options. Options may be
granted at a price not less than 100% of the market value of the stock on the
date of grant. Qualified options are generally exercisable in cumulative 20%
installments. All options expire no later than ten years from the date of grant.
F-8
RECENT ACCOUNTING PRONOUNCEMENTS - On December 16, 2004, the Financial
Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004),
Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting
for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and amends FASB Statement No. 95,
Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar
to the approach described in Statement 123. However, Statement 123(R) requires
all share-based payments to employees, including grants of employee stock
options, to be recognized in the income statement based on their fair values.
Pro forma disclosure is no longer an alternative. Statement 123(R) must be
adopted no later than July 1, 2005. Early adoption will be permitted in periods
in which financial statements have not yet been issued. The Company expects to
adopt Statement 123(R) as of July 1, 2005.
Statement 123(R) permits public companies to adopt its requirements using one of
two methods: 1) A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the requirements of
Statement 123(R) for all share-based payments granted after the effective date
and (b) based on the requirements of Statement 123 for all awards granted to
employees prior to the effective date of Statement 123(R) that remain unvested
on the effective date. 2) A "modified retrospective" method which includes the
requirements of the modified prospective method described above, but also
permits entities to restate based on the amounts previously recognized under
Statement 123 for purposes of pro forma disclosures either (a) all prior periods
presented or (b) prior interim periods of the year of adoption. The Company
plans to adopt Statement 123 using the modified-prospective method.
As permitted by Statement 123, the Company currently accounts for share-based
payments to employees using Opinion 25's intrinsic value method and, as such,
generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method will have an
insignificant impact on our result of operations and our overall financial
position. The precise impact of adoption of Statement 123(R) will depend on
levels of share-based payments granted in the future. Had we adopted Statement
123(R) in prior periods, the impact of that standard would have approximated the
impact of Statement 123 as described in the disclosure of unaudited pro forma
net income and earnings per share in Note 9 to our consolidated financial
statements. Statement 123(R) also requires the benefits of tax deductions in
excess of recognized compensation cost to be reported as a financing cash flow,
rather than as an operating cash flow as required under current literature.
This requirement will reduce net operating cash flows and increase net financing
cash flows in periods after adoption. While the Company cannot estimate what
those amounts will be in the future (because they depend on, among other things,
when employees exercise stock options) there were no operating cash flows
recognized in prior periods for such excess tax deductions.
2. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities is as
follows:
DECEMBER 31, 2004 (IN THOUSANDS)
- -----------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
Available-for-sale securities COST GAINS LOSSES VALUE
- ----------------------------- ---------- ----------- ------------ -------
U.S. Government and agency $ 15,311 $ - $ (90) $15,221
Other securities 7,069 (32) 7,037
---------- ----------- ------------ -------
Total available-for-sale securities $ 22,380 $ - $ (122) $22,258
========== =========== ============ =======
Held-to-maturity securities
- ---------------------------
U.S. Government and agency $ 200 $ - $ (1) $ 199
Other securities 5,894 29 - 5,923
---------- ----------- ------------ -------
Total held-to-maturity securities $ 6,094 $ 29 $ (1) $ 6,122
========== =========== ============ =======
F-9
DECEMBER 31, 2003 (IN THOUSANDS)
- -----------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
Available-for-sale securities COST GAINS LOSSES VALUE
- ----------------------------- ---------- ----------- ------------ -------
U.S. Government and agency $ 7,064 $ - $ (40) $ 7,024
Other securities 8,391 17 - 8,408
---------- ----------- ------------ -------
Total available-for-sale securities $ 15,455 $ 17 $ (40) $15,432
========== =========== ============ =======
Held-to-maturity securities
- ---------------------------
U.S. Government and agency $ 200 $ - $ - $ 200
Other securities 4,836 - (1) 4,835
---------- ----------- ------------ -------
Total held-to-maturity securities $ 5,036 $ - $ (1) $ 5,035
========== =========== ============ =======
At December 31, 2004, $200,000 at carrying value of the above securities was
pledged as collateral to the United States Treasury for its treasury, tax and
loan account and $14,000,000 at carrying value, was pledged under repurchase
agreements which are treated as collateralized financing transactions.
Additionally, $14,100,000 at carrying value was pledged to the Federal Home Loan
Bank, San Francisco, as collateral for current and future advances.
3. LOAN SALES AND SERVICING
SBA Loan Sales - The Company sells the guaranteed portion of selected SBA loans
into the secondary market, on a servicing retained basis, in exchange for a
combination of a cash premium, servicing rights and/or I/O strips. A portion of
the proceeds is recognized as servicing fee income as it occurs and the
remainder is capitalized as excess servicing and is included in the gain on sale
calculation. The Company retains the unguaranteed portion of these loans and
services the loans as required under the SBA programs to retain specified yield
amounts. The SBA program stipulates that the Company retains a minimum of 5% of
the loan balance, which is unguaranteed. The percentage of each unguaranteed
loan in excess of 5% may be periodically sold to a third party for a cash
premium. The Company records servicing liabilities for the unguaranteed loans
sold calculated based on the present value of the estimated future servicing
costs associated with each loan. A portion of this cost is included as a
reduction to the premium collected on the loan sale, and the remainder is
accrued and recognized as servicing expense as it occurs. The balance of all
servicing rights and obligations is subsequently amortized over the estimated
life of the loans using an estimated prepayment rate of 20-25%. Quarterly, the
servicing and I/O strip assets are analyzed for impairment. In 2002, the
Company recognized impairment charges of $1.8 million. The Company also
periodically sells SBA loans originated under the 504 loan program into the
secondary market, on a servicing released basis, in exchange for a cash premium.
