ITEM 1. BUSINESS
General
Pacific Premier Bancorp, Inc.
Pacific Premier Bancorp, Inc., (formerly LIFE Financial Corporation), (the "Corporation"), a Delaware corporation organized in 1997, is a unitary savings and loan holding company that owns 100% of the capital stock of Pacific Premier Bank (the "Bank"), the Corporation's principal operating subsidiary. Additionally, the Corporation owns 100% of the capital stock of Pacific Premier Insurance Services, doing business as Pacific Premier Investment Services, (the "Insurance Subsidiary"). The primary business of Pacific Premier Bancorp, Inc., and its subsidiaries (the "Company") is community banking and real estate lending.
Pacific Premier Bank
The Bank was founded in 1983 as a state chartered savings and loan and became a federally chartered stock savings bank in 1991. The Bank is a member of the Federal Home Loan Bank of San Francisco ("FHLB"), which is a member bank of the Federal Home Loan Bank System. The Bank's deposit accounts are insured up to the $100,000 maximum amount currently allowable under federal laws by the Savings Association Insurance Fund ("SAIF"), which is a separate insurance fund administered by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is subject to examination and regulation by the Office of Thrift Supervision ("OTS") its primary federal regulator, and by the FDIC. The Insurance Subsidiary was organized in 1999 and offers non-deposit and non-FDIC insured investment products such as mutual funds, annuities and insurance. These products are offered to both Bank and non-Bank customers. The Insurance Subsidiary has minimal operations.
The Company is a financial services organization committed to serving consumers and small businesses in Southern California. The Bank currently operates three full-service branches located in our market area of San Bernardino and Orange Counties, California. The Bank closed its Riverside and Redlands depository branches on June 6, 2002 and June 21, 2002 respectively, and the accounts of both branches were consolidated into the nearby San Bernardino branch. The Bank offers a variety of products and services for consumers and small businesses, which include checking, savings, money market accounts and certificates of deposit. The Bank funds it's lending and investment activities primarily with deposits obtained through its branches and advances from the FHLB of San Francisco. In 2002, the Bank's lending activity was focused on originating multi-family residential real estate loans, commercial real estate loans and residential construction loans principally in Southern California. For further information, see "Lending Activities."
The Company's principal sources of income are the net spread between interest earned on loans and investments and the interest costs associated with deposits and other borrowings used to finance its loan and investment portfolio. Additionally, the Bank generates fee income from various products and services offered to both depository and loan customers. At December 31, 2002, the Bank had total assets of $238.3 million, total deposits of $191.2 million, net loans of $158.2 million, and total stockholders equity of $16.5 million.
Company Website
Our internet website address is www.pacificpremierbank.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments thereto, from 1998 to present, are available free of charge on our internet website. These reports are posted on our website as soon as reasonably practicable after such reports are electronically filed with the Securities and Exchange Commission (SEC).
Recent Developments
On January 10, 2002, the Corporation received stockholder approval of the Note and Warrant Purchase Agreement. See "Significant Developments" below. The Closing occurred on January 17, 2002 (the "Closing"), wherein the Corporation received the net proceeds from the Note and utilized those proceeds as follows: (i) the Corporation purchased the Participation Contract from the Bank for its book value of $4.4 million; (ii) the Corporation paid $3.2 million to the Bank for taxes due the Bank; (iii) the Corporation made a capital infusion to the Bank of $3.7 million; and (iv) the Corporation paid transaction costs incurred in connection with the private placement of the Note.
On January 17, 2002, simultaneously with the closing of the transaction and disbursement of the funds by the Corporation to the Bank, the OTS notified the Corporation that it had terminated the Order to Cease and Desist issued on September 25, 2000. Furthermore, the OTS notified the Bank that it had terminated the Marketing Assistance Agreement and Consent to the Appointment of a Conservator or Receiver dated October 25, 2001, and that it had terminated the Prompt Corrective Action Directive issued on March 22, 2001, that it had terminated the Supervisory Agreement issued on September 25, 2000. See "Significant Developments", below.
On August 27, 2002, the Corporation changed its name from Life Financial Corporation to Pacific Premier Bancorp, Inc. and changed the name of the Bank from Life Bank to Pacific Premier Bank. Simultaneously with the name change, the Company relocated its corporate headquarters from Riverside, California to Costa Mesa, California.
Significant Developments
Change in Business Strategy-Beginning in 2002, management implemented a new lending strategy. The new strategy is focused on originating loans secured by multi-family (five units and more) and commercial real estate properties in Southern California, as well as a continuance of the Bank's prior construction lending activities. Prior to 2000, the principal business of the Bank was to originate and purchase sub-prime mortgage loans for sale in the secondary market. These sub-prime loans were secured by first liens on one-to-four family homes. Additionally the Bank originated high loan to value debt consolidation or home improvement loans secured by junior liens on one-to-four family homes. At origination or purchase, mortgage loans were designated as held for sale or held for investment. The Bank sold its loans held for sale either through whole loan sales or loan securitizations with servicing retained or servicing released. In 2000, the Bank ceased originating and purchasing loans for sale in the secondary market in order to focus on its traditional banking operations. In 2001, the Bank sold the substantial majority of its servicing rights on loans. During 2001 the Bank originated and purchased a small amount of prime quality one-to-four family first residential loans. See "Lending Activities, below."
Issuance of Senior Secured Note and Warrants-On January 17, 2002 the Corporation issued a $12,000,000 Senior Secured Note (the "Note") and warrants to purchase 1,166,400 shares of the Corporation's Common Stock issuable at an exercise price of $.75 per share (the "Warrant"), which shares would constitute 47% of the issued and outstanding Common Stock of the Corporation if exercised (the "Warrant"). The Note is due in 2007 with an initial principal amount of $12 million and bearing interest at an initial rate of 12% (increasing over time to 16%). The interest is payable on a quarterly basis. The stock of the Bank and the Participation Contract were pledged as collateral against the Note. See "Senior Notes," below and "Regulation-Prompt Corrective Action Regulations," below.
Participation Contract-On December 31, 1999 the Bank sold its residual mortgage-backed securities retained from securitization and related mortgage servicing rights for $19.4 million in cash and other consideration in the form of a participation contract. The Participation Contract is a contractual right from the purchaser of the Bank's residual mortgage-backed securities for the Company to receive 50% of any cash realized after the purchaser recaptures its initial cash investment
of $8.1 million, a 15% internal rate of return and $200,000 in servicing fees from transaction. During the second quarter of 2002 the Company started to receive cash payments under the Participation Contract. The Company intends to use future payments received from the Participation Contract to meet its debt service obligations under the Note. In January 2002 the Corporation purchased the Participation Contract from the Bank at the Bank's carrying value. The Corporation has pledged the Participation Contract as collateral for the Note issued in January 2002. See Item 8 - "Note 1, Notes to Consolidated Financial Statements" included elsewhere herein and "Risk Factors-The Company will require additional resources to repay the Senior Secured Notes," and "Investment Activities," below.
Regulatory Matters-On September 25, 2000 the Company consented to the issuance of an Order to Cease and Desist by OTS, which required that the Company, among other things, contribute $5.2 million to the capital of the Bank no later than December 31, 2000, subject to extension by the OTS. Also on September 25, 2000 the Bank entered into a Supervisory Agreement with the OTS that required the Bank, among other things, to achieve certain regulatory capital ratios. In March 2001 the OTS issued a Prompt Corrective Action Directive requiring the Bank, among other things, to raise sufficient capital through securities issuance to achieve specifically designated capital ratios or, as an alternative, to recapitalize by merging or being acquired prior to September 30, 2001. In October 2001 the Bank was notified that it was "significantly undercapitalized" and on October 25, 2001 the Bank consented to an OTS request to sign a Marketing Assistance Agreement and Consent to the Appointment of a Conservator or Receiver (the "Marketing Agreement"). On January 17, 2002 the Corporation closed a transaction with New Life Holdings, LLC to issue $12 million in notes and warrants to purchase 1,116,400 shares of the Corporations' Common Stock. Simultaneously with the closing of this transaction and disbursement of the funds by the Corporation to the Bank, all of the foregoing regulatory orders and agreements were terminated. At the request of the OTS, in the fourth quarter of 2002, the Bank was required to develop, submit and implement a Compliance Plan to address safety and soundness issues, related to the Bank's Asset Quality, Iternal Audit function and earnings. See "Regulation-Prompt Corrective Action Regulations" and Item 8 - "Note 2, Notes to Consolidated Financial Statements" included elsewhere herein.
Subordinated Debentures-In March 1997 the Company issued an aggregate principal amount of $10 million in subordinated debentures (the "Debentures") which mature on March 15, 2004 and bear interest at the rate of 13.5% per annum, payable semi-annually. In September 1998, holders of $8.5 million in Debentures exercised their option to have the Company repurchase their Debentures as of December 1998. Accordingly, an aggregate of $1.5 million in principal amount of the Debentures remain outstanding and mature on March 15, 2004. See Item 8 - "Note 10, Notes to Consolidated Audited Financial Statements" contained elsewhere herein.
Lending Activities
Historically, the Bank's principal business was originating and purchasing sub-prime loans secured by first liens on one-to-four family homes and high loan to value debt consolidation or home improvement loans secured by junior liens on one-to-four family homes. Loans originated and purchased were then sold through whole loan sales or loan securitization. Loans were originated and purchased through offices located in the states of California, Colorado, Florida and Massachusetts, which were closed in late 1999 and early 2000.
Sub-prime loans are loans to borrowers who generally do not satisfy the credit or underwriting standards prescribed by conventional mortgage lenders and loan buyers, such as Fannie Mae and Freddie Mac. The Bank's primary determinate in identifying sub-prime loans from "A" or prime credit quality loans had been based solely on the borrower's credit rating known as a Fair, Isaac & Company ("FICO") credit score. All loans to borrowers who possess a FICO credit score of 619 or less had been considered sub-prime. During 2002 the Bank hired an Internal Asset Review Manager to oversee the Bank's Internal Asset Review ("IAR") function. During the fourth quarter of 2002, the IAR Manager
conducted an analysis of the Bank's one-to-four unit residential loan portfolio related to historic delinquency migration of delinquent loans to Real Estate Owned ("REO") and loss rates on loans on a state by state basis. The conclusion of the analysis was that certain loans with FICO scores as high as 660 should be designated sub-prime, namely loans in certain states in the southeast and central portion of the United States and certain loans with FICO credit scores of 600 and less should be designated as sub-prime, namely those loans in certain western states. Based on the conclusion of the analysis the Bank had approximately $10.5 million of sub-prime loans at December 31, 2002.
High loan-to-value loans are secured by junior liens, wherein the Bank is not the holder of the senior or first lien, generally to borrowers with non sub-prime credit histories and for the purpose of either debt consolidation or home improvement. In late 1998, the Bank ceased originating high loan-to-value loans due to a change in the regulatory treatment of such loans, together with a change in the secondary market for such loans. On September 31, 2000, the Bank ceased originating and purchasing sub-prime loans due to concerns over the costs of originating, servicing and owning such loans as well as the overall higher delinquency, default and loss rates of these loans.
During 2001, the Bank originated and purchased a small amount of "A" or prime quality one-to-four family first lien residential loans. Additionally, the Bank continued to originate and service residential construction loans. Beginning in 2002 and corresponding with the Company's recapitalization, management implemented a new lending strategy to augment its residential construction lending activities. The new strategy is focused on originating loans secured by multi-family and commercial real estate properties ("income property") in Southern California. Concurrently with the implementation of this new lending direction the Bank ceased originating one-to-four family residential loans. Management believes that the origination of income property loans provides higher risk-adjusted rates of return, than the lower yielding one-to-four family lending previously engaged in by the Bank. Loans funded during 2002 were held in the Bank's portfolio and totaled $79.3 million. At December 31, 2002, the Company's gross loans outstanding totaled $163.1 million.
The Bank's strategy in sourcing new loans involves hiring account managers who rely on a network of loan brokers operating throughout Southern California for sources of loan applications. The account manager operates primarily in the Bank's corporate offices. Management believes that this loan origination strategy is a more cost-effective method of originating loans, and will afford the Bank greater access to potential loan transactions and a consistent source of loan funding volume. Management believes that the Bank's highly focused lending strategy, timely decision making process, competitive pricing, and flexibility in structuring transactions provide an incentive for brokers to do business with the Bank.
The interest rates charged on income property and residential construction loans generally vary based on a number of factors, including the degree of credit risk, size, maturity of the loan, borrower/property management expertise, whether the loan has a fixed or a variable rate, and prevailing market rates for similar types of loans. Depending on market conditions at the time the loan is originated, certain income property loan agreements will include prepayment penalties. Most loans secured by multi-family, commercial or residential construction properties are subject to an adjustment of their interest rate based on one of several interest rate indices. All loans originated by the Bank in 2002 were adjustable rate loans and have minimum interest rates ("floor rates") at which the rate charged may not be reduced further regardless of further reductions in the underlying interest rate index.
The majority of multi-family, commercial real estate and residential construction borrowers are business owners, individual investors, investment partnerships or limited liability corporations. The lending that the Bank does engage in typically involves larger loans to a single borrower and is generally viewed as exposing the Bank to a greater risk of loss than one-to-four family residential lending. Income producing property values and homes that are under construction are also generally subject to greater volatility than existing residential property values. The liquidation values of income
producing properties may be adversely affected by risks generally incidental to interests in real property, such as:
•Changes or continued weakness in general or local economic conditions;
•Changes or continued weakness in specific industry segments;
•Declines in real estate values;
•Declines in rental, room or occupancy rates in hotels, apartment complexes or commercial properties;
•Increases in other operating expenses (including energy costs);
•The availability of refinancing at lower interest rates or better loan terms;
•Changes in governmental rules, regulations and fiscal policies, including rent control ordinances, environmental legislation and taxation;
•Increases in interest rates, real estate and personal property tax rates; and
•Other factors beyond the control of the borrower or the lender.
In addition to the lending risks discussed above with respect to multi-family residential and commercial real estate loans, construction financing is generally considered to involve a higher degree of credit risk than the financing of improved, owner-occupied real estate. Construction loans also present risks associated with the accuracy of the initial estimate of the property's value at completion of construction compared to the estimated cost (including financing) of construction. These risks can be affected by a variety of factors, including the project management, costs for labor and materials, the availability of materials, city or state laws, regulations and/or ordinances and the weather. If the estimate of value proves to be inaccurate, the Bank may be confronted with a project, when completed, having a value which is insufficient to assure full repayment.
The Bank mitigates these risks by performing a thorough analysis of the cost estimates and actively monitoring the project during each phase of construction. Additional underwriting factors considered when assessing residential construction loans are the builders'/developers' previous experience of timely building, marketing and selling similar properties as that proposed in the potential loan transaction. The Bank utilizes third party experts to review and report on the reasonableness and completeness of the builder's/developer's budget, specifications and plans in assessing each residential construction loan request. The Bank also utilizes third party experts to inspect, monitor and provide written estimates of percentage completion and materials delivered to the property. Bank personnel review the reports in determining the amount and level of disbursement of construction loan proceeds to ensure the amount of disbursed proceeds is consistent with the project progress. The policies also emphasize geographic and product diversification within Southern California.
The Bank will not make loans-to-one borrower that are in excess of regulatory limits. Pursuant to OTS regulations, loans-to-one borrower cannot exceed 15% of the Bank's unimpaired capital and surplus. At December 31, 2002, the Bank's loans-to-one borrower limit equaled $2.7 million. See "Regulation-Federal Savings Institution Regulation-Loans-to-One Borrower."
Underwriting and Approval Authority. The Board of Directors establishes the basic lending policies of the Bank. Each loan must meet minimum underwriting criteria established in the Bank's lending policies and must fit within the Bank's overall strategies for yield and portfolio concentrations. The underwriting and quality control functions are managed through the Bank's corporate offices. The underwriting standards for loans secured by income producing real estate properties consider the borrower's financial resources, credit worthiness, ability to repay the requested loan amount, the level,
quality and stability of cash flow from the underlying collateral, property management experience of similar properties and the loan-to-value ratio.
Upon receipt of a completed loan application from a prospective borrower, a credit report is ordered and, if necessary, additional financial information is requested. An independent appraisal conducted by a licensed appraiser is required on every property securing a loan and, an internal review appraisal is conducted on every loan by the Bank's appraisal department. The Board of Directors of the Bank reviews and approves annually the independent appraisers list used by the Bank and the Bank's appraisal policy. On all multi-family residential and commercial real estate loans, the responsible account manager reviews the property's operating statements and physical condition of the property. On transactions involving a loan over $1.0 million, the property is inspected by either the Chief Credit Officer, the Chief Operating Officer, the Chief Appraiser or an agent designated by the Bank. Our underwriter's credit memorandum includes a description of the prospective borrower and any guarantors, the collateral, and the proposed uses of loan proceeds, as well as an analysis of the borrower's financial statements and the property operating history. Each application is evaluated from a number of underwriting perspectives, including property appraised value, level of debt service coverage, use and condition, as well as borrower liquidity, net worth, credit history and operating experience. Our loans are originated on both a nonrecourse and full recourse basis and we generally seek to obtain personal guarantees from the principals of borrowers, which are single asset or limited liability entities (such as partnerships, limited liability companies, corporations or trusts).
Variable rate loans must generally satisfy an interest rate sensitivity test in order for the loan origination or purchase to be approved; that is, the current stabilized income of the property securing the loan must be adequate to achieve a minimum debt service coverage ratio (the ratio of net earnings on a property to debt service) based on a higher qualifying interest rate than the actual interest rate charged and an increase by 100 basis points above the qualifying interest rate. Following loan approval and prior to funding, the Bank's underwriting and processing departments assure that all loan approval terms have been satisfied, that they conform with lending policies (or are properly authorized exceptions), and that all required documentation is present and in proper form.
Subject to the above standards, the Board of Directors of the Bank delegates authority and responsibility for loan approvals to management up to $1.0 million. Loan amounts up to $1.0 million require the approval of at least two members of the Management Loan Committee consisting of the President, Chief Credit Officer and Director of Retail Branch Banking. All loans in excess of $1.0 million, including total aggregate borrowings in excess of $1.0 million, require a majority approval of the Board's Credit Committee, which is comprised of four directors one of which being the Bank's President.
Multi-family Residential Lending. The Bank originates and purchases loans secured by multi-family residential properties (five units and greater). Pursuant to the Bank's underwriting policies, multi-family residential purchase money loans may be made in an amount up to the lesser of 80% of the appraised value or the purchase price of the underlying property, whichever is less. Loans to refinance multi-family properties may be made up to 75% of the appraised value of the underlying property. In addition, the Bank requires a stabilized minimum debt service coverage ratio of 1.15, based on the qualifying loan interest rate. Loans are generally made for terms up to 30 years with amortization periods up to 30 years. As of December 31, 2002, the Bank had $62.5 million of multi-family real estate secured loans, constituting 38.3% of the Bank's loan portfolio at that date.
