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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
Commission File No: __________
TEMECULA VALLEY BANCORP INC.
(Name of Registrant in its charter)
California 46-0476193
(State or other jurisdiction of (I.R.S. Employer
incorporate or organization) Identification No.)
27710 Jefferson Avenue - Suite A100 92590
Temecula, California (Zip Code)
(Address of principal executive offices)
Registrant's telephone number (951) 694-9940
Securities registered under Section 12(b) of Exchange Act: None
Securities registered under Section 12(g) of Exchange Act:
Common Stock, No Par Value
Check whether the Registrant (1) filed all reports 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-K contained in this form and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
YES [X] NO [ ]
The aggregate market value of the common stock held by non-affiliates of the
Registrant as of June 30, 2004 was approximately $116,800,000.
Number of Registrant's shares of common stock outstanding at March 20, 2005 was
8,812,283.
Documents incorporated by reference: Certain information required by Part III of
this Annual Report is incorporated by reference from the Registrant's definitive
proxy statement to be filed with the Securities and Exchange Commission pursuant
to Regulation 14A not later than 120 days after the end of the fiscal year
covered by this Annual Report.
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1
TABLE OF CONTENTS
PART I ...........................................................................................................4
ITEM 1: BUSINESS........................................................................................4
ITEM 2: PROPERTIES.....................................................................................37
ITEM 3: LEGAL PROCEEDINGS..............................................................................37
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER.............................................38
PART II .........................................................................................................38
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..........................38
ITEM 6. SELECTED FINANCIAL DATA........................................................................41
ITEM 7: MANAGEMENT DISCUSSION AND ANALYSIS.............................................................43
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................60
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................................61
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...........99
ITEM 9A: CONTROLS AND PROCEDURES........................................................................99
ITEM 9B: OTHER INFORMATION ............................................................................102
PART III .......................................................................................................103
ITEM 10: DIRECTORS AND PRINCIPAL OFFICERS..............................................................103
ITEM 11: EXECUTIVE COMPENSATION........................................................................103
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................104
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................104
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES........................................................104
PART IV.........................................................................................................105
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES.......................................................105
EXHIBITS
10.10 First Amendment to James W. Andrews Employment Agreement dated
November 24, 2004
10.11(a) Form of ISO Stock Option Agreement for Employee Plan
10.12(a) Form of NSO Stock Option Agreement for Director Plan
10.17(b) Form of NSO Stock Option Agreement for Stock Incentive Plan
10.17(c) Form of ISO Stock Option Agreement for Stock Incentive Plan
10.25 Robert Flores Employment Agreement dated January 27, 2007
10.27 Amended and Restated Salary Continuation Agreement between
Thomas M. Shepherd and Temecula Valley Bank dated September 30,
2004
10.28 Split Dollar Agreement between Thomas M. Shepherd dated
September 30, 2004
10.29 Amended and Restated Salary Continuation Agreement between
Donald A. Pitcher and Temecula Valley Bank dated September 30,
2004
10.30 Split Dollar Agreement between Temecula Valley Bank and Donald
A. Pitcher dated September 30, 2004
10.31 William H. McGaughey Employment Agreement dated January 4, 2005
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certifications
2
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR"
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
We have made forward-looking statements in this document that are subject
to risks and uncertainties. These statements are based on the beliefs and
assumptions of our management, and on information currently available to our
management. Forward-looking statements include the information concerning our
possible or assumed future results of operations, and statements preceded by,
followed by, or that include the words "will," believes," "expects,"
"anticipates," "intends," "plans," "estimates" or similar expressions.
Our management believes these forward-looking statements are reasonable.
However, you should not place undue reliance on the forward-looking statements,
since they are based on current expectations. Actual results may differ
materially from those currently expected or anticipated.
Forward-looking statements are not guarantees of performance. They involve
risks, uncertainties and assumptions. Our future results and shareholder values
may differ materially from those expressed in these forward-looking statements.
Many of the factors described below that will determine these results and values
are beyond our ability to control or predict. For those statements, we claim the
protection of the safe harbor contained in the Private Securities Litigation
Reform Act of 1995.
A number of factors, some of which are beyond our ability to predict or
control, could cause future results to differ materially from those
contemplated. These factors include but are not limited to (1) a slowdown in the
national and California economies; (2) economic uncertainty created by terrorist
threats and attacks on the United States and the actions taken in response; (3)
the prospect of additional terrorist attacks in the United States and the
uncertain effect of these events on the national and regional economies; (4)
changes in the interest rate environment; (5) changes in the regulatory
environment; (6) increasing competitive pressure in the banking industry; (7)
operational risks including data processing system failures or fraud; (8) the
effect of acquisitions and integration of acquired businesses; (9) volatility of
rate sensitive deposits; (10) asset/liability matching risks and liquidity
risks; and (11) changes in the securities markets. The consequences of these
factors, any of which could hurt our business, could include, among others: (a)
increased loan delinquencies; (b) an escalation in problem assets and
foreclosures; (c) a decline in demand for our products and services; and (d) a
reduction in the value of the collateral for loans made by us, especially real
estate, which, in turn would likely reduce our customers' borrowing power and
the value of assets and collateral associated with our existing loans. See also
"Additional Factors That May Affect Future Results of Operations" in Item 1 and
other risk factors discussed elsewhere in this Annual Report.
3
PART I
ITEM 1: BUSINESS
General
Where You Can Find More Information
Under Sections 13 and 15(d) of the Securities Exchange Act, periodic and
current reports must be filed with the Securities and Exchange Commission
("SEC"). We electronically files the following reports with the SEC: Form 10-K
(Annual Report), Form 10-Q (Quarterly Report), Form 8-K (Report of Unscheduled
Material Events), and Form DEF 14A (Proxy Statement). We may file additional
forms. The SEC maintains an Internet site, www.sec.gov, by which all forms filed
electronically may be accessed. Additionally, shareholder information is
available on our website: www.temvalbank.com. We make our website content
available for information purposes only. It should not be relied upon for
investment purposes. Additionally, neither our website, nor the links within our
website are incorporated into this document.
Temecula Valley Bancorp Inc.
We formed Temecula Valley Bancorp Inc. ("Company") in 2002 to serve as a
holding company for Temecula Valley Bank, N.A. ("Bank"). We reincorporated the
Company from Delaware into California in December 2003. The Company is a bank
holding company registered with the Board of Governors of the Federal Reserve
System ("Federal Reserve") under the Bank Holding Company Act of 1956, as
amended ("BHCA"). The Company's activities consist of owning the outstanding
shares of the Bank, Temecula Valley Statutory Trust I, Temecula Valley Statutory
Trust II and Temecula Valley Statutory Trust III. References to the "Company"
reflects all the activities of the Company and its subsidiaries, including the
Bank, except as otherwise specified by the context of the statement.
Temecula Valley Bank, N.A.
The Bank was organized in 1996 and commenced operations on December 16,
1996 as a national banking association. As a national bank, the Bank is subject
to primary supervision, regulation and examination by the Comptroller of the
Currency ("Comptroller"). The deposits of the Bank are insured by the Federal
Deposit Insurance Corporation ("FDIC") up to the applicable limits. As a
national bank, the Bank is a member of the Federal Reserve System. The Bank has
no subsidiaries.
General Business
The Bank currently has seven full-service banking offices in California
providing services to customers in the Riverside and San Diego Counties. Our
principal office is located in Temecula, California with other California
full-service offices in Corona, El Cajon, Escondido, Fallbrook, Murrieta, and in
the Rancho Bernardo area of San Diego. The Bank anticipates it will open branch
offices in Carlsbad and Indian Wells, both in California, within the next six to
eighteen months.
4
The Bank also operates loan production offices, which offices principally
generate construction and/or mortgage loans in California at the following
locations: Encinitas, Fallbrook and Temecula and Indian Wells. The real estate
industries group of the Bank focuses on construction lending and maintains loan
production offices in Corona and San Rafael, both in California. The Bank also
has SBA loan production offices (some of which are home offices ) in the
following cities in California: Anaheim Hills, Chico, Fresno, Sacramento and
Sherman Oaks (this office will close in June 2005), in Florida: Coral Springs,
Jacksonville, Panama City Beach and St. Petersburg, in Georgia: Jessup, in
Illinois: Gurnee, in New Hampshire: Lee, in New Jersey: Basking Ridge, Ocean
City and Randolph, in North Carolina: Clemmons, in Ohio: Dublin and Kirtland,
and in Washington: Bellevue.
The Bank offers a broad range of banking services, including personal and
business checking accounts and various types of interest-bearing deposit
accounts, including interest-bearing checking, money market, savings, IRA, SEP
and time certificates of deposits. Loan products include consumer installment
(primarily automobile loans), home equity lines of credit, single-family
residential construction loans on both an owner-occupied and a speculation
basis, single family residential tract loans (over 4 units), commercial
construction and permanent loans for office, retail and industrial buildings for
owner-occupancy, investment and speculative re-sale, commercial lines of credit,
term loans and letters of credit for local businesses, and residential mortgage
financing including conventional, VA, FHA and Cal-Vet loans. In addition, the
Bank has developed a nationwide SBA lending program as a "preferred lender".
Through this program we originate and fund both "7A" and "504" loans, primarily
secured by commercial real estate property and guaranteed up to 85% by the Small
Business Administration.
We fund our lending activities primarily from our core deposit base. We
obtain deposits from the local market with no material portion (in excess of 10%
of total deposits) dependent upon any one person, entity or industry.
The Bank also offers safe deposit boxes, night depository facilities,
merchant credit card services, notary services, travelers checks, note
collection, wire transfer services, cashiers checks, drive up facilities at some
locations, 24 hour ATM banking services, telephone banking, internet banking,
direct deposit and automatic transfers between accounts. The Bank is a member of
regional ATM networks and offer nationwide ATM access.
The Company as the parent of the Bank has no operations and conducts no
business of its own other than owning the Bank, Temecula Valley Statutory Trust
I, Temecula Valley Statutory Trust II and Temecula Valley Statutory Trust III.
Accordingly, the discussion of the business which follows concerns the business
conducted by the Bank, unless otherwise indicated. No material portion of our
Company's business is seasonal.
5
Business Strategy
The Board has established the following goals for the Company:
o Increase market share through expansion of the branching system and
loan production offices;
o Continued focus on expansion of the SBA programs and possibly other
government sponsored lending programs;
o Increase profitability and core earnings;
o Maintain consistent superior credit quality;
o Increase core deposit levels and loan volume.
The Company's profitability goals have been realized historically by
increases in net interest income and non-interest income as well as expense
controls during a time of significant internal expansion. This produced record
earnings for 2004 of $10,577,623, compared to $7,854,339 in 2003 and $4,191,054
in 2002. Return on average equity was 28.94% for 2004 compared to 31.84% in 2003
and 24.34% in 2002. Return on average total assets was 2.00% for 2004 compared
to 2.04% for 2003 and 1.69% for 2002. Management expects that during 2005, net
income will increase over the results in 2004 by at least 10% but cannot
guarantee these results.
Net interest income before provision for loan losses has increased to
$27,200,344 for 2004 compared to $18,943,947 in 2003 and $13,384,759 in 2002 due
to increases in interest earning assets even with a declining net interest
margin. Total assets increased 41% to $606,827,529 as of December 31, 2004,
compared to $431,212,118 as of December 31, 2003 and $310,506,097 as of December
31, 2002. Average interest earning assets increased 36% to $454,759,000 for 2004
compared to 334,005,000 in 2003 and $214,832,000 in 2002. The net interest
margin has decreased from 6.23% in 2002 to 5.67% in 2003 and increased to 5.96%
in 2004.
Non-interest income is a significant portion of the profits for the Company
demonstrated by the increase to $28,698,614 for 2004 compared to $24,481,351 in
2003 and $17,941,643 in 2002. This source of income is principally derived from
SBA and mortgage sales related lending activities. The increases each year are
primarily the result of increases in gain on sale of loans, increased levels of
servicing income and concurrent increases in other fee income. Management
currently anticipates that for 2005, non-interest income will continue to
improve but not as dramatically as in 2004 and 2003.
The Company measures operating expenses as a percentage of average assets.
As a percentage of average assets, operating expenses decreased to 6.40% for
2004 compared to 7.55% for 2003 and 8.80% for 2002. This ratio is higher than
peer group comparisons, but is offset by non-interest income that is much higher
than the peer group. The Company expects this ratio to improve slightly in 2005
as the Company gains efficiencies of scale due to growth, which will be offset
by new branch openings and expansion of the SBA department.
6
Lending
Loan Portfolio Composition
The following table summarizes our loan portfolio, excluding deferred loan
fees and the allowance for loan loss, by type of loan and their percentage
distribution:
At December 31,
2004 2003 2002 2001 2000
--------------- ---------------- ---------------- --------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Loan portfolio composition:
Commercial $ 24,676 4% $ 33,008 9% $ 44,976 16% $ 22,775 15% $ 13,621 15%
Real estate - Construction 203,886 38% 113,847 31% 61,568 23% 38,027 25% 23,602 25%
Real estate - Other 302,542 57% 212,996 59% 161,767 59% 84,992 57% 51,433 56%
Consumer 2,796 1% 3,195 1% 4,455 2% 5,170 3% 4,359 4%
-------- --- --------- --- --------- --- -------- --- -------- ---
Total Loans $533,900 100% $363,046 100% $272,766 100% $150,964 100% $ 93,015 100%
======== ==== ======== ==== ======== ==== ======== ==== ======== ====
Loan Maturity
The following table sets for the contractual maturities of the Company's
gross loans at December 31, 2004.
One year More than 1 More than 3 More than Total
or less year to 3 years years to 5 years 5 years loans
-------------- ----------------- ----------------- ----------------- ------------
(Dollars in Thousands)
Commercial $ 57,469 $4,044 $1,909 $ 3,032 $ 46,025
Real estate - construction 246,390 847 791 1,227 249,257
Real estate - other 165,471 7,716 9,271 37,249 219,707
Consumer 2,137 1,203 591 4,221 8,152
--------- ------ ------ -------- ---------
Total Gross loans outstanding $ 471,467 $13,810 $12,562 $ 45,729 $ 543,570
========= ======= ======= ======== =========
7
The following table sets forth, as of December 31, 2004, the dollar amounts
of net loans outstanding that are contractually due after December 31, 2005 and
whether such loans have fixed or adjustable rates.
Due after December 31, 2005
------------------------------------------------------------
Fixed Adjustable Total
------------------------------------------------------------
(Dollars in Thousands)
Commercial $ 8,395 $ 590 $ 8,985
Real estate - construction 2,865 0 2,865
Real estate - other 50,609 3,627 54,236
Consumer 6,015 0 6,015
-------- ------- --------
Total Gross loans outstanding $ 67,884 $ 4,217 $ 72,111
======== ======= ========
Loan Origination and Sale
The following table sets forth the Company's loan originations by category
and purchases, sales and principal repayments of loans for the periods
indicated:
At December 31,
----------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------------- --------------- ---------------- ---------------- --------------
(Dollars in Thousands)
Beginning balance $363,046 $272,766 $150,964 $93,015 $ 56,196
Loans originated:
Commercial 237,064 161,376 144,399 84,285 68,072
Real estate:
SBA & Equity 225,373 192,549 166,563 73,488 25,597
Construction 574,150 367,464 186,741 88,868 50,586
Other 44,942 96,051 85,281 60,711 11,139
Consumer 1,869 2,422 4,298 5,136 5,312
-------- -------- -------- ------- -------
Total loans originated 1,083,398 819,862 587,282 312,488 160,706
-------- -------- -------- ------- -------
Loans sold
Commercial
Real estate:
SBA 199,236 129,813 108,213 44,046 12,336
Construction 0 0 0 0 0
Other - Mortgage 45,243 100,800 83,014 62,099 10,439
-------- -------- -------- ------- -------
Total loans sold 244,479 230,613 191,227 106,145 22,775
-------- -------- -------- ------- -------
Less:
Principal repayments 668,065 498,969 274,253 148,394 101,112
Total loans $533,900 $363,046 $272,766 $150,964 $93,015
======== ======== ======== ======= =======
Brokered Loans Originated (1)
Mortgage $60,604 $ 65,378 $ 72,742 $ 60,953 $36,172
SBA $154,515 $ 65,456 $ 29,612 $ 17,075 $ 0
(1) Brokered refers to loans that were originated by the Bank but funded by
other financial institutions.
8
Underwriting Process
The lending activities of the Company are guided by the basic lending
policies established by the Board of Directors. Each loan must meet minimum
underwriting criteria established in the Company's lending policies and must fit
within the Company's strategies for yield and portfolio enhancement.
For all newly originated loans, upon receipt of a completed loan
application from a prospective borrower, a credit report is ordered and, if
necessary, additional financial information is requested. An independent
appraisal is required on every property securing a Company loan in excess of
$250,000. In addition, the loan officer conducts a review of these appraisals
for accuracy, reasonableness and conformance to the Company's lending policy on
all applications. All revisions to the Company's approved appraiser list must be
approved by the Chief Credit Officer or Assistant Chief Credit Officer.
Credit approval authority is segregated into three levels; the Board of
Directors; the Management Loan Committee, where actions are reviewed and
ratified by the Directors Loan Committee and the individual lending limits of
loan officers. The limits for the various levels are determined by the Board of
Directors and/or the President and reviewed periodically. The Board of Directors
approves loans to insiders and meets monthly or more frequently if needed. The
Management Loan Committee consists of the President, Executive Vice
President/Real Estate Manager, the Executive Vice President/Chief Credit
Officer, the Senior Vice President/Assistant Chief Credit Officer and Executive
Vice President/Senior Loan Officer. The committee is chaired by the Chief Credit
Officer and meets bi-weekly or more frequently as needed.
If the loan is approved, the loan commitment specifies the terms and
conditions of the proposed loan including the amount, interest rate,
amortization term, a brief description of the required collateral, and the
required insurance coverage. Generally, the borrower must provide proof of fire,
flood (if applicable) and casualty insurance on the property serving as
collateral, which insurance must be maintained during the full term of the loan.
Also, generally, title insurance endorsed to the Company is required on all real
estate secured loans.
The Company maintains SBA loan production offices located throughout the
United States. The SBA loan production offices are typically staffed with a
business development officer who prepares the loan applications and compiles the
necessary information regarding the applicant. The other construction lending
and mortgage related loan production offices, all of which are in California,
are typically staffed with business development officers, underwriters, and
processors who send these loans files to the Company's main office where the
credit decision is made. Our retail full service branches may include non-SBA
commercial, mortgage and construction loan officers.
9
SBA Lending Programs
The SBA lending programs are designed by the federal government to assist
the small business community in obtaining financing from financial institutions
that are given government guarantees as an incentive to make the loan. The
Company is a "Preferred Lender" with the SBA. As a "Preferred Lender," the
Company can approve a loan within the authority given it by the SBA without
prior approval from the SBA. "Preferred Lenders" approve, package, fund and
service SBA loans within a range of authority that is not available to other SBA
lenders without the "Preferred Lender" designation.
The Company's SBA loans fall into two categories, loans originated under
the SBA's 7a Program ("7a Loans") and loans originated under the SBA's 504
Program ("504 Loans"). For 2004, 7a Loans have represented approximately 67.4%
of the SBA Loans originated by the Company while 504, piggyback, and B&I loans
have represented the balance.
Under the SBA's 7a Program, loans in excess of $150,000 are guaranteed 75%
by the SBA. Generally, this guarantee may become invalid only if the loan does
not meet the SBA underwriting, documentation, and servicing guidelines. Loans
under $150,000 are guaranteed 85% by the SBA.
In general, during 2004 the Company's policy permits SBA 7a Loans in
amounts up to $2,000,000. Loans collateralized by real estate have terms of up
to 25 years, while loans collateralized by equipment and working capital have
terms of up to 10 years and 7 years, respectively. The Company requires a 10%
down payment on most 7a Loans, with a 15% to 20% down payment on loans
collateralized by hotels, motels and service stations.
The Company sells the guaranteed portion SBA-7A loans, which is usually 75%
of the loan. The remaining portion is the unguaranteed portion of the loans, a
portion of which may also be sold. Approximately 5% of the 7a loans are required
to stay on the books of the Company. Funding for these loans has come
principally from retail deposit sources. The SBA loans generally have an
interest rate of 1.50% to 2.50% over Wall Street Journal Prime Rate.
The Company retains the servicing on the sold guaranteed portion of 7a
Loans. The strategy of selling both the guaranteed and unguaranteed portion of
the 7a Loans allows the Company to manage its capital levels and to ensure that
funding is always available to meet the local community loan demand. Upon sale
in the secondary market, the purchaser of the guaranteed portion of 7a Loans
pays a premium to the Company, which generally is between 8% and 10% of the
guaranteed amount and in the case of a sale of the unguaranteed portion, the
premium is usually between 1% and 4%. The Company also receives a servicing fee
equal to 1% to 5% of the guaranteed amount sold in the secondary market. In the
event that a 7a Loan goes into default within 270 days of its sale, or prepays
within 90 days, the Company is required to repurchase the loan and refund the
premium to the purchaser. In the past three years, the Company has repurchased
28 loans, however only 1 of these repurchased loans required a refund of the
premium. No refunds were owed on the other 27 loans repurchased.
10
Under the SBA's 504 Program, the Company requires a 10% down payment. The
Company then enters into a 50% first trust deed loan to the borrower and an
interim 40% second trust deed loan. The first trust deed loan has a term of 20
years. The second trust deed loan is for a term of 120 days. Within the 120 day
period of entering into the loan, the second trust deed loans are refinanced by
SBA certified development companies and used as collateral for SBA guaranteed
debentures. For 504 construction loans, the 120 day period does not commence
until the notice of completion is filed. The first trust deed loans may be
pre-sold by the Company with no recourse, prior to releasing the funds to the
purchaser. The Company retains no servicing on 504 Loans after they are sold.
The Company's SBA lending program and portions of its real estate lending
are dependent on the continual funding and programs of certain federal agencies
or quasi-government corporations including the SBA. The guaranteed portion of an
SBA loan does not count towards the Company's loans-to-one-borrower limitation
which, at December 31, 2004 was $10,115,471.
SBA lending is a federal government created and administered program. As
such, legislative and regulatory developments can affect the availability and
funding of the program. This dependence on legislative funding and regulatory
restrictions from time to time causes limitations and uncertainties with regard
to the continued funding of such loans, with a resulting potential adverse
financial impact on the Company's business. Currently, the maximum limit of
individual 7a Loans which the SBA will permit is $2,000,000; however, last year,
at this time, the limit was $750,000. Any reduction, like the one we experienced
last year, could have a negative impact on the Company's business. Since the SBA
lending of the Company constitutes a significant portion of the Company's
lending business, this dependence on this government program and its periodic
uncertainty with availability and amounts of funding creates greater risk for
the Company's business than does other parts of its business.
Commercial Lending/Real Estate Lending
Generally, our commercial loans are underwritten in our market area on the
basis of the borrower's ability to service such debt from identified cash flow.
We usually take as collateral a lien on available real estate, equipment or
other assets and obtain a personal guaranty of the business principals.
In addition to commercial loans secured by real estate, we make commercial
mortgage loans to finance the purchase of real property, which generally
consists of real estate on which structures have already been completed or will
be completed and occupied by the borrower. We offer a variety of mortgage loan
products that generally are amortized over five to 25 years. Our commercial
mortgage loans are secured by first liens on real estate. Typically, we have
both fixed and variable interest rates and amortize over a 10 to 25 year period
with balloon payments due at the end of three to ten years. As a Preferred SBA
Lender (discussed above), we also issue full term variable rate real estate loan
commitments when the facility is enhanced by the underlying SBA guaranty. In
underwriting commercial mortgage loans, consideration is given to the property's
operating history, future operating projections, current and projected
occupancy, location and physical condition. The underwriting analysis also
includes credit checks, appraisals, environmental assessments and a review of
the financial condition of the borrower.
11
Construction Lending
The Company originates construction loans on both one- to four-family
residences and on commercial real estate properties. The Company originates two
types of residential construction loans, owner-occupied and speculative. The
Company originates owner-occupied construction loans to build single family
residences. The Company will originate speculative construction loans to
companies engaged in the business of constructing homes for resale. These loans
may be for homes currently under contract for sale or homes built for
speculative purposes to be marketed for sale during construction. For owner
occupied single family residences, the borrower and the property must qualify
for permanent financing. Prequalification for owner occupied single family
residences is required. For commercial property, the borrower must qualify for
permanent financing and the debt service coverage must be 1.20 to 1 or more.
Qualification for commercial properties can be determined by the loan officer as
part of the credit presentation. Absent such prequalification, a construction
loan will not be approved by the Company. The Company originates land
acquisition and development loans with the source of repayment being either the
sale of finished lots or the sale of homes to be constructed on the finished
lots. Construction loans are generally offered with terms up to 18 months.
Construction loans are generally made in amounts up to 75% of the value of
the security property for "spec" single family residences and commercial
properties and up to 80% for owner-occupied single family residences. During
construction, loan proceeds are disbursed in draws as construction progresses
based upon inspections of work in place by independent construction inspectors.
At December 31, 2004, the Company had construction loans, including land
acquisition and development loans totaling $203,885,627 or 38.2% of the
Company's total loan portfolio.
Construction loans are generally considered to involve a higher degree of
credit risk than long-term financing on improved, owner-occupied real estate.
Risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the security property's value upon completion of
construction as compared to the estimated costs of construction, including
interest. Also, the Company assumes certain risks associated with the borrower's
ability to complete construction in a timely and workmanlike manner. If the
estimate of value proves to be inaccurate, or if construction is not performed
timely or accurately, the Company may be confronted with a project which, when
completed, has a value which is insufficient to assure full repayment.
Consumer Lending
Consumer loans include automobile loans, recreational vehicle loans, boat
loans, home improvement loans, home equity lines of credit, personal loans
(collateralized and uncollateralized) and deposit account collateralized loans.
The terms of these loans typically range from 12 to 120 months and vary based
upon the nature of collateral and size of loan. The Company's portfolio of
consumer loans primarily consists of installment loans secured by new or used
automobiles, boats and recreational vehicles and loans secured by deposits. At
December 31, 2004, consumer loans totaled $2,796,327.
12
As of December 31, 2004, home equity loans totaled $4,481,655, or 0.8% of
the Company's gross loan portfolio. The Company's home equity loans are
adjustable-rate and reprice with changes in the Company's internal prime rate.
Adjustable-rate home equity lines of credit are offered in amounts up to 80% of
the appraised value. Home equity lines of credit are offered with terms up to 10
years.
