UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from       to       .

Commission File No.: 0-22193

Pacific Premier Bancorp, Inc.

(Exact name of registrant as specified in its charter)

Delaware	33-0743196
(State of Incorporation)	(I.R.S. Employer Identification No)

1600 Sunflower Ave. 2^nd Floor, Costa Mesa, California 92626

(714) 431-4000

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

None

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

Common Stock, par value $0.01 per share

(Title of class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. o

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

The aggregate market value of the voting stock held by non-affiliates of the registrant, i.e., persons other than directors and executive officers of the registrant is approximately $53,496,686 and is based upon the last sales price as quoted on The NASDAQ Stock Market as of June 30, 2004, the last business day of the most recently completed 2^nd fiscal quarter.

As of March 30, 2005, the Registrant had 5,258,738 shares outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2005 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

 

INDEX

					Page
PART I
ITEM 1.		BUSINESS			3
ITEM 2.		PROPERTIES			29
ITEM 3.		LEGAL PROCEEDINGS			29
ITEM 4.		SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			30
PART II
ITEM 5.		MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES			31
ITEM 6.		SELECTED FINANCIAL DATA			32
ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			34
ITEM 7A.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			48
ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA			51
ITEM 9.		CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE			80
ITEM 9A.		CONTROLS AND PROCEDURES			80
ITEM 9B.		OTHER INFORMATION			80
PART III
ITEM 10.		DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT			80
ITEM 11.		EXECUTIVE COMPENSATION			80
ITEM 12.		SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS			81
ITEM 13.		CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS			81
ITEM 14.		PRINCIPAL ACCOUNTANT FEE AND SERVICES			81
PART IV
ITEM 15.		EXHIBITS AND FINANCIAL STATEMENT SCHEDULES			81
SIGNATURES					84

 

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PART I

ITEM 1. BUSINESS

General

All references to “we”, “us”, “our”, or the “Company” mean Pacific Premier Bancorp, Inc. and our consolidated subsidiaries, including Pacific Premier Bank, our primary operating subsidiary. All references to “Bank” refer to Pacific Premier Bank.

The statements contained herein that are not historical facts are forward looking statements based on management’s current expectations and beliefs concerning future developments and their potential effects on the Company. There can be no assurance that future developments affecting the Company will be the same as those anticipated by management. Actual results may differ from those projected in the forward-looking statements. These forward-looking statements involve risks and uncertainties. These include, but are not limited to, the following risks: (1) changes in the performance of the financial markets, (2) changes in the demand for and market acceptance of the Company’s products and services, (3) changes in general economic conditions including interest rates, presence of competitors with greater financial resources, and the impact of competitive projects and pricing, (4) the effect of the Company’s policies, (5) the continued availability of adequate funding sources, and (6) various legal, regulatory and litigation risks.

We are a California-based community banking institution focused on full service banking to small businesses and consumers. Through our operating subsidiary, the Bank, we emphasize the delivery of depository products and services to our customers through our three branches in Southern California located in the cities of San Bernardino, Seal Beach and Huntington Beach. Our lending has been focused on income property loans. Income property lending consists of originating multi-family residential loans (five units and more) and commercial real estate loans within Southern California. We began originating these loans in the second quarter of 2002 with a focus on small to medium-sized loans, in the $200,000 to $2.0 million range, as management believes this market is underserved, especially in Southern California. Our average multi-family and commercial real estate loans at December 31, 2004 were $729,000 and $991,000, respectively. At December 31, 2004, we had consolidated total assets of $543.1 million, net loans of $470.4 million, total deposits of $288.9 million, consolidated total stockholders’ equity of $44.0 million, and the Bank was considered a “well-capitalized” financial institution for regulatory capital purposes.

At December 31, 2004, an aggregate of 95.2% of our total loans consisted of income property loans, with multi-family loans and commercial real estate loans constituting 83.6% and 11.6%, respectively, of total loans. Substantially all of the income property loans that we originate have adjustable interest rates thereby reducing our interest rate risk with respect to these loans. Mortgage brokers generally refer income property loans to us. In addition, we offer income property loans directly to real estate investors and through referrals from our depository branches; however, we anticipate the substantial majority of these loans will continue to be obtained through referrals from mortgage brokers. From time to time, we may also obtain income property loans through whole loan purchases and through participations with other banks.

The following are our growth and operating strategies:

·        Growth of our Loan Portfolio.   We intend to continue to grow and diversify our loan portfolio through an increase in commercial real estate loans, commercial business loans and by continuing to originate multi-family loans. During 2004, we began offering commercial business loans directly to our business depository customers and hired business development officers to begin to source these types of loans. Our primary method of obtaining multi-family and commercial real estate loans is through referrals from mortgage brokers. We have grown our income property loan portfolio from $14.0 million at December 31, 2001 to $449.1 million at December 31, 2004. Our growth strategy is focused on diversifying the loan portfolio over the coming years to reduce the

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percentage of multi-family loans and increase the amount of commercial real estate and commercial business loans as a percentage of our loan portfolio.

·        Emphasis on Relationship Banking.   We currently have three depository offices, one each in Huntington Beach and Seal Beach in Coastal Orange County, California and one in San Bernardino in the Inland Empire region of California. We intend to expand the growth of our core deposits through an emphasis on relationship banking with business owners and consumers thereby lowering our cost of funds and building franchise value. Additionally, we plan on opening two depository branches in 2005 to further develop our branch network in Southern California. Within our branches we have Senior Relationship Officers and Business Development Officers who are responsible for consistently calling on businesses within our communities to develop both depository and lending relationships with the Bank. Our operations personnel within the branches ensure superior, personalized customer service and are compensated to cross sell various products and services. Funds for our planned lending growth are also generated, as needed, from the Federal Home Loan Bank (“FHLB”), wholesale and/or brokered deposits as well as other borrowings.

