10-K 1 d270236d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

 

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     For the fiscal year ended December 31, 2011

 

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

 

     For the transition period from                      to                     

Commission file number 000-49806

FIRST PACTRUST BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   04-3639825

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

18500 Von Karman Ave, Suite 1100, Irvine, California   92612
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (949) 236-5211

 

 

Securities Registered Pursuant to Section 12(b) of the Act:

Common Stock, par value $0.01 per share

(Title of class)

Nasdaq Global Market

(Name of each exchange on which registered)

Securities Registered Pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨.    NO  x.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨.    NO  x.

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” “and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    ¨  YES.    x  NO.

The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the closing price of such stock on the Nasdaq Global Market as of June 30, 2011, was $142.4 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.) As of March 15, 2012, there were issued and outstanding 11,660,444 shares of the Registrant’s Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

PART III of Form 10-K—Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held during May 2012.

 

 

 


Table of Contents

FIRST PACTRUST BANCORP, INC. AND SUBSIDIARIES

FORM 10-K

December 31, 2011

INDEX

 

         Page  
  PART I   

Item 1

 

Business

     1   

Item 1A

 

Risk Factors

     28   

Item 1B

 

Unresolved Staff Comments

     40   

Item 2

 

Properties

     41   

Item 3

 

Legal Proceedings

     42   

Item 4

 

Mine Safety Disclosures

     42   
  PART II   

Item 5

 

Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

     43   

Item 6

 

Selected Financial Data

     45   

Item 7

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     47   

Item 7A

 

Quantitative and Qualitative Disclosures about Market Risk

     61   

Item 8

 

Financial Statements and Supplementary Data

     63   

Item 9

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     117   

Item 9A

 

Controls and Procedures

     117   

Item 9B

 

Other Information

     117   
  PART III   

Item 10

 

Directors and Executive Officers and Corporate Governance

     118   

Item 11

 

Executive Compensation

     118   

Item 12

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     119   

Item 13

 

Certain Relationships and Related Transactions and Director Independence

     119   

Item 14

 

Principal Accountant Fees and Services

     119   
  PART IV   

Item 15

 

Exhibits and Financial Statement Schedules

     120   
 

Signatures

     123   

 


Table of Contents

PART I

Item 1. Business

General

First PacTrust Bancorp, Inc. (“the Company,” “we,” “us,” “our”) is a unitary savings and loan holding company. The Company was incorporated under Maryland law in March 2002 to hold all of the stock of Pacific Trust Bank (“the Bank”) upon completion in August 2002 of the Bank’s conversion from the mutual to the stock form of ownership and the concurrent initial public offering of the Company’s common stock. As a savings and loan holding company, First PacTrust Bancorp, Inc., must limit its activities to banking, securities, insurance and financial services-related activities. First PacTrust Bancorp, Inc. is not an operating company and it’s assets primarily consist of the outstanding stock of the Bank, cash and fixed income investments. From time to time, the Company has purchase impaired loans, investments and other real estate owned “OREO” from the Bank to assure the Bank’s safety and soundness. First PacTrust Bancorp, Inc. has no significant liabilities other than Board of Director and employee compensation as well as expenses related to strategic initiatives. The management of the Company and the Bank is substantially the same. However, the Company and the Bank each have their own Board of Directors with three of the members serving on both Boards. The Company utilizes the support staff and offices of the Bank and pays the Bank for these services. If the Company expands or changes its business in the future, the Company may hire additional employees of its own. Unless the context otherwise requires, all references to the Company include the Bank and the Company on a consolidated basis.

The Bank is a community-oriented financial institution offering a variety of financial services to meet the banking and financial needs of the communities we serve. The Bank is headquartered in Orange County, California, and as of December 31, 2011 operated eighteen banking offices primarily serving San Diego, Orange, Los Angeles and Riverside Counties in California.

The principal business of the Bank consists of attracting retail deposits from the general public and investing these funds primarily in loans secured by first mortgages on owner-occupied, one-to four- family residences, a variety of consumer loans, multi-family and commercial real estate and commercial business loans. The Company also invests in securities and other assets.

The Bank offers a variety of deposit accounts for both individuals and businesses with varying rates and terms, which generally include savings accounts, money market deposits, certificate accounts and checking accounts. The Bank solicits deposits in its market area and, to a lesser extent, from institutional depositors nationwide, and in the past has accepted brokered deposits.

As a thrift holding company, the Company is subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As a federal savings bank, the Bank is subject to regulation primarily by the Office of the Comptroller of the Currency (the “OCC”). See “—How We Are Regulated.”

The principal executive offices of First PacTrust Bancorp, Inc. are located at 18500 Von Karman Avenue, Suite 1100, California, and its telephone number is (949) 236-5211. The Company’s voting common stock is traded on the Nasdaq Global Market under the symbol BANC.

The Company’s reports, proxy statements and other information the Company files with the SEC, as well as news releases, are available free of charge through the Company’s Internet site at http://www.firstpactrustbancorp.com. This information can be found on the First PacTrust Bancorp, Inc. “News” or “SEC Filings” pages of our Internet site. The annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed and furnished pursuant to Section 13(a) of the Exchange Act are available as soon as reasonably practicable after they have been filed or furnished to the SEC. Reference to the Company’s Internet address is not intended to incorporate any of the information contained on our Internet site into this document.

 

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During much of 2009, 2010 and 2011, market and economic conditions in our industry and in California have declined resulting in increased delinquencies and foreclosures. A number of federal legislative and regulatory initiatives have been enacted to address these conditions. See “Asset Quality” and “How we are Regulated” in Item 1, “Risk Factors” in Item 1A and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.

Pending Acquisitions

On June 3, 2011, the Company entered into a definitive agreement to acquire for cash all of the outstanding stock of Gateway Bancorp, the privately held holding company for Gateway Business Bank, Cerritos, California. At December 31, 2011, Gateway Business Bank had total assets of $202 million, total gross loans of $144 million and total deposits of $173 million. The acquisition includes Mission Hills Mortgage Bankers, the mortgage banking operating division of Gateway Business Bank. Mission Hills has originated over $4.0 billion of mostly prime mortgage loans since 2006, a majority of which have been sold servicing-released through correspondent relationships with money center banks. Gateway Business Bank has two banking offices, one in Los Angeles County and the other in Orange County, California. In addition, Mission Hills has 22 loan production offices, located throughout California, northern Arizona and Oregon. In the transaction, Gateway Bancorp shareholders will receive aggregate consideration of up to $17.0 million, up to $14.5 million of which will be payable at closing, with the remaining $2.5 million to be held in escrow for up to three years after closing to cover the risk that the Company may be required to repurchase mortgage loans sold by Gateway Business Bank. The transaction, which has already been approved by Gateway’s shareholders, is expected to close in 2012, subject to regulatory approvals and other customary closing conditions.

On August 30, 2011, the Company entered into a definitive merger agreement with Beach Business Bank Manhattan Beach, California, providing for the merger of Beach Business Bank with and into a wholly owned subsidiary of the Company. At December 31, 2011, Beach Business Bank total assets of $305 million, total gross loans of $261 million and total deposits of $251 million. Beach Business Bank is headquartered in Manhattan Beach, California, with branches in Manhattan Beach, Long Beach, and Costa Mesa, California and a loan production office in Torrance, California. In the merger, each share of Beach Business Bank common stock will be converted into the right to receive 0.33 of a share of Company common stock, with cash paid in lieu of fractional shares, and $4.61 in cash, subject to certain adjustments. If the value of a share of Company common stock at the closing of the transaction (measured as set forth in the merger agreement) is less than $13.50 or the Company determines that there is a reasonable possibility that the merger will not be treated as a reorganization for tax purposes, (1) the merger will be restructured as a merger of a Company subsidiary with and into Beach Business Bank, and (2) each outstanding share of Beach Business Bank common stock will instead be converted into the right to receive $9.12 in cash and a one-year warrant to purchase 0.33 shares of Company common stock at an exercise price of $14.00 per whole share of Company common stock. The transaction, which has already been approved by the shareholders of Beach Business Bank, is expected to close in 2012, subject to regulatory approvals and other closing conditions.

Forward-Looking Statements

This Form 10-K contains various forward-looking statements that are based on assumptions and describe our future plans and strategies and our expectations. These forward-looking statements are generally identified by words such as “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar words. Our ability to predict results or the actual effect of future plans or strategies is uncertain. Factors which could cause actual results to differ materially from those estimated include, but are not limited to, (i) the occurrence of any event, change or other circumstances that could give rise to the termination of the stock purchase agreement for the Company’s pending acquisition of Gateway Bancorp or the merger agreement for the Company’s pending acquisition of Beach Business Bank; (ii) the inability to complete the Gateway Bancorp or Beach Business Bank transaction due to the failure to satisfy each transaction’s respective conditions to completion, including the receipt of regulatory approvals; (iii) risks that the Gateway Bancorp or Beach Business Bank transaction disrupts

 

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current plans and operations, the potential difficulties in customer and employee retention as a result of the pending transactions and the amount of the costs, fees, expenses and charges related to the proposed transactions; (iv) continuation or worsening of current recessionary conditions, as well as continued turmoil in the financial markets; (v) the credit risks of lending activities, which may be affected by further deterioration in the real estate markets, may lead to increased loan delinquencies, losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses and require us to materially increase our loan loss reserves; (vi) the quality and composition of our securities portfolio; (vii) changes in general economic conditions, either nationally or in our market areas; (viii) changes in the levels of general interest rates, and the relative differences between short- and long-term interest rates, deposit interest rates, our net interest margin and funding sources; (ix) fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in commercial and residential real estate values in our market area; (x) results of examinations of us by regulatory authorities, including the Bank’s compliance with the memorandum of understanding it entered into with its regulator, and the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses, write-down asset values, increase our capital levels, or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; (xi) legislative or regulatory changes that adversely affect our business, including changes in the interpretation of regulatory capital or other rules; (xii) our ability to control operating costs and expenses; (xiii) staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; (xiv) errors in our estimates in determining fair value of certain of our assets, which may result in significant declines in valuation; (xv) the network and computer systems on which we depend could fail or experience a security breach; (xvi) our ability to attract and retain key members of our senior management team; (xvii) costs and effects of litigation, including settlements and judgments; (xviii) increased competitive pressures among financial services companies; (xix) changes in consumer spending, borrowing and saving habits; (xx) adverse changes in the securities markets; (xxi) earthquake, fire or other natural disasters affecting the condition of real estate collateral; (xxii) the availability of resources to address changes in laws, rules or regulations or to respond to regulatory actions; (xxiii) inability of key third-party providers to perform their obligations to us; (xxiv) changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board or their application to our business or final audit adjustments, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; (xxv) war or terrorist activities; and (xxvi) other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this report.

We do not undertake, and specifically disclaim, any obligation to publicly revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Lending Activities

General. The Company’s mortgage loans carry either a fixed or an adjustable rate of interest. Mortgage loans are long-term and amortize on a monthly basis with principal and/or interest due each month or with interest only payments due each month for certain loans. At December 31, 2011, the Company’s net loan portfolio totaled $775.6 million, which constituted 77.64% of our total assets. The breakdown of loans in the portfolio was: 70.62% 1-4 residential (the “SFR Mortgage Portfolio”), 15.75% commercial real estate mortgage, 11.09% multi-family mortgage, 1.15% commercial and industrial, 1.09% other revolving credit and installment and 0.30% land.

The $556.0 million SFR mortgage portfolio was comprised of $546.8 million of first deed of trust loans and $9.2 million of loans secured by subordinated or junior liens. The Company’s SFR mortgage portfolio is comprised of a combination of traditional, fully-amortizing loans and non-traditional loans. The Company’s non-traditional loan portfolio includes our Green Account loans, interest only loans and mortgage loans with potential for negative amortization. At December 31, 2011, the balance of the Company’s Green Account loans totaled $247.5 million. Green Account loans are a first mortgage line of credit with an associated “clearing

 

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account” that allows all types of deposits and withdrawals to be performed, including direct deposit, check debit card, ATM, ACH debits and credits, and internet banking and bill payment transactions. Also, at December 31, 2011, the Company had a total of $382.0 million in interest-only mortgage loans and $23.4 million in mortgage loans with potential for negative amortization.

As of December 31, 2011, the Executive Vice President of Lending may approve loans to one borrower or group of related borrowers up to $2.5 million. The Chief Credit Officer may approve loans to one borrower or group of related borrowers up to $3.5 million. The President/CEO may approve loans to one borrower or group of related borrowers up to $2.5 million. The Management Loan Committee may approve loans to one borrower or group of related borrowers up to $10.0 million, with no single loan exceeding $5.0 million. The Board Loan Committee must approve loans over these amounts or outside our general loan policy.

At December 31, 2011, the maximum amount which the Company could have loaned to any one borrower and the borrower’s related entities was approximately $20.5 million. As of December 31, 2011, the largest lending relationship to a single borrower or a group of related borrowers was a combination of commercial real estate, multi-family and single family loans with an aggregate loan exposure amount of $11.7 million. The properties securing these loans are located in Anaheim and San Diego, California. All of these loans were performing in accordance with their terms as of December 31, 2011.

The following table presents information concerning the composition of the Company’s loan portfolio in dollar amounts and in percentages as of the dates indicated.

 

    December 31,  
    2011     2010     2009     2008     2007  
    Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent  
    (Dollars in Thousands)  

Commercial

                   

Commercial and industrial

  $ 9,019        1.15   $ 6,744        0.98   $ 6,782        0.89   $ 7,348        0.91   $ 1,376        0.19

Real Estate Mortgage

    124,013        15.75        46,568        6.74        47,982        6.32        35,283        4.36        35,500        4.97   

Real Estate Construction

    —          —          —          —          —          —          17,835        2.20        18,866        2.64   

Multi-Family

    87,290        11.09        33,040        4.78        34,235        4.51        34,831        4.31        37,339        5.23   

Land

    2,375        0.30        14,828        2.15        16,020        2.11        21,733        2.69        21,705        3.04   

Consumer

                   

Real estate 1-4 family first mortgage*

    546,760        69.45        568,854        82.31        633,118        83.40        670,401        82.89        578,478        81.01   

Real estate 1-4 family junior lien mortgage*

    9,219        1.17        9,923        1.44        9,613        1.27        9,005        1.11        6,548        0.92   

Other revolving credit and installment

    8,604        1.09        11,031        1.60        11,370        1.50        12,314        1.53        14,315        2.00   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

    787,280        100.00     690,988        100.00     759,120        100.00     808,750        100.00     714,127        100.00

Net deferred loan origination costs

    1,109          1,824          2,262          2,581          2,208     

Allowance for loan losses

    (12,780       (14,637       (13,079       (18,286       (6,240  
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total loans receivable, net

  $ 775,609        $ 678,175        $ 748,303        $ 793,045        $ 710,095     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

* Under regulatory agency guidance, the Bank was required to classify Green Account loans as HELOCs on its quarterly Thrift Financial Report (“TFR”) due to the revolver feature of this product. This increases the Bank’s HELOC exposure from $7.0 million to $254.5 million. Starting on March 31, 2012, the Bank will file Call Reports instead of TFRs, which should allow the Bank to better reflect the terms and characteristics of Green Account mortgage loans in classifying these loans in its regulatory reports. Of the Green mortgages, 90.21% are first trust deed mortgages. Historically, these loans have outperformed the Bank’s traditional one-to four- unit first deed of trust mortgage portfolio. As of December 31, 2011, $1.4 million of the Company’s Green Accounts were nonperforming.