Commercial Real Estate Lending. The Bank originates and purchases loans secured by commercial real estate, such as retail centers, small office and light industrial buildings and other mixed-use commercial properties. The Bank will also, from time to time, make a loan secured by a special purpose property such as an auto wash center or motel. Pursuant to the Bank's underwriting policies, commercial real estate loans may be made in amounts up to the lesser of 75% of the
appraised value or the purchase price of the underlying property, whichever is less. The Bank considers the net operating income of the property and requires a debt service coverage ratio of at least 1.20, based on a qualifying interest rate. Loans are generally made for terms up to ten years with amortization periods up to 25 years. As of December 31, 2002, the Bank had $23.1 million of commercial real estate secured loans, constituting 14.1% of the Bank's loan portfolio at that date.
Construction and Rehabilitation Lending. The Bank originates construction and rehabilitation loans for one-to-four single-family homes and small single family tracts of homes, generally consisting of in-fill projects of 10 homes or fewer. Those projects built on a speculative basis are conducted by small, local builders who have demonstrated by past performance the ability to construct and effectively market the completed product within the approved budget and where management is comfortable with the underlying collateral and economic conditions. These loans are generally adjustable rate with maturities of 18 months or less. The Bank's policies provide that construction loans may be made in amounts up to 75% of the appraised value of the completed property. All construction loans are priced on a variable rate, which is adjusted daily with a spread over Wall Street Journal Prime. The Company generally requires that the borrower maintain a minimum 15% cash equity position in the project. Presently, the Bank lends construction funds only in Southern California. As of December 31, 2002, the Bank had $8.4 million of construction loans (less undisbursed loan funds of $2.4 million), constituting 5.1% of the Bank's loan portfolio at that date.
Loan Servicing. Loan servicing is centralized at the Bank's corporate headquarters. The Bank's loan servicing operations are intended to provide prompt customer service and accurate and timely information for account follow-up, financial reporting and loss mitigation. Following the funding of an approved loan, the data is entered into the Bank's data processing system, which provides monthly billing statements, tracks payment performance, and affects agreed upon interest rate adjustments. The loan servicing activities include (i) the collection and remittance of mortgage loan payments, (ii) accounting for principal and interest and other collections and expenses, (iii) holding and disbursing escrow or impounding funds for real estate taxes and insurance premiums, (iv) inspecting properties when appropriate, (v) contacting delinquent borrowers, and (vi) acting as fiduciary in foreclosing and disposing of collateral properties. When payments are not received by their contractual due date, collection efforts begin by the Bank's Loss Mitigation personnel. Accounts delinquent more than 15 days are reviewed by the Bank's Loss Mitigation Manager and are assigned to collectors to begin the process of collections. The Bank's collectors begin by contacting the borrower telephonically and progress to sending a notice of intention to foreclose within 30 days of delinquency and will initiate foreclosure 30 days thereafter if the delinquent payments are not received in full. The Loss Mitigation Manager conducts an evaluation of all loans 90 days or more past due by obtaining an estimate of value on the underlying collateral. The evaluation may result in the Bank establishing a specific allowance for that loan or charging off the entire loan, however, continuing with collection efforts-see Allowance for Loan Losses. In addition to servicing loans owned by the Bank, the Bank is servicing $7.2 million of loans it sold to other investors. The Bank receives a servicing fee for performing these services for others. The Bank does not expect to increase the level of loans serviced for others in the foreseeable future, other than the participation loan on multifamily.
Loan Portfolio Composition. In 1994, the Bank shifted its lending strategy away from originating traditional one-to-four family home loans. The Bank focused on mortgage banking nationwide, consisting of originating, purchasing and selling residential mortgage loans to borrowers with sub-prime credit and high loan-to-value consumer loans. In late 1998, the Bank ceased originating high loan-to-value loans due to a change in the regulatory treatment of such loans, together with a change in the secondary markets for such loans. On September 31, 2000, the Bank ceased originating and purchasing sub-prime loan products due to concerns over the costs of originating, servicing and owning such loans as well as the overall higher delinquency and default rates of these loans. Beginning in 2002, the Bank commenced lending operations focused on high credit quality multi-family and commercial
real estate secured lending. During the year the Bank originated and purchased a total of $75.5 million of multi-family and commercial real estate loans. The Bank's portfolio of multi-family and commercial real estate secured loans at December 31, 2002 totaled $85.6 million.
A portion of the Bank's one-to-four family loan portfolio consists of loans secured by first liens on real estate to sub-prime credit borrowers. At December 31, 2002, $10.5 million of one-to-four family, loans are considered to be sub-prime. A portion of the Bank's one-to-four family loan portfolio consists of loans secured by junior liens on real estate and are considered high loan-to-value loans. At December 31, 2002, $28,000 of one-to-four family, junior lien loans possess loan-to-values greater than 125% of the appraised value of the property, $9.3 million of one-to-four family, junior lien loans possess loan-to-values between 100% and 125% of the appraised value of the property and $1.5 million of one-to-four family, junior lien loans possess loan-to-values between 90% and 100% of the appraised value of the property.
At December 31, 2002, the Bank's gross loans outstanding held for investment totaled $161.0 million and loans held for sale totaled $2.1 million. The types of loans that the Bank may originate are subject to federal law, state law, and regulations. Interest rates charged by the Bank on loans are affected by the demand for such loans and the supply of money available for lending purposes and the rates offered by competitors. These factors are, in turn, affected by, among other things, economic conditions, monetary policies of the federal government, including the Federal Reserve Board, and legislative tax policies.
The following table sets forth the composition of our loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated (dollars in thousands):
(1)Includes second trust deeds. Loan Maturity. The following table shows the contractual maturity of the Bank's gross loans at December 31, 2002. The table does not reflect prepayment assumptions.
The following table sets forth at December 31, 2002, the dollar amount of gross loans receivable contractually due after December 31, 2003, and whether such loans have fixed interest rates or adjustable interest rates.
The following table sets forth the Bank's loan originations, purchases, sales, and principal repayments for the periods indicated:
(1)Gross loans includes loans held for investment and loans held for sale.
(2)Includes second trust deeds. Delinquencies and Classified Assets. Federal regulations require that the Bank utilize an internal asset classification system to identify and report problem and potential problem assets. The Bank's IAR Manager has responsibility for identifying and reporting problem assets to the Bank's Internal Asset Review Committee ("IARC"), which operates pursuant to the Board-approved IAR policy. The policy incorporates the regulatory requirements of monitoring and classifying all assets of the Bank. The Bank currently designates or classifies problem and potential problem assets as "Special Mention", "Substandard" or "Loss" assets. An asset is considered "Substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the Bank will sustain "some loss" if the deficiencies are not corrected. All REO acquired from foreclosure is classified as "Substandard." Assets classified as "Loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss allowance is not warranted. Assets which do not currently expose the Bank to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated "Special Mention."
When the Bank classifies an asset, or portions thereof, as Substandard under current OTS policy, the Bank is required to consider establishing a general valuation allowance in an amount deemed prudent by management. The general valuation allowance, which is a regulatory term, represents a loss
allowance which has been established to recognize the inherent credit risk associated with lending and investing activities, but which, unlike specific allowances, has not been allocated to particular problem assets. When the Bank classifies one or more assets, or portions thereof, as "Loss," it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.
The Bank's determination as to the classification of its assets and the amount of its valuation allowances are subject to review by the OTS, which can order the establishment of additional general or specific loss allowances or a change in a classification. The OTS, in conjunction with the other federal banking agencies, adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation allowances. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management has analyzed all significant factors that affect the collectability of the portfolio in a reasonable manner; and that management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. While the Bank believes that it has established an adequate allowance for estimated loan losses, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to materially increase at that time its allowance for estimated loan losses, thereby negatively affecting the Bank's financial condition and earnings at that time. Although management believes that an adequate allowance for estimated loan losses has been established, actual losses are dependent upon future events and, as such, further additions to the level of allowances for estimated loan losses may become necessary.
The Bank's IARC reviews the IAR Manager's recommendations for classifying the Bank's assets quarterly and reports the results of its review to the Board of Directors. The Bank classifies assets and establishes both a general allowance and specific allowance in accordance with the Board-approved Allowance for Loan Losses policy. The following table sets forth information concerning substandard assets, REO and total classified assets at December 31, 2002:
At December 31, 2002 the Bank had $7.1 million of Special Mention assets, $7.7 million Substandard assets, and $735,000 assets classified as Loss that are offset by a specific allowance of the same amount. The difference between the specific allowance in the above table and the total specific allowance is the specific allowance on accounts that were Substandard at one time and are currently classified either as Special Mention or Pass.
Impaired Assets. The following table sets forth information regarding impaired assets, troubled-debt restructurings and REO in the Bank's loan portfolio. Included in impaired assets are $669,000 and $886,000 of foreclosures in process less than 90 days past due at December 31, 2002 and 2001, respectively. At December 31, 2002, there were no troubled-debt restructured loans within the meaning of Statement of Financial Accounting Standards ("SFAS") 15, and 32 REO properties for $2.4 million. The Bank's current policy is to cease accruing interest on loans 90 days or more past due. For the years ended December 31, 2002, 2001, 2000, 1999, and 1998, respectively, the amount of interest income that would have been recognized on nonaccrual loans if such loans had continued to perform in accordance with their contractual terms was $708,000, $955,000, $1,300,000, $384,000, and $789,000, none of which was recognized. For the same periods, there was no interest income recognized on troubled debt restructurings.
(1)REO balances are shown net of related loss allowances.
(2)Gross loans include loans receivable held for investment and held for sale.
(3)Impaired assets consist of impaired loans and REO.
The following table sets forth delinquencies in the Bank's loan portfolio as of the dates indicated (dollars in thousands):
Allowance for Loan Losses. The Bank maintains an allowance for loan losses to absorb losses inherent primarily in the loans held for investment portfolio. Loans held for sale are carried at the
lower of cost or estimated market value. Net unrealized losses, if any, are recognized in a lower of cost or market valuation allowance by charges to operations. The allowance is based on ongoing, quarterly assessments of probable estimated losses inherent in the loan portfolios. The Bank's methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance, specific allowance for identified problem loans and the unallocated allowance. In addition, the allowance incorporates the results of measuring impaired loans as provided in SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors for Impairment of Loan-Income Recognition and Disclosures." These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans.
The formula allowance is calculated by applying loss factors to all loans held for investment. The loss factors are applied according to loan program type and loan classification. The loss factors for each program type and loan classification are established based primarily upon the Bank's historical loss experience and are evaluated on a quarterly basis. In determining the loss factors the IAR Manager conducts quarterly loss migration analysis of the Bank's loan portfolio over at least the previous four quarters to determine the percentage of loans migrating from a particular classification category through to a realized loss. The migration analysis and estimation of loss factors is performed on the Bank's loan portfolio and stratified based on geographic location of the collateral and individual loan types. The IAR Manager will also conduct peer analysis by reviewing the Allowance for Loan Losses data of other financial institution's as it becomes available in estimating the Bank's loss factors.
Specific allowances are established for certain loans where management has identified significant conditions or circumstances related to a credit that management believes indicates the probability that a loss has been incurred in excess of the amount determined by the application of the formula allowance. Furthermore, on all one-to-four family loans secured by first and second deeds of trust that are 90 days or more past due, a market evaluation is completed and a specific allowance is determined based on the valuation of the collateral underlying the loan. A specific allowance is calculated by subtracting the current market value less estimated selling and holding costs from the loan balance. Beginning in the fourth quarter of 2002 the Bank revised its procedures related to the market valuation of secured loans and the establishment of specific allowances. The revised methodology takes into consideration the analysis completed by the Bank's newly hired IAR Manager related to the Bank's historic loss experience and the location of the collateral. The revised evaluation methodology was performed on all loans 90 days or more past due and will be substantially completed by March 31, 2003. The revised evaluations are expected to result in the allocation of approximately $186,000 of specific allowances and $571,000 of charge-offs recorded in the quarter ending March 31, 2003. The Bank's Loss Mitigation department continues to pursue all possible avenues of collections on charge-off loans.
The IARC meets monthly to review and monitor conditions in the portfolio and to determine the appropriate allowance for loan losses based on the recommendation of the IAR Manager and the analysis performed. To the extent that any of these conditions are evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, the IARC's estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, the IARC's evaluation of the probable loss related to such condition is reflected in the unallocated allowance. By assessing the probable estimated losses inherent in the loan portfolios on a quarterly basis, the Bank is able to adjust specific and inherent loss estimates based upon more recent information that has become available.
As of December 31, 2002, the Bank's allowance for loan losses, that includes both general and specific reserves, was $2.8 million or 1.74% of total gross loans, and 48.12% of impaired loans compared to an allowance for loan losses of $4.4 million at December 31, 2001 or 2.24% of gross loans
and 31.07% of impaired loans. The following table sets forth activity in the Bank's allowance for loan losses for the periods set forth in the table (dollars in thousands):
The following table sets forth the amount of the Bank's allowance for loan losses, the percent of allowance for loan losses to total allowance and the percent of gross loans to total gross loans in each of the categories listed at the dates indicated (dollars in thousands):
The following table sets forth the allowance for loan losses amounts calculated by the categories listed for the periods set forth in the table (dollars in thousands):
Real Estate Owned. At December 31, 2002, the Bank had 32 REO properties with a book value of $2.4 million. Real estate properties acquired through or in lieu of loan foreclosure are initially recorded at the lower of fair value less cost to sell or the balance of the loan at the date of foreclosure through a charge to the allowance for loan losses. It is the policy of the Bank to obtain an appraisal and /or a market evaluation on all REO at the time of possession. After foreclosure, valuations are periodically performed by management as needed due to changing market conditions or factors specifically attributable to the properties' condition. If the carrying value of a property exceeds its fair value less estimated cost to sell, a charge to operations is recorded.
Investment Activities
Federally chartered savings institutions, such as the Bank, have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certificates of deposit of insured banks and savings institutions, bankers' acceptances, and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment-grade corporate debt securities, and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. Additionally, the Bank must maintain minimum levels of investments that qualify as liquid assets under OTS regulations. See "Item 1 - Regulation-Federal Savings Institution Regulation-Liquidity." Historically, the Bank has maintained liquid assets above the minimum OTS requirements and at a level considered to be adequate to meet its normal daily liquidity needs.
The investment policy of the Bank as established by the Board of Directors attempts to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complement the Bank's lending activities. Specifically, the Bank's policies limit investments to government and federal agency-backed securities and non-government guaranteed securities, including corporate debt obligations, which are investment grade.
At December 31, 2002, the Bank had $30.0 million in its mortgage-backed securities portfolio, all of which were insured or guaranteed by the GNMA, the FHLMC, or the Veteran's Administration and are available for sale. In addition, the Bank owned $19.7 million of the AMF Adjustable Rate
Mortgage (ARM) Fund and $6.5 million of the AMF Intermediate Fund. The ARM Fund invests in Agency adjustable rate mortgages ("Arms"), fixed and floating rate collateralized mortgage obligations ("CMO's") and investment grade Corporate Debt instruments. The Intermediate Fund invests in mortgage-backed securities, U.S. Government Notes and Agency Debentures. The Bank may increase or decrease its investment in mortgage-backed securities and mutual funds in the future depending on its liquidity needs and market opportunities. Investments in mortgage-backed securities and mutual funds which hold mortgage-backed securities involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby reducing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities. In addition, the market value of such securities may be adversely affected by changes in interest rates.
The following table sets forth certain information regarding the carrying and fair values of the Bank's securities at the dates indicated:
On December 31, 1999, the Corporation sold its residual mortgage-backed securities retained from securitization and related mortgage servicing rights for $19.4 million in cash and other consideration and realized a pretax loss of $29.1 million. The $29.1 million loss is the net of the balance of the Residual Assets sold of $36.7 million plus the mortgage servicing rights of $7.5 million less a $4.3 million reserve for the estimated loss to be incurred on the $14.6 million of subperforming loans acquired less cash and other considerations totaling $19.4 million. The $19.4 million was comprised of $5.1 million in cash for the residual assets, $9.3 million value assigned to the Participation Contract, $3.0 million cash for the credit guaranty and $2.0 million cash for the mortgage servicing rights sold.
The Participation Contract is a contractual right from the purchase of the residual mortgage-backed securities to receive 50% of any cash realized, as defined, from the residual mortgage-backed securities (the "Participation Contract"). The Company valued the contractual right at its estimated fair value of $9.3 million at December 31, 1999. The right to receive cash flows under the contract begins after the purchaser recaptures its initial cash investment of $5.1 million, $3.0 million of the credit
guarantee, $200,000 in servicing fees, and a 15% internal rate of return, (the "Hurdle Amount") from the transaction.
The Company entered into a credit guaranty related to a $14.6 million pool of sub-performing loans in the 1998-1A and 1B securitization whereby the Company guaranteed the difference between the December 1, 1999 unpaid principal balance and the realized value of those loans at final disposition. At December 31, 1999, the Company estimated the obligation under the credit guaranty at $4.3 million and it was included in other liabilities. During 2000, the $14.6 million of sub-performing loans were sold to a third party for a net loss of $3.9 million, $2.6 million of which was paid to the purchaser under the credit guaranty and applied to reduce the Hurdle Amount to $5.7 million for cash distributions on the Participation Contract. The remaining balance of the credit guaranty of $356,000 was recognized as income during the year 2000.
The Participation Contract was sold to the Corporation in January 2002. It is recorded on the Corporation's financial statements at December 31, 2002 at $4.9 million. The Corporation does not believe there is an active market for this type of asset and has determined the estimated fair value utilizing a cash flow model which determines the present value of the estimated expected cash flows from this contract using a discount rate the Corporation believes is commensurate with the risks involved. Beginning in June 2001, the residual assets underlying the Participation Contract began to generate cash flow to the lead participants in the contract. The Corporation began receiving cash from the Participation Contract during the second quarter of 2002. Based on the Corporation's analysis of the expected performance of the underlying loans, the total cash to the Corporation is expected to be approximately $13.7 million over the next 6 years. However, the actual performance of the residual assets and cash realized by the Corporation could vary significantly from the Corporation's projections. The assumptions utilized in the projections that could cause a substantial change in the cash realized from the Participation Contract are the estimated levels of future loan losses and the rate of prepayment speeds estimated for the loans underlying the residual assets. The Corporation commenced accreting the discount (recognizing interest income) and the expected yield differential (the difference between the fair market value and the book value) on the Participation Contract during 2002 over the expected remaining life of the contract using a level yield methodology. The accretion will be adjusted for any changes in the expected performance of the contract. The Corporation recorded discount accretion or the recognition of interest income of $3.8 million for the year ended 2002. The Participation Contract has been pledged as collateral for the Note issued in January 2002. See "Risk Factors-The Company will require additional resources to repay the Senior Secured Notes" included elsewhere herein.