·        Diversifying our Balance Sheet.   We believe it is important to diversify our loan portfolio and to increase the percentage of core deposits to total deposits. As a result, we believe it is essential to be able to offer our customers a wide array of products and services. In this regard, management has introduced several products and services to attract new deposit relationships and to expand the relationships with our existing customers. We have introduced the following new products and services: commercial lines of credit, business term loans, on-line banking, and cash management services. These products and services are designed to allow us to capture higher levels of business banking customers and to further our transition to that of a community banking platform and, thus, increase our overall franchise value. Additionally, we expect to generate a higher level of depository relationships with our income property borrowers who have typically not banked with us due in part to the lack of these products and services. We will continue to evaluate our customers’ needs and will consider offering additional products and services in the future consistent with our community banking business model.

Our executive offices are located at 1600 Sunflower Avenue, 2^nd Floor, Costa Mesa, California 92626 and our telephone number is (714) 431-4000. Our internet website address is www.ppbi.net. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments thereto, from 1998 to present, are available free of charge on our internet website. Also on our website are our Code of Ethics, Insider Trading and Beneficial Ownership forms, and Corporate Governance Guidelines. The information contained in our website, or in any websites linked by our website, is not a part of this Annual Report on Form 10-K.

Lending Activities

General.   In 2004, we continued to focus our lending strategy on originating multi-family and commercial real estate loans primarily secured by properties in Southern California. Specifically, we targeted multi-family and commercial real estate loans in the $200,000 to $2.0 million range. We have and will continue to offer loans up to our legal lending limit, which was $7.7 million as of December 31, 2004; however, our focus remains on the smaller balance loans. In the fourth quarter of 2004, the Bank implemented a commercial banking platform offering commercial lines of credit and business term loans for customers. These new business loan products were introduced to assist in establishing depository relationships consistent with the Bank’s strategic direction of increasing core deposits. The Bank originated its first commercial business loan (the only commercial business loan originated in 2004), a $600,000 line of credit, in late December. During 2004, we originated $255.8 million and $42.5 million in multi-family and commercial real estate loans, respectively. The Bank’s portfolio of multi-family and

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commercial real estate secured loans at December 31, 2004 totaled $449.1 million. At December 31, 2004, we had $470.4 million in total net loans outstanding.

Sourcing of our Loans.   We primarily obtain new multi-family and commercial real estate loans from established relationships with mortgage brokers operating throughout Southern California. Our account managers work out of our corporate office and are responsible for building and maintaining these relationships. We currently have relationships with over 70 brokerage companies of which five could be termed significant. In 2004, the top five brokerage companies accounted for 61.61% of the income property loans originated by the Bank. Within these five brokerage companies, we have funded loans with a total of 36 agents that work within the brokerage company itself. Our account managers have relationships with these individuals and seek to maintain the relationship regardless of where these agents are employed. Additionally, our account managers seek to establish relationships with other agents within these brokerage companies that have not done business with us in the past. Management believes that obtaining loans through mortgage brokers is a more cost-effective method of originating loans, and will afford us greater access to potential loan transactions and a consistent source of loan funding volume. Management believes that our highly focused lending strategy, timely decision-making process, competitive pricing, and flexibility in structuring transactions provide an incentive for brokers to do business with us.

Our direct retail originations accounted for 4.77% of our income property loans in 2004. These loans were sourced through referrals from our depository branches and by soliciting these loans directly. Our retail account managers will continue to focus on maintaining and developing relationships with individual investors, commercial real estate investment sales and leasing agents and other banks to increase the percentage of direct referrals in future periods.

Commercial business loans are sourced by our Business Development Officers and Senior Relationship Managers. These bankers call on business owners to develop business banking relationships. Upon securing the business banking relationships, they work with the business owner to offer personal banking products and services to the business owner and the businesses’ employees as well. Additionally, our Senior Relationship Managers work closely with our Account Managers to capture the full banking needs of our income property loan customers.

Interest Rates on Our Loans.   We employ a risk-based pricing strategy on all loans we fund. The interest rates we charge on our loans generally vary based on a number of factors, including the degree of credit risk, size, maturity of the loan, borrower/property management/business expertise, and prevailing market rates for similar types of loans. Depending on market conditions at the time the loan is originated, certain income property loan agreements will include prepayment penalties. Nearly all of the income property loans originated in 2004 had a prepayment penalty provisions. On the four loans that did not have the provision, the borrowers paid an additional fee of 1.5% of the loan amount to exclude the prepayment penalty provision. Most all of our loans are adjustable-rate loans and are based on one of several interest rate indices. All loans originated by the Bank in 2004 were adjustable-rate loans and had minimum interest rates (“floor rates”) at which the rate charged may not be reduced further regardless of further reductions in the underlying interest rate index.

Lending Risks on our Loans.   The majority of our loans typically involve larger loans to a single borrower that are generally viewed as exposing us to a greater risk than one-to-four family residential lending. The liquidation values of income producing properties may be adversely affected by risks generally incidental to interests in real property, such as:

·        Changes or continued weakness in general or local economic conditions;

·        Changes or continued weakness in specific industry segments;

·        Declines in real estate values;

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·        Declines in rental rates

·        Declines in occupancy rates

·        Increases in other operating expenses (including energy costs);

·        The availability of refinancing at lower interest rates or better loan terms;

·        Changes in governmental rules, regulations and fiscal policies, including rent control ordinances, environmental legislation and taxation;

·        Increases in interest rates, real estate and personal property tax rates; and

·        Other factors beyond the control of the borrower or the lender.

We attempt to mitigate these risks through sound and prudent underwriting policies, as well as a proactive loan review process. See “Underwriting and Approval Authority for Our Loans” below.

We will not make loans to any one borrower that is in excess of regulatory limits. Pursuant to Office of Thrift Supervision (“OTS”) regulations, loans-to-one borrower cannot exceed 15% of the Bank’s unimpaired capital and surplus. At December 31, 2004, the Bank’s loans-to-one borrower limit was $7.7 million. See “Regulation—Federal Savings Institution Regulation—Loans-to-One Borrower.”