At December 31, 2011, Green Account loans totaled $247.5 million and included, $223.3 million secured by one-to four–family properties, $8.7 million secured by one-to-four-family junior liens, $11.9 million secured

 

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by commercial real estate mortgage and $3.7 million secured by multi-family properties. At December 31, 2010, Green Account loans totaled $245.5 million and included , $214.5 million secured by one-to four–family properties, $13.7 million secured by commercial properties, $9.3 million secured by second trust deed lines of credit, $3.8 million secured by multi-family properties and $4.2 million secured by land. At December 31, 2009, Green Account loans totaled $237.2 million and included $208.9 million secured by one-to four–family properties, $14.3 million secured by commercial properties, $8.7 million secured by second trust deed lines of credit, $2.8 million secured by multi-family properties and $2.5 million secured by land. At December 31, 2008, Green Account loans totaled $219.1 million and included $192.5 million secured by one-to four-family loans, $14.9 million secured by commercial properties, $8.3 million secured by second trust deed line of credit, $2.5 million secured by multi-family properties, and $798 thousand secured by land. At December 31, 2007, Green Account loans totaled $163.9 million and included $149.3 million secured by one-to four- family properties, $6.2 million secured by commercial properties, $5.7 million secured by second trust deed lines of credit, $2.3 million secured by multi-family properties and $429 thousand secured by land.

The following table shows the composition of the Company’s loan portfolio by fixed- and adjustable-rate at the dates indicated.

 

    December 31,  
    2011     2010     2009     2008     2007  
    Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent  
    (Dollars in Thousands)  

FIXED-RATE LOANS

                   

Commercial:

                   

Commercial & industrial

  $ 6        0.00   $ 500        0.08   $ 511        0.07   $ 525        0.06   $ 500        0.07

Real Estate Mortgage

    57,799        7.34        24,463        3.54        25,048        3.30        25,592        3.16        25,425        3.56   

Multi-family

    4,760        0.60        22,532        3.26        21,992        2.90        22,693        2.81        23,035        3.23   

Land

    1,781        0.23        11,550        1.67        13,762        1.81        21,630        2.67        21,601        3.02   

Consumer:

                   

Real Estate 1-4 family first mortgage

    7,643        0.97        4,542        0.65        5,635        0.74        7,980        0.99        10,226        1.43   

Real Estate 1-4 family junior lien mortgage

    337        0.04        478        0.07        761        0.10        558        0.07        643        0.09   

Other revolving credit and installment

    41        0.00        143        0.02        249        0.03        366        0.05        868        0.12   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed-rate loans

    72,367        9.18        64,208        9.29        67,958        8.95        79,344        9.81        82,298        11.52   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

ADJUSTABLE-RATE

                   

Commercial:

                   

Commercial & industrial

    9,013        1.15        6,244        0.90        6,271        0.82        6,823        0.85        876        0.12   

Real Estate Mortgage

    66,214        8.41        22,105        3.20        22,934        3.02        9,691        1.20        10,075        1.41   

Construction

    —          —          —          —          —          —          17,835        2.20        18,866        2.64   

Multi-family

    82,530        10.49        10,508        1.52        12,243        1.61        12,138        1.50        14,304        2.00   

Land

    594        0.07        3,278        0.48        2,258        0.30        103        0.02        104        0.02   

Consumer:

                   

Real Estate 1-4 family first mortgage

    539,117        68.48        564,312        81.66        627,483        82.66        662,421        81.90        568,252        79.58   

Real Estate 1-4 junior lien mortgage

    8,882        1.13        9,445        1.37        8,852        1.17        8,447        1.04        5,905        0.83   

Other revolving credit and installment

    8,563        1.09        10,888        1.58        11,121        1.47        11,948        1.48        13,447        1.88   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total adjustable-rate loans

    714,913        90.82        626,780        90.71        691,162        91.05        729,406        90.19        631,829        88.48   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

    787,280        100.00     690,988        100.00     759,120        100.00     808,750        100.00     714,127        100.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net deferred loan origination costs

    1,109          1,824          2,262          2,581          2,208     

Allowance for loan losses

    (12,780       (14,637       (13,079       (18,286       (6,240  
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total loans receivable, net

  $ 775,609        $ 678,175        $ 748,303        $ 793,045        $ 710,095     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

5


Table of Contents

The following schedule illustrates the contractual maturity of the Company’s loan portfolio at December 31, 2011. (Dollars in thousands)

 

     Commercial  
     Commercial and Industrial     Real Estate Mortgage     Multi-Family     Land  

Due During Years Ending December 31,

   Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
 

2012

   $ 2,474         6.02   $ —           —     $ 560         4.59   $ 1,780         6.67

2013

     6,545         5.15        6,322         5.67        3,075         6.00        500         5.50   

2014 and 2015

     —           —          3,925         4.97        91         4.25        —           —     

2016 to 2020

     —           —          45,925         5.55        34,195         5.19        —           —     

2021 to 2035

     —           —          64,989         5.63        41,468         5.21        95         2.88   

2036 and following

     —           —          2,852         4.95        7,901         6.27        —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

     9,019         5.69     124,013         5.56     87,290         5.37     2,375         5.68
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     Consumer               
     Real Estate 1-4 Family
First Mortgage
    Real Estate 1-4 Family 
Junior Lien Mortgage
    Other Revolving
Credit and Installment
    TOTALS  

Due During Years Ending December 31,

   Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
 

2012(1)

   $ 575         4.56   $ —           —     $ 1,927         7.82   $ 7,316         7.80

2013

     2,033         6.18        —           —          49         2.71        18,524         4.09   

2014 and 2015

     2,243         4.85        —           —          2,069         3.18        8,328         3.35   

2016 to 2020

     8,018         4.05        175         8.01        4,427         3.44        92,740         3.99   

2021 to 2035

     373,969         3.81        8,865         3.04        132         3.25        489,518         3.95   

2036 and following

     159,922         5.22        179         3.38        —           —          170,854         5.27   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 546,760         4.25   $ 9,219         3.65   $ 8,604         7.23   $ 787,280         6.11
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Includes demand loans, loans having no stated maturity and overdraft loans.

 

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Table of Contents

The following schedule illustrates the Company’s loan portfolio at December 31, 2011 as the loans reprice. Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the loan reprices. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses. (Dollars in thousands).

 

     Commercial  
     Commercial and Industrial     Real Estate Mortgage     Multi-Family     Land  

Due During Years Ending December 31,

   Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
 

2012

   $ 9,013         5.78   $ 48,451         5.57   $ 24,230         5.33   $ 2,375         5.68

2013

     6         5.15        5,269         5.64        6,112         5.84        —           —     

2014 and 2015

     —           —          5,427         5.18        1,026         5.92        —           —     

2016 to 2020

     —           —          40,515         5.57        31,491         5.35        —           —     

2021 to 2035

     —           —          24,351         5.63        24,431         5.21        —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

     9,019         5.69     124,013         5.56     87,290         5.37     2,375         5.68
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     Consumer               
     Real Estate 1-4 Family
First Mortgage
    Real Estate 1-4 Family 
Junior Lien Mortgage
    Other Revolving
Credit and Installment
    TOTALS  

Due During Years Ending December 31,

   Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
 

2012(1)

   $ 353,330         3.96   $ 8,882         3.05   $ 8,595         7.23   $ 454,876         6.33

2013

     89,733         4.64        —           —          9         2.71        101,129         4.69   

2014 and 2015

     63,086         4.89        —           —          —           —          69,539         3.93   

2016 to 2020

     39,933         4.73        174         8.01        —           3.44        112,113         5.05   

2021 to 2035

     678         3.81        163         3.04        —           —          49,623         4.92   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 546,760         4.25   $ 9,219         3.65   $ 8,604         7.23   $ 787,280         6.11
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Includes demand loans, loans having no stated maturity and overdraft loans.

The total amount of loans due after December 31, 2012 which have predetermined interest rates is $41.7 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $597.5 million.

 

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Table of Contents

One- to Four-Family Residential Real Estate Lending. A major focus for the Company is the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences in San Diego, Orange, Los Angeles and Riverside Counties, California. At December 31, 2011, one- to four-family residential mortgage first trust deed loans totaled $546.8 million, or 69.5% of our gross loan portfolio including the portion of the Company’s Green Account home equity loan portfolio that are secured by first trust deeds. At December 31, 2010, one- to four-family residential mortgage loans totaled $568.9 million, or 82.3% of our gross loan portfolio including the portion of the Company’s Green Account home equity loan portfolio that are secured by first trust deeds.

The Company generally underwrites one- to four-family loans based on the applicant’s income and credit history and the appraised value of the subject property. Generally, the Company lends up to 80% of the lesser of the appraised value or purchase price for one- to four-family residential loans. For loans with a loan-to-value ratio in excess of 70%, the Company generally charges a higher interest rate. The Company currently has a very limited quantity of loans with a loan-to-value ratio (at time of closing) in excess of 80% at the date of loan origination. Properties securing our one- to four-family loans are appraised by independent fee appraisers approved by management. Generally, the Company requires borrowers to obtain title insurance, hazard insurance, and flood insurance, if necessary.

National and regional indicators of real estate values show continued depressed collateral values relative to peak levels, however, the Company believes that the current loan loss reserves are adequate to cover inherent losses at the balance sheet date. Further, the Company generally adjusts underwriting criteria by discounting the appraisal value by 9.0% when underwriting mortgages in declining market areas.

The Company currently originates one- to four-family mortgage loans on either a fixed- or an adjustable-rate basis, as consumer demand and Bank risk management dictates. The Company’s pricing strategy for mortgage loans includes setting interest rates that are competitive with other local financial institutions.

Adjustable-rate mortgages, or “ARM” loans are offered with flexible initial and periodic repricing dates, ranging from one year to seven years through the life of the loan. The Company uses a variety of indices to reprice ARM loans. During the year ended December 31, 2011, the Company originated $101.6 million of one- to four-family ARM loans with terms up to 30 years. Of these, $57.0 million were Green Account loans. See further discussion under “Green Account Loans.”

One- to four-family loans may be assumable, subject to the Company’s approval, and may contain prepayment penalties. Most ARM loans are written using generally accepted underwriting guidelines. Mainly, due to the generally large loan size, these loans may not be readily saleable to Freddie Mac or Fannie Mae, but are saleable to other private investors. The Company’s real estate loans generally contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property.

The Company no longer offers ARM loans which may provide for negative amortization of the principal balance and has not offered these loans since March, 2006. At December 31, 2011, the existing negative amortizing loans in the one-to four- family portfolio totaling $21.5 million have monthly interest rate adjustments after the specified introductory rate term, and annual maximum payment adjustments of 7.5% during the first five years of the loan. The principal balance on these loans may increase up to 110% of the original loan amount as a result of the payments not being sufficient to cover the interest due during the first five years of the loan term. These loans adjust to fully amortize after five years through contractual maturity, or upon the outstanding loan balance reaching 110% of the original loan amount with up to a 30-year term. At December 31, 2011, $885.5 thousand of the Company’s negatively amortizing loan portfolio was non-performing.

In addition, the Bank currently offers interest-only loans. At December 31, 2011, the Company had a total of $125.6 million of interest-only mortgage loans secured by one-to four- family homes. These loans become fully amortized after the initial fixed rate period. At December 31, 2011, $2.0 million of the Company’s interest-only

 

8


Table of Contents

loan portfolio was nonperforming. The Company also offers its Green Account secured lines of credit which have interest only minimum payment requirements. See further discussion under “Consumer and Other Real Estate Lending.”

In order to remain competitive in our market areas, the Company, at times, originates ARM loans at initial rates below the fully indexed rate. The Company’s ARM loans generally provide for specified minimum and maximum interest rates, with a lifetime cap, and a periodic adjustment on the interest rate over the rate in effect on the date of origination. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as is the Company’s cost of funds.

ARM loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower’s minimum monthly payment rises, increasing the potential for default.( See “Asset Quality—Non-performing Assets” and “Classified Assets.”) At December 31, 2011, the Company’s one- to four-family ARM loan portfolio comprised of $539.1 million of first deed of trust loans and $8.9 million of loans secured by subordinated or junior liens, 68.5% and 1.1% of our gross loan portfolio, respectively. At that date, the fixed-rate one-to four-family mortgage loan portfolio comprised of $7.6 million of first deed of trust loans and $337 thousand of loans secured by subordinated or junior liens, 1.0% and 0.1% of the Company’s gross loan portfolio, respectively. The interest rate sensitivity composition of the Company’s loan portfolio did not significantly change during 2011. At December 31, 2011, $5.3 million of the Company’s ARM loan portfolio were non-performing loans.

Green Account Loans. The Company has $247.5 million of total Green Account loans which represented 31.4% of the gross loan portfolio at December 31, 2011. At December 31, 2011, the Company had SFR Green Account loans secured by first trust deeds on one-to four- family properties of $223.3 million and other Green Account loans that include second deeds of trust and loans secured against other property types of $24.2 million. Green Account home equity loans generally have a fifteen year draw period with interest-only payment requirements, a balloon payment requirement at the end of the draw period and a maximum 80% loan to value ratio. Home equity lines of credit, other than Green Account loans, may be originated in amounts, together with the amount of the existing first mortgage, up to 80% of the value of the property securing the loan.

Commercial and Multi-Family Real Estate Lending. Another major focus of the Company is the funding of multi-family and commercial real estate loans. These loans are secured primarily by multi-family dwellings, and a limited amount of small retail establishments, hotels, motels, warehouses, and small office buildings primarily located in the Company’s market area, and throughout the West Coast. At December 31, 2011, multi-family and commercial real estate mortgage loans totaled $211.3 million or 26.8% of the Company’s gross loan portfolio, as compared to $79.6 million, or 11.5% of the Company’s gross loan portfolio, at December 31, 2010.

The Company’s loans secured by multi-family and commercial real estate are originated with either a fixed or adjustable interest rate. The interest rate on adjustable-rate loans is based on a variety of indices, generally determined through negotiation with the borrower. Loan-to-value ratios on multi-family real estate loans typically do not exceed 75% of the appraised value of the property securing the loan. These loans typically require monthly payments, may contain balloon payments and have maximum maturities of 30 years. Loan-to-value ratios on commercial real estate loans typically do not exceed 70% of the appraised value of the property securing the loan and have maximum maturities of 25 years.