The table below sets forth certain information regarding the carrying value, weighted average yields and contractual maturities of the Company's securities as of December 31, 2002.
Sources of Funds
General. Deposits, lines of credit, loan repayments and prepayments, and cash flows generated from operations and borrowings are the primary sources of the Bank's funds for use in lending, investing and for other general purposes.
Deposits. The Bank offers a variety of deposit accounts with a range of interest rates and terms. The Bank's deposits consist of passbook savings, checking accounts, money market savings accounts and certificates of deposit. For the year ended December 31, 2002, certificates of deposit constituted 73.5% of total average deposits. The terms of the fixed-rate certificates of deposit offered by the Bank vary from 6 months to 5 years. Specific terms of an individual account vary according to the type of account, the minimum balance required, the time period funds must remain on deposit and the interest rate, among other factors. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. At December 31, 2002, the Bank had $102.7 million of certificate accounts maturing in one year or less.
The Bank relies primarily on customer service and long-standing relationships with customers to attract and retain local deposits. However, market interest rates and rates offered by competing financial institutions significantly affect the Bank's ability to attract and retain deposits.
Although the Bank has a significant portion of its deposits in shorter term certificates of deposit, management monitors activity on the Bank's certificate of deposit accounts and, based on historical experience and the Bank's current pricing strategy, believes that it will retain a large portion of such accounts upon maturity. Further increases in short-term certificate of deposit accounts, which tend to be more sensitive to movements in market interest rates than core deposits, may result in the Bank's deposit base being less stable than if it had a large amount of core deposits which, in turn, may result in further increases in the Bank's cost of deposits. Notwithstanding the foregoing, the Bank believes
that it will continue to have access to sufficient amounts of certificate of deposit accounts which, together with other funding sources, will provide it with the necessary level of liquidity to continue to implement its business strategies.
The following table presents the deposit activity of the Bank for the years ended December 31 (dollars in thousands):
The reduction in total deposits is attributable to the decrease in wholesale and brokered deposits and is consistent with the decrease in the loan portfolio. The decrease in wholesale and brokered deposits was due to the Bank's continued strategy to focus heavily on increasing retail deposits and reducing wholesale certificates of deposits and eliminating brokered deposits. At December 31, 2002, the Bank had $37.7 million in certificate accounts in amounts of $100,000 or more maturing as follows (dollars in thousands):
The following table sets forth the distribution of the Bank's average deposit accounts for the periods indicated and the weighted average interest rates on each category of deposits presented:
The following table presents, by various rate categories, the amount of certificate accounts outstanding at the date indicated and the periods to maturity of the certificate accounts outstanding at December 31, 2002:
FHLB Advances
The FHLB system functions as a source of credit to savings institutions which are members. Advances are secured by certain mortgage loans, certain mortgage-backed securities, and the capital stock of the FHLB owned by the Bank. Subject to the FHLB's advance policies and requirements, these advances can be requested for any business purpose in which the Bank is authorized to engage. In granting advances, the FHLB considers a member's creditworthiness and other relevant factors. At this time, the FHLB maximum advance allowed to the Bank is an amount equal to 15% of the Bank's assets or $34.5 million, as of December 31, 2002. At December 31, 2002, the Bank had two FHLB advances outstanding totaling $20.0 million which had a weighted average interest rate of 3.31% and a weighted average remaining maturity of 0.7 years. See "Item 8 - Note 9, Notes to Consolidated Financial Statements" included elsewhere herein.
Senior Notes
In January 2002, the Corporation issued the Senior Secured Note due 2007 in the initial principal amount of $12 million and bearing interest at an initial rate of 12% (increasing over time to 16%). The interest is payable on a quarterly basis starting on March 31, 2003. However, the Corporation elected to pay the accrued interest due for 2002 in December and has paid the interest due March 31, 2003. The Corporation currently intends to meet its payment obligations on these Notes from the cash it receives under the Participation Contract, although there can be no assurance that funds from the Participation Contract will be sufficient to service such indebtedness. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations-Risk Factors-The Company will require additional resources to repay the Senior Secure Notes".
Debentures
On March 14, 1997, the Company issued subordinated debentures (the "Debentures") in the aggregate principal amount of $10.0 million. On September 15, 1998, holders of $8.5 million in Debentures exercised their option to put their Debentures to the Company as of December 14, 1998, thereby reducing outstanding Debentures to $1.5 million, due March 15, 2004. See "Regulation-Federal Savings Institution Regulation-Capital Requirements." Additionally, see further detail in "Note 10 Subordinated Debentures-Notes to Consolidated Financial Statements."
The following table sets forth certain information regarding the Company's borrowed funds at or for the years ended on the dates indicated:
Subsidiaries
As of December 31, 2002, the Corporation had two subsidiaries: the Bank and the Insurance Subsidiary. Neither the Bank nor the Insurance Subsidiary had any subsidiaries at December 31, 2002.
Personnel
As of December 31, 2002, the Company had 53 full-time employees and 6 part-time employees. The employees are not represented by a collective bargaining unit and the Company considers its relationship with its employees to be satisfactory.
Competition
The banking business in California in general, and specifically in the Company's market areas, is highly competitive with respect to virtually all products and services and has become increasingly more so in recent years. The industry continues to consolidate, and unregulated competitors have entered banking markets with focused products targeted at highly profitable customer segments. Many largely unregulated competitors are able to compete across geographic boundaries, and provide customers increasing access to meaningful alternatives to nearly all significant banking services and products. These competitive trends are likely to continue.
The banking business is largely dominated by a relatively small number of major banks with many offices operating over a wide geographical area. These banks have, among other advantages, the ability to finance wide-ranging and effective advertising campaigns and to allocate their resources to regions of highest yield and demand. Many of the major banks operating in the area offer certain services that we
do not offer directly but may offer indirectly through correspondent institutions. By virtue of their greater total capitalization, such banks also have substantially higher lending limits than the Bank's.
In addition to other savings banks, our competitors include commercial banks, credit unions, and numerous non-banking institutions such as finance companies, leasing companies, insurance companies, brokerage firms, and investment banking firms. In recent years, increased competition has also developed from specialized finance and non-finance companies that offer wholesale finance, credit card, and other consumer finance services, including on-line banking services and personal financial software. Strong competition for deposit and loan products affects the rates of those products as well as the terms on which they are offered to customers. Mergers between financial institutions have placed additional pressure on banks within the industry to streamline their operations, reduce expenses, and increase revenues to remain competitive. Competition has also intensified due to federal and state interstate banking laws enacted in the mid-1990's, which permit banking organizations to expand into other states, and the relatively large California market has been particularly attractive to out-of-state institutions.
Technological innovations have also resulted in increased competition in financial services markets. Such innovation has, for example, made it possible for non-depository institutions to offer customers automated transfer payment services that previously were considered traditional banking products. In addition, many customers now expect a choice of delivery systems and channels, including telephone, mail, home computer, ATMs, self-service branches, and/or in-store branches. The sources of competition in such products include commercial banks as well as credit unions, brokerage firms, money market and other mutual funds, asset management groups, finance and insurance companies, internet-only financial intermediaries, and mortgage banking firms.
In order to compete with these other institutions the Company primarily relies on local promotional activities, personal relationships established by officers, directors and employees of the Company and specialized services tailored to meet the individual needs of the Company's customers.
REGULATION
General
The Corporation, as a savings and loan holding company, is required to file certain reports with, and otherwise comply with the rules and regulations of the OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the activities of savings institutions, such as the Bank, are governed by the HOLA and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB") System and its deposit accounts are insured up to applicable limits by the SAIF managed by the FDIC. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The OTS and/or the FDIC conduct periodic examinations to test the Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the OTS, the FDIC or Congress, could have a material adverse impact on the Corporation, the Bank and their operations. Certain of the regulatory requirements applicable to the Bank and to the Corporation are referred to below or elsewhere herein. The description of statutory provisions and
regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Corporation.
Holding Company Regulation
The Corporation is a nondiversified unitary savings and loan holding company within the meaning of the HOLA. As a unitary savings and loan holding company, the Corporation generally is not restricted under existing laws as to the types of business activities in which it may engage, provided that the Bank continues to be a qualified thrift lender ("QTL"). See "Federal Savings Institution Regulation-QTL Test." Upon any non-supervisory acquisition by the Corporation of another savings institution or savings bank that meets the QTL test and is deemed to be a savings institution by the OTS, the Corporation would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would be subject to extensive limitations on the types of business activities in which it could engage. The HOLA limits the activities of a multiple savings and loan holding company and its non-insured institution subsidiaries primarily to activities permissible for bank holding companies under Section 4-C-(8) of the Bank Holding Company Act ("BHC Act"), subject to the prior approval of the OTS, and certain activities authorized by OTS regulation, and no multiple savings and loan holding company may acquire more than 5% of the voting stock of a company engaged in impermissible activities.
The HOLA prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of the voting stock of another savings institution or holding company thereof, without prior written approval of the OTS or acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, HOLA does prescribe such restrictions on subsidiary savings institutions as described below. The Bank must notify and obtain approval from the OTS 30 days before declaring any dividend to the Corporation. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the OTS and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage (core) capital ratio and an 8% risk-based capital ratio. Core capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The OTS regulations require that, in meeting the tangible, leverage (core) and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities that are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the maintenance of total capital (which is defined as core capital and supplementary capital) to risk-weighted assets to be at least 8%. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% or higher if deemed appropriate, as assigned by the OTS capital regulation based on the risks the OTS believes are inherent in the type of asset. The components of core capital are equivalent to those discussed earlier under the 4% leverage standard. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and, within specified limits, the allowance for loan and lease losses. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
The OTS regulatory capital requirements also incorporate an interest rate risk component. Savings institutions with "above normal" interest rate risk exposure are subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. A savings institution's interest rate risk is measured by the decline in the net portfolio value of its assets (i.e., the difference between incoming and outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts) that would result from a hypothetical 200 basis point increase or decrease in market interest rates divided by the estimated economic value of the institution's assets, as calculated in accordance with guidelines set forth by the OTS. A savings institution whose measured interest rate risk exposure exceeds 2% must deduct an amount equal to one-half of the difference between the institution's measured interest rate risk and 2%, multiplied by the estimated economic value of the institution's assets. The dollar amount is deducted from an institution's total capital in calculating compliance with its risk-based capital requirement. Under the rule, there is a two-quarter lag between the reporting date of an institution's financial data and the effective date for the new capital requirement based on that data. A savings institution with assets of less than $300 million and risk-based capital ratios in excess of 12% is not subject to the interest rate risk component, unless the OTS determines otherwise. The Director of the OTS may waive or defer a savings institution's interest rate risk component on a case-by-case basis. For the present time, the OTS has deferred implementation of the interest rate risk component.
The following table presents the Bank's capital position at December 31, 2002:
Prompt Corrective Action Regulations. Under the OTS prompt corrective action regulations, the OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of
which depends upon the institution's degree of undercapitalization. Generally, a savings institution that has a total risk-based capital of less than 8% or a leverage ratio or a Tier 1 capital ratio that is less than 4% is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio less than 3% or a leverage ratio less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to asset ratio equal to or less than 2% is deemed to be "critically undercapitalized." Numerous mandatory supervisory actions become immediately applicable to the institution depending upon its category, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS could also take any one of a number of discretionary supervisory actions, including requiring a capital plan, the issuance of a capital directive and the replacement of senior executive officers and directors.
During 2000, the Bank's regulatory capital did not meet all minimum regulatory capital requirements. On June 16, 2000 the Bank was deemed by the OTS to be "Undercapitalized" under the Prompt Corrective Action regulations. On September 25, 2000, the Corporation consented to the issuance of an Order to Cease and Desist (the "Order") by the OTS. The Order required the Corporation, among other things, to contribute $5.2 million in capital to the Bank, not later than December 31, 2000, subject to extension by the OTS. The Corporation was also required to observe certain requirements regarding transactions with affiliates, to maintain adequate books and records, to revise its tax sharing arrangements with the Bank, and to maintain a separate corporate existence from the Bank.
Also on September 25, 2000, the Bank entered into a Supervisory Agreement with the OTS. The Supervisory Agreement required the Bank, among other things, to achieve an individual minimum core capital ratio of 6% and a modified risk-based capital ratio of 11% by March 31, 2001. In calculating these ratios, the Bank was required to double risk weight all sub-prime loans beginning in March 2001. The Supervisory Agreement also required that the Bank add at least two new independent members to its Board of Directors, not pay dividends without OTS approval and revise many of its policies and procedures, including those pertaining to internal asset review, allowances for loan losses, interest rate risk management, mortgage banking operations, liquidity, separate corporate existence, loans-to-one-borrower and oversight by the Board of Directors.
During 2001, the Bank's regulatory capital did not meet all minimum regulatory capital requirements. On March 23, 2001 the Bank stipulated to the issuance of a Prompt Corrective Action Directive (the "PCA Directive") by the OTS. The PCA Directive required the Bank, among other things, to raise sufficient capital to achieve total risk-based capital of 8.0%; Tier 1 risk-based capital of 4.0%; and a leverage ratio of 4.0% by June 30, 2001 or to be recapitalized by merging or being acquired prior to September 30, 2001. In addition, the PCA Directive provisions included limitations on capital distributions, restrictions on the payment of management fees, asset growth, acquisitions, branching, and new lines of business, senior executive officers' compensation, and on other activities. The Bank was required to restrict the rates the Bank pays on deposits to the prevailing rates of interest on deposits of comparable amounts and maturities in the region where the Bank is located. The Bank was prohibited from entering into any material transaction other than in the normal course of business without the prior consent of the OTS.
On October 5, 2001 the Bank was notified that it was "significantly undercapitalized" pursuant to the Prompt Corrective Action regulations. On October 25, 2001 the Bank consented to an OTS request to sign a Marketing Assistance Agreement and Consent to the Appointment of a Conservator or Receiver (the "Marketing Agreement"). The Marketing Agreement permitted the OTS to provide confidential information about the Bank to prospective acquirers, merger partners or investors to facilitate the possible acquisition of the Bank or possible merger of the Bank with a qualified merger partner, among other things. The Bank was requested to enter into the Marketing Agreement due to its significantly undercapitalized designation, the fact that the Bank was in violation of the Supervisory
Agreement dated September 25, 2000, and was in violation of the PCA Directive dated March 23, 2001, and that the OTS considered the Bank to be in an unsafe and unsound condition.
On November 20, 2001 the Corporation entered into an agreement for the private placement of a secured note, together with a warrant to purchase Common Stock of the Corporation, with New Life Holdings, LLC, a California limited liability company (the "Investor") in exchange for which the Corporation received $12,000,000. The sale of the note and warrant was made pursuant to a Note and Warrant Purchase Agreement entered into by the Corporation and the Investor. The Corporation issued a Senior Secured Note Due 2007 (the "Note") in the initial principal amount of $12,000,000, and bearing interest at an initial rate of 12% (increasing over time to 16%), which is payable quarterly starting March 31, 2003, and a warrant (the "Warrant") to purchase up to 1,166,400 shares of the Corporation's common stock at an exercise price of $.75 per share. The holders of the Note have the right to nominate three of seven directors of the Corporation and the Bank until the later of (i) such time as the Note has been fully retired or (ii) three years after the Closing. The Corporation pledged the stock of its subsidiaries and the Participation Contract as collateral against the Note.
Upon exercise of the Warrant, which is freely assignable in whole or in part in denominations of not less then 10,000 shares, the Investor or its assignee(s) (the assignees, together with the Investor, the "Warrant Holders" and each a "Warrant Holder") shall have the right to purchase during specified periods a total of up to 1,166,400 shares of Common Stock. Pursuant to the Warrant, on or before the first anniversary of the Closing, the Warrant Holder will be able to purchase 116,640 shares of Common Stock. After the first anniversary of the Closing, but on or before the second anniversary of the Closing, the Warrant Holder will be able to purchase the initial 116,640 shares of Common Stock, plus an additional 116,640 shares of Common Stock. After the second anniversary of the Closing, but on or before the third anniversary of the Closing, the Warrant Holder will be able to purchase the 233,280 shares of Common Stock available during the first two years after Closing, plus an additional 116,640 shares of Common Stock. After the third anniversary of the Closing, but prior to the tenth anniversary of the Closing (the "Expiration"), the Warrant Holder will be able to purchase the 349,920 shares available during the first three years after Closing, plus the remaining 816,480 shares of Common Stock available under the Warrant. Based on 1,333,572 shares outstanding at December 31, 2001, if the entire warrant were exercised, the shares issued upon its exercise would constitute approximately 47% of the Corporation's outstanding stock. To date the warrant holder has not exercised its warrant to purchase any of the Common Stock.
On January 10, 2002 the Corporation received stockholder approval of the Note and Warrant Purchase Agreement. The closing occurred on January 17, 2002, wherein the Corporation received the net proceeds from the Note and utilized those proceeds as follows: (i) the Corporation purchased the Participation Contract from the Bank for its book value of $4.4 million; (ii) the Corporation paid $3.2 million to the Bank for taxes due the Bank; (iii) the Corporation made a capital infusion to the Bank of $3.7 million; and (iv) the Corporation paid transaction costs incurred in connection with the private placement.
On January 17, 2002, simultaneously with the closing of the transaction and disbursement of the funds by the Corporation to the Bank, the OTS notified the Corporation that it had terminated the Order to Cease and Desist issued on September 25, 2000. The OTS also notified the Bank that it had terminated the Marketing Assistance Agreement and Consent to the Appointment of a Conservator or Receiver dated October 25, 2001, that it had terminated the Prompt Corrective Action Directive issued on March 22, 2001, that it had terminated the Supervisory Agreement issued on September 25, 2000.
At the request of the OTS, in the fourth quarter of 2002, the Bank was required to develop, submit and implement a Compliance Plan that addresses the Bank's Asset Quality and IAR function, Internal Audit function and Earnings.
If the Bank fails to comply with the Compliance Plan, the Bank may be subject to further regulatory enforcement action.
Insurance of Deposit Accounts. Deposits of the Bank are presently insured by the SAIF. The FDIC maintains a risk-based assessment system by which institutions are assigned to one of three categories based on their capitalization and one of three subcategories based on examination ratings and other supervisory information. An institution's assessment rate depends on the categories to which it is assigned. Assessment rates for SAIF member institutions are determined semiannually by the FDIC and currently range from zero basis points for the healthiest institutions to 27 basis points for the riskiest.