Underwriting and Approval Authority for Our Loans.   Our board of directors establishes our lending policies. Each loan must meet minimum underwriting criteria established in our lending policies and must fit within our overall strategies for yield and portfolio concentrations. The underwriting and quality control functions are managed through our corporate offices. Each loan application is evaluated from a number of underwriting perspectives. For real estate secured loans, these underwriting perspectives include property appraised value, loan-to-value, level of debt service coverage utilizing both the actual net operating income and forecasted net operating income, use and condition of the property, as well as the borrower’s liquidity, income, credit history, net worth and operating experience. For business loans, underwriting perspectives include historic business cash flows, debt service coverage, loan-to-value ratios of underlying collateral, if any, debt to equity ratios, credit history, business experience, history of business, forecasts of operations, business viability, net worth, and liquidity.

Upon receipt of a completed loan application from a prospective borrower, a credit report and other required reports are ordered and, if necessary, additional information is requested. Prior to processing and underwriting any loan, we issue a letter of interest based on a preliminary analysis conducted by our Account Managers and Commercial Loan Manager, which letter details the terms and conditions on which we will consider the loan request. Upon receipt of the signed letter of interest and a deposit fee, we process and underwrite each loan application and prepare all loan documentation wherein the loan has been approved.

Our credit memorandum, which are prepared by our underwriters, includes a description of the prospective borrower and guarantors, the collateral securing the loan, if any, the proposed uses of loan proceeds, as well as an analysis of the borrower’s business and personal financial statements. For loans secured by real property, the credit memorandum will include an analysis of the historic operating income of the property. Loans secured by real estate require an independent appraisal conducted by a licensed appraiser. All appraisal reports are reviewed by our appraisal department. Our board of directors reviews and approves annually the independent list of acceptable appraisers.

Loans secured by real estate are originated on both a non-recourse and full recourse basis. Business loans are originated as recourse or with full guarantees from key borrowers or borrower principals. On loans facilitated to entities such as partnerships, limited liability companies, corporations or trusts, we generally seek to obtain personal guarantees from the appropriate managing members, major

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shareholders, trustees or other appropriate principals. In 2004, 97% of our income property loans to entities were originated with full recourse and/or personal guarantees from principals of the borrowers.

All of our income property loans must satisfy an interest rate sensitivity test in order for the loan origination or purchase to be approved; that is, the actual effective income of the property securing the loan must be adequate to achieve a minimum debt service coverage ratio (the ratio of net earnings on a property to debt service) based on a higher qualifying interest rate than the actual interest rate charged on our loans, and must meet the established policy minimums for such loans. Additionally, a stress test of 100 basis points above the qualifying interest rate must be adequate to achieve a minimum 1:1 debt service cover ratio. Following loan approval and prior to funding, our underwriting and processing departments assure that all loan approval terms have been satisfied, that they conform with lending policies (or are properly documented exceptions that have been approved), and that all required documentation is present and in proper form.

Commercial business loans are subject to Bank guidelines regarding appropriate covenants and periodic monitoring requirements which include but are not limited to:

·        Capital and lease expenditures

·        Capital levels

·        Salaries and other withdrawals

·        Working capital levels

·        Debt to net worth ratios

·        Sale of assets

·        Change of management

·        Change of ownership

·        Cash flow requirements

·        Profitability requirements

·        Debt service ratio

·        Collateral coverage ratio

·        Current and quick ratios

Subject to the above standards, our board of directors’ delegate authority and responsibility for loan approvals to management up to $1.0 million for all loans secured by real estate and up to $250,000 for commercial business loans not secured by real estate. Loan approvals at the management level require the approval of at least two members of our Management Loan Committee, consisting of our President and Chief Executive Officer, Chief Credit Officer and Chief Lending Officer. All loans in excess of $1.0 million, including total aggregate borrowings in excess of $1.0 million, and any commercial business loan not secured by real estate in excess of $250,000 require a majority approval of our Board’s Credit Committee, which is comprised of three directors, including our President and Chief Executive Officer.

Multi-family Residential Lending.   We originate and purchase loans secured by multi-family residential properties (five units and greater) throughout Southern California. Pursuant to our underwriting policies, multi-family residential loans may be made in an amount up to the lesser of 75% of the appraised value or the purchase price of the underlying property. In addition, we generally require a stabilized minimum debt service coverage ratio of 1.15:1, based on the qualifying loan interest rate. Loans are generally made for terms up to 30 years with amortization periods up to 30 years. As of December 31,

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2004, we had $394.6 million of multi-family real estate secured loans, constituting 83.6% of our loan portfolio. Multi-family loans originated in 2004 had an average outstanding balance of $805,200, loan-to-value of 66.86% and debt coverage ratio of 1.27:1 at origination.

Commercial Real Estate Lending.   We originate and purchase loans secured by commercial real estate, such as retail centers, small office and light industrial buildings and other mixed-use commercial properties throughout Southern California. We will also, from time to time, make a loan secured by a special purpose property such as an auto wash center or motel. Pursuant to our underwriting policies, commercial real estate loans may be made in amounts up to the lesser of 75% of the appraised value or the purchase price of the underlying property. We consider the net operating income of the property and require a debt service coverage ratio of at least 1.25:1, based on a qualifying interest rate. Loans are generally made for terms up to fifteen years with amortization periods up to 30 years. As of December 31, 2004, we had $54.5 million of commercial real estate secured loans, constituting 11.6% of our loan portfolio. Commercial real estate loans originated in 2004 had an average balance of $1,185,100, loan-to-value of 67.37% and debt coverage ratio of 1.41:1 at origination.