As of December 31, 2004 and 2003, the Company had $43.6 million and $36.9
million, respectively, in SBA loans held for sale.
The following is a summary of activity in I/O Strips:
YEAR ENDED DECEMBER 31,
---------------------------
2004 2003 2002
------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $3,548 $ 4,548 $ 7,693
Additions through loan sales - - 240
Valuation adjustment, net (833) (1,000) (3,385)
------- -------- --------
Balance, end of year $2,715 $ 3,548 $ 4,548
======= ======== ========
The following is a summary of activity in Servicing Rights:
YEAR ENDED DECEMBER 31,
---------------------------
2004 2003 2002
------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $2,499 $1,897 $2,489
Additions through loan sales 1,259 1,116 597
Amortization (500) (514) (426)
Valuation adjustment - - (763)
------- -------- --------
Balance, end of year $3,258 $2,499 $1,897
======= ======== ========
F-10
Loans serviced for others are not included in the accompanying consolidated
balance sheets. The principal balance of loans serviced for others at December
31, 2004 and 2003 totaled $167.1 million and $126.8 million, respectively.
4. LOANS HELD FOR INVESTMENT
The composition of the Company's loans held for investment portfolio, excluding
securitized loans is as follows:
DECEMBER 31,
-------------------
2004 2003
--------- --------
(IN THOUSANDS)
Commercial $ 30,893 $ 24,592
Real estate 85,357 71,010
SBA 35,265 30,698
Manufactured housing 66,423 39,073
Other installment 8,645 5,770
--------- --------
226,583 171,143
Less:
Allowance for loan losses 2,785 2,652
Deferred fees, net of costs (103) 69
Discount on unguaranteed portion of SBA loans 1,748 1,548
--------- --------
Loans held for investment, net $222,153 $166,874
========= ========
An analysis of the allowance for loan losses for loans held for investment is as
follows:
YEAR ENDED DECEMBER 31,
---------------------------
2004 2003 2002
------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $2,652 $ 3,379 $ 4,086
Loans charged off (459) (1,822) (5,637)
Recoveries on loans previously charged off 75 802 1,859
------- -------- --------
Net charge-offs (384) (1,020) (3,778)
Provision for loan losses 517 293 3,071
------- -------- --------
Balance, end of year $2,785 $ 2,652 $ 3,379
======= ======== ========
The recorded investment in loans that are considered to be impaired is as
follows:
YEAR ENDED DECEMBER 31,
--------------------------
2004 2003 2002
------- ------- --------
(IN THOUSANDS)
Impaired loans without specific valuation allowances $ 49 $ 235 $ 422
Impaired loans with specific valuation allowances 3,926 6,843 7,971
Specific valuation allowance related to impaired loans (425) (640) (1,127)
------- ------- --------
Impaired loans, net $3,550 $6,438 $ 7,266
======= ======= ========
Average investment in impaired loans $5,137 $6,584 $ 7,565
======= ======= ========
F-11
The following schedule reflects recorded investment at the dates indicated in
certain types of loans:
YEAR ENDED DECEMBER 31,
----------------------------
2004 2003 2002
-------- -------- --------
(IN THOUSANDS)
Nonaccrual loans $ 8,350 $ 7,174 $13,965
SBA guaranteed portion of loans included above (5,287) (4,106) (8,143)
-------- -------- --------
Nonaccrual loans, net $ 3,063 $ 3,068 $ 5,822
======== ======== ========
Troubled debt restructured loans $ 124 $ 193 $ 829
Loans 30 through 90 days past due with interest accruing $ 1,804 $ 3,907 $ 5,122
Interest income recognized on impaired loans $ 103 $ 277 $ 190
Interest foregone on nonaccrual loans and troubled debt restructured
loans outstanding 208 216 1,263
-------- -------- --------
Gross interest income on impaired loans $ 311 $ 493 $ 1,453
======== ======== ========
The Company makes loans to borrowers in a number of different industries. Other
than Manufactured Housing, no single concentration comprises 10% or more of the
Company's loan portfolio. Commercial real estate loans and SBA loans comprised
over 10% of the Company's loan portfolio as of December 31, 2004 and 2003, but
consisted of diverse borrowers. Although the Company does not have significant
concentrations in its loan portfolio, the ability of the Company's customers to
honor their loan agreements is dependent upon, among other things, the general
economy of the Company's market areas.
5. SECURITIZED LOANS
The Company originated and purchased second mortgage loans that allowed
borrowers to borrow up to 125% of their home's appraised value, when combined
with the balance of the first mortgage loan, up to a maximum loan of $100,000.
In 1998 and 1999, the Company transferred $81 million and $122 million,
respectively, of these loans to two special purpose trusts. These loans were
both originated and purchased by the Company. The trusts, then sold bonds to
third party investors that were secured by the transferred loans. The loans and
bonds are held in the trusts independent of the Company, the trustee of which
oversees the distributions to the bondholders. The mortgage loans are serviced
by a third party ("Servicer"), who receives a stated servicing fee. There is an
insurance policy on the bonds that guarantees the payment of the bonds. The
Company did not surrender effective control over the loans transferred at the
time of securitization. Accordingly, the securitizations are accounted for as
secured borrowings and both the loans and bonds in the trusts are consolidated
into the financial statements of the Company.
At December 31, 2004 and 2003, respectively, securitized loans are net of an
allowance for loan losses as set forth below, and include purchase premiums and
deferred fees/costs of $469,000 and $823,000, respectively.