Loan Servicing
Loans are serviced by the Company's loan servicing department except for
single family mortgage loans, which are sold shortly after being originated. The
loan officer is responsible for the day-to-day relationship with the customer,
unless the loan becomes delinquent, at which time the responsibilities are
reassigned to credit administration. The loan servicing is centralized at the
Company's corporate headquarters. As of December 31, 2004, the Company was
servicing $440,301,270 of loans originated by the Company that were sold to
other investors.
The Company's loan servicing operations performed by the loan servicing
department are intended to provide prompt customer service and accurate and
timely information for account follow-up, financial reporting and management
review. Following the funding of an approved loan, all pertinent loan data is
entered into the Company's data processing system, which provides monthly
billing statements, tracks payment performance, and effects agreed upon interest
rate adjustments on loans. Regular loan service efforts include payment
processing and collection notices, as well as tracking the performance of
additional borrower obligations with respect to the maintenance of casualty
insurance coverage, payment of property taxes and senior liens. When payments
are not received by their contractual due date, collection efforts begin on the
11th day of delinquency with a telephone contact. If the borrower is
non-responsive or the loan officer feels more stringent action may be required,
the Chief Credit Officer is consulted. Notices of default are generally filed
when the loan has become 30-90 days past due.
Credit Risk and Loan Review
The Company incurs credit risk whenever it extends credit to, or enters
into other transactions with, its customers. The risks associated with
extensions of credit include general risk, which is inherent in the lending
business, and risk specific to individual borrowers. Loan review and other loan
monitoring practices provide a means for the Company's management to ascertain
whether proper credit, underwriting and loan documentation policies, procedures
and practices are being followed by the Company's loan officers and are being
applied uniformly throughout the Company. The Chief Credit Officer, and the
Assistant Chief Credit Officer oversees the daily administration of loan review.
They also approve loan officer requests for changes in risk ratings. Loan
officers are responsible for continually grading their loans so that individual
credits properly reflect the risk inherent therein. On an semi-annual basis, the
Board of Directors provides for a third-party outside loan review of all loans
that meet certain criteria originated since the previous review. While the
Company continues to review these and other related functional areas, there can
be no assurance that the steps the Company has taken to date will be sufficient
to enable it to identify, measure, monitor and control all credit risk.
13
Concentrations of Credit
The Company's primary investment is in loans, 94.9% of which are secured by
real estate. Therefore, although the Company monitors the real estate loan
portfolio on a regular basis to avoid undue concentrations to a single borrower
or type of real estate collateral, real estate in general is considered a
concentration of investment. The Company seeks to mitigate this risk by
requiring each borrower to have a certain amount of equity in the real estate at
the time of origination, depending on the type of real estate and the credit
quality of the borrower. Trends in the market are monitored closely by
management on a regular basis.
Under federal law, the Company's ability to make aggregate
loans-to-one-borrower is limited to 15% of unimpaired capital and surplus (as of
December 31, 2004, this amount was $10,115,471) plus an additional 10% of
unimpaired capital and surplus if a loan is secured by readily-marketable
collateral (defined to include only certain financial instruments, cash
equivalent collateral and gold bullion).
Investment Activities
The investment policy of the Company, as established by the Board of
Directors, attempts to provide for and maintain liquidity, generate a favorable
return on investments without incurring undue interest rate and credit risk, and
complement the Company's lending activities. The Company's policies provide the
authority to invest in bank-qualified securities. The Company's policies provide
that all investment purchases, that are outside the policy guidelines, be
approved by the Board of Directors or committee thereof. Purchases and sales
under this limitation and within the guidelines of the policies may be completed
in the discretion of the President, the Chief Financial Officer or the Chief
Operating Officer. At December 31, 2004, the Company held $2,377,800 in Federal
Reserve Bank Stock and Federal Home Loan Bank stock as well as $16,800,000 in
federal funds sold.
Asset/Liability Management
Interest rate risk ("IRR") and credit risk are the two greatest sources of
financial exposure for insured financial institutions. IRR represents the impact
that changes in absolute and relative levels of market interest rates may have
upon the Company's net interest income ("NII"). Changes in the NII are the
result of changes in the net interest spread between interest-earning assets and
interest-bearing liabilities (timing risk), the relationship between various
rates (basis risk), and changes in the shape of the yield curve.
The Company realizes a significant portion of its income from the
differential or spread between the interest earned on loans, investments, other
interest-earning assets and the interest incurred on deposits. The volumes and
yields on loans, deposits and borrowings are affected by market interest rates.
As of December 31, 2004, 95.8% of the Company's loan portfolio was tied to
adjustable rate indices. The majority of the adjustable rate loans are tied to
Wall Street Journal prime rate and reprice immediately. The exception is 7a
Loans, which reprice on the first day of the subsequent quarter after a change
in prime. As of December 31, 2004, 52.5% of the Company's deposits were time
deposits with a stated maturity (generally one year or less) and a fixed rate of
interest. As of December 31, 2004, 100% of the Company's borrowings were
floating rate with a remaining term of 28-30 years.
14
Changes in the market level of interest rates directly and immediately
affect the Company's interest spread, and therefore profitability. Sharp and
significant changes to market rates can cause the interest spread to shrink or
expand significantly in the near term, principally because of the timing
differences between the adjustable rate loans and the maturities (and therefore
repricing) of the deposits and borrowings.
Measuring the volume of repricing or maturing assets and liabilities, a
Static Gap analysis, does not always measure the full impact on net interest
income. Static Gap analysis does not account for rate caps on products; dynamic
changes such as increasing prepay speeds as interest rates decrease, basis risk,
or the benefit of non-rate funding sources. The relation between product rate
repricing and market rate changes (basis risk) is not the same for all products.
Consequently, in addition to GAP analysis, we use a simulation model and shock
analysis to test the interest rate sensitivity of net interest income and the
balance sheet, respectively. Contractual maturities and repricing opportunities
of loans are incorporated in the model as are prepayment assumptions, maturity
data and call options within the investment portfolio. Assumptions based on past
experience are incorporated into the model for non-maturity deposit accounts. We
have found that historically interest rates on these deposits change more slowly
in a rising rate environment than in a declining rate environment. Management
expects to experience higher net interest income when rates rise.
Contractual Static GAP Position as of December 31, 2004
-------------------------------------------------------
Within Three Months Year But
Three But Within Within After
Months One Year Five Years Five Years Total
-------- ------------ ---------- ---------- -----------
(Dollars in Thousands)
Interest-Earning Assets:
Federal Funds Sold $ 16,800 $ 0 $ 0 $ 0 $ 16,800
Certificates of Deposit 0 0 0 0 0
Investment Securities 0 0 0 0 0
Loans 455,939 37,749 35,256 4,956 533,900
-------- ------------ ---------- ---------- -----------
Total $ 472,739 $ 37,749 $ 35,256 $ 4,956 $ 550,700
-------- ------------ ---------- ---------- -----------
Interest-Bearing Liabilities
Money Market and NOW $ 73,880 $ 0 $ 0 $ 0 $ 73,880
Savings 41,839 0 0 0 41,839
Time Deposits 141,288 138,743 965 10 281,006
Other Borrowings 20,000 0 0 620 20,620
-------- ------------ ---------- ---------- -----------
Total $ 277,007 $ 138,743 $ 965 $ 630 $ 417,345
-------- ------------ ---------- ---------- -----------
Period GAP $ 195,732 $ (100,994) $ 34,291 $ 4,326
Cumulative GAP 195,732 94,738 129,029 133,355
Period GAP to Total Assets 32.3% (16.6)% 5.6% 0.7%
Cumulative 32.3% 15.6% 21.3% 22.0%
GAP
Total Assets $ 606,827
==========
15
The following table shows the effects of changes in projected net interest
income for 2005 under the interest rate shock scenarios stated in the table. The
table was prepared as of December 31, 2004, at which time the Company's internal
prime rate was 7.25% and Wall Street Journal prime rate was 4.25%.
Projected Net Change from % Change from
Changes in Rates Interest Income Base Case base Case
- --------------------------- ---------------------------- --------------------------------- ----------------------------
(Dollars in Thousands)
+ 300 bp $35,212 $5,413 18%
+ 200 bp $33,342 $3,543 12%
+ 100 bp $31,492 $1,693 6%
0 bp $29,799 $ 0 0%
-100 bp $30,492 $ 693 2%
-200 bp $31,316 $1,517 5%
-300 bp $32,197 $2,398 8%
Assumptions are inherently uncertain, and, consequently, the model cannot
precisely measure net interest income or precisely predict the impact of changes
in interest rates on net interest income. Actual results will differ from
simulated results due to timing, magnitude and frequency of interest rate
changes, as well as changes in market conditions and management strategy.
Non-Accrual, Past Due and Restructured Loans
Nonperforming assets consist of nonperforming loans and Other Real Estate
Owned (OREO). The Company had $1,908,169 of non-performing loans as of December
31, 2002, of which $1,077,597 was guaranteed by the SBA, compared to $6,764,713
of non-performing loans as of December 31, 2003 of which $5,269,317 was
government guaranteed. At December 31, 2004, the Company had $11,799,346 of
nonperforming loans, $8,140,267 of which were government guaranteed. There was
$302,698 of OREO at December 31, 2004 and $485,036 at year end 2003.
Pursuant to SBA operating procedures, real estate collateral is liquidated
when a loan becomes uncollectible. Should there be a shortfall in liquidation
proceeds of an SBA guaranteed loan, the SBA will assume 75% - 85% of that
shortfall. The ratio of nonperforming loans to total loans (after reducing for
SBA guarantees) was .69%, .41% and .31% for the years ended 2004, 2003, and
2002, respectively.
We generally place a loan on nonaccrual status and cease accruing interest
when loan payment performance is deemed unsatisfactory. All loans past due 90
days, however, are placed on nonaccrual status, unless the loan is both well
secured and in the process of collection. Cash payments received while a loan is
classified as nonaccrual are recorded as a deduction of principal as long as
doubt exists as to collection. We are sometimes required to revise a loan's
interest rate or repayment terms in a troubled debt restructuring. As of
December 31, 2002 restructured loans were $1,064,217 as compared to $948,691 at
December 31, 2003 and $154,303 at December 31, 2004. Our internal loan review
department regularly evaluates potential problem loans as to risk exposure to
determine the adequacy of our allowance for loan losses.
16
We review collateral value on loans secured by real estate during the
internal loan review process. New appraisals are acquired when loans are
categorized as nonperforming or potential problem loans. In instances where
updated appraisals reflect reduced collateral values, an evaluation of the
borrower's overall financial condition is made to determine the need, if any,
for possible write-downs or appropriate additions to our allowance for loan
losses.
The following table presents information concerning nonaccrual loans, OREO,
accruing loans which are contractually past due 90 days or more as to interest
or principal payments and still accruing, and restructured loans:
Nonaccrual, Past Due, and Restructured Loans
December 31,
----------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- -------------- --------------- ------------- -----------
(Dollars in Thousands)
Nonaccrual loans (Gross):
Commercial $ 2,582 $ 949 $ 575 $ 0 $ 0
Real estate - Construction 0 0 0 0 0
Real estate - Other 9,217 5,816 1,333 99 272
Installment 0 0 0 0 0
------------ ------------ ------------- ----------- ----------
Total 11,799 6,765 1,908 99 272
OREO 303 485 0 0 0
------------ ------------ ------------- ----------- ----------
Total nonaccrual loans and OREO $ 12,102 $ 7,250 $1,908 $ 99 $ 272
============ ============ ============= =========== ==========
Total nonaccrual loans as a percentage of 2.2% 1.7% .7% .1% .3%
total loans
Total nonaccrual loans and OREO as a 2.3% 2.0% .7% .1% .3%
percentage of total loans and OREO
Allowance for loan losses to total loans 1.2% 1.0% 1.1% .8% 1.0%
Allowance for loan losses to nonaccrual loans 53.9% 86.7% 158.0% 0% 340.0%
Loans past due 90 days or more on accrual status:
Commercial $ 0 $ 0 $ 0 $ 0 $ 0
Real estate 0 0 0 100 0
Installment 0 0 0 0 0
------------ ------------ ------------- ----------- ----------
Total 0 0 0 0 0
============ ============ ============= =========== ==========
Restructured loans:
On accrual status $ 154 949 1,064 0 0
On nonaccrual status 0 0 0 0 0
------------ ------------ ------------- ----------- ----------
Total $ 154 $ 949 $1,064 $ 0 $ 0
============ ============ ============= =========== ==========
The table below summarizes the approximate changes in gross nonaccrual
loans for the years ended December 31, 2004 and 2003.
17
Changes in Gross Nonaccrual Loans
2004 2003
--------------- -----------
(Dollars in Thousands)
Balance, beginning of the year $ 6,675 $1,908
Loans placed on nonaccrual 5,293 4,041
Charge-offs (1,097) (536)
Loans returned to accrual status 0 0
Repayments (including interest applied to principal) 2,338 2,688
Transfers to OREO (1,410) 1,336
--------------- -----------
Balance, end of year $11,799 $6,765
=============== ===========
The additional interest income that would have been recorded from
nonaccrual loans, if the loans had not been on nonaccrual status was $549,105,
$445,311, and $160,715 for the years ended December 31, 2004, 2003, and 2002,
respectively.
Interest payments received on nonaccrual loans are applied to principal
unless there is no doubt as to ultimate full repayment of principal, in which
case, the interest payment is recognized as interest income. Interest income not
recognized on nonaccrual loans reduced the net interest margin by .12%, .13% and
..07% basis points for the years ended December 31, 2004, 2003, and 2002,
respectively.
Other Real Estate Owned
The amount of the Bank's OREO was $302,698 at December 31, 2004 compared to
$485,036 a year ago. The Bank's policy is to record these properties at
estimated fair value, net of selling expenses, at the time they are transferred
into OREO, thereby tying future gains or losses from sale or potential
additional write-downs to underlying changes in the market.
Potential Problem Loans
At December 31, 2004, in addition to loans disclosed above as past due,
nonaccrual or restructured, management also identified $3,078,845 of additional
classified loans net of SBA guaranteed loans, where the ability to comply with
the present loan payment terms in the future is questionable. However, the
inability of the borrowers to comply with repayment terms was not sufficiently
probable to place these loans on nonaccrual status at December 31, 2004. This
amount was determined based on analysis of information known to management about
the borrowers' financial condition and current economic conditions. Estimated
potential losses from these potential problem loans have been provided for in
determining the allowance for loan losses at December 31, 2004.
Management's classification of credits as nonaccrual, restructured or
problems does not necessarily indicate that the principal is uncollectible in
whole or part.
18
Allowance for Loan Losses
The allowance for loan losses is a reserve established through charges to
earnings in the form of a provision for loan losses. We have established an
allowance for loan losses that we believe is adequate for estimated losses in
our loan portfolio. Based on an evaluation of the loan portfolio, management
presents a quarterly review of the allowance for loan losses to our Board of
Directors, indicating any change in the allowance since the last review and any
recommendations as to adjustments. In making its evaluation, we consider the
diversification by industry of our commercial loan portfolio, the effect of
changes in the local real estate market on collateral values, the results of
recent regulatory examinations, the effects on the loan portfolio of current
economic indicators and their probable impact on borrowers, the amount of
charge-offs for the period, the amount of nonperforming loans and related
collateral security, the evaluation of our loan portfolio through our loan
review function and the annual examination of our financial statements by our
independent auditors. Charge-offs occur when loans are deemed to be
uncollectible.
We follow a loan review program to evaluate credit risk in our loan
portfolio. Through the loan review process, we maintain an internally classified
loan watch list, which along with the delinquency list of loans, helps us assess
the overall quality of the loan portfolio and the adequacy of the allowance for
loan losses. Loans classified as "substandard" are those loans with clear and
defined weaknesses such as a highly leveraged position, unfavorable financial
ratios, uncertain repayment sources or poor financial condition, which may
jeopardize ultimate recoverability of the debt.
Loans classified as "doubtful/potential loss" are those loans that have
characteristics similar to substandard accounts but with an increased risk that
a loss may occur, or at least a portion of the loan may require a charge-off if
liquidated at present. Although loans classified as substandard do not duplicate
loans classified as doubtful, both substandard and doubtful loans include some
loans that are delinquent at least 30 days or on nonaccrual status. Loans
classified as "potential loss" are those loans that are identified as having a
high probability of being liquidated with loss within the next 12 months.
In addition to loans on the internal watch list classified as substandard
or doubtful/potential loss, we maintain additional classifications on a separate
watch list which further aids us in monitoring loan portfolios. These additional
loan classifications reflect warning elements where the present status portrays
one or more deficiencies that require attention in the short-term or where
pertinent ratios of the loan account have weakened to a point where more
frequent monitoring is warranted. These loans do not have all of the
characteristics of a classified loan (substandard, doubtful/potential loss) but
do show weakened elements as compared with those of a satisfactory credit. We
regularly review these loans to aid in assessing the adequacy of our allowance
for loan losses.
In order to determine the adequacy of the allowance for loan loss, we
consider the risk classification or delinquency status of loans and other
factors, such as collateral value, portfolio composition, trends in economic
conditions, including those discussed below, and the financial strength of
borrowers. We establish specific allowances for loans which management believes
require reserves greater than those allocated according to their classification
19
or delinquent status as prescribed in SFAS No. 114 (as amended by SFAS No. 118).
The amount of the special allowance is based on the estimated value of the
collateral securing the loans and other analyses pertinent to each situation.
Loans are identified for specific allowances from information provided by
several sources, including asset classification, third party reviews,
delinquency reports, periodic updates to financial statements, public records
and industry reports. All loan types are subject to specific allowances once
identified as impaired or non-performing. In addition, the company has set up a
reserve for undisbursed loans in the amount of 0.2% of the total of undisbursed
loans. This reserve, which is separate from the allowance for loan loss, was
$487,000 at 12/31/04.
Additionally, we use three approaches for the analysis of the performing
portfolio: general factors, historical losses, and examiner rule of thumb. These
methods are further broken down into identified loan pools within our portfolio.
Using these methodologies, we allocate reserves to each identified loan
classification and to performing loan pools. All pools are evaluated by all
methods. We then charge to operations a provision for loan losses to maintain
the allowance for loan losses at an adequate level as determined by the
foregoing methodology.
The economy of our market areas remains somewhat dependent on real estate
and related industries (i.e. construction, housing). While we maintain a
reasonably diverse commercial and consumer loan portfolio, any major downturn in
real estate or construction could have an adverse effect on borrowers' ability
to repay loans and, therefore, could potentially affect our results of
operations and financial condition.
Consequently, in evaluating the adequacy of our allowance for loan losses,
management incorporates, among many other factors, the effect on borrowers of an
economic downturn in the real estate related industries, the diversification of
the loan portfolio and economic indicators and conditions. Additionally, we have
several procedures in place to assist us in minimizing credit risk and
maintaining the overall quality of our loan portfolio. We frequently review and
update our underwriting guidelines and monitor our delinquency levels for any
negative or adverse trends. Due to the current economic indicators and our
portfolio mix, but principally due to our significant growth, we made
substantial provisions to our loan loss reserve collectively during the third
and fourth quarters of 2005. No assurances can be given that additional
substantial increases in the allowance or alteration of underwriting standards
will not be necessary in the future.
The provision for loan loss is the amount expensed in the current year and
added to the allowance for loan loss. The allowance for loan loss is a reserve
kept at a level that is determined by a quarterly analysis of the loan portfolio
and its inherent risks. Examples of inherent risks in the loan portfolio include
the quality of the loans, the concentrations of credit by collateral and
industries, the Bank's lending staff and policies, and external factors such as
economic conditions.
20
The following table summarizes the activity in the allowance for loan
losses for the five years ended December 31, 2004:
Allowance for Loan Losses
Year ended December 31,
-------------------------------------------------------------------------------
2004 2003 2002 2001 2000
-------------------------------------------------------------------------------
(Dollars in Thousands)
Loans outstanding $530,196 $360,749 $268,409 $149,035 $ 91,611
Average amount of loans outstanding 446,493 318,600 284,849 118,440 73,334
Balance of allowance for loan 3,608 3,017 1,239 928 552
losses, beginning of years
Loans charged off:
Commercial (986) (464) (338) 0 0
Real estate - Construction 0 0 0 0 0
Real estate - Other (105) (37) (354) (89) (19)
Consumer (6) (4) (15) 0 (1)
-------- ------- -------- -------- --------
Total loans charged off $ (1,097) $ (505) $ (707) $ (89) $ (20)
======== ======= ======== ======== ========
Recoveries of loans previously charged off:
Commercial 23 19 11 0 0
Real estate - Construction 0 0 0 0 0
Real estate - Other 3 33 3 0 10
Consumer 4 22 11 0 1
-------- ------- -------- -------- --------
Total recoveries 30 74 25 0 11
-------- ------- -------- -------- --------
Net loans charged off (1,067) (431) (652) (89) (9)
Provision for Loan loss Expense 3,821 1,022 2,460 400 385
-------- ------- -------- -------- --------
Balance, end of year $ 6,362 $ 3,608 $ 3,017 $ 1,239 $ 928
======== ======= ======== ======== ========
Ratio of net charge-offs to average .20% .14% .33% .07% .01%
loans
The following table describes the allocation of the allowance for loan
losses among various categories of loans and certain other information for the
dates indicated. The allocation is made for analytical purposes and is not
necessarily indicative of the categories in which future losses may occur. The
total allowance is available to absorb losses from any segment of loans.
At the Years Ended December 31,
2004 2003 2002
------------------------------ -------------------------------- ------------------------------
% in % in % in
Loans in Loans in Loans in
% of Each % of Each % of Each
Allowance Category Allowance Allowance Category Allowance Category
Allowance to Total to Total Amt. to Total to Total Allowance to Total to Total
Amt. Amt. Loans Amt. Loans Amt. Amt. Loans
------------------------------ -------------------------------- ------------------------------
(Dollars in Thousands)
Commercial $ 178 2.8% 3.1% $ 154 4.3% 6.5% $172 5.7% 9.1%
Real Estate 1,590 25.0% 36.4% 655 18.2% 33.4% 667 22.1% 35.9%
Construction/Land
Development 1,958 30.7% 38.0% 589 16.3% 31.2% 391 13.0% 22.4%
Mortgage 0 0% .4% 0 .0% .7% 0 2.8%
SBA 2,612 41.1% 21.6% 2,184 60.5% 27.3% 1,741 57.7% 28.2%
Consumer & Other 24 .4% .5% 26 .7% .9% 46 1.5% 1.6%
------- ------ ------ ------ ------ ------ ------ ------ ------
Total $ 6,362 100.0% 100.0% $3,608 100.0% 100.0% $3,017 100.0% 100.0%
======= ====== ====== ====== ====== ====== ====== ====== ======
21
At the Years Ended December 31,
2001 2000
-------------------------------- -------------------------------
% in % in
Loans in Loans in
% of Each % of Each
Allowance Category Allowance Category
to Total to Total to Total to Total
Amt. Amt. Loans Amt.
Amt. Loans
-------------------------------- -------------------------------
(Dollars in Thousands)
Commercial $80 6.5% 10.8% $86 9.3% 13.3%
Real Estate 291 23.5% 36.9% 212 22.8% 39.1%
Construction/Land
Development 186 15.0% 25.1% 171 18.4% 25.3%
Mortgage 3 .2% 4.4% 4 .4% 1.8%
SBA 639 51.6% 19.4% 424 45.8% 15.8%
Consumer & Other 40 3.2% 3.4% 31 3.3% 4.7%
------- ------ ------ ----- ------ ------
Total $ 1,239 100.0% 100.0% $ 928 100.0% 100.0%
======= ====== ====== ===== ====== ======
Based on the recent history of charge offs in the Company's loan portfolio,
the Company has allocated a higher percentage of its reserve for loan losses,
increasing the percentage allocated from .76% as of December 31, 2003 to 1.08%
as of December 31, 2004 for the low allocation, and from .87% as of December 31,
2003 to 1.20% as of December 31, 2004 for the high allocation. Other changes are
the result of relative changes in the size of the loan portfolios. As a result
of past decreases in local and regional real estate values and the significant
losses experienced by many financial institutions, there has been a greater
level of scrutiny by regulatory authorities of the loan portfolios of financial
institutions undertaken as a part of the examinations of such institutions by
banking regulators. While the Company believes it has established its existing
allowance for loan losses in accordance with generally accepted accounting
principles, there can be no assurance that regulators, in reviewing the
Company's loan portfolio, will not request the Company to increase significantly
its allowance for loan losses. In addition, because future events affecting
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that the existing allowance for loan losses is adequate or that
substantial increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed above. Any material increase in
the allowance for loan losses may adversely affect the Company's financial
condition and results of operations.
Deposits
The daily average balances and weighted average rates paid on deposits and
other borrowings for each of the years ended December 31, 2004, 2003 and 2002
are represented below.
22
Years Ended December 31,
2004 2003 2002
---------------------------------- ----------------------------------- ---------------------------------
% of total Average % of total Average % of total Average
Average Avg. Rate Average Avg. Rate Average Avg. Rate
Balance Deposits % Balance Deposits % Balance Deposits %
(Dollars in Thousands)
Now $31,588 6.5% .14% $24,075 6.7% .10% $18,564 8.2% .10%
Money Market 37,770 7.8% 1.20% 37,238 10.4% 1.43% 38,621 16.9% 1.62%
Savings 50,699 8.4% .46% 32,739 9.2% .59% 27,951 12.3% .82%
Time deposits 113,802 23.4% 2.12% 75,177 21.1% 2.44% 26,509 11.6% 3.04%
less than
$100,000
Time deposits 112,964 23.3% 2.19% 76,998 21.6% 2.46% 35,682 15.7% 3.10%
$100,000 and
over
Other 20,195 4.2% 4.04% 10,906 3.1% 4.32% 10,581 4.6% 3.21%
Borrowings ---------- -------- ----- --------- ------
Total 357,018 73.5% 1.79% 257,133 72.1% 1.92% 157,908 69.3% 1.98%
interest-bearing
liabilities
Non 128,670 26.5% 0.00% 99,565 27.9% 0.00% 69,972 30.7% 0.00%
interest-bearing ---------- -------- ----- --------- ------
deposit
Total $485,689 100.0% 1.32% $356,698 100.0% 1.38% $227,880 100.0% 1.37%
Deposits & ========== ======== ====== ========= ======
Other
Borrowings
At December 31, 2004, the Company had $145,091,164 in time deposits in the
amounts of $100,000 or more consisting of 990 accounts maturing as follows:
Maturity Period Amount Weighted Average Rate
- -------------------------------------------------------------- --------- ---------------------
Three months or less $ 77,279 2.287%
Greater than Three Months to Six Months 42,564 2.255%
Greater than Six Months to Twelve Months 24,720 2.448%
Greater than Twelve Months 528 2.659%
---------
Total $ 145,091 2.312%
=========
23
Short-term Borrowings
Set forth below is a schedule of outstanding short-term borrowings (less
than or equal to 1 year):
Year Ended December 31,
----------------------------------------------------
2004 2003 2002
----------------------------------------------------
(Dollars in Thousands)
Federal Funds Purchased $ 0 $ 0 $ 0
FHLB Advances 0 0 10,000
Line of Credit 0 0 0
------------- ------------- ------------
Total Short-term Borrowings $ 0 $ 0 $10,000
============= ============= ============
Time Certificate of Deposits
Set forth is a maturity schedule of domestic time certificates of deposit
of $100,000 or more at the indicated period.