Commercial Business Lending.   We commenced our commercial business loan program in late 2004 with one origination in the last week of the year. Our Board approved commercial business lending policies allow the Bank to originate six primary loan types which may be secured or unsecured and include:

1.                Liquid Collateral/Certificate of Deposits/Stock Secured Loans

2.                Seasonal Loans

3.                Term Loans

4.                Revolving Lines of Credit

5.                Single Advance Note

6.                Combination Commercial and Real Estate Loan

One-to-Four Family Loans.   The Bank’s portfolio of one-to-four family home loans at December 31, 2004 totaled $22.3 million, of which $16.5 million consists of loans secured by first liens on real estate and $5.8 million consists of loans secured by second or junior liens on real estate.

Loan Servicing.   Loan servicing is centralized at our corporate headquarters. Our loan servicing operations are intended to provide prompt customer service and accurate and timely information for account follow-up, financial reporting and loss mitigation. Following the funding of an approved loan, the data is entered into our data processing system, which provides monthly billing statements, tracks payment performance, and effects agreed upon interest rate adjustments. The loan servicing activities include (i) the collection and remittance of mortgage loan payments, (ii) accounting for principal and interest and other collections and expenses, (iii) holding and disbursing escrow or impounding funds for real estate taxes and insurance premiums, (iv) inspecting properties when appropriate, (v) contacting delinquent borrowers, and (vi) acting as fiduciary in foreclosing and disposing of collateral properties.

When payments are not received by their contractual due date, collection efforts are initiated by our loss mitigation personnel. Accounts delinquent more than 15 days are reviewed by our loss mitigation manager and are assigned to collectors to begin the process of collections. Our collectors begin by contacting the borrower telephonically and progress to sending a notice of intention to foreclose within 30 days of delinquency, and we will initiate foreclosure 30 days thereafter if the delinquent payments are not received in full. Our loss mitigation manager conducts an evaluation of all loans 90 days or more past due by obtaining an estimate of value on the underlying collateral. The evaluation may result in our establishing a specific allowance for that loan or charging off the entire loan, but still continuing with collection efforts.

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Loan Portfolio Composition.   At December 31, 2004, our net loans receivable held for investment totaled $469.8 million and net loans receivable held for sale totaled $532,000. The types of loans that the Bank may originate are subject to federal law, state law, and regulations.

The following table sets forth the composition of our loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated:

		At December 31,
		2004					2003					2002					2001					2000
					% of					% of					% of					% of					% of
		Amount			Total		Amount			Total		Amount			Total		Amount			Total		Amount			Total
		(dollars in thousands)
Real estate loans:
Multi-family		$	394,582		83.66	%	$	188,939		75.54	%	$	62,511		38.33	%	$	7,522		3.85	%	$	8,609		2.57	%
Commercial		54,502			11.56	%	20,667			8.26	%	23,050			14.13	%	6,460			3.31	%	9,092			2.71	%
Construction		—			—		3,646			1.46	%	8,387			5.14	%	14,162			7.26	%	45,657			13.62	%
One-to-four family(1)		22,347			4.74	%	36,632			14.65	%	68,822			42.20	%	166,372			85.26	%	270,754			80.76	%
Other loans		178			0.04	%	233			0.09	%	327			0.20	%	629			0.32	%	1,154			0.34	%
Total gross loans		471,609			100.00	%	250,117			100.00	%	163,097			100.00	%	195,145			100.00	%	335,266			100.00	%
Less (plus):
Undisbursed loan funds		—					1,016					2,372					3,990					15,018
Deferred loan origination (costs), fees and (premiums) and discounts		(1,371		)			(483		)			(341		)			(385		)			(1,860		)
Allowance for loan losses		2,626					1,984					2,835					4,364					5,384
Loans receivable, net		$	470,354				$	247,600				$	158,231				$	187,176				$	316,724

(1)              Includes second trust deeds.

Loan Maturity.   The following table shows the contractual maturity of the Bank’s gross loans for the period indicated. The table does not reflect prepayment assumptions.

		At December 31, 2004
		One-to-Four					Multi			Commercial					Other					Total Loans
		Family					Family			Real Estate					Loans					Receivable
		(in thousands)
Amounts due:
One year or less			$	—			$	411			$	604				$	152				$	1,167
More than one year to three years			15				917				1,279					—					2,211
More than three years to five years			21				—				247					—					268
More than five years to 10 years			4,952				2,865				27,327					—					35,144
More than 10 years to 20 years			5,086				11,546				20,553					26					37,211
More than 20 years			12,273				378,843				4,492					—					395,608
Total amount due			22,347				394,582				54,502					178					471,609
Less (plus):
Undisbursed loan funds			—				—				—					—					—
Deferred loan origination fees (costs) and discounts			(185		)		(1,389		)		(39		)			2					(1,611		)
Lower of cost or market			240				—				—					—					240
Allowance for loan losses			697				1,643				272					14					2,626
Total loans, net			21,595				394,328				54,269					162					470,354
Loans held for sale, net			532				—				—					—					532
Loans held for investment, net			$	21,063			$	394,328			$	54,269				$	162				$	469,822

 

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The following table sets forth at December 31, 2004, the dollar amount of gross loans receivable contractually due after December 31, 2005, and whether such loans have fixed interest rates or adjustable interest rates.