In addition to the assessment for deposit insurance, institutions are required to pay on bonds issued in the late 1980s by the Financing Corporation ("FCO") to recapitalize the predecessor to the SAIF. During 1984, FCO payments for SAIF members approximated 6.10 basis points, while Bank Insurance Fund ("BIF"- the deposit insurance fund that covers most commercial bank deposits) members paid 1.22 basis points. The FCO assessment rates as of January 1, 2002 were $0.0182 per $100 annually (or 2.0 basis points) for BIF-assessable deposits and 2.1 basis points for SAIF-assessable deposits. For the year ended December 31, 2002, assessments for both deposit insurance and the FCO payments were $542,000. These assessments, which may be revised based upon the level of BIF and SAIF deposits, will continue until the bonds mature in the year 2017.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Loans-to-One Borrower. Under the HOLA, savings institutions are generally subject to the limits on loans-to-one borrower applicable to national banks. Generally, savings institutions may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain financial instruments and bullion. At December 31, 2002, the Bank's limit on loans-to-one borrower was $2.7 million. At December 31, 2002, the Bank's largest aggregate outstanding balance of loans-to-one borrower was $2.7 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under the QTL test, a savings association is required to maintain at least 65% of its "portfolio assets" (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period.
A savings association that fails the QTL test must convert to a bank charter or operate under certain restrictions. As of December 31, 2002, the Bank maintained 79.54% of its portfolio assets in qualified thrift investments and, therefore, met the QTL test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The rule establishes three tiers of institutions, which are based primarily on an institution's capital level. An institution that exceeds all fully phased-in capital
requirements before and after a proposed capital distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in need of more than normal supervision, could, after prior notice but without obtaining approval of the OTS, make capital distributions during a calendar year equal to the greater of (i) 100% of its net earnings to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year or (ii) 75% of its net income for the previous four quarters. Any additional capital distributions would require prior regulatory approval. In the event the Bank's capital fell below its regulatory requirements or the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. At December 31, 2002, the Bank was a Tier I Bank, but it has been advised that it is in need of more than normal supervision by the OTS. See "Item 5 - Markets for Registrant's Common Equity and Related Stockholder Matters-Dividends".
Liquidity. The Financial Regulatory Relief and Economic Efficiency Act of 2000 repealed the statutory liquidity requirement for savings association, citing the requirement as unnecessary. In light of this action, the OTS repealed its liquidity regulations and replaced them with a general requirement that thrifts continue to maintain sufficient liquidity to ensure safe and sound operations. The Bank's average liquidity ratio for the year ended December 31, 2002 was 28.30%. The Bank believes that this level of liquidity is extraordinarily high and is proceeding to lower the level of liquidity through the funding of loans.
Branching. OTS regulations permit nationwide branching by federally chartered savings institutions to the extent allowed by federal statute. This permits federal savings institutions to establish interstate networks and to geographically diversify their loan portfolios and lines of business. The OTS authority preempts any state law purporting to regulate branching by federal savings institutions.
Transactions with Related Parties. The Bank's authority to engage in transactions with related parties or "affiliates" (e.g., any company that controls or is under common control with an institution, including the Corporation and its non-savings institution subsidiaries) is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A restricts the aggregate amount of covered transactions with any individual affiliate to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in Section 23A and the purchase of low quality assets from affiliates are generally prohibited. Section 23B generally provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies.
Enforcement. Under the FDI Act, the OTS has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. Under the FDI Act, the FDIC has the authority to recommend to the Director of the OTS enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to
terminate the Bank's deposit insurance. Federal law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The FDI Act requires each federal banking agency to prescribe for all insured depository institutions standards relating to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, and compensation, fees, benefits and such other operational and managerial standards as the agency deems appropriate. The federal banking agencies have adopted final regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") to implement these safety and soundness standards. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by FDI Act. The final rule establishes deadlines for the submission and review of such safety and soundness compliance plans.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to maintain noninterest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations generally required for 2002 that reserves be maintained against aggregate transaction accounts as follows: for accounts aggregating $41.3 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement was 3%; and for accounts aggregating greater than $41.3 million, the reserve requirement was $1.3 million plus 10% (subject to adjustment by the Federal Reserve Board between 8% and 14%) against that portion of total transaction accounts in excess of $41.3 million. The first $5.7 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) were exempt from the reserve requirements. The Bank maintained compliance with the foregoing requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the OTS.
FEDERAL TAXATION
Federal Taxation
General. The Corporation and the Bank report their income on a consolidated basis using the accrual method of accounting, and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Corporation. The Bank has not been audited by the IRS. For its 2002 taxable year, the Bank is subject to a maximum federal income tax rate of 34%. See "Item 8 - Note 11, Notes to Consolidated Financial Statements", included elsewhere herein.
Bad Debt Reserves. For fiscal years beginning prior to December 31, 1996, thrift institutions which qualified under certain definitional tests and other conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans (generally secured by interests in real property improved or to be improved) under (i) the Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience Method. The reserve for nonqualifying loans was computed using the Experience Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was enacted on August 20, 1996, requires savings institutions to recapture (i.e., take into income) certain portions of their accumulated bad debt reserves. The 1996 Act repeals the reserve method of accounting for bad debts effective for tax years beginning after 1995. Thrift institutions that would be treated as small banks are allowed to utilize the Experience Method applicable to such institutions, while thrift institutions that are treated as large banks (those generally exceeding $500 million in assets) are required to use only the specific charge-off method. Thus, the PTI Method of accounting for bad debts is no longer available for any financial institution.
To the extent the allowable bad debt reserve balance using the thrift's historical computation method exceeds the allowable bad debt reserve method under the newly enacted provisions, such excess is required to be recaptured into income under the provisions of Code Section 481(a). Any Section 481(a) adjustment required to be taken into income with respect to such change generally will be taken into income ratably over a six-taxable year period, beginning with the first taxable year beginning after 1995, subject to the residential loan requirement.
Under the residential loan requirement provision, the recapture required by the 1996 Act will be suspended for each of two successive taxable years, beginning with the Bank's current taxable year, in which the Bank originates a minimum of certain residential loans based upon the average of the principal amounts of such loans made by the Bank during its six taxable years preceding its current taxable year.
Under the 1996 Act, the Bank is permitted to use the Experience Method to compute its allowable addition to its reserve for bad debts for the current year. The Bank's bad debt reserve as of December 31, 1995 was computed using the permitted Experience Method computation and was therefore not subject to the recapture of any portion of its bad debt reserve as discussed above.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend distributions" to the Corporation, such distributions will be considered to have been made from the Bank's unrecaptured tax bad debt reserves (including the balance of its reserves as of December 31, 1987) to the extent thereof, and then from the Bank's supplemental reserve for losses on loans, to the extent thereof, and an amount based on the amount distributed (but not in excess of the amount of such reserves) will be included in the Bank's income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of the Bank's current or accumulated earnings and profits will not be so included in the Bank's income.
The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if the Bank makes a non-dividend distribution to the Corporation, approximately one and one-half times the amount of such distribution (but not in excess of the amount of such reserves) would be includable in income for federal income tax purposes, assuming a 34% federal corporate income tax rate. The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.
ITEM 2.
ITEM 2. PROPERTIES
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In December 1999, certain shareholders of the Corporation filed a Federal securities lawsuit against the Company, various officers and directors of the Company, and certain other third parties, titled "Funke v. Life Financial, et al'. The class action lawsuit was filed in the United States District Court for the Southern District of New York to assert claims against the defendants under the Securities Exchange Act of 1934 and the Securities Act of 1933, in connection with the sale of the Corporation's Common Stock in its initial public offering. Plaintiffs seeks unspecified damages in their complaint. A substantially similar action was filed in the United States District Court for the Central District of California in January 2000 and subsequently dismissed without prejudice. In April 2000, the Company and its officer and director defendants filed motions to dismiss the lawsuit or transfer it to California. In December 2002, the Court denied the motion to transfer, dismissed one of the claims, and allowed one of the claims to remain open. The parties are currently in settlement negotiations with respect to the action, but, if it cannot be settled on terms acceptable to the Company, the Company intends to vigorously defend against the claim asserted in the litigation. The Company has submitted this claim to its insurance carrier which has accepted this claim with a customary reservation of rights. Since the Company has already met its deductible under the insurance policy, the insurance company will be paying any additional legal fees and costs incurred with respect to this action. The maximum aggregate coverage for this claim under the insurance policy is $10,000,000.
From time to time, the Company is a party to claims and legal proceedings arising in the ordinary course of business. After taking into consideration information furnished by counsel to the Company as to the current status of these claims or proceedings to which the company is a party, Management is of the opinion that the ultimate aggregate liability represented thereby if any, will not have a material adverse affect on the financial condition of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE BY QUARTERS
The Common Stock of the Corporation has been publicly traded since 1997 and is currently traded on the Nasdaq SmallCap Market under the symbol PPBI. However, trading in the Common Stock has not been extensive and such trades cannot be characterized as constituting an active trading market.
As of March 17, 2003, there were approximately 230 holders of record of the Common Stock. The following table summarizes the range of the high and low closing sale prices per share of Common Stock as quoted by NASDAQ for the periods indicated. All share data has been adjusted for a June 7, 2001 1:5 reverse stock split.
DIVIDENDS
It is the policy of the Corporation to retain earnings, if any, to provide funds for use in its business. The Corporation has never declared or paid dividends on its common stock and does not anticipate declaring or paying any cash dividends in the foreseeable future.
The ability to pay a dividend on common stock will depend upon, among other things, future earnings, operating and financial condition, capital requirements, general business conditions and the receipt of regulatory approvals. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources." In addition, the Corporation's ability to pay dividends at any time may be limited by the Bank's ability to pay dividends to the Corporation. Since the Bank has been advised that it is in need of more than normal supervision by the OTS, the Bank may not currently pay cash dividends without the prior approval of the OTS. See "REGULATION-Federal Savings Institution Regulation-Limitations on Capital Distributions" and "REGULATION-Prompt Corrective Action Regulations."
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2002, with respect to options outstanding and available under the Bank's 2000 Stock Option Plan, and with respect to the outstanding Warrants:
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below is derived from the audited consolidated financial statements of the Company and should be read in conjunction with the Consolidated Financial Statements presented elsewhere herein (dollars in thousands, except per share data):
N/A-not applicable.
(1)Book value per share is based upon the shares outstanding at the end of each period, adjusted retroactively for the June 2001 1:5 reverse stock split.
(2)Earnings (loss) per share is based upon the weighted average shares outstanding during the period, adjusted retroactively for the June 2001 1:5 reverse stock split.
(3)Asset Quality Ratios and Regulatory Capital Ratios are end of period ratios. With the exception of end of period ratios, all ratios are based on average daily or average month-end balances during the indicated periods.
(4)The average interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(5)The net interest margin represents net interest income as a percent of average interest-earning assets.
(6)The efficiency ratio represents noninterest expense less (gain) loss on foreclosed real estate divided by noninterest income plus net interest income before provision for estimated loan losses.
(7)For definitions and further information relating to the Bank's regulatory capital requirements, see "Item 1 - Business-Regulation"
(8)The pro forma capital ratio calculations are based on December 31, 2001 actual amounts adjusted for the capital infusion of $3.7 million, the sale of the Participation Contract for $4.4 million and the receipt of taxes due from the Corporation of $3.2 million.
(9)Impaired assets consist of impaired loans and REO.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Summary
The principal business of the Bank is attracting retail deposits from consumers and small businesses and investing those deposits together with funds generated from operations and borrowings, primarily in income property real estate secured loans and residential secured construction loans. The Bank commenced originating and purchasing income property real estate secured loans through a
network of mortgage brokers located within the state of California in 2002. In 2003, the Bank will fund substantially all of the loans that it originates or purchases through its excess liquidity, deposits, FHLB advances and internally generated funds. Deposit flows and cost of funds are influenced by prevailing market rates of interest primarily on competing investments, account maturities and the levels of savings in the Bank's market area. The Bank's ability to originate and purchase loans is influenced by the general level of product available. The Bank's results of operations are also affected by the Bank's provision for loan losses and the level of operating expenses. The Bank's operating expenses primarily consist of employee compensation and benefits, premises and occupancy expenses, and other general expenses. The Company's results of operations are also affected by prevailing economic conditions, competition, government policies and other actions of regulatory agencies. See "Item 1 - Business." Additionally, all share and per share amounts in the accompanying financial statements and notes have been adjusted to reflect the 1:5 reverse stock split that occurred on June 7, 2001.
Critical Accounting Policies
Management has established various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of the Company's financial statements. The Company's significant accounting policies are described in the Notes to the Consolidated Financial Statements. Certain accounting policies require management to make estimates and assumptions which have a material impact on the carrying value of certain assets and liabilities; management considers these to be critical accounting policies. The estimates and assumptions management uses are based on historical experience and other factors, which management believes to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at balance sheet dates and the Company's results of operations for future reporting periods.
Management believes that the allowance for loan losses, the method for recognition of income on the Participation Contract, and the valuation allowance on deferred taxes are the critical accounting policies that require estimates and assumptions in the preparation of the Company's financial statements that are most susceptible to significant change. For further information, see "Business-Allowances for Loan Losses" and Note 1 to the Consolidated Financial Statements.
Average Balance Sheets
The following tables set forth certain information relating to the Company for the years ended December 31, 2002, 2001, and 2000. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are measured on a daily basis. The yields and costs include fees, which are considered adjustments to yields.
(1)Includes interest on float from cash disbursements.
(2)Includes unamortized discounts and premiums and certificates of deposit.
(3)Amount is net of deferred loan origination fees, unamortized discounts, premiums and allowance for estimated loan losses and includes loans held for sale and impaired loans.
(4)Net interest rate spread represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities.
(5)Net interest margin represents net interest income divided by average interest-earning assets. Rate/Volume Analysis. The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company's interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume
and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
Comparison of Operating Results for the Year Ended December 31, 2002 and December 31, 2001
General
For the year ended December 31, 2002, the Company reported net income of $2.9 million or $1.16 per diluted share, compared with a net loss of $6.1 million or $4.54 per share for the same period in 2001. The $8.9 million increase in net income was primarily the result of lower interest expense ($7.3 million), lower provision for loan losses ($2.2 million), lower noninterest expense ($4.2 million), and an income tax benefit ($2.9 million), offset by a reduction in interest income ($5.6 million) and a reduction in noninterest income ($2.1 million).
Interest Income
Interest income for the year ended December 31, 2002 was $18.8 million, compared to $24.4 million for the year ended December 31, 2001. The decrease of $5.6 million, or 22.9%, is due to a decrease in average balance and yield on interest-earning assets. Interest income on loans receivable decreased $9.6 million to $12.3 million for the year ended December 31, 2002 from $21.9 million for the year ended December 31, 2001. The decrease in interest income on loans was primarily the result of a 87 basis points decrease in the yield on loans receivable and a decrease in the average loan balance from $245.6 million in 2001 to $152.7 million in 2002.
Interest Expense
Interest expense for the year ended December 31, 2002 was $8.9 million, compared to $16.2 million for the year ended December 31, 2001. The $7.3 million decrease primarily reflects a 221 basis points decrease in the cost of interest-bearing deposits related to the prevailing decrease in market interest rates and a decrease in the average interest on deposit balance from $281.5 million in 2001 to $202.7 million in 2002. The $8.7 million decrease in interest-bearing deposits is partially offset by a $1.9 million increase in Notes payable interest as the Company chose to make a payment on the Notes to avoid future interest expense charges.
Net Interest Income
Net interest income before provision for loan losses was $10.0 million for the year ended December 31, 2002, compared to $8.3 million for the year ended December 31, 2001. The $1.7 million increase in net interest income before provision for loan losses is primarily due to the large decrease in the expense on interest-bearing deposits. The average cost of interest-bearing liabilities for the Company decreased to 3.85% during the year ended 2002, compared with 5.42% during the same period in 2001. The Bank's cost of liabilities for 2002 was 3.12%. The Company's yield on average earning assets was 8.29% for the year ended December 31, 2002, compared with 8.33% for the same period in 2001. Total interest income decreased $5.6 million, or 22.8%, while total interest expense decreased $7.3 million, or 44.9%.
Provision for Loan Losses
The provision for loan losses decreased to $1.1 million for the year ended December 31, 2002 from $3.3 million for the year ended December 31, 2001. Net impaired loans decreased by 58.75% from $12.7 million in 2001 to $5.3 million in 2002, with a corresponding decrease in net charge-offs from $4.3 million in 2001 to $2.7 million in 2002. The 2002 decrease in impaired loans is significantly due to the sale of delinquent loans in the 2ndquarter of 2002. Average loans outstanding during 2002 decreased by $92.9 million, or 37.8% over 2001, while the provision for loan losses decreased $2.2 million in 2002, or 65.8%, compared to 2001 provision.
Noninterest Income (Loss)
Noninterest income was $1.9 million for the year ended December 31, 2002, compared to $4.0 million for the year ended December 31, 2001. This $2.1 million decrease is primarily due to lower loan servicing incoming which is reflective of the lower balance of the loan portfolio.
Loan servicing and mortgage banking income was $761,000 for the year ended December 31, 2002 compared to $1.9 million for the year ended December 31, 2001. This $1.1 million decrease is primarily due to the drop in the average balance of the loan portfolio and a lower average yield on the portfolio.
Noninterest Expense
Noninterest expense for the year ended December 31, 2002 was $10.1 million compared to $14.3 million for the year ended December 31, 2001. The $4.2 million decrease in expense was primarily comprised of a decrease in compensation and benefits of $1.0 million and a $2.1 million net decrease in other expenses. The decrease in compensation is mostly due to the reduction of employees from 66 full-time employees at December 31, 2001 to 57 full-time employees at December 31, 2002. As a result of management's diligent efforts to reduce operating expenses, other expenses decreased by a net $2.1 million, losses on foreclosed real estate decreased by $301,000 and premises and occupancy decreased by $623,000.
Income Taxes
The provision for income taxes decreased to a tax benefit of $2.3 million for the year ended December 31, 2002 compared to a provision of $642,000 for the year ended December 31, 2001. The Company had a gain before income taxes of $533,000 for the year ended December 31, 2002 compared to $5.4 million loss before tax provision for the year ended December 31, 2001. The Company increased the deferred tax asset $2.0 million from $350,000 in 2001 to $2.4 million in 2002 based on estimated future taxable income.
Comparison of Financial Condition at December 31, 2002 and December 31, 2001
Total assets of the Company were $238.3 million at December 31, 2002 compared to $243.7 million at December 31, 2001. The 2.2% decrease in total assets of the Company was primarily the result of a $4.1 million decrease in cash and a $26.1 million decrease in the loan portfolio offset by a $23.5 million increase in the investment portfolio and a $4.3 million increase in premises and equipment.
