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EX-31.1 - EX-31.1 - WESTERN LIBERTY BANCORPy90569exv31w1.htm
EX-31.2 - EX-31.2 - WESTERN LIBERTY BANCORPy90569exv31w2.htm
EX-32.1 - EX-32.1 - WESTERN LIBERTY BANCORPy90569exv32w1.htm
EX-32.2 - EX-32.2 - WESTERN LIBERTY BANCORPy90569exv32w2.htm
Table of Contents

 
UNITED STATES 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, 2010
OR
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number: 001-33803
WESTERN LIBERTY BANCORP
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State of incorporation)
  26-0469120
(I.R.S. Employer Identification No.)
     
8363 W. Sunset Road, Suite 350
Las Vegas, Nevada
(Address of principal executive offices)
  89113
(Zip code)
 
Registrant’s telephone number, including area code:
(702) 966-7400
 
Securities registered pursuant to section 12(b) of the Act:
Common Stock, $0.0001 Par Value Per Share
 
Securities registered pursuant to section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 223.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer o
  Accelerated filer o   Non-accelerated filer o
(Do not check if a smaller reporting company)
  Smaller reporting company þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $32,172,566 aggregate market value based on the closing price of $7.55 on June 30, 2010. Shares held as of June 30, 2010 by directors, executive officers, and owners of 10% or more of the registrant’s common equity are excluded from the calculation of aggregate market value of common equity held by non-affiliates, but the exclusion of their shares is not and shall not be deemed to be an admission that these holders are or were affiliates.
 
As of March 30, 2011, there were 15,088,023 shares of common stock outstanding of the registrant.
 


 

 
WESTERN LIBERTY BANCORP
FORM 10-K

TABLE OF CONTENTS
 
             
        Page
 
  Business     3  
  Risk Factors     27  
  Unresolved Staff Comments     39  
  Properties     40  
  Legal Proceedings     40  
  [reserved]     40  
 
PART II
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     40  
  Selected Financial Data     42  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     44  
  Quantitative and Qualitative Disclosures About Market Risk     103  
  Financial Statements and Supplementary Data     103  
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     103  
  Controls and Procedures     103  
  Other Information     104  
 
PART III
  Directors, Executive Officers and Corporate Governance     104  
  Executive Compensation     106  
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     106  
  Certain Relationships and Related Transactions and Director Independence     107  
  Principal Accountant Fees and Services     107  
 
PART IV
  Exhibits and Financial Statement Schedules     107  
    189  
 EX-14.1
 EX-21
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2


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PART I
 
Item 1 — Business
 
Western Liberty Bancorp
 
Western Liberty Bancorp (“WLBC,” “the Company”, “us,” “we” or “our”) became a bank holding company on October 28, 2010 with consummation of its acquisition of Service1st Bank of Nevada a Nevada-chartered non-member bank (“Service1st Bank” or “Service1st”). Although WLBC’s goal in 2007, when it was established as a special purpose acquisition company, was to identify for acquisition domestic and international operating companies engaged in the consumer products and services business, by the spring of 2009, we determined that the banking industry had become an attractive investment opportunity, particularly the community banking industry in Nevada. In October of 2009, we changed our name to Western Liberty Bancorp and eliminated the special purpose acquisition company features of our governing documents. In October 2009, we also began in earnest the process that concluded on October 28, 2010 with the acquisition of Service1st. Our sole subsidiary is Service1st, and we currently conduct no business activities other than acting as the holding company of Service1st. The financial presentations included herein represent one year of activity for the Company and consolidated results with Service1st for two months.
 
Service1st Bank of Nevada
 
Established on January 16, 2007, Service1st is a community bank, providing a full range of banking and related services to locally owned businesses, professional firms, real estate developers and investors, local non-profit organizations, high net worth individuals, and other customers in the greater Las Vegas area. Banking services provided include basic commercial and consumer depository services, commercial working capital and equipment loans, commercial real estate (both owner and non-owner occupied) loans, construction loans, and unsecured personal and business loans. Service1st relies primarily on locally generated deposits to fund its lending activities. Substantially all of our business is generated in the Nevada market.
 
The Acquisition
 
On October 28, 2010, WLBC consummated its acquisition (the “Acquisition”) of Service1st, pursuant to a Merger Agreement (the “Merger Agreement”), dated as of November 6, 2009, as amended by a First Amendment to the Merger Agreement, dated as of June 21, 2010 (“Amendment No. 1” and, together with the Merger Agreement, the “Amended Merger Agreement”), each among WL-S1 Interim Bank, a Nevada corporation and wholly-owned subsidiary of WLBC (“Acquisition Sub”), Service1st and Curtis W. Anderson, as representative of the former stockholders of Service1st. Pursuant to the Amended Merger Agreement, Acquisition Sub merged with and into Service1st, with Service1st being the surviving entity and becoming WLBC’s wholly-owned subsidiary. WLBC previously received the requisite approvals of certain bank regulatory authorities to complete the Acquisition to become a bank holding company.
 
The former stockholders of Service1st received approximately 2,282,668 shares of common stock, par value $0.0001 of WLBC (“Common Stock”) (net of the exercise of dissenter’s rights with respect to 88,054 shares) in exchange for all of the outstanding capital stock of Service1st (the “Base Acquisition Consideration”). In addition, the holders of Service1st’s outstanding options and warrants now hold options and warrants of similar tenor to purchase up to 289,781 shares of Common Stock.
 
In addition to the Base Acquisition Consideration, each of the former stockholders of Service1st may be entitled to receive additional consideration (the “Contingent Acquisition Consideration”), payable in Common Stock, if at any time within the first two years after the consummation of the Acquisition, the closing price per share of the Common Stock exceeds $12.75 for 30 consecutive days. The Contingent Acquisition Consideration is equal to 20% of the tangible book value of Service1st at August 31, 2010 (or approximately $4.4 million). The total number of shares of our common stock issuable to the former Service1st stockholders would be determined by dividing the Contingent Acquisition Consideration by the average of the daily closing


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price of the Common Stock on the first 30 trading days on which the closing price of the Common Stock exceeded $12.75.
 
At the close of business on October 28, 2010, WLBC became a new Nevada bank holding company by consummating the acquisition of Service1st and conducting operations through Service1st. In conjunction with the Acquisition, WLBC infused $25 million of capital onto the balance sheet of Service1st. On October 29, 2010, the Common Stock began trading on the Nasdaq Global Market, under the ticker symbol WLBC.
 
The Acquisition was recorded as an acquisition under current accounting rules and as a result the balance sheet of Service1st was revalued to fair value as of the acquisition date. Any purchase price in excess of the fair value of net assets acquired is recorded as goodwill. The Acquisition resulted in $5.6 million of goodwill. This process is heavily reliant on measuring and estimating the fair values of all the assets and liabilities of the acquired entity. The Company elected to obtain professional assistance in this activity. The Company hired a third-party vendor to assist management in determining the fair value of the loan portfolio, the time deposits, and the contingent consideration discussed above. Additionally, the firm was asked to estimate the value of the intangible asset associated with the deposit base, commonly referred to as the Core Deposit Intangible (“CDI”).
 
The most significant fair value adjustment resulting from the application of purchase accounting adjustments for this acquisition were made to loans. As of the Acquisition date, the gross loan portfolio at Service1st was approximately $125.4 million with a related Allowance for Loan and Lease Losses (“ALLL”) of approximately $9.4 million. The valuation resulted in a discount of approximately $15.8 million at October 28, 2010. While we believe we currently have the best estimate of fair value, the purchase accounting adjustments are not final and we are currently still evaluating all available information to ensure we have an accurate assessment of fair value. In fact, there have been some loan charge-offs and payoffs which impacted the valuation and as a result of reviewing this information, management reduced the discount from the original estimated discount of $15.8 million to approximately $15.1 million. This discount consists of two components: credit discount and yield discount. Loans purchased with credit impairments are loans with credit deterioration since origination and it is probable that not all contractually required principal and interest payments would be collected. The performing loan portfolio was approximately $89.9 million and was discounted by $49,000 for yield and $3.6 million for credit discounts. The remaining $35.6 million of loans were identified as loans with purchased credit impairment (PCI) and those loans had a discount of $576,000 for yield and $10.9 million for credit discounts. The discounts on performing loans are recognized by a “level yield” method over the remaining life of the loans or loan pools. The loans identified as containing purchase credit impairment are treated somewhat differently. The discount associated with yield is accreted as yield discount and the credit discount is not accreted but is left on the books to reduce the current carrying value of the applicable loans. The application of this process requires that the aggregate discount is first netted against the ALLL. Consequently, the first day after the transaction the loan portfolio was approximately $110 million with no ALLL. In addition, current accounting methodology only allows for the establishment of an ALLL to occur as the entity records new loans on the books or identifies subsequent credit deterioration on the original loans marked to fair value at acquisition date.
 
Service1st operates in the Las Vegas market place which has seen significant economic declines in all types of real estate and overall business trends. Since inception, Service1st has charged off approximately $17.8 million of loans through October 28, 2010. The remaining $125 million loan portfolio was further reduced by approximately $15 million in the fair value process as of the acquisition date. As discussed above, approximately $35.6 million of loans with purchased credit impairment were reduced to fair value by the $11.5 million discounts. This translates to a 32% reduction in the carrying value of those loans.
 
The contractual values of time deposits were also marked to fair value. This resulted in Service1st recording a premium of $46,000. This premium will be amortized over the estimated remaining life of the time deposit portfolio of one year.
 
The CDI is the result of a valuation study which attempts to associate a value for the customer’s deposit relationships based on the profitability of the deposits and how long they are


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expected to produce revenue to the entity. This intangible asset was valued at $784,000 for Service1st at October 28, 2010. The intangible asset is amortized on an accelerated basis using an estimated ten year life.
 
The Contingent Acquisition Consideration estimated to be $4.4 million was also fair valued. A decision tree model was used to calculate the probability that the Company’s stock price will reach the threshold. Based on the results the fair value was determined to be approximately $1.8 million. Periodically over the two year period the reasonableness of the estimate will be reviewed and adjusted if deemed necessary.
 
These estimates along with several other estimates were used to complete the fair value process for the balance sheet of Service1st and also to evaluate the fair value of future commitments and off-balance sheet items. Upon completion of these activities the adjustments are posted to the records of the new subsidiary and the difference between the fair value of the consideration given versus the net asset values obtained, an unidentified intangible asset (goodwill) was created in the amount of approximately $5.6 million.
 
In order to assist WLBC in gaining the requisite approval of certain bank regulatory authorities in connection with the Acquisition, on September 23, 2010, WLBC entered into a Letter Agreement (the “Warrant Restructuring Letter Agreement”) with certain warrant holders who represented to WLBC that they collectively hold at least a majority of its outstanding warrants (the “Consenting Warrant Holders”) confirming the basis and terms upon which the parties have agreed to amend the Amended and Restated Warrant Agreement, dated as of July 20, 2009, as amended by the Amendment No. 1, dated as of October 9, 2009, each between WLBC and Continental Stock Transfer & Trust Company, as warrant agent (the “Warrant Agent”) (as amended, the “Warrant Agreement”), previously filed with the SEC. The Warrant Restructuring Letter Agreement serves as the consent and approval of each of the Consenting Warrant Holders to amend and restate the Warrant Agreement.
 
Pursuant to the Warrant Restructuring Letter Agreement, the Warrant Agreement amended where applicable to provide for the automatic exercise of all of the outstanding warrants of WLBC (the “Warrants”) into one thirty-second (1/32) of one share of WLBC’s common stock, par value $0.0001 (“Common Stock”), which occurred concurrently with the consummation of the Acquisition (the “Automatic Exercise Date”). Any Warrants that would entitle a holder of such Warrants to a fractional share of Common Stock after taking into account the automatic exercise of the remainder of such holder’s Warrants into full shares of Common Stock were cancelled on the Automatic Exercise Date. As of September 23, 2010, there were 48,067,758 Warrants outstanding, each exercisable for one share of Common Stock, which will automatically be converted into approximately 1,502,117 shares of Common Stock on the Automatic Exercise Date. As a result of the foregoing, there were no Warrants outstanding after the Automatic Exercise Date. WLBC also paid a consent fee to the holders of Warrants in an amount equal to $0.06 per Warrant on the Automatic Exercise Date, regardless of whether such holders were party to the Warrant Restructuring Letter Agreement.
 
Presentation
 
Since the Company’s operations prior to the acquisition of Service1st were insignificant relative to that of Service1st, management believes that Service1st is the Company’s predecessor. Management has determined this based on an evaluation of the various facts and circumstances including, but not limited to, the life of Service1st, the operations of Service1st, the purchase price paid, and the fact that the operations on a prospective basis will be most similar to Service1st. Accordingly, separate financial statements of Service1st as of October 28, 2010 and December 31, 2009 and for the period January 1, 2010 through October 28, 2010 and the years ended December 31, 2009 and 2008 have been included as an exhibit to the Form 10-K and a separate Management Discussion and Analysis has been included. These items should be read in conjunction with the financial statements of the Company for the periods ended December 31, 2010, 2009 and 2008. The predecessor financials should be read noting that they are not comparable because, at acquisition dates, the assets and liabilities were fair valued and thus a new accounting bases was determined different than their historical costs bases. In general, this change in bases impacts interest income and expense as a result of the amortization of premiums and discounts to arrive at contractual amounts due.


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Market Area and Competition
 
The United States economy entered into a recession in late 2007, which has been deeply felt in the greater Las Vegas area and in its critical tourism and gaming industries. High unemployment rates, declining real property values, declining home sales, low consumer and business confidence levels, and increasing vacancy and foreclosure rates for commercial and residential property have had a dramatically adverse impact on the Las Vegas economy. Further deterioration in the performance of the economy or real estate values in Service1st’s primary market areas could have an adverse impact on collectibility and an adverse effect on profitability.
 
Service1st’s target market primarily consists of small business banking opportunities, private banking clientele, commercial lending, and commercial real estate opportunities. The banking and financial services industries in our market area remain highly competitive despite the recent economic downturn. Many of our competitors are much larger in total assets and capitalization, have greater access to capital markets, and offer a broader range of financial services than we can offer. This increasingly competitive environment is primarily a result of changes in regulation that made mergers and geographic expansion easier; changes in technology and product delivery systems, such as ATM networks and web-based tools; the accelerating pace of consolidation among financial services providers; and the flight of deposit customers to perceived increased safety. The competitive environment is also significantly impacted by federal and state legislation that makes it easier for non-bank financial institutions to compete with us. We compete for loans, deposits and customers with other commercial banks, local community banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other non-bank financial services providers. Competition for deposit and loan products remains strong from both banking and non-banking firms, and this competition directly affects the rates of those products and the terms on which they are offered to consumers. Consumers in our market areas continue to have numerous choices to serve their financial needs. Competition for deposits has increased markedly, with many bank customers turning to deposit accounts at the largest, most-well capitalized financial institutions. These large institutions have greater access to capital markets and offer a broader range of financial services than we will be able to offer. Technological innovation continues to contribute to greater competition in domestic and international financial services markets. Many customers now expect a choice of several delivery systems and channels, including telephone, mail, home computer and ATMs. Mergers between financial institutions have placed additional pressure on banks to consolidate their operations, reduce expenses and increase revenues to remain competitive. In addition, competition has intensified because federal and state interstate banking laws permit banking organizations to expand geographically with fewer restrictions than in the past. These laws allow banks to merge with other banks across state lines, enabling banks to establish or expand banking operations in our market.
 
Lending Activities
 
Service1st provides a variety of financial services, including commercial real estate loans, commercial and industrial loans, construction and land development loans and, to a lesser extent, consumer loans. The bank’s loan portfolio has a concentration of loans secured by real estate. As of December 31, 2010, loans secured by real estate comprised 66.04% of total gross loans. Substantially all of these loans are secured by first liens. Approximately 30.2% of these real-estate-secured loans are owner-occupied properties. A property is considered owner occupied for this purpose if the borrower occupies at least 50% of the collateral property securing the loan. Service1st’s policy is to obtain collateral whenever it is available or desirable, depending upon the degree of risk Service1st is willing to accept. Repayment of loans is expected from the borrower’s cash flows or the sale proceeds of the collateral. Service1st’s principal lending categories are:
 
Commercial real estate loans — The majority of Service1st’s lending activity consists of loans to finance the purchase of commercial real estate and loans to finance inventory and working capital that are additionally secured by commercial real estate. Service1st has a commercial real estate portfolio comprised of loans on professional offices, industrial facilities, retail centers and other commercial properties.


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Construction, land development, and other land loans — Construction loans include loans for the construction of owner-occupied buildings, investment properties (including residential development construction), residences, commercial development, and other properties. Service1st analyzes each construction project in the loan underwriting process to determine whether the type of property, location, construction costs, and contingency funds are appropriate and adequate.
 
Commercial and industrial loans — Service1st focuses its commercial lending on small- to medium-size businesses located in or serving the Las Vegas community. Service1st considers “small businesses” to include commercial, professional and retail businesses. Service1st’s commercial and industrial loan products include:
 
  •  working capital loans and lines of credit,
 
  •  business term loans, and
 
  •  inventory and accounts receivable financing.
 
Residential real estate loans — Although residential mortgage lending is not a significant part of Service1st’s lending business, it has made some loans secured by 1-4 single-family residential properties.
 
Consumer loans — Service1st also originates consumer loans from time to time, such as home equity loans and lines of credit, to satisfy customer demand and to respond to community needs. Consumer loans are not a significant part of Service1st’s loan portfolio.
 
The following table shows the composition of the loan portfolio in dollar amounts and in percentages, along with a reconciliation to loans receivable, net.
 
                 
($ in thousands)   December 31, 2010  
 
Loans secured by real estate:
               
Construction, land development and other land loans
  $ 5,923       5.58 %
Commercial real estate
    54,975       51.75 %
Residential
    9,247       8.71 %
                 
Total loans secured by real estate
    70,145       66.04 %
Commercial and industrial
    35,946       33.84 %
Consumer
    131       0.12 %
                 
Gross loans
    106,222       100.00 %
Net deferred loan costs
    37          
                 
Gross loans, net of deferred costs
    106,259          
Less: Allowance for loan losses
    (36 )        
                 
Net loans
  $ 106,223          
                 
 
The preceding table and the tables to follow should be read in conjunction with the notes to the consolidated financial statements included in or incorporated by reference in this report, including the explanation of the Acquisition and the explanation of acquisition accounting generally. On October 28, 2010, we acquired by merger 100% of Service1st for consideration consisting of stock valued at $15.3 million in the aggregate, based upon our common stock’s market price per share. As explained in the notes to the consolidated financial statements filed with or incorporated by reference in this report, we have recorded the assets acquired and the liabilities assumed in the Acquisition at their fair values as of the acquisition date, consistent with accounting guidance applicable to acquisitions, particularly ASC 805, Business Combinations (formerly SFAS 141(R)), with the related acquisition and restructuring costs expensed in the current period. We recorded goodwill of $5.6 million of goodwill associated with the acquisition, which represents the amount by which the purchase price exceeds the fair values of the identifiable net assets acquired.


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Applicable accounting guidance, ASC 805, allows for a measurement period beyond the acquisition date, which means we may take into account new information that existed as of the acquisition date but that was not known to us when the Acquisition occurred. We anticipate that measurement period adjustments could arise from adjustments to the fair values of assets and liabilities recognized at the acquisition date as additional information is obtained, such as appraisals of collateral securing loans and fixed assets, contracts, legal documentation and selected key borrower data. If a measurement period adjustment is identified, we will recognize the adjustment as part of the acquisition accounting, which could result in an adjustment to goodwill recorded. These subsequent adjustments, if any, will be retrospectively recorded in future filings.
 
Please refer to the notes to consolidated financial statements filed with or incorporated by reference in this report for additional information concerning the Acquisition.
 
The following table presents maturity information for the loan portfolio at December 31, 2010. The table does not include prepayments or scheduled principal repayments. All loans are shown as maturing based on contractual maturities.
 
                                 
    For the Year Ended December 31, 2010  
    Due Within
    Due 1-5
    Due Over
       
    One Year     Years     Five Years     Total  
 
Loans secured by real estate:
                               
Construction, land development and other land loans
  $ 4,428     $ 1,495     $     $ 5,923  
Commercial real estate
    2,544       29,327       23,104       54,975  
Residential real estate (1 to 4 family)
    6,885       2,222       140       9,247  
                                 
Total real estate-secured loans
  $ 13,857     $ 33,044     $ 23,244     $ 70,145  
Loans not secured by real estate:
                               
Commercial and industrial
    18,975       9,297       7,674       35,946  
Consumer
    95       35       1       131  
                                 
Loans, Gross
  $ 32,927     $ 42,376     $ 30,919     $ 106,222  
                                 
Interest rates:
                               
Fixed
  $ 7,429     $ 33,867     $ 5,713     $ 47,009  
Variable
    25,498       8,509       25,206       59,213  
                                 
Loans, Gross
  $ 32,927     $ 42,376     $ 30,919     $ 106,222  
                                 
 
Credit Policies and Administration
 
Loan and credit administration policies adopted by Service1st’s board of directors establish underwriting criteria, concentration limits, and loan authorization limits, as well as the procedures to administer loans, monitor credit risk, and subject loans to appropriate grading and evaluation for impairment. Loan originations are subject to a process that includes the credit evaluation of borrowers, established lending limits, analysis of collateral and procedures for continual monitoring and identification of credit deterioration. Loan officers are required to monitor their individual credit relationships in order to report suspected risks and potential downgrades as early as possible.
 
For real-estate secured loans, appraisals are ordered from outside appraisers at a loan’s inception or renewal, or for commercial real estate loans upon the occurrence of any event causing a “criticized” or “classified” grade to be assigned to the credit. The frequency for obtaining updated appraisals for these adversely graded credits is increased when declining market conditions exist. Appraisals may reflect the collateral’s “as-is”, “as-stabilized,” or “as-developed” values, depending upon the loan type and collateral. Raw land generally is appraised at its “as-is” value. Income producing property may be appraised at its “as-


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stabilized” value, which takes into account the anticipated cash flow of the property based upon expected occupancy rates and other factors. The collateral securing construction loans may be appraised at its “as-if developed” value, which approximates the post-construction value of the collateralized property assuming that such property is developed. “As-developed” values on construction loans often exceed the immediate sales value and may include anticipated zoning changes and successful development by the purchaser. If a loan goes into default before development of a project, the market value of the property may be substantially less than the “as-developed” appraised value. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, Service1st may not recover the outstanding balance of the loan.
 
Service1st’s loan approval procedures are executed through a tiered loan limit authorization process. Each loan officer’s individual lending limit and those of the Senior Loan Committee are set by Service1st’s board of directors. All debt due from the borrower (including unfunded commitments and guaranties) and the borrower’s related entities is aggregated when determining whether a proposed new loan is within the authority of an individual lender or of the Senior Loan Committee. Each senior vice president team leader may unilaterally approve real-estate secured loans of up to $750,000, other secured loans of up to $500,000, and unsecured loans of up to $375,000. Credit applications exceeding a senior vice president team leader’s authority are submitted for approval by Service1st’s Chief Executive Officer, or Chief Credit Officer, each of whom may unilaterally approve real estate-secured loans of up to $1,500,000, other secured loans of up to $1,250,000, and unsecured loans of up to $1,000,000, with higher limits for joint approvals by more than one of the executive officers or senior vice presidents. As an alternative approval process, credits may be submitted to the Senior Loan Committee. The Senior Loan Committee consists of Service1st’s Chief Executive Officer and Chief Credit Officer, and the bank’s senior vice president team leaders. A quorum consists of at least the Chief Executive Officer or Chief Credit Officer plus two other members. The Senior Loan Committee has the authority to approve loan applications, but loans exceeding $5,000,000 also require the approval of the Chief Executive Officer. Service1st’s board of directors also has a loan and investment committee that is responsible for establishing and providing supervision and oversight over Service1st’s credit and investment policies and administration. Credits granted as an exception to loan policy are required to be justified and duly noted in the loan presentation or file memo, as appropriate, and approved or ratified by the necessary approval authority level. Exceptions to loan policies are disclosed to the board’s loan and investment committee.
 
All insider loans must be approved in advance by a majority of the board without the vote of the interested director. It is the policy of Service1st that directors not be present when their loan is presented at a board meeting for discussion and approval. Service1st believes that all of its insider loans were made on terms substantially similar to those offered to unaffiliated individuals. As of December 31, 2010, the aggregate amount of all loans outstanding to Service1st’s executive officers, directors, and greater than 10% stockholders and their respective affiliates was approximately $2.4 million, which represented 2.2% of the bank’s total gross loans.
 
Allowance for Loan Losses
 
Under applicable accounting guidance, assets generally are recorded by a company on its balance sheet at the company’s cost. In the case of a bank, loans originated by the bank are stated at their principal amount outstanding, net of unearned income, charge-offs, and unamortized deferred fees and costs. But, rather than recording the assets and liabilities of Service1st at their historical cost to Service1st because of the October 28, 2010 acquisition, the assets and liabilities of Service1st are, instead, recorded at their fair value as of the acquisition date. Because the fair value of loans takes into account the probability of loan losses, the allowance for loan losses accumulated by an acquired bank is not carried over and maintained thereafter by the acquiring company. Calculating the fair value of acquired loans entails estimating the amount and timing of both principal and interest cash flows expected to be collected and then discounting those cash flows at market interest rates.
 
The allowance is required to cover probable incurred losses in new loans generated since October 28, 2010 and for any subsequent deterioration of loans beyond the fair value determined on October 28, 2010.


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Management will closely monitor the loans existing at October 28, 2010 and establish applicable allowance levels for new loans.
 
The allowance for loan losses reflects Service1st’s evaluation of the probable losses in its loan portfolio. The allowance for loan losses is maintained at a level that represents Service1st management’s best estimate of losses in the loan portfolio at the balance sheet date, losses that are both probable and reasonably estimable. The evaluation is inherently subjective and depends on estimates and projections of factors that will have a material impact but that are subject to significant changes, including estimates and projections of the amount and timing of future cash flows expected to be received on impaired loans. The allowance for loan losses is reviewed by Service1st’s management and adjusted monthly. Factors that influence management’s determination concerning the adequacy of the allowance for loan losses include:
 
  •  general economic and business conditions affecting key lending areas,
 
  •  credit quality trends, including trends in nonperforming loans expected to result from existing conditions,
 
  •  collateral values,
 
  •  loan volumes and concentrations,
 
  •  age of the loan portfolio,
 
  •  specific industry conditions within portfolio segments,
 
  •  the allowance for loan losses at peer institutions, and
 
  •  duration of the current business cycle.
 
To measure asset quality, Service1st grades each loan on a scale of 1 to 10, the designation representing the highest quality loans with the least risk. Loans graded 1 through 6 are considered satisfactory. Consistent with the grading systems used by Federal banking regulators, the other four grades are 7 (special mention), 8 (substandard), 9 (doubtful), and 10 (loss). All loans are assigned a credit risk grade at the time they are made, and each originating loan officer reviews the credit with his or her immediate supervisor quarterly to determine whether a change in the credit risk grade is warranted. The management loan committee also has the responsibility to assign grades. In addition, the grading of Service1st’s loan portfolio is reviewed at least annually by an external, independent loan review firm. As previously discussed, PCI loans were discounted approximately 32% on October 28, 2010. Generally, loans graded as substandard or doubtful, as well as non-performing loans are included as PCI loans.
 
The size of the allowance for loan losses is significantly influenced by the results of loan reviews performed both by bank personnel and by third parties engaged by the bank to supplement the bank’s internal loan review process. The loan review process is integral to identifying loans with credit quality that has weakened over time and to evaluating the risk characteristics of the entire loan portfolio. The loan grading system used by Service1st also plays a role in setting the level of the allowance because each grade tier has a fixed percentage allocation assigned to it. Service1st’s loan loss methodology also provides that management will take into account updated collateral appraisals, especially for loans such as construction and land loans. Because there are factors that cannot be practically assigned to individual loan categories, such as the current volatility of the national and global economy, the assessment also includes an unallocated component. Finally, the Federal Deposit Insurance Corporation (the “FDIC”) and the Nevada Financial Institutions Division (the “Nevada FID”) perform regular examinations of Nevada-chartered nonmember banks such as Service1st. In the examination process, the FDIC and the Nevada FID consider the adequacy of a bank’s loan loss allowance and frequently use their authority to insist upon an increase in a bank’s allowance for loan losses.
 