An analysis of the allowance for loan losses for securitized loans is as
follows:
YEAR END DECEMBER 31,
----------------------------
2004 2003 2002
-------- -------- --------
(IN THOUSANDS)
Balance, beginning of year $ 2,024 $ 2,571 $ 4,189
Loans charged off (1,356) (2,511) (4,012)
Recoveries on loans previously charged off 540 588 566
-------- -------- --------
Net charge-offs (816) (1,923) (3,446)
Provision for loan losses (99) 1,376 1,828
-------- -------- --------
Balance, end of year $ 1,109 $ 2,024 $ 2,571
======== ======== ========
F-12
6. PREMISES AND EQUIPMENT
DECEMBER 31,
------------------
2004 2003
-------- --------
(IN THOUSANDS)
Furniture, fixtures and equipment $ 6,698 $ 6,851
Building and land 896 888
Leasehold improvements 757 771
Construction in progress 29 -
-------- --------
8,380 8,510
Less: accumulated depreciation and amortization (6,617) (6,878)
-------- --------
Premises and equipment, net $ 1,763 $ 1,632
======== ========
The Company leases office facilities under various operating lease agreements
with terms that expire at various dates between January 2005 and December 2011,
plus options to extend the lease terms for periods of up to ten years.
The minimum lease commitments as of December 31, 2004 under all operating lease
agreements are as follows:
(IN THOUSANDS)
2005 $ 760
2006 765
2007 392
2008 131
2009 108
Thereafter 216
---------------
Total $ 2,372
===============
Rent expense for the years ended December 31, 2004, 2003 and 2002, included in
occupancy expense was $724,000 $680,000 and $951,000, respectively.
7. DEPOSITS
At December 31, 2004, the maturities of time certificates of deposits are as
follows:
(IN THOUSANDS)
2005 $ 77,830
2006 25,675
2007 11,225
2008 3,185
2009 14,504
---------------
Total $ 132,419
===============
8. BORROWINGS
Repurchase Agreements
- ----------------------
The Company has entered into a financing arrangement with a third party by which
its government-guaranteed securities can be pledged as collateral for short-term
borrowings. As of December 31, 2004 and 2003, securities with a carrying value
of $14.0 million and $14.7 million respectively, were pledged as collateral for
short-term borrowings. As of December 31, 2004 and December 31, 2003, the
Company had $13.7 million and $14.4 million, respectively, of outstanding
repurchase agreements, with interest rates of 1.40% to 2.35% for 2004 and 1.25%
to 1.43% for 2003, all of which mature within one year.
Federal Home Loan Bank Advances
- -----------------------------------
As a member of the Federal Home Loan Bank of San Francisco ("FHLB"), the Company
has established a credit line under which the borrowing capacity is determined
subject to "delivery" status of qualifying collateral. Generally, this
collateral includes certain mortgages or deeds of trust and securities and notes
of the U.S. Government and its agencies. As of December 31, 2004, the Company
had $33.8 million of loans and $14.1 million of securities pledged as collateral
for current and future FHLB borrowings.
F-13
Information related to advances from FHLB at December 31, 2004 (there were none
as of December 31, 2003 and 2002) as follows:
Scheduled Maturities AMOUNT INTEREST RATES
- -------------------- ------------- ---------------
(DOLLARS IN
THOUSANDS)
Due within one year $ 3,500 1.77%-2.75%
After one year but within three years 7,000 2.59%-3.28%
-------------
Total advances from FHLB $ 10,500
=============
Other information
- ------------------
Weighted average interest rate, end of year 2.71%
Weighted average interest rate during the year 2.09%
Average balance of advances from FHLB $ 5,419
Maximum amount outstanding at any month end 10,500
The total interest expense on advances from FHLB was $113,000 for 2004.
Bonds Payable
- --------------
The following is a summary of the outstanding bonds payable:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
RANGES OF INTEREST STATED MATURITY
2004 2003 RATES DATE
------- ------- ------------------- -----------------
(DOLLARS IN THOUSANDS)
Series 1998-1 $ 179 $ 5,205 8.45% November 25, 2024
Series 1999-1 14,332 22,235 7.85%-8.75% May 25, 2025
------- -------
14,511 27,440
Less: Bond issuance costs 228 477
Bond discount 373 863
------- -------
Bonds payable, net $13,910 $26,100
======= =======
The bonds are collateralized by securitized loans with an outstanding principal
balance of $6.6 million and $16.4 million as of December 31, 2004 for Series
1998-1 and Series 1999-1, respectively. There is no cross collateralization
between the bond issues.
Financial data pertaining to bonds payable were as follows:
YEAR ENDED DECEMBER 31,
----------------------------
2004 2003 2002
-------- -------- --------
(DOLLARS IN THOUSANDS)
Weighted average coupon interest rate, end of year 8.27% 8.26% 8.02%
Annual weighted average interest rate 12.41% 11.89% 11.44%
Average balance of bonds payable, net $19,676 $39,000 $69,251
Maximum amount of bonds payable, net, at any month end $24,706 $50,473 $84,910
As of December 31, 2004, the annual scheduled bond repayments were as follows:
2005 2006 2007 2008 2009 THEREAFTER TOTAL
----- ----- ----- ----- ----- ----------- -------
(IN THOUSANDS)
Bond repayments $ 257 $ 279 $ 303 $ 329 $ 358 $ 12,985 $14,511
The Company has the option to call and pay off the remaining bond balance when
the related loan balances are reduced to 10% of the original pool balance.
F-14
9. STOCKHOLDERS' EQUITY
Common Stock
- -------------
Earnings per share-Calculation of Weighted Average Shares Outstanding
- ----------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
-----------------------
2004 2003 2002
----- ----- -----
(IN THOUSANDS)
Basic weighted average shares outstanding 5,718 5,694 5,690
----- ----- -----
Dilutive effect of stock options 149 64 -
Diluted weighted average shares outstanding 5,867 5,758 5,690
===== ===== =====
The incremental shares from assumed conversions of stock options on 13,674
shares in 2002 were excluded from the computations of diluted earnings per share
because the Company had a net loss for 2002, which made them anti-dilutive.