		Loans Due After December 31, 2005
		At December 31, 2004
		Fixed			Adjustable			Total
		(in thousands)
Residential
One-to-four family		$	13,304		$	9,043		$	22,347
Multi-family		240			393,932			394,172
Commercial real estate		136			53,762			53,898
Other loans		26			—			26
Total gross loans receivable		$	13,706		$	456,737		$	470,443

 

The following table sets forth the Bank’s loan originations, purchases, sales, and principal repayments for the periods indicated:

		For the Year Ended December 31,
		2004			2003			2002
		(in thousands)
Beginning balance of gross loans		$	250,117		$	163,097		$	195,145
Loans originated:
Multi-family		254,714			138,451			42,727
Commercial and land		43,563			9,394			2,933
Construction loans		—			1,150			3,644
Other loans		118			6			—
Total loans originated		298,395			149,001			49,304
Loans purchased		—			12,826			29,983
Sub total—production		298,395			161,827			79,287
Total		548,512			324,924			274,432
Less:
Principal repayments		64,130			55,541			69,649
Sales of loans		12,147			15,938			33,796
Charge-offs		63			1,506			2,663
Transfer to real estate owned		563			1,822			5,227
Total gross loans		471,609			250,117			163,097
Ending balance loans held for sale (gross)		587			896			2,072
Ending balance loans held for investment (gross)		$	471,022		$	249,221		$	161,025

 

Delinquencies and Classified Assets.   Federal regulations require that the Bank utilize an internal asset classification system to identify and report problem and potential problem assets. The Bank’s Internal Asset Review (“IAR”) Manager has responsibility for identifying and reporting problem assets to the Bank’s Internal Asset Review Committee (“IARC”), which operates pursuant to the board-approved IAR policy. The policy incorporates the regulatory requirements of monitoring and classifying all assets of the Bank. The Bank currently designates or classifies problem and potential problem assets as “Special Mention”, “Substandard” or “Loss” assets. An asset is considered “Substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the Bank will sustain “some loss” if the deficiencies are not corrected. All real estate owned (“REO”) acquired from foreclosure is classified as “Substandard”. Assets classified as “Loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss allowance is not

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warranted. Assets which do not currently expose the Bank to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated “Special Mention.”

When the Bank classifies an asset, or portions thereof, as Substandard under current OTS policy, the Bank is required to consider establishing a general valuation allowance in an amount deemed prudent by management. The general valuation allowance, which is a regulatory term, represents a loss allowance which has been established to recognize the inherent credit risk associated with lending and investing activities, but which, unlike specific allowances, has not been allocated to particular problem assets. When the Bank classifies one or more assets, or portions thereof, as “Loss,” it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.

The Bank’s determination as to the classification of its assets and the amount of its valuation allowances are subject to review by the OTS, which can order the establishment of additional general or specific loss allowances or a change in a classification. The OTS, in conjunction with the other federal banking agencies, adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation allowances. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management has analyzed all significant factors that affect the collectability of the portfolio in a reasonable manner; and that management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. While the Bank believes that it has established an adequate allowance for estimated loan losses, there can be no assurance that its regulators, in reviewing the Bank’s loan portfolio, will not request the Bank to materially increase its allowance for estimated loan losses, thereby negatively affecting the Bank’s financial condition and earnings at that time. Although management believes that an adequate allowance for estimated loan losses has been established, actual losses are dependent upon future events and, as such, further additions to the level of allowances for estimated loan losses may become necessary.

The Bank’s IARC reviews the IAR Manager’s recommendations for classifying the Bank’s assets quarterly and reports the results of its review to the board of directors. The Bank classifies assets and establishes both a general allowance and specific allowance in accordance with the board-approved Allowance for Loan Losses policy. The following table sets forth information concerning substandard assets, REO and total classified assets at December 31, 2004 for the Company:

		At December 31, 2004
																				Total Substandard
		Total Substandard Assets									REO									Assets and REO
		Gross Balance					# of Loans				Gross Balance					# of Properties				Gross Balance					# of Assets
		(dollars in thousands)
Residential:
One-to-four family			$	2,320				37				$	351				12				$	2,671				49
Multi-family			—					—				—					—				—					—
Commercial Real Estate			—					—				—					—				—					—
Other loans			—					—				—					—				—					—
Specific Allowance			(221		)			—				—					—				(221		)			—
Total Substandard Assets			$	2,099				37				$	351				12				$	2,450				49

 

At December 31, 2004, the Company had $518,000 of Special Mention assets, $2.4 million of Substandard assets, and $345,000 assets classified as Loss that are offset by a specific allowance of the same

11

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amount. The difference between the specific allowance in the above table and the total specific allowance is the specific allowance on accounts that were Substandard at one time and are currently classified either as Special Mention or as Pass.

The following table sets forth delinquencies in the Company’s loan portfolio as of the dates indicated:

		60-89 Days									90 Days or More
						Principal Balance									Principal Balance
		# of Loans				of Loans					# of Loans				of Loans
		(dollars in thousands)
At December 31, 2004
Multi-family			—				$	—				—				$	—
Commercial real estate			—				—					—				—
Construction and land			—				—					—				—
One-to-four family and other loans			11				525					38				2,371
Total			11				$	525				38				$	2,371
Delinquent loans to total gross loans							0.11		%							0.50		%
At December 31, 2003
Multi-family			—				$	—				—				$	—
Commercial real estate			—				—					—				—
Construction and land			—				—					—				—
One-to-four family and other loans			2				46					45				2,730
Total			2				$	46				45				$	2,730
Delinquent loans to total gross loans							0.02		%							1.09		%
At December 31, 2002
Multi-family			—				$	—				—				$	—
Commercial real estate			—				—					—				—
Construction and land			—				—					—				—
One-to-four family and other loans			17				929					91				5,205
Total			17				$	929				91				$	5,205
Delinquent loans to total gross loans							0.57		%							3.19		%
At December 31, 2001
Multi-family			1				$	66				—				$	—
Commercial real estate			—				—					—				—
Construction and land			—				—					3				2,530
One-to-four family and other loans			29				1,204					155				12,710
Total			30				$	1,270				158				$	15,240
Delinquent loans to total gross loans							0.65		%							7.81		%
At December 31, 2000
Multi-family			—				$	—				1				$	67
Commercial real estate			—				—					—				—
Construction and land			—				—					2				2,184
One-to-four family and other loans			72				3,469					290				20,389
Total			72				$	3,469				293				$	22,640
Delinquent loans to total gross loans							1.03		%							6.75		%

 

Nonperforming Assets.   At December 31, 2004 and 2003, respectively, we had $2.5 million and $3.5 million of net nonperforming assets, respectively, which included $2.1 million and $2.5 million of net nonperforming loans, respectively. Our current policy is not to accrue interest on loans 90 days or more past due. The decrease in nonperforming assets is primarily due to a low interest rate environment which allowed delinquent customers to refinance or sell their homes, and stronger collection efforts, and the discontinuance of the origination of sub-prime credit loans in the year ended December 31, 2000.