Service1st maintains the allowance through provisions for loan losses that it charges to income. As previously discussed, the ALLL was adjusted to zero in conjunction with the fair value accounting process. Therefore, the current ALLL at December 31, 2010 only relates to those loans generated after the Acquisition. No new credit deterioration was recorded during the last two months of 2010. Service1st charges losses on loans against the allowance for loan losses when it believes the collection of loan principal is unlikely. The


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Chief Executive Officer and Chief Credit Officer must approve all charge-offs. Loans deemed uncollectible generally are proposed monthly for charge-off or write-down to collectible levels. Recoveries on loans charged-off are restored to the allowance for loan losses. Allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, is deemed to be uncollectible. Additions to the allowance for loan losses may be made when Service1st’s management has identified significant adverse conditions or circumstances related to a specific loan.
 
As of December 31, 2010, Service1st’s allowance for loan losses was $36,000 representing 0.03% of total loans. We give no assurance that the allowance for loan losses is adequate to cover all losses that may be realized in the future and we give no assurance that additional provisions for loan losses will not be required.
 
Non-performing Assets
 
As a result of the continuing weakness in the Las Vegas economy and real estate markets, Service1st experienced deterioration in the quality of its loan portfolio in 2008, 2009, and 2010. Non-performing assets were 5.4% of total assets at year-end 2010. Service1st generally stops accruing income on loans when interest or principal payments are in arrears for 90 days, or earlier if management deems appropriate. Service1st designates loans on which it stops accruing income as nonaccrual loans and reverses previously accrued interest income on such loans. Nonaccrual loans are returned to accrual status when factors indicating doubtful collection no longer exist and the loan is brought current.
 
If a borrower fails to make a scheduled payment on a loan, Service1st attempts to remedy the deficiency by contacting the borrower and seeking payment. Service1st’s Problem Loan Committee, consisting of its Chief Executive Officer, and the Chief Credit Officer, is responsible for monitoring activity that may indicate increased risk rating, such as past-dues, overdrafts and loan agreement covenant defaults.


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The following table summarizes nonperforming assets by category including PCI loans with no contractual interest being reported. These figures represent loan values after fair value process completed at October 28, 2010, adjusted for any amortization or accretion for the two months, if applicable.
 
         
($’s in thousands)   At December 31, 2010  
 
Nonaccrual loans:
       
Loans secured by real estate construction, land development and other land loans
  $ 2,632  
Commercial real estate
    1,224  
Residential real estate (1-4 family)
    2,900  
         
Total loans secured by real estate
    6,756  
Commercial and industrial
    3,670  
Consumer
    0  
         
Total non-accrual loans
    10,426  
Past due (>90 days) loans and accruing interest:
       
Loans secured by real estate construction, land development and other land loans
  $ 0  
Commercial real estate
    0  
Residential real estate (1-4 family)
    0  
         
Total loans secured by real estate
    0  
Commercial and industrial
    0  
Consumer
    0  
         
Total past due loans accruing interest
    0  
Restructure loans (still on accrual)
    0  
         
Total non-performing loans
  $ 10,426  
Other real estate owned (OREO)
    3,406  
         
Total non-performing assets
  $ 13,832  
         
Non-performing loans as a percentage of total portfolio loans
    9.81 %
Non-performing loans as a percentage of total assets
    4.05 %
Non-performing assets as a percentage of total assets
    5.37 %
Allowance for loan losses as a percentage of non-performing loans
    0.35 %
 
 
(1) As of December 31, 2010 there were no originations from October 28, 2010 through December 31, 2010 that were considered non-performing.
 
Investment Activities
 
Service1st’s investment policy dictates that investment decisions be made based on the safety of the investment, liquidity requirements, potential returns, cash flow targets, and consistency with Service1st’s interest rate risk management policies. Service1st’s Chief Financial Officer is responsible for making security portfolio decisions in accordance with established policies. The Chief Financial Officer has the authority to purchase and sell securities within specified guidelines established by the investment policy.
 
Service1st’s investment policy allows for investment in:
 
  •  cash and cash equivalents, which consists of cash and amounts due from banks, federal funds sold and certificates of deposits with original maturities of three months or less,
 
  •  longer term investment securities issued by companies rated “A” or better,


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  •  securities backed by the full faith and credit of the U.S. government, including U.S. government agency securities,
 
  •  direct obligations of Ginnie Mae,
 
  •  mortgage-backed securities or collateralized mortgage obligations issued by a government-sponsored enterprise such as Fannie Mae, Freddie Mac, or Ginnie Mae, and
 
  •  mandatory purchases of equity securities from the Federal Home Loan Bank.
 
The carrying value of the investment securities portfolio of Service1st Bank as of the end of 2010 is as follows:
 
                                 
    At December 31, 2010  
          Gross
    Gross
       
    Amortized
    Unrealized
    Unrealized
       
Securities Available for Sale   Cost     Gains     Losses     Fair Value  
 
Collateralized Mortgage Obligation Securities-Commercial
  $ 1,819     $ 0     $ 0     $ 1,819  
                                 
    $ 1,819     $ 0     $ 0     $ 1,819  
                                 
 
                                 
    At December 31, 2010  
          Gross
    Gross
       
    Amortized
    Unrecognized
    Unrecognized
       
Securities Held to Maturity   Cost     Gains     Losses     Fair Value  
 
Corporate Debt Securities
  $ 4,663     $ 0     $ (27 )   $ 4,636  
SBA Loans Pools
    651       0       0       651  
                                 
    $ 5,314     $ 0     $ (27 )   $ 5,287  
                                 
 
Service1st does not plan to purchase collateralized debt obligations, adjustable rate preferred securities, or private label collateralized mortgage obligations. The bank’s policies also govern the use of derivatives, allowing Service1st to prudently use derivatives as a risk management tool to reduce its overall exposure to interest rate risk, and not for speculative purposes.
 
Service1st’s investment securities are classified as “available-for-sale” or “held-to-maturity.” Available-for-sale securities are reported at fair value in accordance with generally accepted accounting principles, with unrealized gains and losses excluded from earnings and instead reported as a separate component of stockholders’ equity. Held-to-maturity securities are those securities that Service1st has both the intent and the ability to hold to maturity. These securities are carried at cost, adjusted for amortization of premiums and accretion of discounts.
 
As of December 31, 2010 Service1st also held $658,400 of Federal Home Loan Bank of San Francisco stock, which is a restricted security. Federal Home Loan Bank (“FHLB”) stock represents an equity interest in the FHLB of San Francisco, but the stock does not have a readily determinable market value. The stock can be sold at its par value only and solely to the FHLB or to another member institution. Member institutions are required to maintain a minimum stock investment in the FHLB, based on total assets, total mortgages, and total mortgage-backed securities. Service1st’s minimum investment in FHLB stock at December 31, 2010 was approximately $658,000.
 
Deposits products and other banking services
 
Service1st offers a variety of traditional demand, savings and time deposit accounts to individuals, professionals and businesses within the Nevada region, including checking accounts, interest-bearing checking accounts, traditional savings accounts, money market accounts, and time deposits, including Certificates of Deposit over/under $100,000 and our Freedom CD, a flexible, liquid certificate of deposit product that permits customers to deposit or withdraw funds, subject to certain restrictions, without penalty before the end of the CD term. Service1st’s deposit base is generated from the Nevada area. Competition for these deposits in


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Service1st’s market is strong. Service1st seeks to structure its deposit products to be competitive with the rates, fees, and features offered by other local institutions, but with an emphasis on customer service and relationship-based pricing. As of December 31, 2010, total deposits were $160.3 million. The weighted average cost of Service1st’s interest-bearing deposits was 0.75% for the year ended December 31, 2010.
 
In addition to traditional commercial banking activities, Service1st provides other financial and related services to its customers, including online banking, direct deposits, direct debit and electronic bill payment, wire transfers, lock box services, merchant-related services such as point of sale payment processing, courier service, safe deposit boxes, cash management services such as account reconciliation, collections, and sweep accounts, corporate and consumer credit cards, night depository, cashier’s checks, and notary services.
 
The balances on deposits for the year ended December 31, 2010 are presented below.
 
                 
    At December 31, 2010  
($’s in thousands)   Amount     % of total  
 
Non-interest bearing deposits
  $ 67,087       41.85 %
Interest bearing deposits
    31,837       19.86 %
Money markets
    24,672       15.39 %
Savings
    1,273       0.79 %
Time deposits under $100,000
    4,919       3.07 %
Time deposits $100,000 and over
    30,498       19.03 %
                 
Total deposits
  $ 160,286       100.00 %
                 
 
The following table shows the amount of time deposits of $100,000 or more as of December 31, 2010, including certificates of deposit, by time remaining until maturity.
 
Certificates of Deposit Maturities >$100 thousand
 
         
($’s in thousands)   December 31, 2010  
 
Three months or less
  $ 1,671  
Over three months to six months
    3,504  
Over six months to twelve months
    25,323  
Over 12 months
    0  
         
Total
  $ 30,498  
         
 
Employees
 
We have approximately 40 full-time equivalent, non-union employees at December 31, 2010.
 
Supervision and Regulation
 
The following summary of Federal and state laws governing the supervision and regulation of bank holding companies and banks is not comprehensive. The summary is qualified in its entirety by reference to applicable statutes and regulations.
 
Holding companies
 
We have sought and received approval of the Federal Reserve Board (the “Federal Reserve”) to become a bank holding company under the Bank Holding Company Act of 1956. Bank holding companies are subject to extensive regulation, supervision, and examination by the Federal Reserve, acting principally through its local Federal Reserve Bank.
 
A bank holding company must serve as a source of financial and managerial strength for its subsidiary banks and must not conduct its operations in an unsafe or unsound manner. The Federal Reserve requires bank


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holding companies to maintain capital at or above certain prescribed levels. It is the Federal Reserve’s policy that a bank holding company should provide capital to its subsidiary banks during periods of financial stress or adversity and maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting subsidiary banks. Bank holding companies may also be required to give written notice to and receive approval from the Federal Reserve before purchasing or redeeming common stock or other equity securities.
 
Under Bank Holding Company Act section 5(e), the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary if the Federal Reserve determines that the activity or control constitutes a serious risk to the financial safety, soundness, or stability of a subsidiary bank. Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 addition of the prompt corrective action provisions to the Federal Deposit Insurance Act, section 38(f)(2)(I) of the Federal Deposit Insurance Act now provides that a federal bank regulatory authority may require a bank holding company to divest itself of an undercapitalized bank subsidiary if the agency determines that divestiture will improve the bank’s financial condition and prospects.
 
A bank holding company must obtain Federal Reserve approval to:
 
  •  acquire ownership or control of any voting shares of another bank or bank holding company, if after the acquisition the acquiring company would own or control more than 5% of the shares of the other bank or bank holding company (unless the acquiring company already owns or controls a majority of the shares),
 
  •  acquire all or substantially all of the assets of another bank, or
 
  •  merge or consolidate with another bank holding company.
 
The Federal Reserve will not approve an acquisition, merger, or consolidation that would have a substantially anticompetitive result unless the anticompetitive effects of the proposed transaction are clearly outweighed by a greater public interest in satisfying the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial factors in its review of acquisitions and mergers, as well as the parties’ performance under the Community Reinvestment Act of 1977.
 
With certain exceptions, the Bank Holding Company Act prohibits a bank holding company from acquiring or retaining ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company or from engaging in activities other than banking, managing or controlling banks, or providing services for holding company subsidiaries. The principal exceptions to these prohibitions involve non-bank activities identified by statute, by Federal Reserve regulation, or by Federal Reserve order as activities so closely related to the business of banking or of managing or controlling banks as to be a proper incident thereto, including securities brokerage services, investment advisory services, fiduciary services, and management advisory and data processing services, among others. A bank holding company that also qualifies as and elects to become a “financial holding company” may engage in a broader range of activities that are financial in nature (and complementary to such activities), specifically non-bank activities identified by the Gramm-Leach-Bliley Act of 1999 or by Federal Reserve and Treasury regulation as financial in nature or incidental to a financial activity. Activities that are defined as financial in nature include securities underwriting, dealing, and market making, sponsoring mutual funds and investment companies, engaging in insurance underwriting and agency activities, and making merchant banking investments in non- financial companies. To become and remain a financial holding company, a bank holding company and its subsidiary banks must be well capitalized, well managed, and, except in limited circumstances, have at least a satisfactory rating under the Community Reinvestment Act. If, after becoming a financial holding company and undertaking activities not permissible for a bank holding company, the company fails to satisfy the standards for financial holding company status, the company must enter into an agreement with the Federal Reserve to comply with all applicable capital and management requirements. If the company does not return to compliance within 180 days, the Federal Reserve may order the company to divest its subsidiary bank or banks or the company may discontinue the activities that are permissible solely for a financial holding company.


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The Bank Holding Company Act, the Change in Bank Control Act of 1978, and the Federal Reserve’s Regulation Y require that advance notice be given to the Federal Reserve or that affirmative approval of the Federal Reserve be obtained to acquire control of a bank or bank holding company, with limited exceptions. The Federal Reserve may act during the advance notice period to prevent the acquisition of control. Subject to guidance issued by the Federal Reserve in September 2008, control is conclusively presumed to exist if a person or entity acquires 25% or more of any class of voting stock of a bank holding company or insured depository institution. Control is rebuttably presumed to exist if a person or entity acquires 10% or more but less than 25% of the voting stock and either the issuer has a class of securities registered under section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”), as we do, or no other person or entity will own, control, or hold the power to vote a greater percentage of voting stock immediately after the transaction. In its September 2008 guidance, the Federal Reserve stated that generally it will be able to conclude that an investor does not have a controlling influence over a bank or bank holding company if the investor does not own more than 15% of the voting power and 33% of the total equity of the bank or bank holding company, including nonvoting equity securities. The investor may, however, be required to make passivity commitments to the Federal Reserve, promising to refrain from taking various actions that might constitute exercise of a controlling influence. Under prior Federal Reserve guidance, a board seat was generally not permitted for an investment of 10% or more of the equity or voting power. But under the September 2008 guidance, the Federal Reserve may permit a non-controlling investor to have a board seat.
 
We are also subject to examination by and may be required to file reports with the Nevada FID under sections 666.065 et seq. of the Nevada Revised Statutes. We would have to obtain the approval of the Nevada Commissioner of Financial Institutions to acquire another bank, and any transfer of control of a Nevada bank holding company would have to be approved in advance by the Nevada Commissioner.
 
Banks
 
Service1st is chartered by the State of Nevada and is therefore subject to regulation, supervision, and examination not only by the FDIC but also by the Nevada FID. Federal and state statutes governing the business of banking and insurance of bank deposits as well as implementing regulations promulgated by the Federal and state banking regulatory agencies cover most aspects of bank operations, including capital requirements, reserve requirements against deposits, reserves for possible loan losses and other contingencies, dividends and other distributions to stockholders, customers’ interests in deposit accounts, payment of interest on certain deposits, permissible activities and investments, securities that a bank may issue and borrowings that a bank may incur, rate of growth, number and location of branch offices, and acquisition and merger activity with other financial institutions. In addition to minimum capital requirements, Federal law imposes other safety and soundness standards having to do with such things as internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, and compensation and benefits.
 
If, as a result of examination the FDIC determines that a bank’s 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 in violation of any law or regulation, the FDIC may take a number of remedial actions. Federal bank regulatory agencies make regular use of their authority to bring enforcement actions against banks and bank holding companies for unsafe or unsound practices in the conduct of their businesses and for violations of any law, rule or regulation, any condition imposed in writing by the appropriate federal banking regulatory authority or any written agreement with the authority. Possible enforcement actions include appointment of a conservator or receiver, issuance of a cease-and-desist order that could be judicially enforced, termination of a bank’s deposit insurance, imposition of civil money penalties, issuance of directives to increase capital, issuance of formal and informal agreements, including memoranda of understanding, issuance of removal and prohibition orders against institution-affiliated parties, and enforcement of such actions through injunctions or restraining orders. In addition, a bank holding company’s inability to serve as a source of strength for its subsidiary banks could serve as an additional basis for a regulatory action against the bank holding company. Under Nevada Revised Statutes section 661.085, if the stockholders’ equity of a Nevada-chartered bank becomes impaired, the Nevada Commissioner must require the bank to make the


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impairment good within three months. If the impairment is not made good, the Nevada Commissioner may take possession of the bank and liquidate it.
 
Capital: Regulatory capital guidelines
 
A bank’s capital hedges its risk exposure, absorbing losses that can be predicted as well as losses that cannot be predicted. According to the Federal Financial Institutions Examination Council’s explanation of the capital component of the Uniform Financial Institutions Rating System, commonly known as the “CAMELS” rating system, a rating system employed by the Federal bank regulatory agencies, a financial institution must “maintain capital commensurate with the nature and extent of risks to the institution and the ability of management to identify, measure, monitor, and control these risks. The effect of credit, market, and other risks on the institution’s financial condition should be considered when evaluating the adequacy of capital.” The minimum ratio of total capital to risk-weighted assets is 8.0%, of which at least 4.0% must consist of so-called Tier 1 capital. The minimum Tier 1 leverage ratio — Tier 1 capital to average assets — is 3.0% for the highest rated institutions and at least 4.0% for all others. These ratios are absolute minimums. In practice, banks are expected to operate with more than the absolute minimum capital. As of December 31, 2010, Service1st’s total risk-based capital ratio was 31.0%, its Tier 1 risk-based capital ratio was 30.6%, and its Tier 1 equity to average assets ratio was 18.1%. The FDIC may establish greater minimum capital requirements for specific institutions, as discussed below. A bank that does not achieve and maintain the required capital levels may be issued a capital directive by the FDIC to ensure the maintenance of required capital levels. The Federal Reserve imposes substantially similar capital requirements on bank holding companies as well.
 
Tier 1 capital consists of common stock, retained earnings, non-cumulative perpetual preferred stock, trust preferred securities up to a certain limit, and minority interests in certain subsidiaries, less most other intangible assets. Tier 2 capital consists of preferred stock not qualifying as Tier 1 capital, limited amounts of subordinated debt, other qualifying term debt, a limited amount of the allowance for loan and lease losses, and certain other instruments that have some characteristics of equity. To determine risk-weighted assets, the nominal dollar amounts of assets on the balance sheet and credit-equivalent amounts of off-balance-sheet items are multiplied by one of several risk adjustment percentages ranging from 0.0% for assets considered to have low credit risk, such as cash and certain U.S. government securities, to 100.0% for assets with relatively higher credit risk, such as business loans, and a 200% risk-weight for selected investments that are rated below investment grade or, if not rated, that are equivalent to investments rated below investment grade. A banking organization’s risk-based capital ratios are obtained by dividing its Tier 1 capital and total qualifying capital (Tier 1 capital and a limited amount of Tier 2 capital) by its total risk-adjusted assets.
 
During the application process for the Acquisition we made a written commitment to the FDIC that we will maintain the Tier 1 leverage capital ratio of Service1st at 10% or greater. This commitment will expire three years after the October 28, 2010 completion of the Acquisition or, if later, when the September 1, 2010 Consent Order agreed to by Service1st with the FDIC and the Nevada FID terminates.
 
Prompt corrective action
 
To resolve the problems of undercapitalized institutions and to prevent a recurrence of the banking crisis of the late 1980s and early 1990s, the Federal Deposit Insurance Corporation Improvement Act of 1991 established a system known as “prompt corrective action.” Under the prompt corrective action provisions and implementing regulations, every institution is classified into one of five categories, depending on its total risk-based capital ratio, its Tier 1 risk-based capital ratio, its leverage ratio, and subjective factors. The categories are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” To be considered well capitalized for purposes of the prompt corrective action rules, a bank must maintain total risk-based capital of 10.0% or greater, Tier 1 risk-based capital of 6.0% or greater, and leverage capital of 5.0% or greater. An institution with a capital level that might qualify for well-capitalized or adequately capitalized status may nevertheless be treated as though it were in the next lower capital category if its primary federal banking supervisory authority determines that an unsafe or unsound condition or practice warrants that treatment. Notwithstanding that Service1st’s capital ratios make the bank


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eligible to be considered “well capitalized” on the basis of capital ratios, the FDIC by letter dated July 29, 2010, advised Service1st that imposition of the Consent Order effective September 1, 2010, would result in the institution being considered “adequately capitalized” for prompt corrective action purposes.
 
A financial institution’s operations can be significantly affected by its capital classification under the prompt corrective action rules. For example, an institution that is not well capitalized generally is prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market without advance regulatory approval, which can have an adverse effect on the bank’s liquidity. At each successively lower capital category, an insured depository institution is subject to additional restrictions. Undercapitalized institutions are required to take specified actions to increase their capital or otherwise decrease the risks to the federal deposit insurance funds. A bank holding company must guarantee that a subsidiary bank that adopts a capital restoration plan will satisfy its plan obligations. Any capital loans made by a bank holding company to a subsidiary bank are subordinated to the claims of depositors in the bank and to certain other indebtedness of the subsidiary bank. If bankruptcy of a bank holding company occurs, any commitment by the bank holding company to a Federal banking regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and would be entitled to priority of payment. Bank regulatory agencies generally are required to appoint a receiver or conservator shortly after an institution becomes critically undercapitalized.
 
Deposit insurance
 
Bank deposits are insured by the FDIC to applicable limits through the Deposit Insurance Fund. Insured banks must pay deposit insurance premiums assessed semiannually and paid quarterly. The insurance premium amount is based upon a risk classification system established by the FDIC. Banks with higher levels of capital and a low degree of supervisory concern are assessed premiums at a lower rate than banks with lower levels of capital or a higher degree of supervisory concern. Effective January 1, 2009, the FDIC increased assessment rates uniformly for all risk categories by 7 cents for the first quarter 2009 assessment period. In 2009, the FDIC adopted a rule that imposed a special assessment on banks, which was payable in September 2009, and that allowed the FDIC to impose additional special assessments to replenish the Deposit Insurance Fund, which was badly depleted by bank failures. As an alternative to imposing additional special assessments on insured depository institutions or borrowing from the U.S. Treasury, on November 12, 2009, the FDIC adopted a proposal to increase deposit insurance assessments effective on January 1, 2011 and to require all insured depository institutions to prepay by the end of 2009 their deposit insurance assessments for the fourth quarter of 2009 and for the entirety of 2010 through 2012. Institutions recorded the prepaid FDIC insurance assessments as an asset as of December 31, 2009, later charging the assessments to expense in the periods to which the assessments apply. We anticipate that assessment rates will continue to increase for the foreseeable future because of the significant cost of bank failures, because of the relatively large number of troubled banks, and because of the requirement of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act that the FDIC increase its insurance fund reserves to no less than $1.35 for each $100 of insured deposits (as of September 30, 2010, the reserve fund was negative $0.15 for each $100 of insured deposits). Effective as of April 1, 2011, the FDIC changed its assessment base from total domestic deposits to average total assets minus average tangible equity, as required in the Dodd-Frank Wall Street Reform and Consumer Protection Act. The FDIC intends to raise the same expected revenue under the new base as under the current assessment base.
 
During a December 14, 2010 meeting of the FDIC board, the FDIC voted on a final rule to set the deposit insurance fund’s designated reserve ratio at 2% of estimated insured deposits effective January 1, 2011. The FDIC said a historical analysis of losses to the insurance fund showed that a long-term, minimum goal of at least 2% is necessary to maintain a positive fund balance and stable assessment rates. The Federal Deposit Insurance Act requires the FDIC board to set the designated reserve ratio annually based on the risk of loss to the insurance fund and the economic conditions affecting the banking industry, and with the aim of preventing sharp swings in assessment rates.


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The $100,000 basic deposit insurance limit in place for many years was increased temporarily to $250,000 by the Emergency Economic Stabilization Act of 2008, which became law on October 3, 2008. On July 21, 2010, section 335 of the Dodd-Frank Act made the $250,000 insurance limit permanent.
 
Dividends and distributions
 
We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings for future growth and do not anticipate paying any cash dividends for the foreseeable future. Any determination in the future to pay dividends will be at the discretion of our board of directors and will depend on our earnings, financial condition, results of operations, business prospects, capital requirements, regulatory restrictions, contractual restrictions and other factors that the board of directors may deem relevant.
 
A bank holding company’s ability to pay dividends is subject to Federal Reserve supervisory authority, taking into account the bank holding company’s capital position, its ability to satisfy its financial obligations as they come due, and its capacity to act as a source of financial strength to its subsidiaries. In addition, Federal Reserve policy discourages the payment of dividends by a bank holding company if the dividends are not supported by current operating earnings. Federal Reserve and FDIC policy statements provide that banks should generally pay dividends solely out of current operating earnings. A bank may not pay a dividend if the bank is undercapitalized or if payment would cause the bank to become undercapitalized.
 
A bank holding company may not purchase or redeem its equity securities without advance written approval of the Federal Reserve under Federal Reserve Rule 225.4(b) if the purchase or redemption combined with all other purchases and redemptions by the bank holding company during the preceding 12 months equals or exceeds 10% of the bank holding company’s consolidated net worth. However, advance approval is not necessary if the bank holding company is well managed, not the subject of any unresolved supervisory issues, and both before and immediately after the purchase or redemption is well capitalized.
 
Under sections 661.235 and 661.240 of the Nevada Revised Statutes, a Nevada-chartered bank, such as Service1st, whose deposits are insured by the FDIC may not make distributions (including dividends) to or for the benefit of its stockholders if the distributions would reduce the bank’s stockholders’ equity below the bank’s initial stockholders’ equity. Pursuant to Nevada Revised Statutes section 78.288(2), which applies to Nevada corporations generally, including Service1st, a corporation may not make distributions (including dividends) to or for the benefit of its stockholders if, after giving effect to the distribution, the corporation would be unable to pay its debts as they become due in the usual course of business, or the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed to satisfy the preferential rights (if any) upon dissolution of stockholders whose preferential rights are superior to those receiving the distribution (unless the corporation’s articles of incorporation override this latter limitation, which Service1st’s articles do not). Relying on 12 U.S.C. 1818(b), the FDIC may restrict a bank’s ability to pay a dividend if the FDIC has reasonable cause to believe that the dividend would constitute an unsafe and unsound practice. A bank’s ability to pay dividends may be affected also by the FDIC’s capital maintenance requirements and prompt corrective action rules.
 
Transactions with affiliates
 
Transactions by a bank with an affiliate, including a holding company, are subject to restrictions imposed by Federal Reserve Act sections 23A and 23B and implementing regulations, which are intended to protect banks from abuse in financial transactions with affiliates, preventing federally insured deposits from being diverted to support the activities of unregulated entities engaged in nonbanking businesses. Affiliate-transaction limits could impair our ability to obtain funds from our bank subsidiary for our cash needs, including funds for payment of dividends, interest, and operational expenses. Affiliate transactions include but are not limited to extensions of credit to affiliates, investments in securities issued by affiliates, the use of affiliates’ securities


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as collateral for loans to any borrower, and purchase of affiliate assets. Generally, section 23A and section 23B of the Federal Reserve Act:
 
  •  limit the extent to which a bank or its subsidiaries may lend to or engage in various other kinds of transactions with any one affiliate to an amount equal to 10% of the institution’s capital and surplus, limiting the aggregate of covered transactions with all affiliates to 20% of capital and surplus,
 
  •  impose strict collateral requirements on loans or extensions of credit by a bank to an affiliate,
 
  •  impose restrictions on investments by a subsidiary bank in the stock or securities of its holding company,
 
  •  impose restrictions on the use of a holding company’s stock as collateral for loans by the subsidiary bank, and
 
  •  require that affiliate transactions be on terms substantially the same as those provided to a non-affiliate.
 
Loans to insiders
 
Service1st’s authority to extend credit to insiders — meaning executive officers, directors and greater than 10% stockholders — or to entities those persons control, is subject to section 22(g) and section 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve. Among other things, these laws require insider loans to be made on terms substantially similar to those offered to unaffiliated individuals, place limits on the amount of loans a bank may make to insiders based in part on the bank’s capital position, and require that specified approval procedures be adhered to by the bank. Loans to an individual insider may not exceed the Federal legal limit on loans to any one borrower, which in general terms is 15% of capital but can be higher in some circumstances. The aggregate of all loans to all insiders may not exceed the bank’s unimpaired capital and surplus. Insider loans exceeding the greater of 5% of capital or $25,000 must be approved in advance by a majority of the board, with any interested director not participating in such voting by the board. Executive officers may borrow in unlimited amounts to finance their children’s education or to finance the purchase or improvement of their residence, but they may borrow no more than $100,000 for most other purposes. Loans to executive officers exceeding $100,000 may be allowed if the loan is fully secured by government securities or a segregated deposit account. A violation of these restrictions could result in the assessment of substantial civil monetary penalties, the imposition of a cease-and-desist order or other regulatory sanctions.
 
Loans to one borrower
 
Under section 662.145 of the Nevada Revised Statutes, a Nevada-chartered bank’s outstanding loans to one person generally may not exceed 25% of the bank’s Tier 1 capital plus allowance for loan losses. Loans by a bank to parties that have certain relationships with a particular borrower and certain investments by a bank in the securities of a particular borrower may be aggregated with the bank’s loans to that borrower for purposes of applying this 25% limit.
 