Stock Option Plans
- --------------------
As of December 31, 2004, options were outstanding at prices ranging from $3.00
to $12.50 per share with 276,467 options exercisable and 372,451 options
available for future grant. As of December 31, 2003, options were outstanding at
prices ranging from $3.00 to $14.88 per share with 256,327 options exercisable
and 475,651 options available for future grant. As of December 31, 2004, the
average life of the outstanding options was approximately 6.81 years.
Stock option activity is as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
2004 2003 2002
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
2004 EXERCISE 2003 EXERCISE 2002 EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
-------- --------- -------- --------- --------- ---------
Options outstanding, January 1, 463,207 $ 6.04 350,852 $ 6.30 432,624 $ 6.31
Granted 151,500 9.10 198,000 5.51 88,128 4.60
Canceled (48,300) 7.22 (69,100) 6.22 (169,900) 5.77
Exercised (23,100) 6.31 (16,545) 4.63 - -
-------- --------- -------- --------- --------- ---------
Options outstanding, December 31, 543,307 $ 6.77 463,207 $ 6.04 350,852 $ 6.30
======== ========= ======== ========= ========= =========
Options exercisable, December 31, 276,467 $ 6.39 256,327 $ 6.53 208,992 $ 6.49
======== ========= ======== ========= ========= =========
The fair value of each stock option grant under the Company's stock option plan
during 2004, 2003 and 2002 was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
YEAR ENDED DECEMBER 31,
------------------------
2004 2003 2002
------- ------- ------
Annual dividend yield 1.7% 0.0% 0.0%
Expected volatility 35.7% 32.4% 45.1%
Risk free interest rate 4.2% 3.9% 4.0%
Expected life (in years) 6.8 7.3 7.3
The grant date estimated fair value of options was $2.91 per share in 2004,
$2.83 per share in 2003 and $2.90 per share in 2002. The Company applies
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its stock option plan. Accordingly, no compensation cost has
been recognized for its stock option plan. Had compensation cost for the
Company's stock option plan been determined based on the fair value at the grant
dates for awards under the plan consistent with the method prescribed by SFAS
No. 123, the Company's net income (loss) and income (loss) per share for the
years ended December 31, 2004, 2003 and 2002 would have been adjusted to the pro
forma amounts indicated below:
F-15
YEAR ENDED DECEMBER 31,
-------------------------------------
2004 2003 2002
------------- ------------ ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Income (loss):
As reported $3,835 $2,183 $( 1,270)
Pro forma 3,664 1,975 ( 1,434)
Income (loss) per common share - basic
As reported 0.67 0.38 ( 0.22)
Pro forma 0.64 0.35 ( 0.25)
Income (loss) per common share - diluted
As reported 0.65 0.38 ( 0.22)
Pro forma 0.62 0.34 ( 0.25)
10. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
YEAR ENDED DECEMBER 31,
--------------------------
2004 2003 2002
------- ------- --------
(IN THOUSANDS)
Current:
Federal $2,423 $ 647 $(1,873)
State 543 7 2
------- ------- --------
2,966 654 (1,871)
Deferred:
Federal (441) 712 1,223
State 163 (238) (4)
------- ------- --------
(278) 474 1,219
------- ------- --------
Total provision (benefit) $2,688 $1,128 $ (652)
======= ======= ========
The federal income tax provision (benefit) differs from the applicable statutory
rate as follows:
YEAR ENDED DECEMBER 31,
-----------------------
2004 2003 2002
------ ------ -------
Federal income tax at statutory rate 34.0% 34.0% (34.0)%
State franchise tax, net of federal benefit 7.2% 7.0% (7.1)%
Other 2.0% 0.1% 3.2%
Valuation allowance (2.0)% (7.0)% 4.0%
------ ------ -------
41.2% 34.1% (33.9)%
====== ====== =======
Significant components of the Company's net deferred taxes as of December 31 are
as follows:
2004 2003
-------- --------
(IN THOUSANDS)
Deferred tax assets:
Allowance for loan losses $ - $ 263
Depreciation 453 516
Net operating loss - 194
Deferred loan costs 202 193
Other 100 931
-------- --------
755 2,097
-------- --------
Less: valuation allowance - (193)
-------- --------
755 1,904
-------- --------
Deferred tax liabilities:
Deferred loan fees (1,256) (2,801)
Allowance for loan losses (189) -
Deferred loan costs (161) -
Other (150) (383)
-------- --------
(1,756) (3,184)
-------- --------
Net deferred taxes $(1,001) $(1,280)
======== ========
F-16
The Company had previously provided a valuation reserve for California net
operating loss carryovers as the utilization of these losses was uncertain. In
2004, the Company determined the uncertainty was removed and accordingly
reversed the related valuation allowance.
11. SUPPLEMENTAL DISCLOSURE TO THE CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statement of Cash Flows
Listed below are the supplemental disclosures to the Consolidated Statement of
Cash Flows:
YEAR ENDED DECEMBER 31,
-----------------------
2004 2003 2002
------ ------ -------
(IN THOUSANDS)
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $6,600 $9,006 $10,864
Cash paid for income taxes 2,497 947 3
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real estate owned 89 1,570 939
Transfers from loans held for sale to loans held for investment - - 1,587
12. EMPLOYEE BENEFIT PLAN
The Company has established a 401(k) plan for the benefit of its employees.