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Real estate owned (“REO”) was $351,000 (consisting of 17 properties) at December 31, 2004, compared to $959,000 (consisting of 25 properties) at December 31, 2003. Properties acquired through or in lieu of foreclosure are initially recorded at the lower of fair value less cost to sell, or the balance of the loan at the date of foreclosure through a charge to the allowance for loan losses. It is the policy of the Bank to obtain an appraisal and/or a market evaluation on all REO at the time of possession. After foreclosure, valuations are periodically performed by management as needed due to changing market conditions or factors specifically attributable to the properties’ condition. If the carrying value of the property exceeds its fair value less estimated cost to sell, a charge to operations is recorded. The decline in REO over the periods represented reflects the improvements in asset quality and sales of REO properties.

The following tables set forth information concerning nonperforming loans and REO at the periods indicated:

		At December 31,
		2004			2003			2002			2001			2000
		(dollars in thousands)
Nonperforming assets(1)
Real Estate:
One-to-four family		$	2,371		$	2,729		$	5,203		$	12,687		$	20,310
Multi-family		—			—			—			—			67
Commercial		—			—			—			—			—
Construction and land		—			—			—			2,530			2,184
Other loans		—			1			2			23			79
Total nonaccrual loans		2,371			2,730			5,205			15,240			22,640
Foreclosures in process		—			43			425			786			4,454
Specific allowance		(244		)	(299		)	(627		)	(1,310		)	(386		)
Total nonperforming loans, net		2,127			2,474			5,003			14,716			26,708
Foreclosed real estate owned(2)		351			979			2,427			4,172			1,683
Total nonperforming assets, net(3)		$	2,478		$	3,453		$	7,430		$	18,888		$	28,391
Restructured loans(4)		$	—		$	—		$	—		$	—		$	19
Allowance for loan losses as a percent of gross loans receivable(5)		0.56		%	0.79		%	1.74		%	2.24		%	1.61		%
Allowance for loan losses as a percent of total nonperforming loans, gross		110.77		%	71.55		%	50.35		%	27.23		%	19.87		%
Nonperforming loans, net of specific allowances, as a percent of gross loans receivable		0.45		%	0.99		%	3.07		%	7.54		%	7.97		%
Nonperforming assets, net of specific allowances, as a percent of total assets		0.46		%	1.12		%	3.12		%	7.75		%	6.85		%

(1)          During the years ended December 31, 2004, 2003, 2002, 2001, and 2000, approximately $131,000, $299,000, $313,000, $555,000, and $842,000, respectively, of interest income related to these loans was included in net income. Additional interest income of approximately $317,000, $406,000, $708,000, $1.7 million, and $1.8 million, respectively, would have been recorded for the years ended December 31, 2004, 2003, 2002, 2001, and 2000 if these loans had been paid in accordance with their original terms and had been outstanding throughout the applicable period then ended or, if not outstanding throughout the applicable period then ended, since origination.

(2)          Foreclosed real estate owned balances are shown net of related loss allowances.

(3)          Nonperforming assets consist of nonperforming loans and REO. Nonperforming loans consisted of all loans 90 days or more past due and foreclosures in process less than 90 days and still accruing interest.

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(4)          A “restructured loan” is one wherein the terms of the loan were renegotiated to provide a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower. We did not include in interest income any interest on restructured loans during the periods presented.

(5)          Gross loans include loans receivable held for investment and held for sale.

Allowance for Loan Losses.   We maintain an allowance for loan losses to absorb losses inherent in the loans held for investment portfolio. Loans held for sale are carried at the lower of cost or estimated market value. Net unrealized losses, if any, are recognized in a lower of cost or market valuation allowance by charges to operations. The allowance is based on ongoing, quarterly assessments of probable estimated losses inherent in our loan portfolio. The allowance is increased by a provision for loan losses which is charged to expense and reduced by charge-offs, net of recoveries.

As of December 31, 2004, the allowance for loan losses totaled $2.6 million, compared to $2.0 million at December 31, 2003 and $2.8 million at December 31, 2002. The December 31, 2004, allowance for loan losses, as a percent of nonperforming loans and gross loans was 110.8% and 0.6%, respectively, compared with 71.5% and 0.8% at December 31, 2003, and 50.4% and 1.7% at December 31, 2002. The specific allowance amount included in the allowance for loan losses totaled $345,000, $430,000 and $735,000, as of December 31, 2004, December 31, 2003 and December 31, 2002, respectively.

The Bank’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance, specific allowance for identified problem loans and the unallocated allowance. The formula allowance is calculated by applying loss factors to all loans held for investment.

The loan loss factors for the multi-family loan portfolio are based primarily upon the thrift industry’s nationwide and West Region historic charge-off data, a peer analysis of other financial institutions engaged in similar lending activities, a quantitative and qualitative analysis of the portfolio and management’s past experience with such loan types. Management believes the utilization of industry-wide historic loss data of multi-family loans is more reflective of potential losses due to the fact that the Bank has not had a loss or a delinquency on any of the multi-family loans since it began originating these loan types in the second quarter of 2002. The industry’s average annual charge-off loss experience over the last 10 years was 32 basis points on a nationwide level for multi-family loans and 1 basis point for the West Region, which includes California, during the past 7½ year period. The West Region’s charge-off data is only available over the past 7½ year time period. However, the Bank used the data for the longer period as a starting point in developing the multi-family loan loss factors. Management has adopted a tiered system that establishes the highest loss factors for loans with a loan-to-value (“LTV”) ratio greater than 65% at origination and with less than 12 months of payment history (“seasoning”). Loans that possess a LTV ratio less than 65% at origination and a satisfactory payment history for the past 13 months or more are considered to have less credit risk and, therefore, are assigned a lower loss factor. The tiered system has four categories to address the unique characteristics of the Bank’s multi-family loan portfolio and are reviewed and updated quarterly.