Guidance concerning commercial real estate lending
 
In December 2006, the FDIC and other Federal banking agencies issued final guidance on sound risk management practices for concentrations in commercial real estate lending, including acquisition and development lending, construction lending, and other land loans, which recent experience in Nevada and elsewhere has shown can be particularly high-risk lending. According to a 2009 FDIC publication, a majority of the community banks that became problem banks or failed in 2008 had similar risk profiles: the banks often had extremely high concentrations, relative to their capital, in residential acquisition, development, and construction lending, loan underwriting and credit administration functions at these institutions typically were criticized by examiners, and many of the institutions had exhibited rapid asset growth funded with brokered deposits.
 
The guidance does not establish rigid limits on commercial real estate lending but does create a much sharper supervisory focus on the risk management practices of banks with concentrations in commercial real estate lending. According to the guidance, an institution that has experienced rapid growth in commercial real


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estate lending, has notable exposure to a specific type of commercial real estate, or is approaching or exceeds the following supervisory criteria may be identified for further supervisory analysis of the level and nature of its commercial real estate concentration risk:
 
  •  total reported loans for construction, land development, and other land represent 100% or more of the institution’s total capital, or
 
  •  total commercial real estate loans represent 300% or more of the institution’s total capital and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more during the prior 36 months.
 
These measures are intended merely to enable the banking agencies to identify institutions that could have an excessive commercial real estate lending concentration, potentially requiring close supervision to ensure that the institutions have sound risk management practices in place.
 
Guidance concerning subprime lending
 
In 2007 the FDIC and other Federal banking agencies issued final guidance on subprime mortgage lending to address issues relating to certain subprime mortgages, especially adjustable-rate mortgage products that can cause payment shock. The subprime guidance identified prudent safety and soundness and consumer protection standards that the regulators expect banks and financial institutions to follow to ensure borrowers obtain loans they can afford to repay.
 
Guidance concerning newly organized banks
 
The FDIC issued supervisory guidance on August 28, 2009 extending from three years to seven the period in which newly organized institutions are subject to enhanced supervision. The FDIC extended the period of enhanced supervision beyond three years because banks in their first seven years of operation were over-represented among banks that failed in 2008 and 2009. Service1st commenced operations in January, 2007. The expansion of the supervisory period includes subjecting young banks to higher capital requirements and more frequent examinations over seven years. A bank subject to the expanded supervisory period is not permitted to deviate materially from the bank’s approved business plan without first obtaining the FDIC’s approval. As a condition to obtaining FDIC approval of the Acquisition, we agreed to give the FDIC notice at least 60 days in advance for any major deviation from the business plan that we submitted to the FDIC during the acquisition application process and not to deviate from the business plan unless we receive written non-objection from the FDIC. We also assured the FDIC in writing during the application process that we will not seek to expand by acquisition until Service1st is restored to a satisfactory condition, which at a minimum means that the September 1, 2010 Consent Order must first be terminated. Until that occurs, any growth on Service1st’s part must be the result of organic growth in the bank’s existing business. This commitment will expire three years after the Acquisition of Service1st or, if later, when the September 1, 2010 Consent Order agreed to by Service1st with the FDIC and the Nevada Financial Institution Division terminates.
 
Interstate banking and branching
 
Section 613 of the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in July 2010 amends the interstate branching provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. These expanded de novo branching authority amendments will authorize a state or national bank to open a de novo branch in another state if the law of the state where the branch is to be located would permit a state bank chartered by that state to open the branch. Under prior law, an out-of-state bank could open a de novo branch in another state only if the particular state permitted out-of-state banks to establish a de novo branch. In section 607, the Dodd-Frank Act also increases the approval threshold for interstate bank acquisitions, requiring that a bank holding company be well capitalized and well managed as a condition to approval of an interstate bank acquisition, rather than being merely adequately capitalized and adequately managed, and that an acquiring bank be and remain well capitalized and well managed as a condition to approval of an interstate bank merger.


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Consumer protection laws and regulations
 
Service1st is subject to regular examination by the FDIC to ensure compliance with statutes and regulations applicable to the bank’s business, including consumer protection statutes and implementing regulations, some of which are discussed below. Violations of any of these laws may result in fines, reimbursements, and other related penalties.
 
Community Reinvestment Act
 
The Community Reinvestment Act of 1977 is intended to encourage insured depository institutions to satisfy the credit needs of their communities, within the limits of safe and sound lending. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions, nor does the Community Reinvestment Act limit an institution’s discretion to develop the types of products and services management believes are best suited to the bank’s particular community. The Act requires that bank regulatory agencies conduct regular Community Reinvestment Act examinations and provide written evaluations of institutions’ Community Reinvestment Act performance. The Act also requires that an institution’s Community Reinvestment Act performance rating be made public. Community Reinvestment Act performance evaluations are based on a four-tiered rating system: Outstanding, Satisfactory, Needs to Improve and Substantial Noncompliance. Community Reinvestment Act performance evaluations are used principally in the evaluation of regulatory applications submitted by an institution. Performance evaluations are considered in evaluating applications for such things as mergers, acquisitions, and applications to open branches. According to its CRA Performance Evaluation dated March 18, 2009, Service1st was rated Satisfactory.
 
Equal Credit Opportunity Act
 
The Equal Credit Opportunity Act generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.
 
Truth in Lending Act
 
The Truth in Lending Act is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the Truth in Lending Act, all creditors must use the same credit terminology to express rates and payments, including the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule, among other things.
 
Fair Housing Act
 
The Fair Housing Act makes it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap, or familial status. A number of lending practices have been held by the courts to be illegal under the Fair Housing Act, including some practices that are not specifically mentioned in the Federal Housing Act.
 
Home Mortgage Disclosure Act
 
The Home Mortgage Disclosure Act arose out of public concern over credit shortages in certain urban neighborhoods. The Home Mortgage Disclosure Act requires financial institutions to collect data that enable regulatory agencies to determine whether the financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The Home Mortgage Disclosure Act also requires the collection and disclosure of data about applicant and borrower characteristics as a way to identify possible discriminatory lending patterns. The vast amount of information that financial institutions collect and disclose concerning applicants and borrowers receives attention not only from state and Federal banking supervisory authorities but also from community-oriented organizations and the general public.


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Real Estate Settlement Procedures Act
 
The Real Estate Settlement Procedures Act requires that lenders provide borrowers with disclosures regarding the nature and cost of real estate settlements. The Real Estate Settlement Procedures Act also prohibits abusive practices that increase borrowers’ costs, such as kickbacks and fee-splitting without providing settlement services.
 
Privacy
 
Under the Gramm-Leach-Bliley Act, all financial institutions are required to establish policies and procedures to restrict the sharing of non-public customer data with non-affiliated parties and to protect customer data from unauthorized access. In addition, the Fair Credit Reporting Act of 1971 includes many provisions concerning national credit reporting standards and permits consumers to opt out of information-sharing for marketing purposes among affiliated companies.
 
Predatory lending
 
What is commonly referred to as predatory typically involves one or more of the following elements :
 
  •  making unaffordable loans based on a borrower’s assets rather than the consumer’s ability to repay an obligation,
 
  •  inducing a consumer to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced, or loan flipping, and
 
  •  engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated consumer.
 
The Home Ownership and Equity Protection Act of 1994 and implementing regulations adopted by the Federal Reserve require specified disclosures and extend additional protection to consumers in closed-end consumer credit transactions, such as home repairs or renovation, that are secured by a mortgage on the borrower’s primary residence. The disclosures and protections are applicable to “high cost” transactions with any of the following features -
 
  •  interest rates for first lien mortgage loans more than eight percentage points above the yield on U.S. Treasury securities having a comparable maturity,
 
  •  interest rates for subordinate lien mortgage loans more than 10 percentage points above the yield on U.S. Treasury securities having a comparable maturity, or
 
  •  total points and fees paid in the credit transaction exceed the greater of either 8% of the loan amount or a specified dollar amount that is inflation-adjusted each year.
 
The Home Ownership and Equity Protection Act prohibits or restricts numerous credit practices, including loan flipping by the same lender or loan servicer within a year of the residential mortgage loan being refinanced. Lenders are presumed to have violated the law unless they document that the borrower has the ability to repay. Lenders that violate the rules face cancellation of loans and penalties equal to the finance charges paid. The Home Ownership and Equity Protection Act also governs so-called “reverse mortgages.” In January 2008, the Federal Reserve issued final rules under the Home Ownership and Equity Protection Act to address practices in the subprime mortgage market before the onset of the Great Recession. The rules require disclosures and additional protections or prohibitions on certain practices connected with “higher-priced mortgages,” which the rules define as closed-end mortgage loans that are secured by a consumer’s principal dwelling and that have an annual percentage rate that exceeds the average prime offer rates for a comparable transaction published by the Federal Reserve Board by at least 1.5 percentage points for first-lien loans, or 3.5 percentage points for subordinate-lien loans. The Federal Reserve derives average prime offer rates from the Freddie Mac Primary Mortgage Market Survey®. For higher-priced mortgage loans, the final rules:
 
  •  Prohibit creditors from extending credit without regard to a consumer’s ability to repay from sources other than the collateral itself,


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  •  Require creditors to verify income and assets relied upon to determine repayment ability,
 
  •  Prohibit prepayment penalties except under certain conditions, and
 
  •  Require creditors to establish escrow accounts for taxes and insurance in the case of first-lien higher-priced mortgage loans, but permit creditors to allow borrowers to cancel escrows 12 months after loan consummation.
 
Corporate governance and accounting legislation
 
The Sarbanes-Oxley Act of 2002 was adopted to enhance corporate responsibility, increase penalties for accounting and auditing improprieties at publicly traded companies, and protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act of 2002 applies generally to all companies that file or are required to file periodic reports with the Securities and Exchange Commission (the “SEC”) under the Exchange Act, including WLBC. Under the Sarbanes-Oxley Act, the SEC and securities exchanges adopted extensive additional disclosure, corporate governance and other related rules. Among its many provisions, the Sarbanes-Oxley Act subjects bonuses issued to top executives to disgorgement if a subsequent restatement of a company’s financial statements was due to corporate misconduct, prohibits an officer or director from misleading or coercing an auditor, prohibits insider trades during pension fund “blackout periods,” imposes new criminal penalties for fraud and other wrongful acts, and extends the period during which securities fraud lawsuits can be brought against a company or its officers.
 
Anti-money laundering and anti-terrorism legislation
 
The Bank Secrecy Act of 1970 requires financial institutions to maintain records and report transactions to prevent the financial institutions from being used to hide money derived from criminal activity and tax evasion. The Bank Secrecy Act establishes (a) record keeping requirements to assist government enforcement agencies with tracing financial transactions and flow of funds, (b) reporting requirements for Suspicious Activity Reports and Currency Transaction Reports to assist government enforcement agencies with detecting patterns of criminal activity, (c) enforcement provisions authorizing criminal and civil penalties for illegal activities and violations of the Bank Secrecy Act and its implementing regulations, and (d) safe harbor provisions that protect financial institutions from civil liability for their cooperative efforts.
 
Title III of the USA PATRIOT Act of 2001 added anti-terrorist financing provisions to the requirements of the Bank Secrecy Act and its implementing regulations. Among other things, the USA PATRIOT Act requires all financial institutions, including subsidiary banks and non-banking affiliates, to institute and maintain a risk-based anti-money laundering compliance program that includes a customer identification program, provides for information sharing with law enforcement and between certain financial institutions by means of an exemption from the privacy provisions of the Gramm-Leach-Bliley Act, prohibits U.S. banks and broker-dealers from maintaining accounts with foreign “shell” banks, establishes due diligence and enhanced due diligence requirements for certain foreign correspondent banking and foreign private banking accounts, and imposes additional record keeping requirements for certain correspondent banking arrangements. The USA PATRIOT Act also grants broad authority to the Secretary of the Treasury to take actions to combat money laundering. Federal bank regulators are required to evaluate the effectiveness of a financial institution’s efforts to combat money laundering when evaluating an application submitted by the financial institution.
 
The Treasury’s Office of Foreign Asset Control administers and enforces economic and trade sanctions against targeted foreign countries, entities, and individuals based on U.S. foreign policy and national security goals. As a result, financial institutions must scrutinize transactions to ensure that they do not represent obligations of or ownership interests in entities owned or controlled by sanctioned targets.
 
Monetary policy
 
The earnings of financial institutions are affected by the policies of regulatory authorities, including monetary policy of the Federal Reserve. An important function of the Federal Reserve is regulation of


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aggregate national credit and money supply. The Federal Reserve accomplishes these goals with measures such as open market transactions in securities, establishment of the discount rate on bank borrowings, and changes in reserve requirements against bank deposits. These methods are used in varying combinations to influence overall growth and distribution of financial institutions’ loans, investments and deposits, and they also affect interest rates charged on loans or paid on deposits. Monetary policy is influenced by many factors, including inflation, unemployment, short-term and long-term changes in the international trade balance, and fiscal policies of the United States government. Federal Reserve monetary policy has had and will continue to have a significant effect on the operating results of financial institutions.
 
Developments affecting management and corporate governance
 
In June of 2010, the Federal banking agencies jointly published their final Guidance on Sound Incentive Compensation Policies. The goal is to enable financial organizations to manage the safety and soundness risks of incentive compensation arrangements and to assist banks and bank holding companies with identification of improperly-structured compensation arrangements. To ensure that incentive compensation arrangements do not encourage employees to take excessive risks that undermine safety and soundness, the incentive compensation guidance sets forth these key principles:
 
  •  incentive compensation arrangements should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose the organization to imprudent risk,
 
  •  these arrangements should be compatible with effective controls and risk management, and
 
  •  these arrangements should be supported by strong corporate governance, including active and effective oversight by the board of directors.
 
To implement the interagency guidance, a financial organization must regularly review incentive compensation arrangements for all executive and non-executive employees who, either individually or as part of a group, have the ability to expose the organization to material amounts of risk, as well as to review the risk-management, control, and corporate governance processes related to these arrangements. The organization must immediately address any identified deficiencies in compensation arrangements or processes that are inconsistent with safety and soundness and must ensure that incentive compensation arrangements are consistent with the principles discussed in the guidance.
 
In addition to numerous provisions that affect the business of banks and bank holding companies, the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act includes in Title IX a number of provisions affecting corporate governance and executive compensation, for example the requirements that stockholders be given the opportunity to consider and vote upon executive compensation disclosed in a company’s annual meeting proxy statement, that a company’s compensation committee be comprised entirely of independent directors and that the committee have stated minimum authorities, that annual meeting proxy statements disclose the ratio of CEO compensation to the median compensation of all other employees, that company policy provide for recovery of excess incentive compensation after an accounting restatement, and that stockholders have the ability to designate director nominees for inclusion in a company’s annual meeting proxy statement. Section 956 also provides for adoption of incentive compensation guidelines jointly by the Federal banking agencies and the SEC, the National Credit Union Administration, and the Federal Housing Finance Agency. Due for adoption by the end of April 2011, the guidelines could be different from the Guidance on Sound Incentive Compensation Policies adopted by the Federal bank regulators in June of 2010. The new guidelines adopted under Dodd-Frank Act section 956 could impose additional compliance burdens beyond those already imposed by the Federal bank regulatory agency guidelines adopted in June of 2010.
 
Finally, during the application process for the acquisition of Service1st, we made a written commitment to the FDIC that we will make no change in the directors or executive management of Service1st unless we first receive the FDIC’s non-objection to the proposed change. This commitment will expire three years after the October 28, 2010 completion of the acquisition of Service1st or, if later, when the September 1, 2010 Consent Order agreed to by Service1st with the FDIC and the Nevada FID terminates.


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Recent initiatives
 
Enacted on October 3, 2008, the Emergency Economic Stabilization Act of 2008 created the Troubled Asset Relief Program (“TARP”), giving the U.S. Treasury Department authority to purchase and insure certain types of troubled assets. One component of TARP is a generally available capital access program known as the Capital Purchase Program under which a financial institution may issue preferred shares and warrants to purchase shares of its common stock to the Treasury. The goal of the Capital Purchase Program was to help stabilize the financial system as a whole and ensure the availability of credit necessary for the country’s economic recovery. Service1st is not a participant in the Capital Purchase Program. Enacted on February 17, 2009, the American Recovery and Reinvestment Act of 2009 includes numerous economic stimulus provisions and makes more restrictive the executive compensation limits applicable to Capital Purchase Program participants.
 
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act became law. The Dodd-Frank Act is a landmark financial reform bill, changing the current bank regulatory structure and affecting the lending, investment, trading, and operating activities of financial institutions and holding companies. Implementation of the Dodd-Frank Act will require new mandatory and discretionary rulemakings by numerous Federal regulatory agencies. The Dodd-Frank Act includes the following provisions:
 
  •  section 111 establishes a new Financial Stability Oversight Counsel to monitor systemic financial risks. The Board of Governors of the Federal Reserve is given extensive new authorities to impose strict controls on large bank holding companies with total consolidated assets equal to or in excess of $50 billion and systemically significant non-bank financial companies to limit the risk they might pose for the economy and to other large interconnected companies. The Dodd-Frank Act also grants to the Treasury Department, FDIC and the FRB broad new powers to seize, close and wind-down “too big to fail” financial institutions (including non-bank institutions) in an orderly fashion.
 
  •  Title X establishes a new independent Federal regulatory body within the Federal Reserve System that is dedicated exclusively to consumer protection. Known as the Bureau of Consumer Financial Protection, this new regulatory body will assume responsibility for most consumer protection laws, with rulemaking, supervisory, examination, and enforcement authority. It will also be in charge of setting appropriate consumer banking fees and caps. According to Dodd-Frank Act section 1025, the new regulatory body has examination and enforcement authority over banks with more than $10 billion in assets, but section 1026 makes clear that banks with assets of $10 billion or less will continue to be examined by their bank regulators for consumer law compliance. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the Consumer Financial Protection Bureau. Although our bank does not currently offer many of these consumer products or services, compliance with any such new regulations would increase our cost of operations and, as a result, could limit our ability to expand into these products and services,
 
  •  section 171 restricts the amount of trust preferred securities that may be considered Tier 1 capital. For depository institution holding companies with total assets of less than $15 billion, trust preferred securities issued before May 19, 2010 may continue to be included in Tier 1 capital, but future issuances of trust preferred securities will no longer be eligible for treatment as Tier 1 capital, and
 
  •  under section 334 the FDIC’s minimum reserve ratio is to be increased from 1.15% to 1.35%, with the goal of attaining that 1.35% level by September 30, 2020; however, financial institutions with assets of less than $10 billion, including Service1st, are to be exempt from the cost of the increase. FDIC insurance coverage of up to $250,000 for deposit accounts is made permanent by section 335, section 343 extends until January 1, 2013 unlimited FDIC insurance for non-interest-bearing demand deposit accounts, more commonly known as checking accounts, and section 627 repeals the longstanding prohibition against financial institutions paying interest on checking accounts.
 
  •  Section 331 changes the way deposit insurance premiums are calculated by the FDIC as well. That is, deposit insurance premiums are calculated based upon an institution’s so-called assessment base. Until


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  the Dodd-Frank Act became law, the assessment base consisted of an institution’s deposit liabilities. Section 331, however, makes clear that the assessment base shall now be the difference between total assets and tangible equity, so in other words the assessment base will take account of all liabilities, not merely deposit liabilities. This change is likely to have a greater impact on large banks, which tend to rely on a variety of funding sources, than on smaller community banks, which tend to rely primarily on deposit funding:
 
  •  the Office of the Comptroller of the Currency’s ability to preempt state consumer protection laws is constrained by section 1044, and because of section 1042 state attorneys general have greater authority to enforce state consumer protection laws against national banks and their operating subsidiaries,
 
  •  section 619 embodies the so-called “Volcker rule,” prohibiting a banking entity from engaging in proprietary trading or from sponsoring or investing in a hedge fund or private equity fund, and
 
  •  imposing a 5% risk retention requirement on securitizers of asset-backed securities, section 941 could have an impact on financial institutions that originate mortgages for sale into the secondary market. Like other provisions of the Dodd-Frank Act, the scope and impact of section 941 will be determined by future rulemaking.
 
We are evaluating the potential impact of the Dodd-Frank Act on our business, financial condition, results of operations, and prospects. The Dodd-Frank Act could affect the profitability of community banking, require changes in the business practices of community banking organizations, lead to more stringent capital and liquidity requirements, and otherwise adversely affect the community banking business. However, because much of the Dodd-Frank Act will be phased in over time and will not become effective until Federal agency rulemaking initiatives are completed, we cannot predict with confidence precisely how the Dodd-Frank Act will affect community banking organizations. We are confident, however, that short- and long-term compliance costs for all financial organizations, both large and small, will be greater because of the Dodd-Frank Act.
 
Item 1A — Risk Factors
 
As a newly formed public bank holding company, we will incur significant legal, accounting, compliance and other expenses.
 
As a newly formed public bank holding company, we will incur significant legal, accounting and other expenses. For example, we are required to prepare and file quarterly, annual and current reports with the SEC, as well as comply with a myriad of rules applicable to public companies, such as the proxy rules, beneficial ownership reporting requirements and other obligations. In addition, the Sarbanes-Oxley Act of 2002 and the rules implemented by the SEC in response to that legislation have required significant changes in corporate governance practices of public companies. While we have had to comply with such rules and regulations in the past, we expect these rules and regulations to significantly affect legal and financial compliance, and to make some activities more time-consuming and costly.
 
Additionally, as a newly formed bank holding company, we are required to prepare supplemental qualitative disclosure regarding our assets and operations as set forth in Article 9 of Regulation S-X and Industry Guide No. 3, which includes information such as portfolio loan composition, yield, costs, loan terms, maturities, re-pricing characteristics, credit ratings and risk elements such as non-accrual and past due items, which will add to our legal and compliance costs going forward.
 
As the provider of financial services, our business and earnings are significantly affected by general business and economic conditions, particularly in the real estate industry, and accordingly, our business and earnings could be further harmed in the event of a continuation or deepening of the current U.S. recession or further market deterioration or disruption.
 
The global and U.S. economies and the local economies in the Nevada market, where substantially all of our loan portfolio was originated, experienced a steep decline beginning in 2007, which has continued throughout 2010. The financial markets and the financial services industry in particular suffered unprecedented disruption, causing many financial institutions to fail or require government intervention to avoid failure.


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These conditions were largely the result of the erosion of the U.S. and global credit markets, including a significant and rapid deterioration of the mortgage lending and related real estate markets. We give you no assurance that economic conditions that have adversely affected the financial services industry and the capital, credit, and real estate markets generally, will improve in the near term.
 
Our business and earnings are sensitive to general business, economic and market conditions in the United States. These conditions include changes in short-term and long-term interest rates, inflation, deflation, fluctuation in the real estate and debt capital markets, developments in national and regional economies and changes in government policies and regulations.
 
Our business and earnings are particularly sensitive to economic and market conditions affecting the real estate industry because a large portion of our loan portfolio consists of commercial real estate and construction loans. Real estate values have been declining in Nevada, steeply in some cases, which has affected collateral values and has resulted in increased provisions for loan losses for Nevada banks.
 
While generally containing lower risk than unsecured loans, commercial real estate and construction loans generally involve a high degree of credit risk. Such loans also generally involve larger individual loan balances. In addition, real estate construction loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because many real estate construction borrowers’ ability to repay their loans is dependent on successful development of their properties, as well as the factors affecting residential real estate borrowers. Risk of loss on a construction loan depends largely upon whether the initial estimate of the property’s value at completion of construction equals or exceeds the cost of property construction (including interest), the ability of the borrowers to stabilize leasing or rental income to qualify for permanent financing and the availability of permanent take-out financing, itself a market we believe that is largely non-existent at present. During the construction phase, a number of factors can result in delays and cost overruns. Construction and commercial real estate loans also involve greater risk because they may not be fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower’s ability to make a balloon payment may depend on the borrower being able to refinance the loan, timely sell the underlying property or liquidate other assets.
 
The current U.S. recession has resulted in a reduction in the value of many of the real estate assets securing a large portion of our loans. Any increase in the number of delinquencies or defaults would result in higher levels of nonperforming assets, net charge-offs and provisions for loan losses, adversely affecting our results of operations and financial condition.
 
Our geographic concentration is tied to business, economic and regulatory conditions in Nevada.
 
Unfavorable business, economic or regulatory conditions in Nevada, where we conduct the substantial majority of our business, could have a significant adverse impact on our business, financial condition and results of operations. In addition, because our business is concentrated in Nevada, and substantially all our loan portfolio originated from Nevada, we could also be adversely affected by any material change in Nevada law or regulation and may be exposed to economic and regulatory risks that are greater than the risks we would face if the business were spread more evenly by geographic region.
 
Furthermore, the recent decline in Nevada in the value of real estate assets and local business revenues, particularly in the gaming and hospitality industries, could continue and will likely have a significant adverse impact on business, financial conditions and results of operations. There can be no assurance that the real estate market or local industry revenues will not continue to decline. Further erosion in asset values in Nevada could impact our existing loans and could make it difficult for us to find attractive alternatives to deploy our capital, impeding our ability to grow our business.
 
The Las Vegas market is substantially dependent on gaming and tourism revenue, and the downturn in the gaming and tourism industries has indirectly had an adverse impact on Nevada banks.
 
The economy of the Las Vegas area is unique in the United States for its level of dependence on services and industries related to gaming and tourism. Regardless of whether a Nevada bank has substantial customer


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relationships in the gaming and tourism industries, a downturn in the Nevada economy adversely affects the bank’s customers, resulting in an increase in loan delinquencies and foreclosures, a reduction in the demand for products and services, and a reduction of the value of collateral for loans, with an associated adverse impact on the bank’s business, financial condition, results of operations, and prospects.
 
An event or state of affairs that adversely affects the gaming or tourism industry adversely impacts the Las Vegas economy generally. Gaming and tourism revenue is particularly vulnerable to fluctuations in the economy. Virtually any development or event that dissuades travel or spending related to gaming and tourism adversely affects the Las Vegas economy. The Las Vegas economy is more susceptible than the economies of many other cities to such issues as higher gasoline and other fuel prices, increased airfares, unemployment levels, recession, rising interest rates, and other economic conditions, whether domestic or foreign. Gaming and tourism are also susceptible to political conditions or events, such as military hostilities and acts of terrorism, whether domestic or foreign. In addition, Las Vegas competes with other areas of the country and other parts of the world for gaming revenue, and it is possible that the expansion of gaming operations in other states, such as California, and other countries would significantly reduce gaming revenue in the Las Vegas area.
 
The soundness of other financial institutions with which we do business could adversely affect us.
 
The financial services industry and the securities markets have been materially adversely affected by significant declines in values of almost all asset classes and by extreme lack of liquidity in the capital and credit markets. Financial institutions specifically have been subject to increased volatility and an overall loss in investor confidence. Financial institutions are interrelated as a result of trading, clearing, counterparty, investment, or other relationships, including loan participations, derivatives, and hedging transactions and investments in securities or loans originated or issued by financial institutions or supported by the loans they originate. Many of these transactions expose a financial institution to credit or investment risk arising out of default by the counterparty. In addition, a bank’s credit risk may be exacerbated if the collateral the bank holds cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or other exposure. These circumstances could lead to impairments or write-downs in a bank’s securities portfolio and periodic gains or losses on other investments under mark-to-market accounting treatment. We could incur additional losses to our securities portfolio in the future as a result of these issues. These types of losses could have a material adverse effect on our business, financial condition or results of operation. Furthermore, if we are unable to ascertain the credit quality of certain potential counterparties, we may not pursue otherwise attractive opportunities and we may be unable to effectively grow our business.
 
Our earnings may be significantly affected by the fiscal and monetary policies of the federal government and its agencies.
 
The Federal Reserve regulates the supply of money and credit in the United States. Federal Reserve policies determine in large part cost of funds for lending and investing and the return earned on those loans and investments, both of which impact net interest margin, and can materially affect the value of financial instruments, such as debt securities. Its policies can also affect borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in Federal Reserve policies will be beyond our control and difficult to predict or anticipate. To the extent that changes in Federal Reserve policies have a disproportionate effect on our cost of funding or on the health of our borrowers, such changes could materially affect our operating results.
 
If there was a depletion of the FDIC’s Deposit Insurance Fund, the FDIC could impose additional assessments on the banking industry.
 
If there was a depletion of the FDIC’s Deposit Insurance Fund, we believe that the FDIC would impose additional assessments on the banking industry. In such case, our profitability would be reduced by any special assessments from the FDIC to replenish the Deposit Insurance Fund. Please see the discussion in the section entitled “Supervision and Regulation — Deposit Insurance.”