Employees are eligible to participate in the plan after three months of
consecutive service. Employees may make contributions to the plan and the
Company may make discretionary profit sharing contributions, subject to certain
limitations. The Company's contributions were determined by the Board of
Directors and amounted to $137,000, $129,000 and $171,000, in 2004, 2003 and
2002, respectively.
13. FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required to interpret market
data to develop estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Company could realize
in a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
The following table represents the estimated fair values:
DECEMBER 31,
----------------------------------------------
2004 2003
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
--------- ----------- --------- -----------
(IN THOUSANDS)
Assets:
Cash and cash equivalents $ 30,205 $ 30,205 $ 22,056 $ 22,056
Time deposits in other financial institutions 647 647 792 792
Federal Reserve and Federal Home Loan Bank stock 2,012 2,012 812 812
Investment securities 28,352 28,380 20,468 20,467
Interest-only strips 2,715 2,715 3,548 3,548
Net loans 290,506 291,483 244,274 247,460
Servicing assets 3,258 3,260 2,499 2,695
Liabilities:
Deposits (other than time deposits) 152,149 152,149 96,091 96,091
Time deposits 132,419 132,186 128,764 129,564
Securities sold under agreements to repurchase 13,672 13,642 14,394 14,401
Federal Home Loan Bank advances 10,500 10,429 - -
Bonds payable 13,910 14,154 26,100 27,114
The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below:
F-17
Cash and cash equivalents - The carrying amounts approximate fair value because
of the short-term nature of these instruments.
Time deposits in other financial institutions - The carrying amounts approximate
fair value because of the relative short-term nature of these instruments.
Federal Reserve Stock - The carrying value approximates the fair value because
the stock can be sold back to the Federal Reserve at anytime.
Federal Home Loan Bank Stock - The carrying value approximates the fair value
because the stock can be sold back to the Federal Home Loan Bank at anytime.
Investment securities - The fair value is based on quoted market prices from
security brokers or dealers.
Interest Only Strips - The fair value of the interest-only strips has been
determined by the discounted cash flow method, using market discount and
prepayment rates.
Loans - The fair value of loans is estimated for portfolios of loans with
similar financial characteristics, primarily fixed and adjustable rate interest
terms. The fair value of fixed-rate mortgage loans is based upon discounted cash
flows utilizing the rate that the Company currently offers as well as
anticipated prepayment schedules. The fair value of adjustable rate loans is
also based upon discounted cash flows utilizing discount rates that the Company
currently offers, as well as anticipated prepayment schedules.
Servicing Assets - Fair value is determined using discounted future cash flows
calculated on a loan-by-loan basis and aggregated to the total asset level.
Deposits - The fair values of deposits are estimated based upon the type of
deposit products. Demand accounts, which include savings and transaction
accounts, are presumed to have equal book and fair values, since the interest
rates paid on these accounts are based on prevailing market rates. The estimated
fair values of time deposits are determined by discounting the cash flows of
segments of deposits that have similar maturities and rates, utilizing a yield
curve that approximates the prevailing rates offered to depositors as of the
measurement date.
Securities sold under agreements to repurchase - The fair value is estimated
using discounted cash flow analysis based on rates for similar types of
borrowing arrangements.
Bonds Payable - The fair value is estimated using discounted cash flow analysis
based on rates for similar types of borrowing arrangements.
Commitments to Extend Credit, Commercial and Standby Letters of Credit - Due to
the proximity of the pricing of these commitments to the period end, the fair
values of commitments are immaterial to the financial statements.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 2004 and 2003. Although management
is not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since those dates and, therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
14. REGULATORY MATTERS
The Company (on a consolidated basis) and CWB are subject to various regulatory
capital requirements administered by the Federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could have
a direct material effect on the Company's and CWB's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and CWB must meet specific capital guidelines that involve
quantitative measures of the Company's and CWB's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
The Company's and CWB's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors. Prompt corrective action provisions are not applicable to bank
holding companies.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") contains
rules as to the legal and regulatory environment for insured depository
institutions, including reductions in insurance coverage for certain kinds of
deposits, increased supervision by the federal regulatory agencies, increased
reporting requirements for insured institutions and new regulations concerning
internal controls, accounting and operations. The prompt corrective action
regulations of FDICIA define specific capital categories based on the
institutions' capital ratios. The capital categories, in declining order, are
"well capitalized", "adequately capitalized", "undercapitalized", "significantly
undercapitalized" and "critically undercapitalized". To be considered "well
capitalized", an institution must have a core capital ratio of at least 5% and a
total risk-based capital ratio of at least 10%.
F-18
Additionally, FDICIA imposes Tier I risk-based capital ratio of at least 6% to
be considered "well capitalized". Tier I risk-based capital is, primarily,
common stock and retained earnings, net of goodwill and other intangible assets.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as
defined) to average assets (as defined). The Company's and CWB's actual capital
amounts and ratios as of December 31, 2004 and 2003 are also presented in the
table below:
RISK- ADJUSTED TOTAL TIER 1 TIER 1
(DOLLARS IN TOTAL TIER 1 WEIGHTED AVERAGE CAPITAL CAPITAL LEVERAGE
THOUSANDS) CAPITAL CAPITAL ASSETS ASSETS RATIO RATIO RATIO
-------- -------- --------- --------- -------- -------- ---------
DECEMBER 31, 2004
- -----------------
CWBC (Consolidated) $ 41,047 $ 37,315 $ 298,359 $ 358,623 13.76% 12.51% 10.41%
CWB 38,550 34,819 298,309 354,889 12.92 11.67 9.81
DECEMBER 31, 2003
- -----------------
CWBC (Consolidated) 37,150 34,096 242,730 305,666 15.31% 14.05% 11.15%
CWB 34,695 31,648 242,170 301,024 14.33 13.07 10.51
Well capitalized ratios 10.00 6.00 5.00
Minimum capital ratios 8.00 4.00 4.00
As of December 31, 2004, management believed that CWB met all applicable capital
adequacy requirements and is correctly categorized as "well capitalized" under
the regulatory framework for prompt corrective action.