The loss factors for the commercial real estate loan portfolio are developed and applied in a similar manner as the multi-family loan portfolio and thus considers the thrift industry’s nationwide and West Region historic charge-off data, a peer analysis of other financial institutions engaged in similar lending activities, a quantitative and qualitative analysis of the portfolio and management’s past experience with such loan types. The industry’s average annual charge-off over the last 8½ years was 18 basis points on a nationwide level and 2 basis points for the West Region during the past 6½ year period, the only years for which the data is available. Management also considers the past loss experience related to Southern California commercial real estate in establishing loan loss factors for the commercial real estate portfolio.

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The loan loss factors for the commercial business loan portfolio is based primarily upon the thrift industry’s nationwide and West Region historic charge-off data, a peer analysis of other financial institutions engaged in similar lending activities, a quantitative and qualitative analysis of the portfolio and management’s past experience with such loan types. Since this portfolio is relatively unseasoned, the Bank’s loss experience is nonexistent and, therefore, management relies upon available recent industry data to support the loss factor for this portfolio. The Bank’s IAR Department has reviewed and analyzed the data for commercial business loans over a period of five years (2000-2004). The data represents commercial business loan charge-offs on a national basis for the OTS regulated thrift industry. Based upon this analysis, the IAR Department has determined that for this period, the average annual charge-off rate was 1.39 percent nationwide. For the year ended December 31, 2004, the charge-off rate for commercial business loans for the West Region was 1.58 percent. Management will continue to analyze and evaluate the adequacy of the loss factors for this loan portfolio segment on a quarterly basis.

For the homogeneous single-family residential loan portfolio, the loss factors are developed by the Bank’s IAR Department using a loss migration analysis over the prior one year period to determine the percentage of loans from a particular classification category that flows through to a realized loss. The migration analysis is performed quarterly on the Bank’s single-family residential loan portfolio and is stratified based upon the geographic location of the collateral and the individual loan pool type (standard/subprime). The formula allowance is calculated based upon the developed loss factors and is assigned to the homogeneous single-family residential loan portfolio by geographic regions, loan pool type and classification.

Specific allowances are established for certain loans where management has identified significant conditions or circumstances related to a credit that management believes indicates the probability that a loss has been incurred in excess of the amount determined by the application of the formula allowance. Furthermore, on all one-to-four family loans secured by first and second deeds of trust that are 90 days or more past due, a market evaluation which includes adjusting the value for the location of the collateral and the Bank’s historical loss experience for that location is completed. A specific allowance is determined based on the valuation of the collateral underlying the loan and is calculated by subtracting the current market value less estimated selling and holding costs from the loan balance.

The IARC meets monthly to review and monitor conditions in the portfolio and to determine the appropriate allowance for loan losses based on the recommendation of the IAR Department and the analysis performed. To the extent that any of these conditions are evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, the IARC’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, the IARC’s evaluation of the probable loss related to such condition is reflected in the unallocated allowance. By assessing the probable estimated losses inherent in the loan portfolios on a quarterly basis, the Bank is able to adjust specific and inherent loss estimates based upon more recent information that has become available.

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The following table sets forth activity in the Bank’s allowance for loan losses for the periods indicated:

		As of and For the Year Ended December 31,
		2004			2003			2002			2001			2000
		(dollars in thousands)
Balances:
Average net loans outstanding during the period		$	351,968		$	184,460		$	152,738		$	245,629		$	417,498
Total loans outstanding at end of the period		471,609			250,117			163,097			195,145			335,266
Allowance for Loan Losses:
Balance at beginning of period		1,984			2,835			4,364			5,384			2,749
Provision for loan losses		705			655			1,133			3,313			2,910
Charge-offs:
Real Estate:
One-to-four family		252			1,612			1,908			3,829			273
Multi-family		—			—			—			—			—
Commercial		—			—			—			—			—
Construction and land		—			—			386			—			—
Other loans		148			388			820			847			134
Total charge-offs		400			2,000			3,114			4,676			407
Recoveries :
Real Estate:
One-to-four family		122			197			295			125			31
Multi-family		—			—			—			—			—
Commercial		—			—			—			—			—
Construction and land		—			—			—			—			—
Other loans		215			297			157			218			101
Total recoveries		337			494			452			343			132
Net loan charge-offs		63			1,506			2,662			4,333			275
Balance at end of period		$	2,626		$	1,984		$	2,835		$	4,364		$	5,384
Ratios:
Net charge-offs to average net loans		0.02		%	0.82		%	1.74		%	1.76		%	0.07		%
Allowance for loan losses to gross loans at end of period		0.56		%	0.79		%	1.74		%	2.24		%	1.61		%
Allowance for loan losses to total nonperforming loans		110.77		%	71.55		%	50.35		%	27.23		%	19.87		%

 

The following table sets forth the Bank’s allowance for loan losses and the percent of gross loans to total gross loans in each of the categories listed at the dates indicated:

				As of December 31,
				2004							2003							2002
Balance at End of Period Applicable to				Amount			% of Loans in Category to Total Loans				Amount			% of Loans in Category to Total Loans				Amount			% of  Loans in Category to Total Loans
				(dollars in thousands)
Real Estate:
Residential:
One-to-four family				$	661			4.74	%		$	843			14.65	%		$	2,205			42.20	%
Multi-family				1,643				83.66	%		812				75.54	%		316				38.33	%
Commercial real estate				272				11.56	%		105				8.26	%		121				14.13	%
Construction and land				—				—			41				1.46	%		92				5.14	%
Other Loans				14				0.04	%		15				0.09	%		16				0.20	%
Unallocated				36				—			168				—			85				—
Total				$	2,626			100.00	%		$	1,984			100.00	%		$	2,835			100.00	%