At December 31, 2004
-------------------------------
(Dollars in Thousands)
Three months or less $ 77,280
Over three through 12 months 67,283
Over one through five years 528
-----------
Total $ 145,091
===========
Supervision and Regulation
Bank holding companies and national banks are extensively regulated under
federal law and to a lesser extent, state law. The following is a brief summary
of certain statutes and rules that affect or will affect the Company and the
Bank. This summary is qualified in its entirely by reference to the particular
statute and regulatory provisions referred to below and is not intended to be an
exhaustive description of all applicable statutes and regulations.
As a bank holding company, the Company principally is subject to Federal
Reserve regulations. The Company is required to file with the Federal Reserve
quarterly and annual reports and such additional information the Federal Reserve
may require pursuant to the BHCA. The Federal Reserve may conduct examinations
of bank holding companies and their subsidiaries.
Under a policy of the Federal Reserve with respect to bank holding company
operations, a bank holding company is required to serve as a source of financial
strength to its subsidiary depository institutions and to commit resources to
support such institutions in circumstances where it might not do so absent such
a policy. The Federal Reserve under the BHCA also has the authority to require a
bank holding company to terminate any activity or to relinquish control of a
nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal
Reserve's determination that such activity or control constitutes a serious risk
24
to the financial soundness and stability of any bank subsidiary of the bank
holding company. The Federal Reserve may also prohibit the Company, except in
certain instances prescribed by statute, from acquiring or engaging in
non-banking activities, other than activities that are deemed by the Federal
Reserve to be so closely related to banking or managing or controlling banks as
to be a proper incident thereto. See "Recent and Proposed Legislation" in this
Section.
In addition, insured depository institutions under common control are
required to reimburse the FDIC for any loss suffered by its deposit insurance
funds as a result of the default of a commonly controlled depository institution
or for any assistance provided by the FDIC to a commonly controlled insured
depository institution in danger of default. The FDIC may decline to enforce the
cross-guarantee provisions if it determines that a waiver is in the best
interest of the deposit insurance funds. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or its
holding company but is subordinate to claims of depositors, secured creditors
and holders of subordinated debt (other than affiliates) of the commonly
controlled insured depository institutions.
The Bank as a national banking association is subject to regulation,
supervision and examination by the Comptroller and subject to applicable laws
and regulations under the National Bank Act, the Federal Deposit Insurance Act
and Federal Reserve Act, as well as others. The Bank's deposits are insured
(presently $100,000 per account) by the Bank Insurance Fund ("BIF"). As a result
of this deposit insurance function, the FDIC also has certain supervisory
authority and powers over the Bank as well as all other FDIC insured
institutions. If, as a result of an examination of the Bank, the Comptroller
should determine that the financial condition, capital resources, asset quality,
earnings prospects, management, liquidity or other aspects of the Bank's
operations are unsatisfactory or that the Bank or its management is violating or
has violated any law or regulation, various remedies are available to the
Comptroller. Such remedies include the power to enjoin unsafe or unsound
practices, to require affirmative action to correct any conditions resulting
from any violation or practice, to issue an administrative order that can be
judicially enforced, to direct an increase in capital, to restrict growth, to
assess civil monetary penalties, to remove officers and directors and ultimately
to request the FDIC to terminate the Bank's deposit insurance. The Bank has
never been subject to any such enforcement action. The Bank is also subject to
certain provisions of California law if not in conflict with or preempted by
federal law or regulation.
Various requirements and restrictions under the laws of the United States
affect the operations of the Bank. Statutes and regulations relate to many
aspects of the Bank's operations, including reserves against deposits, ownership
of deposit accounts, interest rates payable on deposits, loans, investments,
mergers and acquisitions, borrowings, dividends, locations of branch offices and
capital requirements. Further, the Bank is required to maintain certain levels
of capital. See "Capital Adequacy Requirements" in this Section below.
Recent and Proposed Legislation
From time to time, legislation is enacted which has the effect of
increasing the cost of doing business, limiting or expanding permissible
activities or affecting the competitive balance between banks and other
financial institutions. Proposals to change the laws and regulations governing
the operations and taxation of banks and other financial institutions are
frequently made in Congress, in the California legislature and by various bank
regulatory agencies.
25
Sarbanes-Oxley Act
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of
2002 ("Sox") implementing legislative reforms intended to address corporate and
accounting fraud. In addition to the establishment of a new accounting oversight
board which will enforce auditing, quality control and independence standards
and will be funded by fees from all publicly traded companies, the bill
restricts provision of both auditing and consulting services by accounting
firms. To ensure auditor independence, any non-audit services being provided to
an audit client will require pre-approval by the company's audit committee
members. In addition, the audit partners must be rotated. Sox requires chief
executive officers and chief financial officers, or their equivalent, to certify
to the accuracy of periodic reports filed with the SEC, subject to civil and
criminal penalties if they knowingly or willfully violate this certification
requirement. In addition, under Sox, legal counsel will be required to report
evidence of a material violation of the securities laws or a breach of fiduciary
duty by a company to its chief executive officer or its chief legal officer,
and, if such officer does not appropriately respond, to report such evidence to
the audit committee or other similar committee of the Board of Directors or the
Board itself.
Longer prison terms and increased penalties will also be applied to
corporate executives who violate federal securities laws. The period during
which certain types of suits can be brought against a company or its officers
has been extended, and bonuses issued to top executives prior to restatement of
a company's financial statements are now subject to disgorgement if such
restatement was due to corporate misconduct. Executives are also prohibited from
trading during retirement plan "blackout" periods, and loans to company
executives are restricted (banks are generally exempted from this restriction).
Sox accelerates the time frame for disclosures by public companies, including
fairly immediately disclosure of any material changes in their financial
condition or operations. Directors and executive officers must also provide
information for most changes in ownership in a company's securities within two
business days of the change.
Sox also prohibits any officer or director of a company or any other person
acting under their direction from taking any action to fraudulently influence,
coerce, manipulate or mislead any independent public or certified accountant
engaged in the audit of the company's financial statements for the purpose of
rendering the financial statement's materially misleading. Sox also required the
SEC to prescribe rules requiring inclusion of an internal control report and
assessment by management in the annual report to shareholders. In addition, Sox
requires that each financial report required to be prepared in accordance with
(or reconciled to) GAAP and filed with the SEC reflect all material correcting
adjustments that are identified by a "registered public accounting firm" in
accordance with accounting principles generally accepted in the United States of
America and the rules and regulations of the SEC.
The Company believes it has complied, and will use its best efforts to
continue to comply, with the requirements of Sox and the regulations and ruling
promulgated thereunder. As with most other companies that are required to comply
with Sox, the Company has incurred, and will in the future incur, significant
costs as a result of its compliance efforts. Such costs and efforts, however,
are not expected to have a material adverse effect upon the Company.
26
USA PATRIOT Act
On October 26, 2001, the President signed the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism Act of 2001 ("USA PATRIOT Act"). Under the USA PATRIOT Act, financial
institutions are subject to prohibitions against specified financial
transactions and account relationships as well as enhanced due diligence and
"know your customer" standards in their dealings with foreign financial
institutions and foreign customers. For example, the enhanced due diligence
policies, procedures and controls generally require financial institutions to
take reasonable steps: (1) to conduct enhanced scrutiny of account relationships
to guard against money laundering and report any suspicious transaction; (2) to
ascertain the identity of the nominal and beneficial owners of, and the source
of funds deposited into, each account as needed to guard against money
laundering and report any suspicious transactions; (3) to ascertain for any
foreign bank, the shares of which are not publicly traded, the identity of the
owners of the foreign bank, and the nature and extent of the ownership interest
of each such owner; and (4) to ascertain whether any foreign bank provides
correspondent accounts to other foreign banks and, if so, the identity of those
foreign banks and related due diligence information.
In October 2003, the Board of Directors of Bank adopted comprehensive
policies and procedures to address the requirements of the USA PATRIOT Act and
in October 2004, these policies will be substantially amended and will be
reviewed and again adopted by the Board. Although compliance with the USA
PATRIOT Act has caused the Company to incur some expense and change some of it
record and bookkeeping policies and procedures, compliance has not had a
material adverse effect upon the Company and it is not expected that future
compliance will cause this to change.
Gramm-Leach-Bliley Act
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act. That legislation eliminated many of the barriers that
had separated the insurance, securities and banking industries since the Great
Depression. The federal banking agencies (the Federal Reserve, FDIC and
Comptroller) among others, have drafted regulations to implement the
Gramm-Leach-Bliley Act.
The Gramm-Leach-Bliley Act is the result of a decade of debate
in the Congress regarding a fundamental reformation of the nation's
financial system. The law is subdivided into seven titles, by functional area.
Title I acts to facilitate affiliations among banks, insurance companies and
securities firms. Title II narrows the exemptions from the securities laws
previously enjoyed by banks, requires the Federal Reserve and the SEC to work
together to draft rules governing certain securities activities of banks and
creates a new, voluntary investment bank holding company. Title III restates the
proposition that the states are the functional regulators for all insurance
activities, including the insurance activities of federally-chartered banks. The
law bars the states from prohibiting insurance activities by depository
institutions. The law encourages the states to develop uniform or reciprocal
rules for the
27
licensing of insurance agents. Title IV prohibits the creation of additional
unitary thrift holding companies. Title V imposes significant requirements on
financial institutions related to the transfer of nonpublic personal
information. These provisions require institutions to develop and distribute to
accountholders an information disclosure policy, and require that the policy
allow customers to, and for the institution to, honor a customer's request to
"opt-out" of the proposed transfer of specified nonpublic information to third
parties. Title VI reforms the Federal Home Loan Bank system to allow broader
access among depository institutions to the system's advance programs, and to
improve the corporate governance and capital maintenance requirements for the
system. Title VII addresses a multitude of issues including disclosure of ATM
surcharging practices, disclosure of agreements among non-governmental entities
and insured depository institutions which donate to non-governmental entities
regarding donations made in connection with the CRA, and disclosure by the
recipient non-governmental entities of how such funds are used. Additionally,
the law extends the period of time between CRA examinations of community banks.
The Company does not believe that the Gramm-Leach-Bliley Act has had or
will have a material adverse effect upon the operations of the Company. While
many companies have stated that the effect could be increased competition, the
Company has not experienced this in any manner that is apparently attributable
to the Gramm-Leach-Bliley Act.
Community Reinvestment Act and Fair Lending Developments
The Bank is subject to certain fair lending requirements and reporting
obligations involving home mortgage lending operations and Community
Reinvestment Act ("CRA") activities. The CRA generally requires the federal
banking agencies to evaluate the record of a financial institution in meeting
the credit needs of their local communities, including low and moderate income
neighborhoods. In addition to substantive penalties and corrective measures that
may be required for a violation of certain fair lending laws, the federal
banking agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities.
Safety and Soundness Standards
The Federal Deposit Insurance Corporation Act ("FDICIA") also implemented
certain specific restrictions on transactions and required federal banking
regulators to adopt overall safety and soundness standards for depository
institutions related to internal control, loan underwriting and documentation
and asset growth. Among other things, FDICIA limits the interest rates paid on
deposits by undercapitalized institutions, restricts the use of brokered
deposits, limits the aggregate extensions of credit by a depository institution
to an executive officer, director, principal shareholder or related interest,
and reduces deposit insurance coverage for deposits offered by undercapitalized
institutions for deposits by certain employee benefits accounts. The federal
banking agencies may require an institution to submit to an acceptable
compliance plan as well as have the flexibility to pursue other more appropriate
or more effective courses of action depending upon the circumstances and the
severity of noncompliance.
28
Activities of Subsidiaries of National Banks
Activities permissible for financial subsidiaries of national banks include, but
are not limited to, the following: (a) lending, exchanging, transferring,
investing for others, or safeguarding money or securities; (b) insuring,
guaranteeing, or indemnifying against loss, harm, damage, illness, disability or
death, or providing and issuing annuities, and acting as principal, agent, or
broker for purposes of the foregoing, in any state; (c) providing financial,
investment or economic advisory services, including advising an investment
company; (d) issuing or selling instruments representing interests in pools of
assets permissible for a bank to hold directly; and (e) underwriting, dealing in
or making a market in securities.
Privacy
As required under Title V of the Gramm-Leach-Bliley Act, federal banking
regulators issued final rules on May 10, 2000 to implement the privacy
provisions of Title V. Pursuant to the rules, financial institutions must
provide (i) initial notices to customers about their privacy policies,
describing the conditions under which they may disclose nonpublic personal
information to nonaffiliated third parties and affiliates; (ii) annual notices
of their privacy policies to current customers; and (iii) a reasonable method
for customers to "opt out" of disclosures to nonaffiliated third parties.
Compliance with the rules was optional until July 1, 2001. As of July 1, 2001,
and thereafter, the Company has implemented and, as necessary, updated and
enhanced its procedures and practices in this critical area. California as well
as other states has adopted additional privacy rules. In the case of California,
the rules are more restrictive than the federal laws and regulations. These
California rules might not apply to the Bank but would likely apply to any
activities at the Company level.
Pending Legislation
Changes to federal and state laws and regulations (including changes in
interpretation or enforcement) can affect the operating environment of bank
holding companies and their subsidiaries in substantial and unpredictable ways.
From time to time, various legislative and regulatory proposals are introduced.
These proposals, if codified, may change banking statutes and regulations and
the Company's operating environment in substantial and unpredictable ways. If
codified, these proposals could increase or decrease the cost of doing business,
limit or expand permissible activities or affect the competitive balance among
banks, savings associations, credit unions and other financial institutions. The
Company cannot accurately predict whether those changes in laws and regulations
will occur, and, if those changes occur, the ultimate effect they would have
upon our financial condition or results of operations. It is likely, however,
that the current high level of enforcement and compliance-related activities of
federal and state authorities will continue and potentially increase.
Capital Adequacy Requirements
The Federal Reserve and the Comptroller have adopted regulations
establishing minimum requirements for capital adequacy. These agencies may
29
establish higher minimum requirements if, for example, a bank or company
previously has received special attention or has a high susceptibility to
interest rate risk.
The Federal Reserve has adopted capital adequacy guidelines for bank
holding companies and banks that are members of the Federal Reserve System and
have consolidated assets of $150 million or more. Bank holding companies subject
to the Federal Reserve's capital adequacy guidelines are required to comply with
the Federal Reserve's risk-based capital guidelines. Under these regulations,
the minimum ratio of total capital to risk-adjusted assets is 8%. At least half
of the total capital is required to be "Tier I capital," principally consisting
of common stockholders' equity, noncumulative perpetual preferred stock, and a
limited amount of cumulative perpetual preferred stock, less certain goodwill
items. The remainder ("Tier II capital") may consist of a limited amount of
subordinated debt, certain hybrid capital instruments and other debt securities,
perpetual preferred stock, and a limited amount of the general loan loss
allowance. In addition to the risk-based capital guidelines, the Federal Reserve
has adopted a minimum Tier I capital (leverage) ratio, under which a bank
holding company must maintain a minimum level of Tier I capital to average total
consolidated assets of at least 3% in the case of a bank holding company which
has the highest regulatory examination rating and is not contemplating
significant growth or expansion. All other bank holding companies are expected
to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the
stated minimum.
As of December 31, 2004, the Company's Tier I leverage ratio was 9.20%,
Tier I risk-based ratio was 9.68% and its total risk-based ratio was 11.81%.
The Comptroller's leverage-based capital guidelines require national banks
to maintain a minimum 3% Tier I leverage capital ratio for the most highly-rated
banks, with all other banks required to meet a higher minimum leverage ratio
that is 1% or more above the minimum. The risk-based capital guidelines provide
that banks must maintain a minimum capital-to-risk-weighted-assets ratio of 8%
and a minimum ratio of Tier I capital-to-risk-weighted-assets of 4%. The
guidelines provide a general framework for assigning assets and off-balance
sheet items to broad risk categories and provide procedures for the calculation
of the risk-based capital ratio.
As of December 31, 2004, the Tier I leverage ratio of the Bank's was
10.03%, the Bank's Tier I risk-based ratio was 10.54% and the total risk-based
ratio was 11.64%.
The federal banking regulators are required to take "prompt corrective
action" with respect to capital-deficient institutions. Agency regulations
define, for each capital category, the levels at which institutions are "well
capitalized," "adequately capitalized," "under capitalized," "significantly
under capitalized" and "critically under capitalized." A "well capitalized" bank
has a total risk-based capital ratio of 10.0% or higher; a Tier I risk-based
capital ratio of 6.0% or higher; a leverage ratio of 5.0% or higher; and is not
subject to any written agreement, order or directive requiring it to maintain a
specific capital level for any capital measure. An "adequately capitalized" bank
has a total risk-based capital ratio of 8.0% or higher; a Tier I risk-based
capital ratio of 4.0% or higher; a leverage ratio of 4.0% or higher (3.0% or
higher if the bank was rated a composite 1 in its most recent examination report
and is not experiencing significant growth); and does not meet the criteria for
a well capitalized bank. A bank is "under capitalized" if it fails to meet any
one of the ratios required to be adequately capitalized.
30
In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
As an institution's capital decreases, the federal agency's enforcement
powers become more severe. A significantly undercapitalized institution is
subject to mandated capital raising activities, restrictions on interest rates
paid and transactions with affiliates, removal of management, and other
restrictions. A federal agency has only very limited discretion in dealing with
a critically undercapitalized institution and is virtually required to appoint a
receiver or conservator.
Banks with risk-based capital and leverage ratios below the required
minimums may also be subject to certain administrative actions, including the
termination of deposit insurance upon notice and hearing, or a temporary
suspension of insurance without a hearing in the event the institution has no
tangible capital.
The Bank was "well-capitalized" according the guidelines discussed above,
as of December 31, 2004.
Deposit Insurance Assessments
The Bank must pay assessments to the FDIC for federal deposit insurance
protection. FDIC insured depository institutions pay insurance premiums at rates
based on their risk classification. Institutions assigned to higher-risk
classifications (that is, institutions that pose a greater risk of loss to their
respective deposit insurance funds) pay assessments at higher rates than
institutions that pose a lower risk. An institution's risk classification is
assigned based on its capital levels and the level of supervisory concern the
institution poses to the regulators. In addition, the FDIC can impose special
assessments in certain instances. The Bank paid $57,543 of FDIC Assessments in
2004, as compared to $44,715 in 2003. The current range of BIF and Saving
Association Insurance Fund ("SAIF") assessments are (not including FICO bond
assessments) between 0.0% and 0.27% of deposits. The rate for the Bank was 0%
for 2003 and 2004.
The FDIC established a process for raising or lowering all rates for
insured institutions semi-annually if conditions warrant a change. Under this
system, the FDIC has the flexibility to adjust the assessment rate schedule
twice a year without seeking prior public comment, but only within a range of
five cents per $100 above or below the premium schedule adopted. Changes in the
31
rate schedule outside the five cent range above or below the current schedule
can be made by the FDIC only after a full rulemaking with opportunity for public
comment.
An increase in the assessment rate may have a material adverse effect on
the Company's earnings, depending on the amount of the increase. Based upon an
increase in the amount of the bank insurance fund ("BIF") for the quarter ended
June 30, 2004 and the preliminary results for September 30, 2004, which show a
further increase, it appears that an increase in the deposit insurance premium
amount is unlikely in the near term.
The FDIC is authorized to terminate a depository institution's deposit
insurance upon a finding by the FDIC that the institution's financial condition
is unsafe or unsound or that the institution has engaged in unsafe or unsound
practices or has violated any applicable rule, regulation, order or condition
enacted or imposed by the institution's regulatory agency.
Change in Control
The BHCA prohibits the Company from acquiring direct or indirect control of
more than 5% of the outstanding voting securities or substantially all the
assets of any bank or savings bank or merging or consolidations with another
bank holding company or savings bank holding company without prior approval of
the Federal Reserve. Similarly, Federal Reserve approval (or in certain cases,
nondisapproval) must be obtained prior to any person acquiring control of a bank
holding company. Control is conclusively presumed to exist if, among other
things, a person acquires more that 25% of any class of voting stock of the
Company or controls in any manner the election of a majority of the directors of
the Company. Control is presumed to exist if a person acquires more that 10% of
any class of voting stock and the stock is registered under Section 12 of the
Exchange Act or the acquirer will be the largest stockholder after the
acquisition.
Examinations
The Federal Reserve through the BHCA has the authority to examine and
evaluate the Company and its subsidiaries. The Comptroller periodically examines
and evaluates national banks, including the Bank. These examinations review
areas such as capital adequacy, reserves, loan portfolio quality and management,
consumer and other compliance issues, investments and management practices. In
addition to these regular examinations, we are required to furnish quarterly and
annual reports to the Federal Reserve and the Comptroller. Both agencies may
exercise cease and desist or other supervisory powers if actions represent
unsafe or unsound practices or violations of law. Further, any proposed addition
of any individual to the board of directors of a bank or the employment of any
individual as a senior executive officer of a bank, or the change in
responsibility of such an officer, will be subject to 90 days prior written
notice to the Comptroller if a bank is not in compliance with the applicable
minimum capital requirements, is otherwise a troubled institution or the
Comptroller determines that such prior notice is appropriate for a bank. The
Comptroller then has the opportunity to disapprove any such appointment.
Federal Securities Law
32
The Company has registered its common stock with the SEC pursuant to
Section 12(g) of the Exchange Act. As a result of such registration, the proxy
and tender offer rules, insider trading reporting requirements, annual and
periodic reporting and other requirements of the Exchange Act are applicable to
the Company.
Transactions with Insiders and Affiliates
Depository institutions are subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act with respect to loans to directors,
executive officers and principal stockholders. Under Section 22(h), loans to
directors, executive officers and stockholders who own more than 10% of a
depository institution and certain affiliated entities of any of the foregoing,
may not exceed, together with all other outstanding loans to such person and
affiliated entities, the institution's loans-to-one-borrower limit (as discussed
below). Section 22(h) also prohibits loans above amounts prescribed by the
appropriate federal banking agency to directors, executive officers and
stockholders who own more than 10% of an institution, and their respective
affiliates, unless such loans are approved in advance by a majority of the board
of directors of the institution. Any "interested" director may not participate
in the voting. The prescribed loan amount (which includes all other outstanding
loans to such person), as to which such prior board of director approval is
required, is the greater of $25,000 or 5% of capital and surplus (up to
$500,000). Further, pursuant to Section 22(h), the Federal Reserve requires that
loans to directors, executive officers, and principal stockholders be made on
terms substantially the same as offered in comparable transactions with
non-executive employees of the Bank. There are additional limits on the amount a
bank can loan to an executive officer.
Transactions between a bank and its "affiliates" are quantitatively and
qualitatively restricted under the Federal Reserve Act. The Federal Deposit
Insurance Act applies Sections 23A and 23B to insured nonmember banks in the
same manner and to the same extent as if they were members of the Federal
Reserve System. The Federal Reserve has also recently issued Regulation W, which
codified prior regulations under Sections 23A and 23B of the Federal Reserve Act
and provides interpretative guidance with respect to affiliate transactions.
Regulation W incorporates the exemption from the affiliate transaction
rules but expands the exemption to cover the purchase of any type of loan or
extension of credit from an affiliate. Affiliates of a bank include, among other
entities, the bank's holding company and companies that are under common control
with the Bank. The Company is considered to be an affiliate of the Bank.
Monetary Policy
The monetary policies of regulatory authorities, including the Federal
Reserve, have a significant effect on the operating results of banks. The
Federal Reserve supervises and regulates the national supply of bank credit.
Among the means available to the Federal Reserve to regulate the supply of bank
credit are open market purchases and sales of U.S. government securities,
changes in the discount rate on borrowings from the Federal Reserve and changes
in reserve requirements with respect to deposits. These activities are used in
varying combinations to influence overall growth and distribution of bank loans,
33
investments and deposits on a national basis and their use may affect interest
rates charged on loans or paid for deposits.
Federal Reserve monetary policies and the fiscal policies of the federal
government have materially affected the operating results of commercial banks in
the past and are expected to continue to do so in the future. We cannot predict
the nature of future monetary and fiscal policies and the effect of such
policies on our future business and earnings.
Additional Factors That May Affect Future Results of Operations
In addition to the other information contained in this Annual Report, the
following risks may affect the Company. If any of these risks occur, the
Company's business, financial condition or operating results could be adversely
affected.
The Company's Business Strategy Relies Upon its Chief Executive Officer and
Other Key Employees
Stephen H. Wacknitz has been the president and chief executive officer of
the Company and the Bank since the inception of both entities. Mr. Wacknitz
developed numerous aspects of the Company's current business strategy and the
implementation of such strategy depends heavily upon the active involvement of
Mr. Wacknitz. The loss of Mr. Wacknitz' services could have a negative impact on
the implementation and success of the Company's business strategy. The Company's
success will also depend in large part upon its ability to attract and retain
highly qualified management, technical and marketing personnel to execute the
strategic plan. Competition for qualified personnel, especially those in
management, sales and marketing is intense. The Company cannot assure you that
it will be able to attract and retain these persons.
The Company's Growth May Not Be Managed Successfully
The Company has grown substantially from $431,212,118 in total assets and
$383,487,366 in total deposits at December 31, 2003 to $606,827,529 in total
assets and $534,766,705 in total deposits at December 31, 2004. The Company
expects to continue to experience significant growth in assets, deposits and
scale of operations. If the Company does not manage its growth effectively, the
Company will not have adequate resources to maintain and secure key
relationships contemplated by its business plan, and its business and prospects
could be harmed. The Company's growth subjects it to increased capital and
operating commitments. The Company must recruit experienced individuals that
have the skills and experience that it needs to transition the areas of its
lending concentration. The plans for continued growth have placed and will
continue to place a significant strain on the Company's personnel, systems, and
resources. The Company cannot guarantee that it will be able to obtain and train
qualified individuals to implement its business strategy in a timely, cost
effective and efficient manner.