15. COMMITMENTS AND CONTINGENCIES
Commitments
- -----------
In the normal course of business, the Company is a party to financial
instruments with off-balance-sheet risk to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
standby letters of credit. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the balance sheet. The Company's 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. As of December 31, 2004 and 2003, the Company had commitments to
extend credit of approximately $42.1 million and $40.7 million, respectively,
including obligations to extend standby letters of credit of approximately
$403,000 and $522,000, respectively.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support private borrowing arrangements. All guarantees are
short-term and expire within one year.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for extending loan facilities to customers. The Company
evaluates each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company upon extension of
credit, is based on management's credit evaluation of the counterparty.
Collateral held varies but may include accounts receivable, inventory, property,
plant and equipment and income-producing commercial properties.
Loans Sold
- -----------
The Company has sold loans that are guaranteed or insured by government agencies
for which the Company retains all servicing rights and responsibilities. The
Company is required to perform certain monitoring functions in connection with
these loans to preserve the guarantee by the government agency and prevent loss
to the Company in the event of nonperformance by the borrower. Management
believes that the Company is in compliance with these requirements. The
outstanding balance of the sold portion of such loans was approximately $167.1
million, $126.8 million and $150.2 million at December 31, 2004, 2003 and 2002,
respectively.
The Company retains a substantial degree of risk relating to the servicing
activities and retained interest in sold SBA loans. In addition, during the
period of time that the loans are held for sale, the Company is subject to
various business risks associated with the lending business, including borrower
default, foreclosure and the risk that a rapid
F-19
increase in interest rates would result in a decline of the value of loans held
for sale to potential purchasers. In connection with its loan sales, the
Company enters agreements which generally require the Company to repurchase or
substitute loans in the event of a breach of a representation or warranty made
by the Company to the loan purchaser, any misrepresentation during the mortgage
loan origination process or, in some cases, upon any fraud or early default on
such mortgage loans.
Executive Salary Continuation
- -------------------------------
The Company has an agreement with a former officer/director, which provides for
a monthly cash payment to the officer or beneficiaries in the event of death,
disability or retirement, beginning in December 2003 and extending for a period
of fifteen years. The Company purchased a life insurance policy as an
investment. The cash surrender value of the policy was $714,000 and $693,000
at December 31, 2004 and 2003, respectively, and is included in other assets.
The present value of the Company's liability under the agreement was calculated
using a discount rate of 6% and is included in accrued interest payable and
other liabilities in the accompanying consolidated balance sheets. In 2004, the
Company paid $54,000 to the former officer/director under the terms of this
agreement. The accrued executive salary continuation liability was $473,000 and
$499,000 at December 31, 2004 and 2003, respectively.
The Company also has certain Key Man life insurance policies related to a former
officer/director. The combined cash surrender value of the policies was
$183,000 and $178,000 at December 31, 2004 and 2003, respectively.
Litigation
- ----------
The Company is involved in litigation of a routine nature that is handled and
defended in the ordinary course of the Company's business. In the opinion of
management, based in part on consultation with legal counsel, the resolution of
these other litigation matters will not have a material impact on the Company's
financial position or results of operations.
16. COMMUNITY WEST BANCSHARES FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
DECEMBER 31,
----------------
BALANCE SHEETS 2004 2003
- -------------- ------- -------
(IN THOUSANDS)
Assets
Cash and equivalents $ 3,073 $ 2,776
Time deposits in financial institutions 99 297
Investment in subsidiary 35,144 31,898
Loans, net of allowance for loan losses of $11,000 in 2004 and $17,000 in 2003 207 225
Other assets - 302
------- -------
Total assets $38,523 $35,498
======= =======
Liabilities and stockholders' equity
Other liabilities $ 882 $ 1,152
Common stock 30,020 29,874
Retained earnings 7,621 4,472
------- -------
Total stockholders equity 37,641 34,346
------- -------
Total liabilities and stockholders' equity $38,523 $35,498
======= =======
YEAR ENDED DECEMBER 31,
-------------------------
INCOME STATEMENT 2004 2003 2002
- ---------------- ------- ------ --------
(IN THOUSANDS)
Total income $ 12 $ 17 $ 105
Total expense 188 198 474
Equity in undistributed subsidiaries: Net income (loss) from subsidiaries 3,933 2,303 (1,026)
------- ------ --------
Income (loss) before income tax provision (benefit) 3,757 2,122 (1,395)
Income tax provision (benefit) (78) 61 (125)
------- ------ --------
Net income (loss) $3,835 $2,183 $(1,270)
======= ====== ========
F-20
YEAR ENDED DECEMBER 31,
----------------------------
STATEMENT OF CASH FLOWS 2004 2003 2002
- ----------------------- -------- -------- --------
(IN THOUSANDS)
Cash flows from operating activities:
Net (loss) income $ 3,835 $ 2,183 $(1,270)
Adjustments to reconcile net income (loss) to cash used in operating
activities:
Equity in undistributed (income) loss from subsidiaries (3,933) (2,303) 1,026
Net change in other liabilities (270) (33) (1,828)
Net change in other assets 321 (3) (13)
-------- -------- --------
Net cash used in operating activities (47) (156) (2,085)
Cash flows from investing activities:
Net decrease in time deposits in other financial institutions 198 891 3,299
Net dividends from and investments in subsidiaries 686 - (1,250)
-------- -------- --------