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The financial services industry is heavily regulated by federal and state agencies.
 
Federal and state regulation is to protect depositors, federal deposit insurance funds and the banking system as a whole, not security holders. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the business going forward in substantial and unpredictable ways including limiting the types of financial services and products we may offer and/or increasing the ability of nonbanks to offer competing financial services and products. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies and damage to our reputation. For further discussion of applicable regulations, please see the section entitled “Supervision and Regulation.”
 
We operate in a highly regulated environment and changes in the laws and regulations that govern our operations, changes in the accounting principles that are applicable to us, and our failure to comply with the foregoing, may adversely affect us.
 
We are subject to extensive regulation, supervision, and legislation that governs almost all aspects of our operations. See the section entitled “Supervision and Regulation.” The laws and regulations applicable to the banking industry could change at any time and are primarily intended for the protection of customers, depositors, and the deposit insurance funds, not stockholders. Changes in these laws or in applicable accounting principles could make it more difficult and expensive for us to comply with laws, regulations, or accounting principles and could affect the way we conduct business.
 
Moreover, the United States, state, and foreign governments have taken extraordinary actions to deal with the worldwide financial crisis and the severe decline in the global economy. Many of these actions have been in effect for only a limited time and have produced limited or no relief to the capital, credit, and real estate markets. We cannot assure you that these actions or other actions under consideration will ultimately be successful. Although we cannot reliably predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors and stockholders. Compliance with the initiatives may increase our costs and limit our ability to pursue business opportunities.
 
Any current or future litigation, regulatory investigations, proceedings, inquiries or changes could have a significant impact on the financial services industry.
 
The financial services industry has experienced unprecedented market value declines caused primarily by the current U.S. recession and real estate market deterioration. As a result of the current market perceptions of stockholder advocacy groups as well as the current U.S. Administration in Washington, D.C., litigation, proceedings, inquiries or regulatory changes are all distinct possibilities for financial institutions. Such actions or changes could result in significant costs. Because we are a relatively new financial institution, any costs and/or burdens imposed by such actions or changes could affect us disproportionately from how they affect our competitors.
 
The removal or reduction in stimulus activities sponsored by the Federal Government and its agents may have a negative impact on Service1st’s results and operations.
 
The Federal Government has intervened in an unprecedented manner to stimulate economic growth. Some of these activities have included the following:
 
  •  Target fed funds rates which have remained close to zero percent;
 
  •  Mortgage rates that have remained at historical lows in part due to the Federal Reserve Bank of New York’s $1.25 trillion mortgage-backed securities purchase program;


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  •  Bank funding that has remained stable through an increase in FDIC deposit insurance to a covered limit of $250,000 per account from the previous coverage limit of $100,000; and
 
  •  Housing demand that has been stimulated by homebuyer tax credits.
 
The expiration or rescission of any of these programs may have an adverse impact on Service1st’s operating results by increasing interest rates, increasing the cost of funding, and reducing the demand for loan products, including mortgage loans.
 
Current market volatility and industry developments may adversely affect business and financial results.
 
The volatility in the capital and credit markets along with the housing declines during the last few years has resulted in significant pressure on the financial services industry. If current volatility and market conditions continue or worsen, there can be no assurance that the financial services industry, results of operations or the business will not continue to be significantly adversely impacted. We may have further increases in loan losses, deterioration of capital or limitations on their access to funding or capital, if needed.
 
Further, if other financial institutions fail to be adequately capitalized or funded, it may negatively impact business and financial results. In the past, we have routinely interacted with numerous financial institutions in the ordinary course of business and have therefore been exposed to operational and credit risk to those institutions. Failures of such institutions may significantly adversely impact our operations going forward.
 
Strategies to manage interest rate risk may yield results other than those anticipated.
 
Changes in the interest rate environment are difficult to predict. Net interest margins can expand or contract, and this can significantly impact overall earnings. Changes in interest rates can also adversely affect the application of critical management estimates, their projected returns on investments, as well as the determination of fair values of certain assets. We have certain assets and liabilities with fixed interest rates. Unexpected and dramatic changes in interest rates may materially impact our operating results.
 
Negative public opinion could damage our reputation and adversely impact our business and revenues.
 
Financial institutions’ earnings and capital are subject to risks associated with negative public opinion. Negative public opinion could result from actual, alleged or perceived conduct in any number of activities, including lending practices, the failure of any product or service to meet customers’ expectations or applicable regulatory requirements, corporate governance, acquisitions, as a defendant in litigation, or from actions taken by government regulators or community organizations. Negative public opinion could adversely affect our ability to attract and/or retain customers and can expose us to litigation or regulatory action. We are highly dependent on our customer relationships. Any negative perception of us which impacted our customer relationships could materially affect our business prospects by reducing our deposit base.
 
Material breaches in security of Service1st’s systems may have a significant effect on Service1st’s business.
 
Service1st collects, processes and stores sensitive consumer data by utilizing computer systems and telecommunications networks operated by both Service1st and third party service providers. Service1st has security, backup and recovery systems in place, as well as a business continuity plan to ensure the system will not be inoperable. Service1st also has security to prevent unauthorized access to the system. In addition, Service1st requires its third party service providers to maintain similar controls. However, Service1st cannot be certain that the measure will be successful. A security breach in the system and loss of confidential information could result in losing the customers’ confidence and thus the loss of their business as well as additional significant costs for privacy monitoring activities.
 
Service1st’s necessary dependence upon automated systems to record and process its transaction volume poses the risk that technical system flaws or employee errors, tampering or manipulation of those systems will result in losses and may be difficult to detect. Service1st may also be subject to disruptions of its operating systems arising from events that are beyond its control (for example, computer viruses or electrical or


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telecommunications outages). Service1st is further exposed to the risk that its third party service providers may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors as Service1st). These disruptions may interfere with service to Service1st’s customers and result in a financial loss or liability.
 
Changes in interest rates could adversely affect our profitability, business and prospects.
 
Most of the assets and liabilities of a bank holding company are monetary in nature, exposed to significant risks from changes in interest rates that can affect net income and the valuation of assets and liabilities. Increases or decreases in prevailing interest rates could have an adverse effect on our business, asset quality, and prospects. Our operating income and net income will depend to a great extent on our net interest margin, the difference between the interest yields we receive on loans, securities, and other interest-earning assets and the interest rates we pay on interest-bearing deposits, borrowings, and other liabilities. These rates are highly sensitive to many factors beyond our control, including competition, general economic conditions, and monetary and fiscal policies of various governmental and regulatory authorities, including the Federal Reserve. If the rate of interest we pay on interest-bearing deposits, borrowings, and other liabilities increases more than the rate of interest we receive on loans, securities, and other interest-earning assets, our net interest income and therefore our earnings could be adversely affected. Our earnings could also be adversely affected if the rates on our loans and other investments fall more quickly than those on our deposits and other liabilities.
 
In addition, loan volumes are affected by market interest rates on loans. Rising interest rates generally are associated with a lower volume of loan originations while lower interest rates are usually associated with increased loan originations. Conversely, in rising interest rate environments, loan repayment rates decline and in a falling interest rate environment loan repayment rates increase. We cannot assure you that we will be able to minimize our risk exposure to changing interest rates. In addition, an increase in the general level of interest rates may adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations.
 
Interest rates also affect how much money we can lend. When rates rise, the cost of borrowing increases. Accordingly, changes in market interest rates could materially and adversely affect our net interest spread, asset quality, loan origination volume, business, financial condition, results of operations, and cash flows.
 
Increasing our existing market share may depend on market acceptance and regulatory approval of new products and services.
 
Our ability to increase our market share will depend, in part, on our ability to create and adapt products and services to evolving industry standards. There is increasing pressure on financial services companies to provide products and services at lower prices. This can reduce net interest margin and revenues from fee-based products and services. In addition, the widespread adoption of new technologies, including internet-based services, could require us to make substantial expenditures to modify or adapt our existing products and services. We may not successfully introduce new products and services, achieve market acceptance of products and services and/or be able to develop and maintain loyal customers. As a condition to obtaining FDIC approval for Western Liberty Bancorp to acquire Service1st Bank of Nevada, Western Liberty agreed during the first three years of operation that Service1st Bank would not make any major deviation or material change to the business plan submitted as part of Western Liberty Bancorp’s application to acquire Service1st Bank of Nevada. Until such time as the FDIC terminates the September 1, 2010 Consent Order, we believe the FDIC will be reluctant to permit the bank to make a major deviation or material change in the FDIC-approved business plan unless the proposed change to the FDIC-approved business plan would lower the risk profile of the bank. The application approval condition prohibiting a material change to the FDIC-approved business plan may limit the bank’s ability to introduce new products or services until the FDIC terminates the Consent Order. See the Risk Factor disclosure captioned “Bank regulatory restrictions with the FDIC and the Nevada Financial Institutions Division are likely to limit growth and new product development that were not in the business plan approved by bank regulators at the time Western Liberty Bancorp was approved to acquire Service1st Bank of Nevada.”


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The historical financial information included in this Form 10-K is not necessarily indicative of our future performance.
 
The historical financial information included in this Form 10-K is not necessarily indicative of future financial position, results of operations and cash flows. The results of future periods may be different as a result of, among other things, the additional costs associated with being a public bank holding company and the pace of growth of our business in the future, which is likely to differ from the historical growth reflected in the financial information presented herein.
 
Service1st has experienced significant losses since it began operations in January of 2007. There is no assurance that it will become profitable.
 
Service1st commenced operations as a commercial bank on January 16, 2007, with initial capital of $50.0 million. Since inception, Service1st has not been profitable. To some extent, the lack of profitability is attributable to the start-up nature of its business; time is required to build assets sufficient to generate enough interest income to cover operating expenses. However, in addition to the customary challenges of building profitability for a start-up bank, Service1st has experienced deterioration in the quality of its loan portfolio, largely as a result of the challenging economic conditions in the Nevada market during the last two years. As a result, Service1st experienced losses of $4.2 million in 2007, $5.1 million in 2008, $17.4 million in 2009 and $8.7 million through October 28, 2010.
 
We have incurred certain transitional expenses that are relatively large in proportion to the scale of our operations. In addition, we have no earnings history and there is no guarantee that we will ever be profitable or be able to successfully implement an effective business model. In order for Service1st to become profitable, we believe that we will need to attract a larger amount of deposits and a larger portfolio of loans than Service1st currently has. We must avoid further deterioration in Service1st’s loan portfolio and increase the amount of its performing loans so that the combination of Service1st’s net interest income and non-interest income, after deduction of its provision for loan losses, exceeds Service1st’s non-interest expense. The source of the majority of Service1st’s loan losses can be traced primarily to real estate loans that were reliant on continuation of a growing and prosperous economic environment. Beginning in early to mid-2008, increased emphasis on underwriting standards and risk selection was introduced, which effectively discontinued the making of construction, land development, other land loans and any other loans in which the primary source of repayment was subject to greater risk than our current standards would require (such as repayment from proceeds from sales, rentals, leases or refinancing, including permanent take out financing) or based upon projections, unless such loans were accompanied by additional financial support from the borrowers or guarantors. Service1st’s future profitability may also be dependent on numerous other factors, including the success of the Nevada economy and favorable government regulation. The Nevada economy has experienced a significant decline in recent years due to the current economic climate. This economy, in which substantially all of Service1st’s loans have been made, continues to exhibit weakness, and there can be no assurance that further material losses will not be experienced in the portfolio. Continued deterioration of the national and/or local economies, adverse government regulation or our inability to grow our business could affect our ability to become profitable. If this happens, there continues to be a risk that we will not operate on a profitable basis in the near or long term, and Service1st may never become profitable.
 
Further deterioration in the quality of our loan portfolio may result in additional charge-offs which will adversely affect our operating results.
 
During the last two years, Service1st suffered from a deterioration in the quality of its loan portfolio. The depressed economic conditions in Nevada which contributed significantly to this deterioration are expected to continue throughout 2011. As of December 31, 2010, performing loans that are classified as potential problem loans constituted approximately 11.7% of total loans. See the section entitled “Management’s Discussion & Analysis of Service1st Bank of Nevada — Financial Condition.”
 
A significant source of risk arises from the possibility that the Company could sustain losses because borrowers, guarantors, and related parties may fail to perform in accordance with the terms of their loans. This


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risk is normally addressed by means of an allowance for loan losses in the amount of management’s estimate of losses inherent in Service1st’s loan portfolio. As explained in Note 1. “Nature of Business and Summary of Significant Accounting Policies” to the Consolidated Financial Statements, the Company was required under generally accepted accounting principles to estimate the fair value of its loan portfolio after the close of business on October 28, 2010 (the “Transaction Date”) and write the loan portfolio down to that fair value estimate. For most loans, this meant computing the net present value of estimated cash flows to be received from borrowers. The allowance for loan and lease losses that had been maintained as an estimate of losses inherent in the loan portfolio was eliminated in this accounting. A new allowance for loan and lease losses will be established for loans made subsequent to the Transaction Date and for any subsequent lowering of the estimate of cash flows to be received from the loans held by Service1st that had shown evidence of credit deterioration since origination.
 
The estimate of fair value as of the Transaction Date was based on economic conditions at the time and on management’s projections regarding both future economic conditions and the ability of Service1st’s borrowers to continue to repay their loans. However, the estimate of fair value may prove to be overly optimistic and Service1st may suffer losses in excess of those estimated as of that date. The allowance for loan and lease losses established for new loans or for revised estimates may prove to be inadequate to cover actual losses, especially if economic conditions worsen.
 
While management believes that both the estimate of fair value and the allowance for loan and lease losses are adequate to cover current losses, no underwriting and credit monitoring policies and procedures that Service1st could adopt to address credit risk could provide complete assurance that there will not be unexpected losses. These losses could have a material adverse effect on the Company’s business, financial condition, results of operations and cash flows. In addition, the FDIC periodically evaluates the adequacy of Service1st’s allowance for loan losses and may require Service1st to increase its provision for loan losses or recognize further loan charge-offs based on judgments different from those of management.
 
A substantial portion of our loan portfolio consists of loans maturing within one year, and there is no guarantee that these loans will be replaced upon maturity or renewed on the same terms or at all.
 
As of December 31, 2010, approximately 31.00% of Service1st’s loan portfolio consists of loans maturing within one year. As a result, we will either need to renew or replace these loans during the course of the year. There is no guarantee that these loans will be originated or renewed by borrowers on the same terms or at all, as demand for such loans may decrease. Furthermore, there is no guarantee that borrowers will qualify for new loans or that existing loans will be renewed by us on the same terms or at all, as collateral values may be insufficient or the borrowers’ cash flow maybe materially less than when the loan originated. This could result in a significant decline in the performance of our loan portfolio.
 
We rely upon independent appraisals to determine the value of the real estate which secures a significant portion of Service1st’s loans, and the values indicated by such appraisals may not be realizable if we are forced to foreclose upon such loans.
 
A significant portion of Service1st’s loan portfolio consists of loans secured by real estate. As of December 31, 2010, approximately 66.04% of Service1st’s loans were secured by real estate. We rely upon independent appraisers to estimate the value of the real estate which secures Service1st’s loans. Appraisals may reflect the estimated value of the collateral on an “as-is” basis, an “as-stabilized” basis or an “as-if-developed” basis, depending upon the loan type and collateral. Raw land generally is appraised at its “as-is” value. Income producing property may be appraised at its “as-stabilized” value, which takes into account the anticipated cash flow of the property based upon expected occupancy rates and other factors. The collateral securing construction loans may be appraised at its “as-if-developed” value, which approximates the post-construction value of the collateralized property assuming that such property is developed. “As-if-developed” values on construction loans often exceed the immediate sales value and may include anticipated zoning changes, and successful development by the purchaser.


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Appraisals are only estimates of value and the independent appraisers may make mistakes of fact or judgment which adversely affect the reliability of their appraisal. In addition, events occurring after the initial appraisal may cause the value of the real estate to decrease. With respect to appraisals conducted on an “as-if-developed” basis, if a loan goes into default prior to development of a project, the market value of the property may be substantially less than the “as-if-developed” appraised value. As a result of any of these factors, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the outstanding balance of the loan.
 
We currently are not permitted to expand by acquisition
 
During the application process for the acquisition of Service1st by WLBC, we made a number of commitments to the FDIC. We assured the FDIC in writing during the application process that we will not seek to expand by acquisition until Service1st is restored to a satisfactory condition, which at a minimum means that the September 1, 2010 Consent Order between the FDIC and the bank must first be terminated. Until that occurs, any growth on Service1st’s part must be the result of organic growth in the bank’s existing business. Prior to the acquisition of Service1st, Western Liberty had announced an intended business strategy of using Service1st as the platform to grow through acquisition of failed banks. By committing to the FDIC that Western Liberty would only acquire Service1st with the immediate and near-term plans to restore Service1st to a safe and sound, and profitable, institution, growth through acquisition of failed banks was excluded from the application terms that the FDIC approved. Although these growth restrictions limit our opportunities currently, such restrictions typically would not survive a future acquisition, assuming the acquirer is a well-established banking organization considered by Federal and state bank regulatory agencies to be well capitalized and well managed.
 
Bank regulatory restrictions with the FDIC and the Nevada Financial Institutions Division are likely to limit growth and new product development that were not in the business plan approved by bank regulators at the time Western Liberty Bancorp was approved to acquire Service1st Bank of Nevada.
 
As a condition to securing bank regulatory approval from the FDIC and the Nevada Financial Institutions Division to acquire Service1st Bank, we also agreed to seek advance approval both from the FDIC and the Nevada Financial Institutions Division for any major deviation from the Service1st Bank three year business plan that we submitted during the acquisition application process.
 
The Service1st Bank three year business plan approved by the FDIC and the Nevada Financial Institutions Division provides for modest loan growth funded by core deposits and Federal Home Loan Bank borrowing. Any growth in Service1st that occurs is expected to be the result of organic growth within the bank’s existing market and its existing business profile, without reliance on strategies such as acquisitions, branch additions, brokered deposits, above-market-rate deposit pricing, or significant expansion of the bank’s market or the bank’s product and service offerings. Service1st is and will remain primarily a business bank, with a target market of professionals and small and medium-sized businesses in southern Nevada principally and potentially elsewhere as well. Service1st has and will continue to have a significant concentration in commercial real estate lending, with significant construction and land development lending and commercial and industrial lending as well and, to a much lesser degree, consumer lending. To manage the risks of commercial real estate lending, we anticipate that an increasing percentage of Service1st commercial real estate lending concentration will come to be represented by owner-occupied properties and less so by non-owner-occupied commercial real estate investment properties. Until the FDIC’s September 1, 2010 Consent Order is terminated, we believe the FDIC and the Nevada Financial Institutions Division are unlikely to agree to a major deviation or material change in our approved business plan unless the major deviation would reduce the risk profile o f the bank. As a result, we may not be able to implement new business initiatives, and our ability to grow may be inhibited.
 
In addition to the application approval condition that we would not make any material change in the approved three year business plan, Service1st Bank is subject to special supervisory conditions applicable to newly chartered (so called, “de novo”) banks for a probationary period of seven years. During such probationary period, we are required to operate within the parameters of a business plan submitted to the FDIC (an amended version of which was most recently submitted during application processing for the acquisition


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of Service1st), and to provide the FDIC 60 days’ advance notice of any proposed material change or material deviation from the business plan, before making any such change or deviation. During the seven-year de novo period, we will remain on a 12-month risk management examination cycle. Consequently, we will be under a high degree of regulatory scrutiny, at least through January, 2014, and proposed new business initiatives not included in the business plan submitted to the FDIC will require prior FDIC approval.
 
As a commitment made to the FDIC during acquisition application processing, we also agreed to maintain the Tier 1 leverage capital ratio of Service1st at 10% or greater until October 28, 2013 or, if later, when the September 1, 2010 Consent Order agreed to by Service1st with the FDIC and the Nevada Financial Institutions Division terminates. We also agreed that for that same time period we will make no change in the directors or executive management of Service1st unless we first receive the FDIC’s non-objection to the proposed change.
 
Service1st is subject to regulatory restrictions, including a Consent Order, that restricts its operations, affect its ability to obtain regulatory approval for future initiatives requiring such approval and to hire and retain qualified senior management.
 
In May of 2009, Service1st entered into a Memorandum of Understanding (“MOU”) with the FDIC and the Nevada FID. Pursuant to the MOU, Service1st agreed, among other initiatives, to develop and submit a comprehensive strategic plan covering at least a three-year operating period; to reduce the level of adversely classified assets and review loan grading criteria and procedures to ensure accurate risk ratings; to develop a plan to strengthen credit administration of construction and land loans (including the reduction of concentration limits in land, construction and development loans and the improvement of stress testing of commercial real estate loan concentrations); to review its methodology for determining the adequacy of the allowance for loan and lease losses; and to correct apparent violations listed in its most recent report of examination.
 
In addition, since mid-2009, Service1st has been required (i) to provide the FDIC with at least 30 days’ prior notice before appointing any new director or senior executive officer or changing the responsibilities of any senior executive officer; and (ii) to obtain FDIC approval before making (or agreeing to make) any severance payments (except pursuant to a qualified pension or retirement plan and certain other employee benefit plans). The FDIC is likely to use the prior notice requirement in practice as a means of objecting to the appointment of new directors or senior executives (or changes in the responsibilities of senior executives) it deems not qualified for the positions sought (or to changes in the responsibilities of senior executives it deems not qualified for the new responsibilities proposed). These regulatory requirements could make it more difficult for us to retain and hire qualified senior management. These regulatory restrictions will remain in effect until modified or terminated by the regulators.
 
On September 1, 2010, Service1st, without admitting or denying any possible charges relating to the conduct of its banking operations, agreed with the FDIC and the Nevada FID to the issuance of a Consent Order. The Consent Order supersedes the MOU. Under the Consent Order, Service1st has agreed, among other things, to: (i) assess the qualification of, and have retained qualified, senior management commensurate with the size and risk profile of Service1st; (ii) maintain a Tier I leverage ratio at or above 8.5% (as of December 31, 2010, Service1st’s Tier I leverage ratio was at 18.1%) and a total risk-based capital ratio at or above 12% (as of December 31, 2010, Service1st’s total risk-based capital ratio was at 31.0%); (iii) continue to maintain an adequate allowance for loan and lease losses; (iv) not pay any dividends without prior bank regulatory approval; (v) formulate and implement a plan to reduce Service1st’s risk exposure to adversely classified assets; (vi) not extend additional credit to any borrower whose loan has been charged-off or classified “loss”; (vii) not extend any additional credit to any borrower whose loan has been classified as “substandard” or “doubtful” without prior approval from Service1st’s board of directors or loan committee; (viii) formulate and implement a plan to reduce risk exposure to its concentration in commercial real estate loans in conformance with Appendix A of Part 365 of the FDIC’s Rules and Regulations; (ix) formulate and implement a plan to address profitability; and (x) not accept brokered deposits (which includes deposits paying interest rates significantly higher than prevailing rates in Service1st’s market area) and reduce its reliance on existing brokered deposits, if any.


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Our stock price could fluctuate and could cause you to lose a significant part of your investment.
 
The market price of our securities may be influenced by many factors, some of which are beyond our control, including those described above and the following:
 
  •  changes in our perceived ability to increase our assets and deposits;
 
  •  changes in financial estimates by analysts;
 
  •  announcements by us or our competitors of significant contracts, productions, acquisitions or capital commitments;
 
  •  fluctuations in our quarterly financial results or the quarterly financial results of companies perceived to be similar to us;
 
  •  general economic conditions;
 
  •  changes in market valuations of similar companies;
 
  •  terrorist acts;
 
  •  changes in our capital structure, such as future issuances of securities or the incurrence of additional debt;
 
  •  future sales of our Common Stock;
 
  •  regulatory developments in the United States, foreign countries or both;
 
  •  litigation involving us, our subsidiaries or our general industry; and
 
  •  additions or departures of key personnel.
 
The trading volume of the Company’s common stock is limited.
 
The Company’s common stock trades on Nasdaq under the symbol “WLBC” and trading volume is modest. The limited trading market for the common stock may lead to exaggerated fluctuations in market prices and possible market inefficiencies, as compared to a more actively traded stock. It may also make it more difficult to dispose of the common stock at expected prices, especially for holders seeking to dispose of a large number of such stock.
 
If we are unable to effectively maintain a system of internal control over financial reporting, we may not be able to accurately or timely report financial results, which could materially adversely affect our business.
 
Section 404 of the Sarbanes-Oxley Act of 2002 requires that a public company evaluate the effectiveness of its internal control over financial reporting as of the end of each fiscal year, and to include a management report assessing the effectiveness of its internal control over financial reporting in its annual report on Form 10-K for that fiscal year. Our ability to comply with the annual internal control report requirements of Section 404 depends on the effectiveness of our financial reporting and data systems and controls across our operations. We expect the implementation of these systems and controls to involve significant expenditures, and our systems and controls will become increasingly complex. To effectively implement these systems and manage this complexity, we will likely need to continue to improve our operational, financial and management controls and our reporting systems and procedures.
 
Our allowance for loan losses may not be adequate to cover actual loan losses, which may require us to take a charge to our earnings and adversely impact our financial condition and results of operations.
 
We maintain an allowance for estimated loan losses that we believe is adequate for absorbing the inherent losses in Service1st’s loan portfolio. As of December 31, 2010, our allowance for loan and lease losses was $36,000. This allowance relates to new loan originations of $995,000 since acquisition date as there has been


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no additional credit deterioration in the portfolio acquired that has not been reflected in the fair value estimate as of the date of acquisition.
 
Pursuant to the acquisition method of accounting for business combinations, the allowance for loan losses from acquired entities does not transfer to the acquiring entity. In addition, the acquiring bank should establish loan loss allowances for the acquired held-for-investment loans in periods after the acquisition, but only for losses incurred on these loans due to credit deterioration after acquisition. Therefore, management will determine the provision for loan losses based upon an analysis of general market conditions, credit quality of the loan portfolios, and performance of customers relative to their financial obligations. The amount of future losses is susceptible to changes in economic, operating, and other conditions, including changes in interest rates that may be beyond our control and such losses may exceed the allowance for estimated loan losses. Although we expect that the allowance for estimated loan losses will be adequate to absorb any inherent losses on existing loans that may become uncollectible, there can be no assurance that the allowance will prove sufficient to cover actual loan losses in the future. Significant increases to the provision for loan losses may be necessary if material adverse changes in general economic conditions occur or the performance of the loan portfolio deteriorates. Additionally, banking regulators, as an integral part of their supervisory function, periodically review the allowance for estimated loan losses. If these regulatory agencies require us to increase the allowance for estimated loan losses, it could have a negative effect on our results of operations and financial condition.
 
If we are unable to recruit and retain experienced management personnel and recruit and retain additional qualified personnel, our business and prospects could be adversely affected.
 
Our success depends in significant part on our ability to retain senior executives and other key personnel in technical, marketing and staff positions. There can be no assurance that we will be able to successfully attract and retain highly qualified key personnel, either in existing markets and market segments or in new areas that we may enter. If we are unable to recruit and retain an experienced management team or recruit and retain additional qualified personnel, our business, and consequently our sales and results of operations, may be materially adversely affected.
 
We have approximately 40 full-time equivalent, non-union employees. We seek to employ adequate staffing commensurate with levels of banking activities and customer service requirements for a community bank.
 
Our success depends in part on our ability to retain key customers, and to hire and retain management and employees and successfully manage the broader organization. Competition for qualified individuals may be intense and key individuals may depart because of issues relating to the uncertainty and difficulty of integration or a general desire not to remain with us. Furthermore, we will face challenges inherent in efficiently managing an increased number of employees. Accordingly, no assurance can be given that we will be able to attract and retain key customers, management or employees, which could result in disruption to our business and negatively impact our operations and financial condition.
 
We are exposed to risk of environmental liabilities with respect to properties to which we take title.
 
In the course of our business we may foreclose and take title to real estate, potentially becoming subject to environmental liabilities associated with the properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs or we may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. Costs associated with investigation or remediation activities can be substantial. If we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. These costs and claims could adversely affect our business and prospects.


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Compliance with governmental regulations and changes in laws and regulations and risks from investigations and legal proceedings could be costly and could adversely affect operating results.
 
Our operations could be impacted by changes in the legal and business environments in which we operate, as well as the outcome of ongoing government and internal investigations and legal proceedings. Also, as a result of new laws and regulations or other factors, we could be required to curtail or cease certain operations. Changes that could impact the legal environment include new legislation, new regulation, new policies, investigations and legal proceedings and new interpretations of the existing legal rules and regulations. Changes that impact the business environment include changes in accounting standards, changes in environmental laws, changes in tax laws or tax rates, the resolution of audits by various tax authorities, and the ability to fully utilize any tax loss carry forwards and tax credits. These changes could have a significant financial impact on our future operations and the way we conduct, or if we conduct, business in the affected countries.
 