Dependence on Real Estate
A significant portion of the loan portfolio of the Bank is dependent on
real estate. At December 31, 2004, real estate served as the principal source of
34
collateral with respect to approximately 94.9% of the Bank's loan portfolio. 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, the value of real estate and other collateral securing loans
and the value of real estate owned by the Bank, as well as the Company's
financial condition and results of operations in general and the market value of
the Company's common stock. Acts of nature, including earthquakes and floods,
which may cause uninsured damage and other loss of value to real estate that
secures these loans, may also negatively impact the Company's financial
condition.
In the course of business, the Company may in the future acquire, through
foreclosure, properties securing loans which are in default. In commercial real
estate lending, there is a risk that hazardous substances could be discovered on
these properties. In this event, the Bank might be required to remove these
substances from the affected properties at its sole cost and expense. The cost
of this removal could substantially exceed the value of affected properties. The
Bank may not have adequate remedies against the prior owner or other responsible
parties or could find it difficult or impossible to sell the affected
properties. This could have a material adverse effect on the Company's business,
financial condition and operating results.
Interest Rate Changes
The earnings of the Company are substantially affected by changes in
prevailing interest rates. Changes in interest rates affect the demand for new
loans, the credit profile of existing loans, the rates received on loans and
securities and the rates the Bank must pay on deposits and borrowings. The
difference between the rates the Bank receives on loans and securities and the
rates it must pay on deposits and borrowings is known as the interest rate
spread. Given the Bank's current volume and mix of interest bearing assets, the
Bank's interest rate spread can be expected to increase when market interest
rates are rising, and to decline when market interest rates are declining.
Although the Bank believes its current level of interest rate sensitivity is
reasonable, significant fluctuations in interest rates may have an adverse
impact on its business, financial condition and result of operations.
Competition
Competition may adversely affect the Company's performance. The financial
services business in the Company's market area is highly competitive and
becoming more so due to changes in regulation, technological advances and the
accelerating pace of consolidation among financial service providers. The Bank
faces competition both in attracting deposits and making loans. The Bank
competes for loans principally through competitive interest rates and the
efficiency and quality of the services provided. Increasing levels of
competition in the banking and financial services businesses may reduce the
market share or cause the prices charged for services to fall. Many of the
financial intermediaries operating in the Bank's market area offer certain
services, such as trust, investment and international banking services, which
the Bank does not offer directly. Additionally, banks and other financial
institutions with larger capitalization and financial intermediaries have larger
lending limits. These services the Bank may not offer directly may prompt
customers to do business with competitors instead of with the Bank. Results may
differ in future periods depending on the nature or level of competition.
35
Regulation
Both the Company and the Bank are subject to government regulation that
could limit or restrict their activities, adversely affecting operations. The
financial services industry is heavily regulated. Federal and state regulation
is designed to protect the deposits of consumers, not to benefit shareholders.
The regulations impose significant limitations on operations, and may be changed
at any time, possibly causing results to vary significantly from past results.
Government policy and regulation, particularly as implemented through the
Federal Reserve System, significantly affects credit conditions for the Company
and the Bank.
SBA lending is a federal government created and administered program. As
such, legislative and regulatory developments can affect the availability and
funding of the program. This dependence on legislative funding and regulatory
restrictions from time to time causes limitations and uncertainties with regard
to the continued funding of such loans, with a resulting potential adverse
financial impact on the Bank's business. Currently, the maximum limit on
individual 7a loans which the SBA will permit is $2,000,000. Any reduction in
this level could have a negative impact on the Company's business. Since the SBA
business at the Bank constitutes a significant portion of the Bank's lending
business, this dependence on this government program and its periodic
uncertainty with availability and amounts of funding creates greater risk for
the Bank's business than does other parts of its business.
Borrower's Failure to Perform
A significant number of the Bank's borrowers and guarantors may fail to
perform their obligations as required by the terms of their loans, which could
result in larger than expected losses. This risk increases when the economy is
weak. The Bank has adopted underwriting and credit policies, and loan monitoring
procedures, including the establishment and monitoring of allowance for loan
losses. Management believes these provisions are reasonable and adequate, and
should keep loan losses within expected limits by assessing the likelihood of
nonperformance, tracking loan performance and diversifying the credit portfolio.
However, these policies and procedures may not be adequate to prevent unexpected
losses that could materially and adversely affect the results of operations.
Operations Risks
The Bank is subject to certain operations risks, including, but not limited
to, data processing system failures and errors, customers or employee fraud and
catastrophic failures resulting from terrorist acts or natural disasters. The
Bank maintains a system of internal controls to mitigate against such
occurrences and maintains insurance coverage when available to protect against
such risks, but should such an event occur that is not prevented or detected by
the Bank's internal controls, or is uninsured or in excess of applicable
insurance limits, it could have a significant adverse impact on the Company's
business, financial condition or results of operations.
36
Geographic Concentration
The Company's operations are located almost entirely in California, except
SBA lending. As a result of the California geographic concentration, our results
depend largely upon economic and business conditions in this region.
Deterioration in economic and business conditions in our market area could have
a material adverse impact on the quality of our loan portfolio and the demand
for our products and services, which in turn may have a material adverse effect
on our results of operations.
Subsidiaries
The Bank is a subsidiary of the Company. In June 2002, the Company formed
Temecula Valley Statutory Trust I, a Connecticut statutory trust and wholly
owned subsidiary of the Company for the purpose of issuing trust preferred
securities. In September 2003, the Company formed Temecula Valley Statutory
Trust II, a Connecticut statutory trust and wholly owned subsidiary of the
Company for the purpose of issuing trust preferred securities. In September
2004, the Company formed Temecula Valley Statutory Trust III, a Delaware
statutory trust and wholly owned subsidiary of the Company for the purpose of
issuing trust preferred securities.
Employees
As of December 31, 2004, the Bank had 229 full-time employees, 9 of whom
were executive officers. There are no employees at the Company. We provide
medical insurance and other benefits to our full-time employees. Our employees
are not represented by any collective bargaining group. We consider our
relations with our employees to be satisfactory.
ITEM 2: PROPERTIES
The Bank conducts business at seven full-service banking offices in
Southern California and multiple loan production offices in nine states,
including California. The main office facilities are located at 27710 Jefferson
Avenue, Suite A100, Temecula, California. As of December 31, 2004, the Bank
owned the property at one of its branch locations. The remaining banking offices
and other offices are leased by the Bank. Most of the leases contain multiple
renewal options and provisions for rental increases, principally for changes in
the cost of living index, property taxes and maintenance. Total future annual
rental payments (exclusive of operating charges and real property taxes) are
approximately $5,505,957, with lease expiration dates ranging from 2005 to 2014,
exclusive of renewal options.
We believe that our existing facilities are adequate for our present
purposes and that the properties are adequately covered by insurance.
ITEM 3: LEGAL PROCEEDINGS
From time to time, we are involved in legal proceedings arising in the
normal course of business. We do not believe that there is any pending or
37
threatened proceeding against the Company or the Bank which, if determined
adversely, would have a material effect on our business, financial condition or
results of operation.
The Company is not aware of any material proceedings to which any director,
officer or affiliate of the Company, any owner of record or beneficially of more
than 5% of the voting securities of the Company as of December 31, 2004, or any
associate of any such director, officer, affiliate of the Company, or security
holder is a party adverse to the Company or any of its subsidiaries or has a
material interest adverse to the Company or any of its subsidiaries.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER
No matters were submitted to a vote of security holders during the fourth
quarter of 2004.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS
Trading Information
The Company's common stock is quoted in The Over-the-Counter market under
the symbol TMCV.OB. As reported by the OTC Bulletin Board, information
concerning the range of high and low bid information prices for the Company's
common stock for each quarterly period within the past two fiscal years is set
forth below. The below quotations reflect inter-dealer prices without retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.
Quarter Ended High/Ask Low/Bid
------------- -------- -------
2004
March 31 $ 14.00 $ 10.75
June 30 $ 15.45 $ 11.01
September 30 $ 19.50 $ 14.85
December 31 $ 18.50 $ 15.30
2003
March 31 $ 6.75 $ 5.45
June 30 $ 8.50 $ 6.10
September 30 $ 9.75 $ 7.75
December 31 $ 14.50 $ 9.13
Holders
As of February 28, 2005, the low and high bids of the Company's stock as
quoted in the over-the-counter bulletin board market were $18.00 and $18.25,
38
respectively. As of that date, there were approximately 444 record holders of
the Company's common stock and directors and executive offices owned
approximately 26% of our outstanding shares.
Dividends
No cash dividends were paid by the Bank prior to the formation of the
Company in 2002 and none have been paid by the Company since its formation in
2002.
The Company is a legal entity separate and distinct from the Bank. The
Company's shareholders are entitled to receive dividends when and as declared by
its Board of Directors, out of funds legally available therefore, subject to the
restrictions set forth in the California General Corporation Law as well as
other restrictions discussed below. Under California law, a dividend can be paid
if the amount of the retained earnings of the Company immediately prior to such
payment equals or exceeds the amount of the proposed distribution. Additionally,
a dividend can be paid if immediately after giving effect thereto: (1) the sum
of the assets of the Company (exclusive of goodwill, capitalized research and
development expenses and deferred charges) would be at least equal to 1 1/4
times its liabilities (not including deferred taxes, deferred income and other
deferred credits) and (2) the current assets of the corporation would be at
least equal to its current liabilities or, if the average of the earnings of the
corporation before taxes on income and before interest expense for the two
preceding fiscal years was less than the average of the interest expense of the
corporation for those fiscal years, at least equal to 1 1/4 times its current
liabilities.
The Federal Reserve has broad authority to prohibit the payment of
dividends by the Company depending upon the condition of each entity within the
corporate structure. In addition, the future payment of cash dividends will
generally depend, subject to regulatory restraints, upon the Company's earnings
during any period, and the assessment by the Board of the capital requirements
the Company and other factors, including the maintenance of an adequate
allowance for loan losses at the Bank.
The availability of operating funds for the Company and the ability of the
Company to pay a cash dividend depends largely on the Bank's ability to pay a
cash dividend to the Company. The payment of cash dividends by the Bank is
subject to restrictions set forth in the National Bank Act. In general,
dividends may not be paid from any of the Bank's capital. Dividends must be paid
out of available net profits, after deduction of all current operating expenses,
actual losses, accrued dividends on preferred stock, if any, and all federal and
state taxes. Additionally, a national bank is prohibited from declaring a
dividend on its shares of common stock until its surplus fund equals its common
capital, or, if its surplus fund does not equal its common capital, until at
least one-tenth of such bank's net profits, for the preceding half year in the
case of quarterly or semi-annual dividends, or the preceding two half-years in
the case of an annual dividend, are transferred to its surplus fund each time
dividends are declared. The approval of the Comptroller is required if the total
of all dividends declared by a national bank in any calendar year exceeds the
total of its net profits for that year combined with its retained net profits of
the two preceding years, less any required transfers to surplus or a fund for
the retirement of any preferred stock. Furthermore, the Comptroller also has
authority to prohibit the payment of dividends by a national bank when it
determines such payment to be an unsafe and unsound banking practice.
39
The Company declared a two-for-one stock split to shareholders in December
2003, April 1999 and April 1998. Whether or not stock dividends will be paid in
the future will be determined by the Board of Directors after consideration of
various factors. The Company's and the Bank's profitability and regulatory
capital ratios in addition to other financial conditions will be key factors
considered by the Board of Directors in making such determinations regarding the
payment of dividends.
40
ITEM 6. SELECTED FINANCIAL DATA
The following table represents selected financial information for the five
years ended December 31, 2004 for the Company and subsidiaries on a consolidated
basis. This table should be read in conjunction with the Company's financial
statements and related notes. All share and per share data have been restated to
reflect three two-for-one stock splits, one in December 2003, one in April 1999
and one in April 1998.
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Income Statement:
Interest income $33,614,887 $23,890,500 $16,509,441 $12,002,878 $9,359,710
Interest expense 6,414,543 4,946,553 3,124,682 2,734,407 2,452,901
----------------------------------------------------------------------------------
Net interest income 27,200,344 18,943,947 13,384,759 9,268,471 6,906,809
Provision for loan losses 3,821,300 1,022,000 2,460,000 400,000 385,000
----------------------------------------------------------------------------------
Net after provision for loan losses 23,379,044 17,921,947 10,924,759 8,868,471 6,521,809
Non interest income 28,698,614 24,481,351 17,941,642 8,971,641 3,195,569
Non interest expense 33,964,229 29,121,070 21,800,837 14,831,513 7,621,741
----------------------------------------------------------------------------------
Income before income taxes 18,113,429 13,282,228 7,065,564 3,008,599 2,095,637
Provision for income taxes 7,535,806 5,427,889 2,874,510 1,205,018 835,335
----------------------------------------------------------------------------------
Net income $10,577,623 $ 7,854,339 $ 4,191,054 $ 1,803,581 $1,260,302
==================================================================================
Per Share Data:
Basic earnings per share $ 1.24 $ 1.00 $ 0.57 $ 0.28 $ 0.24
Diluted earnings per share $ 1.13 $ 0.89 $ 0.50 $ 0.25 $ 0.22
Average common shares outstanding 8,503,179 7,823,950 7,372,504 6,484,108 5,239,378
Average common shares & equivalents 9,363,868 8,861,706 8,370,040 7,142,290 5,694,492
Book value per share $ 4.90 $ 3.64 $ 2.63 $ 2.06 $ 1.62
Equity shares-beginning balance 8,151,914 7,446,646 7,326,324 5,505,322 5,099,744
Warrants - Shares Issued 0 324,598 66,628 5,058 0
Options - Shares Issued 600,689 380,670 53,694 215,944 405,578
Stock offering 0 0 0 1,600,000 0
----------------------------------------------------------------------------------
Equity shares-ending balance 8,752,603 8,151,914 7,446,646 7,326,324 5,505,322
==================================================================================
Balance Sheet Data:
Assets $606,827,529 $431,212,118 $310,506,097 $ 190,024,416 $117,757,861
Loans 530,196,252 360,749,391 271,425,826 150,274,574 92,037,318
Allowance for loan loss 6,362,534 3,607,833 3,017,395 1,239,308 927,509
Other Real Estate Owned 302,698 485,036 0 0 0
Fed Funds Sold & Investments 16,800,000 21,400,000 0 16,400,000 12,225,250
Securities
FRB/FHLB Stock 2,377,800 1,145,000 1,460,050 517,250 214,700
Deposits 534,766,705 383,487,366 269,321,220 172,928,225 107,306,736
FHLB advances 0 0 10,000,000 0 0
Trust preferred borrowing 20,620,000 12,372,000 7,217,000 0 0
Stockholders' equity 42,902,538 29,683,065 19,616,203 15,103,944 8,937,182
ALLL beginning balance $ 3,607,883 $ 3,017,395 $ 1,239,308 $ 927,509 $ 551,792
Charge offs (1,096,698) (505,586) (707,455) (88,201) (20,402)
Recoveries 30,099 74,024 25,542 0 11,119
Provision for loan losses 3,821,300 1,022,000 2,460,000 400,000 385,000
----------------------------------------------------------------------------------
41
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
ALLL ending balance $ 6,362,534 $3,607,833 $3,017,395 $1,239,308 $ 927,509
==================================================================================
Non-performing loans $ 11,799,346 $6,764,713 $1,908,169 $ 198,861 $ 271,495
Government guaranteed portion (8,140,267) (5,269,317) (1,077,597) (92,895) (203,621)
----------------------------------------------------------------------------------
Net non-performing loans $ 3,659,079 $ 1,495,396 $ 830,572 $ 105,966 $ 67,874
==================================================================================
SBA 7A participation sold - period $421,529,332 $287,345,585 $168,163,922 $ 66,819,282 $29,187,738
end
Other participations sold 18,771,938 18,906,176 8,911,376 3,085,662 7,423,766
----------------------------------------------------------------------------------
Total participation sold - period $440,301,270 $306,251,761 $177,075,298 $69,904,944 $36,611,504
end
==================================================================================
Asset Quality:
Nonaccrual loans
ORE
Selected Ratio's:
Return on average assets 2.00% 2.04% 1.69% 1.15% 1.21%
Return on average equity 28.94% 31.84% 24.34% 14.82% 16.10%
Income tax rate 41.60% 40.90% 40.70% 40.00% 39.80%
Tier I leverage ratio 9.20% 9.06% 8.53% 7.91% 7.54%
Tier I risk based ratio 9.68% 10.01% 9.30% 9.39% 8.93%
Total risk based ratio 11.81% 11.54% 10.61% 10.17% 9.86%
Allowance for loan loss/loans 1.20% 1.00% 1.11% 0.82% 1.00%
Allowance for loan loss/net 173.87% 241.34% 363.06% 1,180.00% 1,366.51%
nonperforming loans
Loan to deposit ratio 99.15% 94.07% 100.78% 86.40% 87.53%
Avg int earning assets/total assets 86.09% 86.34% 86.40% 87.53% 88.39%
Investment yield (includes 1.37% 1.07% 1.54% 3.72% 6.26%
FRB/FHLB)
Loan yield 7.48% 7.45% 7.99% 9.54% 11.14%
Total interest bearing assets 7.37% 7.17% 7.71% 8.72% 10.16%
Interest bearing deposit cost 1.66% 1.82% 1.89% 2.93% 3.91%
Borrowing cost 4.04% 4.32% 3.21% N/A N/A
Net interest margin 5.96% 5.67% 6.23% 6.73% 7.50%
Net interest spread 5.58% 5.25% 5.72% 5.79% 6.25%
SBA Loan Servicing:
SBA excess servicing asset $ 7,585,712 $6,116,679 $ 3,763,779 $ 1,538,437 $ 708,401
SBA I/O strip receivable asset 24,679,520 20,495,511 13,120,093 4,136,809 1,381,098
----------------------------------------------------------------------------------
Total SBA servicing asset 32,265,232 $26,612,190 $16,883,872 $ 5,675,246 $2,089,499
==================================================================================
SBA servicing-cash income $ 8,737,520 $ 6,026,300 $ 2,674,726 $ 763,445 $ 465,409
SBA servicing-asset (6,118,947) (4,233,596) (1,462,019) (402,442) (192,742)
SBA servicing-guarantee fee to SBA (118,130) (98,868) (83,379) (21,943) (1,853)
----------------------------------------------------------------------------------
SBA servicing-net servicing income $2,500,443 $1,693,836 $ 1,129,328 $ 339,060 $ 270,814
==================================================================================
Loan Sales:
SBA 7A sales - guaranteed $ 146,880,937 $129,813,081 $108,212,760 $42,872,549 $10,438,650
SBA 7A guaranteed-sales gain 8,794,797 8,148,585 6,014,821 1,642,461 694,931
SBA 7A sales - unguaranteed $ 35,365,372 $ 19,208,615 $12,573,048 $ 5,933,122 $ 0
42
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Unguaranteed SBA 7A sales gain 6,360,569 3,191,211 2,094,818 940,392 0
Mortgage loan sales $ 45,243,206 $ 100,800,159 $83,014,280 $55,224,847 $10,439,365
Mortgage loan sales gain 1,511,330 3,568,235 3,100,170 1,553,409 306,177
SBA Broker referral income $ 2,505,611 $ 2,844,613 $ 1,971,774 $ 1,070,945 $ 0
Mortgage Broker referral income 962,813 1,037,621 907,568 864,230 508,201
Employee Related:
Full time employees 229 194 181 148 86
Part time employees 16 14 18 13 11
Full time equivalent employees 238 204 194 156 92
Salary continuation plan expense $ 1,084,646 $ 531,240 $ 267,108 $ 165,682 $ 156,844
CSV life insurance balance 9,593,824 5,740,729 $ 3,983,183 $2,832,254 $ 2,159,329
CSV life insurance income 378,089 $ 250,368 $ 175,901 $ 144,262 $ 115,481
CSV Llfe insurance expense (61,274) (44,822) (24,972) (19,337) (19,323)
----------------------------------------------------------------------------------
Net life insurance income $ 316,815 $ 205,546 $ 150,929 $ 124,925 $ 96,158
==================================================================================
ITEM 7: MANAGEMENT DISCUSSION AND ANALYSIS
See "Cautionary Statement for Purposes of the "Safe Harbor" Provision of
the Private Securities Litigation Reform Act of 1995," on the pages immediately
following the table of contents in connection with "forward looking" statements
included in this Annual Report.
Analysis of Financial Condition and Results of Operations
This discussion should be read in conjunction with the financial statements
of the Company, including the notes thereto, appearing elsewhere in this Annual
Report.
Results of Operations
Net Income
For 2004, net income was $10,577,623 or $1.24 per basic share and $1.13 per
diluted share. For 2003, net income was $7,854,339, or $1.00 per basic share and
$0.89 per diluted share and for 2002 it was $4,191,054 or $0.57 per basic share
and $0.50 per diluted share. The net interest margin for the last three years
has been consistently strong. This factor coupled with income increases in gain
on sale of loans, servicing income and other fee income, most significantly in
connection with SBA and mortgage loan sales, represents a significant portion of
the profit dynamics of the Company. The Company sold $35,365,372 of the
unguaranteed portion of SBA 7A loans in 2004, which added $6,360,569 to net
income. For 2003 we sold $19,208,615, which added $3,191,211 to income and in
2002, we sold $12,573,048, which added $2,094,218 to income. The Company expects
to continue to sell SBA loans in the secondary market while retaining a
significant portion of the servicing rights. The return on average assets was
2.00% for 2004 compared to 2.04% in 2003 and 1.69% in 2002. The return on
43
average equity was 28.94% for 2004 compared to 31.84% for 2003 and 24.34% for
2002. Due to low interest rates and increasing real estate values resulting in
equity availability for other investments, loan activity has been robust.
Similar but somewhat tempered activity is expected for 2005.
Net Interest Income
Net interest income was $27,200,344 in 2004 compared to $18,943,947 in 2003
and $13,384,759 in 2002. These interest income levels have been achieved as a
result of net interest margins that have been consistently higher than
expectations in this interest rate environment as well as growth of the loan
portfolio. Net interest margins were 5.96%, 5.67% and 6.23% for years ended
2004, 2003 and 2002, respectively. The loan-to-deposit ratio at December 31,
2004 was 99.15%, at December 2003 it was 94.07% and at December 31, 2002 it was
100.78%. Loans produced a yield of 7.48% in 2004, 7.45% in 2003 and 7.99% in
2002. Investments, yielded 1.37% in 2004, 1.07% in 2003 and 1.54% in 2002. Total
interest earning assets yielded 7.37% in 2004, 7.16% in 2003 and 7.70% in 2002.
The cost of interest bearing deposits was 1.66% in 2004, 1.82% in 2003 and 1.89%
in 2002. For 2004, the cost of other borrowings was 4.04% and consisted of FHLB
advances and Trust Preferred Borrowings. For 2003, the cost of other borrowings
was 4.32% and consisted of Federal Funds Purchased, FHLB advances and Trust
Preferred Borrowings. No other borrowings were incurred.
The Company tries to maximize the percentage of assets it maintains as
interest earning assets, with the goal of the Company to maintain at least 90%
in that category. Effectively, all of the increases in non-interest earning
assets in 2004, 2003 and 2002 were in the cash surrender value of life insurance
(BOLI), the SBA servicing and SBA I/O strip receivable assets.
The following table shows average balances with corresponding interest
income and interest expense as well as average yield and cost information for
the last three years. Average balances are derived from daily balances, and
non-accrual loans are included as interest bearing loans for the purposes of
these tables.
44
Average Balances with Rates Earned and Paid
Year ended December 31
--------------------------------------------------------------------------------------------------
2004 2003 2002
Interest Average Interest Average Interest Average
Average Income/ Interest Average Income/ Interest Average Income/ Interest
Balance Expense Rate Balance Expense Rate Balance Expense Rate
---------------------------- ---------------------------- -------------------------------
(Dollars in Thousands)
Assets
Due From Banks-Time $ 0 $ 0 0% $ 0 $ 0 0.00% $ 0 $ 0 0.00%
Securities-HTM (1) 168 2 1.13% 41 0 .82% 222 4 1.65%
Federal Funds Sold 8,098 111 1.37% 14,191 152 1.07% 8,870 137 1.54%
---------------------------- ---------------------------- -------------------------------
Total Investments 8,266 113 1.37% 14,232 152 1.07% 9,092 141 1.54%
Total Loans(2) 446,493 33,502 7.48% 318,600 23.738 7.45% 204,849 16,369 7.99%
---------------------------- ---------------------------- -------------------------------
Total Interest Earning Assets 454,759 33,615 7.37% 334,005 23,890 7.17% 214,832 16,510 7.71%
------------------- ------------------- ------------------
Allowance for Loan Loss (4,395) (3,152) (1,588)
Cash & Due From Banks 21,994 17,295 13,779
Premises & Equipment 2,820 2,196 2,271
Other Assets 53,061 36,310 18,335
--------- --------- ---------
Total Assets $528,239 $385,481 $247,629
========= ========= =========
Liabilities and
Shareholders' Equity
Interest Bearing Demand $ 31,588 45 .14% $ 24,075 24 .10% $ 18,564 18 .10%
Money Market 37,770 456 1.20% 37,238 532 1.43% 38,621 628 1.62%
Savings 50,699 186 .46% 32,739 192 .59% 27,951 228 .82%
Time Deposits under 113,802 2,425 2.12% 75,177 1,833 2.44% 26,509 806 3.04%
$100,000
Time Deposits $100,000 or more 112,964 2,484 2.19% 76,998 1,894 2.46% 35,682 1,105 3.10%
Other Borrowings 20,195 819 4.04% 10,906 471 4.32% 10,581 340 3.21%
---------------------------- ---------------------------- -------------------------------
Total Interest Bearing 357,018 6,415 1.79% 257,133 4,946 1.92% 157,908 3,125 1.98%
Liabilities ------------------- ------------------- ------------------
Non-interest Demand 128,670 99,565 69,972
Deposits
Other Liabilities 5,934 4,108 2,530
Shareholders' Equity 36,617 24,675 17,219
--------- --------- ---------
Total Liabilities and
Shareholders' equity $ 28,239 $385,481 $247,629
======== ======== =========
Net Interest Income $ 27,200 $ 18,944 $ 13,385
========== ========== =========
Interest Spread (3) 5.58% 5.25% 5.72%
========= ========= =============
Net Interest Margin (4) 5.96% 5.67% 6.23%
========= ========= =============
(1) There are no tax exempt investments in any of the reported years.
(2) Average balances are net of deferred fees/gains that are amortized to
interest income over the term of the respective loan.