Net cash provided by investing activities 884 891 2,049
Cash flows from financing activities:
Proceeds from issuance of common stock 146 76 -
Cash dividend payments to shareholders (686) - -
-------- -------- --------
Net cash (used in) provided by financing activities (540) 76 -
Net increase (decrease) in cash and cash equivalents 297 811 (36)
Cash and cash equivalents at beginning of year 2,776 1,965 2,001
-------- -------- --------
Cash and cash equivalents, at end of year $ 3,073 $ 2,776 $ 1,965
======== ======== ========
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
Results of operations on a quarterly basis were as follows:
YEAR ENDED DECEMBER 31, 2004
-----------------------------------------------------------
Q4 Q3 Q2 Q1 TOTALS
---------- ---------- ----------- ---------- ----------
(IN THOUSANDS, EXCEPT SHARE DATA)
Interest income $ 5,728 $ 5,711 $ 5,245 $ 5,161 $ 21,845
Interest expense 2,007 1,954 1,945 1,939 7,845
---------- ---------- ----------- ---------- ----------
Net interest income 3,721 3,757 3,300 3,222 14,000
Provision for loan losses 167 186 (30) 95 418
---------- ---------- ----------- ---------- ----------
Net interest income after provision for
loan losses 3,554 3,571 3,330 3,127 13,582
Non-interest income 2,433 2,157 3,438 2,434 10,462
Non-interest expenses 4,359 4,086 5,000 4,076 17,521
---------- ---------- ----------- ---------- ----------
Income before income taxes 1,628 1,642 1,768 1,485 6,523
Provision for income taxes 674 675 728 611 2,688
---------- ---------- ----------- ---------- ----------
NET INCOME $ 954 $ 967 $ 1,040 $ 874 $ 3,835
========== ========== =========== ========== ==========
Earnings per share - basic $ 0.17 $ 0.17 $ 0.18 $ 0.15 $ 0.67
Earnings per share - diluted 0.16 0.16 0.18 0.15 0.65
Weighted average shares:
Basic 5,729,869 5,719,647 5,714,168 5,707,415 5,717,813
Diluted 5,928,946 5,868,973 5,834,584 5,834,439 5,867,236
F-21
YEAR ENDED DECEMBER 31, 2003
----------------------------------------------------------
Q4 Q3 Q2 Q1 TOTALS
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest income $ 4,985 $ 5,020 $ 5,199 $ 5,179 $ 20,383
Interest expense 2,099 2,198 2,427 2,618 9,342
---------- ---------- ---------- ---------- ----------
Net interest income 2,886 2,822 2,772 2,561 11,041
Provision for loan losses 664 298 363 344 1,669
---------- ---------- ---------- ---------- ----------
Net interest income after provision for
loan losses 2,222 2,524 2,409 2,217 9,372
Non-interest income 2,476 3,013 2,517 2,669 10,675
Non-interest expenses 4,014 4,196 4,171 4,355 16,736
---------- ---------- ---------- ---------- ----------
Income before income taxes 684 1,341 755 531 3,311
Provision for income taxes 232 456 257 183 1,128
---------- ---------- ---------- ---------- ----------
NET INCOME $ 452 $ 885 $ 498 $ 348 $ 2,183
========== ========== ========== ========== ==========
Earnings per share - basic $ .08 $ 0.16 $ 0.09 $ 0.06 $ .38
Earnings per share - diluted .08 0.15 0.09 0.06 .38
Weighted average shares:
Basic 5,701,932 5,692,732 5,690,224 5,690,224 5,693,807
Diluted 5,827,918 5,773,400 5,734,690 5,711,031 5,758,200
F-22
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- -------- -------------------------------------------------------------------
FINANCIAL DISCLOSURE
---------------------
None
ITEM 9A. CONTROLS AND PROCEDURES
- -------- -------------------------
Under the supervision and with the participation of the Company's management,
the Chief Executive Officer and the Chief Financial Officer evaluated the
effectiveness of the design and operation of the Company's disclosure controls
and procedures as of December 31, 2004. Based on and as of the time of such
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiary) required to be included in the Company's reports that
it files with or submits to the Securities and Exchange Commission under the
Securities Exchange Act of 1934. There have been no changes in the Company's
internal control over financial reporting that occurred during the Company's
quarter ended December 31, 2004, that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
ITEM 9B. OTHER INFORMATION
- --------- ------------------
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- --------- ------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
--------------------------------------------------------
The information concerning the directors and executive officers of the Company
is incorporated herein by reference from the section entitled "Proposal 1 -
Election of Directors" contained in the definitive proxy statement ("Proxy
Statement") of the Company to be filed pursuant to Regulation 14A within 120
days after the end of the Company's last fiscal year.
The Company has adopted a code of ethics that applies to all its principal
executive officer, principal financial officer, principal accounting officer or
controller and persons performing similar functions. A copy of the code of
ethics is available on the Company's website at www.communitywest.com.
ITEM 11. EXECUTIVE COMPENSATION
- --------- -----------------------
Information concerning executive compensation is incorporated herein by
reference from the section entitled "Proposal 1 - Election of Directors"
contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------- --------------------------------------------------------------
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the section entitled
"Security Ownership of Certain Beneficial Owners, Directors and Executive
Officers" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------- --------------------------------------------------
Information concerning certain relationships and related transactions is
incorporated herein by reference from the section entitled "Proposal 1 -
Election of Directors" contained in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
- --------- ------------------------------------------
Information concerning principal accountant fees and services is incorporated
herein by reference from the section entitled "Independent Auditors" contained
in the Proxy Statement.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- -------- ---------------------------------------------------------------
(a)(1) The following consolidated financial statements of Community West
Bancshares are filed as part of this Annual Report.