Loans secured by multi-family and commercial real estate are underwritten based on the income producing potential of the property and the financial strength of the borrower. The net operating income, which is the income derived from the operation of the property less all operating expenses, must be sufficient to cover the payments related to the outstanding debt. The Company generally requires an assignment of rents or leases in order to be assured that the cash flow from the project will be used to repay the debt. Appraisals on properties securing multi-family and commercial real estate loans are performed by independent state licensed fee appraisers approved by management. See “—Loan Originations, Purchases, Sales and Repayments.” The

 

9


Table of Contents

Company generally maintains a tax or insurance escrow account for loans secured by multi-family and commercial real estate. In order to monitor the adequacy of cash flows on income-producing properties, the borrower may be required to provide periodic financial information.

Loans secured by multi-family and commercial real estate properties generally involve a greater degree of credit risk than one- to four-family residential mortgage loans. These loans typically involve large balances to single borrowers or groups of related borrowers. The largest multi-family or commercial real estate loan at December 31, 2011 was secured by six one-to four- unit properties located in San Diego County with a principal balance of $10.6 million and a remaining line of credit limit of $120 thousand. At December 31, 2011, this loan was performing in accordance with the terms of the note.

Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of these loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. See “—Asset Quality—Non-performing Loans” in Item 1.

Construction Lending and Land Loans. The Company has not historically originated a significant amount of construction loans. From time to time the Company has purchased participations in real estate construction loans, however, it has not done so since 2008. In addition, the Company may in the future originate or purchase loans or participations in construction. The Company had no construction loans at December 31, 2011.

The Company had $2.4 million in land loans at December 31, 2011. The Company has not historically originated a significant amount of land loans. From time to time the Company purchased participations in real estate construction loans, The Company may in the future originate or purchase loans or participations secured by land.

Consumer and Other Real Estate Lending. Consumer loans generally have shorter terms to maturity or variable interest rates, which reduce our exposure to changes in interest rates, and carry higher rates of interest than do conventional one- to four-family residential mortgage loans. In addition, management believes that offering consumer loan products helps to expand and create stronger ties to the Company’s existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities. At December 31, 2011, the Company’s consumer and other loan portfolio totaled $17.8 million, or 2.26% of our gross loan portfolio. The Company offers a variety of secured consumer loans, including second trust deed home equity loans and home equity lines of credit and loans secured by savings deposits. The Company also offers a limited amount of unsecured loans. The Company originates consumer and other real estate loans primarily in its market area.

The Company’s home equity lines of credit totaled $7.0 million, and comprised 0.9% of the gross loan portfolio at December 31, 2011. Additionally, the Company had $247.5 million of Green Account loans which represented 31.4% of the gross loan portfolio at December 31, 2011. Other home equity lines of credit have a seven or ten year draw period and require the payment of 1.0% or 1.5% of the outstanding loan balance per month (depending on the terms) during the draw period, which amount may be re-borrowed at any time during the draw period. Home equity lines of credit with a 10 year draw period have a balloon payment due at the end of the draw period. For loans with shorter term draw periods, once the draw period has lapsed, generally the payment is fixed based on the loan balance at that time. The Company actively monitors changes in the market value of all home loans contained in its portfolio. For instance, in 2011 the Company purchased independent, third party valuations of every property in its residential loan portfolio twice during the year. The most recent valuations were as of November 30, 2011. The Company has the right to adjust, and has adjusted, existing lines of credit to address current market conditions subject to the rules and regulations affecting home equity lines of credit. At December 31, 2011, unfunded commitments on Green Accounts totaled $31.0 million and $11.7 million on other consumer lines of credit. Other consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower.

 

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Table of Contents

Consumer and other real estate loans may entail greater risk than do one- to four-family residential mortgage loans, particularly in the case of consumer loans which are secured by rapidly depreciable assets, such as automobiles and recreational vehicles. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy. See “—Asset Quality—Non-performing Loans” in Item 1.

Commercial Business Lending. At December 31, 2011, commercial business loans totaled $9.0 million or 1.15% of the gross loan portfolio. The Company’s commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis. The Company may obtain personal guarantees on our commercial business loans. Nonetheless, these loans are believed to carry higher credit risk than more traditional single-family home loans.

Unlike residential mortgage loans, commercial business loans are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, is often dependent in part upon general economic conditions). The Company’s commercial business loans are usually, but not always, secured by business assets. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. See “—Asset Quality—Non-performing Loans” in Item 1.

Loan Originations, Purchases, Repayments, and Servicing

The Company originates real estate secured loans primarily through mortgage brokers and banking relationships. By originating most loans through brokers, the Company is better able to control overhead costs and efficiently utilize management resources. The Company is a portfolio lender of products not readily saleable to Fannie Mae and Freddie Mac, although they are saleable to private investors. The Company did not attempt to sell any of its loans during 2011.

The Company also originates consumer and real estate loans on a direct basis through our marketing efforts, and our existing and walk-in customers. The Company originates both adjustable and, to a much lesser extent, fixed-rate loans, however, the ability to originate loans is dependent upon customer demand for loans in our market areas. Demand is affected by competition and the interest rate environment. During the last few years, the Company has significantly increased origination of ARM loans. The Company has also purchased ARM loans secured by one-to four-family residences and participations in construction and commercial real estate loans in the past. During 2011, the Company purchased ARM loans secured by purchased multi-family properties totaling $58.0 million. Loans and participations purchased must conform to the Company’s underwriting guidelines or guidelines acceptable to the management loan committee. In periods of economic uncertainty, the ability of financial institutions to originate or purchase large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in interest income. During 2005, the Company introduced a new lending product called the “Green Account”, a fully transactional flexible mortgage account. Originations of this product totaled $61.7 million and $85.2 million for the years ended December 31, 2011 and 2010, respectively.

 

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The following table shows loan origination, purchase, sale, and repayment activities for the periods indicated.

 

     Year Ended December 31,  
     2011     2010     2009  
     (In thousands)  

Originations by type:

      

Adjustable rate:

      

Real estate—one- to four-family

   $ 44,554      $ 3,552      $ 16,293   

—multi-family, commercial and land

     12,826        3,742        1,096   

—construction or development

     —          —          —     

Consumer and other

     64,851     89,389     92,311

—commercial business

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Total adjustable-rate

     122,231        96,683        109,700   

Fixed rate:

      

Real estate—one- to four-family

     —          —          260   

—multi-family, commercial and land

     76,299        —          19   

Non-real estate—consumer

     97        387        427   

—commercial business

     493        871        297   
  

 

 

   

 

 

   

 

 

 

Total fixed-rate

     76,889        1,258        1,003   

Total loans originated

     199,120        97,941        110,703   

Purchases:

      

Real estate—one- to four-family

     —          182        —     

—multi-family, commercial and land

     58,027        —          —     

—construction or development

     —          —          —     

Consumer and other

     —          —          —     

—commercial business

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Total loans purchased

     58,027        182        —     

Repayments:

      

Principal repayments

     (162,700     (158,573     (137,913

Increase (decrease) in other items, net

     2,987        (9,424     (17,532
  

 

 

   

 

 

   

 

 

 

Net increase (decrease)

   $ 97,434      $ (69,874   $ (44,742
  

 

 

   

 

 

   

 

 

 

 

* For 2011, of this total, $61.7 million represents originations of the Company’s Green Account product, of which $57.0 million is secured by one-to four-family properties, $591 thousand is secured by land, $737 thousand is secured by multi-family properties and $3.3 million is secured by commercial properties. For 2010, of this total, $85.2 million represents originations of the Company’s Green Account product, of which $75.3 million is secured by one-to four-family properties, $5.1 million is secured by land, $1.4 million is secured by multi-family properties and $3.4 million is secured by commercial properties. For 2009, of this total, $87.7 million represents originations of the Company’s Green Account product, of which $81.4 million is secured by one-to four-family properties, $3.5 million is secured by land, $1.8 million is secured by multi-family properties and $978 thousand is secured by commercial properties.

Asset Quality

Real estate loans are serviced in house, as stringently (or more so) as dictated by secondary market guidelines. When a borrower fails to make a payment on a mortgage loan , a late charge notice is mailed 16 days after the due date. All delinquent accounts are reviewed by a collector, who attempts to cure the delinquency by contacting the borrower prior to the loan becoming 30 days past due. If the loan becomes 60 days delinquent, the collector will generally contact the borrower by phone, send a personal letter and/or engage a field service company to visit the property in order to identify the reason for the delinquency. Once the loan becomes 90 days delinquent, contact with the borrower is made requesting payment of the delinquent amount in full, or the establishment of an acceptable repayment plan to bring the loan current. When a loan becomes 90 days delinquent, a drive-by inspection is made and if an acceptable repayment plan has not been agreed upon, a collection officer will generally initiate foreclosure or refer the account to the Company’s counsel to initiate foreclosure proceedings.

 

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For consumer loans a similar process is followed, with the initial written contact being made once the loan is 10 days past due with a follow-up notice at 16 days past due. Follow-up contacts are generally on an accelerated basis compared to the mortgage loan procedure.

Accruing Loans in Past Due Status. The following table is a summary of our performing loans that were past due at least 30 days but less than 90 days past due as of December 31, 2011 and December 31, 2010. The Company ceases accruing interest, and therefore classifies as nonperforming, any loan to which principal or interest has been in default for period of 90 days or more, or if repayment in full of interest or principal is not expected (dollars in thousands) The Company maintains specific allowance allocations of $283 thousand and $238 thousand for these loans as of December 31, 2011 and 2010.

 

     December 31,
2011
    December 31,
2010
 

Performing loans past due 30 to 89 days:

    

Commercial:

    

Commercial and industrial

     —          —     

Real estate mortgage

     291        665   

Multi-family

     —          540   

Land

     —          2,538   

Consumer:

    

Real estate 1-4 family mortgage

   $ 10,669      $ 27,070   

Real estate 1-4 family junior lien mortgage

     —          698   

Other revolving credit

     4        6   
  

 

 

   

 

 

 

Total performing loans past due 30 to 89 days

   $ 10,964      $ 31,517   
  

 

 

   

 

 

 

Ratios:

    

Performing loans past due 30 to 89 days as a percentage of total loans

     1.39     4.56

Performing loans past due 90 days or more as a percentage of total loans

     0.00     0.00

Total performing loans in past due status as a percentage of total loans

     1.39     4.56

Nonaccrual Loans. The following table summarizes our nonaccrual loans, at December 31, 2011, 2010, 2009, 2008, and 2007. This table includes troubled debt restructured loans on nonaccrual. There were no loans past due 90 days or more and still accruing interest at December 31, 2011, 2010, 2009, 2008 and 2007. Nonaccrual loans at December 31, 2011, 2010, 2009, 2008 and 2007 totaling $16.3 million, $35.4 million and $40.6 million, $31.0 million and $12.4 million were net of specific reserve allocations of $2.9 million, $3.4 million, $5.6 million, $13.2 million and $1.7 million, respectively.

 

     December 31,
2011
     December 31,
2010
     December 31,
2009
     December 31,
2008
     December 31,
2007
 

Commercial:

              

Commercial and industrial

   $ —         $ —         $ —         $ —         $ 775  

Real estate mortgage

     —           —           —           —           —     

Multi-family

     3,090         8,502         10,519         5,412         57   

Real estate construction

     —           —           —           17,835        9,957  

Land

     1,887         9,715         7,247         9,377         —     

Consumer:

              

Real estate 1-4 family first mortgage

     14,272         20,611         24,443         11,503         3,443   

Real estate 1-4 family junior lien mortgage

     —           —           3,856        —           —     

Other revolving credit and installment

     5         2         107         92         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 19,254       $ 38,830       $ 46,172       $ 44,219       $ 14,132   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Non-Performing Assets.

The following table is a summary of our non-performing loans, including non-performing restructured loans at December 31, 2011 and 2010. Non-performing loans at December 31, 2011 and 2010 totaling $16.3 million and $35.4 million were net of specific reserve allocations of $2.9 million and $3.4 million, respectively. Other real estate owned at December 31, 2011 and 2010 totaling $14.7 million and $6.6 million was net of specific reserve allocations of $4.1 million and $3.4 million, respectively.

 

     At December 31,
2011
     At December 31,
2010
 

Nonperforming loans

     

Commercial:

     

Commercial and industrial

   $ —         $ —     

Real estate mortgage

     —           —     

Multi-family

     3,090         8,502   

Real estate construction

     —           —     

Land

     1,887         9,715   

Consumer:

     

Real estate 1-4 family first mortgage and green

     14,272         20,611   

Real estate 1-4 family junior lien mortgage and green

     —           —     

Other revolving credit and installment

     5         2   
  

 

 

    

 

 

 

Total nonperforming loans

   $ 19,254       $ 38,830   

Other real estate owned

   $ 14,692       $ 6,562   
  

 

 

    

 

 

 

Total nonperforming assets

   $ 33,946       $ 45,392   
  

 

 

    

 

 

 

Troubled Debt Restructured Loans (TDRs). As of December 31, 2011 the Company had 26 loans with an aggregate balance of $16.1 million classified as TDR. Specific valuation allowances totaling $2.1 million have been established for these loans. When a loan becomes a TDR the Company ceases accruing interest, and classifies it as non-accrual until the borrower demonstrates that the loan is again performing.

 

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Of the 26 loans classified as TDR, 23 loans totaling $15.2 million are making payments according to their modified terms and are less than 90-days delinquent. Of the aforementioned $15.2 million in TDR loans, $12.0 million in loans are secured by single family residence, $487 thousand in loans are secured by land, $2.7 million are secured by multi-family and the remaining is comprised of an unsecured $2 thousand consumer loan. Three TDR loans with an aggregate balance of $915 thousand are over 90 days delinquent and are secured by SFRs. The following table presents the seasoning of the Bank’s restructured loans, their classified balance (principal balance minus SVA charged-off and SVA), and their weighted average interest rates (dollars in thousands):

 

Performing Restructured Loans As of December 31, 2011

 

Payments

   # of loans      Book Value      Average
Loan Size
     Weighted
Average
Interest Rate
 
     (Dollars in Thousands)  

1 Payment

     1      $ 153       $ 153        6.25 %

2 Payments

     1        3,600        3,600        5.00 %

3 Payments

     1         231         231         4.62

4 Payments

     —           —           —           —     

5 Payments

     —           —           —           —     

6 Payments

     1        443        443        3.00 %

7 Payments

     —           —           —           —     

8 Payments

     —           —           —           —     

9 Payments

     —           —           —           —     

10 Payments

     —           —           —           —     

11 Payments

     —           —           —           —     

12+ Payments

     19         10,789         568         5.35
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     23       $ 15,216       $ 662         5.20
  

 

 

    

 

 

    

 

 

    

 

 

 

Real Estate Owned. At December 31, 2011, other real estate acquired in settlement of loans totaled $14.7 million, net of a valuation allowance of $4.1 million, based on the fair value of the collateral less estimated costs to sell (typically 9.0% of the newly appraised property value). The real estate owned balance consisted of one construction property and five single family properties currently held for sale.

Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the OCC to be of lesser quality, as “substandard,” “doubtful” or “loss.” 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 insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” 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 reserve is not warranted.

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allocation allowances for loan losses in an amount deemed prudent by management and approved by the Board of Directors. General allocation allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allocation allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. An institution’s determination as to the classification of its assets and the amount of its specific allocation allowances is subject to review by the OCC and the FDIC, which may order the establishment of additional general or specific loss allocation allowances.

 

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Table of Contents

In connection with the filing of the Bank’s periodic reports with the OCC and in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review of assets, at December 31, 2011, the Company had classified assets (including OREO) totaling $47.2 million, of which $47.2 million was classified as substandard, $0 as doubtful and $0 as loss. The total amount classified represented 25.60% of the Company’s shareholders equity and 4.73% of the Company’s total assets at December 31, 2011.

Provision for Loan Losses. The past year proved to be a challenging operating environment, as witnessed by the continued deterioration of the national and local housing markets. In 2011, the local market declined over 2010 levels with a 5.4% decrease in housing values between November, 2010 and November, 2011 as measured by the S&P Case Schiller Home Price Index for San Diego County, after increasing in 2010. Continued weaknesses still exist as evidenced by continued high levels of foreclosures and delinquencies which are exacerbated by persistently high but declining unemployment in California and the United States. The Company continues its expansion plan as loan originations grew in Los Angeles County, CA during the year. The Company, however, saw declines in the level and composition of the Bank’s non-performing and classified assets between December 31, 2010 and December 31, 2011. As a result, the Company recorded a smaller loan loss provision for the year ended December 31, 2011 of $5.4 million, compared to a loan loss provision of $9.0 million for the year ended December 31, 2010. The provision for loan losses is charged or credited to income to adjust our allowance for loan losses to reflect probable losses presently inherent in the loan portfolio based on the factors discussed below under “Allowance for Loan Losses.”

Allowance for Loan Losses. The Company maintains an allowance for loan losses to absorb probable incurred losses inherent in the loan portfolio at the balance sheet date. The allowance is based on ongoing assessment of the estimated probable losses presently inherent in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers the types of loans and the amount of loans in the loan portfolio, peer group information, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This methodology takes into account many factors, including the Company’s own historical and peer loss trends, loan-level credit quality ratings, loan specific attributes along with a review of various credit metrics and trends. The process involves subjective as well as complex judgments. During 2011, the Company used a rolling three year loss experience in analyzing an appropriate reserve factor for all loans versus a one year rolling loss experience in the prior year. Management tested this enhancement and determined that it did not have a material effect on the prior year’s allowance calculation. In addition, the Company uses adjustments for numerous factors including those found in the Interagency Guidance on Allowance for Loan and Lease Losses, which include current economic conditions, loan seasoning, underwriting experience, and collateral value changes among others. The Company evaluates all impaired loans individually using guidance from ASC 310 primarily through the evaluation of cash flows or collateral values.

At December 31, 2011, our allowance for loan losses was $12.8 million or 1.62% of the total loan portfolio. Assessing the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. In the opinion of management, the allowance, when taken as a whole, reflects estimated probable losses presently inherent in our loan portfolios.

 

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Table of Contents

The following table sets forth an analysis of our allowance for loan losses.

 

     Year Ended December 31,  
     2011     2010     2009     2008     2007  
     (Dollars in Thousands)  

Balance at beginning of period

   $ 14,637      $ 13,079      $ 18,286      $ 6,240      $ 4,670   

Charge-offs

          

Commercial:

          

Commercial and industrial

     —          —          —          (647     —     

Real Estate construction

     —          —          (12,557     —          —     

Multi-family

     (2,136     —          —          —          —     

Land

     (1,899     (2,695     (6,266     —          —     

Consumer:

          

Real Estate 1-4 family first mortgage

     (3,276     (4,747     (1,666     (461     —     

Real Estate 1-4 family junior lien mortgage

     (66     (47     (1,345     (197     —     

Other revolving credit and installment

     (135     (42     (671     (246     (24
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (7,512     (7,531     (22,505     (1,551     (24

Recoveries

          

Commercial:

          

Commercial and industrial

     —          —          —          —          —     

Real Estate construction

     —          —          —          —          —     

Multi-family

     68        —          —          —          —     

Land

     24        6        —          —          —     

Consumer:

          

Real Estate 1-4 family first mortgage

     165        92        —          —          —     

Real Estate 1-4 family junior lien mortgage

     —          14        —          —          —     

Other revolving credit and installment

     10        20        2        50        6   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     267        132        2        50        6   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     (7,245     (7,399     (22,503     (1,501     (18

Provision/(recovery) for loan losses

     5,388        8,957        17,296        13,547        1,588   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 12,780      $ 14,637      $ 13,079      $ 18,286      $ 6,240   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs to average loans during this period

     1.06     1.04     2.89     0.20     —  

Allowance for loan losses to non-performing loans

     66.38     37.70     56.20     50.45     44.16

Allowance as a % of total loans (end of period)

     1.62     2.12     1.72     2.26     0.87

Investment Activities

Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, including callable agency securities, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements, and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. See “How We Are Regulated—Pacific Trust Bank” and “—Qualified Thrift Lender Test” for a discussion of additional restrictions on our investment activities.

The general objectives of our investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. See Item 7A “—Quantitative and Qualitative Disclosures About Market Risk.”

 

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Table of Contents

The Company currently invests in mortgage-backed securities (MBS) as part of our asset/liability management strategy. Management believes that MBS can represent attractive investment alternatives relative to other investments due to the wide variety of maturity and repayment options available through such investments. In particular, the Company has from time to time concluded that short and intermediate duration MBS (with an expected average life of less than ten years) represent a better combination of rate and duration than adjustable rate mortgage-backed securities. All of the Company’s negotiable securities, including MBS, are held as “available for sale.”

The following table sets forth the composition of our securities portfolio and other investments at the dates indicated. Our securities portfolio at December 31, 2011, did not contain securities of any issuer with an aggregate book value in excess of 10% of our stockholders’ equity, excluding those issued by the United States Government or its agencies. Collateralized mortgage obligations totaling $129.0 million were purchased during 2011. Of this total, five were sold during 2011 totaling $23.3 million. These agency and private label mortgage-backed securities are collateralized with one-to four- family and multi-family residential loans.

 

     December 31,  
     2011     2010     2009  
     Carrying
Value
     % of
Total
    Carrying
Value
     % of
Total
    Carrying
Value
     % of
Total
 
     (Dollars in Thousands)  

Securities Available for Sale:

               

U.S government-sponsored entities and agency securities

   $ 4,038         3.97   $ 5,055         7.80   $ 5,168         9.88

Municipal securities

     5,713         5.62        —           0.00        —           0.00   

Private label residential mortgage-backed securities

     91,862         90.40        54,246         83.73        47,131         90.11   

Federal National Mortgage Association mortgage-backed securities

     3         0.01        3         0.00        4         0.01   

Government National Mortgage Association securities

     —           0.00        5,486        8.47     1         0.00   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 101,616         100.00   $ 64,790         100.00   $ 52,304         100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Estimated average remaining life of securities

     3.0 years           2.3 years           3.1 years      

Other interest earning assets:

               

Interest-earning deposits with banks

   $ 37,720         84.40   $ 53,729         86.59   $ 3,884         10.55

Federal funds sold

     —           0.00        —           0.00        23,580         64.03   

FHLB stock

     6,972         15.60        8,323         13.41        9,364         25.42   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 44,692         100.00   $ 62,052         100.00   $ 36,828         100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents

The composition and maturities of the securities portfolio, excluding Federal Home Loan Bank stock, as of December 31, 2011 are indicated in the following table.

 

     December 31, 2011  
     One Year or
Less
    After One Year
through Five
Years
    After Five Years
Through 10
Years
    After 10
Years
    Total Securities  
     Amortized
Cost
    Amortized
Cost
    Amortized
Cost
    Amortized
Cost
    Amortized
Cost
    Fair
Value
 
     (Dollars in Thousands)  

Available for Sale:

            

U.S. government-sponsored entities and agency securities

   $ —        $ —        $ 4,000     $ —        $ 4,000      $ 4,038   

Municipal securities

     —          2,517        2,264        860       5,641        5,713   

Private label residential mortgage-backed securities

     28,292        53,374        9,266        2,635       93,567        91,862   

Federal National Mortgage Association mortgage-backed securities

     —          3        —          —          3        3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities

   $ 28,292      $ 55,894      $ 15,530      $ 3,495     $ 103,211      $ 101,616   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average yield

     2.57     3.00     4.06     2.94     3.04  

Sources of Funds

General. The Company’s primary sources of funds are deposits, payments and maturities of outstanding loans and investment securities; and other short-term investments and funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. In addition, the Company invests excess funds in short-term interest-earning assets, which provide liquidity to meet lending requirements. The Company also generates cash through borrowings. The Company utilizes Federal Home Loan Bank advances to leverage its capital base, to provide funds for its lending activities, as a source of liquidity, and to enhance its interest rate risk management.

Deposits. The Company offers a variety of deposit accounts to both consumers and businesses having a wide range of interest rates and terms. The Company’s deposits consist of savings accounts, money market deposit accounts, NOW and demand accounts, and certificates of deposit. The Company solicits deposits primarily in our market area and from institutional investors. The Company did not hold any brokered certificates of deposit at December 31, 2011. The Company primarily relies on competitive pricing policies, marketing and customer service to attract and retain deposits.

The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition. The variety of deposit accounts the Company offers has allowed the Company to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. The Company has become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. The Company tries to manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors. Based on our experience, the Company believes that our deposits are relatively stable sources of funds. Despite this stability, the Company’s ability to attract and maintain these deposits and the rates paid on them has been and will continue to be significantly affected by market conditions.

 

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Table of Contents

The following table sets forth our deposit flows during the periods indicated.

 

     Year Ended December 31,  
     2011     2010     2009  
     (Dollars in Thousands)  

Opening balance

   $ 646,308      $ 658,432      $ 598,177   

Deposits net of withdrawals

     135,037        (20,057     47,456   

Interest credited

     4,989        7,933        12,799   
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 786,334      $ 646,308      $ 658,432   
  

 

 

   

 

 

   

 

 

 

Net increase/(decrease)

   $ 140,026      $ (12,124   $ 60,255   
  

 

 

   

 

 

   

 

 

 

Percent increase/(decrease)

     21.67     (1.84 %)      10.07
  

 

 

   

 

 

   

 

 

 

The following table sets forth the dollar amount of savings deposits in the various types of deposit programs we offered at the dates indicated.

 

     December 31,  
     2011     2010     2009  
     Amount      Percent of
Total
    Amount      Percent of
Total
    Amount      Percent of
Total
 
     (Dollars in Thousands)  

Noninterest-bearing demand

   $ 20,039         2.55   $ 15,171         2.35   $ 14,021         2.13

Savings

     39,176         4.98        124,620         19.28        121,503         18.45   

NOW

     68,578         8.72        44,860         6.94        43,942         6.67   

Money market

     188,658         23.99        89,708         13.88        81,771         12.42   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     316,451         40.24        274,359         42.45        261,237         39.67   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Certificates of deposit

               

0.00% - 0.99%

     319,729         40.66        131.737         20.38        40,386         6.13   

1.00% - 1.99%

     123,944         15.76        199,565         30.88        230,776         35.05   

2.00% - 2.99%

     15,774         2.01        23,527         3.64        78,079         11.86   

3.00% - 3.99%

     4,498         0.57        8,418         1.30        26,382         4.01   

4.00% - 4.99%

     5,350         0.68        7,286         1.13        19,755         3.00   

5.00% - 5.99%

     199         0.03        1,416         0.22        1,817         0.28   

6.00% - 6.99%

     349         0.04        —           —          —           —     

8.00% - 8.99%

     40         0.01        —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Certificates of deposit

     469,883         59.76        371,949         57.55        397,195         60.33   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 786,334         100.00   $ 646,308         100.00   $ 658,432         100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The following table (in thousands) indicates the amount of the Company’s certificates of deposit by time remaining until maturity as of December 31, 2011.

 

     2012     2013     2014     2015     2016     Total  

0.00% - 2.99%

   $ 335,019      $ 82,428      $ 27,873      $ 8,847      $ 5,280      $ 459,447   

3.00% - 3.99%

     509        862        3,127        —          —          4,498   

4.00% - 4.99%

     2,254        3,096        —          —          —          5,350   

5.00% - 5.99%

     199        —          —          —          —          199   

6.00% - 6.99%

     141        141        67        —          —          349   

8.00% - 8.99%

     40        —          —          —          —          40   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 338,162      $ 86,527      $ 31,067      $ 8,847      $ 5,280      $ 469,883   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

$100,000 and over

   $ 229,198      $ 69,582      $ 26,665      $ 7,168      $ 4,310      $ 336,923   

Below $100,000

     108,964        16,945        4,402        1,679        970        132,960   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 338,162      $ 86,527      $ 31,067      $ 8,847      $ 5,280      $ 469,883   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted Average Interest Rate

     0.73     1.23     1.37     1.77     1.54     0.89
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Borrowings. Although deposits are our primary source of funds, the Company may utilize borrowings when they are a less costly source of funds and can be invested at a positive interest rate spread, when the Company desires additional capacity to fund loan demand or when they meet our asset/liability management goals. The Company’s borrowings historically have consisted of advances to the Bank from the Federal Home Loan Bank of San Francisco (FHLB). However, the Bank also has the ability to borrow from the Federal Reserve Bank.

The Company may obtain advances from the FHLB by collateralizing the advances with certain of the Company’s mortgage loans and mortgage-backed and other securities. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features. At December 31, 2011, the Bank had $20.0 million in Federal Home Loan Bank advances outstanding and the ability to borrow an additional $130.3 million. The Bank also had the ability to borrow $117.1 million from the Federal Reserve Bank as of that date. See also Note 11 of the Notes to the Company’s consolidated financial statements at Item 8 of this report for additional information regarding FHLB advances. The $20.0 million in FHLB borrowings outstanding as of December 31, 2011, are expected to mature in 2012. These maturing advances carry a weighted average rate of 1.79%.

The following table sets forth certain information as to our FHLB advances at the dates and for the years indicated. We had no other borrowings during the years indicated.