 

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				As of December 31,
				2001							2000
Balance at End of Period Applicable to				Amount			% of Loans in Category to Total Loans				Amount			% of Loans in Category to Total Loans
				(dollars in thousands)
Real Estate:
Residential:
One-to-four family				$	3,611			85.26	%		$	4,597			80.76	%
Multi-family				44				3.85	%		53				2.57	%
Commercial real estate				39				3.31	%		68				2.71	%
Construction and land				618				7.26	%		617				13.62	%
Other Loans				52				0.32	%		49				0.34	%
Unallocated				—				—			—				—
Total				$	4,364			100.00	%		$	5,384			100.00	%

 

The following table sets forth the allowance for loan losses amounts calculated by the categories listed for the periods set forth in the table:

				As of December 31,
				2004							2003							2002
Balance at End of Period Applicable to				Amount			% of Allowance to Total				Amount			% of Allowance to Total				Amount			% of Allowance to Total
				(dollars in thousands)
Formula allowance				$	2,245			85.5	%		$	1,386			69.8	%		$	2,015			71.1	%
Specific allowance				345				13.1	%		430				21.7	%		735				25.9	%
Unallocated allowance				36				1.4	%		168				8.5	%		85				3.0	%
Total				$	2,626			100.0	%		$	1,984			100.0	%		$	2,835			100.0	%

 

				As of December 31,
				2001							2000
Balance at End of Period Applicable to				Amount			% of Allowance to Total				Amount			% of Allowance to Total
				(dollars in thousands)
Formula allowance				$	2,976			68.2	%		$	4,998			92.8	%
Specific allowance				1,388				31.8	%		386				7.2	%
Unallocated allowance				—				0.0	%		—				0.0	%
Total				$	4,364			100.0	%		$	5,384			100.0	%

 

Investment Activities

Our investment policy as established by our board of directors attempts to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complement our lending activities. Specifically, our policies limit investments to U.S. government securities, federal agency-backed securities, non-government guaranteed securities, municipal bonds, corporate bonds and mutual funds comprised of the above.

Our investment securities portfolio amounted to $44.8 million at December 31, 2004, as compared to $48.3 million at December 31, 2003. As of December 31, 2004, the portfolio consisted of $9.2 million of mortgage-backed securities, $27.2 million of mutual funds, and $8.4 million of FHLB stock. The decrease in securities in 2004 is primarily due to the sale or termination of the three residual interest components of a participation contract, (the terms of which are discussed below, the “Participation Contract”), the sale of $2.0 million of the mutual funds, and the receipt of the principal of the Veteran Administration mortgage-backed security, partially offset by a $6.0 million increase in FHLB stock.

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At December 31, 2004, our $9.2 million mortgage-backed security is guaranteed by Freddie Mac and is accounted for as available for sale. The mutual fund investments are comprised of two separate funds under the Shay Asset Management Funds, with $17.1 million invested in the Adjustable Rate Mortgage (“ARM”) Fund and $10.1 million in the Intermediate Fund. The ARM Fund invests in U.S. government agency adjustable-rate mortgage-backed securities, fixed and floating-rate collateralized mortgage obligations and investment grade corporate debt instruments. The Intermediate Fund invests in mortgage-backed securities, U.S. government notes and U.S. government agency debentures. We may increase or decrease our investment in mortgage-backed securities and mutual funds in the future depending on our liquidity needs and market opportunities.

On December 31, 1999, the Company sold, pursuant to the Participation Contract, its residual mortgage-backed securities retained from prior securitizations, namely 1997-2, 1997-3 and 1998-1, and related mortgage servicing rights for $19.4 million in cash and other consideration and realized a pretax loss of $29.1 million. The Participation Contract represents a contractual right from the purchase of the residual mortgage-backed securities to receive 50% of any cash realized, as defined, from the residual mortgage-backed securities. The Company valued the contractual right at its estimated fair value of $9.3 million at December 31, 1999. Our right to receive cash flows under the contract was to begin after the purchaser recaptured its initial cash investment of $5.1 million, and satisfied certain other conditions including a 15% internal rate of return.

The Participation Contract was sold to the Corporation by the Bank in January 2002. It was recorded on our financial statements at December 31, 2003 at approximately $6.0 million. We had determined the estimated fair value utilizing a cash flow model which determines the present value of the estimated expected cash flows from this contract using a discount rate we believe is commensurate with the risks involved. Beginning in June 2001, the residual assets underlying the Participation Contract began to generate cash flow to the lead participants in the contract. We began receiving cash from the Participation Contract during the second quarter of 2002. In 2004, we received $10.4 million and over the last three years we received a total of $16.2 million. The three securitizations were terminated and their assets sold during 2004; however, we still retain the rights to 50% of the recoveries of amounts charged off in the 1997-2 and 1997-3 securitizations prior to the terminations. We have chosen, due to the uncertainty of the collections on these amounts, to not place a value on our rights to such recoveries.

The following table sets forth certain information regarding the carrying and fair values of the Company’s securities at the dates indicated:

		2004						2003
		Carrying Value			Fair Value			Carrying Value			Fair Value
		(in thousands)
Available for sale:
Mortgage-backed securities		$	9,214		$	9,214		$	10,375		$	10,375
Mutual funds		27,241			27,241			29,470			29,470
Total securities available for sale		36,455			36,455			39,845			39,845
Held to maturity:
Participation Contract		—			—			5,977			7,342
FHLB Stock		8,389			8,389			2,430			2,430
Total securities and Participation Contract held to maturity		8,389			8,389			8,407			9,772
Total securities and Participation Contract		$	44,844		$	44,844		$	48,252		$	49,617

 

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