The value of the Federal Home Loan Bank stock that we own could be adversely affected by weakness in the FHLB system.
 
Service1st is a member of the FHLB of San Francisco, which is one of the twelve regional banks comprising the FHLB System. The FHLB provides credit for member financial institutions. The 12 FHLBs obtain their funding primarily through issuance of consolidated obligations of the FHLB System. The U.S. government does not guarantee these obligations, and each of the 12 FHLBs is jointly and severally liable for repayment of the debt of the other FHLBs. Therefore, our investment in the equity stock of the FHLB of San Francisco could be adversely affected by the operations of the other FHLBs. Certain FHLBs, including the FHLB of San Francisco, have experienced lower earnings from time to time and have paid out lower dividends to their members. If an FHLB’s capital drops below 4% of its assets, restrictions on the redemption or repurchase of member banks’ FHLB stock are imposed by law. If FHLBs are restricted from redeeming or repurchasing member banks’ FHLB stock due to adverse financial conditions affecting either individual FHLBs or the FHLB system as a whole, member banks may be required to recognize an impairment charge on their FHLB equity stock investments. Future problems at the FHLBs could have an impact on the collateral necessary to secure borrowings and limit the borrowings extended to member banks, as well as require additional capital contributions by member banks. If this occurs, our short-term liquidity needs could be adversely affected. If we are restricted from using FHLB advances due to weakness in the FHLB System or weakness at the FHLB of San Francisco, we may be forced to find alternative funding sources. These alternative funding sources may include seeking lines of credit with third party banks or the Federal Reserve Bank of San Francisco, borrowing under repurchase agreement lines, increasing deposit rates to attract additional funds, accessing brokered deposits, or selling certain investment securities categorized as available-for-sale in order to maintain adequate levels of liquidity.
 
Our legal lending limit could be a competitive disadvantage.
 
Service1st’s legal lending limit is approximately $8.9 million as of December 31, 2010. Accordingly, the size of the loans which we can offer to potential clients is less than the size of loans our competitors with larger lending limits can offer. Our legal lending limit affects our ability to seek relationships with the area’s larger and more established businesses. Through our previous experience and relationships with a number of the region’s other financial institutions, we are generally able to accommodate loan amounts greater than our legal lending limit by selling participations in those loans to other banks, although we tend to retain a significant portion of the loans we originate. However, we cannot assure you of any success in attracting or retaining clients seeking larger loans or (taking into account the economic downturn and its effects on other financial institutions) that we can engage in participation transactions for those loans on terms favorable to us.
 
Item 1B — Unresolved Staff Comments
 
Not applicable.


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Item 2 — Properties
 
We operate from three leased locations. We maintain our principal executive offices at 8363 West Sunset Road, Suite 350, in Las Vegas, Nevada 89113. We also have two banking offices, one located at 8349 West Sunset Road Suite B, Las Vegas, Nevada 89113, and the other at 8965 South Eastern Avenue Suite 190, Las Vegas Nevada 89123.
 
Item 3 — Legal Proceedings
 
From time to time Service1st Bank is involved in legal proceedings that are incidental to its business. In the opinion of management, no current legal proceedings are material to the business or financial condition of Western Liberty Bancorp or Service1st Bank, either individually or in the aggregate.
 
Item 4 — [reserved]
 
PART II
 
Item 5 — Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Market information — The Common Stock is listed on the Nasdaq Global Market (“Nasdaq”), trading under the symbol “WLBC.” Our outstanding securities listed on Nasdaq consist solely of shares of common stock. The following table sets forth for each quarter in the years ended December 31, 2010 and 2009 the high and low sales price of our units, Common Stock and warrants.
 
                                                 
    Units   Common stock   Warrants
    High   Low   High   Low   High   Low
 
2009
                                               
First quarter
  $ 9.55     $ 9.15     $ 9.48     $ 9.14     $ 0.17     $ 0.08  
Second quarter
    9.76       9.48       9.69       9.44       0.23       0.09  
Third quarter
    10.70       9.90       9.89       9.65       1.20       0.20  
Fourth quarter
    10.30       7.75       9.83       6.42       1.20       0.55  
2010
                                               
First quarter
    8.60       7.95       8.04       6.18       0.80       0.35  
Second quarter
    7.50       7.00       9.00       5.75       0.45       0.22  
Third quarter
    7.50       7.50       7.80       4.80       0.30       0.18  
Fourth quarter
    7.50       7.50       7.80       4.80       0.30       0.18  
 
Trading under the symbol “WLBC,” our Common Stock has been listed on the Nasdaq since October 29, 2010, trading immediately prior to that on the Over-the-Counter (OTC) Bulletin Board, an electronic stock listing service provided by the Nasdaq Stock Market, Inc. Our Common Stock was listed on the New York Stock Exchange AMEX until approximately February 25, 2010. The figures in the table above are the high and low prices as reported on Nasdaq, the OTC Bulletin Board, or the New York Stock Exchange Amex during the applicable time periods. As a result of Acquisition, our only publicly traded security is our Common Stock.
 
Holders of Common Equity
 
On March 29, 2011, there were approximately 197 holders of record of our public common stock. Such numbers do not include beneficial owners holding shares, or holders of our private shares. On March 29, 2011, there were approximately 71 holders of record private shares.
 
Dividends
 
We have never paid cash dividends on our Common Stock and we do not intend to pay cash dividends for the foreseeable future. The payment of dividends will depend on our revenues and earnings, if any, capital


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requirements, and general financial condition. The payment of dividends will be within the discretion of our board of directors. The board currently intends to retain any earnings for use in our business operations. Service1st Bank’s ability to pay dividends to us is subject to bank regulatory restrictions. In addition, by the terms of the September 1, 2010 Consent Order, Service1st Bank cannot pay cash dividends unless it first obtains the written consent of the FDIC and the Commissioner of the Nevada FID.
 
Recent sales of unregistered securities
 
On July 16, 2007, we issued 8,575,000 shares of Common Stock in private placement transactions for the purchase price of $0.001 per share. On August 1, 2007, we issued 25,000 shares in private placement transactions for the purchase price of $0.001 per share. On September 28, 2007, we issued 25,000 shares in private placement transactions for the purchase price of $0.001 per share. In total, prior to our initial public offering, we issued 8,625,000 shares in private placement transactions for an aggregate amount of $8,625 in cash. Of those shares, 637,786 were redeemed because the underwriters did not fully exercise their over-allotment option, resulting in a total of 7,987,214 shares issued in private placements and remaining outstanding after the redemption.
 
On August 1, 2007, our former Chief Executive Officer agreed to purchase 1,000,000 warrants to acquire our common stock, completing the purchase of the warrants immediately prior to the consummation of our initial public offering on November 27, 2007. On October 19, 2007, Hayground Cove Asset Management LLC, our former sponsor (“Hayground Cove”), agreed to purchase 7,500,000 warrants to acquire our Common Stock, completing the purchase of the warrants immediately prior to the consummation of our initial public offering on November 27, 2007. On July 20, 2009, we entered into a Private Shares Restructuring Agreement with Hayground Cove. Under the terms of the Private Shares Restructuring Agreement, 7,618,908 of the 7,987,214 shares issued in private placements (and remaining outstanding after the redemption of 637,786 shares), constituting more than 95% of those shares, were cancelled and exchanged for warrants to acquire our Common Stock. After the cancellation and exchange provided by the terms of the Private Shares Restructuring Agreement, there were outstanding a total of 16,118,908 warrants to acquire Common Stock and 368,306 shares issued in private placements.
 
On September 27, 2010, we entered into an Amended Warrant Agreement with our warrant agent, Continental Stock Transfer & Trust Company. By the terms of the Amended Warrant Agreement, all outstanding warrants were exercised for one thirty-second (1/32) of one share of our common stock concurrently with completion of the Acquisition. As a result, we issued 1,502,088 shares of Common Stock and paid each warrant holder $0.06 for each warrant exercised. The Common Stock issuable upon exercise of the warrants was previously registered under the Exchange Act during WLBC’s initial public offering, and such shares were freely tradable immediately upon issuance.
 
Concurrently with completion of the Acquisition, we issued restricted stock to William E. Martin, who became a member of our board of directors and serves as our Chief Executive Officer and as Chief Executive Officer of Service1st, and George A. Rosenbaum, Jr., our Chief Financial Officer and the Executive Vice President of Service1st. Mr. Martin received 155,279 shares of restricted stock, equal to $1.0 million divided by the $6.44 closing price of the common stock on October 28, 2010, in consideration for his future services in accordance with the terms of his employment agreement. Mr. Rosenbaum received 38,819 shares of restricted stock, equal to $250,000 divided by the $6.44 closing price of the common stock on October 28, 2010, in consideration for his future services in accordance with the terms of his employment agreement. The shares of restricted stock granted to each of Messrs. Martin and Rosenbaum will vest 20% on each of the first, second, third, fourth, and fifth anniversaries of the October 28, 2010 acquisition completion date, subject to Messrs. Martin’s and Rosenbaum’s respective and continuous employment through each vesting date. Fifty percent of the shares of restricted stock that vest in accordance with the prior sentence will remain restricted stock that will vest upon a termination of the holder’s employment for any other reason than (x) by us for cause, or (y) by the holder without good reason before October 28, 2015. The restricted stock is subject to restrictions on transfer for one year after each vesting date.
 
In consideration of their substantial service to and support of Western Liberty Bancorp during the period in which we sought the requisite regulatory approval to become a bank holding company and to acquire Service1st Bank, on October 28, 2010 each of Jason N. Ader, our former Chairman and Chief Executive


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Officer and a current member of our board of directors, Daniel B. Silvers, our former President, Andrew P. Nelson, our former Chief Financial Officer and a former member of our board, Michael Tew, an outside consultant, and Laura Conover-Ferchak, an outside consultant, entered into Letter Agreements providing for a grant of restricted stock units, as follows: Mr. Ader, 50,000 restricted stock units; Mr. Silvers, 100,000 restricted stock units; Mr. Nelson, 25,000 restricted stock units; Mr. Tew, 20,000 restricted stock units; and Mrs. Conover-Ferchak, 5,000 restricted stock units. Each restricted stock unit is immediately and fully vested and will be settled for one share of our common stock on the earlier to occur of (x) a change of control and (y) October 28, 2013. Finally, in consideration of their substantial service to and support during the period in which we sought regulatory approval to become a bank holding company and to acquire Service1st Bank, on October 28, 2010 we made a one-time grant of 50,000 shares of Common Stock to each of Michael Frankel, the current Chairman of the board, Richard A.C. Coles, a current member of our board of directors, and Mark Schulhof, a former member of the board of directors.
 
The foregoing sales of securities were deemed to be exempt from the registration under the Securities Act of 1933 in reliance on section 3(a)(9) or section 4(2) of the Securities Act, as applicable. In addition, the future issuance of Common Stock underlying the restricted stock units will be similarly exempt. The purchasers of the securities issued in private placements represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were affixed to the instruments representing the securities issued in the transactions.
 
Issuer purchases of equity securities in the fourth quarter
 
There were no repurchases of any of our securities in the fourth quarter of 2010.
 
Item 6 — Selected Financial Data
 
SELECTED HISTORICAL FINANCIAL INFORMATION — WESTERN LIBERTY BANCORP (WLBC)
 
WLBC’s balance sheet data for the years ended December 31, 2010, 2009 and 2008 and related statements of operations, changes in shareholders’ equity and cash flows for the years ended December 31, 2010, 2009 and 2008, are derived from WLBC’s audited financial statements, which are included elsewhere in this Form 10-K.
 
Information for December 31, 2010 includes the two months of operations of Service1st and the related balances.
 
This information should be read together with WLBC’s audited financial statements and related notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — WLBC” and other financial information included elsewhere in this Form 10-K. The historical results included below and elsewhere in this Form 10-K are not indicative of the future performance of WLBC.
 
Selected Financial Data of WLBC
 
Set forth below are selected financial data of WLBC for the years ended December 31, 2010, 2009 and 2008. You should read this information in conjunction with WLBC’s audited financial statements and notes to the financial statements included elsewhere in this Form 10-K.


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WESTERN LIBERTY BANCORP
SELECTED FINANCIAL DATA
 
                         
    Years Ended December 31,  
    2010(3)     2009     2008  
    ($ in thousands except per share data)  
 
Selected Results of Operations Data:
                       
Interest income
  $ 1,530     $ 139     $ 5,691  
Interest expense
    115              
                         
Net interest income
    1,415       139       5,691  
Provision for loan losses
    36              
                         
Net interest (loss) income after provision for loan losses
    1,379       139       5,691  
Non-interest income
    108              
Non-interest expense
    9,137       15,037       7,244  
                         
Net Loss
  $ (7,650 )   $ (14,898 )   $ (1,553 )
                         
Per Share data:
                       
Net loss per common share
  $ (0.65 )   $ (0.45 )   $ (0.05 )
Book Value(5)
  $ 6.22     $ 8.02     $ 5.34  
Selected Balance Sheet Data:
                       
Total Assets
  $ 257,546     $ 88,520     $ 318,395  
Cash and cash equivalents
    103,227       87,969       1,446  
Certificates of deposit(4)
    26,889              
Securities, available for sale
    1,819              
Securities, held to maturity
    5,314              
Gross loans, including net deferred loan fees
    106,259              
Allowance for loan losses
    36              
Deposits
    160,286              
Stockholders’ equity
    93,829       87,891       213,145  
Value of common stock which may be redeemed for cash
                94,984  
Performance Ratios:
                       
Net interest margin(1)
    3.33 %     N/A       N/A  
Efficiency ratio(2)
    599.93 %     N/A       N/A  
Return on average assets
    (2.60 )%     N/A       N/A  
Return on average equity
    (5.89 )%     N/A       N/A  
Asset Quality:
                       
Nonperforming loans(6)
  $ 10,426     $ N/A     $ N/A  
Allowance for loan losses as a percentage of nonperforming loans(6)
    0.35 %     N/A       N/A  
Allowance for loan losses as a percentage of portfolio loans
    0.03 %     N/A       N/A  
Nonperforming loans as a percentage of total portfolio loans(6)
    9.81 %     N/A       N/A  
Nonperforming loans as a percentage of total assets(6)
    4.05 %     N/A       N/A  
Net charge-offs to average portfolio loans
    0.00 %     N/A       N/A  
Capital Ratios:
                       
Average equity to average assets
    44.11 %     68.73 %     67.11 %
Tier 1 equity to average assets
    30.5 %     N/A       N/A  
Tier 1 Risk-Based Capital ratio
    68.4 %     N/A       N/A  
Total Risk-Based Capital ratio
    68.8 %     N/A       N/A  
 
 
(1) Net interest margin represents net interest income as a percentage of average interest-earning assets.
 
(2) Efficiency ratio represents non-interest expenses as a percentage of the total of net interest income plus non-interest income.


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(3) Service1st was acquired in 100% stock exchange on October 28, 2010. Thus, the 2010 data represents a full year for WLBC and a partial year (two months) for Service1st.
 
(4) Certificates of deposit issued by other banks with original maturities greater than three months.
 
(5) Book value is calculated by dividing total stockholder’s equity at December 31 by the number of shares outstanding as of December 31.
 
(6) Nonperforming loans includes PCI loans for which no contractual interest is being recorded.
 
Item 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — WESTERN LIBERTY BANCORP
 
The following discussion and analysis should be read in conjunction with WLBC’s audited financial statements and notes to the financial statements included elsewhere in this Form 10-K. This discussion and analysis contains forward-looking statements that involve risk, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth under “Cautionary Note Regarding Forward-Looking Statements” may cause actual results to differ materially from those projected in the forward-looking statements.
 
Overview
 
Business of WLBC:  WLBC became a bank holding company on October 28, 2010 with consummation of the Acquisition. Although our goal in 2007, when it was established as a special purpose acquisition company, was to identify for acquisition domestic and international operating companies engaged in the consumer products and services business, by the spring of 2009, we determined that the banking industry had become an attractive investment opportunity, particularly the community banking industry in Nevada. In October of 2009, we changed our name to Western Liberty Bancorp and eliminated the special purpose acquisition company features of our governing documents. In October 2009, we also began in earnest the process that concluded on October 28, 2010 with the acquisition of Service1st. Our sole subsidiary is Service1st. We currently conduct no business activities other than acting as the holding company of Service1st.
 
As bank holding company, operating from its headquarters and two retail banking locations in the greater Las Vegas area, WLBC provides a variety of loans to its customers, including commercial real estate loans, construction and land development loans, commercial and industrial loans, Small Business Administration (“SBA”) loans, and to a lesser extent consumer loans. As of December 31, 2010, loans secured by real estate constituted 66.04% of WLBC’s loan portfolio. This ratio is calculated by adding together loans secured by real estate at December 31, 2010 (construction, land development and other land loans of $5.9 million, commercial real estate loans of $55.0 million and residential real estate loans of $9.2 million, which total $70.1 million of loans secured by real estate) and dividing this balance by Gross Loans of $106.3 million at December 31, 2010. WLBC relies on locally-generated deposits to provide WLBC with funds for making loans. The majority of its business is generated in the Nevada market.
 
WLBC generates substantially all of its revenue from interest on loans and investment securities and service fees and other charges on customer accounts. This revenue is offset by interest expense paid on deposits and other borrowings and non-interest expense such as administrative and occupancy expenses. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as customer deposits and other borrowings used to fund those assets. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities and the level of nonperforming assets combine to affect net interest income.
 
WLBC receives fees from its deposit customers in the form of service fees, checking fees and other fees. Other services such as safe deposit and wire transfers provide additional fee income. WLBC may also generate income from time to time from the sale of investment securities. The fees collected by WLBC are found under


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“Non-interest Income” in the statements of operations contained within WLBC’s audited financial statements for the year ended December 31, 2010 (which are included elsewhere in this Form 10-K). Offsetting these earnings are operating expenses referred to as “Non-Interest Expense” in the statements of operations. Because banking is a very people intensive industry, the largest operating expense is employee compensation and related expenses.
 
Local Economic Conditions.  According to the National Bureau of Economic Research, the United States economy entered into the longest and most severe recession in the post-war year beginning in December of 2007. The recession and continued economic downturn have been deeply felt in the greater Las Vegas area. Beginning in 2008, job losses, declining real property values, low consumer and business confidence levels and increasing vacancy and foreclosure rates for commercial and residential property dramatically affected the Las Vegas economy. According to a monthly report produced by The Center for Business & Economic Research at the University of Nevada Las Vegas (the “CBER Report”), the local unemployment rate in Las Vegas rose from 5.6% as of December 31, 2007, to 9.1% as of December 31, 2008, to 13.1% at December 31, 2009 and to 14.9% at December 31, 2010. In addition, new home sales decreased 53.4% from December 2007 to December 2008, falling a further 25.7% from December 2008 to December 2009 and down 27.3% from December 2009 to December 2010. During the same year, median new home prices decreased 21.7% from December 2007 to December 2008, decreased 11.2% from December 2008 to December 2009 and decreased 0.3% from December 2009 to December 2010. Although new home sales decreased by 27.3% for the year ended December 31, 2010 compared to the same year in 2009, median new home prices continued to decrease by 0.3% for the year ended December 31, 2010 compared to the same year in 2009. The national recession also adversely affected tourism and Las Vegas’ critical gaming industry. According to the CBER Report, Las Vegas area gaming revenues decreased 18.4% from December 2007 to December 2008, decreased 2.4% from December 2008 to December 2009, and decreased 4.7% for the year ended December 31, 2010 compared to same year for 2009. Data derived from The Applied Analysis, Las Vegas Market Reports (2nd quarter 2010) shows that Las Vegas vacancy rates for office, industrial and retail space rose from December 31, 2007 to December 31, 2008 to December 31, 2009 to December 31, 2010: office — from 13.6%, to 17.3%, to 23.0%, to 24.2%; industrial — from 6.6%, to 8.9%, to 13.7%, to 16.9%; and retail — from 4.0%, to 7.4%, to 10.0%, to 10.2%.
 
Summary of Results of Operations and Financial Condition
 
Since formation at the beginning of 2007, Service1st has not been profitable. To some extent, the lack of profitability is attributable to the start-up nature of its business: time is required to build assets sufficient to generate enough interest income to cover operating expenses. However, in addition to the customary challenges of building profitability for a start-up bank, Service1st has experienced deterioration in the quality of its loan portfolio, largely as a result of the challenging economic conditions in the Las Vegas market.
 
For the year ended December 31, 2010, WLBC recorded a net loss of $7.7 million or $0.65 per common share, as compared with a net loss of $14.9 million or $0.45 per common share in 2009 and a loss of $1.6 million or $0.05 per common share in 2008. The $7.2 million decrease in net loss for the year ended December 31, 2010, when compared to the year ended December 31, 2009, was the result of a $5.9 million decrease in noninterest expense coupled with the acquisition of Service1st which resulted in $1.3 million in additional net interest income after provision for loan loss. Professional fees totaled $12.6 million for the year ended December 31, 2009 compared to $3.9 million for the year ended December 31, 2010, a reduction of $8.7 million. In 2009, WLBC pursued more than one potential target for acquisition, including Service1st, while in 2010, that focus narrowed to the acquisition of Service1st and resulted in reduced professional fees. WLBC successfully acquired Service1st on October 28, 2010 and resulted in $258.2 million in interest bearing assets which contributed the majority of the $1.5 million in interest income and $93.4 million in interest bearing liabilities that resulted in $115,000 in interest expense for the last two months of 2010, resulting in $1.4 million in net interest income before provision for loan losses.
 
Critical Accounting Policies and Estimates
 
WLBC’s significant accounting policies are described in Note 1 of its audited financial statements (which are included elsewhere in this Form 10-K), including information regarding recently issued accounting pronouncements, WLBC’s adoption of such policies and the related impact of their adoption. Certain of these


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policies, along with various estimates that WLBC is required to make in recording its financial transactions, are important to have a complete understanding of WLBC’s financial position. In addition, these estimates require WLBC to make complex and subjective judgments, many of which include matters with a high degree of uncertainty. The following is a summary of these critical accounting policies and significant estimates.
 
As previously discussed, the Acquisition was accounted for as a business combination which resulted in application of fair value accounting to the subsidiary’s balance sheet. The total discount to the loan portfolio was approximately $15.1 million. The loan portfolio was segregated into performing loans and non-performing loans or purchased loans with credit impairment.
 
The performing loans totaled approximately $89.9 million and were marked with a credit discount of $3.6 million and approximately $49,000 of yield discount. In accordance with current accounting pronouncements, the discounts on performing loans are being recognized on a method that approximates a level yield over the expected life of the loan.
 
The loans identified as purchased with credit impairments were approximately $35.6 million as of the acquisition date. A credit discount of approximately $10.9 million was recorded and an additional $576,000 of yield discount was also recorded. The yield discount will be accreted into income using the same method described above for the performing loans. WLBC does not expect to accrete the discount into income until such time as the loan is removed from the bank. The only exception would be on a case-by-case basis when a material event that significantly improves the quality of the loan and reduces the risk to the bank such that management believes it would be prudent to start recognizing some of the discount is documented. The credit discount represents approximately 30% of the transaction date value of the credit impaired loans. Throughout this document, presentations for non-performing loans, or potential problem loans have generally been subjected to the credit discount discussed above.
 
Allowance for Loan Losses
 
As previously discussed, the ALLL was adjusted to zero in conjunction with the fair value accounting process. Therefore, the current ALLL at December 31, 2010 only relates to those loans generated after the October 28, 2010 acquisition date. No new credit deterioration was recorded during the last two months of 2010.
 
The allowance for loan losses is an estimate of the credit risk in WLBC’s loan portfolio and appears on the balance sheet as a “contra asset” which reduces gross loans. The allowance is established (or once established, increased) by recording provision expense. Loans charged off on WLBC’s books reduce the allowance. Subsequent recoveries of charged off loans, if any, increase the allowance.
 
The allowance is an amount that WLBC’s management believes will be adequate to absorb probable incurred losses on existing loans that may become uncollectible, based on evaluation of the collectability of loans and prior credit loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, specific problem credits, peer bank information, and current economic conditions that may affect the borrower’s ability to pay. Due to the credit concentration of WLBC’s loan portfolio in real estate-secured loans, future adjustments to the allowance may be necessary if there are significant changes in economic or other conditions. In addition, the FDIC and state banking regulatory agencies, as an integral part of their examination process, review WLBC’s allowance for loan losses, and may require WLBC to make additions to the allowance based on their judgment about information available to them at the time of their examinations. The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired. For such loans, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative and environmental factors.
 
A loan is impaired when it is probable WLBC will be unable to collect all contractual principal and interest payments due in accordance with the original terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest


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rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses.
 
Investment Securities Portfolio
 
Securities classified as available for sale are equity securities and those debt securities WLBC intends to hold for an indefinite year of time, but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of WLBC’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar considerations. Securities available for sale are reported at fair value with unrealized gains or losses reported as other comprehensive income (loss), net of related deferred tax effect. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings.
 
Securities classified as held to maturity are those debt securities WLBC has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs, or general economic conditions. These securities are carried at amortized cost, adjusted for amortization of premium and accretion of discount computed by the interest method over the contractual lives. The sale of a security within three months of its maturity date or after at least 85% of the principal outstanding has been collected is considered a maturity for purposes of classification and disclosure. Purchase premiums and discounts are generally recognized in interest income using the effective-yield method over the term of the securities.
 
WLBC’s management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, including an evaluation of credit ratings, (3) the impact of changes in market interest rates, (4) the intent of WLBC to sell a security and (5) whether it is more likely than not WLBC will have to sell the security before recovery of its cost basis.
 
Stock-Based Compensation
 
WLBC awarded common stock, restricted stock, restricted stock units and assumed the Service1st stock options outstanding at October 28, 2010. This described more fully in Note 12 to WLBC’s audited financial statements for the year ended December 31, 2010, which are included elsewhere in this Form 10-K. WLBC records the fair value of stock compensation granted to employees and directors as expense over the vesting year(s). The cost of the award is based on the grant-date fair value. The compensation expenses recognized was approximately $1.8 million for the year ended December 31, 2010, $869,000 in 2009 and $4.6 million in 2008.
 
Income Taxes
 
Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effect of changes in tax laws and rates on the date of enactment. As a result of the Acquisition which was finalized at the close of business on October 28, 2010, WLBC’s net operating loss utilization will be subject to an annual limitation on the net operating loss against future taxable income. Internal Revenue Code section 382 places a limitation on the amount of taxable income that can be offset by net operating loss carry forwards after a change in control (generally greater than 50% change in ownership) of a loss corporation.


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Acquisition of Service1st Bank of Nevada
 
On October 28, 2010, WLBC consummated the Acquisition of Service1st pursuant to the Amended Merger Agreement. Pursuant to the Amended Merger Agreement, Acquisition Sub merged with and into Service1st, with Service1st being the surviving entity and becoming WLBC’s wholly-owned subsidiary. WLBC previously received the requisite approvals of certain bank regulatory authorities to complete the Acquisition to become a bank holding company.
 
The former stockholders of Service1st received approximately 2,282,668 shares of Common Stock (net of dissenter’s rights exercised with respect to 88,054 shares) in exchange for all of the outstanding shares of capital stock of Service1st as Base Acquisition Consideration. In addition, the holders of Service1st’s outstanding options and warrants now hold options and warrants of similar tenor to purchase up to 289,781 shares of Common Stock at an exercise price of $21.01.
 
In addition to the Base Acquisition Consideration, each of the former stockholders of Service1st may be entitled to receive Contingent Acquisition Consideration, payable in Common Stock, if at any time within the first two years after the consummation of the Acquisition, the closing price per share of the Common Stock exceeds $12.75 for 30 consecutive days. The Contingent Acquisition Consideration would be equal to 20% of the tangible book value of Service1st at the close of business on the last day of the calendar month immediately before the calendar month in which the final regulatory approval necessary for the completion of the Acquisition was obtained. The total number of shares of our common stock issuable to the former Service1st stockholders would be determined by dividing the Contingent Acquisition Consideration by the average of the daily closing price of the Common Stock on the first 30 trading days on which the closing price of the Common Stock exceeded $12.75.
 
At the close of business on October 28, 2010, WLBC was a new Nevada bank holding company by consummating the acquisition of Service1st and conducting operations through Service1st. In conjunction with the transaction, WLBC infused $25 million of capital onto the balance sheet of Service1st. On October 29, 2010, the common shares of WLBC began trading on Nasdaq, under the ticker symbol WLBC.
 