 

     At or for the Year Ended December 31,  
             2011                     2010                     2009          
     (Dollars in Thousands)  

Average balance outstanding

   $ 39,918      $ 94,548      $ 158,549   

Maximum month-end balance

   $ 70,000      $ 120,000      $ 175,000   

Balance at end of year

   $ 20,000      $ 75,000      $ 135,000   

Weighted average interest rate during the year

     2.63     3.02     3.27

Weighted average interest rate at end of the year

     1.79     3.02     3.10

Subsidiary and Other Activities

As a federally chartered savings bank, Pacific Trust Bank is permitted by the OCC to invest up to 2% of our total assets or $19.7 million at December 31, 2011, in the stock of, or unsecured loans to, service corporation subsidiaries. The Company may invest an additional 1% of our assets in secure corporations where such additional funds are used for inner city or community development purposes. At December 31, 2011, Pacific Trust Bank did not have any subsidiary service corporations.

Competition

The Company faces strong competition in originating real estate and other loans and in attracting deposits. Competition in originating real estate loans comes primarily from other savings institutions, commercial banks, credit unions and mortgage bankers. Other savings institutions, commercial banks, credit unions and finance companies provide vigorous competition in consumer lending.

The Company attracts deposits through the branch office system and through the internet. Competition for those deposits is principally from other savings institutions, commercial banks and credit unions located in the same community, as well as mutual funds and other alternative investments. The Company competes for these deposits by offering superior service and a variety of deposit accounts at competitive rates. Based on the most recent branch deposit data as of June 30, 2011 provided by the FDIC, Pacific Trust Bank’s share of deposits was 1.11% and 0.50% in San Diego and Riverside Counties, respectively.

 

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Employees

At December 31, 2011, we had a total of 128 full-time employees and 19 part-time employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be satisfactory.

HOW WE ARE REGULATED

As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), effective July 20, 2011, the regulation and supervision of savings and loan holding companies, including the Company, was transferred from the Office of Thrift Supervision (“OTS”) to the Federal Reserve Board, and regulation and supervision of federal savings banks, including the Bank, was transferred from the OTS to the OCC. Oversight of the Company by the Federal Reserve Board is substantially similar to that conducted by the OTS, except for the Dodd-Frank Act’s requirement that the Company serve as a source of financial and managerial strength for the Bank, particularly when the Bank is in financial distress. Oversight of the Bank by the OCC is substantially similar to that conducted by the OTS. In addition to the OCC, the FDIC, which also insures our deposits, also has authority to regulate and supervise the Bank. The Dodd-Frank Act created the Consumer Financial Protection Bureau (“CFPB”) that has authority to promulgate regulations intended to protect consumers with respect to financial products and services, including those provided by the Bank, and to restrict unfair, deceptive or abusive conduct by providers of consumer financial products and services. As a public company, the Company is subject to the regulation and reporting requirements of the SEC.

Set forth below is a brief description of material information regarding certain laws and regulations that are applicable to the Company and the Bank.

Legislation is introduced from time to time in the United States Congress that may affect our operations. In addition, the regulations governing the Company and the Bank may be amended from time to time by the OCC, the FDIC, the Federal Reserve Board, the CFPB or the SEC, as appropriate. Any legislative or regulatory changes in the future, including those resulting from the Dodd-Frank Act, could adversely affect our operations and financial condition. This includes the authority, effective July 21, 2011, for financial institutions to pay interest on demand deposits, which could increase our interest expense.

The Federal Reserve Board has extensive enforcement authority over the Company and the OCC and the FDIC have extensive enforcement authority over the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OCC. Except under certain circumstances, public disclosure of formal enforcement actions by the Federal Reserve Board, the OCC and the FDIC is required by law.

First PacTrust Bancorp, Inc.

The Company is required to register and file reports with the Federal Reserve Board and is subject to regulation and examination by the Federal Reserve Board. The activities of the Company and its subsidiaries other than the Bank are restricted to activities permissible for a financial holding company (generally, banking, securities and insurance) and certain other activities authorized for savings and loan holding companies. Federal Reserve Board approval is required for acquisition of a subsidiary or another financial institution or holding company thereof. As a savings and loan holding company, the Company is not subject to any regulatory capital requirements currently. The Dodd-Frank Act requires new capital regulations for bank depository institution to be promulgated within 18 months after it is enacted, but capital regulations will not apply to savings and loan holding companies until five years after enactment.

 

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The voting common stock of First PacTrust Bancorp, Inc. is registered with the SEC under the Securities Exchange Act of 1934, as amended. The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Securities Exchange Act of 1934.

Company stock held by persons who are affiliates of the Company may not be resold without registration unless sold in accordance with certain resale restrictions. Affiliates are generally considered to be officers, directors and principal stockholders. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period.

Pacific Trust Bank

The investment and lending authority of the Bank is prescribed by federal laws and regulations and the Bank is prohibited from engaging in any activities not permitted by such laws and regulations.

As a federally chartered savings bank, the Bank is required to meet a qualified thrift lender (“QTL”) test, under which the Bank is required to maintain a significant portion of its assets in housing-related loans and investments. Failure to meet the QTL test can trigger certain restrictions on the Bank and the Company, and can be the basis for enforcement action. As of December 31, 2011, the Bank met the QTL test.

The Bank is subject to a 35% of total assets limit on consumer loans, commercial paper and corporate debt securities, and a 20% limit on commercial non-mortgage loans. Separately, the Bank has authority to invest up to 400% of its capital in loans secured by non-residential real estate. The Bank met these limits as of December 31, 2011.

The branching authority of the Bank is regulated by the OCC. The Bank is generally authorized to branch nationwide, subject to OCC approval. The OCC also must approve the Bank’s acquisition of other financial institutions and certain other acquisitions.

The Bank’s general limit on aggregate loans to one borrower is equal to the greater of $500 thousand or 15% of unimpaired capital and surplus, including allowance for loan losses. At December 31, 2011, the Bank’s lending limit under this restriction was $20.5 million. The Bank is in compliance with the loans-to-one-borrower limitation.

The OCC’s oversight of the Bank includes reviewing its compliance with the customer privacy requirements imposed by the Gramm-Leach-Bliley Act of 1999 and the anti-money laundering provisions of the USA Patriot Act. The Gramm-Leach-Bliley privacy requirements place limitations on the sharing of consumer financial information with unaffiliated third parties.

The Bank is required to maintain sufficient liquidity to ensure safe and sound operations.

Transactions between the Bank and its affiliates are required to be on terms as favorable to the Bank as transactions with non-affiliates, and certain of these transactions are restricted to a percentage of the Bank’s capital, and, in the case of loans, require eligible collateral in specified amounts. In addition, the Bank may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates.

OCC regulations impose various restrictions on the ability of a federal savings bank to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Generally, if both before and after the proposed distribution, a federal savings bank would remain well-capitalized, it may make capital distributions during any calendar year equal to up to 100% of net income for the year-to-date plus retained net income for the two preceding years. However, the OCC may restrict dividends by an institution deemed to be in need of more than normal supervision. The Bank may pay dividends in accordance with this general authority.

 

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A federal savings bank proposing to make a capital distribution must submit written notice to the OCC prior to such distribution if, like the Bank, it is a subsidiary of a holding company, or if it would not remain well-capitalized following the distribution. An institution that does not, or would not meet its current minimum capital requirements following a proposed capital distribution or proposes to exceed these net income limitations must obtain OCC approval prior to making such distribution. The OCC may object to the distribution on safety and soundness concerns. See “—Regulatory Capital Requirements.”

The Community Reinvestment Act (“CRA”) requires the OCC to assess the Bank’s record in meeting the credit needs of the communities served by the Bank, including low and moderate income neighborhoods. Under the CRA, institutions are assigned a rating of outstanding, satisfactory, needs to improve, or substantial non-compliance. The Bank received a satisfactory rating in its most recent CRA evaluation.

The OCC has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution which fails to comply with these standards must submit a compliance plan.

The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts, primarily checking, NOW and Super NOW checking accounts. At December 31, 2011, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OCC.

The Bank is a member of the Federal Home Loan Bank of San Francisco, which makes loans or advances to members. All advances are required to be fully secured by sufficient collateral as determined by the Federal Home Loan Bank, and all long-term advances are required to provide funds for residential home financing. The Bank is required to purchase and maintain stock in the FHLB of San Francisco. At December 31, 2011, the Bank had $7.0 million in FHLB stock, which was in compliance with this requirement.

FDIC Regulation and Insurance of Accounts

The Bank’s deposits are insured up to the applicable limits by the FDIC, and such insurance is backed by the full faith and credit of the United States. Deposits are insured up to the applicable limits by the FDIC. Effective July 21, 2010, the basic deposit insurance limit is $250,000 per insured deposit account holder. Non-interest bearing transaction accounts receive unlimited coverage through December 31, 2012.

As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. Our deposit insurance premiums for the year ended December 31, 2011 were $1.2 million. Those premiums have increased due to recent strains on the FDIC Deposit Insurance Fund (“DIF”) due to the cost of large bank failures and increase in the number of troubled banks. FDIC-insured institutions are required to pay an additional quarterly assessment called the FICO assessment in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. This assessment will continue until the bonds mature in the years 2017 through 2019. For the fiscal year ended December 31, 2011, the Bank paid $58 thousand in FICO assessments.

The FDIC assesses deposit insurance premiums quarterly on each FDIC-insured institution based on annualized rates. Each institution is assigned to one of four risk categories based on its capital, supervisory ratings and other factors, with higher risk institutions paying higher premiums. Its deposit insurance premiums are based on the rates applicable to its risk category, subject to certain adjustments. As required by the Dodd-Frank Act, the FDIC has issued regulations assessing insurance premiums on the amount of an institution’s total assets minus its Tier 1 capital, effective for assessments for the second quarter of 2011. The new regulations did not substantially change the level of premiums paid notwithstanding the use of assets as the assessment base instead of deposits.

 

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As a result of a decline in the reserve ratio (the ratio of the net worth of the DIF to estimated insured deposits) and concerns about expected failure costs and available liquid assets in the DIF, the FDIC required insured institutions to prepay on December 30, 2009 the estimated amount of their quarterly assessments for the fourth quarter of 2009 and all quarters through the end of 2012. The prepaid amount is recorded as an asset and institutions record quarterly expenses for deposit insurance. If events cause actual assessments during the prepayment period to vary from the prepaid amount, institutions will pay excess assessments in cash, or receive a rebate of prepaid amounts not exhausted after collection of assessments due on January 13, 2013, as applicable. Collection of the prepayment does not preclude the FDIC from changing assessment rates or revising the risk-based assessment system in the future.

Regulatory Capital Requirements

The Bank is required to maintain specified levels of regulatory capital under regulations of the OCC. To be adequately capitalized, an institution must have a leverage ratio of at least 4.0%, a Tier 1 risk-based capital ratio of at least 4.0% and a total risk-based capital ratio of at least 8.0%. To be well capitalized, an institution must have a leverage ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 10.0%. Institutions that are not well-capitalized are subject to certain restrictions on brokered deposits and interest rates on deposits.

The term leverage ratio means the ratio of Tier 1 (core) capital to adjusted total assets. The term Tier 1 risk-based capital ratio means the ratio of Tier 1 capital to risk-weighted assets. The term total risk-based capital ratio means the ratio of total capital to risk-weighted assets. Tier 1 (core) capital generally consists of common stockholders’ equity and retained earnings and certain noncumulative perpetual preferred stock and related earnings, excluding most intangible assets. Total capital consists of the sum of an institution’s Tier 1 (core) capital and the amount of its Tier 2 capital up to the amount of its Tier 1 (core) capital. Tier 2 capital consists generally of certain permanent and maturing capital instruments, the amount of the institution’s allowance for loan and lease losses up to 1.25% of risk-weighted assets and certain unrealized gains on equity securities. Adjusted total assets consist of total assets as specified for call report purposes, less such items as disallowed servicing assets and accumulated gains/losses on available-for-sale securities. Risk-weighted assets are determined under the OCC capital regulations, which assign to every asset, including certain off-balance sheet items, a risk weight generally ranging from 0% to 100% based on the inherent risk of the asset. At December 31, 2011, the Bank’s regulatory capital ratios exceeded the ratios required to qualify as well-capitalized.

The OCC has the ability to establish an individual minimum capital requirement for a particular institution, based on its circumstances, which varies from the capital levels that would otherwise be required under the capital regulations. The OCC has not imposed any such requirement on the Bank.

The OCC is authorized and, under certain circumstances, required to take certain actions against a savings institution that is less than adequately capitalized. Such an institution must submit a capital restoration plan, including a specified guaranteed by its holding company, and until the plan is approved by the OCC may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions.

For institutions that are not at least adequately capitalized, progressively more severe restrictions generally apply as capital ratios decrease, or if the OCC reclassifies an institution into a lower capital category due to unsafe or unsound practices or unsafe or unsound condition. Such restrictions may cover all aspects of operations and may include a forced merger or acquisition. An institution that becomes “critically undercapitalized” because it has a tangible capital ratio of 2.0% or less is generally subject to the OCC’s appointment of the FDIC as receiver or conservator for the institution within 90 days after it becomes critically undercapitalized. The imposition by the OCC of any of these measures on the Bank may have a substantial adverse effect on its operations and profitability.

 

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TAXATION

Federal Taxation

General. First PacTrust Bancorp, Inc. and Pacific Trust Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to the Company or the Bank. The Bank’s federal income tax returns have never been audited. Prior to January 1, 2000, the Bank was a credit union, not generally subject to corporate income tax.

Method of Accounting. For federal income tax purposes, Pacific Trust Bank currently reports its income and expenses on the accrual method of accounting and uses a fiscal year ending on December 31, for filing its federal income tax return.

Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. Pacific Trust Bank has not been subject to the alternative minimum tax, nor does the Company have any such amounts available as credits for carryover.

Net Operating Loss Carryovers. A financial institution may carryback net federal operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. This provision applies to losses incurred in taxable years beginning after August 6, 1997. At December 31, 2011, First PacTrust Bancorp, Inc had $13.2 million in net operating loss carryforwards for California income tax purposes.

Corporate Dividends-Received Deduction. First PacTrust Bancorp, Inc. may eliminate from its income dividends received from the Bank as a wholly owned subsidiary of the Company if it elects to file a consolidated return with the Bank. The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payor of the dividend. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.

State Taxation

First PacTrust Bancorp, Inc. and Pacific Trust Bank are subject to the California corporate franchise (income) tax which is assessed at the rate of 10.8%. For this purpose, California taxable income generally means federal taxable income subject to certain modifications provided for in the California law.

Executive Officers Who are Not Directors

The business experience for at least the past five years for each of our executive officers who do not serve as directors is set forth below.