(3) Net interest spread is the yield earned on interest earning assets less the
rate paid on interest bearing liabilities.
(4) Net interest margin is the net interest income divided by the interest
earning assets.
45
Rate/Volume Analysis
Increase/Decrease in Net Interest Income
Year Ended December 31
2004 2003 2002
-----------------------------------------------------------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL VOLUME RATE TOTAL
Assets
Due From Banks-Time $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
Securities-HTM (1) 1 10 2 (4) 0 (4) 1 (7) (6)
FRB/FHLB Stock 15 3 18 26 1 27
Federal Funds Sold (65) 24 (41) 82 (67) 15 (365) (192) (557)
-----------------------------------------------------------------------------------
Total Investments (64) 25 (39) 93 (64) 29 (338) (198) (536)
Total Loans (2) 9,630 134 9,764 9,089 (1,720) 7,369 8,245 (3,175) 5,070
-----------------------------------------------------------------------------------
Total Interest Earning 9,566 159 9,725 9,182 (1,784) 7,398 7,907 (3,373) 4,534
Assets -----------------------------------------------------------------------------------
Liabilities and
Shareholders' Equity
Interest Bearing Demand (8) (13) (21) (6) 0 (6) (30) 85 55
Money Market (11) 87 76 25 71 96 (521) 413 (108)
Savings (47) 53 6 36 11 36 11 394 394
Time Deposits under $100,000 (956) 364 (592) (1,478) 451 (1,027) (580) 459 (121)
Time Deposits $100,000 or more (805) 305 (590) (1,282) 493 (789) (835) 564 (271)
Other Borrowings (405) 57 (348) (10) (121) (131) 0 (340) (340)
-----------------------------------------------------------------------------------
Total Interest Bearing (2,232) 853 (1,469) (2,790) 969 (1,821) (1,955) 1564 (391)
Liabilities -----------------------------------------------------------------------------------
Net Interest Income $ 7,244 $1,012 $8,256 $6,377 $ (818) $5,559 $5,926 $(1,810) $4,116
===================================================================================
- -------------------------------------
(1) There are no tax exempt investments in any of the reported years.
(2) Average balances are net of deferred fees/gains that are amortized to
interest income over the term of the respective loan.
(3) Net interest spread is the yield earned on interest earning assets less the
rate paid on interest bearing liabilities.
(4) Net interest margin is the net interest income divided by the interest
earning assets.
Based on expectations for loan and deposit growth, and economic conditions
anticipat9ed for 2005, management currently expects the net interest margin for
2005 to be in the range of 5.84% to 6.09% due to higher rate CDs maturing and a
different mix of interest earning assets.
Non Interest Income
Non-interest income of $ 28,698,614 in 2004, $24,481,351 in 2003 and
$17,941,643 in 2002 contributed significantly to earnings. Service charges and
fees decreased from $792,292 in 2003 to $667,743 in 2004 mainly due to a
decrease in NSF Fees. SBA loan servicing income increased to $2,500,443 in 2004
from $1,693,836 in 2003 and $1,129,328 in 2002 due to the increase in the size
of the servicing portfolio. The gain on sale of loans was $18,858,056 in 2004
compared to $15,779,079 in 2003 and $11,389,023 in 2002 due to significantly
higher SBA and mortgage loan sales in 2003 and higher SBA but lower mortgage
loan sales in 2004. The loan sales consisted primarily of SBA guaranteed and
unguaranteed loans and mortgage loans that are sold service released. The SBA
and mortgage loan sales are expected to continue in the future.
46
Analysis of Changes in Non-Interest Income
Increase / (Decrease) Increase / (Decrease)
-------------------------- -----------------------
2004 Amount % 2003 Amount % 2002
---- ------ - ---- ------ - ----
(Dollars in Thousands)
Service charges and fees $ 668 $ (124) (16)% $ 792 $ (173) (18%) $ 965
Gain on loan sales 18,858 3,079 20% 15,779 4,390 39% 11,389
Loan broker income 3,468 (414) (11)% 3,882 1,003 35% 2,879
Servicing income 2,500 806 48% 1,694 565 50% 1,129
Construction fund
control fees 977 137 16% 840 444 112% 396
Other income 2,228 734 49% 1,494 310 26% 1,184
----------- --------- ---------- --------- -------
Total $ 28,699 $ 4,281 $ 24,481 $ 6,523 $17,942
=========== ========= ========== ========= =======
Non-Interest Expense
Non interest expenses are comprised of salaries and benefits, occupancy,
furniture and equipment, processing, office expense, professional fees and costs
such as legal and auditing, marketing, and regulatory fees. These expenses are
closely reviewed and controlled in an effort to maintain the most cost effective
operational level.
Non-interest expense was $33,964,229 in 2004 compared to $29,121,070 in
2003 and $21,800,838 in 2002. Salaries and benefits increased from $14,866,458
in 2002, to $20,484,132 in 2003 and to $22,514,965 in 2004. The increase in 2002
was due to the continued expansion of the SBA and related staff as well as the
real estate tract-lending department. The increase in 2003 was due to
commissions and incentives paid from increase in loan production. The increase
in 2004 was due to the addition of branches in Corona and Rancho Bernardo, as
well as the general growth of the Company. Loan funding expenses, higher due to
increases in loan volume, were $1,764,034, $1,708,170, and $1,211,541 for 2004,
2003 and 2002, respectively. Office expenses have increased over the last three
years principally due to internal expansion.
The following table presents for the periods indicated the major categories
of non-interest expense:
47
Analysis of Changes in Non-Interest Expense
Increase / (Decrease) Increase / (Decrease)
------------------------------ ------------------------
2004 Amount % 2003 Amount % 2002
---- ------ - ---- ------ - ----
(Dollars in Thousands)
Salaries and employee
benefits $ 22,515 $ 2,031 9% $ 20,484 $ 5,617 38% $14,867
Occupancy of premises 1,725 542 46% 1,183 173 17% 1,010
Loan funding expense 1,764 56 3% 1,708 497 41% 1,211
Furniture and equipment 1,136 244 27% 892 50 6% 842
Data processing 1,015 27 3% 988 96 11% 892
Office expenses 2,237 648 41% 1,589 184 13% 1,405
All other expenses 3,572 1,295 57% 2,277 703 45% 1,574
---------- --------- --------- -------- ------
Total $ 33,964 $ 4,783 17% $ 29,121 $ 7,320 34% $21,801
========== ========= ========= ======== ======
Income Taxes
For 2002 the tax expense was $2,874,510 for an effective rate of 40.7%; for
2003 the tax expense was $5,427,889 for an effective rate of 40.9%; and for 2004
the tax expense was $7,535,806 for an effective rate of 41.6%
Financial Condition
General
As of December 31, 2004, total assets increased 41% to $606,827,529
compared to $431,212,118 as of December 31, 2003. Total gross loans increased to
$533,899,733 as of December 31, 2004, or 47%, compared to $363,046,406 as of
December 31, 2003.
Deposits grew 39% to $534,766,705 as of December 31, 2004, compared to
$383,487,366 as of December 31, 2003. Shareholders' equity increased to
$42,902,538 or 45%, as of December 31, 2004 compared to $29,683,065 as of
December 31, 2003.
Capital
The Company's capital increased 45% to $42,902,538 as of December 31, 2004
compared to $29,683,065 as of December 31, 2003. The Company's equity to assets
ratio was 7.1% and 6.9% at December 31, 2004 and 2003, respectively. The
Company's budgeting process and strategic plan address the future capital needs
of the Company.
The Company declared a two-for-one stock split to shareholders in December
2003. Whether or not stock dividends or any cash dividends will be paid in the
future will be determined by the Board of Directors after consideration of
various factors. The Company's and the Bank's profitability and regulatory
capital ratios, in addition to other financial conditions, will be key factors
considered by the Board of Directors in making such determinations regarding the
payment of dividends.
48
On September 20, 2004, the Company issued $8,248,000 of junior subordinated
debt securities to Temecula Valley Statutory Trust III ("Trust III"), a
statutory trust created under the laws of the State of Delaware. These debt
securities are subordinated to effectively all borrowings of the Company and are
due and payable on September 20, 2034. Interest is payable quarterly on these
debt securities at 3-Month LIBOR plus 2.20% for an effective rate of 4.78% as of
September 30, 2004. The debt securities can be redeemed for 107.5% of the
principal balance through September 17, 2009 and at par thereafter. Trust III
used the proceeds from the sale of the securities to purchase junior
subordinated debentures of the Company. The Company received $8,248,000 from
Trust III upon issuance of the junior subordinated debentures, of which
$8,000,000 was contributed to the Bank to increase its capital. The trust
preferred debentures are shown as borrowings on the Company's books.
During September 2003, the Company issued $5,155,000 of junior subordinated
debt securities to the Company's wholly owned subsidiary, Temecula Valley
Statutory Trust II, ("Trust II"), a Connecticut business trust. The securities
have quarterly interest payments with a rate at 3-month LIBOR plus 2.95% for an
effective rate of 5.53% as of December 31, 2003, with principal due at maturity
in 2033. Trust II used the proceeds from the sale of the securities to purchase
junior subordinated debentures of the Company. The Company received $5,155,000
from Trust II upon issuance of the junior subordinated debentures, of which
$5,000,000 was contributed to the Bank to increase its capital. The trust
preferred debentures are shown as borrowings on the Company's books.
During June 2002, the Company issued $7,217,000 of junior subordinated debt
securities to the Company's wholly owned subsidiary, Temecula Valley Statutory
Trust I, ("Trust I"), a Connecticut business trust. The securities have
quarterly interest payments with a rate at 3-month LIBOR plus 3.45% for an
effective rate of 6.08% as of December 31, 2003, with principal due at maturity
in 2032. The trust used the proceeds from the sale of the securities to purchase
junior subordinated debentures of the Company. The Company received $7,217,000
from the trust upon issuance of the junior subordinated debentures, of which
$6,789,000 was contributed to the Bank to increase its capital. The trust
preferred debentures are shown as borrowings on the Company's books.
At the end of 2004 and 2003, all Bank capital ratios were above all current
Federal capital guidelines for a "well-capitalized" bank. Management considers
capital requirements as part of its strategic planning process. The strategic
plan calls for continuing increases in assets and liabilities, and the capital
required may therefore be in excess of retained earnings. The ability to obtain
capital is dependent upon the capital markets as well as performance of the
Company. Management regularly evaluates sources of capital and the timing
required to meet its strategic objectives.
49
The following tables present the regulatory standards for well
capitalized institutions and the capital ratios for the Company and the Bank at
December 31, 2004, 2003 and 2002.
To Be Well Capitalized
Minimum Required for Under Prompt Corrective
Capital Adequacy Corrective Action Actual Ratio
Purposes Provisions December 31
-----------
2004 2003 2002
---- ---- ----
Temecula Valley Bancorp
Tier 1 leverage 4.0% (1) 5.0% 9.2% 9.0% 8.5%
Tier 1 risk-based capital 4.0% 6.0% 9.7% 10.0% 9.3%
Total risk-based capital 8.0% 10.0% 11.8% 11.5% 10.6%
To Be Well Capitalized
Minimum Required for Under Prompt Corrective
Capital Adequacy Corrective Action Actual Ratio
Purposes Provisions December 31
-----------
2004 2003 2002
---- ---- ----
Temecula Valley Bank
Tier 1 leverage 4.0% (1) 5.0% 10.0% 9.4% 8.7%
Tier 1 risk-based capital 4.0% 6.0% 10.5% 10.3% 9.4%
Total risk-based capital 8.0% 10.0% 11.6% 11.3% 10.5%
(1) The Comptroller may require the Bank to maintain a leverage ratio of up
to 100 basis points above the standard minimum.
Loan Portfolio
Total loans, excluding deferred loan fees, were $533,899,733 and
$363,046,406 at December 31, 2004 and 2003, respectively, a 47% increase. Much
of the increase is due to increases in construction loans, real estate loans,
and to a lessor extent SBA loans. SBA loans, of which the Bank is an active
originator and consist of both commercial and real estate loans, comprise
approximately 21.6% of loans outstanding at December 31, 2004, 28.4% of total
loans outstanding at December 31, 2003 and 28% as of December 31, 2002. Due to
the strong real estate market, and due to the inherent nature of community bank
loan markets, over 94% of the loan portfolio is in real estate secured loans as
of December 31, 2004, compared to 85% and 82% for comparable periods in 2003 and
2002, respectively. The rate of loan growth should continue to be strong.
The majority of our loans have floating rates tied to our base rate or
other market rate indicator. This serves to lessen the risk from movement in
interest rates, particularly rate increases.
Healthy loan demand resulted in a 79.1% increase in construction lending, a
28.6% decrease in commercial loans and a 47.2% increase in real estate lending.
Mortgage loans outstanding decreased from $2,541,975 as of December 31, 2003 to
$2,240,758 as of December 31, 2004. The Bank mortgage loans originated,
including brokered loans of $105,545,627 in 2004, compared with $161,409,182 in
2003 and $158,023,525 in 2002. Sales of mortgage loans totaled $45,243,206 in
2004, compared with $100,800,159 in 2003 and $56,752,396 in 2002. The servicing
portfolio, which consists primarily of SBA loans sold to other investors, being
serviced by the Company was $440,301,270 as of December 31, 2004 compared to
$306,251,761 as of December 31, 2003.
50
Non-Performing Assets
Nonperforming assets consist of nonperforming loans and Other Real Estate
Owned (OREO). The Company had $1,908,169 of non-performing loans as of December
31, 2002, of which $1,077,000 was guaranteed by the SBA, compared to $6,675,000
of non-performing loans as of December 31, 2003, of which $5,269,000 were
government guaranteed. At December 31, 2004, the Company had $11,799,346 of
non-performing loans of which $8,140,267 were government guaranteed. As of
December 31, 2002, restructured loans were $1,064,217 as compared to $948,691 at
December 31, 2003 and $154,303 at December 31, 2004.
Nonaccrual Loans
Nonaccrual loans, net of the government guaranteed portion, decreased to
$3,659,000 or .69 % of total gross loans as of December 31, 2004 compared to
$1,405,000 or .22% of total gross loans as of December 31, 2003.
Classified Assets
From time to time, management has reason to believe that certain borrowers
may not be able to repay their loans within the parameters of the present
repayment terms, even though, in some cases, the loans are current at the time.
These loans are graded in the classified loan grades of "substandard,"
"doubtful," or "loss" and include non-performing loans. Each classified loan is
monitored monthly. Classified assets, net of government guarantees, (consisting
of nonaccrual loans, loans graded as substandard or lower and OREO) at December
31, 2004 and 2003 were $3,734,754 and $1,980,432, respectively.
Risk Management
The investment of the Company's funds is primarily in loans where a greater
degree of risk is normally assumed than in other forms of investments. Sound
underwriting of loans and continuing evaluations of the underlying collateral
and performance of the borrowers are an integral part in the maintenance of a
high level of quality in the total assets of the Company. Net loan charge-offs
for the year ended December 31, 2004 were $1,066,600 or .23% of average gross
loans outstanding, compared to $431,561 or .14% of average gross loans
outstanding, for the year ended December 31, 2003.
Allowance for Loan Losses
As of December 31, 2004 the balance in the allowance for loan losses was
$6,362,534 compared to $3,607,833 as of December 31, 2003. Risks and
uncertainties exist in all lending transactions and, even though there have
historically been very few charge offs in any category of the Company's loans,
the Board of Directors has established reserve levels for each category based
upon loan type as well as market conditions for the underlying real estate and
other collateral, considering such factors as trends in the real estate market,
51
economic uncertainties and other risks, where it is probable that losses could
be incurred in future periods. In general, there are no reserves established for
the government guaranteed portion of commitments to extend credit. As of
December 31, 2004, the allowance was 1.2% of total gross loans compared to 1.0%
as of December 31, 2003. The allowance for loan losses as a percentage of
nonaccrual loans was 53.9% as of December 31, 2004, compared to 86.7% as of
December 31, 2003. The allowance for loan losses to non-performing loans, net of
government guarantees was 173.9% as of December 31, 2004, compared to 461.8% as
of December 31, 2003. During 2002 and 2003, net charge offs as a percentage of
average loans outstanding were only .33% and .14%, respectively. The low levels
of net charge offs in 2001 and 2002 can be attributed to the strong economy in
the Company's primary market area, including the significant rise in real estate
values across all collateral types. In 2004, net charge offs as a percent of
average loans outstanding increased to .24%. The growth in total loans
outstanding, resulted in an increase in the level of reserves required from
$3,607,833 as of December 31, 2003 to $6,362,534 as of December 31, 2004. The
Bank has also established reserve levels for each category based upon loan type.
Certain loan types may not have incurred losses or have historically had minimal
losses, but it is probable that losses could be incurred in future periods. The
Bank considers trends in delinquencies, potential charge offs by loan type,
market for underlying real estate or other collateral, trends in industry types,
economic changes and other risks.
During the year ended December 31, 2004, management charged off $1,066,600
(net of recoveries) and provided $3,281,000 to the provision for loan losses.
During the year ended December 31, 2003, management charged off $431,561 (net of
recoveries) to the allowance while it provided $1,022,000 to the provision for
loan losses. For the year ended December 31, 2004, net charge offs as a
percentage of average loans outstanding was .23%, compared to .14% for the year
ended December 31, 2003. Management believes the allowance at December 31, 2004
is adequate based upon its ongoing analysis of the loan portfolio, historical
loss trends and other factors. Although management believes that they use the
best information available to make such determinations, future adjustments to
the allowance for loan losses may be necessary and results of operations could
be significantly and adversely affected if circumstances differ substantially
from the assumptions used in making the determinations.
Other Assets
Premises and equipment, accrued interest and other assets, income tax
receivable, servicing asset, interest only strips and cash surrender value of
life insurance, are the major components of other assets. Premises and equipment
increased to $4,379,809, or 100.4% as of December 31, 2004 compared to
$2,185,543 as of December 31, 2003 due to depreciation expense being less than
the replacement or upgrade of existing assets, and the asset additions for new
locations.
Accrued interest and other assets increased from $4,761,049 as of December
31, 2003 to $6,586,197 as of December 31, 2004. The major component of accrued
interest and other assets is interest accrued and not yet received on loans. The
increase in accrued interest from $1,396,000 at December 31, 2003 to $1,948,000
at December 31, 2004 is due to the increase in yield on loans from 7.45% for the
year ended December 31, 2003 to 7.48% for the year ended December 31, 2004 and
the significant increase in loan balances. Average loan balances increased from
$318,599,785 for 2003 to $446,493,154 for 2004.
52
The servicing asset, net, increased to $7,585,712 as of December 31, 2004,
compared to $6,116,680 as of December 31, 2003. The increase reflects the
additions due to loan sales during the year ended December 31, 2004 and
decreased due to amortization of the servicing asset. The valuation of the
servicing asset reflects estimates of the expected life of the underlying loans,
which may be adversely affected by higher than expected levels of pay-offs in
periods of lower rates or charge-offs in periods of economic difficulty. In
addition, when property values increase due to general economic conditions,
borrowers have refinancing opportunities available to them, which may result in
higher prepayment rates. Management evaluates the servicing asset for impairment
quarterly. For purposes of measuring impairment, the future servicing cashflows
are stratified based on original term to maturity and the expected life of the
loans. The amount of impairment recognized is the amount by which the servicing
assets for a stratum exceeds their fair value. The weighted average prepayment
speed was 15.22% as of December 31, 2004 compared to 15.67% as of December 31,
2003. See the footnotes to the financial statements, found elsewhere in this
Annual Report, for further information on servicing assets.
Rights to future interest income from serviced loans that exceed
contractually specified servicing fees are classified as interest-only strips.
Interest-only strips increased to $24,679,520 as of December 31, 2004, compared
to $20,495,511 as of December 31, 2003. The increase is due to the increase in
loans serviced for others as a result of the loan sales in 2004. The average
prepayment speed is the same as the servicing asset.
Life Insurance -Cash Surrender Value
The cash surrender value of life insurance is bank owned life insurance
("BOLI"). The BOLI death benefit provides key man insurance for the Bank as well
as providing coverage for the unaccrued liability in the event of the death of
the executive for the executive Salary Continuation Plans ("SCP"). The BOLI had
a balance of $9,593,824 at December 31, 2004 compared to $5,740,729 a year
earlier. The total death benefit at December 31, 2004 was approximately
$18,000,000. The BOLI earnings in 2004, net of mortality cost, were $316,815,
compared to $205,546 in 2003. The net earnings of BOLI are tax-free. The SCP
expense before tax in 2004 was $1,084,646 compared to $531,240 in 2003. See the
notes in the financial statements for additional information.
Investments/Financial Assets
Federal Reserve Bank and Federal Home Loan Bank stock, which are not
included in the investment category, was $2,377,800 at December 31, 2004 and
$1,145,000 at December 31, 2003. The Bank had $16,800,000 in Fed Funds Sold at
December 31, 2004 compared to $21,400,000 at December 31, 2003. The change from
year to year is largely attributable to loans and servicing asset increasing
more than deposits and borrowings.
At the date of purchase, we are required to classify equity and debt
securities into one of three categories: held-to-maturity, trading or
available-for-sale. At each annual reporting date, the appropriateness of the
classification is reassessed. Investments classified as held-to-maturity are
measured at amortized cost in the financial statements and can be so classified
53
only if management has the positive intent and ability to hold those securities
to maturity. Securities that are bought and held principally for the purpose of
sale in the near-term are classified as trading and measured at fair value in
the financial statements with unrealized gains and losses included in earnings.
Investments not classified as either held-to-maturity or trading are classified
as available-for-sale and measured at fair value in the financial statements
with unrealized gains and losses reported, net of tax, in a separate component
of shareholders' equity until realized.
For 2004 the ratio of interest earning assets to total assets was 86.09%,
for 2003 it was 86.34% and for 2002 it was 86.40%. The target for the Company is
to keep this ratio above 90%, but has remained below that level due to the
increase in the SBA servicing asset, the related SBA interest only strip
receivable, and the cash surrender value of life insurance. The SBA servicing
asset was $7,585,712, the SBA I/O strip receivable was $24,679,520 and the cash
surrender value of life insurance was $9,593,824 at December 31, 2004. At
December 31, 2003 the SBA servicing asset was $6,116,680, the SBA I/O strip
receivable was $20,495,511 and the cash surrender value of life insurance was
$5,740,729. The SBA servicing asset was $3,763,799, the SBA I/O strip receivable
was $13,120,093 and the cash surrender value of life insurance was $3,983,183 at
December 31, 2002. Even though these assets are not considered interest bearing
for net interest margin purposes, they do produce, or are related to, income
that is part of non-interest income.
At December 31,
---------------------------------------------------------------------------------
2004 2003 2002
-------------------------- --------------------------- --------------------------
Carrying Estimated Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value Value Fair Value
------------ ------------- -------------- ------------ ------------ -------------
(Dollars in Thousands)
Financial Assets:
Cash and due from banks $ 6,317 $ 6,317 $ 9,348 $ 9,348 $ 12,180 $ 12,180
Federal funds sold 16,800 16,800 21,400 21,400
Loans, net 523,834 524,201 357,142 359,914 268,409 270,245
Federal Reserve and Federal Home
Loan Bank Stock 2,378 2,378 1,145 1,145 1,460 1,460
I/O Strips receivable and servicing
assets 32,265 32,265 26,612 26,612 16,884 16,884
Cash surrender value - life
insurance 9,594 9,594 5,741 5,741 3,983 3,983
Accrued interest receivable 1,948 1,948 1,396 1,396 1,153 1,153
Deposits and Borrowed Funds
The Bank offers a variety of deposit accounts having a wide range of
interest rates and terms, consisting of demand, savings, money market and time
accounts. We rely primarily on competitive pricing policies, customer service
and referrals to attract and retain these deposits. We do not accept brokered
deposits.
54
Deposits increased to $534,766,705 at December 31, 2004 from $383,487,366
at December 31, 2003 and $269,321,220 at December 31, 2002. Demand deposits
comprised nearly 26% of the deposits in 2004, 29% in 2003 and 32% in 2002,
tiered savings nearly 8% in 2004, 9% in 2003 and 11% in 2002, tiered money
market accounts nearly 8% in 2004, 9% in 2003 and 16% in 2002, NOW accounts
comprised 6% in 2004, 8% in 2003 and 7% in 2002 and certificate of deposits over
52% in 2004, 45% in 2003 and 34% in 2002. The increase in the ratio of
certificates of deposits is due to certificate of deposit promotions in 2003 and
2004 to fund the rapid loan growth. More than 52% of deposits have balances of
$100,000 or more. No one customer has balances that exceed 10% of the deposits
of the Bank. The Bank depends on core deposits as a source of funds for the loan
portfolio. Consequently, the Bank tries to attract core accounts yet maintain a
reasonable funding cost. The core deposit base has grown as a result of the
addition of two branches in 2001, two branches in 2004, and the continued
deposit increases at the three other branches. It is anticipated that the core
deposit base will increase in 2005 as a result of two new branches scheduled to
open in 2005, one in Carlsbad, CA and the other in Indian Wells, CA. The Bank
will continue to solicit core deposits to diminish reliance on volatile funds.
At December 31, 2004 there were no short-term advances from the Federal
Home Loan Bank. The borrowing capacity at the Federal Home Loan Bank as of
December 31, 2004 was $36,354,213.
On September 20, 2004, the Company issued $8,248,000 of junior subordinated
debt securities to the Company's wholly owned subsidiary, Temecula Valley
Statutory Trust III ("Trust III"), a statutory trust created under to laws of
the State of Delaware. The securities have quarterly interest payments with a
rate at 3-month LIBOR plus 2.20% for an effective rate of 4.78% as of December
31, 2004, with principal due at maturity in 2034. On September 17, 2003, the
Company issued $5,155,000 of junior subordinated debt securities to the
Company's wholly owned subsidiary, Temecula Valley Statutory Trust II, ("Trust
II"), a Connecticut business trust. The securities have quarterly interest
payments with a rate at 3-month LIBOR plus 2.95% for an effective rate of 5.53%
as of December 31, 2004, with principal due at maturity in 2033. During June
2002, the Company issued $7,217,000 of junior subordinated debt securities to
the Company's wholly owned subsidiary, Temecula Valley Statutory Trust I,
("Trust I"), a Connecticut business trust. The securities have quarterly
interest payments with a rate at 3-month LIBOR plus 3.45% for an effective rate
of 6.08% as of December 31, 2004, with principal due at maturity in 2032.