Total Bank deposits at December 31, 2002 were $191.1 million compared to $232.2 million at December 31, 2001. The 17.7% decrease in deposits is the result of the reduction of brokered and wholesale deposits. During 2002, the Bank continued its strategy to focus heavily on increasing retail deposits to reduce wholesale certificates of deposit and other borrowings and eliminate brokered deposits. Additionally, the ratio of retail deposits to total deposits increased to 98.3% for the period ended December 31, 2002, compared to 97.1% at December 31, 2001. The cost of the Bank's retail deposits at December 31, 2002 was 2.79% versus 3.59% at December 31, 2001.
The allowance for loan losses was $2.8 million at December 31, 2002, compared to $4.4 million at December 31, 2001. The December 31, 2002 allowance for loan losses, as a percent of impaired loans and gross loans was 48.12% and 1.74%, respectively, compared with 31.07% and 2.24% At December 31, 2001. The Bank's net credit loss rate for the year ended December 31, 2002 was 1.74% versus 1.76% for the year ended December 31, 2001. The Bank's 30+ day delinquency rate at December 31, 2002 was 4.72%, compared to 10.97% at December 31, 2001.
Foreclosed real estate was $2.4 million at December 31, 2002, compared to $4.2 million at December 31, 2001. The $1.7 million decrease, or 41.8%, is primarily due to $6.0 million in sales of foreclosed real estate offset by $5.2 million in new foreclosed real estate. In 2002 the amount of loans transferred to REO decreased from $10.3 million in 2001 to $5.2 million in 2002 reflecting the lower overall delinquency trends.
In the first quarter 2001, the Bank sold substantially all of its entire mortgage servicing rights. Mortgage servicing rights were $51,000 at December 31, 2002, compared to $101,000 at December 31, 2001.
Comparison of Operating Results for the Year Ended December 31, 2001 and December 31, 2000
General
For the year ended December 31, 2001, the Company reported a net loss of $6.1 million or $4.54 per share, compared with a net loss of $20.8 million or $15.58 per share for the same period in 2000. The $14.7 million decrease in net loss was primarily the result of losses occurring in 2001. These include losses from mortgage banking operations of $5.7 million, a write down on the Participation Contract of $4.9 million, and a tax provision of $3.0 million. There was also $849,000 in restructuring charges related to a comprehensive restructuring in the third quarter of 2000 of all of the Company's operations.
Interest Income
Interest income for the year ended December 31, 2001 was $24.4 million, compared to $41.5 million for the year ended December 31, 2000. The decrease of $17.1 million, or 41.2%, is due to a decrease in average balance and yield on interest-earning assets. Interest income on loans receivable decreased $16.3 million to $22.0 million for the year ended December 31, 2001 from $38.3 million for the year ended December 31, 2000. The decrease in interest income on loans was primarily the result of a 22 basis points decrease in the yield on loans receivable and a decrease in the average loan balance from $417.5 million in 2000 to $245.6 million in 2001.
Interest Expense
Interest expense for the year ended December 31, 2001 was $16.2 million, compared to $28.4 million for the year ended December 31, 2000. The $12.2 million decrease primarily reflects a 58 basis points decrease in the cost of interest-bearing deposits related to the prevailing decrease in market interest rates and a decrease in the average deposit balance from $432.3 million in 2000 to $281.5 million in 2001. The remaining $1.7 million decrease is predominately due to a drop in the average borrowings balance from $36.3 million in 2000 to $15.5 million in 2001. This reduction in borrowings is in line with the decrease in our loan portfolio.
Net Interest Income
Net interest income before provision for loan losses was $8.3 million for the year ended December 31, 2001, compared to $13.1 million for the year ended December 31, 2000. The $4.8 million decrease in net interest income before provision for loan losses is reflective of a lower average balance and yield on interest-earning assets. The Company's yield on average earning assets was 8.33% for the year ended December 31, 2001, compared with 8.87% for the same period in 2000. The average cost of interest- bearing liabilities for the Company decreased to 5.42% during the year ended 2001, compared with 6.05% during the same period in 2000. Total interest income decreased $17.1 million, or 41.1%, while total interest expense decreased $12.3 million, or 43.1%.
Provision for Loan Losses
The provision for loan losses increased to $3.3 million for the year ended December 31, 2001 from $2.9 million for the year ended December 31, 2000. Net impaired loans decreased by 52.33% from $26.7 million in 2000 to $12.7 million in 2001, partially resulting in an increase in net charge-offs from $275,000 in 2000 to $4.3 million in 2001. Average loans outstanding during 2002 decreased by $171.9 million, or 41.2% over 2000, while the provision for loan losses increased $403,000 in 2001, or 13.8%, compared to 2000 provision. In June 2001, the Company transferred $9.3 million in non-performing loans from loans held for investment to loans held for sale. At that time, a lower of cost or market adjustment of $634,000 was recorded as a charge-off against the allowance for loan losses.
Noninterest Income (Loss)
Noninterest income was $4.0 million for the year ended December 31, 2001, compared to a loss of $2.1 million for the year ended December 31, 2000. This $6.1 million increase is primarily due to a lower of cost or market adjustment in 2000 of $3.0 million against the held-for-sale loan portfolio to adjust the value to the lower of cost or market and losses from the sale of loans in 2000 as a result of the Company's exit from mortgage banking.
Loan servicing and mortgage banking income was $1.9 million for the year ended December 31, 2001 compared to $7.0 million for the year ended December 31, 2000. This $5.1 million decrease is primarily due to the drop in servicing fee income after the sale in the first quarter 2001 of substantially
all of the Bank's mortgage servicing rights, which resulted in a gain of $166,000. This sale is consistent with the Bank's strategy to reduce risk in the balance sheet.
Noninterest Expense
Noninterest expense for the year ended December 31, 2001 was $14.3 million compared to $25.8 million for the year ended December 31, 2000. The $11.5 million decrease in expense was primarily comprised of a decrease in compensation and benefits of $5.9 million and a $2.4 million net decrease in other expenses. The decrease in compensation is mostly due to the reduction of employees from 100 full-time employees at December 31, 2000 to 66 full-time employees at December 31, 2001. As a result of the Bank's exit from mortgage banking and management's diligent efforts to reduce operating expenses, other expenses decreased by a net $2.4 million, which included an offsetting increase of $808,000 in the Bank's deposit insurance premiums in 2001.
Income Taxes
The provision for income taxes decreased to a tax provision of $642,000 for the year ended December 31, 2001 compared to a provision of $3.0 million for the year ended December 31, 2000. The loss before income taxes decreased to $5.4 million for the year ended December 31, 2001 compared to $17.8 million loss before tax benefit for the year ended December 31, 2000. The Company increased the deferred tax valuation allowance by $1.7 million from $9.9 million in 2000 to $11.6 million, as it is more likely than not that the benefit will not be realized.
Comparison of Financial Condition at December 31, 2001 and December 31, 2000
Total assets of the Company were $243.7 million at December 31, 2001 compared to $414.4 million at December 31, 2000. The 41.2% decrease in total assets of the Company was primarily the result of a $129.5 million decrease in the loan portfolio.
Total Bank deposits at December 31, 2001 were $232.2 million compared to $345.1 million at December 31, 2000. The 32.7% decrease in deposits is the result of the reduction of brokered and wholesale deposits. During 2001, the Bank continued its strategy to focus heavily on increasing retail deposits to reduce wholesale certificates of deposit and other borrowings and eliminate brokered deposits. Additionally, the ratio of retail deposits to total deposits increased to 97.1% for the period ended December 31, 2001, compared to 82.3% at December 31, 2000. The cost of the Bank's retail deposits at December 31, 2001 was 3.59% versus 5.95% at December 31, 2000.
The allowance for loan losses was $4.4 million at December 31, 2001, compared to $5.4 million at December 31, 2000. The December 31, 2001 allowance for loan losses, as a percent of impaired loans and gross loans was 31.07% and 2.24%, respectively, compared with 19.89% and 1.61% At December 31, 2000. The Bank's net credit loss rate for the year ended December 31, 2001 was 1.76% versus 0.07% for the year ended December 31, 2000. LIFE Bank's 30+ day delinquency rate at December 31, 2001 was 10.9%, compared to 7.47% at December 31, 2000.
Foreclosed real estate was $4.2 million at December 31, 2001, compared to $1.7 million at December 31, 2000. The $2.5 million increase, or 147%, is a partial result of the Company's drop in impaired loans, net of specific allowance, from $26.7 million in 2000 to $12.7 million in 2001.
In the first quarter 2001, the Bank sold substantially its entire mortgage servicing rights. Mortgage servicing rights were $101,000 at December 31, 2001, compared to $5.7 million at December 31, 2000.
Liquidity and Capital Resources
The Company's primary sources of funds are principal and interest payments on loans and deposits and FHLB advances. While maturities and scheduled amortization of loans are a predictable source of
funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. However, the Company believes it has continued to maintain at least the required minimum level of liquid assets to assure a safe and sound operation. The Bank's average liquidity ratios were 28.30%, 14.39%, and 8.36% for the years ended December 31, 2002, 2001 and 2000, respectively. "See "Item 1 - REGULATION-Federal Savings Institution Regulation-Liquidity."
The Company's cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities and financing activities. Cash flows provided by (used in) operating activities was $5.8 million for the year ended December 31, 2002, compared to ($250,000) for the year ended December 31, 2001. The increase in cash provided by operating activities was primarily a result of the positive net income of $2.9 million for the year ended December 31, 2002 compared to a net loss of $6.1 million for the year ended December 31, 2001. Net cash provided by (used in) investing activities was ($947,000) and $159.5 million for the year ended December 31, 2002 and 2001, respectively. The decrease in cash provided by investing activities is primarily a result of an increase of $145.8 million in the purchase of securities, partially offset by an increase of $111.1 million in proceeds from the sale of investment securities, as well as an increase of $46.0 million in the purchase and loan origination of loans held for investment. Net cash (used in) financing activities were ($9.0) million and ($160.1) million for the year ended December 31, 2002 and 2001, respectively. This decrease of $151.1 million was primarily due to the issuance of the $12 million Senior Secured Note, the proceeds of $20 million from FHLB advances in 2002 as well as repayment of the 2001 FHLB advances of $47.1 million, and a reduction in deposit accounts of $71.9 million.
The Company's most liquid assets are unrestricted cash and short-term investments. The levels of these assets are dependent on the Company's operating, financing, lending and investing activities during any given period. At December 31, 2002, cash and short-term investments totaled $3.6 million. The Company has other sources of liquidity if a need for additional funds arises, including the utilization of Federal Home Loan Bank (FHLB) advances. At December 31, 2002, the Bank had $20 million outstanding advances from the FHLB. Effective January 22, 2002, the Bank had access of up to 15% of its assets in FHLB advances.
The OTS capital regulations require savings institutions to meet three minimum capital requirements: a 1.5% tangible capital ratio, a 3.0% leverage (core capital) ratio, and an 8.0% risk-based capital ratio. The core capital requirement has been effectively increased to 4.0% because the prompt corrective action legislation provides that institutions with less than 4.0% core capital will be deemed "undercapitalized." In addition, the OTS, under the prompt corrective action regulation, can impose various constraints on institutions depending on their level of capitalization ranging from "well capitalized" to "critically undercapitalized." "See "Item 1 - REGULATION-Federal Savings Institution Regulation-Capital Requirements."
The Company had no material contractual obligations or commitments for capital expenditures at December 31, 2002. At December 31, 2002, the Company had $2.4 million outstanding commitments to originate or purchase mortgage loans compared to $5.7 million at December 31, 2001. The Company anticipates that it will have sufficient funds available to meet its current and anticipated loan origination commitments. Certificates of deposit, which are scheduled to mature in one year or less from December 31, 2002, totaled $105.1 million. The Company expects that a substantial portion of the maturing certificates of deposit will be retained by the Company at maturity.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto presented herein have been prepared in accordance with accounting principles generally accepted in the United States which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.
Impact of New Accounting Standards
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 142, "Accounting for Goodwill and Other Intangible Assets," effective starting with fiscal years beginning after December 15, 2001. This standard establishes new accounting standards for goodwill and continues to require the recognition of goodwill as an asset but does not permit amortization of goodwill as previously required by the Accounting Principles Board Opinion ("APB") Opinion No. 17. The standard also establishes a new method of testing goodwill for impairment. It requires goodwill to be separately tested for impairment at a reporting unit level. The amount of goodwill determined to be impaired would be expensed to current operations. Management believes that the adoption of the statement will not have a material effect on the Company's financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123." This Statement amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The interim disclosure provisions are effective for financial reporting containing financial statements for interim periods beginning after December 15, 2002. Because the company accounts for the compensation cost associated with its stock option plans under the intrinsic value method, the alternative methods of transition will not apply to the Company. The additional disclosure requirements of the statement are included in these financial statements. In Management's opinion, the adoption of this Statement would not have a material impact on the Company's consolidated financial position or results of operations.
Risk Factors
You should carefully consider the following risk factors and all other information contained in this annual report on Form 10-K. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial also may impair our business. If any of the events described in the following risk factors occur, our business, results of operations and financial condition could be materially adversely affected. In addition, the trading price of our common stock could decline due to any of the events described in these risks.
The Company may incur losses. The Company incurred net income of $2.9 million and a net loss of $6.1 million for the years ended December 31, 2002 and 2001, respectively and may incur losses in
the future. The Company may not be able to sustain or increase profitability on a quarterly or annual basis. The failure to remain profitable may reduce the value of investment in its common stock.
The estimation of the future cash flows of the Participation Contract may fluctuate. Based on the Company's analysis of the expected default rates and prepayment speeds of the underlying loans, the total cash to the Company as of December 31, 2002 is expected to be approximately $13.7 million over 6 years. Due to changing market conditions and other unforeseen events beyond the Company's control, the actual default and prepayment speeds may vary considerably, thus changing the amount of cash proceeds received from the underlying loans.
The Company will require additional resources to repay the Senior Secured Notes. The Company issued $12,000,000 of Senior Secured Notes in January 2002. The Senior Secured Notes are secured by all of the outstanding stock of the Bank and the Participation Contract. The Company prepaid all of the interest on the Senior Secured Notes from issuance through March 31, 2003. Beginning June 30, 2003, interest only on the Senior Secured Notes will be due quarterly. The interest rate on the notes is 13% per annum for 2003, escalating to 14% in 2004, 15% in 2005 and 16% in 2006. The current quarterly interest payment is $390,000. All principal is due on January 17, 2007, but principal may be prepaid at the option of the Company in whole or in part.
Interest payments made to date have been funded by payments received by the Company on the Participation Contract, totaling $3.2 million in 2002. The Company will be dependent on the Participation Contract to generate sufficient cash flow to make interest payments on the Senior Secured Notes. The Bank is not in a position to make dividend payments to the Company and has no plans to do such for the foreseeable future.
The cash flows available from the Participation Contract may vary considerably from those projected by the Company. Should payments on the Participation Contract not be sufficient to service the Senior Secured Notes and dividends not be available from the Bank, the Company will be required to obtain additional resources to service such debt. No assurance can be given that the additional resources necessary to service or refinance the Senior Secured Notes will be available in the capital markets.
Failure to implement the strategic plan could adversely affect the operations. The strategic plan is to transform the Bank from an institution whose operations consist primarily of originating and selling residential mortgage loans to borrowers with sub-prime credit and high loan-to-value loans, to a community-based banking institution. As part of this plan, the Company has refocused on retail deposit taking and originating higher credit quality and larger balance real estate mortgage loans secured by income properties and loans for the construction of individual and small in-fill tracts of residences for our portfolio. The financial position and results of operations depend on the ability to successfully implement the strategic plan. The failure to implement the strategic plan could harm the business and harm the results of operations.
Competition can take many forms, including convenience in obtaining a loan, service, marketing and distribution channels and interest rates. During periods of rising rates, competitors who have "locked in" low borrowing costs may have a competitive advantage. During periods of declining rates, competitors may solicit the Company's borrowers to refinance their loans. During economic slowdowns or recessions, the Bank's borrowers may have financial difficulties and may be receptive to offers by the Bank's competitors.
In addition, the Company faces increasing competition for deposits and other financial products from non-bank institutions such as brokerage firms and insurance companies in such areas as short-term money market funds, corporate and government securities funds, mutual funds and annuities. In order to compete with these other institutions with respect to deposits and fee services, the Company relies principally upon local promotional activities, personal relationships established by
officers, directors and employees of the Company and specialized services tailored to meet the individual needs of the Company's customers.
Loans to borrowers with sub-prime credit involve a higher risk of default. Sub-prime loans are loans to borrowers who generally do not satisfy the credit or underwriting standards prescribed by conventional mortgage lenders and loan buyers, such as Fannie Mae and Freddie Mac. The Bank's primary determinate in identifying sub-prime loans from "A" or prime credit quality loans had been based solely on the borrower's credit rating known as a Fair, Isaac & Company ("FICO") credit score. All loans to borrowers who possess a FICO credit score of 619 or less had been considered sub-prime. During 2002 the Bank hired an Internal Asset Review Manager to oversee the Bank's Internal Asset Review ("IAR") function. During the fourth quarter of 2002 the IAR Manager conducted an analysis of the Bank's one-to-four unit residential loan portfolio related to historic delinquency, migration of delinquent loans to Real Estate Owned ("REO") and loss rates on loans on a state by state basis. The conclusion of the analysis was that certain loans with FICO scores as high as 660 should be designated sub-prime, namely loans in certain states in the southeast and central portion of the United States and certain loans with FICO credit scores of 600 and less should be designated as sub-prime, namely those loans in certain western states. Based on the conclusion of the analysis the Bank had $10.5 million of sub-prime loans at December 31, 2002. While the Bank believes that the underwriting procedures and appraisal processes employed enabled the Bank to somewhat reduce the risks inherent in loans made to these borrowers, the Bank cannot assure you that such procedures or processes will afford adequate protection against such risks.
Loans that are not fully secured involve a higher risk of loss. The Bank no longer originates high loan-to-value real estate secured loans, where the amount of the loan, together with more senior loans secured by the real estate, exceeds the value of the real estate. However, at December 31, 2002, the Bank still owned $10.8 million of these loans, which represented 4.54% of total assets. In the event of a default on such a loan by a borrower, there generally would be insufficient collateral to pay off the balance of the loan and, as holder of a second position on the property, the Company would likely lose all or a substantial portion of its investment.
Investing in loans in states other than California may expose the Company to unfamiliar laws and market risks. In addition to lending activity in California, the Bank has originated or purchased a significant number of one- to four-family residential mortgage loans on a nationwide basis through a network of originators. There are risks involved in investing in loans on properties located throughout the nation, including:
•some of the properties securing loans may be located in states which are experiencing adverse economic conditions, including a general softening in real estate markets and the local economies, which may result in increased loan delinquencies and loan losses; and
•regulations and practices regarding the liquidation of properties (e.g., foreclosure) and the rights of mortgagors in default vary greatly from state to state, and these restrictions may limit the Bank's ability to foreclose on a property or seek other recovery.