Gaylin Anderson. Age 45 years. Mr. Anderson became Executive Vice President and Chief Retail Banking Officer of the Bank effective January 3, 2011. Prior to joining the Bank, Mr. Anderson served as SVP, Consumer Branch Performance for U.S. Bank in Los Angeles, and as Director of Retail Banking for California National Bank, a $7.7 billion asset 68-branch community banking franchise serving Los Angeles, Orange, Ventura and San Bernardino counties. Mr. Anderson has held executive management positions for CitiBank, N.A., and California Federal Bank.

 

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Matthew Bonaccorso. Age 60 years. Mr. Bonaccorso became Executive Vice President and Chief Credit Officer of the Bank effective January 3, 2011. Prior to joining the Bank, Mr. Bonaccorso served at U.S. Bank where he managed its Special Assets Group-West operation with offices in Los Angeles, San Francisco, San Diego, Newport Beach and Sacramento. Previously, he was EVP and Chief Credit Officer of California National Bank from 2001 to 2009. Prior to joining Cal National in 2001, Mr. Bonaccorso held executive positions at Knowledge First, Inc., and at Bank of America.

Marangal Domingo. Age 51 years. Mr. Domingo became Executive Vice President and Chief Financial Officer of First PacTrust Bancorp and the Bank on May 6, 2011. Prior to joining us, Mr. Domingo served as Principal for Decision Advisors LLC, where he provided business strategy and capital markets advice to both financial institutions and investors seeking to invest in banks. From 2006 to 2009, he was Chief Financial Officer and Executive Vice President of Doral Financial Corp and of its bank subsidiary, Doral Bank, located in Puerto Rico where he participated in a large-scale recapitalization, restructuring and stabilization of Doral Financial. Prior to joining Doral Financial, Mr. Domingo served as Executive Vice President, Finance and Strategy for Countrywide Bank. From 1991 to 2004 he held a variety of positions with Washington Mutual and its predecessor company, American Savings, and last served as Executive Vice President, Capital Markets for the Home Loan & Insurance Services Group, responsible for capital markets, finance, market risk management, correspondent lending and conduit operations. After leaving Washington Mutual in 2004, he served as President and Chief Executive Officer of Downey Financial Corporation

Richard Herrin. Age 43 years. Mr. Herrin became Executive Vice President and Chief Administrative Officer of the Bank effective December 6, 2010. Prior to joining the Bank, Mr. Herrin served at the FDIC as a member of the strategic operations group, which has overall responsibility for managing problem banks on behalf of the FDIC. As part of this group, Mr. Herrin acted as the Receiver-in-Charge of a number of the largest failed banks in the western region of the United States. Previously, he was the Manager of Asset Management Division within the FDIC where he served as a voting member of the Credit Review Committee for all receiverships in the western region of the United States. Prior to joining the FDIC in 2009, Mr. Herrin held executive positions at Vineyard Bank, Excel National Bank, Imperial Capital Bank and Bank of America.

Chang Liu. Age 45 years. Mr. Liu became Executive Vice President and Chief Lending Officer of the Bank effective January 3, 2011. Prior to joining the Bank, Mr. Liu served at U.S. Bank as Senior Vice President where he managed the Los Angeles, Newport Beach and San Diego offices of its Special Assets Group. Previously, he was a Senior Vice President, Senior Loan Officer and Manager of California National Bank’s Los Angeles commercial real estate lending activity. Prior to joining Cal National in 1999, Mr. Liu held commercial real estate commercial lending and corporate finance positions at The Fuji Bank, Ltd., and Sumitomo Bank of California.

 

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Item 1A. Risk Factors

RISK FACTORS

An investment in our securities is subject to certain risks. These risk factors should be considered by prospective and current investors in our securities when evaluating the disclosures in this Annual Report on Form 10-K (particularly the forward-looking statements.) The risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, results of operations and financial condition could suffer. In that event, the value of our securities could decline, and you may lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ materially from those discussed in these forward-looking statements.

Risks Relating to Our Business and Operating Environment

Our business strategy includes significant growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.

We intend to pursue an organic and acquisition growth strategy for our business. We regularly evaluate potential acquisitions and expansion opportunities. If appropriate opportunities present themselves, we expect to engage in selected acquisitions of financial institutions, branch acquisitions and other business growth initiatives or undertakings. There can be no assurance that we will successfully identify appropriate opportunities, that we will be able to negotiate or finance such activities or that such activities, if undertaken, will be successful.

There are risks associated with our growth strategy. To the extent that we grow through acquisitions, we cannot ensure that we will be able to adequately or profitably manage this growth. Acquiring other banks, branches or other assets, as well as other expansion activities, involves various risks including the risks of incorrectly assessing the credit quality of acquired assets, encountering greater than expected costs of integrating acquired banks or branches into the Bank, the risk of loss of customers and/or employees of the acquired institution or branch, executing cost savings measures, not achieving revenue enhancements and otherwise not realizing the transaction’s anticipated benefits. Our ability to address these matters successfully cannot be assured. In addition, our strategic efforts may divert resources or management’s attention from ongoing business operations and may subject us to additional regulatory scrutiny.

Our growth initiatives may also require us to recruit experienced personnel to assist in such initiatives. Accordingly, the failure to identify and retain such personnel would place significant limitations on our ability to successfully execute our growth strategy. In addition, to the extent we expand our lending beyond our current market areas, we could incur additional risks related to those new market areas. We may not be able to expand our market presence in our existing market areas or successfully enter new markets.

If we do not successfully execute our acquisition growth plan, it could adversely affect our business, financial condition, results of operations, reputation and growth prospects. In addition, if we were to conclude that the value of an acquired business had decreased and that the related goodwill had been impaired, that conclusion would result in an impairment of goodwill charge to us, which would adversely affect our results of operations. While we believe we will have the executive management resources and internal systems in place to successfully manage our future growth, there can be no assurance growth opportunities will be available or that we will successfully manage our growth.

We may fail to realize all of the anticipated benefits of our pending acquisition of Gateway Bancorp.

On June 3, 2011, we entered into a definitive agreement to acquire all of the outstanding stock of Gateway Bancorp, the holding company for Gateway Business Bank. The closing of the transaction is subject to the

 

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satisfaction of certain conditions, including the receipt of all necessary or advisable regulatory approvals. No assurance can be given as to when or whether these approvals will be received. The success of our pending acquisition of Gateway Bancorp will depend on, among other things, our ability to realize anticipated cost savings and to combine the businesses of the Bank and Gateway Business Bank in a manner that does not materially disrupt the existing customer relationships of either institution or result in decreased revenues from our respective customers. If we are not able to successfully achieve these objectives, the anticipated benefits of the acquisition may not be realized fully or at all or may take longer to realize than expected.

The Bank and Gateway Bancorp have operated and, until the completion of the merger of the two institutions, will continue to operate, independently. It is possible that the integration process could result in the loss of key employees, the disruption of each institution’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with customers, depositors and employees or to achieve the anticipated benefits of the acquisition. Integration efforts between the two institutions will also divert management attention and resources. These integration matters could have an adverse effect on the combined institution following completion of the acquisition.

One of the anticipated benefits of the Gateway Bancorp acquisition is the diversification of our revenue stream through non-interest income realized from the mortgage banking operations of Mission Hills Mortgage Bankers, a division of Gateway Business Bank. Most of the revenues generated by Mission Hills come from gains on the sale of single-family mortgage loans pursuant to programs currently offered by Fannie Mae, Freddie Mac and investors other than government sponsored enterprises on a servicing-released basis. These entities account for a substantial portion of the secondary market in residential mortgage loans. Any future changes in these programs, reduction in number of entities to sell to, eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially reduce the revenues generated by Mission Hills. Further, in a rising or higher interest rate environment, originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage banking revenues and a corresponding decrease in our non-interest income following the Gateway Bancorp acquisition. Our post-acquisition results of operations also will be affected by the amount of non-interest expense associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations.

We may fail to realize all of the anticipated benefits of our pending acquisition of Beach Business Bank.

On August 30, 2011, we entered into a merger agreement to acquire Beach Business Bank. The closing of the transaction is subject to the satisfaction of certain conditions, including the receipt of all necessary or advisable regulatory approvals. No assurance can be given as to when or whether these approvals will be received. The success of our pending acquisition of Beach Business Bank will depend on, among other things, our ability to realize anticipated cost savings and to combine the businesses of the Bank and Beach Business Bank in a manner that does not materially disrupt the existing customer relationships of either institution or result in decreased revenues from our respective customers. If we are not able to successfully achieve these objectives, the anticipated benefits of the acquisition may not be realized fully or at all or may take longer to realize than expected.

The Bank and Beach Business Bank have operated and, until the completion of the merger of the two institutions, will continue to operate, independently. It is possible that the integration process could result in the loss of key employees, the disruption of each institution’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with customers, depositors and employees or to achieve the anticipated benefits of the acquisition. Integration efforts between the two institutions will also divert management attention and resources. These integration matters could have an adverse effect on the combined institution following completion of the acquisition.

 

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The Bank is subject to a regulatory memorandum of understanding, which imposes certain requirements and restrictions on the Bank.

In August 2009, the Bank entered into a memorandum of understanding (the “MOU”) with the OTS(which was succeeded by the OCC as the Bank’s primary regulator effective July 21, 2011) to address certain concerns of the OTS following its examination of the Bank. The MOU requires the Bank to: (i) submit a three-year business plan to the OTS and provide to the OTS quarterly variance reports of the Bank’s compliance with that plan; (ii) submit a non-traditional mortgage analysis plan to the OTS designed to ensure compliance with applicable regulatory guidance concerning the risks of that loan product type; (iii) adopt a concentrations risk management policy addressing concentration risks for loan types other than conforming single family residential loans and for all funding sources; (iv) submit a plan to the OTS to ensure the Bank’s allowance for loan losses methodology is consistent with regulatory requirements and guidance and that the allowance is adequate at each quarter end; (v) adopt a pre-purchase analysis procedure that requires full documentation of all factors and research considered by management prior to the purchase of complex securities; (vi) provide the OTS with quarterly updates of problem assets; and (vii) refrain from increasing the dollar amount of brokered deposits above the amount held by the Bank as of June 30, 2009, excluding interest credited, without the prior written non-objection of the OTS.

The Bank believes it is currently in full compliance with the MOU but will remain subject to the MOU until such time as all or any portion of the MOU has been modified, suspended or terminated by the Bank’s regulator. Failure by the Bank to comply fully with the terms of the MOU or any of the plans or policies adopted by the Bank pursuant to the MOU could result in further regulatory action against the Bank.

Our financial condition and results of operations are dependent on the economy, particularly in the Bank’s market area. The current economic conditions in the market areas we serve may continue to impact our earnings adversely and could increase the credit risk of our loan portfolio.

Our primary market area is concentrated in the greater San Diego market area. Adverse economic conditions in that market area can reduce our rate of growth, affect our customers’ ability to repay loans and adversely impact our financial condition and earnings. General economic conditions, including inflation, unemployment and money supply fluctuations, also may affect our profitability adversely. Weak economic conditions and ongoing strains in the financial and housing markets have resulted in higher levels of loan delinquencies, problem assets and foreclosures and a decline in the values of the collateral securing our loans.

A further deterioration in economic conditions in the market areas we serve could result in the following consequences, any of which could have a material adverse effect on our business, financial condition and results of operations:

 

   

demand for our products and services may decline;

 

   

loan delinquencies, problem assets and foreclosures may increase;

 

   

collateral for our loans may further decline in value; and

 

   

the amount of our low-cost or non-interest-bearing deposits may decrease.

We cannot accurately predict the effect of the weakness in the national economy on our future operating results or the market price of our voting common stock.

The national economy in general and the financial services sector in particular are currently facing challenges of a scope unprecedented in recent history. We cannot accurately predict the severity or duration of the current economic downturn, which has adversely impacted the markets we serve. Any further deterioration in national or local economic conditions would have an adverse effect, which could be material, on our business, financial condition, results of operations and prospects, and could also cause the market price of our voting

 

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common stock to decline. While it is impossible to predict how long these conditions may exist, the current economic downturn could present substantial risks for some time for the banking industry and for us.

Our allowance for loan losses may prove to be insufficient to absorb probable incurred losses in our loan portfolio.

Lending money is a substantial part of our business. Every loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:

 

   

cash flow of the borrower and/or the project being financed;

 

   

in the case of a collateralized loan, the changes and uncertainties as to the future value of the collateral;

 

   

the credit history of a particular borrower;

 

   

changes in economic and industry conditions; and

 

   

the duration of the loan.

We maintain an allowance for loan losses which we believe is appropriate to provide for probable incurred potential losses in our loan portfolio. The amount of this allowance is determined by our management through a periodic review and consideration of several factors, including, but not limited to:

 

   

an ongoing review of the quality, size and diversity of the loan portfolio;

 

   

evaluation of non-performing loans;

 

   

historical default and loss experience;

 

   

historical recovery experience;

 

   

existing economic conditions;

 

   

risk characteristics of the various classifications of loans; and

 

   

the amount and quality of collateral, including guarantees, securing the loans.

If our loan losses exceed our allowance for probable incurred loan losses, our business, financial condition and profitability may suffer.

The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and the loss and delinquency experience, and evaluate economic conditions and make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for additions to our allowance through an increase in the provision for loan losses. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. Our allowance for loan losses was 1.62% of gross loans held for investment and 66.38% of nonperforming loans at December 31, 2011. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than that of management. If charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition and results of operations.

 

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Our business may be adversely affected by credit risk associated with residential property and declining property values.

At December 31, 2011, $563.0 million, or 71.5% of our total gross loan portfolio, was secured by single-family mortgage loans and home equity lines of credit. This type of lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. The decline in residential real estate values as a result of the downturn in the California housing markets has reduced the value of the real estate collateral securing these types of loans and increased the risk that we would incur losses if borrowers default on their loans. Residential loans with high combined loan-to-value ratios generally will be more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, the borrowers may be unable to repay their loans in full from the sale proceeds. As a result, these loans may experience higher rates of delinquencies, defaults and losses, which will in turn adversely affect our financial condition and results of operations.

Our loan portfolio possesses increased risk due to our level of adjustable rate loans.

A substantial majority of our real estate secured loans held are adjustable-rate loans. Any rise in prevailing market interest rates may result in increased payments for borrowers who have adjustable rate mortgage loans, increasing the possibility of defaults that may adversely affect our profitability.

Our non-traditional, interest-only single-family residential loans expose us to increased lending risk.