Liquidity Management
Liquidity management involves the Company's ability to meet cash flow
requirements arising from fluctuations in deposit levels and demands of daily
operations, which include providing for customers' credit needs and ongoing
repayment of borrowings. The Company's liquidity is actively managed on a daily
basis and reviewed periodically by the Board of Directors. This process is
intended to ensure the maintenance of sufficient funds to meet the needs of the
Company.
The Company's primary source of liquidity is core deposits although it also
relies upon advances from the Federal Home Loan Bank of San Francisco and
55
Federal Fund lines of credit. These funding sources are augmented by payments of
principal and interest on loans and sales and participation of eligible loans.
Primary uses of funds include withdrawal of and interest payments on deposits,
originations and purchases of loans and payment of operating expenses.
The Company experienced net cash inflows of $8,338,279 during the year
ended December 31, 2004 and net cash inflows of $9,168,776 during the year ended
December 31, 2003 from operating activities. Net cash inflows from operating
activities during 2004 were primarily from net income of the Company,
accompanied by the net proceeds from the sale of loans held for sale which were
greater than the origination of loans held for sale. During 2004 the overall net
cash outflows were the result of an increase in loans that was greater than the
increase in deposits offset by the Trust Preferred proceeds and the net income
for the year. Net cash outflows from investing activities totaled $187,748,183
and $101,709,937 during 2004 and 2003, respectively. Net cash outflows from
investing activities for both periods can be attributed primarily to the growth
in the Bank's loan portfolio in excess of proceeds from principal repayments on
loans held for investment. The Company experienced net cash inflows from
financing activities of $161,201,529 during 2004 and $111,108,759 during 2003,
primarily due to the growth in deposits.
As a means of augmenting its liquidity, the Company has established federal
funds lines with correspondent banks. At December 31, 2004, the Company's
available borrowing capacity includes approximately $18,000,000 in federal funds
line facilities, and $36,354,213 in unused Federal Home Loan Bank advances.
Management believes its liquidity sources to be stable and adequate. At December
31, 2004, management was not aware of any information that was reasonably likely
to have a material effect on the Company's liquidity position.
The liquidity of the parent company, Temecula Valley Bancorp Inc. is
primarily dependent on the payment of cash dividends by its subsidiary, Temecula
Valley Bank, N.A. subject to limitations imposed by the National Bank Act as
well as other regulatory instructions. For the year ended December 31, 2004 and
2003, no dividends were paid by the Bank to Temecula Valley Bancorp. As of
December 31, 2004, approximately $9,412,000 million of undivided profits of the
Bank were available for dividends to the Company, (an amount that would allow
maintenance of the "well capitalized" level).
Interest Rate Sensitivity
Contractual Obligations and Commitments
At December 31, 2004, the Company had commitments to extend credit of
approximately $242,499,000 and obligations under letters of credit of
$1,113,000, all of which expire within one year. Commitments to extend credit
are agreements to lend to customers, provided 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.
Commitments are generally variable rate, and many of these commitments are
expected to expire without being drawn upon. As such, the total commitment
amounts do not necessarily represent future cash requirements. The Company uses
the same credit underwriting policies in granting or accepting such commitments
or contingent obligations as it does for on-balance-sheet instruments, which
consist of evaluating customers' creditworthiness individually.
56
Standby letters of credit are conditional commitments issued by the Company
to guarantee the financial performance of a customer to a third party. Those
guarantees are primarily issued to support private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. When deemed necessary,
the Company holds appropriate collateral supporting those commitments.
Management does not anticipate any material losses as a result of these
transactions.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets and liabilities, revenues and expenses, and related disclosures of
contingent assets and liabilities at the date of our financial statements.
Actual results may differ from these estimates under different assumptions or
conditions.
The most significant accounting policies followed by the Company are
presented in Note A to the consolidated financial statements. These policies,
along with the disclosures presented in the other financial statement notes and
in this discussion, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined. Based on the valuation techniques used and the sensitivity of
financial statement amounts to the methods, assumptions, and estimates
underlying those amounts, management has identified the Allowance for Loan
Losses to be the accounting area that requires the most subjective or complex
judgments, and as such could be most subject to revision as new information
becomes available.
Accounting for the allowance for loan losses
The provision for loan losses charged to operations reflects management's
judgment of the adequacy of the allowance for loan losses and is determined
through quarterly analytical reviews of the loan portfolio, problem loans and
consideration of such other factors as the Bank's loan loss experience, trends
in problem loans, concentrations of credit risk, and current economic
conditions, as well as the results of the Bank's ongoing credit examination
process and that of its regulators. As conditions change, our level of
provisioning and allowance for loan losses may change.
Larger balance, non-homogenous exposures representing significant
individual credit exposures are evaluated based upon the borrower's overall
financial condition, resources, and payment record; the prospects for support
from any financially responsible guarantors; and, if appropriate, the realizable
value of any collateral. The allowance for loan losses attributed to these loans
is established via a process that begins with estimates of probable loss
inherent in the portfolio based upon various statistical analyses. These
57
analyses consider historical and projected default rates and loss severities;
internal risk ratings; geographic, industry and other environmental factors; and
model imprecision. Management also considers overall portfolio indicators,
including trends in internally risk-rated exposures, classified exposures,
cash-basis loans and historical and forecasted write-offs; and a review of
industry, geographic and portfolio concentrations, including current
developments within those segments. In addition, management considers the
current business strategy and credit process, including credit limit setting and
compliance, credit approvals, loan underwriting criteria and loan workout
procedures.
Within the allowance for loan losses, amounts are specified for
larger-balance, non-homogeneous loans that have been individually determined to
be impaired. These amounts consider all available evidence, including, as
appropriate, the present value of the expected future cash flows discounted in
the loan's contractual effective rate, the secondary market value of the loan
and the fair value of collateral.
Each portfolio of smaller balance, homogeneous loans, including residential
first mortgage, revolving credit and most other consumer loans, is collectively
evaluated for loss potential. The allowance for loan losses is established via a
process that begins with estimates of probable losses inherent in the portfolio,
based upon various statistical analyses. These include migration analysis, in
which historical delinquency and credit loss experience is applied to the
current aging of the portfolio, together with analyses that reflect current
trends and conditions. Management also considers overall portfolio indicators,
including historical loan losses, delinquent, non-performing and classified
loans, and trends in volumes and terms of loans, an evaluation of overall credit
quality and the credit process, including lending policies and procedures,
economic, geographical, product, and other environmental factors and model
imprecisions.
Accounting for stock options
The Company applies APB Opinion No. 25 in accounting for the plans and,
accordingly, no compensation cost has been recognized for its stock options in
the financial statements. As a practice, the Company's incentive stock option
grants are such that the exercise price equals the current market price of the
common stock. The nonqualified grants, as a practice, equal 85% of the current
market price of the common stock. Had the Company determined compensation cost
based on the fair value at the grant date for its stock options under SFAS No.
123, the Company's proforma net income would have been reduced to the proforma
amounts indicated below:
Dollars in thousands, except per share amounts 2004 2003 2002
- ---------------------------------------------- ---- ---- ----
Net income, as reported $10,577,623 $7,854,339 $4,191,054
Proforma net income $10,235,576 $7,359,559 $3,887,017
Net income per share, basic, as reported $ 1.24 $ 1.00 $ 0.57
Proforma net income per share, basic $ 1.20 $ 0.94 $ 0.53
Net income per share, diluted, as reported $ 1.13 $ .089 $ 0.50
Proforma net income per share, diluted $ 1.09 $ 0.82 $ 0.46
Percentage reduction in net income per share, diluted 3.7% 8.5% 8.7%
58
The actual value, if any, which a grantee may realize will depend upon the
difference between the option exercise price and the market price of the
Company's common stock on the date of exercise.
In December 2004, FASB revised SFAS 123 and issued it under its new name,
"Share-Based Payment". This statement eliminates the alternative to use Opinion
25's intrinsic value of accounting discussed in the previous paragraph. Instead,
this Statement generally requires entities to recognize the cost of employee
services received in exchange for awards of stock options, or other equity
instruments, based on the grant-date fair value of those awards.
The Company must adopt this Statement in the third quarter of 2005 for all
new stock option awards as well as any existing awards that are modified,
repurchased or cancelled. In addition, the unvested portion of previously
awarded options will also be recognized as expense. The Company is unable to
estimate the total impact of this Statement on its financial condition and
results of operations as the decision to grant option awards is made annually on
a case-by-case basis, and, accordingly, the Company cannot estimate the amount
of stock awards that will be made in 2005. However, options outstanding at
December 31, 2004 that subsequently vest will result in net compensation costs
of $130,000 and $130,000 in the third and fourth quarters of 2005 and $408,000
for the year ended December 31, 2006.
Servicing Assets and Interest Only Strips
Servicing assets are recognized when loans are sold with servicing
retained. Servicing assets are amortized in proportion to and over the period of
estimated future net servicing income. The fair value of servicing assets is
estimated by discounting the future cash flows at estimated future current
market rates for the expected life of the loans. The Company uses industry
prepayment statistics in estimating the expected life of the loan. Management
quarterly evaluates servicing assets for impairment. For purposes of measuring
impairment, the rights are stratified based on original term to maturity. The
amount of impairment recognized is the amount by which the servicing asset for a
stratum exceeds its fair value.
Rights to future interest income from serviced loans that exceed
contractually specified servicing fees are classified as interest-only strips.
The interest-only strips are accounted for as trading securities and recorded at
fair value with any unrealized gains or losses recorded in earnings in the
period of change of fair value. Unrealized gains or losses on interest-only
strips were not material during the years ended December 31, 2004, 2003 and
2002.
Changes in these assumptions and economic factors may result in increases
or decreases in the valuation of our servicing assets and interest-only strips.
Real Estate Owned and Other Repossessed Assets
Real estate or other assets acquired through foreclosure or deed-in-lieu of
foreclosure are initially recorded at the lower of cost or fair value less
estimated costs to sell through a charge to the allowance for estimated loan
losses. Subsequent declines in value are charged to operations. There was one
real estate or other assets acquired through foreclosure or deed-in-lieu of
foreclosure or other repossessed assets as of December 31, 2004.
59
Further information on these and other significant accounting policies is
in Note A to the Consolidated Financial Statements included in Item 8 of this
Annual Report.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not currently engage in trading activities or use
derivative instruments to control interest rate risk, even though such
activities may be permitted with the approval of the Company's Board of
Directors.
Interest rate risk as discussed above is the most significant market risk
affecting the Company. Other types of market risk, such as foreign currency
exchange risk, equity price risk and commodity price risk, are not significant
in the normal course of the Company's business activities.
60
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
61
CONTENTS
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
ON THE CONSOLIDATED FINANCIAL STATEMENTS 63
- --------------------------------------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition 64 and 65
Consolidated Statements of Income 66
Consolidated Statement of Changes in Shareholders' Equity 67
Consolidated Statements of Cash Flows 68
Notes to Consolidated Financial Statements 69 through 95
- --------------------------------------------------------------------------------
62
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
Temecula Valley Bancorp Inc. and Subsidiary
We have audited the accompanying consolidated statements of financial condition
of Temecula Valley Bancorp Inc. and Subsidiary as of December 31, 2004 and 2003
and the related consolidated statements of income, changes in shareholders'
equity, and cash flows for the three years 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 standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Temecula Valley
Bancorp Inc. and Subsidiary as of December 31, 2004 and 2003, and the results of
its operations and its cash flows for the three years ended December 31, 2004,
in conformity with accounting principles generally accepted in the United States
of America.
/s/ Vavrinek, Trine, Day & Co., LLP
- -----------------------------------
Laguna Hills, California
March 23, 2005
63
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2004 and 2003
2004 2003
------------------ -------------------
ASSETS
Cash and Due from Banks $ 6,317,261 $ 9,348,013
Federal Funds Sold 16,800,000 21,400,000
------------------ -------------------
TOTAL CASH AND CASH EQUIVALENTS 23,117,261 30,748,013
Loans Held for Sale 15,142,720 17,005,198
Loans:
Commercial 23,560,360 33,008,385
Real Estate - Construction 203,885,627 113,846,726
Real Estate - Other 288,514,699 195,991,515
Consumer 2,796,327 3,194,582
------------------ -------------------
TOTAL LOANS 518,757,013 346,041,208
Net Deferred Loan Fees (3,703,481) (2,297,015)
Allowance for Loan Losses (6,362,534) (3,607,833)
------------------ -------------------
NET LOANS 508,690,998 340,136,360
Federal Reserve and Federal Home Loan Bank Stock, at Cost 2,377,800 1,145,000
Premises and Equipment 4,379,809 2,185,543
Other Real Estate Owned 302,698 485,036
Cash Surrender Value of Life Insurance 9,593,824 5,740,729
Deferred Tax Assets 4,370,990 2,393,000
Servicing Assets 7,585,712 6,116,679
Interest-Only Strips Receivable 24,679,520 20,495,511
Accrued Interest and Other Assets 6,586,197 4,761,049
------------------ -------------------
$ 606,827,529 $ 431,212,118
================== ===================
The accompanying notes are an integral part of these consolidated financial statements.
64
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2004 and 2003
2004 2003
----------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-Bearing Demand $ 138,041,385 $112,367,018
Money Market and NOW 73,880,005 61,340,428
Savings 41,838,703 35,180,027
Time Deposits, Under $100,000 135,915,448 88,771,099
Time Deposits, $100,000 and Over 145,091,164 85,828,794
-------------- ------------
TOTAL DEPOSITS 534,766,705 383,487,366
Junior Subordinated Debt Securities 20,620,000 12,372,000
Accrued Interest and Other Liabilities 8,538,286 5,669,687
-------------- ------------
TOTAL LIABILITIES 563,924,991 401,529,053
Commitments and Contingencies - Notes C and M - -
Shareholders' Equity:
Common Stock No Par Value; 40,000,000 Shares
Authorized; 8,752,603 and 8,151,914 Shares Issued
and Outstanding at December 31, 2004 and 2003 16,724,128 14,082,278
Retained Earnings 26,178,410 15,600,787
-------------- ------------
TOTAL SHAREHOLDERS' EQUITY 42,902,538 29,683,065
-------------- ------------
$ 606,827,529 $431,212,118
============== ============
The accompanying notes are an integral part of these consolidated financial statements.
65
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2004, 2003 and 2002
2004 2003 2002
-------------- --------------- ---------------
INTEREST INCOME
Interest and Fees on Loans $ 33,501,670 $ 23,738,166 16,369,293
Interest on Investment Securities 1,906 336 3,651
Interest on Federal Funds 111,311 151,998 136,497
-------------- --------------- ---------------
TOTAL INTEREST INCOME 33,614,887 23,890,500 16,509,441
INTEREST EXPENSE
Interest on Money Market and NOW 500,661 555,883 645,911
Interest on Savings Deposits 186,154 192,313 228,373
Interest on Time Deposits 4,909,109 3,727,584 1,910,417
Interest on Junior Subordinated Debt Securities and Other
Borrowings 818,619 470,773 339,981
-------------- --------------- ---------------
TOTAL INTEREST EXPENSE 6,414,543 4,946,553 3,124,682
-------------- --------------- ---------------
NET INTEREST INCOME 27,200,344 18,943,947 13,384,759
Provision for Loan Losses 3,821,300 1,022,000 2,460,000
-------------- --------------- ---------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 23,379,044 17,921,947 10,924,759
NONINTEREST INCOME
Service Charges and Fees 667,743 792,292 965,067
Gain on Sale of Loans 18,858,056 15,779,079 11,389,023
Gain (Loss) on Other Assets/ REO (67,998) 27,430 (836)
Servicing Income 2,500,443 1,693,836 1,129,328
Loan Broker Income 3,468,424 3,882,234 2,879,342
Other Income 3,271,946 2,306,480 1,579,719
-------------- --------------- ---------------
28,698,614 24,481,351 17,941,643
-------------- --------------- ---------------
52,077,658 42,403,298 28,866,402
NONINTEREST EXPENSE
Salaries and Employee Benefits 22,514,965 20,484,132 14,866,458
Occupancy Expenses 1,725,034 1,183,460 1,010,348
Furniture and Equipment 1,136,173 892,154 841,822
Data Processing 1,015,480 988,279 891,906
Marketing and Business Promotion 968,218 723,429 455,253
Legal and Professional 704,747 411,537 419,011
Regulatory Assessments 175,814 137,506 128,279
Loan Funding Expense 1,764,034 1,708,170 1,211,541
Office Expenses 2,237,347 1,589,448 1,404,963
Other Expenses 1,722,417 1,002,955 571,257
-------------- --------------- ---------------
33,964,229 29,121,070 21,800,838
-------------- --------------- ---------------
INCOME BEFORE INCOME TAXES 18,113,429 13,282,228 7,065,564
Income Taxes 7,535,806 5,427,889 2,874,510
-------------- --------------- ---------------
NET INCOME $ 10,577,623 $ 7,854,339 $ 4,191,054
============== =============== ===============
Per Share Data :
Net Income - Basic $ 1.24 $ 1.00 $ 0.57
Net Income - Diluted $ 1.13 $ 0.89 $ 0.50
The accompanying notes are an integral part of these consolidated financial statements.
66
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2004, 2003 and 2002
Common Retained
Shares Stock Earnings Total
---------------- ---------------- ---------------- ----------------
Balance at
January 1, 2002 7,326,324 $ 11,548,550 $ 3,555,394 $ 15,103,944
Exercise of Stock Options,
Including the Realization
of Tax Benefits of $32,123 53,694 154,635 154,635
Exercise of Warrants 66,628 166,570 166,570
Net Income 4,191,054 4,191,054
--------- ---------- --------- ----------
Balance at
December 31, 2002 7,446,646 11,869,755 7,746,448 19,616,203
Exercise of Stock Options,
Including the Realization
of Tax Benefits of $424,910 380,670 1,401,026 1,401,026
Exercise of Warrants 324,598 811,497 811,497
Net Income 7,854,339 7,854,339
--------- ---------- --------- ----------
Balance at
December 31, 2003 8,151,914 14,082,278 15,600,787 29,683,065
Exercise of Stock Options,
Including the Realization
of Tax Benefits of $967,660 600,689 2,641,850 2,641,850
Net Income 10,577,623 10,577,623
--------- ---------- --------- ----------
Balance at
December 31, 2004 8,752,603 $ 16,724,128 $ 26,178,410 $ 42,902,538
========= ============ ============ =============
67
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2004, 2003 and 2002
OPERATING ACTIVITIES 2004 2003 2002
---------------- --------------- -------------------
Net Income $ 10,577,623 $ 7,854,339 $ 4,191,054
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Depreciation and Amortization 6,970,596 4,946,316 2,132,475
Provision for Loan Losses 3,821,300 1,022,000 2,460,000
Deferred Taxes (1,977,990) (665,000) (909,000)
Gain on Sale of Loans (18,858,056) (15,798,959) (11,389,023)
Loans Originated for Sale (242,616,862) (246,036,807) (202,264,842)
Proceeds from Loan Sales 259,284,600 257,672,323 196,781,986
Loss (Gain) on Sale of Other Real Estate Owned 72,998 (19,880) -
Net Increase in Cash Surrender Value of Life Insurance (281,095) (205,546) (150,929)
Net Change in Accrued Interest, Other Assets
and Other Liabilities 1,922,788 399,990 50,241
---------------- --------------- ------------------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES 8,338,279 9,168,776 (9,098,038)
INVESTING ACTIVITIES
Purchases of Held-to-Maturity Investments (997,794) (299,664) (955,939)
Purchases of Federal Reserve and Federal Home Loan Bank Stock (1,232,800) (224,950) (924,500)
Proceeds from Maturities of Held-to-Maturity Securities 1,000,000 300,000 950,000
Proceeds from Sale of Federal Home Loan Bank Stock - 571,900 -
Net Increase in Loans (181,505,131) (100,889,635) (116,172,110)
Purchase of Cash Surrender Value Life Insurance (3,572,000) (1,552,000) (1,000,000)
Proceeds from Sale of Premises and Equipment 49,000 29,000 57,477
Proceeds from Sale of Other Real Estate Owned 1,519,340 870,880 -
Purchases of Premises and Equipment (3,008,798) (515,468) (701,446)
---------------- --------------- -----------------
NET CASH USED BY INVESTING ACTIVITIES (187,748,183) (101,709,937) (118,746,518)
FINANCING ACTIVITIES
Net Increase in Demand Deposits and Savings Accounts 44,872,620 31,444,106 41,796,778
Net Increase in Time Deposits 106,406,719 82,722,040 54,596,217
Net Change in Federal Home Loan Bank Advances - (10,000,000) 10,000,000
Proceeds from Issuance of Junior Subordinated Debt Securities 8,248,000 5,155,000 7,217,000
Proceeds from Issuance of Common Stock - - -
Proceeds from Exercise of Warrants - 811,497 166,570
Proceeds from Exercise of Stock Options 1,674,190 976,116 122,512
---------------- --------------- ----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 161,201,529 111,108,759 113,899,077
---------------- --------------- ----------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (7,630,752) 18,567,598 (13,945,479)
Cash and Cash Equivalents at Beginning of Year 30,748,013 12,180,415 26,125,894
---------------- --------------- ----------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 23,117,261 $ 30,748,013 $ 12,180,415
================ =============== ================
Supplemental Disclosures of Cash Flow Information:
Interest Paid $ 6,287,236 $ 4,895,119 $ 3,029,930
Income Taxes Paid $ 8,469,371 $ 7,117,636 $ 3,155,090
Transfer of Loans to Other Real Estate Owned $ 1,410,000 $ 1,336,036 $ -
68
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of Temecula Valley
Bancorp Inc. and its wholly-owned subsidiary, Temecula Valley Bank (the "Bank"),
collectively referred to herein as the "Company". All significant intercompany
transactions have been eliminated.
Nature of Operations
- --------------------
The Company has been organized as a single operating segment and operates seven
branches in Temecula, Murrieta, Fallbrook, El Cajon, Escondido, Corona, and
Rancho Bernardo California. In addition, the Company operates business loan
centers in California, North Carolina, Florida, New Jersey, Georgia, Illinois
and Washington. The Bank's primary sources of revenue are providing loans to
customers, who are predominately small and middle-market businesses and
individuals and originating mortgage and government guaranteed loans for sale to
institutional investors in the secondary market. The Company also generates fee
income by servicing the government guaranteed loans.
Use of Estimates in the Preparation of Financial Statements
- -----------------------------------------------------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
- -------------------------
For purposes of reporting cash flows, cash and cash equivalents include cash,
due from banks and federal funds sold. Generally, federal funds are sold for one
day periods.
Cash and Due From Banks
- -----------------------
Banking regulations require that all banks maintain a percentage of their
deposits as reserves in cash or on deposit with the Federal Reserve Bank. The
Bank complied with the reserve requirements as of December 31, 2004.
The Company maintains amounts due from banks which exceed federally insured
limits. The Company has not experienced any losses in such accounts.
Investment Securities
- ---------------------
Bonds, notes, and debentures for which the Company has the positive intent and
ability to hold to maturity are reported at cost, adjusted for premiums and
discounts that are recognized in interest income using the interest method over
the period to maturity.
69
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Investment Securities - Continued
- ---------------------------------
Investments not classified as trading securities nor as held to maturity
securities are classified as available-for-sale securities and recorded at fair
value. Unrealized gains or losses on available-for-sale securities are excluded
from net income and reported as an amount net of taxes as a separate component
of other comprehensive income included in shareholders' equity. Premiums or
discounts on held-to-maturity and available-for-sale securities are amortized or
accreted into income using the interest method. Realized gains or losses on
sales of held-to-maturity or available-for-sale securities are recorded using
the specific identification method.
Loans
- -----
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their outstanding
unpaid principal balances reduced by any charge-offs or specific valuation
accounts and net of any deferred fees or costs on originated loans, or
unamortized premiums or discounts on purchased loans.
Loan origination fees and certain direct origination costs are capitalized and
recognized as an adjustment of the yield of the related loan.
The accrual of interest on impaired loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
interest accrual is discontinued, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments are
received.
For impairment recognized in accordance with Financial Accounting Standards
Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 114,
"Accounting by Creditors for Impairment of a Loan", as amended by SFAS No. 118,
the entire change in the present value of expected cash flows is reported as
either provision for loan losses in the same manner in which impairment
initially was recognized, or as a reduction in the amount of provision for loan
losses that otherwise would be reported.
The Bank has adopted SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities". The Statement provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities. Under this Statement, after a
transfer of financial assets, an entity recognizes the financial and servicing
assets it controls and liabilities it has incurred, derecognizes financial
assets when control has been surrendered, and derecognizes liabilities when
extinguished.
To calculate the gain (loss) on sale of loans, the Bank's investment in the loan
is allocated among the retained portion of the loan, the servicing retained, the
interest-only strip and the sold portion of the loan, based on the relative fair
market value of each portion. The gain (loss) on the sold portion of the loan is
recognized at the time of sale based on the difference between the sale proceeds
and the allocated investment. As a result of the relative fair value allocation,
the carrying value of the retained portion is discounted, with the discount
accreted to interest income over the life of the loan.
70
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Loans - Continued
- -----------------
Servicing assets are amortized over an estimated life using a method that is in
proportion to the estimated future servicing income; in the event future
prepayments exceed Management's estimates and future expected cash flows are
inadequate to cover the unamortized servicing asset, additional amortization
would be recognized. The portion of servicing fees in excess of the contractual
servicing fees is reflected as interest-only (I/O) strips receivable, which are
classified as available for sale and are carried at fair value.
Loans Held for Sale
- -------------------
Mortgage loans and SBA loans originated and intended for sale in the secondary
market are carried at the lower of cost or estimated market value in the
aggregate. Net unrealized losses are recognized through a valuation allowance by
charges to income.
Allowance for Loan Losses
- -------------------------
The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries). Quarterly detailed reviews are performed to
identify the risks inherent in the loan portfolio, assess the overall quality of
the loan portfolio and to determine the adequacy of the allowance for loan
losses and the related provision for loan losses to be charged to expense. Loans
identified as less than "acceptable" are reviewed individually to estimate the
amount of probable losses that need to be included in the allowance. These
reviews include analysis of financial information as well as evaluation of
collateral securing the credit. Additionally, the Company considers the inherent
risk present in the "acceptable" portion of the loan portfolio taking into
consideration historical losses on pools of similar loans, adjusted for trends,
conditions and other relevant factors that may affect repayment of the loans in
these pools.
Premises and Equipment
- ----------------------
Land is carried at cost. Premises and equipment are carried at cost less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives, which ranges from three to
ten years for furniture and fixtures and ten to thirty years for buildings.