Risks related to factors outside the Company's control, including interest rate fluctuations, could harm profitability. The Company's profitability depends to a large extent upon net interest income, which is the difference between interest income on interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Any change in general market interest rates, whether as a result of changes in the monetary policy of the Federal Reserve or otherwise, may have a significant effect on net interest income. The assets and liabilities may react differently to changes in overall market rates or conditions. See "Quantitative and Qualitative Disclosures about Market Risk-Interest Rate Risk Management." If interest rates rise, the Company anticipates that its net interest income would decline, as interest paid on its deposits would increase more quickly than the interest earned on its assets. Moreover, in periods of rising interest rates,
financial institutions typically originate fewer mortgage loans. If interest rates decline, the Bank's loans may be refinanced at lower rates or paid off and its investments may be prepaid earlier than expected. If that occurs, the Bank may have to redeploy the loan or investment proceeds into lower yielding assets, which might also decrease the Company's income.
We may be unable to successfully compete in our industry. The Bank's operating results and its growth prospects are most directly and materially influenced by (1) the health and vibrancy of the United States real estate markets, and the underlying economic forces which affect such markets, (2) the overall complexion of the interest rate environment, including the absolute level of market interest rates and the volatility of such rates, (3) the prominence of competitive forces which provide customers, or potential customers, of the Company with alternative sources of deposits and mortgage funds or investments which compete with the Company's products and services, and (4) regulations promulgated by the regulatory authorities, including those of the OTS, the FDIC and the FRB. The Company's success in identifying trends in each of these factors, and implementing strategies to exploit such trends, strongly influence the Company's long-term results and growth prospects.
The Bank's income property and construction lending businesses are subject to intense local competition from larger banking companies, community banks, and thrift institutions.
Poor Economic Conditions in Our Market Areas May Cause Us to Suffer Higher Default Rates on Our Loans. A substantial majority of our assets and deposits are generated in Southern California. As a result, poor economic conditions in Southern California could cause us to incur losses associated with higher default rates and decreased collateral values in our loan portfolio. The United States entered into an economic recession in 2001, and Southern California was also impacted. In addition, the war with Iraq could have a significant negative effect on the national economy. If current recessionary conditions continue or deteriorate, we expect that our level of non-performing assets could increase.
Concentrations of Real Estate Loans Could Subject Us to Increased Risks in the Event of a Real Estate Recession or Natural Disaster. Our loan portfolio consists almost entirely of real estate loans. In the early 1990's, the entire state of California experienced an economic recession that particularly impacted real estate values and resulted in increases in the level of delinquencies and losses for many financial institutions. If a similar real estate recession affects our market areas in the future, the security for many of our loans could be reduced in value and the ability of some of our borrowers to pay could decline. Similarly, the occurrence of a natural disaster like those California has experienced in the past, including earthquakes, brush fires, and flooding could impair the value of the collateral we hold for real estate secured loans and negatively impact our results of operations.
We May Experience Loan Losses in Excess of Our Allowance for Loan Losses. We try to limit the risk that borrowers will fail to repay loans by carefully underwriting the loans, nevertheless losses can and do occur. We create an allowance for estimated loan losses in our accounting records, based on estimates of the following:
•industry standards;
•historical experience with our loans;
•evaluation of economic conditions;
•regular reviews of the quality mix and size of the overall loan portfolio;
•regular reviews of delinquencies; and
•the quality of the collateral underlying our loans.
We maintain an allowance for loan losses at a level that we believe is adequate to absorb any specifically identified losses as well as any other losses inherent in our loan portfolio. However, changes in economic, operating and other conditions, including changes in interest rates, that are beyond our
control, may cause our actual loan losses to exceed our current allowance estimates. If the actual loan losses exceed the amount reserved, it will hurt our business. In addition, the OTS, as part of its supervisory function, periodically reviews our allowance for loan losses. Such agency may require us to increase our provision for loan losses or to recognize further loan losses, based on their judgments, which may be different from those of our management. Any increase in the allowance required by the OTS could also hurt our business.
Upon exercise of the Warrant shareholders will experience significant dilution in their shares of Common Stock. The holder of the Warrant has the right to purchase 1,116,400 shares of the Corporation's common stock at an exercise price of $.75 per share, which shares, once exercised, would represent approximately 47% of the issued and outstanding shares of the Company. The trading price of the Corporation's common stock has been significantly higher than $.75 per share for the last two fiscal years and at March 25, 2003, the closing price of the Common Stock was $5.26 per share. Upon exercise of the Warrant, existing shareholders will experience significant dilution of the shares of Common Stock which they hold.
You may have difficulty selling your shares in the future if a more active trading market in our Common Stock does not develop and if the warrant is issued. Although our Common Stock is traded on the Nasdaq Small Cap Market, trading in our Common Stock has not been extensive and cannot be characterized as amounting to an active trading market. Further, following the exercise of the Warrant, an additional 1,116,400 shares of the Company's stock will be issued and outstanding and will be eligible for sale in the public market upon registration thereof under the Securities Act of 1933, as amended. The availability of sale, as well as actual sale, of shares exercisable upon the exercise of the Warrant would likely depress the market price of the Common Stock.
Adverse outcomes of litigation against the Company could harm its business and results of operation. As a result of the consumer-oriented nature of the industry in which it operates and uncertainties with respect to the application of various laws and regulations in some circumstances, industry participants are named from time to time as defendants in litigation, including class action suits, involving alleged violations of federal and state consumer lending or other similar laws and regulations. A significant judgment against the Bank in connection with any litigation could harm its business and results of operations. See LEGAL PROCEEDINGS.
ITEM 7(A) Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
Interest Rate Risk Management. The principal objective of the Company's interest rate risk management function is to evaluate the interest rate risk included in certain balance sheet accounts, determine the level of appropriate risk given the Company's business focus, operating environment, capital and liquidity requirements and performance objectives and manage the risk consistent with Board-approved guidelines through the establishment of prudent asset and liability concentration guidelines. Through such management, the management of the Company seeks to reduce the vulnerability of the Company's operations to changes in interest rates. Management of the Company monitors its interest rate risk as such risk relates to its operational strategies. The Bank's Board of Directors reviews on a quarterly basis the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios. The extent of the movement of interest rates, higher or lower, is an uncertainty that could have a negative impact on the earnings of the Company.
Net Portfolio Value. The Bank's interest rate sensitivity is monitored by management through the use of a model which estimates the change in net portfolio value ("NPV") over a range of interest rate scenarios. NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. A NPV Ratio, in any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. The sensitivity measure is the decline in the NPV Ratio, in basis points, caused by a 2% increase or decrease in rates; whichever produces a larger decline (the "Sensitivity Measure"). The higher an institution's Sensitivity Measure is, the greater its exposure to interest rate risk is considered to be. The Bank utilizes a market value model prepared by the OTS (the "OTS NPV model"), which is prepared quarterly, based on the Bank's quarterly Thrift Financial Reports filed with the OTS. The OTS NPV model measures the Bank's interest rate risk by estimating the Bank's NPV, which is the net present value of expected cash flows from assets, liabilities and any off-balance sheet contracts, under various market interest rate scenarios which range from a 300 basis point increase to a 300 basis point decrease in market interest rates. The OTS has incorporated an interest rate risk component into its regulatory capital rule. Under the rule, an institution whose Sensitivity Measure in the event of a 200 basis point increase or decrease in interest rates exceeds 2% would be required to deduct an interest rate risk component in calculating its total capital for purpose of the risk-based capital requirement. The OTS has postponed indefinitely the date the component will first be deducted from an institution's total capital. See "Item 1 - Business-Federal Savings Institution Regulation. See "Item 1 - Business-Regulation-Federal Savings Institution Regulation."
As of December 31, 2002 and 2001, the Bank's Sensitivity Measure, as measured by the OTS, was -23 and -115 basis points, respectively; as a result of a hypothetical 200 basis point instantaneous increase in interest rates. This would correspondingly result in a $959 thousand and $3.5 million reduction in the NPV of the Bank. There has been a significant decrease in interest rate risk exposure to the Bank between December 31, 2001 and December 31, 2002.
The following tables show the NPV and projected change in the NPV of the Bank at December 31, 2002 and December 31, 2001, assuming an instantaneous and sustained change in market interest rates of 100, 200, and 300 basis points ("bp"):
Interest Rate Sensitivity of Net Portfolio Value (NPV)
* The model was not able to calculate meaningful results due to the low interest rate environment.
* The model was not able to calculate meaningful results due to the low interest rate environment.
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV requires the making of certain assumptions that may tend to oversimplify the manner in which actual yields and costs respond to changes in market interest rates. First, the models assume that the composition of the Bank's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured. Second, the models assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Third, the model does not take into account the impact of the Bank's business or strategic plans on the structure of interest-earning assets and interest- bearing liabilities. Although the NPV measurement provides an indication of the Bank's interest rate risk exposure at a particular point in time, such measurement is not intended to and does not provide a precise forecast of the effect of changes in market interest rates on the Bank's net interest income and will differ from actual results.
Selected Assets and Liabilities which are Interest Rate Sensitive. The following table provides information regarding the Bank's primary categories of assets and liabilities which are sensitive to changes in interest rates for the years ended December 31, 2002 and 2001. The information presented reflects the expected cash flows of the primary categories by year including the related weighted average interest rate. The cash flows for loans are based on maturity and re-pricing date. The loans and
mortgage-backed securities which have adjustable rate features are presented in accordance with their next interest-repricing date. Cash flow information on interest-bearing liabilities such as passbooks, NOW accounts and money market accounts also is adjusted for expected decay rates, which are based on historical information. Also, for purposes of cash flow presentation, premiums or discounts on purchased assets, and mark-to-market adjustments are excluded from the amounts presented. All certificates of deposit and borrowings are presented by maturity date.
(1)During the first quarter of 2001, the Bank sold substantially all of its mortgage servicing rights. The Bank does not have any foreign exchange exposure or any commodity exposure and therefore does not have any market risk exposure for these issues.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Independent Auditors' Report
Board of Directors and Stockholders
Pacific Premier Bancorp, Inc., and Subsidiaries
Costa Mesa, California
We have audited the accompanying consolidated balance sheet of Pacific Premier Bancorp, Inc., (formerly LIFE Financial Corporation) and Subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related consolidated statements of operations, changes in stockholders' equity and comprehensive loss, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pacific Premier Bancorp, Inc., (formerly LIFE Financial Corporation) and Subsidiaries as of December 31, 2002 and 2001, and the results of its operations, changes in its stockholders' equity, and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ VAVRINEK, TRINE, DAY & CO., LLP Vavrinek, Trine, Day & Co., LLP
Certified Public Accountants
Rancho Cucamonga, California
February 28, 2003
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Pacific Premier Bancorp, Inc.
We have audited the accompanying consolidated statement of operations, stockholders' equity and comprehensive loss, and cash flows of Pacific Premier Bancorp, Inc. and Subsidiaries (previously Life Financial Corporation) for the year ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Pacific Premier Bancorp, Inc. and Subsidiaries for the year ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the previously issued December 31, 2000 financial statements, included in the Annual report on Form 10-K for such year, the Company had suffered recurring losses and was deemed to be undercapitalized for regulatory purposes pursuant to an Office of Thrift Supervision ("OTS") examination of the Company. As a result, the Company was issued a Prompt Corrective Action Directive from the OTS in March 2001, which stipulates that the Company must restore capital ratios to satisfactory levels, by June 30, 2001. In addition, in March 2001 the Company was notified by the Federal Home Loan Bank that the Company's borrowing capacity is limited to overnight advances and that new borrowings will require credit committee approval. These factors, and others, raised substantial doubt about the Company's ability to continue as a going concern. Management's plan in regards to these matters were also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ GRANT THORNTON LLP
Irvine, California
March 16, 2001
PACIFIC PREMIER BANCORP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data)
See Notes to Consolidated Financial Statements.
PACIFIC PREMIER BANCORP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
See Notes to Consolidated Financial Statements.
PACIFIC PREMIER BANCORP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND OTHER COMPREHENSIVE INCOME
(dollars in thousands, except per share data)
(1)See Note 9 to Consolidated Financial Statements.
PACIFIC PREMIER BANCORP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Periods Ended,
(dollars in thousands)
See Notes to Consolidated Financial Statements.
PACIFIC PREMIER BANCORP, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For Each of the Three Years in Period Ended December 31, 2002
1. Description of Business and Summary of Significant Accounting Policies
Basis of Presentation and Description of Business-The consolidated financial statements include the accounts of Pacific Premier Bancorp, Inc., (formerly LIFE Financial Corporation)(the "Corporation") and its wholly owned subsidiaries, Pacific Premier Bank (formerly LIFE Bank, Federal Savings Bank) (the "Bank") and Pacific Premier Investment Services, Inc. (collectively, the "Company"). All significant intercompany accounts and transactions have been eliminated in consolidation.
The Corporation, a Delaware corporation organized in 1997, is a savings and loan holding company that owns 100% of the capital stock of the Bank, the Corporation's principal operating subsidiary. The Bank was incorporated and commenced operations in 1983.
The principal business of the Bank is attracting retail deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, primarily in multi-family (five units or more) mortgages and commercial real estate property and residential construction loans. At December 31, 2002, the Bank had three retail bank branches located in Orange and San Bernardino Counties, California.
Cash and cash equivalents-Cash and cash equivalents include cash on hand and due from banks. At December 31, 2002, $691,000 was allocated to cash reserves required by the Federal Reserve Bank for depository institutions based on the amount of deposits held. The Bank maintains amounts due from banks which exceed federally insured limits. The Bank has not experienced any losses in such accounts.
Securities Available for Sale-Investments in debt securities that management has no immediate plan to sell, but which may be sold in the future, are valued at fair value. Realized gains and losses, based on the amortized cost of the specific security, are included in noninterest income as net gain (loss) on investment securities. Unrealized holding gains and losses, net of tax, on available for sale securities are reported as a net amount in a separate component of capital until realized.
Securities Held to Maturity-Investments in debt securities that management has the positive intent and ability to hold to maturity are reported at cost and adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity.
Participation Contract-The Participation Contract is recorded on the Company's financial statements at December 31, 2002 at $4.9 million. The Participation Contract represents the right to receive 50% of any cash realized from three residual mortgage-backed securities. The right to receive cash flows under the Participation Contract began after the purchaser of the residual mortgage-backed securities recaptured its initial cash investment and a 15% internal rate of return. The Bank does not believe there is an active market for this type of asset and has determined the estimated fair value utilizing a cash flow model which determines the present value of the estimated expected cash flows from this contract using a discount rate the Bank believes is commensurate with the risks involved.
Emerging Issues Task Force 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" ("EITF 99-20") provides guidance on how transferors that retain an interest in a securitization transaction, and companies that purchase a beneficial interest in such a transaction, should account for interest income and impairment. The EITF concluded that the holder of a beneficial interest should recognize interest income over the life of the investment based on an anticipated yields determined by periodically estimating cash flows. Interest income would be revised prospectively for changes in cash flows. If the fair value of the beneficial interest has declined below its amortized cost and the decline is other-than-temporary, an entity should
apply impairment of securities guidance using the fair value method. This method differs significantly from the previously acceptable accounting method whereby impairment was measured using a risk-free rate of return.
Effective January of 2001, the Company adopted the provisions of EITF 99-20 on a prospective basis based on the actual cash flows of the securitization trusts underlying the Participation Contract. At that time the Company had decided that due to the uncertainty and inadequate cash flow history from the securitizations to the holders of the asset, that it was prudent to leave the Participation Contract on a non-accrual basis until there was a sufficient cash flow history. Based on the cash flows and other events affecting the expected yield of the Participation Contract, the adoption of EITF 99-20 did not have a material impact on the Company's financial statements for the year ended December 31, 2001. The Company commenced accreting the discount and the expected yield differential (the difference between the fair market value and the book value) on the Participation Contract during 2002 over the expected remaining life of the contract using a level yield methodology. The accretion will be adjusted for any changes in the expected performance of the contract. The Company recorded discount accretion of $3.8 million and received cash proceeds of $3.4 million for the year ended December 31, 2002.
The following table summarizes the factors used in determining the fair value of the Participation Contract at December 31, 2002 and the effects of adverse adjustments to these factors. The key assumptions in valuing the carrying value of the Participation Contract are the weighted average prepayment speed of 33.52%, the weighted average discount rate of 66.75%, and the weighted average default rate of 4.30%. The assumptions used for the prepayment speeds and credit losses are based on the historical performance of each of the three residual mortgage-backed securities. These assumptions and the sensitivity of the value of the Participation Contract to immediate adverse changes in the key assumptions are presented in the following table (dollars in thousands):
These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.
The table below shows data from the three securitizations that the Company has an interest in through the Participation Contract. Included are the outstanding principal loan balances, the credit losses for the year and the delinquent principal amounts for the periods indicated.
The residual assets underlying the Participation Contract began generating a cash flow to the holder of the assets in June 2001.
Loans Held for Sale-Loans held for sale, consisting primarily of loans secured by one-to-four family residential units, are carried at the lower of cost or market, computed using the aggregate method by asset type. Premiums paid and discounts obtained on such loans held for sale are deferred as an adjustment to the carrying value of the loans until the loans are sold. Interest is recognized as revenue when earned according to the terms of the loans and when, in the opinion of management, it is collectible. Loans are evaluated for collectability, and if appropriate, previously accrued interest is reversed.
Loans Held for Investment-The Bank's real estate loan portfolio consists primarily of long-term loans secured by first and second trust deeds on single-family residences.
Loans held for investment are carried at amortized cost and net of deferred loan origination fees and costs and allowance for loan losses. Net deferred loan origination fees and costs on loans are amortized or accreted using the interest method over the expected lives of the loans. Amortization of deferred loan fees is discontinued for nonperforming loans. Loans held for investment are not adjusted to the lower of cost or estimated market value because it is management's intention, and the Bank has the ability, to hold these loans to maturity.
Interest on loans is credited to income as earned. Interest receivable is accrued only if deemed collectible.
The Bank considers a loan impaired when it is probable that the Bank will be unable to collect all contractual principal and interest payments under the terms of the original loan agreement. Loans are evaluated for impairment as part of the Bank's normal internal asset review process. However, in determining when a loan is impaired, management also considers the loan documentation, current loan to value ratios and the borrower's current financial position. Included as impaired loans are all loans delinquent 90 days or more and all loans that have a specific loss allowance applied to adjust the loan to fair value. The accrual of interest on impaired loans is discontinued after a 90-day delinquent period or when, in management's opinion, the borrower may be unable to meet payments as they become due. When the interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. Where impairment is considered other than temporary, a charge-off is recorded; where impairment is considered temporary, an allowance is established. Impaired loans, which are performing under the contractual terms, are
reported as performing loans, and cash payments are allocated to principal and interest in accordance with the terms of the loans.