Many of the residential mortgage loans we have originated for investment consisted of non-traditional single family loans that do not conform to Fannie Mae or Freddie Mac underwriting guidelines as a result of characteristics of the borrower or property, the loan terms, loan size or exceptions from agency underwriting guidelines, including our Green Account loans. The Green Account is a first mortgage line of credit with an associated “clearing account” that allows all types of deposits and withdrawals to be performed, including direct deposit, check, debit card, ATM, ACH debits and credits, and internet banking and bill payment transactions. At December 31, 2011, we had $247.5 million of Green Account loans, which represented 31.4% of our gross loan portfolio as of that date. Green Account home equity loans generally have a fifteen year draw period with interest-only payment requirements, a balloon payment requirement at the end of the draw period and a maximum 80% loan to value ratio. In addition to the Green Account loans, we had other interest-only single family residential mortgage loans totaling $125.6 million at December 31, 2011, representing 15.95% of our gross loan portfolio as of that date, and single family residential negative amortization loans (a loan in which accrued interest exceeding the required monthly loan payment may be added to loan principal) totaling $21.5 million, representing 2.73% of our gross loan portfolio as of December 31, 2011. We ceased originating negative amortization loans in 2006.

In the case of interest-only loans, a borrower’s monthly payment is subject to change when the loan converts to fully-amortizing status. Since the borrower’s monthly payment may increase by a substantial amount even without an increase in prevailing market interest rates, the borrower might not be able to afford the increased monthly payment. In addition, interest-only loans have a large, balloon payment at the end of the loan term, which the borrower may be unable to pay. Negative amortization involves a greater risk to us because credit risk exposure increases when the loan incurs negative amortization and the value of the home serving as collateral for the loan does not increase proportionally. Negative amortization is only permitted up to 110% of the original loan to value ratio during the first five years the loan is outstanding, with payments adjusting periodically as provided in the loan documents, potentially resulting in higher payments by the borrower. The adjustment of these loans to higher payment requirements can be a substantial factor in higher loan delinquency levels because the borrowers may not be able to make the higher payments. Also, real estate values may decline, and credit standards may tighten in concert with the higher payment requirement, making it difficult for borrowers to sell their homes or refinance their loans to pay off their mortgage obligations. For these reasons, interest-only loans and negative amortization loans are considered to have an increased risk of delinquency, default and foreclosure than

 

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conforming loans and may result in higher levels of realized losses. Furthermore, these loans are not as readily saleable as loans that conform to agency guidelines and often can be sold only after discounting the amortized value of the loan. As of December 31, 2011, 0.53% of our interest-only loans, totaling $2.0 million, were in non-performing status. None of our negatively amortizing loans were in non-performing status as of December 31, 2011.

Our income property loans, consisting of commercial and multi-family real estate loans, involve higher principal amounts than other loans and repayment of these loans may be dependent on factors outside our control or the control of our borrowers.

We originate commercial and multi-family real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. These loans typically involve higher principal amounts than other types of loans, and repayment is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial and multifamily real estate loans also expose us to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our commercial and multifamily real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment.

If we foreclose on a commercial and multi-family real estate loan, our holding period for the collateral typically is longer than for residential mortgage loans because there are fewer potential purchasers of the collateral. Additionally, commercial and multi-family real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, if we make any errors in judgment in the collectability of our commercial and multi-family real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios. As of December 31, 2011, our commercial and multi-family real estate loans totaled $220.3 million, or 28.0% of our total gross loan portfolio.

If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.

We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed upon and the property is taken in as other real estate owned (“OREO”), and at certain other times during the asset’s holding period. Our net book value (“NBV”) in the loan at the time of foreclosure and thereafter is compared to the updated market value (fair value) of the foreclosed property less estimated selling costs. A charge-off is recorded for any excess in the asset’s NBV over its fair value. If our valuation process is incorrect, the fair value of our investments in real estate may not be sufficient to recover our NBV in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations. Our bank regulator periodically reviews our REO and may require us to recognize further charge-offs. Any increase in our charge-offs, as required by such regulator, may have a material adverse effect on our financial condition and results of operations.

Other-than-temporary impairment charges in our investment securities portfolio could result in losses and adversely affect our continuing operations.

As of December 31, 2011, the Company’s investment securities portfolio consisted of fifty-four securities, thirty-seven of which were in an unrealized loss position. The majority of unrealized losses are related to the Company’s private label residential mortgage-backed securities, as discussed below.

 

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The Company’s private label residential mortgage-backed securities that are in a loss position had a fair value of $73.1 million with unrealized losses of approximately $1.9 million at December 31, 2011. These non-agency private label residential mortgage-backed securities were rated AAA at purchase and are not within the scope of ASC 325. The Company monitors to ensure it has adequate credit support and as of December 31, 2011, the Company believes there is no other than temporary impairment (OTTI) and did not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery. See further discussion in Note 5-Securities.

We closely monitor our investment securities for changes in credit risk. The valuation of our investment securities also is influenced by external market and other factors, including implementation of Securities and Exchange Commission and Financial Accounting Standards Board guidance on fair value accounting. Accordingly, if market conditions deteriorate further and we determine our holdings of other investment securities are OTTI, our future earnings, shareholders’ equity, regulatory capital and continuing operations could be materially adversely affected.

Rising interest rates may hurt our profits.

To be profitable, we have to earn more money in interest that we receive on loans and investments than we pay to our depositors and lenders in interest. If interest rates rise, our net interest income and the value of our assets could be reduced if interest paid on interest-bearing liabilities, such as deposits and borrowings, increases more quickly than interest received on interest-earning assets, such as loans, other mortgage-related investments and investment securities. This is most likely to occur if short-term interest rates increase at a faster rate than long-term interest rates, which would cause net income to go down. In addition, rising interest rates may hurt our income, because they may reduce the demand for loans and the value of our securities. In a rapidly changing interest rate environment, we may not be able to manage our interest rate risk effectively, which would adversely impact our financial condition and results of operations.

We face significant operational risks.

We operate many different financial service functions and rely on the ability of our employees, third-party vendors and systems to process a significant number of transactions. Operational risk is the risk of loss from operations, including fraud by employees or outside persons, employees’ execution of incorrect or unauthorized transactions, data processing and technology errors or hacking and breaches of internal control systems.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.

We may elect or be compelled to seek additional capital in the future, but that capital may not be available when it is needed.

We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. At some point, we may need to raise additional capital to support continued growth, both organically and through acquisitions. If we raise additional capital, we may seek to do so through the issuance of, among

 

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other things, our common stock or preferred stock. The issuance of additional shares of common stock or convertible securities to new stockholders would be dilutive to our current stockholders.

Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through organic growth and acquisitions could be materially impaired and our financial condition and liquidity could be materially and adversely affected.

We depend on our key employees.

Our future prospects are and will remain highly dependent on our directors and executive officers. Our success will, to some extent, depend on the continued service of our directors and continued employment of the executive officers. The unexpected loss of the services of any of these individuals could have a detrimental effect on our business. Although we have entered into employment agreements with members of our senior management team, no assurance can be given that these individuals will continue to be employed by us. The loss of any of these individuals could negatively affect our ability to achieve our growth strategy and could have a material adverse affect on our results of operations and financial condition.

We currently hold a significant amount of bank-owned life insurance.

At December 31, 2011, we held $18.5 million of bank-owned life insurance or BOLI on certain key and former employees and executives, with a cash surrender value of $18.4 million. The eventual repayment of the cash surrender value is subject to the ability of the various insurance companies to pay death benefits or to return the cash surrender value to us if needed for liquidity purposes. We continually monitor the financial strength of the various companies with whom we carry these policies. However, any one of these companies could experience a decline in financial strength, which could impair its ability to pay benefits or return our cash surrender value. If we need to liquidate these policies for liquidity purposes, we would be subject to taxation on the increase in cash surrender value and penalties for early termination, both of which would adversely impact earnings.

If our investment in the Federal Home Loan Bank of San Francisco becomes impaired, our earnings and shareholders’ equity could decrease.

At December 31, 2011, we owned $7.0 million in FHLB stock. We are required to own this stock to be a member of and to obtain advances from our FHLB. This stock is not marketable and can only be redeemed by our FHLB, which currently is not redeeming any excess member stock. Our FHLB’s financial condition is linked, in part, to the eleven other members of the FHLB System and to accounting rules and asset quality risks that could materially lower their capital, which would cause our FHLB stock to be deemed impaired, resulting in a decrease in our earnings and assets.

Our information systems may experience an interruption or breach in security; we may have fewer resources than many of our competitors to continue to invest in technological improvements.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could

 

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have a material adverse effect on our financial condition and results of operations. In addition, our future success will depend, in part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our clients.

We operate in a highly regulated environment and our operations and income may be affected adversely by changes in laws and regulations governing our operations.

We are subject to extensive regulation and supervision by the Federal Reserve Board, the OCC and the FDIC. Such regulators govern the activities in which we may engage, primarily for the protection of depositors and the deposit insurance fund. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on a bank’s operations, reclassify assets, determine the adequacy of a bank’s allowance for loan losses and determine the level of deposit insurance premiums assessed. Any change in such regulation and oversight, whether in the form of regulatory policy, new regulations or legislation or additional deposit insurance premiums could have a material adverse impact on our operations. Because our business is highly regulated, the laws and applicable regulations are subject to frequent change. Any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or growth prospects. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. The recently enacted regulatory reform legislation described below will, among other things, change our primary regulator, create a new consumer finance protection agency and impose capital requirements on us at the holding company level. These changes could adversely impact our operations and net income.

The Dodd-Frank Act could have a material adverse effect on us.

The Dodd-Frank Act, which was enacted into law on July 21, 2010, provides for, among other things, new restrictions and an expanded framework of regulatory oversight for financial institutions and their holding companies. Under the Dodd-Frank Act, effective July 21, 2011, the Bank’s primary regulator, the OTS, was eliminated and existing federal thrifts, including the Bank, became subject to regulation and supervision by the OCC, which also supervises and regulates all national banks. In addition, on July 21, 2011, all savings and loan holding companies, including the Company, became subject to regulation and supervision by the Federal Reserve Board, which also supervises and regulates all bank holding companies. This change in regulation of savings and loan holding companies may result in the imposition of holding company capital requirements and additional restrictions on investments and other holding company activities. The Dodd-Frank Act also creates a new consumer financial protection bureau that will have the authority to promulgate rules intended to protect consumers in the financial products and services market. The creation of this independent bureau is likely to result in new regulatory requirements and raise the cost of regulatory compliance. In addition, new regulations mandated by the Dodd-Frank Act could require changes in regulatory capital requirements, loan loss provisioning practices and compensation practices. Effective July 21, 2011, financial institutions may pay interest on demand deposits, which could increase our interest expense. At this time, we cannot determine the full impact of the Dodd-Frank Act on our business and operations.

Increases in deposit insurance premiums and special FDIC assessments will negatively impact our earnings.

During 2009, our FDIC insurance premiums increased significantly and we may pay higher FDIC premiums in the future. The Dodd-Frank Act increased the minimum reserve ratio from 1.15% to 1.35%. The FDIC has adopted a plan under which it will meet this ratio by the statutory deadline of September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect of the increase in the minimum reserve ratio on institutions with

 

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assets less than $10.0 billion. The FDIC has not announced how it will implement this offset. In addition to the minimum reserve ratio, the FDIC must set a designated reserve ratio. The FDIC has set a designated reserve ratio of 2.0, which exceeds the minimum reserve ratio.

As required by the Dodd-Frank Act, the FDIC has adopted final regulations under which insurance premiums are based on an institution’s total assets minus its tangible equity instead of its deposits. While our FDIC insurance premiums initially will be reduced by these regulations, it is possible that our future insurance premiums will increase under the final regulations.

We rely on dividends from the Bank for substantially all of the Company’s revenue.

The Company’s primary source of revenue is earnings of available cash and securities and dividends from the Bank. The OCC regulates and must approve the amount of Bank dividends to the Company. If the Bank is unable to pay dividends, the Company may not be able to service its debt, pay its other obligations or pay dividends on the Company’s preferred and common stock which could have a material adverse impact on our financial condition or the value of your investment in our common stock.

The Company has a significant deferred tax asset and may or may not be fully realized.

The Company has a significant deferred tax asset and cannot assure that it will be fully realized. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the carrying amounts and the tax basis of assets and liabilities computed using enacted tax rates. If we determine that we will not achieve sufficient future taxable income to realize our net deferred tax asset, we are required under generally accepted accounting principles to establish a full or partial valuation allowance. If we determine that a valuation allowance is necessary, we are required to incur a charge to operations. We regularly assess available positive and negative evidence to determine whether it is more likely than not that our net deferred tax asset will be realized. Realization of a deferred tax asset requires us to apply significant judgment and is inherently speculative because it requires estimates that cannot be made with certainty. At December 31, 2011, the Company had a net deferred tax asset of $7.6 million, net of a deferred tax asset valuation allowance of $1.3 million. Although realization is not assured, the Company believes that the realization of the recognized net deferred tax asset at December 31, 2011 is more likely than not based upon available tax planning strategies and expectations as to future taxable income.

Our ability to utilize its DTAs to offset future taxable income may be significantly limited if the Company experiences an “ownership change” under the Internal Revenue Code.

As of December 31, 2011, the Company had recognized net DTAs of approximately $7.6 million, which are included in its tangible common equity. The Company’s ability to utilize its DTAs to offset future taxable income may be significantly limited if the Company experiences an “ownership change” as defined in Section 382 of the Internal Revenue Code of 1986, as amended (“the Code”). In general, an ownership change will occur if there is a cumulative change in the Company’s ownership by “5-percent or more shareholders” (as defined in the Code) that exceeds 50 percentage points over a rolling three-year period. If this were to occur, the Company would be subject to an annual limitation on its pre-ownership change DTAs equal to the value of the corporation immediately before the ownership change, provided that the annual limitation would be increased each year to the extent that there is an unused limitation in a prior year.

Changes in accounting standards may affect our performance.

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time there are changes in the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we report and record our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in a retrospective adjustment to prior financial statements.

 

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Strong competition within our market area may limit our growth and profitability.

Competition in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have substantially greater name recognition, resources and lending limits than we do and may offer certain services or prices for services that we do not or cannot provide. Our profitability depends upon our continued ability to successfully compete in our market.

Risks Relating to Our Common Stock

The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell our common stock when you want or at prices you find attractive.

We cannot predict how our common stock will trade in the future. The market value of our common stock will likely continue to fluctuate in response to a number of factors including the following, most of which are beyond our control, as well as the other factors described in this “Risk Factors” section:

 

   

actual or anticipated quarterly fluctuations in our operating and financial results;

 

   

developments related to investigations, proceedings or litigation that involve us;

 

   

changes in financial estimates and recommendations by financial analysts;

 

   

dispositions, acquisitions and financings;

 

   

actions of our current stockholders, including sales of common stock by existing stockholders and our directors and executive officers;

 

   

fluctuations in the stock price and operating results of our competitors;

 

   

regulatory developments; and

 

   

developments related to the financial services industry.