Leasehold improvements are amortized using the straight-line method over the
estimated useful lives of the improvements or the remaining lease term,
whichever is shorter. Expenditures for betterments or major repairs are
capitalized and those for ordinary repairs and maintenance are charged to
operations as incurred.
71
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Other Real Estate Owned
- -----------------------
Real estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at the lesser of the outstanding loan balance or the fair
value at the date of foreclosure minus estimated costs to sell. Any valuation
adjustments required at the time of foreclosure are charged to the allowance for
loan losses. After foreclosure, the properties are carried at the lower of
carrying value or fair value less estimated costs to sell. Any subsequent
valuation adjustments, operating expenses or income, and gains and losses on
disposition of such properties are recognized in current operations.
Advertising
- -----------
The Bank expenses the costs of advertising in the period incurred.
Income Taxes
- ------------
Deferred income taxes are computed using the asset and liability method, which
recognizes a liability or asset representing the tax effects, based on current
tax law, of future deductible or taxable amounts attributable to events that
have been recognized in the consolidated financial statements. A valuation
allowance is established to reduce the deferred tax asset to the level at which
it is "more likely than not" that the tax asset or benefits will be realized.
Realization of tax benefits of deductible temporary differences and operating
loss carryforwards depend on having sufficient taxable income of an appropriate
character within the carryforward periods.
Comprehensive Income
- --------------------
Beginning in 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income", which requires the disclosure of comprehensive income and its
components. For the years ending December 31, 2004, 2003 and 2002, the Company
had no accumulated other comprehensive income and there were no significant
components of comprehensive income with the exceptions of net income for 2004,
2003 and 2002.
Financial Instruments
- ---------------------
In the ordinary course of business, the Company has entered into off-balance
sheet financial instruments consisting of commitments to extend credit,
commitments under credit card arrangements, commercial letters of credit, and
standby letters of credit. Such financial instruments are recorded in the
financial statements when they are funded or related fees are incurred or
received, as described in Note M.
Disclosure About Fair Value of Financial Instruments
- ----------------------------------------------------
SFAS No. 107 specifies the disclosure of the estimated fair value of financial
instruments. The Company's estimated fair value amounts have been determined by
the Company using available market information and appropriate valuation
methodologies.
72
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
However, considerable judgment is required to develop the estimates of fair
value. Accordingly, the estimates are not necessarily indicative of the amounts
the Company could have realized 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.
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 the balance sheet date
and, therefore, current estimates of fair value may differ significantly from
the amounts presented in the accompanying notes.
Earnings Per Share (EPS)
- ------------------------
Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur if
options or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the Company.
Stock-Based Compensation
- ------------------------
SFAS No. 123, "Accounting for Stock-Based Compensation", encourages, but does
not require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Bank accounts for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
Interpretations. Accordingly, compensation cost for stock options will be
measured as the excess, if any, of the quoted market price of the Bank's stock
at the date of the grant over the amount an employee must pay to acquire the
stock.
73
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Had compensation cost for the Bank's stock option plans been determined based on
the fair value at the grant dates for awards under those plans consistent with
the method of SFAS No. 123, the Bank's net income and earnings per share would
have been reduced to the pro forma amounts indicated below:
2004 2003 2002
---------------- -------------- ---------------
Net Income:
As reported $ 10,577,623 $ 7,854,339 $ 4,191,054
Stock-Based Compensation
Using the Intrinsic Value Method 26,376 10,677 10,677
Stock-Based Compensation
That Would Have Been Reported
Using the Fair Value Method of SFAS 123 (368,423) (505,457) (314,714)
---------------- -------------- -------------
Pro Forma Net Income $ 10,235,576 $ 7,359,559 $ 3,887,017
================ ============== =============
Per Share Data:
Net Income - Basic
As Reported $ 1.24 $ 1.00 $ 0.57
Pro Forma $ 1.20 $ 0.94 $ 0.53
Net Income - Diluted
As Reported $ 1.13 $ 0.89 $ 0.50
Pro Forma $ 1.09 $ 0.82 $ 0.46
Current Accounting Pronouncements
- ---------------------------------
In December 2004, FASB revised SFAS 123 and issued it under its new name,
"Share-Based Payment". This statement eliminates the alternative to use Opinion
25's intrinsic value of accounting discussed in the previous paragraph. Instead,
this Statement generally requires entities to recognize the cost of employee
services received in exchange for awards of stock options, or other equity
instruments, based on the grant-date fair value of those awards.
The Company must adopt this Statement in the third quarter of 2005 for all new
stock option awards as well as any existing awards that are modified,
repurchased or cancelled. In addition, the unvested portion of previously
awarded options will also be recognized as expense. The Company is unable to
estimate the total impact of this Statement on its financial condition and
results of operations as the decision to grant option awards is made annually on
a case-by-case basis, and, accordingly, the Company cannot estimate the amount
of stock awards that will be made in 2005. However, options outstanding at
December 31, 2004 that subsequently vest will result in net compensation costs
of $130,000 and $130,000 in the third and fourth quarters of 2005 and $408,000
for the year ended December 31, 2006.
74
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 requires an issuer to classify a financial instrument that is within its
scope as a liability. Many of those instruments were previously classified as
equity. SFAS No. 150 is generally effective for financial instruments entered
into or modified after May 31, 2003, and otherwise effective at the beginning of
the first interim period beginning after June 15, 2003; however, management does
not believe adoption will have a material impact on the Bank's financial
statements.
In December 2003, FASB issued FASB Interpretation (FIN) No. 46, "Consolidation
of Variable Interest Entities, an interpretations of ARB No.51." This
interpretation addresses the consolidation of variable interest entities as
defined in the Interpretations. This Interpretation will require companies that
have issued trust preferred securities to deconsolidate the related entities.
The Company has deconsolidated its trust preferred securities as of December 31,
2003 and 2004, which did not have a material impact on the Company's financial
statements.
Reclassifications
- -----------------
Certain reclassifications were made to prior year's presentation to conform to
the current year. These classifications are of a normal recurring nature.
75
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE B - LOANS
The Bank's loan portfolio consists primarily of loans to borrowers within
Temecula, California, its surrounding communities, and the surrounding
communities of the other business loan centers. Although the Bank seeks to avoid
concentrations of loans to a single industry or based upon a single class of
collateral, real estate and real estate associated businesses are among the
principal industries in the Bank's market area and, as a result, the Bank's loan
and collateral portfolios are, to some degree, concentrated in those industries.
The Bank also originated mortgage and SBA loans for sale to institutional
investors. A substantial portion of the Bank's revenues are from origination of
loans guaranteed by the Small Business Administration under its Section 7a
program and sale of the guaranteed portions of those loans. Funding for the
Section 7a program depends on annual appropriations by the U.S. Congress.
At December 31, 2004, 2003, and 2002, the Bank was servicing approximately
$440,301,000, $306,252,000 and $177,075,000, respectively, in loans previously
sold. A summary of the changes in the related servicing assets and interest-only
strips receivable are as follows:
Servicing Assets
--------------------------------------------------------
2004 2003 2002
--------------- ---------------- --------------------
Balance at Beginning of Year $ 6,116,679 $ 3,763,779 $ 1,538,437
Increase from Loan Sales 3,731,175 3,251,793 2,708,148
Amortization Charged to Income (2,262,142) (898,893) (425,806)
Increase in Valuation Allowance - - (57,000)
--------------- ---------------- --------------------
Balance at End of Year $ 7,585,712 $ 6,116,679 $ 3,763,779
============== ================ ===================
Interest-Only Strips Receivable
--------------------------------------------------------
2004 2003 2002
--------------- ---------------- --------------------
Balance at Beginning of Year $ 20,495,511 $ 13,120,093 $ 4,136,809
Increase from Loan Sales 8,040,814 10,710,121 10,034,996
Amortization Charged to Income (3,856,805) (3,334,703) (1,036,212)
Writedown of Interest-Only Strips Receivable - - (15,500)
--------------- ---------------- --------------------
Balance at End of Year $ 24,679,520 $ 20,495,511 $ 13,120,093
=============== ================ ====================
76
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE B - LOANS - Continued
The estimated fair value of the servicing assets approximated the carrying
amount at December 31, 2004, 2003 and 2002. Fair value is estimated by
discounting estimated future cash flows from the servicing assets using discount
rates that approximate current market rates over the expected lives of the loans
being serviced. Management has estimated the expected life of these loans to be
approximately 25% to 30% of the remaining life at the time of sale. For purposes
of measuring impairment, the Bank has identified each servicing asset with the
underlying loan being serviced. A valuation allowance is recorded where the fair
value is below the carrying amount of the asset. At December 31, 2004, 2003 and
2002, the Bank had a valuation allowance of $390,000.
The Bank may also receive a portion of subsequent interest collections on loans
sold that exceed the contractual servicing fee. In that case the Bank records an
interest-only strip based on the relative fair market value of it and the other
components of the loan. At December 31, 2004, 2003 and 2002, the Bank had
interest-only strips of $24,679,520, $20,495,511, and $13,120,093, respectively,
which approximates fair value. Fair value is estimated by discounting estimated
future cash flows from the interest-only strips using assumptions similar to
those used in valuing servicing assets.
At December 31, 2004, key economic assumptions used to fair value the servicing
assets and interest-only strips on SBA loans sold, along with the potential
decline in the fair value of these assets due to an immediate 10 percent and 20
percent adverse change in those assumptions are as follows:
SBA
Loans
Sold
----------------
Carrying Value of Servicing Assets and I/O Strips - Fair Value $32,265,232
Weighted-Average Life (in months) 60
Repayment Speed Assumption (annual rate) 15.22%
Decline in Fair Value from a 10% Adverse Change 2,100,000
Decline in Fair Value from a 20% Adverse Change 3,900,000
Discount Rate (annual rate) 10.35%
Decline in Fair Value from a 10% Adverse Change 1,200,000
Decline in Fair Value from a 20% Adverse Change 2,300,000
The declines in fair value due to changes in the assumptions are hypothetical
and should be used with caution. For purposes of this table, the effect of an
adverse change is calculated for each assumption without changing any other
assumptions; however, in reality changes in one factor may result in positive or
negative changes in another factor, which might magnify or counteract the
sensitivities.
77
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE B - LOANS - Continued
A summary of the changes in the allowance for loan losses as of December 31
follows:
2004 2003 2002
---------------- ---------------- ----------------
Balance at Beginning of Year $ 3,607,833 $ 3,017,395 $ 1,239,308
Additions to the Allowance Charged to Expense 3,821,300 1,022,000 2,460,000
Recoveries on Loans Charged Off 30,099 74,024 25,542
---------------- ---------------- ----------------
7,459,232 4,113,419 3,724,850
Less Loans Charged Off (1,096,698) (505,586) (707,455)
---------------- ---------------- ----------------
$ 6,362,534 $ 3,607,833 $ 3,017,395
================ ================ ================
The following is a summary of the investment in impaired loans, the related
allowance for loan losses, and income recognized thereon as of December 31:
2004 2003 2002
----------------- --------------------------------
Recorded Investment in Impaired Loans $ 11,799,000 $ 6,675,000 $ 1,908,000
Guaranteed Portion of Impaired Loans (8,140,000) (5,269,000) (1,077,000)
-------------- ------------- -------------
Net Impaired Loans $ 3,659,000 $ 1,405,000 $ 831,000
============== ============ =============
Related Allowance for Impaired Loans $ 221,000 $ 368,000 $ 172,000
Average Recorded Investment in Impaired Loans $ 2,250,000 $ 637,000 $ 353,000
Interest Income Recognized for Cash Payments None None None
Total Nonaccrual Loans $ 11,799,000 $ 6,765,000 $ 1,908,000
Total Loans Past-Due Nintey Days
or More and Still Accruing $ - $ - $ -
78
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE C - PREMISES AND EQUIPMENT
A summary of premises and equipment as of December 31 follows:
2004 2003
----------------- -------------------
Land $ 500,000 $ 500,000
Buildings and Leasehold Improvements 1,895,440 542,567
Autos 1,096,977 1,032,446
Furniture, Fixtures, and Equipment 3,568,376 2,337,729
----------------- -------------------
7,060,793 4,412,742
Less Accumulated Depreciation and Amortization (2,680,984) (2,227,199)
----------------- -------------------
$ 4,379,809 $ 2,185,543
================= ===================
Depreciation and amortization expense for premises and equipment was $765,532 in
2004, $643,615 in 2003, and $597,957 in 2002.
The Bank has entered into several leases for its branches and loan production
offices, which expire at various dates through 2014. These leases include
provisions for periodic rent increases as well as payment by the lessee of
certain operating expenses. Rental expense relating to these leases was
approximately $1,132,000 in 2004, $811,000 in 2003, and $701,000 in 2002.
The approximate future minimum annual payments for these leases by year are as
follows:
Year Amount
- ------------------ ------------------
2005 $ 1,485,403
2006 1,273,836
2007 1,070,903
2008 959,367
2009 251,667
Thereafter 464,783
------------------
$ 5,505,959
==================
The minimum rental payment shown above are given for the existing lease
obligations and are not a forecast of future rental expense.
79
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE D - DEPOSITS
At December 31, 2004 the schedule maturities of time deposits are as follows:
Year Amount
- ------------------ -----------------
2005 $ 280,031,000
2006 - 2007 541,000
Thereafter 434,000
-----------------
$ 281,006,000
=================
The five largest depositors with the Bank had approximately $24,228,000 on
deposit at December 31, 2004.
NOTE E - FHLB ADVANCES AND OTHER BORROWINGS
As of December 31, 2004, there were no Federal Home Loan Bank Advances
outstanding. The Bank is required to pledge a certain amount of loans with the
Federal Home Loan Bank for collateralization purposes. As of December 31, 2004,
approximately $70,442,000 in loans was pledged for an aggregate borrowing line
of $36,354,213. The Bank also had no Federal Home Loan Bank Advances as of
December 31, 2003.
The Bank maintains unused federal lines of credit with three financial
institutions in the aggregate amount of $18,000,000 as of December 31, 2004. As
of December 31, 2004, no amounts were outstanding under these arrangements.
NOTE F - JUNIOR SUBORDINATED DEBT SECURITIES
On June 26, 2002, the Company issued $7,217,000 of junior subordinated debt
securities (the "debt securities") to Temecula Valley Statutory Trust I, a
statutory trust created under the laws of the State of Connecticut. These debt
securities are subordinated to effectively all borrowings of the Company and are
due and payable on June 26, 2032. Interest is payable quarterly on these debt
securities at 3-Month LIBOR plus 3.45% for an effective rate of 6.08% as of
December 31, 2004. The debt securities can be redeemed for 107.5% of the
principal balance through June 26, 2007 and at par thereafter. The debt
securities can also be redeemed at par if certain events occur that impact the
tax treatment or the capital treatment of the issuance.
80
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE F - JUNIOR SUBORDINATED DEBT SECURITIES - Continued
On September 17, 2003, the Company issued $5,155,000 of junior subordinated debt
securities (the "debt securities") to Temecula Valley Statutory Trust II, a
statutory trust created under the laws of the State of Delaware. These debt
securities are subordinated to effectively all borrowings of the Company and are
due and payable on September 17, 2033. Interest is payable quarterly on these
debt securities at 3-Month LIBOR plus 2.95% for an effective rate of 5.53% as of
December 31, 2004. The debt securities can be redeemed for 107.5% of the
principal balance through September 17, 2008 and at par thereafter. The debt
securities can also be redeemed at par if certain events occur that impact the
tax treatment or the capital treatment of the issuance.
On September 20, 2004, the Company issued $8,248,000 of junior subordinated debt
securities (the "debt securities") to Temecula Valley Statutory Trust III, a
statutory trust created under the laws of the State of Delaware. These debt
securities are subordinated to effectively all borrowings of the Company and are
due and payable on September 20, 2034. Interest is payable quarterly on these
debt securities at 3-Month LIBOR plus 2.20% for an effective rate of 4.78% as of
December 31, 2004. The debt securities can be redeemed for 107.5% of the
principal balance through September 20, 2009 and at par thereafter. The debt
securities can also be redeemed at par if certain events occur that impact the
tax treatment or the capital treatment of the issuance.
The Company also purchased a 3% minority interest in Temecula Valley Statutory
Trusts I, II, and III. The balance of the equity of Temecula Valley Statutory
Trusts I, II, and III is comprised of mandatorily redeemable preferred
securities. Under FASB Interpretation (FIN) No. 46, "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51," the Company is not allowed
to consolidate Temecula Valley Statutory Trusts I and II into the Company
financial statements. Prior to the issuance of FIN No. 46, Bank Holding
companies typically consolidated these entities. The Federal Reserve Board has
ruled that these mandatorily redeemable preferred securities qualifies as Tier 1
Capital. As of December 31, 2004, 2003, and 2002 the Company has included the
net junior subordinated debt in its Tier1 Capital for regulatory capital
purposes.
NOTE G - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Bank has granted loans to certain
directors and the companies with which they are associated. In the Bank's
opinion, all loans and loan commitments to such parties are made on
substantially the same terms including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons. The
following is a summary of the activity of these loans:
2004 2003
----------------- ----------------
Balance at the Beginning of Year $ 842,000 $ 790,000
Advances 876,000 149,000
Payments (363,000) (97,000)
----------------- ----------------
$ 1,355,000 $ 842,000
================= ================
Deposits from related parties held by the Bank at December 31, 2004 and 2003
amounted to approximately $1,068,000 and $860,000, respectively.
81
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE H - INCOME TAXES
The provision for income taxes included in the statements of income as of the
years ended December 31 consist of the following:
2004 2003 2002
---------------- ---------------- ----------------
Current:
Federal $ 7,039,937 $ 4,504,304 $ 2,852,583
State 2,473,869 1,588,585 930,927
---------------- ---------------- ----------------
9,513,806 6,092,889 3,783,510
Deferred (1,978,000) (665,000) (909,000)
---------------- ---------------- ----------------
$ 7,535,806 $ 5,427,889 $ 2,874,510
================ ================ ================
Deferred taxes are a result of differences between income tax accounting and
generally accepted accounting principles with respect to income and expense
recognition. The Bank's principal timing differences are from loan loss
provision accounting, deferred compensation plans, and depreciation differences.
The provision for income taxes varies from the federal statutory rate as
follows:
2004 2003 2002
----------------------------- ----------------------------- -----------------------------
Percent Percent Percent
of Pretax of Pretax of Pretax
Amount Income Amount Income Amount Income
------------ ------------- ------------ -------------- ----------- ---------------
Federal Tax Rate $ 6,159,000 34.0% $ 4,516,000 34.0% $ 2,402,000 34.0%
State Income Taxes, Net of
Federal Income Tax Benefit 1,282,000 7.1 944,000 7.1 500,000 7.1
Tax Free Income (108,000) (0.6) (70,000) (0.5) (51,000) (0.7)
Other Items, Net 202,806 1.1 37,889 0.3 23,510 0.3
------------ ------------- ------------ -------------- ----------- ---------------
$ 7,535,806 41.6% $ 5,427,889 40.9% $ 2,874,510 40.7%
============ ============= ============ ============== =========== ===============
82
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE H - INCOME TAXES - Continued
The following is a summary of the components of the net deferred tax asset
accounts recognized in the accompanying statements of financial condition:
2004 2003
---------------- ----------------
Deferred Tax Assets:
Allowance for Loan Losses $ 2,276,000 $ 1,260,000
Depreciation Differences - 51,000
Deferred Compensation Plans 1,039,000 571,000
State Taxes 746,000 507,000
Reserve for Undisbursed Loans 200,000 -
Non-accrual Interest 189,000 -
Other Assets/Liabilities 66,000 -
---------------- ----------------
4,516,000 2,393,000
Deferred Tax Liabilities:
Depreciation Differences (145,000) -
---------------- ----------------
(145,000) -
---------------- ----------------
Net Deferred Tax Assets $ 4,371,000 $ 2,393,000
================ ================
NOTE I - EARNINGS PER SHARE (EPS)
The following is a reconciliation of net income and shares outstanding to the
income and number of shares used to compute EPS:
2004 2003 2002
----------------------------- ---------------------------- -----------------------------
Income Shares Income Shares Income Shares
----------- -------------- ----------- -------------- ----------- ----------------
Net Income as Reported $10,577,623 $7,854,339 $4,191,054
Weighted Average Shares
Outstanding During the Year 8,503,179 7,823,951 7,372,504
----------- -------------- ----------- -------------- ----------- ----------------
Used in Basic EPS 10,577,623 8,503,179 7,854,339 7,823,951 4,191,054 7,372,504
Dilutive Effect of Stock
Options and Warrants 860,689 1,037,755 997,536
----------- -------------- ----------- -------------- ----------- ----------------
Used in Dilutive EPS $10,577,623 9,363,868 $7,854,339 8,861,706 $4,191,054 8,370,040
=========== ============== =========== ============== =========== ================
83
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE J - STOCK OPTION PLAN
At December 31, 2004, the Company has three fixed option plans under which
4,000,000 shares of the Company's common stock may be issued. The compensation
expense that has been charged against income for these stock-based compensation
plans totaled $45,512 in 2004 and $18,097 in 2003 and 2002.
During 1996, the Company established an incentive stock option plan for officers
and employees. Under this plan the Company may grant options for 1,800,000
shares of common stock at not less than 100% of the fair market value at the
date the options are granted.
During 1997, the Company established a nonqualified stock option plan for
directors of the Company. Under this plan, the Company may grant options for
1,500,000 shares of common stock at not less than 85% of the fair market value
at the date the options are granted.
During 2004, the Company established an incentive/nonqualified stock option plan
for directors, officers and employees. Under this plan the Company may grant
options for 700,000 shares of common stock at not less than 100% of the fair
market value for officers and employees and 85% of the fair market value for
directors at the date the options are granted.
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions: risk-free
rates of 3.61% in 2004, 3.00% in 2003, and 3.75% in 2002; expected lives of five
years in 2004, five years in 2003 and three years in 2002; and volatility of
27.9% for 2004, 22.9% for 2003, and 40.3% for 2002.
84
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE J - STOCK OPTION PLAN - Continued
A summary of the status of the Bank's fixed stock option plan as of December 31,
and changes during the years ending on those dates is presented below:
2004 2003 2002
--------------------------- -------------------------- --------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------------------------- -------------------------- --------------------------
Outstanding at Beginning
of Year 1,912,674 $ 3.74 2,042,348 $ 2.79 2,028,042 $ 2.68
Granted 302,078 14.93 273,000 9.26 78,000 5.35
Options Exercised (600,689) 2.79 (380,670) 2.56 (53,694) 2.28
Options Cancelled (34,340) 11.25 (22,004) 4.01 (10,000) 2.94
------------- ------------- ----------- -----------
Outstanding at End of Year 1,579,723 6.09 1,912,674 3.74 2,042,348 2.79
============= ============= ===========
Options Exercisible
at End of Year 1,231,635 4.24 1,617,008 3.24 1,598,146 2.60
Weighted-Average Fair
Fair Value of Options
Granted During the Year 5.07 3.01 1.68
85
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE J - STOCK OPTION PLAN - Continued
The following table summarizes information about fixed options outstanding at
December 31, 2004:
Options Outstanding Options Exercisable
----------------------------------------------------- --------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Number Remaining Exercise Number Exercise
Price Outstanding Contractual Life Price Exercisable Price
- ---------------------- -------------- ----------------- ---------------- -------------- ----------------
$1.00 to $1.99 146,476 2.14 $ 1.38 146,476 $ 1.38
$2.00 to $2.99 483,186 4.86 $ 2.57 483,186 $ 2.57
$3.00 to $3.99 347,983 4.69 $ 3.47 326,753 $ 3.47
$4.00 to $4.99 27,000 7.17 $ 4.85 17,664 $ 4.81
$5.00 to $5.99 62,000 7.51 $ 5.69 37,326 $ 5.71
$6.00 to $9.99 146,000 8.78 $ 8.84 122,000 $ 9.33
$10.00 to $13.99 144,078 9.19 $ 12.00 98,230 $12.37
$14.00 to $17.99 203,000 9.52 $ 15.31 - $ -
$18.00 to $21.99 20,000 9.98 $ 18.00 - $ -
----------------- ----------------
1,579,723 6.13 $ 6.09 1,231,635 $ 4.24
================= ================
NOTE K - EMPLOYEE RETIREMENT SAVINGS PLAN
During 2000, the Bank adopted a retirement savings plan for the benefit of its
employees. Contributions to the plan are determined annually by the Board of
Directors. The expense for this plan was approximately $310,000 in 2004,
$263,000 in 2003, and $167,000 in 2002.
NOTE L - FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the amount at which the asset or
obligation could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. Fair value estimates are made at a
specific point in time based on relevant market information and information
about the financial instrument. These estimates do not reflect any premium or
discount that could result from offering for sale at one time the entire
holdings of a particular financial instrument. Because no market value exists
for a significant portion of the financial instruments, fair value estimates are
based on judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other
factors. These estimates are subjective in nature, involve uncertainties and
matters of judgment and, therefore, cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.
86
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE L - FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued
Fair value estimates are based on financial instruments both on and off the
balance sheet without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments. Additionally, tax consequences related to the realization
of the unrealized gains and losses can have a potential effect on fair value
estimates and have not been considered in many of the estimates.
The following methods and assumptions were used to estimate the fair value of
significant financial instruments:
Financial Assets
- ----------------
The carrying amounts of cash, short-term investments, due from customers on
acceptances, and Bank acceptances outstanding are considered to approximate fair
value. Short-term investments include federal funds sold, securities purchased
under agreements to resell, and interest bearing deposits with Banks. The fair
values of investment securities, including available-for-sale, are generally
based on quoted market prices. The fair value of loans are estimated using a
combination of techniques, including discounting estimated future cash flows and
quoted market prices of similar instruments where available.
Financial Liabilities
- ---------------------
The carrying amounts of deposit liabilities payable on demand, commercial paper,
and other borrowed funds are considered to approximate fair value. For fixed
maturity deposits, fair value is estimated by discounting estimated future cash
flows using currently offered rates for deposits of similar remaining
maturities. The fair value of long term debt is based on rates currently
available to the Bank for debt with similar terms and remaining maturities.
Off-Balance Sheet Financial Instruments
- ---------------------------------------
The fair value of commitments to extend credit and standby letters of credit is
estimated using the fees currently charged to enter into similar agreements. The
fair value of these financial instruments is not material.