The transaction was recorded as a business combination under the current accounting rules and as a result the balance sheet of Service1st was revalued to fair value as of the transaction date. This process is heavily reliant on measuring and estimating the fair values of all the assets and liabilities of the acquired entity. WLBC elected to obtain professional assistance in this activity. The Company hired a third-party vendor to assist Management in determining the fair value of the loan portfolio, the time deposits, and the contingent consideration discussed above. Additionally, the firm was asked to assist in the determination of the value of the intangible asset associated with the CDI.
 
As of the acquisition date, the gross loan portfolio at Service1st Bank was approximately $125.4 million with a related ALLL of approximately $9.4 million. The valuation resulted in a discount of approximately $15.8 million at October 28, 2010. While we believe we currently have the best estimate of fair value, the purchase accounting adjustments are not final and we are currently still evaluating all available information to ensure we have an accurate assessment of fair value. In fact, there have been some loan charge-offs and payoffs which impacted the valuation and as a result of reviewing this information, management reduced the discount from the original $15.8 million to approximately $15.1 million. This discount consists of two components: credit discount and yield discount. The performing portfolio was approximately $89.9 million and was discounted by $49,000 for yield and $3.6 million for credit discounts. The remaining $35.6 million of loans were identified as loans with purchased credit impairment and those loans had a discount of $576,000 for yield and $10.9 million for credit discounts. The discounts on performing loans are recognized by a “level yield” method over the remaining life of the loans or loan pools. The loans identified as containing purchase credit impairment are treated somewhat differently. The discount associated with yield is accreted as yield discount and the credit discount is not accreted but is left on the books to reduce the current carrying value of the applicable loans. The application of this process requires that the aggregate discount is first netted against the ALLL, reducing the ALLL to zero. Consequently, the first day after the transaction the loan portfolio was approximately $110 million with no ALLL. In addition, current accounting methodology only allows for the


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establishment of an ALLL to occur as the entity records new loans on the books or identifies subsequent credit deterioration on the original loans marked to fair value at acquisition date.
 
Service1st operates in the Las Vegas market place which has seen significant economic declines in all types of real estate and overall business trends. Since inception, Service1st has charged off approximately $17.8 million of loans through October 28, 2010. The remaining $125 million loan portfolio was further reduced by approximately $15 million in the fair value process as of the acquisition date. As this document presents the balances of loans that represent problem loans or potential problem loans, it is important to remember that these loans are as of the October 28, 2010 fair values.
 
The contractual values of time deposits were also marked to fair value. This resulted in Service1st recording a premium of $46,000. This premium will be amortized over the estimated remaining life of the time deposit portfolio of one year.
 
The CDI is the result of a valuation study which attempts to associate a value for the customer’s deposit relationships based on the profitability of the deposits and how long they are expected to produce revenue to the entity. This intangible asset was valued at $784,000 for Service1st at October 28, 2010. The intangible asset is amortized on an accelerated basis using an estimated ten year life.
 
The Contingent Acquisition Consideration estimated to be $4.4 million was also fair valued. The valuation firm used a decision tree model to calculate the probability that WLBC’s stock price will reach the threshold. Based on the results the fair value was determined to be approximately $1.8 million. Periodically over the two year period in which the contingent consideration could become payable the reasonableness of the estimate will be reviewed and adjusted if deemed necessary.
 
These estimates along with several other estimates were used to complete the fair value process for the balance sheet of Service1st and also to evaluate the fair value of future commitments and off-balance sheet items. Upon completion of these activities the adjustments are posted to the records of the new subsidiary. The difference between the fair value of the consideration given versus the net asset values obtained is an unidentified intangible asset (goodwill) created in the amount of approximately $5.6 million.
 
Results of Operations
 
The results of WLBC includes the operations of Service1st for the last two months of the year. This substantially impacts interest income, interest expense, provision for loan losses and various non interest income and expense items which were not applicable to WLBC prior to the Acquisition. The interest income line is also impacted by the accretion of discount on the loan portfolio which approximated $436,000.
 
WLBC’s results of operations depend substantially on its ability to generate net interest income, which is the difference between the interest income on its interest-earning assets (primarily loans and investment securities) minus interest expense on its interest-bearing liabilities (primarily deposits). Revenue is also generated by non-interest income, consisting principally of account and other service fees. These sources of revenue are burdened by two categories of expense: first, the provision for loan losses, which consists of a charge against earnings in an amount that WLBC’s management judges necessary to maintain WLBC’s allowance for loan losses at a level deemed adequate to absorb probable incurred loan losses inherent in the loan portfolio; and second, non-interest expense, which consists primarily of operating expenses, such as compensation to employees.
 
The management of interest income and interest expense is fundamental to the performance of WLBC. Net interest income and interest expense on interest-bearing liabilities, such as deposits and other borrowings, is the largest component of WLBC’s net revenue. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the rates earned or paid on them. WLBC’s management closely monitors both total net interest income and the net interest margin (net interest income divided by average earning assets).
 
Net interest income and net interest margin are affected by several factors including (1) the level of, and the relationship between the dollar amount of interest earning assets and interest-bearing liabilities; and (2) the


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relationship between re-pricing or maturity of WLBC’s variable-rate and fixed-rate loans, securities, deposits and borrowings.
 
Variable rate loans constitute approximately 55.74% of WLBC’s portfolio for the year end December 31, 2010, and approximately 51.21% of WLBC’s variable rate loans are indexed to the national prime rate. However, a majority of these prime-rate based loans are subject to “floors,” ranging from 5.5% to 8.5%. Currently the prime rate is under the applicable floor rate for substantially all of WLBC’s prime-rate based loans.
 
Movements in the national prime rate that increase the applicable loan rates above applicable floors have a direct impact on WLBC’s loan yield and interest income. The national prime rate remained at 3.25% throughout 2009 and 2010, as the Federal Reserve maintained the targeted federal funds rate steady. Based on economic forecasts generally available to the banking industry, WLBC currently believes it is reasonably possible that the targeted federal funds rate and the national prime rate will remain flat in the foreseeable future and increase in the long term; however, there can be no assurance to that effect or as to the timing or the magnitude of any increase should an increase occur, as changes in market interest rates are dependent upon a variety of factors that are beyond WLBC’s control.
 
WLBC, through its asset and liability policies and practices, seeks to maximize net interest income without exposing WLBC to an excessive level of interest rate risk. Interest rate risk is managed by monitoring the pricing, maturity and re-pricing options of all classes of interest-bearing assets and liabilities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations of WLBC— Quantitative and Qualitative Disclosures About Market Risk” in this section for more information.
 
The following table sets forth WLBC’s average balance sheet, average yields on earning assets, average rates paid on interest-bearing liabilities, net interest margins and net interest income/spread for the years ended December 31, 2010, 2009 and 2008.
 
                                                                         
    Year Ended December 31,
    Year Ended December 31,
    Year Ended December 31,
 
    2010(4)     2009     2008  
          Interest
                Interest
                Interest
       
    Average
    Income/
          Average
    Income/
          Average
    Income/
       
($ in thousands)   Balance     Expense     Yield     Balance     Expense     Yield     Balance     Expense     Yield  
 
Interest Earning Assets:
                                                                       
Certificates of deposit
    26,889     $ 56       1.27 %   $ 0     $ 0       0.00 %   $ 0     $ 0       0.00 %
Money Market funds
    76,804       8       0.06 %     237,577       139       0.06 %     315,590       5,691       1.80 %
Interest Bearing deposits
    39,308       16       0.25 %     0       0       0.00 %     0       0       0.00 %
Investment securities
    7,898       47       3.62 %     0       0       0.00 %     0       0       0.00 %
Portfolio loans(1)
    107,275       1,403       7.96 %     0       0       0.00 %     0       0       0.00 %
                                                                         
Total interest-earnings assets/interest income
    258,174       1,530       3.61 %     237,577       139       0.06 %     315,590       5,691       1.80 %
Noninterest Earning Assets:
                                                                       
Cash and due from banks
    12,035                       22,294                       2,060                  
Allowance for loan losses
    (18 )                     0                       0                  
Other assets
    13,243                       218                       144                  
                                                                         
Total assets
  $ 283,434                     $ 260,089                     $ 317,794                  
                                                                         


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    Year Ended December 31,
    Year Ended December 31,
    Year Ended December 31,
 
    2010(4)     2009     2008  
          Interest
                Interest
                Interest
       
    Average
    Income/
          Average
    Income/
          Average
    Income/
       
($ in thousands)   Balance     Expense     Yield     Balance     Expense     Yield     Balance     Expense     Yield  
 
Liabilities and Stockholders’ Equity
                                                                       
Interest-Bearing Liabilities:
                                                                       
Demand deposits
    31,275       43       0.84 %     0       0       0.00 %     0       0       0.00 %
Money markets
    26,048       25       0.58 %     0       0       0.00 %     0       0       0.00 %
Savings
    1,272       1       0.48 %     0       0       0.00 %     0       0       0.00 %
Time deposits under $100,000
    4,910       7       0.87 %     0       0       0.00 %     0       0       0.00 %
Time deposits $100,00 and over
    29,943       39       0.79 %     0       0       0.00 %     0       0       0.00 %
Repurchase Agreements
                0.00 %     0       0       0.00 %     0       0       0.00 %
Short-term borrowings
                0.00 %                 0.00 %     0             0.00 %
                                                                         
Total interest-bearing liabilities/interest expense
    93,448       115       0.75 %     0       0       0.00 %     0       0       0.00 %
Noninterest Bearing Liabilities:
                                                                       
Non-interest-bearing demand deposits
    68,493                       0                       0                  
Accrued interest on deposits and other liabilities
    2,221                       81,320                       104,527                  
                                                                         
Total liabilities
    164,162                       81,320                       104,527                  
Stockholders’ equity(5)
    87,704                       178,769                       213,267                  
                                                                         
Total liabilities and stockholders’ equity(6)
  $ 251,866                     $ 260,089                     $ 317,794                  
                                                                         
Net interest income and Interest rate spread(2)
          $ 1,415       2.86 %           $ 139       0.06 %           $ 5,691       1.80 %
                                                                         
Net interest margin(3)
                    3.33 %                     0.06 %                     1.80 %
Ratio of Average Interest-Earning Assets to Interest-Bearing Liabilities
    276 %                     0.00 %                     0.00 %                
 
 
(1) Average balances include nonaccrual loans of approximately $10,426, $0, and $0 for the years ended December 31, 2010, 2009 and 2008, respectively. Net loan (fees) or costs of $37,000, $0 and $0 are included in the yield computation for the years ended December 31, 2010, 2009 and 2008, respectively.
 
(2) Net interest spread represents the average yield earned on interest earning assets less the average rate paid on interest bearing liabilities.
 
(3) Net interest margin represents net interest income as a percentage of average interest earning assets.
 
(4) Service1st was acquired by Western Liberty Bancorp on October 28, 2010, thus the 2010 data represents a full year for WLBC; and a partial year for Service1st, October 28, 2010 through December 31, 2010. Average balances are computed by taking the balance at each quarter end for WLBC, adding the four quarters together and dividing by four. Average balances for Service1st are computed by taking November and December 2010’s month end balance, adding them together and dividing by two. Interest income for 2010 represents a full year for WLBC and two months of income for Service1st.
 
(5) Stockholders equity was computed by taking WLBC’s balance for each quarter end, adding the four quarters together and dividing by four, to compute a yearly average. No balance for Service1st is included in the 2010 stockholder’s equity balance as the calculation combines four quarters of WLBC’s balances to compute an average, but is skewed when only the last two month’s of Service1st’s 2010 balances can be

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utilized, due to date of acquisition. Thus, the elimination of investment in subsidiary, which needs to occur in consolidation accounting, impacts the consolidated numbers.
 
(6) As a result of the assumption noted in note (5) above, Total Assets will not equal Total Liabilities plus Stockholder’s Equity for 2010.
 
The following Volume and Rate Variances table sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted years, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in the average balance times the prior year rate and rate variances are equal to the increase or decrease in the average rate times the prior year average balance. Variances attributable to both rate and volume changes are equal to the change in rate times the change in average balance and are allocated proportionately to the changes due to volume and changes due to rate.
 
                         
    Year Ended December 31,
 
    2010 compared to Year Ended December 31, 2009
 
    Increase (Decrease)
 
    Due to Changes in:  
                Net
 
    Average
    Average
    Increase
 
($’s in thousands)   Volume     Rate     (Decrease)  
 
Interest income:
                       
Certificates of deposit
  $ 56     $ 0     $ 56  
Interest bearing deposits
    (121 )     6       (115 )
Federal funds sold
    0       0       0  
Investment securities
    47       0       47  
Portfolio loans
    1,403       0       1,403  
                         
Total increase (decrease) in interest income
    1,385       6       1,391  
                         
Interest expense:
                       
Interest checking
  $ 43     $ 0     $ 43  
Money markets
    25       0       25  
Savings
    1       0       1  
Time deposits under $100,000
    7       0       7  
Time deposits $100,000 and over
    39       0       39  
Repurchase Agreements
    0       0       0  
Short-term borrowings
    0       0       0  
                         
Total increase (decrease) in interest expense
    115       0       115  
                         
Net increase (decrease) in net interest income
  $ 1,270     $ 6     $ 1,276  
                         
 


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    Years Ended December 31,
 
    2009 Compared to 2008
 
    Increase (Decrease)
 
    Due to Changes in:  
                Net
 
    Average
    Average
    Increase
 
($’s In thousands)   Volume     Rate     (Decrease)  
 
Interest income:
                       
Certificates of deposit
  $ 0     $ 0     $ 0  
Interest bearing deposits
    (46 )     (5,506 )     (5,552 )
Federal funds sold
    0       0       0  
Investment securities
    0       0       0  
Portfolio loans
    0       0       0  
                         
Total increase (decrease) in interest income
    (46 )     (5,506 )     (5,552 )
                         
Interest expense:
                       
Interest checking
  $ 0     $ 0     $ 0  
Money markets
    0       0       0  
Savings
    0       0       0  
Time deposits under $100,000
    0       0       0  
Time deposits $100,000 and over
    0       0       0  
Repurchase Agreements
    0       0       0  
Short-term borrowings
    0       0       0  
                         
Total increase (decrease) in interest expense
    0       0       0  
                         
Net increase (decrease) in net interest income
  $ (46 )   $ (5,506 )   $ (5,552 )
                         
 
Comparison of 2010 with 2009
 
For the year ended December 31, 2010, average interest-earning assets were $258.2 million and average interest-bearing liabilities were $93.4 million, generating net interest income of $1.4 million which includes $436,000 of accretion of discount on loans for two months. For the year ended December 31, 2009, average interest-earning assets were $237.6 million and average interest-bearing liabilities were $0, generating net interest income of $139,000. Average balances of interest earning assets increased by an average of $20.6 million, or 8.67% from $237.8 million for the year ended December 31, 2009 to $258.2 million for the year ended December 31, 2010, due to the Acquisition partially being offset by the return of approximately $235.6 million in investor’s funds when Global Consumer Acquisition Corporation eliminated the special purpose acquisition features from the company’s governing documents in October 2009 and changed the company’s name to Western Liberty Bancorp. The increase in WLBC’s average interest earning balances was partially offset by the addition of Money Market funds which decreased $160.8 million, from $237.6 million as of December 31, 2009 to $76.8 million as of December 31, 2010. Average loan balances increased to $107.3 million from $0 at December 31, 2009, interest bearing deposits increased to $39.3 million at December 31, 2010 from $0 at December 31, 2009, certificates of deposit increased to $26.9 million from $0 at December 31, 2009, while securities increased to $7.9 million at December 31, 2010, from $0 million at December 31, 2009. WLBC noninterest earning assets at December 31, 2010 consisted of $12.0 million in cash and due from banks, a decrease of $10.3 million from $22.3 million as of December 31, 2009. In addition, WLBC’s other assets increased $13.0 million, from $218,000 as of December 31, 2009 to $13.2 million as of December 31, 2010.
 
Interest income was positively impacted by the increase in interest earning assets. Interest income grew from $139,000 at December 31, 2009, to $1.5 million, or a 979.14% at December 31, 2010. The $139,000 reflects 12 months of earnings by WLBC prior to the Acquisition, while the $1.5 million earned in 2010, reflects a year of WLBC and two months of earnings from Service1st as the acquisition of Service1st occurred

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on October 28, 2010. Interest income from loans contributed $1.4 million to total interest income, or 91.70%. On average, loans yielded 7.96% for the year ended December 31, 2010. The interest income on loans was positively impacted by the purchase accounting adjustments. The discount accretion for loans approximated $436,000 for two month period, as a result of the short term nature of the loans, refinancing and prepayments.
 
For the year ended December 31, 2010, average interest-bearing liabilities were $93.4 million, generating interest expense of $115,000 in 2010, compared with $0 in average interest-bearing liabilities for the year ended December 31, 2009, which generated no expense. WLBC’s average interest bearing liabilities at December 31, 2010 are as follows: interest checking accounts average $31.3 million, money market accounts average $26.0 million, savings average $1.3 million, time deposits under $100,000 average $4.9 million and time deposits $100,000 and over average $29.9 million. In addition, WLBC also purchased an average of $68.5 million in non-interest bearing checking accounts and an average of $2.2 million in other assets.
 
Interest expense was slightly impacted by the average increase of $93.4 million in interest bearing liabilities. Interest expense grew from $0 at December 31, 2009, to $115,000 for the two months ended December 31, 2010. Interest expense on time deposits over and under $100,000 contributed $46,000 to total interest expense, or 40.00% while interest bearing demand deposit checking accounts contributed $43,000 or 37.39% followed by money markets which contributed $25,000 or 21.74% of total interest expense. On average, interest earning deposits yielded 0.75% for the period ended December 31, 2010.
 
As a result WLBC’s net interest rate spread (yield earned on average interest-earning assets less the average rate paid on interest-bearing liabilities) was 2.86% and its net interest margin was 3.33%, yielding a net interest margin of $1.4 million for the year ended December 31, 2010.
 
Comparison of 2009 with 2008
 
For the year ended December 31, 2009, average interest-earning assets were $237.6 million and average interest-bearing liabilities was $0, generating net interest income of $139,000. For the year ended December 31, 2008, average interest-earning assets were $315.6 million and average interest-bearing liabilities were $0, generating net interest income of $5.7 million. Average balances of interest earning assets decreased by $78.0 million, or 24.71%, while average balances of interest-bearing liabilities remained flat year over year.
 
During 2009, WLBC had a net loss of $14.9 million. Since there was only $5.7 million in interest income, from funds held in a trust account, the remaining funds came from a reduction in the trust account funds. In addition, WLBC incurred $211.8 million for the payment of redemption of common shares as well as $4.0 million for the payment of underwriter’s discount and offering costs for the year ended December 31, 2009.
 
Provision for Loan Losses
 
The provision for loan losses in each year is reflected as a charge against earnings in that year. The provision is equal to the amount required to maintain the allowance for loan losses at a level that, in WLBC’s judgment, is adequate to absorb probable loan losses inherent in the loan portfolio. The amount of the provision for loan losses in any year is affected by reductions to the allowance in the year resulting from charge-offs and increases to the allowance in the year as a result of recoveries from charged-off loans. In addition, changes in the size of the loan portfolio and the recognition of changes in current risk factors affect the amount of the provision.
 
During 2010, WLBC continued to experience significant competitive pressures and challenging economic conditions in the markets in which it operates. The Las Vegas economy, as well as the national economy, has continued to show signs of significant weakness. Weakness in the residential market has expanded into the commercial real estate market, as builders and related industries downsize. These economic trends have adversely affected WLBC’s asset quality and increased charge-offs. WLBC has responded by increasing provision expense to replenish and build the allowance for loan losses allocable to adversely affected segments of WLBC’s loan portfolio — in particular, construction and land development loans and commercial and industrial loans. Continuation of these economic and real estate factors is likely to continue to affect WLBC’s asset quality and overall performance during the coming year.


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Comparison of 2010 with 2009
 
WLBC’s provision for loan losses of $36,000 provided for new loan growth for the year ended December 31, 2010, compared with $0 for the year ended December 31, 2009. The provision for loan losses from 2009 to 2010 is primarily attributable new loan growth of $995,000; $363,000 in November 2010 and $632,000 in December 2010 as a result of WLBC’s acquisition of Service1st on October 28, 2010, as there was no additional deterioration in loans acquired at October 28, 2010.
 
Each quarter, management determines an estimate of the amount of allowance for loan and lease losses adequate to provide for losses inherent in the Bank’s loan portfolios. The provision for loan losses is determined by the net change in the allowance for loan and lease losses. The purchase accounting used for the acquisition had a substantial impact on provision for loan losses.
 
The accounting guidance requiring the Company to record all assets and liabilities at their fair value eliminated the ALLL for all loans as of the acquisition date because fair values estimated for the loans included an estimate of the contractual cash flows which were not expected to be collected, for which the ALLL was provided. In other words, if an estimate of uncollectible amounts is already considered in setting the fair value, a valuation allowance to adjust the carrying amount of the loans for an estimate of uncollectible cash flows is not needed. Consequently, provision expense would be necessary only for any credit deterioration occurring between the acquisition date and December 31, 2010 and for newly originated loans.
 
Second, there is additional accounting guidance within purchase accounting that relates to loans that evidenced credit deterioration at the time they were acquired. These loans are termed Purchase Credit-Impaired loans or (“PCI loans”). There are different accounting methods used both for recognizing interest income and for recognizing credit deterioration subsequent to the acquisition for PCI loans than are used for loans that were not credit impaired when acquired or are specifically excluded from the PCI classification.
 
For loans that are credit-impaired when acquired, in addition to determining their fair value, the Company must differentiate between contractual cash flows that are expected to be received and those that are not expected to be received. The cash flows expected to be received is the fair value of the loan, and the discount amount is the accretable yield that will be recognized through accretion as interest income over the term of the loan. The difference between the total contractual payments and the undiscounted amount of the expected cash flows is termed the “nonaccretable difference”. This amount is not recognized as an allowance for credit loss because it was already considered in determining the fair value of the loan. If the borrower pays as expected, or pays more than expected, then no allowance is needed for a PCI loan and there would be no provision expense. If the borrower pays less than expected, then it is assumed that further credit deterioration has occurred subsequent to the acquisition and an allowance must be provided through a charge to provision expense as well as a reduction in the amount of the accretable yield that will be recognized in subsequent periods.
 
The accounting guidance for PCI loans permits the acquirer to aggregate loans with similar risk characteristics into pools. These pools are accounted for as a single unit of account in that only if, as an aggregate, actual cash flows are significantly less than the estimated cash flows, will an allowance, and therefore provision expense, be necessary. Once a pool of PCI loans is established, the integrity of the pool is maintained. No new loans are added to the pools and loans are not removed unless they are paid in full, charged-off, foreclosed-on, or sold. Cash flows received in excess of expected amounts for one pool may not be used to offset deficient payments in another pool.
 
There was no provision for loan losses related to PCI loans for the two month period ended December 31, 2010 because cash flows from the pools were not significantly different than expected.
 
Comparison of 2009 with 2008
 
WLBC’s provision for loan losses was $0 for the year ended December 31, 2009, compared with $0 for the year ended December 31, 2008. The lack of provision expense for both year ends is due to WLBC not owning a financial institution during these time periods.


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Non-Interest Income
 
Non-interest income primarily consists of loan documentation and late fees, service charges on deposits and other fees such as wire and ATM fees.
 
Comparison of 2010 with 2009
 
Non-interest income totalled $108,000 for the year ended December 31, 2010 and $0 for the year ended December 31, 2009. The $108,000 increase in non-interest income is the result of WLBC’s acquisition of Service1st on October 28, 2010. Thus, non-interest income reflects income generated on Service1st’s books for the period of October 28, 2010 through December 31, 2010.
 
Comparison of 2009 with 2008
 
Non-interest income was $0 for the year ended December 31, 2009 and $0 for the year ended December 31, 2008.
 
Non-Interest Expense
 
The following table sets for the principal elements of non-interest expenses for 2010, 2009 and 2008.
 
                         
    Years Ended December 31,  
($ In thousands)   2010(1)     2009     2008  
 
Non-interest expenses:
                       
Salaries and employee benefits
  $ 1,461     $ 72     $ 83  
Occupancy, equipment and depreciation
    269       0       0  
Computer service charges
    51       0       0  
Federal deposit insurance
    90       0       0  
Professional fees
    3,851       12,612       0  
Advertising and business development
    7       1       1,670  
Insurance
    825       301       301  
Telephone
    19       0       0  
Printing and supplies
    314       748       6  
Stock based compensation
    1,770       869       4,625  
Other
    480       434       559  
                         
Total non-interest expenses
  $ 9,137     $ 15,037     $ 7,244  
                         
 
 
(1) For the year January 1, 2010 through December 31, 2010 for WLBC and for the two months ended 2010 for Service1st.
 
Comparison of 2010 with 2009
 
Non-interest expense was $9.1 million for the year ended December 31, 2010, compared with $15.0 million for 2009. Salaries and employee benefits total $1.5 million, compared with $72,000 for 2009. The $1.4 million increase in salaries and employee benefits expense is the result of WLBC acquiring Service1st which employed 40 full time employees. Professional fees decreased $8.7 million, from $12.6 million in 2009 to $3.9 million for the year ended December 31, 2010. The $8.7 million decrease is largely due to the majority of legal, audit and consulting fees being incurred in 2009 by WLBC in connection with its acquisition of Service1st as well as WLBC’s attempt to acquire other entities. For the year ended December 31, 2010, WLBC recorded $1.8 million in stock-based compensation expense compared to $869,000 in 2009 due to WLBC’s issuance of stock in 2010.


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Comparison of 2009 with 2008
 
Non-interest expense was $15.0 million for 2009, compared with $7.2 million for 2008, an increase of $7.8 million, year over year. Professional fees increased $12.6 million due to additional legal, audit and consulting fees incurred by WLBC in connection with its pending acquisition of Service1st as well its attempt to acquire other entities.
 
Income Taxes
 
Due to WLBC incurring operating losses from inception, no provision for income taxes has been recorded since the inception of WLBC.
 
Financial Condition
 
Assets
 
Total assets stood at $257.5 million for the year ended December 31, 2010, an increase of $169.0 million, or 190.96% from $88.5 million as of December 31, 2009. The growth in total assets was principally attributable to WLBC acquiring Service1st which resulted new assets such as $106.3 million in gross loans including net deferred loan fees of $37,000, $26.9 million in certificates of deposits, $7.1 million in investment securities, $5.6 million in goodwill, $3.0 million in accrued interest receivable, while cash and cash equivalents (consisting of cash and due from banks, federal funds sold and certificates of deposits with original maturities of three months or less) increased $15.3 million.
 
Cash and Cash Equivalents
 
Cash and cash equivalents consist of cash and due from banks, federal funds sold and certificates of deposits with original maturities of three months or less. Cash and cash equivalents totalled $103.2 million for the year ended December 31, 2010 and $88.0 million at December 31, 2009. Cash and cash equivalents are managed based upon liquidity needs. The decrease reflected WLBC’s efforts to reduce its liquidity in reaction to the reductions in loan portfolio balances and growth. See “— Liquidity and Asset/Liability Management” in this section below for more information.
 
Investment Securities and Certificates of Deposits held at other Banks
 
WLBC invests in investment grade securities and certificates of deposits at other banks with original maturities exceeding three months for the following reasons: (i) such investments can be readily reduced in size to provide liquidity for loan balance increases or deposit balance decreases; (ii) they provide a source of assets to pledge to secure lines of credit (and, potentially, deposits from governmental entities), as may be required by law or by specific agreement with a depositor or lender; (iii) they can be used as an interest rate risk management tool, since they provide a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of WLBC; and (iv) they represent an alternative interest-earning use of funds when loan demand is weak or when deposits grow more rapidly than loans. Further, if and when WLBC becomes profitable, tax free investment securities can be a source of partially tax-exempt income.
 
WLBC uses two portfolio classifications for its investment securities: “Held to Maturity”, and “Available for Sale”. The Held to Maturity portfolio consists only of securities that WLBC has both the intent and ability to hold until maturity, to be sold only in the event of concerns with an issuer’s credit worthiness, a change in tax law that eliminates their tax exempt status, or other infrequent situations as permitted by generally accepted accounting principles. Accounting guidance requires Available for Sale securities to be marked to estimated fair value with an offset, net of taxes, to accumulated other comprehensive income, a component of stockholders’ equity.
 
WLBC’s investment portfolio is currently composed primarily of: (i) U.S. Government Agency securities; (ii) investment grade corporate debt securities; and (iii) collateralized mortgage obligations. For the year ended


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December 31, 2010, investment securities and certificates of deposit totalled $34.0 million, compared with $0 at December 31, 2009.
 