Allowance for Loan Losses-It is the policy of the Bank to maintain an allowance for loan losses at a level deemed appropriate by management to provide for known or inherent risks in the portfolio. Management's determination of the adequacy of the loan loss allowance is based on an evaluation of the composition of the portfolio, actual loss experience, current economic conditions, industry trends and other relevant factors in the area in which the Bank's lending and real estate activities are based. These factors may affect the borrowers' ability to pay and the value of the underlying collateral. The Bank's methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance, specific allowance for identified non-homogeneous problem loans and the unallocated allowance. The formula allowance is calculated by applying loss factors to loans held for investment. The loss factors are applied according to loan program type and loan classification. The loss factors for each program type and loan classification are established based primarily upon the Bank's historical loss experience and are evaluated on a quarterly basis. The unallocated allowance is based upon management's evaluation of various conditions, the effect of which are not directly measured in the determination of the formula and specific allowance. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated allowance include the following conditions that existed as of the balance sheet date: (1) then-existing general economic and business conditions affecting the key lending areas of the Bank, (2) credit quality trends, (3) loan volumes and concentrations, (4) recent loss experience in particular segments of the portfolio, and (5) regulatory examination results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management. Specific allowances are established for certain non-homogeneous loans where management has identified significant conditions or circumstances related to a credit that management believes indicates the probability that a loss has been incurred in excess of the amount determined by the application of the formula allowance. A specific allowance is calculated by subtracting the current market value less estimated selling and holding costs from the loan balance. Specific loss allowances are established if the fair value of the loan or the collateral is estimated to be less than the gross carrying value of the loan. At December 31, 2002, the Bank had $735,000 in a specific allowance on loans.
Although management uses the best information available to make these estimates, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions that may be beyond the Bank's control.
Mortgage Banking and Loan Servicing Operations-Prior to 2000, the Bank primarily acquired mortgage loans for sale in the secondary market. At origination or purchase, mortgage loans were designated as held for sale or held for investment. Loans held for sale were carried at the lower of cost or estimated market value determined on an aggregate basis by outstanding investor commitments or current investor requirements. Cost includes related loan origination costs and fees, as well as premiums or discounts for purchased loans. Net unrealized losses, if any, are recognized in a valuation allowance by charges to operations. Any transfers of loans held for sale to the investment portfolio were recorded at the lower of cost or estimated market value on the transfer date.
The Bank sold its loans held for sale as either servicing retained or servicing released. Under the servicing agreements for loans sold with servicing retained, the investor was paid its share of the principal collections together with interest at an agreed-upon rate, which generally differed from the loans' contractual interest rate. The loan-servicing portfolio is comprised of loans owned by the Bank and loans sold by the Bank to other investors on a servicing retained basis.
In 2000, the Bank ceased originating and purchasing loans for sale in the secondary market in order to focus on its traditional banking operations. Accordingly, certain costs were incurred relating to this transition. The costs primarily pertained to the write-off of property and equipment that could no longer be used in the current operations and also for accrual of employee incentives. These restructuring costs totaled approximately $849,000 for the year ended December 31, 2000 and included the loss on sale of a building of $90,000, the abandonment of furniture, equipment and leaseholds of $574,000, and severance expenses consisting of a buyout of an employee contract and retention bonuses totaling $132,000. No additional severance expense was incurred for the 164 planned terminations.
The Bank evaluates its capitalized mortgage servicing rights (MSRs) for impairment based on the fair value of those rights. The Bank's periodic evaluation is performed on a desegregated basis whereby MSRs are stratified based on type of interest rate (variable or fixed), loan type and original loan term. Impairment is recognized in a valuation allowance for each pool in the period of impairment. The Bank determines fair value based on the present value of estimated net future cash flows related to servicing income. In estimating fair values at December 31, 2002 and 2001, the Bank utilized a weighted average prepayment assumption of 20.0% and 18.6%, respectively, and a weighted average discount rate of 13.5%. The cost allocated to servicing rights is amortized in proportion to, and over the period of, estimated net future servicing fee income.
At December 31, 2000, the Bank serviced in excess of $582 million in mortgage and consumer loans for others. In the first quarter of 2001, the Bank sold the servicing rights of $526 million in loans. A significant portion of the balance of the MSR at December 31, 2000 was sold in these transactions. At December 31, 2002 the Bank had $51,000 in MSR remaining.
On December 31, 1999, the Company sold its residual mortgage-backed securities retained from securitization and related mortgage servicing rights for $19.4 million in cash and other consideration and realized a pretax loss of $29.1 million. The $29.1 million loss is the net of the balance of the Residual Assets sold of $36.7 million plus the mortgage servicing rights of $7.5 million less a $4.3 million reserve for the estimated loss to be incurred on the $14.6 million of sub-performing loans acquired less cash and other considerations totaling $19.4 million. The $19.4 million was comprised of $5.1 million in cash for the residual assets, $3.0 million cash for the credit guaranty, $2.0 million cash for the mortgage servicing rights sold and $9.3 million in other consideration. The other consideration consisted of a contractual right from the purchaser of the residual mortgage-backed securities to receive 50% of any cash realized, as defined, from the residual mortgage-backed securities (the "Participation Contract"). The Company valued the contractual right at its estimated fair value of $9.3 million at December 31, 1999. The right to receive cash flows under the contract begins after the purchaser recaptures their initial cash investment of $8.1 million, a 15% internal rate of return (the "Hurdle amount"), and $200,000 in servicing fees from the transaction. Additionally, the Company entered into a credit guaranty related to a $14.6 million pool of sub-performing loans in the 1998-1A and 1B securitization whereby the Company guaranteed the difference between the December 1, 1999, unpaid principal balance and the realized value of those loans at final disposition. At December 31, 1999, the Bank estimated the obligation under the credit guaranty at $4.3 million and was included in other liabilities. During 2000, the $14.6 million of sub-performing loans were sold, or otherwise disposed of, for a net loss of $3.9 million, of which $2.6 million was paid to the purchaser under the credit guaranty and applied to reduce the Hurdle Amount to $5.7 million for cash distributions on the Participation Contract. During the year ended December 31, 2000, the Bank recorded a $4.9 million write-down of the Participation Contract as a result of an increase in the discount rate from 15% to 40% and a change in the composite prepayment speeds from 21.6% in 1999 to 24.6% in 2000 in the Bank's valuation model. See detailed discussion of valuation of Participation Contract in "Note 1-Participation Contract".
Foreclosed Real Estate-Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at fair value at the date of foreclosure through a charge to the allowance for
estimated loan losses. After foreclosure, valuations are periodically performed by management; and additional write downs are charged to operations if the carrying value of a property exceeds its fair value less estimated costs to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net loss on foreclosed real estate in the consolidated statement of operations.
Premises and Equipment-Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, which range from 31 years for buildings, 15 years for leasehold improvements, 7 years for furniture, fixtures and equipment, and 3 years for computer and telecommunication equipment.
The Company periodically evaluates the recoverability of long-lived assets, such as premises and equipment, to ensure the carrying value has not been impaired.
Income Taxes-Deferred tax assets and liabilities are recorded for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, all expected future events other than enactments of changes in the tax law or rates are considered. If necessary, a valuation allowance is established based on management's determination of the likelihood of realization of deferred tax assets.
Presentation of Cash Flows-For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks.
Use of Estimates-The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of the Participation Contract, foreclosed real estate, and deferred tax assets.
Comprehensive Income-Beginning in 1998, the Company adopted Statement of Financial Accounting Standard (SFAS) No.130, "Reporting Comprehensive Income", which requires the disclosure of comprehensive income and its components. Changes in unrealized gain (loss) on available-for-sale securities net of income taxes is the only component of accumulated other comprehensive income for the Company.
Stock-Based Compensation-SFAS No. 123, "Accounting for Stock-Based Compensation", issued in 1995, encourages companies to account for stock compensation awards based on their fair value at the date the awards are granted. SFAS No. 123 does not require the application of the fair value method for employee awards and allows for the continuance of current accounting methods, which require accounting for stock compensation awards based on their intrinsic value as of the grant date. However, SFAS No. 123 requires pro forma disclosure of net income and, if presented, earnings per share, as if the fair value based method of accounting defined in this statement had been applied. The Company did not adopt the fair value accounting method in SFAS No. 123 with respect to its stock option plans and continues to account for such plans in accordance with Accounting Principles Board (APB) Opinion No. 25.
Recent Accounting Developments-In calendar year 2001, the Bank has adopted SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". The Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Under this Statement, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished.
To calculate the gain (loss) on sale of loans, the Bank's investment in the loan is allocated among the retained portion of the loan, the servicing retained, and the sold portion of the loan, based on the relative fair market value of each portion. The gain (loss) on the sold portion of the loan is recognized at the time of sale based on the difference between the sale proceeds and the allocated investment. As a result of the relative fair value allocation, the carrying value of the retained portion is discounted, with the discount accreted to interest income over the life of the loan. That portion of the excess servicing fees that represent contractually specified servicing fees (contractual servicing) are reflected as a servicing asset which is amortized over an estimated life using a method approximating the level yield method; in the event future prepayments exceed Management's estimates and future expected cash flows are inadequate to cover the unamortized servicing asset, additional amortization would be recognized. The adoption of this standard did not have an effect on the Company's financial condition, results of operations or cash flows.
In June 2001, the FASB issued SFAS No. 142, "Accounting for Goodwill and Other Intangible Assets," effective starting with fiscal years beginning after December 15, 2001. This standard establishes new accounting standards for goodwill and continues to require the recognition of goodwill as an asset but does not permit amortization of goodwill as previously required by the Accounting Principles Board Opinion ("APB") Opinion No. 17. The standard also establishes a new method of testing goodwill for impairment. It requires goodwill to be separately tested for impairment at a reporting unit level. The amount of goodwill determined to be impaired would be expensed to current operations. Management believes that the adoption of the statement will not have a material effect on the Company's financial statements.
In August 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, "Accounting for Asset Retirement Obligations", which requires the Company to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of long-term assets. SFAS No. 143 is effective for the Company in 2003; however, management does not believe adoption will have a material impact on the Company's financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123." This Statement amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The interim disclosure provisions are effective for financial reporting containing financial statements for interim periods beginning after December 15, 2002. Because the company accounts for the compensation cost associated with its stock option plans under the intrinsic value method, the alternative methods of transition will not apply to the Company. The additional disclosure requirements of the statement are included in these financial statements. In Management's opinion, the adoption of this Statement would not have a material impact on the Company's consolidated financial
position or results of operations. The pro forma effects of applying SFAS No. 123 are disclosed below (dollars in thousands, except per share data):
Reclassifications-Certain reclassifications have been made to the 2000 and 1999 consolidated financial statements to conform to the 2001 presentation.
2. Regulatory Capital Requirements and Other Regulatory Matters
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk- weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). At periodic intervals, both the Office of Thrift Supervision and the Federal Deposit Insurance Corporation routinely examine the Bank's financial statements as part of their legally prescribed oversight of the savings and loan industry. Based on these examinations, the regulators can direct that the Bank's financial statements be adjusted in accordance with their findings.
The Bank's actual capital amounts and ratios are also presented in the table. (dollars in thousands)
On September 25, 2000, the Corporation consented to the issuance of an Order to Cease and Desist (the "Order") by the OTS. The Order required the Corporation, among other things, to contribute $5.2 million of capital to the Bank, not later than December 31, 2000, subject to extension by the OTS. The Corporation was also required to observe certain requirements regarding transactions with affiliates, adequate books and records, tax sharing arrangements with the Bank, and the maintenance of a separate corporate existence from the Bank.
Also on September 25, 2000, the Bank entered into a Supervisory Agreement with the OTS. The Supervisory Agreement required the Bank, among other things, to achieve a minimum individual core capital ratio of 6% and a minimum individual modified risk-based capital ratio of 11% by March 31, 2001. In calculating these ratios, the Bank was required to double risk weight all sub-prime loans starting March 31, 2001. The Supervisory Agreement also required that the Bank add at least two new independent members to its Board of Directors, not pay dividends without OTS approval and revise many of its policies and procedures, including those pertaining to internal asset review, allowances for loan losses, interest rate risk management, mortgage banking operations, liquidity, separate corporate existence, loans to one borrower and oversight by the Board of Directors.
During 2001, the Bank's regulatory capital did not meet all minimum regulatory capital requirements. On March 23, 2001 the Bank stipulated to the issuance of a Prompt Corrective Action Directive (the "PCA Directive") by the OTS. The PCA Directive required the Bank, among other things, to raise sufficient capital to achieve total risk-based capital of 8.0%; Tier 1 risk-based capital of 4.0%; and a leverage ratio of 4.0% by June 30, 2001 or to be recapitalized by merging or being acquired prior to September 30, 2001. In addition, the PCA provisions included limitations on capital distributions, restrictions on the payment of management fees, asset growth, acquisitions, branching, and new lines of business, senior executive officers' compensation, and on other activities. The Bank was required to restrict the rates the Bank pays on deposits to the prevailing rates of interest on deposits of comparable amounts and maturities in the region where the Bank is located. The Bank was prohibited from entering into any material transaction other than in the normal course of business without the prior consent of the OTS.
On October 5, 2001 the Bank was notified that it was "significantly undercapitalized" pursuant to the Prompt Corrective Action regulations. On October 25, 2001 the Bank consented to an OTS request
to sign a Marketing Assistance Agreement and Consent to the Appointment of a Conservator or Receiver (the "Marketing Agreement"). The Marketing Agreement; among other things, permitted the OTS to provide confidential information about the Bank to perspective acquirers, merger partners or investors to facilitate the possible acquisition of the Bank or possible merger of the Bank with a qualified merger partner. The Bank was requested to enter into the Marketing Agreement due to its significantly undercapitalized designation, the fact the Bank was in violation of the Supervisory Agreement dated September 25, 2000, in violation of the PCA Directive dated March 23, 2001, and the OTS considered the Bank to be in an unsafe and unsound condition.
On November 20, 2001 the Corporation entered into an agreement for the private placement of a secured note, together with a warrant to purchase Common Stock of the Corporation, with New Life Holdings, LLC, a California limited liability company (the "Investor") in exchange for which the Corporation received $12,000,000. The Note and Warrant Purchase Agreement was finalized in January 2002.
In January 2002, the Corporation received stockholder approval of the Note and Warrant Purchase Agreement. On January 17, 2002, the Corporation closed the transaction with New Life Holdings, LLC to issue $12,000,000 in notes and warrants to purchase 1,166,400 shares. The intrinsic value of the warrants at the execution of the Purchase Agreement was $700,000. The Corporation utilized the proceeds from the issuance of the notes to infuse $3.7 million of capital into the Bank, to purchase the Participation Contract from the Bank for $4.4 million, to pay the tax receivable of $3.2 million owed to the Bank, and to pay transaction costs incurred in connection with the Private Placement. The stock of the Corporation's subsidiaries and the Participation Contract were pledged as collateral against the Note.
Since the Bank has been advised that it is in need of more than normal supervision by the OTS, the Bank may not currently pay cash dividends without the prior approval of the OTS.
3. Investment Securities
The amortized cost and estimated fair value of securities were as follows at December 31 (in thousands):
The Bank, during 2001, did not recognize any unrealized gain on the Participation Contract due to the uncertainties surrounding the asset.
During 2000, it was management's decision to transfer all held to maturity investment securities to available for, sale due to the increased market risk associated with those securities and the changes in the securities prepayment speeds. An initial write down to market value was recorded at that time, which was not significant, and re-evaluations are made monthly. The unrealized gains and losses are recorded, net of related income tax effects, in accumulated other comprehensive income (loss).
The weighted average interest rates on total investment securities, which excludes the Participation Contract, were 4.00% and 5.03% at December 31, 2002 and 2001, respectively.
At December 31, 2002, $30.0 million in mortgage-backed securities mature in excess of 10 years, no mortgage-backed securities mature in 5 to 10 years, and $26.3 million in mutual funds and $1.9 million of FHLB stock are redeemable with a one-day notice unless pledged for borrowings. At December 31, 2002, $28.1 million of the securities portfolio were pledged as collateral to the FHLB.
4. Loans Held for Investment
Loans held for investment consisted of the following at December 31 (in thousands):
From time to time the Bank may purchase or sell loans in order to manage concentrations, maximize interest income, change risk profiles, improve returns and generate liquidity. Total loans reclassified in 2001 from held to maturity to held for sale had a carrying value of $9.3 million, total lower of cost or market adjustments of $900,000, and a fair market value of $8.4 million.
The Bank grants residential and commercial loans held for investment to customers located primarily in Southern California. Consequently, a borrower's ability to repay may be impacted by economic factors in the region.
The following summarizes activity in the allowance for loan losses for the year ended December 31 (in thousands):
The Bank had nonaccrual and nonperforming loans at December 31, 2002, 2001, and 2000 of $5.2 million, $15.2 million, and $22.6 million, respectively. If such loans had been performing in accordance with their original terms, the Bank would have recorded interest income of $12.6 million, $23.0 million, and $39.6 million, respectively, instead of interest income actually recognized of
$12.3 million, $22.0 million, and $38.3 million, respectively, for the years ended December 31, 2002, 2001, and 2000.
The following summarizes information related to the Bank's impaired loans at December 31 (in thousands):
The Bank is not committed to lend additional funds to debtors whose loans have been modified.
The Bank is subject to numerous lending-related regulations. Under FIRREA, the Bank may not make real estate loans to one borrower in excess of 15% of its unimpaired capital and surplus except for loans not to exceed $500,000. This 15% limitation results in a dollar limitation of approximately $2.7 million at December 31, 2002. At December 31, 2002, the Bank's largest aggregate outstanding balance of loans-to-one borrower was $2.7 million.
There were no loans to or activity with directors and executive officers during the year ended December 31, 2002 or 2001.
5. Mortgage Banking and Loan Servicing Operations
Loans serviced for others at December 31, 2002 and 2001 totaled $7.2 million and $19.8 million respectively.
In connection with mortgage servicing activities, the Bank held funds in trust for others totaling approximately $272,000 and $433,000 at December 31, 2002 and 2001, respectively. At December 31, 2002 and 2001, $266,000 and $433,000, respectively, of these funds are maintained in deposit accounts of the Bank (subject to FDIC insurance limits) and are included in the assets and liabilities of the Company.
Although the Bank sold without recourse substantially all of the mortgage loans it originated or purchased, the Bank retained some degree of risk on substantially all of the loans it sold.