87
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE L - FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued
The estimated fair value of financial instruments at December 31, 2004 and
2003 is summarized as follows: (dollar amounts in thousands)
December 31,
---------------------------------------------------------
2004 2003
---------------------------- ----------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------ -------------- ----------- -------------
Financial Assets:
Cash and Due From Banks $ 6,317 $ 6,317 $ 9,348 $ 9,348
Federal Funds Sold 16,800 16,800 21,400 21,400
Loans Held for Sale and Loans, net 523,834 524,201 357,142 359,914
Federal Reserve and Federal Home
Loan Bank Stock 2,378 2,378 1,145 1,145
I/O Strips Receivable and Servicing Assets 32,265 32,265 26,612 26,612
Cash Surrender Value - Life Insurance 9,594 9,594 5,741 5,741
Accrued Interest Receivable 1,948 1,948 1,396 1,396
Financial Liabilities:
Deposits 534,767 534,755 383,487 383,574
Junior Subordinated Debt Securities 20,620 20,620 12,372 12,372
Accrued Interest and Other Liabilities 8,538 8,538 5,670 5,670
NOTE M - COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company enters into financial commitments
to meet the financing needs of its customers. These financial commitments
include commitments to extend credit and standby letters of credit. Those
instruments involve to varying degrees, elements of credit and interest rate
risk note recognized in the statement of financial position.
The Company's exposure to loan loss in the event of nonperformance on
commitments to extend credit and standby letters of credit is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments as it does for loans reflected in the financial
statements.
88
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE M - COMMITMENTS AND CONTINGENCIES - Continued
As of December 31, 2004 and 2003, the Company had the following outstanding
financial commitments whose contractual amount represents credit risk:
2004 2003
----------------- ------------------
Commitments to Extend Credit $ 242,499,000 $ 171,159,000
Letters of Credit 1,113,000 1,440,000
----------------- ------------------
$ 243,612,000 $ 172,599,000
================= ==================
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. Standby
letters of credit are conditional commitments to guarantee the performance of a
Company customer to a third party. Since many of the commitments and standby
letters of credit are expected to expire without being drawn upon, the total
amounts do not necessarily represent future cash requirements. The Company
evaluates each customer's credit worthiness on a case-by-case basis. The amount
of collateral obtained if deemed necessary by the Company is based on
management's credit evaluation of the customer.
The Company is involved in various litigation, which has arisen in the ordinary
course of its business. In the opinion of management, the disposition of such
pending litigation will not have a material effect on the Company's financial
statements.
The Company has entered into retirement benefit agreements with certain officers
providing for future benefits aggregating approximately $7,600,000 payable in
equal annual installments ranging from ten years to a lifetime benefit from the
retirement dates of each participating officer. The estimated future benefits to
be paid are being accrued over the period from the effective date of the
agreements until the expected retirement dates of the participants. As of
December 31, 2004, approximately $2,347,000 has been accrued in conjunction with
these agreements. The expense incurred and accrued was $1,085,000, $531,000, and
$267,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The
Company is the beneficiary under split dollar agreements of life insurance
policies that have been purchased as a method of financing the benefits under
the agreements.
NOTE N - REGULATORY MATTERS
The Company and the Bank 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 Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
89
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE N - REGULATORY MATTERS - Continued
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) 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). Management believes, as of December 31, 2004, that the Bank
meets all capital adequacy requirements to which it is subject.
As of December 31, 2004, the most recent notification from the Comptroller of
the Currency categorized the Bank as well-capitalized under the regulatory
framework for prompt corrective action (there are no conditions or events since
that notification that management believes have changed the Bank's category). To
be categorized as well-capitalized, the Bank must maintain minimum ratios as set
forth in the table below. The following table also sets forth the Bank's actual
capital amounts and ratios (dollar amounts in thousands):
Amount of Capital Required
To Be Well-
Capitalized
For Capital Under Prompt
Adequacy Corrective
Actual Purposes Provisions
---------------------- --------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ---------- ---------- --------- --------- ------------
As of December 31, 2004:
Total Capital (to Risk-Weighted Assets) $ 67,436 11.6% $ 46,348 8.0% $ 57,934 10.0%
Tier 1 Capital (to Risk-Weighted Assets) $ 61,074 10.5% $ 23,178 4.0% $ 34,767 6.0%
Tier 1 Capital (to Average Assets) $ 61,074 10.0% $ 24,357 4.0% $ 30,446 5.0%
As of December 31, 2003:
Total Capital (to Risk-Weighted Assets) $ 43,584 11.3% $ 30,964 8.0% $ 38,705 10.0%
Tier 1 Capital (to Risk-Weighted Assets) $ 39,977 10.3% $ 15,482 4.0% $ 23,223 6.0%
Tier 1 Capital (to Average Assets) $ 39,977 9.4% $ 17,070 4.0% $ 21,338 5.0%
The Company is subject to similar requirements administered by its primary
regulator, the Federal Reserve Board. For capital adequacy purposes, the Company
must maintain total capital to risk-weighted assets and Tier 1 capital to
risk-weighted assets of 8.0% and 4.0%, respectively. Its total capital to
risk-weighted assets and Tier 1 capital to risk-weighted assets was 11.5% and
10.0%, respectively at December 31, 2003. Its total capital to risk-weighted
assets and Tier 1 capital to risk-weighted assets was 11.8% and 9.2%,
respectively at December 31, 2004.
The Bank is restricted as to the amount of dividends that can be paid to the
holding company. Dividends declared by national banks that exceed the net income
(as defined) for the current year plus retained net income for the preceding two
years must be approved by the OCC. The Bank may not pay dividends that would
result in its capital levels being reduced below the minimum requirements shown
above.
90
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE O - WARRANTS
In connection with a stock offering that was completed in June 2001, the Bank
issued 400,000 units, with each unit containing four shares of common stock and
one warrant to purchase one share of common stock at an exercise price of $2.50
per share. The warrants expired June 23, 2003.
NOTE P - FORMATION OF TEMECULA VALLEY BANCORP INC.
On June 3, 2002, Temecula Valley Bancorp Inc. acquired all the outstanding
shares of Temecula Valley Bank N.A. by issuing 3,673,203 shares of common stock
in exchange for the surrender of all outstanding shares of Temecula Valley Bank
N.A.'s common stock. There was no cash involved in this transaction. The
acquisition was accounted for as a reverse merger. The consolidated financial
statements contained herein have been restated to give full effect to this
transaction.
NOTE Q - STOCK SPLIT
On December 22, 2003, the Bancorp's Board of Directors approved a 2-for-1 stock
split of the Company's outstanding common stock. All per share data in the
financial statements and related footnotes have been retroactively adjusted to
reflect this split.
NOTE R - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY
Temecula Valley Bancorp Inc. operates Temecula Valley Bank, N.A. Temecula
Valley Bancorp Inc. commenced operations during 2002. The earnings of the
subsidiary are recognized on the equity method of accounting. Condensed
financial statements of the parent company only are presented below:
91
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE R - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY - Continued
CONDENSED BALANCE SHEETS
December 31, December 31,
2004 2003
---------------- ----------------
ASSETS:
Cash $ 1,054,806 $ 825,456
Investment in Temecula Valley Statutory Trust I 217,000 217,000
155,000
Investment in Temecula Valley Statutory Trust II 155,000
Investment in Temecula Valley Statutory Trust III 248,000 -
Investment in Temecula Valley Bank, N.A. 61,823,513 40,588,549
Other Assets 208,167 283,033
---------------- ----------------
$ 63,715,486 $ 42,069,038
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Other Liabilities $ 192,948 $ 13,973
Junior Subordinated Debt Securities 20,620,000 12,372,000
Shareholders' Equity 42,902,538 29,683,065
---------------- ----------------
$ 63,715,486 $ 42,069,038
================ ================
92
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE R - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY - Continued
CONDENSED STATEMENTS OF INCOME Year Ended Year Ended
December 31, December 31,
2004 2003
------------------ ------------------
INCOME:
Cash Dividends from Statutory Trusts $ 20,274 $ 11,853
------------------ ------------------
TOTAL INCOME
EXPENSES:
Interest on Junior Subordinated Debt Securities 766,078 449,454
Other 403,973 155,018
Allocated Tax Benefit (483,435) (243,889)
------------------ ------------------
TOTAL EXPENSES 686,616 360,583
------------------ ------------------
LOSS BEFORE EQUITY IN UNDISTRIBUTED
INCOME OF SUBSIDIARY (666,342) (348,730)
EQUITY IN UNDISTRIBUTED
INCOME OF SUBSIDIARY 11,243,965 8,203,069
------------------ ------------------
NET INCOME $ 10,577,623 $ 7,854,339
================== ==================
93
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE R - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY - Continued
CONDENSED STATEMENTS OF CASH FLOWS Year Ended Year Ended
December 31, December 31,
2004 2003
--------------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 10,577,623 $ 7,854,339
Noncash items included in net income:
Equity in income of Subsidiary (11,243,965) (8,203,069)
Other 973,502 (84,740)
--------------------- ------------------
NET CASH USED IN
OPERATING ACTIVITIES 307,160 (433,470)
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in Subsidiaries (10,000,000) (5,683,687)
Dividends received from Subsidiaries - -
--------------------- ------------------
NET CASH USED BY
INVESTING ACTIVITIES (10,000,000) (5,683,687)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Junior Subordinated Debt Securities 8,248,000 5,155,000
Proceeds from exercise of stock options 1,674,190 976,116
Proceeds from exercise of warrants - 811,497
--------------------- ------------------
NET CASH PROVIDED
BY FINANCING ACTIVITIES 9,922,190 6,942,613
--------------------- ------------------
NET INCREASE IN
CASH AND CASH EQUIVALENTS 229,350 825,456
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 825,456 -
--------------------- ------------------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 1,054,806 $ 825,456
===================== ==================
94
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
NOTE S - QUARTERLY DATA (UNAUDITED)
The following table sets forth the Company's unaudited results of operations for
the four quarters ended in 2004 and 2003:
For the year
For the Quarter Ended in 2004 Ended
--------------------------------------------------------------------- -----------------------
March 31, June 30, September 30, December 31, December 31, 2004
----------------- ----------------- ---------------- --------------- -----------------------
Interest Income $ 6,816,628 $ 7,790,647 $ 8,783,386 $ 10,224,226 $ 33,614,887
Interest Expense (1,242,563) (1,375,641) (1,750,845) (2,045,494) (6,414,543)
----------------- ----------------- ---------------- --------------- -----------------------
Net Interest Income 5,574,065 6,415,006 7,032,541 8,178,732 27,200,344
Provision for Loan Losses (500,000) (250,000) (1,635,000) (1,436,300) (3,821,300)
Noninterest Income 6,727,789 6,726,899 7,288,248 7,955,678 28,698,614
Noninterest Expense (7,444,608) (8,407,711) (8,665,678) (9,446,232) (33,964,229)
----------------- ----------------- ---------------- --------------- -----------------------
Income before Income Taxes 4,357,246 4,484,194 4,020,111 5,251,878 18,113,429
Income Taxes (1,785,096) (1,837,568) (1,645,749) (2,267,393) (7,535,806)
----------------- ----------------- ---------------- --------------- -----------------------
Net Income $ 2,572,150 $ 2,646,626 $ 2,374,362 $ 2,984,485 $ 10,577,623
================= ================= ================ =============== ========================
Per Share Data:
Net Income - Basic $ .31 $ .32 $ .27 $ .34 $ 1.24
Net Income - Diluted $ .28 $ .28 $ .25 $ .31 $ 1.13
For the year
For the Quarter Ended in 2003 Ended
-----------------------------------------------------------------------
March 31, June 30, September 30, December 31, December 31, 2003
----------------- ----------------- ---------------- --------------- -----------------------
Interest Income $ 5,279,705 $ 5,844,313 $ 6,367,114 $ 6,463,159 $ 23,954,290
Interest Expense (1,197,749) (1,262,567) (1,219,119) (1,267,118) (4,946,553)
----------------- ----------------- ---------------- --------------- -----------------------
Net Interest Income 4,081,956 4,581,746 5,147,995 5,196,041 19,007,737
Provision for Loan Losses (150,000) (350,000) (150,000) (372,000) (1,022,000)
Noninterest Income 5,182,918 6,318,554 6,424,132 6,491,957 24,417,561
Noninterest Expense (6,577,879) (7,428,364) (7,399,214) (7,715,614) (29,121,070)
----------------- ----------------- ---------------- --------------- -----------------------
Income before Income Taxes 2,536,995 3,121,936 4,022,913 3,600,384 13,282,228
Income Taxes (1,041,716) (1,273,256) (1,643,420) (1,469,497) (5,427,889)
----------------- ----------------- ---------------- --------------- -----------------------
Net Income $ 1,495,279 $ 1,848,680 $ 2,379,493 $ 2,130,887 $ 7,854,339
================= ================= ================ =============== =======================
Per Share Data:
Net Income - Basic $ .20 $ .24 $ .30 $ .26 $ 1.00
Net Income - Diluted $ .18 $ .21 $ .27 $ .23 $ .89
95
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
WITH
INDEPENDENT AUDITORS' REPORT
DECEMBER 31, 2004, 2003 and 2002
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
-----------------------------------------------------------
AND FINANCIAL DISCLOSURE
------------------------
None.
ITEM 9A: CONTROLS AND PROCEDURES
-----------------------
The Company's principal executive officer and the person
performing the functions of the Company's principal financial officer have
evaluated the effectiveness of the Company's "disclosure controls and
procedures," as such term is defined in Rule 13a-15(e) of the Securities
Exchange Act of 1934, as amended, as of December 31, 2004. Based upon their
evaluation, the principal executive officer and principal financial officer
concluded that the Company's disclosure controls and procedures are effective.
The evaluation did not identify any change in the Company's internal control
over financial reporting that occurred during the quarter ended December 31,
2004 that has materially affected, or is reasonably likely to materially affect,
the Company's internal control over financial reporting.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Temecula Valley Bancorp Inc. and Temecula Valley
Bank (the "Company") is responsible for establishing and maintaining adequate
internal control over financial reporting, and for performing an assessment of
the effectiveness of internal control over financial reporting as of December
31, 2004. Internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. The Company's system of internal
control over financial reporting includes those policies and procedures that (i)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the Company;
(ii) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors of
the Company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of the
Company's assets that could have a material effect on the financial statements.
There are inherent limitations in the effectiveness of internal controls,
including the possibility of human error and the circumvention or overriding of
controls. Accordingly, even effective internal controls can provide only
reasonable assurance with respect to financial statement preparation. Further,
because of changes in condition, the effectiveness of internal controls and
procedures may vary over time.
Management performed an assessment of the effectiveness of the
Company's internal control over financial reporting as of December 31, 2004
based upon criteria in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based
on this assessment, management determined that the Company's internal control
over financial reporting was effective as of December 31, 2004 based on the
criteria in Internal Control -- Integrated Framework issued by COSO.
99
Management assessed its compliance with the designated laws
and regulations relating to safety and soundness. Based on this assessment,
management believes that the Company complied in all significant respects with
designated laws and regulations relating to safety and soundness for the year
ended December 31, 2004.
The Company's independent public accounting firm has issued an
attestation report on Management's assessment of the Company's internal control
over financial reporting. This report is included below.
/s/ Stephen H. Wacknitz /s/ Donald A. Pitcher
- ----------------------- ---------------------
Chief Executive Officer Chief Financial Officer
Dated March 29, 2005
100
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Temecula Valley Bancorp, Inc. and Subsidiary
Temecula, California
We have audited management's assessment, included in the accompanying Report of
Management, that Temecula Valley Bancorp, Inc. and Subsidiary (the "Company")
maintained effective internal control over financial reporting as of December
31, 2004, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and the receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Temecula Valley Bancorp, Inc. and
Subsidiary maintained effective internal control over financial reporting as of
December 31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Also in our
opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2004, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO).
101
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets as
of December 31, 2004 and 2003, and the related consolidated statements of
income, stockholders equity and cash flows for each of the years in the period
ended December 31, 2004 and our report dated March 23, 2005 expressed an
unqualified opinion.
/s/ Vavrinek, Trine, Day & Co., LLP
Laguna Hills, California
March 23, 2005
ITEM 9B: OTHER INFORMATION
-----------------
None.
102
PART III
ITEM 10: DIRECTORS AND PRINCIPAL OFFICERS
--------------------------------
The information required by this Item is incorporated by
reference from the Company's definitive Proxy Statement to be filed with the SEC
pursuant to Regulation 14A within 120 days after the fiscal year covered by this
Annual Report ("Company's Proxy Statement") under the captions "Item-1 Election
of Directors," "Corporate Governance and Our Directors and Executive Officers,"
"Executive Officers and Compensation" and "Section 16(a) Beneficial Ownership
Reporting Compliance."
With regard to Item 406, the Company has adopted a Code of
Ethics that applies to its principal executive officer, principal financial
officer and controller. The policy may be viewed at the Company's website at
www.temvalbank.com. Neither our website, nor the hyperlinks within our website
are incorporated into this document.
ITEM 11: EXECUTIVE COMPENSATION
----------------------
The information required by this Item is incorporated by
reference from the Company's Proxy Statement for the 2005 Annual Meeting of
Shareholders under the caption "Executive Officers and Compensation."
103
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The information required by this Item is incorporated by
reference from the Company's Proxy Statement for the 2005 Annual Meeting of
Shareholders under the caption "Stock Ownership."
Securities Authorized For Issuance Under Equity Compensation Plans
Equity Compensation Plan Information as of December 31, 2004
- --------------------------------------------------------------------------------------------------------------------
Number of securities to be
issued upon exercise of Weighted average exercise
outstanding options, price of outstanding Number of securities
warrants and rights options, warrants and remaining available for
Plan category rights future issuance
- -------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans 1,912,674 $3.74 27,984
approve by security holders
Equity compensation plans not 0 0 0
- - -
approve by security holders
Total 1,912,674 $3.74 27,984
========= ======
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
The information required by this Item is incorporated by
reference from the Company's Proxy Statement for the 2005 Annual Meeting of
Shareholders under the caption "Certain Relationships and Other Transactions."
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
--------------------------------------
The information required by this Item is incorporated by
reference from the Company's Proxy Statement for the 2005 Annual Meeting of
Shareholders under the caption "Selection of Independent Auditors."
104
PART IV
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES
---------------------------------------
(a) Documents Filed as Part of this Annual Report
(1) The following financial statements are incorporated by reference from Item 8 hereto:
Independent Auditors Report Page 63
Consolidated Statements of Financial Condition as of December 31,
2004 and 2003. Page 64
Consolidated Statements of Income for Each of the Years Ended
December 31, 2004, 2003 and 2002.
Page 66
Consolidated Statement of Changes in Shareholders' Equity for the
years ended December 31, 2004, 2003 and 2002 Page 67
Notes to Consolidated Financial Statements Page 69
(2) Financial Statement Schedules
Not applicable.
(b) Exhibits
Exhibit No. Description of Exhibit
----------- ----------------------
2.(i) Bank and Company Amended and Restated Plan of
Reorganization dated as of April 2, 2002, filed on June
3, 2002 as an Exhibit to Form 8-A12G
2.(ii) Agreement and Plan of Merger of Temecula Merger
Corporation and Temecula Valley Bancorp is an Exhibit to
the Company's Definitive 14A filed November 20, 2003
3.(i) Articles of Incorporation of Temecula Valley Bancorp
Inc., a California corporation, is an Exhibit to the
Company's Definitive 14A, filed November 20, 2003
3.(ii) Bylaws of the Company, as amended, filed on May 17, 2004
as an Exhibit to the Company's Form 10-Q
105
4.1 Common Stock Certificate of the Company, filed on May 17,
2004 as an Exhibit to the Company's Form 10-Q
4.2 Warrant Certificate of Temecula Valley Bank, N.A. as
adopted by Temecula Valley Bancorp Inc., filed on June 3,
2002 as an Exhibit to Temecula Valley Bancorp's Form
8-A12G
10.1 Temecula Valley Bank, N.A. Lease Agreement for Main
Office, filed on March 11, 2003 as an Exhibit to the
Company's Form 10KSB
10.2 Stephen H. Wacknitz Employment Agreement effective
October 1, 2003, filed on March 31, 2004 as an Exhibit to
the Company's Form 10K
10.4 Luther J. Mohr Employment Agreement effective October 1,
2003, filed on March 31, 2004 as an Exhibit to the
Company's Form 10K
10.6 401(k) filed April 16,2004 as an Exhibit to the Company's
10-K/A
10.8 Thomas P. Ivory Employment Agreement effective January
25, 2001, filed on March 11, 2003 as an Exhibit to
Temecula Valley Bancorp's Form 10KSB
10.9 James W. Andrews Employment Agreement dated June 1, 2002
filed on April 11, 2003 as an Exhibit to the Company's
Form 10KSB
10.10 First Amendment to James W. Andrews Employment Agreement
dated November 24, 2004
10.11 1996 Incentive and Non Qualified Stock Option Plan
(Employees), as amended by that certain First Amendment
effective May 15, 2001 and that certain Second Amendment
effective May 15, 2002, filed on April 11, 2003 as an
Exhibit to the Company's Form 10KSB ("Employee Plan")
10.11(a) Form of ISO Stock Option Agreement for Employee Plan
10.12 1997 Non Qualified Stock Option Plan (Directors), as
amended by that certain First Amendment effective May 15,
2001 and that certain Second Amendment effective May 15,
2002, filed on April 11, 2003 as an Exhibit to the
Company's Form 10KSB ("Director Plan")
10.12(a) Form of NSO Stock Option Agreement for Director Plan
10.13 Amended and Restated Salary Continuation Agreement
between Temecula Valley Bank and Stephen H. Wacknitz
dated September 30, 2004, filed on November 18, 2004 as
an Exhibit to the Company's Form 10-Q/A
106
10.14 Amended and Restated Salary Continuation Agreement
between Temecula Valley Bank and Luther J. Mohr dated
January 28, 2004, filed on November 18, 2004 as an
Exhibit to the Company's Form 10-Q/A
10.17 Executive Deferred Compensation Agreement between
Temecula Valley Bank and Thomas P. Ivory dated April 1,
2001, filed on November 18, 2004 as an Exhibit to the
Company's Form 10-Q/A
10.17(a) Temecula Valley Bancorp Inc. 2004 Stock Incentive Plan,
as amended, filed on August 20, 2004 as an Exhibit to
the Company's Form 10-Q ("Stock Incentive Plan")
10.17(b) Form of NSO Stock Option Agreement for Stock Incentive
Plan
10.17(c) Form of ISO Stock Option Agreement for Stock Incentive
Plan
10.18 Executive Deferred Compensation Agreement between
Temecula Valley Bank and Stephen H. Wacknitz dated
September 30, 2004, filed on November 18, 2004 as an
Exhibit to the Company's Form 10-Q/A
10.19 Salary Continuation Agreement between Temecula Valley
Bank and Stephen H. Wacknitz dated January 28, 2004 filed
on November 18, 2004 as an Exhibit to the Company's Form
10-Q/A.
10.20 Amended and Restated Salary Continuation Agreement
between Temecula Valley Bank and Scott J. Word dated
September 30, 2004, filed on November 18, 2004 as an
Exhibit to the Company's Form 10-Q/A
10.21 Split Dollar Agreement between Temecula Valley Bank and
Thomas P. Ivory dated September 30, 2004, filed on
November 18, 2004 as an Exhibit to the Company's Form
10-Q/A
..
10.22 Split Dollar Agreement between Temecula Valley Bank and
Luther J. Mohr dated September 30, 2004, filed on
November 18, 2004 as an Exhibit to the Company's Form
10-Q/A
10.23 Split Dollar Agreement between Temecula Valley Bank and
Stephen H. Wacknitz dated September 30, 2004, filed on
November 18, 2004 as an Exhibit to the Company's Form
10-Q/A
10.24 Split Dollar Agreement between Temecula Valley Bank and
Scott J. Word dated September 30, 2004, filed on November
18, 2004 as an Exhibit to the Company's Form 10-Q/A
10.25 Robert Flores Employment Agreement dated January 27, 2007
107
10.27 Amended and Restated Salary Continuation Agreement
between Thomas M. Shepherd and Temecula Valley Bank dated
September 30, 2004
10.28 Split Dollar Agreement between Thomas M. Shepherd dated
September 30, 2004
10.29 Amended and Restated Salary Continuation Agreement
between Donald A. Pitcher and Temecula Valley Bank dated
September 30, 2004
10.30 Split Dollar Agreement between Temecula Valley Bank and
Donald A. Pitcher dated September 30, 2004
10.31 William H. McGaughey Employment Agreement dated January
4, 2005.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certifications
108
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
TEMECULA VALLEY BANCORP INC.
DATE: March 29, 2005 BY: /s/ Stephen H. Wacknitz
-------------------------------------
Stephen H. Wacknitz, President/CEO,
Chairman of the Board
BY: /s/ Donald A. Pitcher
-------------------------------------
Donald A. Pitcher, Senior Vice President
Chief Financial Officer
109
Pursuant to the requirements of the Securities Exchange Act of
1934, this Annual Report has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Steven W. Aichle Director March 29, 2005
- ----------------------------------------
Dr. Steven W. Aichle
/s/ Dr. Robert P. Beck Director March 29, 2005
- ----------------------------------------
Dr. Robert P. Beck
/s/ Neil M. Cleveland Director March 29, 2005
- ----------------------------------------
Neil M. Cleveland
/s/ George Cossolias Director March 29, 2005
- ----------------------------------------
George Cossolias
/s/ Luther J. Mohr Director March 29, 2005
- ----------------------------------------
Luther J. Mohr
/s/ Stephen H. Wacknitz Chairman March 29, 2005
- ----------------------------------------
Stephen H. Wacknitz
/s/ Richard W. Wright Director March 29, 2005
- ----------------------------------------
Richard W. Wright
110
EXHIBIT LIST
------------
Exhibit
- -------
10.10 First Amendment to James W. Andrews Employment Agreement dated
November 24, 2004
10.11(a) Form of ISO Stock Option Agreement for Employee Plan
10.12(a) Form of NSO Stock Option Agreement for Director Plan
10.17(b) Form of NSO Stock Option Agreement for Stock Incentive Plan
10.17(c) Form of ISO Stock Option Agreement for Stock Incentive Plan
10.25 Robert Flores Employment Agreement dated January 27, 2007
10.27 Amended and Restated Salary Continuation Agreement between Thomas M.
Shepherd and Temecula Valley Bank dated September 30, 2004
10.28 Split Dollar Agreement between Thomas M. Shepherd dated September 30,
2004
10.29 Amended and Restated Salary Continuation Agreement between Donald A.
Pitcher and Temecula Valley Bank dated September 30, 2004
10.30 Split Dollar Agreement between Temecula Valley Bank and Donald A.
Pitcher dated September 30, 2004
10.31 William H. McGaughey Employment Agreement dated January 4, 2005.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certifications
111