WLBC has not used interest rate swaps or other derivative instruments to hedge fixed rate loans or to otherwise mitigate interest rate risk.
 
The tables below summarize WLBC’s investment portfolio for the year ended December 31, 2010. Securities are identified as available-for-sale or held to maturity. Unrealized gains or losses on available-for-sale securities are recorded as accumulated other comprehensive income in stockholders’ equity. Held-to-maturity securities are carried at cost, adjusted for amortization of premiums or accretion of discounts. Amortization of premiums or accretion of discounts on mortgage-backed securities is adjusted for estimated prepayments. Securities measured at fair value are reported at fair value, with unrealized gains and losses included in current earnings.
 
                                 
    For the Year Ended December 31, 2010  
          Gross
    Gross
       
    Amortized
    Unrealized
    Unrealized
    Fair
 
(Dollars in thousands)   Cost     Gains     Losses     Value  
 
U.S. Government Agency Securities
  $     $     $     $  
Collateralized Mortgage Obligations-Commercial
    1,819                   1,819  
                                 
Total
  $ 1,819     $     $     $ 1,819  
                                 
 
                                 
    For the Year Ended December 31, 2010  
          Gross
    Gross
       
    Amortized
    Unrecognized
    Unrecognized
    Fair
 
(Dollars in thousands)   Cost     Gains     Losses     Value  
 
Investments-Held to Maturity
                               
Corporate debt securities
  $ 4,663     $ 0     $ (27 )   $ 4,636  
SBA Loan Pools
    651       0             651  
                                 
Total
  $ 5,314     $ 0     $ (27 )   $ 5,287  
                                 
 
The table below summarizes the maturity dates and investment yields on WLBC’s investment portfolio for the year ended December 31, 2010 for securities identified as available for sale or held to maturity. These securities were acquired with the October 28, 2010 acquisition, and no such securities were owned prior to that date by the Company.
 
                                                                                 
    For the Year Ended December 31, 2010  
    Due Under
    Due
                                     
    1 Year
    1-5 Years
    Due 5-10 Years
    Due Over 10 Years
    Total
 
    Amount/Yield     Amount/Yield     Amount/Yield     Amount/Yield     Amount/Yield  
 
Available for Sale
                                                                               
U.S. Government Agency Securities
  $ 0       0.00 %   $ 0       0.00 %   $ 0       0.00 %   $ 0       0.00 %   $ 0       0.00 %
Corporate Debt Securities
    0       0.00 %     0       0.00 %     0       0.00 %     0       0.00 %     0       0.00 %
Collateralized Mortgage Obligations-Commercial
    1,417       2.55 %     402       2.69 %     0       0.00 %     0       0.00 %     1,819       2.58 %
Small Business Administration Loan Pools
    0       0.00 %     0       0.00 %     0       0.00 %     0       0.00 %     0       0.00 %
                                                                                 
Total available for sale
  $ 1,417       2.55 %   $ 402       2.69 %   $ 0       0.00 %   $ 0       0.00 %   $ 1,819       2.58 %
                                                                                 
Held to Maturity
                                                                               
U.S. Government Agency Securities
  $ 0       0.00 %   $ 0       0.00 %   $ 0       0.00 %   $ 0       0.00 %   $ 0       0.00 %
Corporate Debt Securities
    3,075       7.17 %     1,561       7.00 %     0       0.00 %     0       0.00 %     4,636       7.11 %
Collateralized Mortgage Obligations-Commercial
    0       0.00 %     0       0.00 %     0       0.00 %     0       0.00 %     0       0.00 %
Small Business Administration Loan Pools
    5       3.00 %     14       4.33 %     99       2.57 %     534       2.76 %     651       2.77 %
                                                                                 
Total held to maturity
  $ 3,080       7.16 %   $ 1,575       6.98 %   $ 99       2.57 %   $ 534       2.76 %   $ 5,287       6.57 %
                                                                                 


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Loans
 
For the year ended December 31, 2010, substantially all of WLBC’s loan customers were located in Nevada.
 
The following table shows the composition of the loan portfolio in dollar amounts and in percentages, along with a reconciliation to loans receivable, net.
 
                 
($ in thousands)   December 31, 2010  
 
Loans secured by real estate:
               
Construction, land development and other land loans
  $ 5,923       5.58 %
Commercial real estate
    54,975       51.75 %
Residential
    9,247       8.71 %
                 
Total loans secured by real estate
    70,145       66.04 %
Commercial and industrial
    35,946       33.84 %
Consumer
    131       0.12 %
                 
Gross loans
    106,222       100.00 %
                 
Net deferred loan costs
    37          
                 
Gross loans, net of deferred costs
    106,259          
Less: Allowance for loan losses
    (36 )        
                 
Net loans
  $ 106,223          
                 
 
Total gross loans were $106.3 million for the year ended December 31, 2010, compared to $0 at December 31, 2009 and 2008, as a result of WLBC’s acquisition of Service1st on October 28, 2010. Gross loans, net of deferred fees and the allowance for loan losses totaled $106.3 million for the year ended December 31, 2010, as a result of a $36,000 increase in the allowance for loan losses.
 
Commercial real estate loans balances were $55.0 million, or 51.75% of total loans for the year ended December 31, 2010, commercial and industrial loans totaled $35.9 million, or 33.84% of total loans, residential real estate loans were $9.2 million, or 8.71% of total loans while construction, land development and other land loans totaled $5.9 million, or 5.58% of total loans.


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The following table presents maturity information for the loan portfolio at December 31, 2010. The table does not include prepayments or scheduled principal repayments. All loans are shown as maturing based on contractual maturities.
 
                                 
    For the Year Ended December 31, 2010  
    Due Within
    Due 1-5
    Due Over
       
    One Year     Years     Five Years     Total  
 
Loans secured by real estate:
                               
Construction, land development and other land loans
  $ 4,428     $ 1,495     $     $ 5,923  
Commercial real estate
    2,544       29,327       23,104       54,975  
Residential real estate (1 to 4 family)
    6,885       2,222       140       9,247  
                                 
Total real estate-secured loans
  $ 13,857     $ 33,044     $ 23,244     $ 70,145  
Loans not secured by real estate:
                               
Commercial and industrial
    18,975       9,297       7,674       35,946  
Consumer
    95       35       1       131  
                                 
Loans, Gross
  $ 32,927     $ 42,376     $ 30,919     $ 106,222  
                                 
Interest rates:
                               
Fixed
  $ 7,429     $ 33,867     $ 5,713     $ 47,009  
Variable
    25,498       8,509       25,206       59,213  
                                 
Loans, Gross
  $ 32,927     $ 42,376     $ 30,919     $ 106,222  
                                 
 
Concentrations
 
WLBC’s loan portfolio has a concentration of loans secured by real estate. For the year ended December 31, 2010, loans secured by real estate comprised 66.04% of total gross loans. Substantially all of these loans are secured by first liens. Approximately 30.2% of these real estate-secured loans are owner occupied for the year ended December 31, 2010. A loan is considered owner occupied if the borrower occupies at least fifty one percent of the collateral securing such loan. WLBC’s policy is to obtain collateral whenever it is available, depending upon the degree of risk WLBC is willing to accept. Repayment of loans is expected from the borrower’s cash flows or the sale proceeds of the collateral. Deterioration in the performance of the economy and real estate values in WLBC’s primary market areas has had, and is expected to continue to have, an adverse impact on collectibility of outstanding loans.
 
Interest Reserves
 
Interest reserves are generally established at the time of the loan origination as an expense item in the budget for a construction and land development loan. WLBC’s practice is to monitor the construction, sales and/or leasing progress to determine the feasibility of ongoing construction and development projects. If at any time during the life of the loan the project is determined not to be viable, WLBC generally has the ability to discontinue the use of the interest reserve and take appropriate action to protect its collateral position via negotiation and/or legal action as deemed appropriate. For the year ended December 31, 2010, WLBC had no loans with an interest reserve.
 
Nonperforming Assets
 
Nonperforming assets consist of:
 
(i) nonaccrual loans. In general, loans are placed on nonaccrual status when WLBC determines timely recognition of interest to be in doubt due to the borrower’s financial condition and collection efforts. WLBC generally discontinues accrual of interest when a loan is 90 days delinquent unless the loan is well secured and in the process of collection;


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(ii) loans past due 90 days or more and still accruing interest. Loans past due 90 days or more and still accruing interest consist primarily of loans 90 days or more past their maturity date but not their interest due date;
 
(iii) restructured loans. Restructured loans have modified terms to reduce either principal or interest due to deterioration in the borrower’s financial condition; and
 
(iv) other real estate owned, or OREO. If a bank takes title to the borrower’s real property that serves as collateral for a defaulted loan, such property is referred to as other real estate owned (“OREO”).
 
The following table summarizes nonperforming assets by category including PCI loans with no contractual interest being reported. These figures represent loan values after the fair value process was completed at October 28, 2010, adjusted for any amortization or accretion for the two months, if applicable.
 
         
    For the Year Ended
 
($’s in thousands)   December 31, 2010  
 
Nonaccrual loans:
       
Loans Secured by Real Estate
       
Construction, land development and other land loans
  $ 2,632  
Commercial real estate
    1,224  
Residential real estate (1-4 family)
    2,900  
Total loans secured by real estate
    6,756  
Commercial and industrial
    3,670  
Consumer
    0  
         
Total nonaccrual loans
    10,426  
Past due (>90days) loans and accruing interest:
       
Loans Secured by Real Estate
       
Construction, land development and other land loans
  $ 0  
Commercial real estate
    0  
Residential real estate (1-4 family)
    0  
         
Total loans secured by real estate
    0  
Commercial and industrial
    0  
Consumer
    0  
         
Total past due loans accruing interest
    0  
Restructured loans (still on accrual)(1)
    0  
         
Total nonperforming loans
  $ 10,426  
Other real estate owned (OREO)
    3,406  
         
Total nonperforming assets
  $ 13,832  
         
Non-Performing Loans as a percentage of total portfolio loans
    9.81 %
Non-Performing assets as a percentage of total assets
    4.05 %
Non-Performing assets as a percentage of total assets
    5.37 %
Allowance for loan losses as a percentage of nonperforming loans
    0.35 %
 
 
(1) For the year ended December 31, 2010, WLBC had approximately $5.9 million in loans classified as restructured loans. All of such loans were on nonaccrual.
 
For the year ended December 31, 2010, nonperforming loans totaled $10.4 million, or 9.81%, of total portfolio loans due to the Acquisition. Total nonperforming assets for the year ended December 31, 2010 were $13.8 million which is reflective of the adverse economic conditions in the Nevada market.


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The largest category of nonperforming assets is commercial and industrial loans of $3.7 million followed by residential real estate loans of $2.9 million, construction, land development and other land loans of $2.6 million and commercial real estate loans of $1.2 million. These balances are reflective of the adverse economic conditions in the Nevada market. With many real estate projects requiring an extended time to market, many of WLBC’s borrowers have exhausted their liquidity and stopped making payments, thereby requiring WLBC to place the loans on nonaccrual. Given the current economic conditions in Nevada, WLBC has effectively stopped making commercial real estate loans and construction, land development and other land loans (except for contractually required disbursements under existing facilities) unless borrowers can provide strong financial support outside the project under development.
 
Potential Problem Loans
 
WLBC classifies its loans consistent with federal banking regulations using a ten category grading system. The loans discussed in the following table have been recorded at fair value as discussed in Note 5 of WLBC’s financial statements and presents information regarding potential problem loans, which are graded but still performing as of the dates indicated. These graded loans are referred to in applicable banking regulations as “Other Loans Especially Mentioned”, “Substandard”, “Doubtful”, and “Loss”. These loan grades are described in further detail in the section entitled “Information Related to WLBC — Potential Problem Loans”.
 
                                 
    For the Year Ended December 31, 2010  
    # of
    Loan
          Percent of
 
    Loans     Balance     %     Total Loans  
 
Construction, land development and other land loans
    3     $ 1,997       16.12 %     1.88 %
Commercial real estate
    5       6,042       48.78 %     5.69 %
Residential real estate (1-4 family)
    1       2,357       19.03 %     2.22 %
Commercial and industrial
    15       1,990       16.07 %     1.87 %
Consumer
    0       0       0.00 %     0.00 %
                                 
Total Loans
    24     $ 12,386       100 %     11.66 %
                                 
 
WLBC’s potential problem loans consisted of 24 loans and totaled approximately $12.4 million for the year ended December 31, 2010. The problem loans presented above are the result of a difficult economic environment in the markets WLBC operates. Commercial real estate comprises approximately 48.78% of the total aggregate balance of potential problem loans for the year ended December 31, 2010. Construction, land development and other land loans comprise approximately 16.12% of the total balance of potential problem loans for the year ended December 31, 2010. Commercial and industrial loans comprise approximately 16.07% of the total aggregate balance of potential problem loans for the year ended December 31, 2010. Residential real estate loans comprise approximately 19.03% of the total balance of potential problem loans for the year ended December 31, 2010.
 
Impaired Loans
 
A loan is impaired when it is probable that WLBC will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans have been recorded at fair value as discussed in Note 5 of WLBC’s financial statements and are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are either included in the allowance for loan losses or charged off WLBC’s books, if deemed necessary.
 
The categories of nonaccrual loans and impaired loans overlap, although they are not coextensive. WLBC considers all circumstances regarding the loan and borrower on an individual basis when determining whether a loan is impaired such as the collateral value, reasons for the delay, payment record, the amount past due, and number of days past due.


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At December 31, 2010, the aggregate total amount of loans classified as impaired, was $11.4 million. The total specific allowance for loan losses related to these loans was $0 for the year ended December 31, 2010. The increase in total impaired loans reflects the overall decline in economic conditions in Nevada.
 
At December 31, 2010, WLBC had approximately $5.4 million in loans classified as restructured loans. Five of the seven loans were on accrual status as of December 31, 2010. The following is a summary of these loans, even though they are fair valued at October 28, 2010:
 
A $550,000 unsecured line of credit to an individual for business investment purposes and classified as a commercial and industrial loan was restructured in May 2010. A restructured loan was approved and put in place which included a reduced monthly payment. The borrower has been cooperative and is making payments as agreed. At December 31, 2010 the balance on the unsecured line of credit was $125,000.
 
A $2.3 million commercial real estate loan, which was secured by a tavern/bar, was restructured in July 2010. The restructure deferred past due interest payments to the end of the note term and reduced principal and interest payments beginning in April 2011 for the next twelve months. At December 31, 2010, the outstanding balance on this restructured loan was $1.2 million.
 
A $4.1 million land loan which is secured by 12.0 acres of vacant land was restructured. The borrower was an investment limited liability company (LLC) supported by a guarantor. The guarantor indicated that the LLC was unable to sell the property or continue to service the debt. WLBC agreed to a restructure of this loan. At December 31, 2010, the outstanding balance on this restructured loan was $1.1 million and the borrower is paying as agreed.
 
Four related loans to the same borrower were restructured in June 2010. The loans consist of two commercial and industrial loans totaling $650,000 that were related to the borrower’s medical practice and two real estate-secured loans totaling $5.4 million, consisting of a $3.2 million loan on the property in which the borrower’s medical office is located and a $2.2 million loan for the purchase of a medical office building for lease. The borrower had already defaulted on several single family residential properties, demonstrating to WLBC his financial weakness and inability to service all of his obligations. Given the borrower’s financial deterioration, WLBC agreed to a reduction in monthly payments of the combined credits. At December 31, 2010, the outstanding balance was $3.0 million.
 
The breakdown of total impaired loans, which have been recorded at fair value as discussed in Note 5 of WLBC’s financial statements, and the related specific reserves for the year ended December 31, 2010 is as follows:
 
                                                 
    For the Year Ended December 31, 2010  
    Impaired
          Percent of
    Reserve
          Percent of Total
 
($ in thousands)   Balance     %     Total Loans     Balance     %     Allowance  
 
Construction, land development and other land loans
  $ 3,220       28.15 %     3.03 %   $ 0       0.00 %     0.00 %
Commercial real estate
    1,648       14.41 %     1.55 %     0       0.00 %     0.00 %
Residential real estate (1-4 family)
    2,900       25.35 %     2.73 %     0       0.00 %     0.00 %
Commercial and industrial
    3,670       32.09 %     3.46 %     0       0.00 %     0.00 %
Consumer
    0       0.00 %     0.00 %     0       0.00 %     0.00 %
                                                 
Total impaired loans
  $ 11,438       100.00 %     10.77 %   $ 0       0.00 %     0.00 %
                                                 
 
The amount of interest income recognized on impaired loans for the two months ended December 31, 2010 was approximately $39,000.


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Allowance for Loan Losses
 
The following table presents the activity in WLBC’s allowance for loan losses for 2010.
 
Analysis of loss experience by loan type
 
         
    For the Year Ended
 
($’s in thousands)   December 31, 2010  
 
Allowance for Loan and Lease Loss:
       
Balance at the beginning of the year
  $ 0  
Provisions charged to operating expenses
    36  
Recoveries of loans previously charged off:
       
Construction, land development and other land loans
    0  
Commercial real estate
    0  
Residential real estate (1-4 family)
    0  
Commercial and industrial
    0  
Consumer
    0  
         
Total recoveries
    0  
         
Loans charged-off:
       
Construction, land development and other
    0  
Commercial
    0  
Residential (including multi-family)
    0  
Commercial and industrial
    0  
Consumer
    0  
         
Total charged-off
    0  
         
Net charge-offs
    0  
         
Balance at end of year
  $ 36  
         
Net Charge-offs to average loans outstanding
    0.00 %
Allowance for Loan Loss to outstanding loans
    0.03 %
 
The accounting principles used by WLBC in maintaining the allowance for loan losses are discussed in the section entitled “Critical Accounting Policies — Allowance for Loan Losses.” The allowance is maintained at a level management believes to be adequate to absorb estimated future credit losses inherent in WLBC’s loan portfolio, based on evaluation of the collectibility of the loans, prior credit loss experience, credit loss experience of other banks and other factors deemed relevant.
 
In accordance with current accounting standards, the allowance for loan losses was eliminated as part of the purchase accounting. The allowance is required to cover probable losses in new loans generated since October 28, 2010 and for any subsequent deterioration of loans beyond the fair value determined on October 28, 2010. Management will closely monitor the loans existing at October 28, 2010 and establish applicable allowance levels for new loans.
 
The allowance for loan losses is established through a provision for loan losses charged to operations and is increased by the collection of monies on loans previously charged off (recoveries) and reduced by loans that are charged off. Service1st’s board of directors reviews the adequacy of the allowance for loan losses on a monthly basis. The allowance of $36,000 discussed in the table above is required based on loan growth in November and December 2010. All loans at date of acquisition were recorded at fair value as discussed in Note 5 of WLBC’s financial statements. Thus, for the year ended December 31, 2010, WLBC had established an allowance of $36,000, after increasing the allowance by $36,000 in provisions and recording no recoveries or charge-offs. The allowance for loan loss to outstanding loans is 0.03% for the year ended December 31,


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2010, reflecting a very minimal deterioration in the loan portfolio after it was marked to market due to the acquisition of Service1st by WLBC.
 
WLBC’s methodology for the allowance for loan losses incorporates several quantitative and qualitative risk factors used to establish the appropriate allowance for loan loss at each reporting date. Quantitative factors include delinquency and charge-off trends, collateral values, the composition, volume and overall quality of the loan portfolio (including outstanding loan commitments), changes in nonperforming loans, concentrations and information about individual loans. Historical loss experience is an important quantitative factor for many banks, but thus far less so for WLBC, because it has been in operation for just over three years. Qualitative factors include the economic condition of WLBC’s operating markets. Specific changes in the risk factors are based on perceived risk of similar groups of loans classified by collateral type and purpose. Statistics on local trends and peers are also incorporated into the allowance. While WLBC management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary, if there are significant changes in economic or other conditions. In addition, the FDIC and the Nevada FID, as an integral part of their examination processes, review WLBC’s allowances for loan losses, and may require additions to WLBC’s allowance based on their judgment about information available to them at the time of their examinations. WLBC reviews the assumptions and formula used in determining the allowance and makes adjustments, if required to reflect the current risk profile of the portfolio.
 
When WLBC determines that it is unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement, the loan becomes impaired. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses or charged off WLBC’s books, if deemed necessary.
 
WLBC’s loan portfolio has a concentration of loans in commercial real-estate related loans and includes significant credit exposure to the commercial real estate industry. The specific reserves for collateral dependent impaired loans are based on the fair value of the collateral less estimated selling costs (including brokerage fees) and other miscellaneous costs that may be incurred to make the collateral more marketable (such as clean-up costs) and to cure past due amounts (such as delinquent property taxes). The fair value of collateral is determined based on third-party appraisals. See “Information Related to WLBC Bank of Nevada — Allowance for Loan Losses” for more information. In some cases, adjustments are made to the appraised values due to known changes in market conditions or known changes in the collateral.
 
WLBC’s management believes that the allowance for the year ended December 31, 2010 and the methodology utilized in deriving that level are adequate to absorb known and inherent risks in the loan portfolio. However, credit quality is affected by many factors beyond WLBC’s control, including local and national economies, and facts may exist which are not currently known to WLBC that adversely affect the likelihood of repayment of various loans in the loan portfolio and realization of collateral upon default. Accordingly, no assurance can be given that WLBC will not sustain loan losses materially in excess of the allowance for loan losses. In addition, the FDIC, as a major part of its examination process, reviews the allowance for loan losses and could require additional provisions to be made. The allowance is based on estimates, and actual losses may vary from the estimates. However, as the volume of the loan portfolio grows, additional provisions will be required to maintain the allowance at adequate levels. No assurance can be given that continuing adverse economic conditions or unforeseen events will not lead to increases in delinquent loans, the provision for loan losses and/or charge-offs.


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The following table presents the allocation of WLBC’s allowance for loan losses by loan category and percentage of loans in each category to total loans as of the dates indicated.
 
Allocation of the allowance and percentage of allowance by loan type. The allowance of $36,000 discussed in the table below is required based on loan growth in November and December 2010. All loans at date of acquisition were recorded at fair value as discussed in Note 5 of WLBC’s financial statements.
 
                 
    For the Year Ended December 31, 2010  
($’s in thousands)   Amount     % of loans  
 
Allowance for Loan and Lease Loss:
               
Loans Secured by Real Estate
               
Construction, land development and other land loans
  $ 0       5.58 %
Commercial real estate
    0       51.75 %
Residential real estate (1-4 family)
    0       8.71 %
                 
Total loans secured by real estate
    0       66.04 %
Commercial and industrial
    36       33.84 %
Consumer
    0       0.12 %
                 
Total allowance for loan loss
    36       100 %
                 
 
The commercial and industrial loan category had provision expense of $36,000 for the year ended December 31, 2010. There were no charge-offs or recoveries noted in 2010.
 
Deferred Tax Asset
 
For the year ended December 31, 2010 and year ended December 31, 2009, a valuation allowance for the entire net deferred tax asset was considered necessary as WLBC determined it was not more likely than not that the deferred tax asset would be realized. Federal operating loss carry forwards begin to expire in 2027.
 
Internal Revenue Code Section 382 places a limitation on the amount of taxable income that can be offset by net operating loss carry forwards after a change in control (generally greater than 50% change in ownership) of a loss corporation. Accordingly, utilization of net operating loss carry forwards may be subject to an annual limitation regarding their utilization against future taxable income upon a change in control.
 
Deposits
 
WLBC’s activities are primarily based in Nevada and its deposit base is also primarily generated from this geographic region. Deposits have historically been the primary source for funding WLBC’s asset growth.
 
During the last two months of 2010, WLBC sought to decrease the rates on its deposit base in order to increase its net interest income, interest rate spread and net interest margin. Deposits totaled $160.3 million at December 31, 2010, up from $0 as of December 31, 2009 due to the acquisition of Service1st. Time deposits increased $35.4 million from December 31, 2009 to December 31, 2010 while money market accounts increased $24.7 million from December 31, 2009 to December 31, 2010. Overall rates on interest-bearing deposit accounts were 3.00%, for the year ended December 31, 2010, however, the calculation of this rates takes into consideration only two months of expense, due to the acquisition of Service1st on October 28, 2010, while the average balance for this same period of time is divided by four quarters when only one quarter of the year, quarter ended December 31, 2010 contained a balance. Interest expense totaled $115,000 for the year ended December 31, 2010. The overall increase in total deposits of 100.00% is reflective of WLBC acquiring Service1st on October 28, 2010.


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The following table reflects the summary of deposit categories by dollar and percentage for the year ended December 31, 2010:
 
                 
    December 31, 2010  
($’s in thousands)   Amount     % of Total  
 
Non-interest-bearing deposits
  $ 67,087       41.85 %
Interest-bearing deposits
    31,837       19.86 %
Money Markets
    24,672       15.39 %
Savings
    1,273       0.79 %
Time deposits under $100,000
    4,919       3.07 %
Time deposits $100,000 and over
    30,498       19.03 %
                 
Total Deposits
  $ 160,286       100.00 %
                 
 
Certificates of deposits of $100,000 or more for the year ended December 31, 2010 and December 31, 2009 totaled $30.5 million and $0, respectively. These deposits are generally more rate sensitive than other deposits and are more likely to be withdrawn to obtain higher yields elsewhere, if available. Scheduled maturities of certificates of deposits in amounts of $100,000 or more at December 31, 2010 were as follows:
 
Certificates of Deposit Maturities > $100,000
 
         
($’s in thousands)   Amount  
 
Three months or less
  $ 1,671  
Over three months to six months
    3,504  
Over six months to twelve months
    25,323  
Over 12 months
    0  
         
Total
  $ 30,498  
         
 
Capital Resources
 
The current and projected capital position of WLBC and the impact of capital plans on long term strategies are reviewed regularly by management. WLBC’s capital position represents the level of capital available to support continuing operations and expansion.
 
WLBC is subject to certain regulatory capital requirements mandated by the FDIC and generally applicable to all banks in the United States. For more information, see the section entitled “Supervision and Regulation.” Failure to meet minimum capital requirements can result in restrictions on activities (including restrictions on the rates paid on deposits), and otherwise may cause federal or state bank regulators to initiate enforcement and/or other action against WLBC. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet item as calculated under regulatory accounting practices. WLBC’s capital amounts and classifications are also subject to qualitative judgments by the FDIC about components, risk weightings and other factors. In accordance with Service1st’s consent order dated September 1, 2010, WLBC must maintain its Tier 1 capital in such an amount to ensure that its leverage ratio equals or exceeds 8.5%.
 
On September 1, 2010, Service1st, without admitting or denying any possible charges relating to the conduct of its banking operations, agreed with the FDIC and the Nevada FID to the issuance of a Consent Order. The Consent Order supersedes a Memorandum of Understanding entered into by Service1st with the FDIC and Nevada FID in May of 2009. Under the Consent Order, Service1st has agreed, among other things, to: (i) assess the qualification of, and have retained qualified, senior management commensurate with the size and risk profile of Service1st; (ii) maintain a Tier I leverage ratio at or above 8.5% (as of December 31, 2010, Service1st’s Tier I leverage ratio was at 18.1%) and a total risk- based capital ratio at or above 12% (as of


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December 31, 2010, Service1st’s total risk-based capital ratio was at 31.0%); (iii) continue to maintain an adequate allowance for loan and lease losses; (iv) not pay any dividends without prior bank regulatory approval; (v) formulate and implement a plan to reduce Service1st’s risk exposure to adversely classified assets; (vi) not extend additional credit to any borrower whose loan has been charged-off or classified “loss”; (vii) not extend any additional credit to any borrower whose loan has been classified as “substandard” or “doubtful” without prior approval from Service1st’s board of directors or loan committee; (viii) formulate and implement a plan to reduce risk exposure to its concentration in commercial real estate loans in conformance with Appendix A of Part 365 of the FDIC’s Rules and Regulations; (ix) formulate and implement a plan to address profitability; and (x) not accept brokered deposits (which includes deposits paying interest rates significantly higher than prevailing rates in Service1st’s market area) and reduce its reliance on existing brokered deposits, if any.
 