In connection with its whole loan sales, the Bank entered into agreements which generally required the Bank to repurchase or substitute loans in the event of a breach of a representation or warranty made by the Bank to the loan purchaser, any misrepresentation during the mortgage loan origination process or, in some cases, upon any fraud or early default on such mortgage loans. The remedies available to a purchaser of mortgage loans from the Bank were generally broader than those available to the Bank against the sellers of such loans; and if a loan purchaser enforces its remedies, the Bank may not be able to enforce whatever remedies the Bank may have against such sellers. If the loans were originated directly by the Bank, the Bank will be solely responsible for any breaches of representations or warranties.
The following is a summary of activity in mortgage servicing rights for the year ended December 31 (in thousands):
The following is a summary of activity in the valuation allowance for mortgage servicing rights for the year ended December 31 (in thousands):
6. Premises and Equipment
Premises and equipment consisted of the following at December 31 (in thousands):
Depreciation expense was $680,000, $1,176,000, and $1,970,000 for the years ended December 31, 2002, 2001 and 2000, respectively. During the year ended December 31, 2001, premises and equipment had a write down of approximately $655,000 due to abandonment.
7. Foreclosed Real Estate
The following summarizes the activity in the real estate owned, net of the allowance, for the year ended December 31 (in thousands):
During 2000, the Bank began charging valuation adjustments directly against the property recorded in foreclosed real estate.
8. Deposit Accounts
Deposit accounts consisted of the following at December 31, (in thousands):
The aggregate annual maturities of certificate accounts at December 31 are approximately as follows (in thousands):
Interest expense on deposit accounts for the years ended December 31 is summarized as follows (in thousands):
9. Advances from Federal Home Loan Bank and Other Borrowings
On March 16, 2001 the Bank was notified by the Federal Home Loan Bank (FHLB) that the Bank's borrowing capacity was limited to overnight advances and new borrowings and would require credit committee approval. The advances outstanding at the time of the notice totaled $20 million and were not affected by the change in borrowing status. In January 2002, the Bank received notification from the FHLB that the restrictions were removed and its credit line had been reinstated, the use of which is contingent upon continued compliance with the Advances and Security Agreement and other eligibility requirements established by the FHLB. The Bank had $20 million and $0 borrowings with the FHLB at December 31, 2002 and 2001, respectively, the maturities of which consist of $10 million due March 2003 and $10 million due March 2004. Advances from the FHLB and/or the line of credit are collateralized by certain real estate loans with an aggregate principal balance of $0 and $64.9 million, certain investment securities of $26.2 million and $0, and FHLB stock of $1.9 million and $3.1 million at December 31, 2002 and 2001, respectively.
The following table summarizes activities in advances from the FHLB for the years ended December 31:
The maturities of FHLB advances are as follows (in thousands):
Other borrowings consist of a Senior Secured Note payable to New Life Holdings, LLC at December 31, 2002. The following summarizes activities in other borrowings:
In addition to the $12,000,000 Senior Secured Note, issued in January 2002, the Corporation issued warrants to purchase 1,166,400 shares of stock at an exercise price of $0.75 per share. The closing price of the Company's stock on November 19, 2001, the day before execution of the financing agreement, was $1.35 per share. The intrinsic value of the warrants at the time of the transaction was $700,000, which was accounted for as an original issue discount. The discount is being amortized over the term of the Senior Secured Note, which is due in 2007. The unamortized balance of the discount as of December 31, 2002, is $559,872. Interest expense of $1.9 million related to the Senior Secured Note, including $139,968 of discount amortization, was charged to operations for the year ended December 31, 2002. The interest rate on the note is 13% per annum for 2003, escalating to 14% in 2004, 15% in 2005 and 16% in 2006.
10. Subordinated Debentures
On March 14, 1997, the Bank issued subordinated debentures (Debentures) in the aggregate principal amount of $10,000,000 through a private placement and pursuant to a Debenture Purchase Agreement. The Debentures will mature on March 15, 2004 and bear interest at the rate of 13.5% per annum, payable semi-annually. In March 1998, the Bank substituted the Corporation in its place as obligors on the Debentures. The Debentures are direct, unconditional obligations ranking with all other existing and future unsecured and subordinated indebtedness.
The Debentures are redeemable at the option of the Company, in whole or in part, at any time after September 15, 1998, at the aggregate principal amount thereof, plus accrued and unpaid interest, if any. Holders of the Debentures had the option at September 15, 1998 to require the Company to purchase all or part of the holder's outstanding Debentures at a price equal to 100% of the principal amount repurchased plus accrued interest through the repurchase date.
On September 15, 1998, holders of $8.5 million in Debentures exercised their option to have the Company repurchase their Debentures as of December 14, 1998, thereby reducing outstanding Debentures to $1.5 million.
11. Income Taxes
Income taxes for the year ended December 31 consisted of the following (in thousands):
A reconciliation from statutory federal income taxes to the Company's effective income taxes for the year ended December 31 is as follows:
Deferred tax assets (liabilities) were comprised of the following at December 31 (in thousands):
At December 31, 2002, a valuation allowance of approximately $9.6 million has been recorded against the deferred tax asset as it is more likely than not that such benefit would not be recognized. The Company has a net operating loss carry forward of approximately $22.7 million for federal income tax purposes which expires through 2020. In addition, the Bank has a net operating loss carryforward of approximately $11.7 million for state franchise tax purposes which expires through 2013. State Net Operating Losses have been suspended for 2002 and 2003. If the Company has an "ownership change" as defined under Internal Revenue Code Section 382, its net operating losses may be subject to limitation. Under Section 382, which has also been adopted under California law, if during any three-year period there is more than a 50 percentage point change in the ownership of the Company, then the future use of any pre-change net operating losses or built-in losses of the Company may be subject to an annual percentage limitation based on the value of the company at the ownership change date.
12. Commitments, Contingencies and Concentrations of Risk
Legal Proceedings-In December 1999, certain shareholders of the Corporation filed a federal securities lawsuit against the Company, various officers and directors of the Company, and certain other third parties. The lawsuit was filed in the United States District Court for the Southern District of New York to assert claims against the defendants under the Securities Exchange Act of 1934 and the Securities Act of 1933. A substantially similar action was filed in the United States District Court for the Central District of California in January 2000 and subsequently dismissed without prejudice. In April 2000, the Company and its officer and director defendants filed motions to dismiss the lawsuit or transfer it to California. In December 2002, the Court denied the motion to transfer, dismissed one of the claims, and allowed one of the claims to remain open. The Company intends to vigorously defend against the claim asserted in the litigation.
During the years ended December 31, 2001 and 2002 the Company was named in six lawsuits alleging various violations of state laws relating to origination fees, interest rates, and other charges. The complaints seek to invalidate the mortgage loans, or make them conform to state laws. The Company has responded to or is in the process of responding to these lawsuits. As of December 31, 2002 there were 3 such lawsuits open that the Company was named in.
The Company and the Bank are not involved in any other pending legal proceedings other than legal proceedings occurring in the ordinary course of business. Management believes that none of these legal proceedings, individually or in the aggregate, will have a material adverse impact on the results of operations or financial condition of the Company or the Bank.
Lease Commitments-The Company leases a portion of its facilities from non-affiliates under operating leases expiring at various dates through 2006. The following schedule shows the minimum annual lease payments, excluding property taxes and other operating expenses, due under these agreements (in thousands):
Rental expense under all operating leases totaled $558,000, $675,000, and $1,021,000 for the years ended December 31, 2002, 2001, and 2000, respectively.
Employment Agreements-The Company and the Bank have negotiated an employment agreement with their Chief Executive Officer. This agreement provides for the payment of a base salary, a bonus based upon performance of the Company, and the payment of severance benefits upon termination.
Availability of Funding Sources-The Company funds substantially all of the loans, which it originates or purchases through deposits, internally generated funds, or other borrowings. The Company competes for deposits primarily on the basis of rates, and, as a consequence, the Company could experience difficulties in attracting deposits to fund its operations if the Company does not continue to offer deposit rates at levels that are competitive with other financial institutions. To the extent that the Company is not able to maintain its currently available funding sources or to access new funding sources, it would have to curtail its loan production activities or sell loans earlier than is optimal. Any such event could have a material adverse effect on the Company's results of operations, financial condition and cash flows.
13. Benefit Plans
401(k) Plan-The Company maintains an Employee Savings Plan (the Plan) which qualifies under section 401(k) of the Internal Revenue Code. Under the Plan, employees may contribute from 1% to 15% of their compensation. The Company will match, at its discretion, 25% of the amount contributed by the employee up to a maximum of 8% of the employee's salary. The amount of contributions made to the Plan by the Company were approximately $24,000, $40,000, and $80,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
LIFE Financial Corporation 2000 Stock Option Incentive Plan (the Plan)-The Plan is an amendment and restatement of the 1997 Stock Option Plan and the 1996 Stock Option Plan. The Plan authorizes the granting of options equal to 194,600 shares of the common stock, after adjusting for the June 7, 2001 1:5 reverse stock split, for issuances to executives, key employees, officers and directors. The Plan will be in effect for a period of ten years from April 27, 2000, the date the Plan was adopted. Options granted under the Plan will be made at an exercise price equal to the fair market value of the stock on the date of grant. Awards granted to officers and employees may include incentive stock options, nonstatutory stock options and limited rights, which are exercisable only upon a change in control of the Company. The options granted pursuant to the Plan will vest at a rate of 33.3% per year. The following is a summary of activity in the 2000 Option Plan during the years ended December 31, 2002 and 2001.
The fair value of options granted under the 2000 Option Plan during 2002 and 2001 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used: no dividend yield for any year, volatility rate of 139%, risk-free interest rate of 3.72% and 5.2%, respectively and expected average lives of 8 years. Options were granted at an exercise price of $5.85 per share which is equal to the fair market value at date of grant.
14. Financial Instruments with Off Balance Sheet Risk
The Company is a party to financial instruments with off balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of originating loans or providing funds under existing lines of credit. These instruments involve, to varying degrees; elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated statements of financial condition.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require payment of a fee. Since many commitments are expected to expire, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The Company's commitments to extend credit at December 31, 2002 and 2001 totaled $5.0 million and $9.4 million, respectively.
15. Fair Value of Financial Instruments
The following disclosures of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, Disclosures About Fair Value of Financial Instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The Company utilized the following methods and assumptions to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents-The carrying amount approximates fair value.
Securities-Fair values are based on quoted market prices.
Loans Held for Sale-Fair values are based on quoted market prices or dealer quotes.
Loans Held for Investment-The fair value of gross loans receivable has been estimated using the present value of cash flow method, discounted using the current rate at which similar loans would be made to borrowers with similar credit ratings and for the same maturities, and giving consideration to estimated prepayment risk and credit loss factors. The fair value of nonperforming loans with a carrying value of approximately $5.2 million and $15.2 million at December 31, 2002 and 2001, respectively, was not estimated because it is not practicable to reasonably assess the credit adjustment that would be applied in the market place for such loans. These impaired loans are primarily residential real estate loans.
Participation Contract-Fair value is estimated using discounted cash flows based on the internal rate of return assigned according to the level of risks and uncertainties of the asset. Further information regarding the Participation Contract is provided in Note 1-Description of Business and Summary of Significant Accounting Policies "Participation Contract". The Participation Contract is recorded on the Company's financial statements at $4.8 million for the year ended December 31, 2002 with an estimated fair value of $7.0 million. The Participation Contract was previously recorded on the Bank's financial statements at $4.4 million for the year ended December 31, 2001with an estimated fair value of $7.3 million. The Company does not believe there is an active market for this type of asset and has determined the estimated fair value utilizing a cash flow model which determines the present value of the estimated expected cash flows from this contract using a discount rate the Company believes is commensurate with the risks involved.
Mortgage Servicing Rights-Fair values are based on the present value of estimated net future cash flows related to servicing income.
Accrued Interest Receivable/Payable-The carrying amount approximates fair value.
Deposit Accounts-The fair value of checking, passbook and money market accounts is the amount payable on demand at the reporting date. The fair value of certificate accounts is estimated using the rates currently offered for deposits of similar remaining maturities.
Other Borrowings and Subordinated Debentures-The carrying amount approximates fair value as the interest rate, based on risk, currently approximates market.
The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2002 and 2001.
16. Earnings (Loss) Per Share
A reconciliation of the numerators and denominators used in basic and diluted earnings (loss) per share computations is as follows (in thousands, except per share data):
Loss per share has been adjusted retroactively to reflect the June 2001 1:5 reverse stock split. The per share amounts and weighted average shares outstanding included in the accompanying consolidated financial statements have been restated to reflect the reverse stock split.
17. Parent Company Financial Information
PACIFIC PREMIER BANCORP, INC.
(Parent company only)
(dollars in thousands)
PACIFIC PREMIER BANCORP, INC.
(Parent company only)
(dollars in thousands)
PACIFIC PREMIER BANCORP, INC.
(Parent company only)
(In thousands)
18. Quarterly Results of Operations (Unaudited)
The following is a summary of quarterly results for the years ended December 31:
The loss in the quarter ended September 30, 2001, includes a valuation allowance of $949,000 or $.71 per share that was recorded against the deferred tax asset due to uncertainty of the realizability of the asset.
The loss in the quarter ended December 31, 2001, includes a write down of fixed assets in the amount of $655,000 or $.49 per share due to the abandonment of surplus equipment.
ITEM 9.
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
As reported in the Company's Form 8-K dated February 5, 2002, the Company terminated the relationship with its principal independent accountant Grant Thornton LLP on January 30, 2002. During the Company's two most recent fiscal years up to and through January 30, 2002, there were no disagreements with Grant Thornton LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Grant Thornton LLP, would have caused it to make reference to the subject matter of the disagreement in connection with its report.
Grant Thornton LLP's report on the Company's financial statements for the fiscal years ended December 31, 2000 and 1999, did not contain an adverse opinion or a disclaimer of opinion, and were not qualified or modified as to audit scope or accounting principles. The December 31, 1999 report did not contain any uncertainties. However, the December 31, 2000 report did contain an uncertainty regarding the Company's ability to continue as a going concern.
During the Company's prior fiscal years up to and through January 30, 2002, Grant Thornton LLP did not advise the Company of any "reportable events" as defined in Item 304(a)(1)(v) of Regulation S-K.
As reported in the Company's Form 8-K dated February 5, 2002, Vavrinek, Trine, Day & Co., LLP was engaged as the Company's independent accountants for the fiscal year ended December 31, 2001, to audit the Company's financial statements.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to Directors and Executive Officers of the Registrant is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 23, 2002, which will be filed with the Securities and Exchange Commission within 120 days after the end of the Registrant's fiscal year.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to executive compensation and directors' compensation is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 23, 2002, excluding the Stock Performance Graph and Compensation Report. The Proxy Statement will be filed within 120 days after the end of the Registrant's fiscal year.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 23, 2002, which will be filed within 120 days after the end of the Registrant's fiscal year.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related transactions is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 23, 2002, which will be filed within 120 days after the end of the Registrant's fiscal year.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
(a)Within 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of its management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings.
(b)Subsequent to the date of this evaluation, there have been no changes in the Company's internal controls or in other factors that could significantly affect these controls, and no discoveries of any significant deficiencies or material weaknesses in such controls that would require the Company to take corrective actions.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)The following documents are filed as a part of this report:
(1)Consolidated Financial Statements of the Company are included herein at Item 8.
(2)All schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto.
(3)Exhibits
(a)The following exhibits are filed as part of this report:
3.1
Certificate of Incorporation of Pacific Premier Bancorp, Inc.
3.2
Bylaws of Pacific Premier Bancorp, Inc.
4.0
Stock Certificate of Pacific Premier Bancorp, Inc.*
4.1
Form of Warrants to purchase an aggregate 1,166,400 shares of Common Stock**
10.1
2000 Stock Option Plan****
10.2
Purchase of Residual Securities and Related Servicing-Bear Stearns, Inc. and EMC Mortgage***
10.3
Note and Warrant Agreement**
21.0
Subsidiary information is incorporated herein by reference to "Part I-Subsidiaries"
23.1
Consent of Vavrinek, Trine, Day & Co., LLP
23.2
Consent of Grant Thornton, LLP
99.1
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
*Incorporated herein by reference from the Exhibits on Registration Statement Form S-4, filed on January 27, 1997 (Registration No. 333-20497).
**Incorporated herein by reference to the Registrant's Proxy Statement for the Special Meeting of Stockholders Held January 10, 2002.
***Incorporated herein by reference from the Exhibits on Registrant's Form 10K/A filed May 1, 2001.
****Incorporated herein by reference to the Registrant's Form S-8 filed on April 10, 2001.
(b)Reports on Form 8-K-There were no reports on Form 8-K were filed during the first quarter of 2003:
SIGNATURES
Pursuant to the requirements of Section 13 the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed by the following persons in the capacities and on the dates indicated.
Signature
Title
Date
/s/ STEVEN R. GARDNER Steven R. Gardner
President and Chief Executive Officer
March 27, 2003
/s/ JOHN SHINDLER John Shindler
Senior Vice President and Chief Financial Officer
(principal financial and accounting officer)
March 27, 2003
/s/ RONALD G. SKIPPER Ronald G. Skipper
Chairman of the Board and Directors
March 27, 2003
/s/ JOHN D. GODDARD John D. Goddard
Director
March 27, 2003
/s/ KENT G. SNYDER Kent G. Snyder
Director
March 27, 2003
/s/ EZRI NAMVAR Ezri Namvar
Director
March 27, 2003
/s/ THOMAS PALMER Thomas Palmer
Director
March 27, 2003
/s/ RICHARD MARR Richard Marr
Director
March 27, 2003
Pacific Premier Bancorp, Inc.,
Annual Report on Form 10-K
for the Year ended December 31, 2002
CERTIFICATION
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Steven R. Gardner, certify that:
1.I have reviewed this annual report on Form 10-K of Pacific Premier Bancorp, Inc.;
2.Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4.The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 of the Exchange Act) for the registrant and we have:
a)designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b)evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c)presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a)all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6.The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Dated: March 27, 2003
/s/ STEVEN R. GARDNER Steven R. Gardner
President and Chief Executive Officer
Pacific Premier Bancorp, Inc.,
Annual Report on Form 10-K
for the Year ended December 31, 2002
CERTIFICATION
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, John Shindler, certify that:
1.I have reviewed this annual report on Form 10-K of Pacific Premier Bancorp, Inc.;
2.Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4.The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 of the Exchange Act) for the registrant and we have:
a)designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b)evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c)presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a)all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6.The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Dated: March 27, 2003
/s/ JOHN SHINDLER John Shindler
Senior Vice President and Chief Financial Officer
ITEM 1. BUSINESS
ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7(A) Quantitative and Qualitative Disclosures about Market Risk
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 14. CONTROLS AND PROCEDURES
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K