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets as of December 31, 2004 and 2003 F-2
Consolidated Income Statements for each of the three years
in the period ended December 31, 2004 F-3
Consolidated Statements of Stockholders' Equity for each
of the three years ended in the period ended December 31, 2004 F-4
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 2004 F-5
Notes to Consolidated Financial Statements F-6
(a)(2) Financial Statement Schedules
Financial statement schedules other than those listed above have been omitted
because they are either not applicable or the information is otherwise included.
(b) A report on Form 8-K was filed as follows:
January 28, 2004, Item 5 - Other Events
July 1, 2004, Item 5 - Other Events
(c) Exhibits. The following is a list of exhibits filed as a part of this
report.
2.1 Plan of reorganization (1)
2.2 Definitive Agreement to sell Palomar (4)
3.1 Articles of Incorporation (3)
3.2 Bylaws (3)
4.1 Common Stock Certificate (2)
10.1 1997 Stock Option Plan and Form of Stock Option Agreement (1)
10.3 Salary Continuation Agreement between Goleta National Bank and Llewellyn Stone,
President and CEO (3)
10.4 Agreement between the Company's subsidiary, Goleta National Bank, and ACE Cash
Express Inc (5)
10.6 Memorandum of Understanding between the Company and the Federal Reserve Bank of San Francisco,
dated February 22, 2001 (6)
10.7 Consulting Agreement between the Goleta National Bank and Llewellyn Stone (6)
10.9 Indemnification Agreement between the Company and Lynda Nahra, dated December 20, 2001 (6)
10.13 Consent Order between Goleta National Bank and the Comptroller of the Currency of the United States,
dated October 28, 2002 (7)
10.14 Stipulation and Consent to the Issuance of a Consent Order by the Office of the Comptroller of the
Currency, dated October 28, 2002 (7)
10.15 Amendment Number 3 to Master Loan Agency Agreement between Goleta National Bank and Ace Cash
Express, Inc., dated as of November 1, 2002 (7)
10.16 Amendment Number 1 to Collection Servicing Agreement between Goleta National Bank and Ace Cash
Express, Inc., dated as of November 1, 2002 (7)
10.17 Indemnification Agreement between the Company and Charles G. Baltuskonis, dated March 18, 2003 (8)
10.18 Letter issued by the Comptroller of the Currency and Order Terminating the Consent Order, dated October
21, 2003 (9)
10.19 Letter dated November 6, 2003 from the Federal Reserve Bank of San Francisco rescinding the
Memorandum of Understanding, dated February 2001 (9)
10.20 Employment and Confidentiality Agreement, Goleta National Bank, between the Company and
Lynda J. Nahra dated April 23, 2003 (9)
21 Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP
31.1 Certification of the Chief Executive Officer
31.2 Certification of the Chief Financial Officer
32.1 Certification pursuant to 18 U.S.C. Section 1350
__________________________
(1) Incorporated by reference from the Registrant's Registration
Statement on Form S-8 filed with the Commission on December 31,
1997.
(2) Incorporated by reference from the Registrant's Amendment to
Registration Statement on Form 8-A filed with the Commission on
March 12, 1998.
(3) Incorporated by reference from the Registrant's Annual
Report on Form 10-K filed with the Commission on March 26, 1998.
(4) Filed as an exhibit to the Registrant's Form 8-K filed with
the Commission on December 5, 2000.
(5) Incorporated by reference from the Registrant's quarterly
report on Form 10-Q for the quarter ended September 30, 2001
filed by the Registrant with the Commission on November 16, 2001.
(6) Incorporated by reference from the Registrant's Annual
Report on Form 10-K for the year ended December 31, 2001 filed by
the Registrant with the Commission on April 16, 2002.
(7) Incorporated by reference from the Registrant's Form 8-K
filed with the Commission on November 4, 2002.
(8) Incorporated by reference from the Registrants Annual Report
on Form 10-K for the year ended December 31, 2002 filed with the
Commission on March 31, 2003.
(9) Incorporated by reference from the Registrants Annual Report
on Form 10-K for the year ended December 31, 2003 filed with the
Commission on March 29, 2004.
SIGNATURES
- ----------
Pursuant to the requirements of Section 13 of 15(d) of the Securities and
Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
COMMUNITY WEST BANCSHARES
(Registrant)
Date: March 24, 2005 By: /s/ William R. Peeples
-------------------------
William R. Peeples
Chairman of the Board
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated.
Signature Title Date
- --------- ------ ----
/s/ William R. Peeples Director and March 24, 2005
- -------------------------- Chairman of the Board
William R. Peeples
/s/ Charles G. Baltuskonis Executive Vice President and March 24, 2005
- -------------------------- Chief Financial Officer
Charles G. Baltuskonis
/s/ Robert H. Bartlein Director March 24, 2005
- --------------------------
Robert H. Bartlein
/s/ Jean W. Blois Director March 24, 2005
- --------------------------
Jean W. Blois
/s/ John D. Illgen Director and Secretary March 24, 2005
- -------------------------- of the Board
John D. Illgen
/s/ Lynda J. Nahra Director, President and March 24, 2005
- -------------------------- Chief Executive Officer
Lynda J. Nahra
/s/ James R. Sims Jr. Director March 24, 2005
- --------------------------
James R. Sims Jr.
/s/ Kirk B. Stovesand Director March 24, 2005
- --------------------------
Kirk B. Stovesand
/s/ C. Richard Whiston Director March 24, 2005
- ---------------------------
C Richard Whiston