WLBC became a bank holding company on October 28, 2010 with the consummation of the acquisition of Service1st. As of December 31, 2010, WLBC’s capital was $93.8 million, which WLBC deems adequate to support continuing operations and growth. As a de novo bank, Service1st is required to maintain a Tier 1 capital leverage ratio of not less than 8.0% during Service1st’s first seven years of operations. WLBC’s capital ratios at December 31, 2010, relative to the ratios require of “well-capitalized” banks under the prompt corrective action regime put in place by federal banking regulations, are as follows:
 
                         
            “To Be Well
            Capitalized
            Under
            Regulatory
Capital Ratios:   WLBC   Service1st   Agreement”
 
Tier 1 equity to average assets
    30.5 %     18.1 %     10.0 %
Tier 1 risk-based capital ratio
    68.4 %     30.6 %     6.0 %
Total risk-based capital ratio
    68.8 %     31.0 %     12.0 %
 
The acquisition of Service1st by WLBC was consummated at close of business on October 28, 2010. Per the Merger Agreement, WLBC injected an additional $25 million of capital into Service1st. As a commitment made to the FDIC during acquisition application processing, we also agreed to maintain the Tier 1 leverage capital ratio of Service1st at 10% or greater until October 28, 2013 or, if later, when the September 1, 2010 Consent Order agreed to by Service1st with the FDIC and the Nevada Financial Institutions Division terminates.
 
Liquidity and Asset/Liability Management
 
Liquidity management refers to WLBC’s ability to provide funds on an ongoing basis to meet fluctuations in deposit levels as well as the credit needs and requirements of its clients. Both assets and liabilities contribute to WLBC’s liquidity position. Lines of credit with the regional Federal Reserve Bank and FHLB, as well as short term investments, increases in deposits and loan repayments all contribute to liquidity while loan funding, investing and deposit withdrawals decrease liquidity. WLBC assesses the likelihood of projected funding requirements by reviewing current and forecasted economic conditions and individual client funding needs.
 
WLBC’s sources of liquidity consists of cash and due from correspondent banks, overnight funds sold to correspondents and the Federal Reserve Bank, certificates of deposits at other financial institution (non-brokered), unpledged security investments and lines of credit with the Federal Reserve Bank of San Francisco and FHLB of San Francisco. For the year ended December 31, 2010, WLBC had approximately $103.2 million in cash and cash equivalents, approximately $26.9 million in certificates of deposits at other financial institutions, with maturities of one year or less. In addition, WLBC had $2.5 million in unpledged security investments, of which $1.8 million is classified as available for sale, while the remaining $652,000 is classified as held to maturity. WLBC also has a $4.0 million collateralized line of credit with the Federal Reserve Bank of San Francisco and a $18.0 million collateralized line of credit with the Federal Home Loan Bank of San Francisco. Both the $4.0 million line of credit with the Federal Reserve of San Francisco and the $18.0 million line of credit with the Federal Home Loan Bank have a zero balance.


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Liquidity is also affected by portfolio maturities and the effect of interest rate fluctuations on the marketability of both assets and liabilities. WLBC can sell any of its unpledged securities held in the available for sale category to meet liquidity needs. These securities are also available to pledge as collateral for borrowings, if the need should arise.
 
WLBC’s management believes the level of liquid assets and available credit facilities are sufficient to meet current and anticipated funding needs during the next twelve months. In addition, Service1st Bank’s Asset/Liability Management Committee oversees Service1st Bank’s liquidity position by reviewing a monthly liquidity report. While management recognizes that Service1st may use some of its existing liquidity to issue loans during the next twelve months, it is not aware of any trends, demands, commitments, events or uncertainties that are reasonably likely to impair WLBC’s liquidity.
 
Off-Balance Sheet Arrangements
 
In the normal course of business, WLBC is a party to financial instruments with off-balance-sheet risk. These financial instruments include commitments to extend credit and letters of credit. To varying degrees, these instruments involve elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position.
 
                         
    At December 31,
    2010   2009   2008
    ($ in thousands)
 
Commitments to extend credit
  $ 18,504       0       0  
Standby commercial letters of credit
    590       0       0  
 
WLBC maintains an allowance for unfunded commitments, based on the level and quality of WLBC’s undisbursed loan funds, which comprises the majority of WLBC’s off-balance sheet risk. For the year ended December 31, 2010 and December 31, 2009, the allowance for unfunded commitments was approximately $372,000 and $0, respectively.
 
Management is not aware of any other material off-balance sheet arrangements or commitments outside of the ordinary course of WLBC’s business.
 
Contractual Obligations
 
The following table is a summary of WLBC’s contractual obligations as of December 31, 2010, by contractual maturity date for the next five years.
 
                                                 
          Payments Due by Year  
($s in thousands)         Less Than
    1-3
    3-5
    After
 
Contractual Obligations   Total     1 Year     Years     Years     5 Years  
 
        Long Term Borrowed Funds   $ 0     $ 0     $ 0     $ 0     $ 0  
        Capital Lease Obligations     0       0       0       0       0  
        Operating Lease Obligations     2,096       910       1,186       0       0  
        Purchase Obligations     0       0       0       0       0  
        Other Long Term Liabilities     0       0       0       0       0  
                                                 
            $ 2,096     $ 910     $ 1,186     $ 0     $ 0  
                                                 
 
Quantitative and Qualitative Disclosures About Market Risk
 
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. These changes may be the result of various factors, including interest rates, foreign exchange rates, commodity prices and/or equity prices. As a financial institution, WLBC’s primary component of market risk is interest rate volatility. Net interest income is the primary component of WLBC’s net income, and fluctuations in interest rates will ultimately affect the level of both income and expense recorded on a large portion of WLBC’s assets and liabilities. In addition to directly impacting net interest income, changes


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in the level of interest rates can also affect (i) the amount of loans originated and sold by WLBC, (ii) the ability of borrowers to repay adjustable or variable rate loans, (iii) the average maturity of loans, (iv) the rate of amortization of premiums paid on securities, (v) the fair value of WLBC’s saleable assets, (vi) the amount of unrealized gains and losses on securities available for sale, the volume of interest bearing non-maturity deposits and (vii) the early withdrawal likelihood of customer originated certificates of deposit.
 
Interest rate risk occurs when assets and liabilities re-price at different times as interest rates change. In general, the interest that WLBC earns on its assets and pays on its liabilities is established contractually for a specified period of time. Market interest rates change over time and if a financial institution cannot quickly adapt to changes in interest rates, it may be exposed to volatility in earnings. For instance, if WLBC were to fund long-term fixed rate assets with short-term variable rate deposits, and interest rates were to rise over the term of the assets, the short-term variable deposits would rise in cost, adversely affecting net interest income. Similar risks exist when rate sensitive assets (for example, prime rate based loans) are funded by longer-term fixed rate liabilities in a falling interest rate environment.
 
WLBC manages its mix of assets and liabilities with the goals of limiting its exposure to interest rate risk, ensuring adequate liquidity, and coordinating its sources and uses of funds while maintaining an acceptable level of net interest income given the current interest rate environment. WLBC’s primary source of funds has been retail deposits, consisting primarily of interest-bearing checking accounts and time deposits. WLBC’s management believes retail deposits, unlike brokered deposits, reduce the effects of interest rate fluctuations because they generally represent a more stable source of funds. WLBC has no brokered deposits. WLBC also maintains availability of lines of credit from the FHLB of San Francisco and the Federal Reserve Bank of San Francisco as additional sources of funds, but has not drawn on them. Borrowings under these lines generally have a long-term to maturity than retail deposits.
 
WLBC also uses interest rate “floors,” ranging from 5.5% to 8.5%, on a majority of its prime-rate based loans to protect against a loss of net interest income that would result from a decline in interest rates. At December 31, 2010, approximately 43% of WLBC’s loans are indexed to the national prime rate. Currently the prime rate is under the applicable floor rate for substantially all of WLBC’s prime-rate based loans. WLBC’s net interest income may be adversely impacted, if the prime rate were to increase but remain below the applicable floor rate since any such increase may result in an increase in WLBC’s interest expenses without an increase in WLBC’s interest income derived from such prime-rate based loans until the prime rate exceeds the applicable floor rate.
 
WLBC has an interest rate risk management system that captures material sources of interest rate risk and generates reports for senior management and the board of directors. WLBC board establishes interest rate risk management policies that govern the measurement and control of interest rate risk. The asset/liability management committee provides oversight of WLBC’s interest rate risk management. The Chief Financial Officer is responsible for day-to-day management of WLBC’s interest rate sensitivity position and examines the potential impact of differing interest rate scenarios. Key measurements include, but are not limited to, traditional gap ratios, earnings at risk, economic value of equity, net interest margin trends relative to peer banks and performance relative to market interest rate cycles.
 
Risk tolerance limits are set based on net profit impact of instantaneous and sustained interest rate shocks of +/- 100 basis points, with quarterly measures of shocks up 300 basis points and down 200 basis points. The effect of interest rate shocks on WLBC’s economic value of equity will also be considered. WLBC’s interest rate risk model is back-tested to ensure integrity of key assumptions and to compare actual results after significant rate changes to predicted results. Applicable measurements are reviewed for consistency with WLBC’s target aggregates and for indication of actual or potential adverse trends. Interest rate risk management reports are prepared quarterly and back-tested as market conditions warrant.
 
The computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, asset prepayments and deposit decay, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions WLBC may undertake in response to changes in interest rates. Actual amounts may differ from the projections set forth below should market conditions vary from underlying assumptions.


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December 31, 2010
Sensitivity of Net Interest Income
 
                 
          Percentage
 
    Adjusted Net
    Change
 
Interest Rate Scenario   Interest Income     from Base  
    (Dollars in thousands)  
 
Up 300 basis points
  $ 10,749       5.25 %
Up 200 basis points
    10,559       3.39 %
Up 100 basis points
    10,374       1.58 %
BASE
    10,213       0.00 %
Down 100 basis points
    10,069       −1.41 %
Down 200 basis points
    9,637       −5.63 %
 
SELECTED HISTORICAL FINANCIAL INFORMATION — SERVICE1ST BANK OF NEVADA
 
Service1st’s balance sheet data for the period ended October 28, 2010, and years ended December 31, 2009 and December 31, 2008 and related statements of operations, changes in shareholders’ equity and cash flows for the period ended October 28, 2010 and each of the years ended December 31, 2009 and December 31, 2008, are derived from Service1st’s audited financial statements, which are included elsewhere in this Form 10-K.
 
This information should be read together with Service1st’s audited financial statements and related notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Service1st Bank of Nevada” and other financial information included elsewhere in this Form 10-K. The historical results included below and elsewhere in this Form 10-K are not indicative of the future performance of Service1st.
 
Selected Financial Data of Service1st
 
Set forth below are selected financial data of Service1st for the period ended October 28, 2010 and years ended December 31, 2009 and 2008. You should read this information in conjunction with Service1st’s audited financial statements and notes to the financial statements included elsewhere in this Form 10-K.
 
SERVICE1ST BANK OF NEVADA
SELECTED FINANCIAL DATA
 
                         
    Period Ended October 28, 2010 and Years Ended 2009 and 2008  
    2010(3)     2009     2008  
    ($ in thousands except per share data)  
 
Selected Results of Operations Data:
                       
Interest income
  $ 6,620     $ 9,043     $ 8,497  
Interest expense
    1,147       2,676       2,022  
                         
Net interest income
    5,473       6,367       6,475  
Provision for loan losses
    6,329       15,666       3,670  
                         
Net interest (loss) income after provision for loan losses
    (856 )     (9,299 )     2,805  
Non-interest income
    507       514       341  
Non-interest expense
    8,368       8,593       8,263  
                         
Net Loss
  $ (8,717 )   $ (17,378 )   $ (5,117 )
                         
Per Share data:
                       
Net loss per common share
  $ (175.00 )   $ (342.86 )   $ (100.70 )
Book Value
  $ 330.01     $ 492.24     $ 832.80  


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    Period Ended October 28, 2010 and Years Ended 2009 and 2008  
    2010(3)     2009     2008  
    ($ in thousands except per share data)  
 
Selected Balance Sheet Data:
                       
Total Assets
  $ 179,956     $ 211,760     $ 159,494  
Cash and cash equivalents
    15,091       49,633       9,987  
Certificates of deposit(4)
    31,928       9,313       0  
Investment securities
    10,432       17,635       11,740  
Gross loans, including net deferred loan fees
    125,404       136,967       137,216  
Allowance for loan losses
    9,418       6,404       2,883  
Deposits
    162,066       185,320       109,891  
Stockholders’ equity
    16,438       24,519       42,316  
Performance Ratios:
                       
Net interest margin(1)
    3.24 %     3.22 %     4.59 %
Efficiency ratio(2)
    139.93 %     124.88 %     121.25 %
Return on average assets
    (4.98 )%     (8.48 )%     (3.52 )%
Return on average equity
    (46.72 )%     (43.24 )%     (11.12 )%
Asset Quality:
                       
Nonperforming loans
  $ 20,326     $ 7,799     $ 3,434  
Allowance for loan losses as a percentage of nonperforming loans
    46.34 %     82.11 %     83.95 %
Allowance for loan losses as a percentage of portfolio loans
    7.51 %     4.68 %     2.10 %
Nonperforming loans as a percentage of total portfolio loans
    16.21 %     5.69 %     2.50 %
Nonperforming loans as a percentage of total assets
    12.63 %     3.68 %     2.15 %
Net charge-offs to average portfolio loans
    2.54 %     8.43 %     1.44 %
Capital Ratios:
                       
Average equity to average assets
    10.66 %     19.60 %     31.62 %
Tier 1 equity to average assets
    8.70 %     10.95 %     25.78 %
Tier 1 Risk-Based Capital ratio
    12.80 %     16.28 %     28.21 %
Total Risk-Based Capital ratio
    14.10 %     17.57 %     29.48 %
 
 
(1) Net interest margin represents net interest income as a percentage of average interest-earning assets.
 
(2) Efficiency ratio represents non-interest expenses as a percentage of the total of net interest income plus non-interest income.
 
(3) Service1st was acquired in 100% stock exchange on October 28, 2010. Thus, the 2010 data represents a partial year.
 
(4) Certificates of deposit issued by other banks with original maturities greater than three months.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — SERVICE1ST BANK OF NEVADA
 
The following discussion and analysis should be read in conjunction with Service1st’s audited financial statements and notes to the financial statements included elsewhere in this Form 10-K. This discussion and analysis contains forward-looking statements that involve risk, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth under “Cautionary Note Regarding Forward-Looking Statements” may cause actual results to differ materially from those projected in the forward-looking statements.

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Overview
 
Business of Service1st
 
Service1st was formed on November 3, 2006 and commenced operations as a commercial bank on January 16, 2007 under a state charter from the Nevada FID and with federal deposit insurance from the FDIC. Service1st was initially capitalized with $50 million raised in a private placement. At October 28, 2010, Service1st had total assets of $180.0 million, total gross loans of $125.4 million and total deposits of $162.1 million.
 
As a traditional community bank, operating from its headquarters and two retail banking locations in the greater Las Vegas area, Service1st provides a variety of loans to its customers, including commercial real estate loans, construction and land development loans, commercial and industrial loans, Small Business Administration (“SBA”) loans, and to a lesser extent consumer loans. As of October 28, 2010, loans secured by real estate constituted 65.77% of Service1st’s loan portfolio. Service1st relies on locally-generated deposits to provide Service1st with funds for making loans. The overwhelming majority of its business is generated in the Nevada market.
 
Service1st generates substantially all of its revenue from interest on loans and investment securities and service fees and other charges on customer accounts. This revenue is offset by interest expense paid on deposits and other borrowings and non-interest expense such as administrative and occupancy expenses. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as customer deposits and other borrowings used to fund those assets. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities and the level of nonperforming assets combine to affect net interest income.
 
Service1st receives fees from its deposit customers in the form of service fees, checking fees and other fees. Other services such as safe deposit and wire transfers provide additional fee income. Service1st may also generate income from time to time from the sale of investment securities. The fees collected by Service1st are found under “Non-interest Income” in the statements of operations contained within Service1st’s audited financial statements for the period ended October 28, 2010 (which are included elsewhere in this Form 10-K). Offsetting these earnings are operating expenses referred to as “Non-Interest Expense” in the statements of operations. Because banking is a very people intensive industry, the largest operating expense is employee compensation and related expenses.
 
Local Economic Conditions
 
According to the National Bureau of Economic Research, the United States economy entered into the longest and most severe recession in the post-war year beginning in December of 2007. The recession and continued economic downturn have been deeply felt in the greater Las Vegas area. Beginning in 2008, job losses, declining real property values, low consumer and business confidence levels and increasing vacancy and foreclosure rates for commercial and residential property dramatically affected the Las Vegas economy. According to a monthly report produced by The Center for Business & Economic Research at the University of Nevada Las Vegas (the “CBER Report”), the local unemployment rate in Las Vegas rose from 5.6% as of December 31, 2007, to 9.1% as of December 31, 2008, to 13.1% at December 31, 2009 and to 14.9% at December 31, 2010. In addition, new home sales decreased 53.4% from December 2007 to December 2008, falling a further 25.7% from December 2008 to December 2009 and down 27.3% from December 2009 to December 2010. During the same year, median new home prices decreased 21.7% from December 2007 to December 2008, decreased 11.2% from December 2008 to December 2009 and decreased 0.3% from December 2009 to December 2010. Although new home sales decreased by 27.3% for the year ended December 31, 2010 compared to the same year in 2009, median new home prices continued to decrease by 0.3% for the year ended December 31, 2010 compared to the same year in 2009. The national recession also adversely affected tourism and Las Vegas’ critical gaming industry. According to the CBER Report, Las Vegas area gaming revenues decreased 18.4% from December 2007 to December 2008, decreased 2.4% from December 2008 to December 2009, and decreased 4.7% for the year ended December 31, 2010 compared to same year for 2009. Data derived from The Applied Analysis, Las Vegas Market Reports (2nd quarter


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2010) shows that Las Vegas vacancy rates for office, industrial and retail space rose from December 31, 2007 to December 31, 2008 to December 31, 2009 to December 31, 2010: office — from 13.6%, to 17.3%, to 23.0%, to 24.2%; industrial — from 6.6%, to 8.9%, to 13.7%, to 16.9%; and retail — from 4.0%, to 7.4%, to 10.0%, to 10.2%.
 
Summary of Results of Operations and Financial Condition
 
Since formation at the beginning of 2007, Service1st has not been profitable. To some extent, the lack of profitability is attributable to the start-up nature of its business: time is required to build assets sufficient to generate enough interest income to cover operating expenses. However, in addition to the customary challenges of building profitability for a start-up bank, Service1st has experienced deterioration in the quality of its loan portfolio, largely as a result of the challenging economic conditions in the Las Vegas market.
 
For the period ended October 28, 2010, Service1st recorded a net loss of $8.7 million or $175.00 per common share, as compared with a net loss of $17.4 million or $342.86 per common share in 2009 and a loss of $5.1 million or $100.70 per common share in 2008. The $8.7 million decrease in net loss for the period ended October 28, 2010, when compared to the period ended December 31, 2009, was the result of a $9.3 million decrease in the provision for loan losses. The provision expense was $6.3 million for the period end October 28, 2010, compared to $15.7 million in 2009, and $3.7 million in 2008. The $9.3 million decrease in provision for loan losses for the period ended October 28, 2010 versus the twelve months ended December 31, 2009 is the result of $8.2 million in fewer loan charges offs in Service1st’s loan portfolio. The total amount of loans charged off was $3.9 million for the period end October 28, 2010, compared to $12.2 million in 2009, and $1.7 million in 2008. These numbers indicate a substantial turn around in the deterioration of the loan portfolio which can be seen in the progression of the percentage of net charge-offs to average loans outstanding, which was 2.54% for the period ended October 28, 2010, 8.43% at December 31, 2009, compared with 1.44% at December 31, 2008.
 
Net interest income was adversely impacted in 2010, and to a lesser extent in 2009 and 2008, by the increase in nonaccrual loans. With many real estate projects requiring an extended time to market, some borrowers have exhausted their liquidity and ceased making payments on their loans, which has required Service1st to place their loans on nonaccrual status. Service1st’s nonaccrual loans increased to 16.21% total portfolio loans for the period ended October 28, 2010 as compared to 5.69% at year end 2009, and were 2.50% at year end.
 
The allowance for loan and lease losses has grown steadily since inception of the bank, as a result of the increasing numbers and percentages of problem loans in Service1st’s loan portfolio. The allowance stood at $9.4 million, or 7.51% of loans for the period ended October 28, 2010, compared to $6.4 million at year end 2009, or 4.68% of loans, and $2.9 million at year end 2008, or 2.10% of loans. The increase in 2010 was primarily attributable to a provision for loan losses of $6.3 million and recoveries of $615,000, mostly offset by charge-offs of $3.9 million. The increase in 2009 was primarily attributable to a provision for loan losses of $15.7 million, mostly offset by charge-offs of $12.2 million. The increase in 2008 was primarily attributable to a provision for loan losses of $3.7 million, partially offset by $1.7 million in charge-offs.
 
As Service1st commenced operations with $50.0 million of capital, it has sufficient capital to absorb the losses it has experienced during its years of operations. With total stockholder’s equity of $16.4 million at October 28, 2010, Service1st had a leverage ratio (the ratio of Tier 1 equity to average assets) of 8.7% of total assets, well above the 5.0% regulatory requirements for well-capitalized banks and just above the 8.5% requirement for Service1st due to its consent order. At October 28, 2010, Tier 1 risk-based capital stood at 12.8%, and total risk-based capital at 14.10%, well above the requirement of 12.0% due to its consent order, both of which exceed the risk-based capital guidelines for “well capitalized” banks of 6.0% and 10.0%, respectively.
 
Critical Accounting Policies and Estimates
 
Service1st’s significant accounting policies are described in Note 1 of its audited financial statements (which are included elsewhere in this Form 10-K), including information regarding recently issued accounting


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pronouncements, Service1st’s adoption of such policies and the related impact of their adoption. Certain of these policies, along with various estimates that Service1st is required to make in recording its financial transactions, are important to have a complete understanding of Service1st’s financial position. In addition, these estimates require Service1st to make complex and subjective judgments, many of which include matters with a high degree of uncertainty. The following is a summary of these critical accounting policies and significant estimates.
 
Allowance for Loan Losses
 
The allowance for loan losses is an estimate of the credit risk in Service1st’s loan portfolio and appears on the balance sheet as a “contra asset” which reduces gross loans. The allowance is established (or once established, increased) by recording provision expense. Loans charged off on Service1st’s books reduce the allowance. Subsequent recoveries of charged off loans, if any, increase the allowance.
 
The allowance is an amount that Service1st’s management believes will be adequate to absorb probable losses on existing loans that may become uncollectible, based on evaluation of the collectability of loans and prior credit loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, specific problem credits, peer bank information, and current economic conditions that may affect the borrower’s ability to pay. Due to the credit concentration of Service1st’s loan portfolio in real estate-secured loans, future adjustments to the allowance may be necessary if there are significant changes in economic or other conditions. In addition, the FDIC and state banking regulatory agencies, as an integral part of their examination process, periodically review Service1st’s allowance for loan losses, and may require Service1st to make additions to the allowance based on their judgment about information available to them at the time of their examinations.
 
The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired. For such loans, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative and environmental factors.
 
A loan is impaired when it is probable Service1st will be unable to collect all contractual principal and interest payments due in accordance with the original terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses.
 
Investment Securities Portfolio
 
Securities classified as available for sale are equity securities and those debt securities Service1st intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of Service1st’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar considerations. Securities available for sale are reported at fair value with unrealized gains or losses reported as other comprehensive income (loss), net of related deferred tax effect. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings.
 
Securities classified as held to maturity are those debt securities Service1st has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs, or general economic conditions. These securities are carried at amortized cost, adjusted for amortization of premium and accretion of discount computed by the interest method over the contractual lives. The sale of a security within three months of its maturity date or after at least 85% of the principal outstanding has been collected is considered a maturity for purposes of classification and disclosure. Purchase premiums and discounts are generally recognized in interest income using the effective-yield method over the term of the securities.


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Service1st’s management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, including an evaluation of credit ratings, (3) the impact of changes in market interest rates, (4) the intent of Service1st to sell a security and (5) whether it is more likely than not Service1st will have to sell the security before recovery of its cost basis.
 
Stock-Based Compensation
 
Service1st’s 2007 Stock Option Plan is described more fully in Note 9 to Service1st’s audited financial statements for the period ended October 28, 2010, which are included elsewhere in this Form 10-K. Service1st records the fair value of stock compensation granted to employees and directors as expense over the vesting period. The cost of the award is based on the grant-date fair value. The compensation expenses recognized related to stock options granted under Service1st’s 2007 Stock Option Plan was approximately $633,000 for the period ended October 28, 2010, $379,000 in 2009 and $423,000 in 2008.
 
Income Taxes
 
Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effect of changes in tax laws and rates on the date of enactment. As a result of the Acquisition, which was finalized at the close of business on October 28, 2010, Service1st’s net operating loss utilization will be subject to an annual limitation on the net operating loss against future taxable income. Internal Revenue Code section 382 places a limitation on the amount of taxable income that can be offset by net operating loss carry forwards after a change in control (generally greater than 50% change in ownership) of a loss corporation.
 
Results of Operations
 
Service1st’s results of operations depend substantially on its ability to generate net interest income, which is the difference between the interest income on its interest-earning assets (primarily loans and investment securities) minus interest expense on its interest-bearing liabilities (primarily deposits). Revenue is also generated by non- interest income, consisting principally of account and other service fees. These sources of revenue are burdened by two categories of expense: first, the provision for loan losses, which consists of a charge against earnings in an amount that Service1st’s management judges necessary to maintain Service1st’s allowance for loan losses at a level deemed adequate to absorb probable loan losses inherent in the loan portfolio; and second, non-interest expense, which consists primarily of operating expenses, such as compensation to employees.
 
The management of interest income and interest expense is fundamental to the performance of Service1st. Net interest income and interest expense on interest-bearing liabilities, such as deposits and other borrowings, is the largest component of Service1st’s net revenue. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the rates earned or paid on them. Service1st’s management closely monitors both total net interest income and the net interest margin (net interest income divided by average earning assets).
 
Net interest income and net interest margin are affected by several factors including (1) the level of, and the relationship between the dollar amount of interest earning assets and interest-bearing liabilities; and (2) the relationship between re-pricing or maturity of Service1st’s variable-rate and fixed-rate loans, securities, deposits and borrowings.
 
Variable rate loans constitute 58.21% of Service1st’s portfolio for the period end October 28, 2010, and approximately 51.21% of Service1st’s variable rate loans are indexed to the national prime rate. However, a


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majority of these prime-rate based loans are subject to “floors,” ranging from 5.5% to 8.5%. Currently the prime rate is under the applicable floor rate for substantially all of Service1st’s prime-rate based loans.
 
Movements in the national prime rate that increase the applicable loan rates above applicable floors have a direct impact on Service1st’s loan yield and interest income. The national prime rate remained at 3.25% throughout 2009 and the first nine months of 2010, as the Federal Reserve maintained the targeted federal funds rate steady. Based on economic forecasts generally available to the banking industry, Service1st currently believes it is reasonably possible that the targeted federal funds rate and the national prime rate will remain flat in the foreseeable future and increase in the long term; however, there can be no assurance to that effect or as to the timing or the magnitude of any increase should an increase occur, as changes in market interest rates are dependent upon a variety of factors that are beyond Service1st’s control.
 
Service1st, through its asset and liability policies and practices, seeks to maximize net interest income without exposing Service1st to an excessive level of interest rate risk. Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations of Service1st Bank of Nevada — Quantitative and Qualitative Disclosures About Market Risk” in this section for more information.


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The following table sets forth Service1st’s average balance sheet, average yields on earning assets, average rates paid on interest-bearing liabilities, net interest margins and net interest income/spread for the period ended October 28, 2010 and the years ended December 31, 2009 and 2008.
 
                                                                         
    Period Ended October 28,
    Year Ended December 31,
    Year Ended December 31,
 
    2010(4)     2009     2008  
          Interest
                Interest
                Interest
       
    Average
    Income/
          Average
    Income/
          Average
    Income/
       
($ in thousands)   Balance     Expense     Yield     Balance     Expense     Yield     Balance     Expense     Yield  
 
INTEREST-EARNING ASSETS:
                                                                       
Certificates of deposit
  $ 28,913     $ 287       1.19 %   $ 9,562     $ 125       1.31 %   $ 845     $ 37       4.38 %
Interest-bearing deposits
    28,880       60       0.25 %     24,585       62       0.25 %     5,024       115       2.29 %
Federal funds sold
                0.00 %     3,522       8       0.23 %     7,958       152       1.91 %
Investment securities
    14,483       472       3.91 %     15,856       646       4.07 %     8,598       357       4.15 %
Portfolio loans(1)
    130,401       5,801       5.34 %     143,984       8,202       5.70 %     118,536       7,837       6.61 %
                                                                         
Total interest-earnings assets/interest income
    202,677       6,620       3.92 %     197,509       9,043       4.58 %     140,961       8,498       6.03 %
NONINTEREST EARNING ASSETS:
                                                                       
Cash and due from banks
    9,285                       8,329                       2,603                  
Allowance for loan losses
    (7,628 )