The market value of our common stock may also be affected by conditions affecting the financial markets in general, including price and trading fluctuations. These conditions may result in (i) volatility in the level of, and fluctuations in, the market prices of stocks generally and, in turn, our common stock and (ii) sales of substantial amounts of our common stock in the market, in each case that could be unrelated or disproportionate to changes in our operating performance. These broad market fluctuations may adversely affect the market value of our common stock.

There may be future sales of additional common stock or other dilution of our shareholders’ equity, which may adversely affect the market price of our common stock.

We are not restricted from issuing additional common stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or any substantially similar securities. The market value of our common stock could decline as a result of sales by us of a large number of shares of common stock or similar securities in the market or the perception that such sales could occur.

Our SBLF Preferred Stock impacts net income available to our common shareholders and earnings per common share.

The dividends declared on the preferred stock we issued to the U.S. Treasury pursuant to the Small Business Lending Fund (“SBLF”) program (the “SBLF Preferred Stock”) reduce the net income available to common shareholders and our earnings per common share. The SBLF Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of First PacTrust Bancorp.

 

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The dividend rate on the SBLF Preferred Stock will fluctuate initially from 1% to 5% based on our level of “Qualified Small Business Lending,” or “QSBL,” as compared to our “baseline” level. The cost of the capital we received from the SBLF Preferred Stock will increase significantly if the level of our “QSBL” as of September 30, 2013 does not represent an increase from our “baseline” level. This cost also will increase significantly if we have not redeemed the SBLF Preferred Stock before the fourth anniversary of the SBLF transaction.

The per annum dividend rate on the SBLF Preferred Stock can fluctuate on a quarterly basis during the first ten quarters during which the SBLF Preferred Stock is outstanding, based upon changes in the amount of “QSBL” by the Bank from a “baseline” level (the average of the Bank’s quarter-end QSBL for the four quarters ended June 30, 2010, which was $36.1 million). The dividend rate for the initial dividend period (which ended on September 30, 2011) was 5%, the dividend rate for the second dividend period (which ended on December 31, 2011) was 3.888375%. For the third dividend period through the tenth dividend period, the dividend rate may be adjusted to between one percent and five percent, to reflect the amount of percentage change in the Bank’s level of QSBL from the baseline level to the level as of the end of the second quarter proceeding the dividend period in question. For the eleventh dividend period to the fourth anniversary of the SBLF transaction, the dividend rate will be fixed at between 1% and 5%, based upon the percentage increase in QSBL from the baseline level to the level as of the end of the ninth dividend period (i.e., as of September 30, 2013); however, if there is no increase in QSBL from the baseline level to the level as of the end of the ninth dividend period (or if QSBL has decreased during that time period), the dividend rate will be fixed at 7.0%. From and after the fourth anniversary of the SBLF transaction, the dividend rate will be fixed at 9.0%, regardless of the level of QSBL. Depending on our financial condition at the time, any such increases in the dividend rate could have a material negative effect on our liquidity.

Regulatory and contractual restrictions may limit or prevent us from paying dividends on and repurchasing our common stock.

The Company is an entity separate and distinct from its principal subsidiary, the Bank, and derives substantially all of its revenue in the form of dividends from that subsidiary. Accordingly, the Company is and will be dependent upon dividends from the Bank to pay the principal of and interest on its indebtedness, to satisfy its other cash needs and to pay dividends on its common and preferred stock. The Bank’s ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory requirements. In the event the Bank is unable to pay dividends to the Company, the Company may not be able to pay dividends on its common or preferred stock. Also, the Company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. This includes claims under the liquidation account maintained for the benefit of certain eligible deposit account holders of the Bank established in connection with the Bank’s conversion from the mutual to the stock form of ownership.

Under the terms of the SBLF Preferred Stock and the securities purchase agreement between us and the U.S. Treasury in connection with the SBLF transaction our ability to pay dividends on or repurchase our common stock is subject to a limit requiring us generally not to reduce our Tier 1 capital from the level on the SBLF closing date by more than 10%. In addition, if we fail to pay an SBLF dividend, there are further restrictions on our ability to pay dividends on or repurchase our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, as and if declared by our board of directors. Although we have historically paid cash dividends on our common stock, we are not required to do so and our board of directors could reduce, suspend or eliminate our common stock cash dividend in the future.

Holders of the SBLF Preferred Stock have limited voting rights.

Until and unless we fail to pay full dividends on the SBLF Preferred Stock for six or more dividend periods, whether or not consecutive, and the aggregate liquidation preference amount of the then-outstanding shares of SBLF Preferred Stock is at least $25.0 million, the holders of the SBLF Preferred Stock will have no voting

 

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rights except with respect to certain fundamental changes in the terms of the SBLF Preferred Stock and except as may be required by law. If, however, dividends on the SBLF Preferred Stock are not paid in full for six dividend periods, whether or not consecutive, and if the aggregate liquidation preference amount of the then-outstanding shares of SBLF Preferred Stock is at least $25.0 million, then the total number of positions on the Company’s Board of Directors will automatically increase by two and the holders of the SBLF Preferred Stock, acting as a single class, will have the right, but not the obligation, to elect two individuals to serve in the new director positions. This right and the terms of such directors will end when we have paid full dividends for at least four consecutive dividend periods.

The voting limitation provision in our charter could limit your voting rights as a holder of our common stock.

Our charter provides that any person or group who acquires beneficial ownership of our common stock in excess of 10% of the outstanding shares may not vote the excess shares. Accordingly, if you acquire beneficial ownership of more than 10% of the outstanding shares of our common stock, your voting rights with respect to the common stock will not be commensurate with your economic interest in our company.

Anti-takeover provisions could negatively impact our shareholders.

Provisions in our charter and bylaws, the corporate law of the State of Maryland and federal regulations could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our shareholders, or otherwise adversely affect the market price of any class of our equity securities, including our common stock. These provisions include: a prohibition on voting shares of common stock beneficially owned in excess of 10% of total shares outstanding, supermajority voting requirements for certain business combinations with any person who beneficially owns more than 10% of our outstanding common stock; the election of directors to staggered terms of three years; advance notice requirements for nominations for election to our Board of Directors and for proposing matters that stockholders may act on at stockholder meetings, a requirement that only directors may fill a vacancy in our Board of Directors, supermajority voting requirements to remove any of our directors and the other provisions of our charter. Our charter also authorizes our Board of Directors to issue preferred stock, and preferred stock could be issued as a defensive measure in response to a takeover proposal. In addition, pursuant to federal banking regulations, as a general matter, no person or company, acting individually or in concert with others, may acquire more than 10% of our common stock without prior approval from the our federal banking regulator.

These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy contests and make it more difficult for holders of our common stock to elect directors other than the candidates nominated by our Board of Directors.

Our executive officers and directors and the directors of the Bank could have the ability to influence shareholder actions in a manner that may be adverse to your personal investment objectives.

As of December 31, 2011, our executive officers and the directors of the Bank as a group beneficially owned 575,407 shares of our voting common stock, representing approximately 4.94% of the total shares of voting common stock outstanding as of that date. Due to their collective ownership interest, these individuals may be able to exercise influence over the management and business affairs of our company and the Bank. For example, using their collective voting power, these individuals may be able to influence the outcome of director elections or block significant transactions, such as a merger or acquisition, or any other matter that might otherwise be favored by other shareholders.

Item 1B. Unresolved Staff Comments

None.

 

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Item 2. Properties

At December 31, 2011, the Bank had nine full service offices and four limited service offices. The Bank owns the office building in which our home office and executive offices are located. At December 31, 2011, the Bank owned all but six of our other branch offices. The net book value of the Bank’s investment in premises, equipment and leaseholds, excluding computer equipment, was approximately $10.0 million at December 31, 2011. See further discussion in Note 9—Premises and Equipment in the notes to the consolidated financial statements contained in Item 8 of this report.

The following table provides a list of Pacific Trust Bank’s main and branch offices and indicates whether the properties are owned or leased:

 

Location

   Owned or
Leased
   Lease Expiration
Date
   Net Book Value at
December 31, 2011
               (Dollars in Thousands)

MAIN AND EXECUTIVE OFFICES

        

610 Bay Boulevard

Chula Vista, CA 91910(1)

   Owned    N/A    $510

18500 Von Karman Avenue

Irvine, CA 92612(1)

   Leased    May, 2018    N/A

350 S. Figueroa Street

Los Angeles, CA 90071

   Leased    December, 2012    N/A

BRANCH OFFICES:

        

279 F Street

Chula Vista, CA 91912

   Owned    N/A    $389

850 Lagoon Drive

Chula Vista, CA 91910

   *    N/A    N/A

350 Fletcher Parkway

El Cajon, CA 91910

   Leased    December, 2014    N/A

5508 Balboa Avenue

San Diego, CA 92111

   Leased    October, 2021    N/A

27425 Ynez Road

Temecula, CA 92591

   Owned    N/A    $699

8200 Arlington Avenue

Riverside, CA 92503

   *    N/A    N/A

5030 Arlington Avenue

Riverside, CA 92503

   Owned    N/A    $217

16536 Bernardo Center Drive

San Diego, CA 92128(2)

   Leased    December, 2013    N/A

16840 Bernardo Center Drive

San Diego, CA 92128

   Leased    October, 2021    N/A

7877 Ivanhoe Street

La Jolla, CA 92037

   Owned    N/A    $2,220

7877 Ivanhoe Street (land lease)

La Jolla, CA 92037(3)

   Leased    October, 2017    N/A

1642 West San Marcos Boulevard

San Marcos, CA 92078

   Owned    N/A    $2,017

1880 Century Park East

Los Angeles, CA 90067

   Leased    July, 2021    N/A

2635 Wilshire Boulevard

Santa Monica, CA 90403 (expected to open in 2012)

   Leased    September, 2021    N/A

13031 Newport Avenue

Tustin, CA 92780(expected to open in 2012)

   Leased    February, 2022    N/A

 

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* These sites, which are on Goodrich Aerostructures facilities, are provided to the Company at no cost as an accommodation to Goodrich Aerostructures’ employees.
(1) On March 5, 2012, the Company relocated the corporate office from Chula Vista, CA to Irvine, CA.
(2) The Bernardo Center Drive branch moved locations with the intention to end the prior lease in 2012.
(3) The La Jolla branch leases the land on which it resides.

Item 3. Legal Proceedings

From time to time we are involved as plaintiff or defendant in various legal actions arising in the normal course of business. We do not anticipate incurring any material liability as a result of such currently pending litigation.

On December 14, 2011, CMG Financial Services, Inc. (“CMG”) initiated a patent lawsuit against the Bank in the United States District Court for the Central District of California (styled CMG Financial Services, Inc. v. Pacific Trust Bank, F.S.B., et al., Case No. 2:11-cv-10344-PSG-MRW) (the “Action”) alleging infringement of U.S. Patent No. 7,627,509 (the “509 Patent”) of limited number of financial products previously offered by the Company. The 509 Patent relates to the origination and servicing of loans with characteristics similar to the Bank’s Green Accounts. The Company and its counsel believe the asserted claim is without merit and the resolution of the matter is not expected to have a material impact on the Company’s business, financial condition or results of operations, though no assurance can be given in this regard.

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s voting common stock is traded on the Nasdaq Global Market under the symbol “BANC.” The approximate number of holders of record of the Company’s common stock as of December 31, 2011 was 267. Certain shares of the Company are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. At December 31, 2011 there were 10,581,704 shares of voting common stock (net of Treasury stock) and 1,054,991 shares of Class B non-voting common stock issued and outstanding. The following table presents quarterly market information for the Company’s voting common stock for the two years ended December 31, 2011 and December 31, 2010.

 

     Market Price Range         

2011

       High              Low          Dividends  

Quarter Ended

        

December 31, 2011

   $ 13.21       $ 10.09       $ 0.12   

September 30, 2011

   $ 15.52       $ 10.37       $ 0.115   

June 30, 2011

   $ 16.61       $ 13.93       $ 0.11   

March 31, 2011

   $ 16.59       $ 13.53       $ 0.105   
        

 

 

 
         $ 0.45   
        

 

 

 

 

     Market Price Range      Dividends  

2010

       High              Low         

Quarter Ended

        

December 31, 2010

   $ 13.27       $ 10.45       $ 0.10   

September 30, 2010

   $ 10.70       $ 7.21       $ 0.05   

June 30, 2010

   $ 10.30       $ 7.12       $ 0.05   

March 31, 2010

   $ 8.40       $ 5.35       $ 0.05   
        

 

 

 
         $ 0.25   
        

 

 

 

DIVIDEND POLICY

The timing and amount of cash dividends paid to the Company’s common shareholders depends on the Company’s earnings, capital requirements, financial condition and other relevant factors. The ability of the Company to pay cash dividends to common stockholders depends, in large part, upon its receipt of dividends from the Bank, because the Company has limited sources of income other than dividends from the Bank and earnings from the investment of stock issuance proceeds from the sale of shares of common stock retained by the Company. There were no dividends paid from the Bank to the Company during the fiscal year of 2011. For a description of the regulatory restrictions on the ability of the Bank to pay dividends to the Company, see “Item 1. Business—How We Are Regulated-Pacific Trust Bank.”

The terms of the SBLF Preferred Stock impose limits on the ability of the Company to pay dividends and repurchase shares of common stock. Under the terms of the SBLF Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the SBLF Preferred Stock, junior preferred shares, or other junior securities (including the common stock) during the current quarter and for the next three quarters following the failure to declare and pay dividends on the SBLF Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach.

Under the terms of the SBLF Preferred Stock, the Company may only declare and pay a dividend on the common stock or other stock junior to the SBLF Preferred Stock, or repurchase shares of any such class or series

 

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of stock, if, after payment of such dividend, or after giving effect to such repurchase, (i) the dollar amount of the Company’s Tier 1 Capital would be at least equal to the “Tier 1 Dividend Threshold” and (ii) full dividends on all outstanding shares of SBLF Preferred Stock for the most recently completed dividend period have been or are contemporaneously declared and paid. As of December 31, 2011, we satisfied this condition.

The “Tier 1 Dividend Threshold” means 90% of (A) $159,588,000 (the Company’s consolidated Tier 1 capital as of June 30, 2011) plus (B) $32,000,000 (the aggregate liquidation amount of the SBLF Preferred Stock issued) minus (C) the net amount of loans charged off by the Bank since August 30, 2011. The Tier 1 Dividend Threshold is subject to reduction, beginning on the first day of the eleventh dividend period following the date of issuance of the SBLF Preferred Stock, by $3,200,000 (ten percent of the aggregate liquidation amount of the Series A Preferred Stock initially issued, without regard to any subsequent partial redemptions) for each one percent increase in qualified small business lending from the baseline level under the terms of the SBLF Preferred Stock (i.e., $36,082,000) to the ninth dividend period.

ISSUER PURCHASES OF EQUITY SECURITIES

The following table sets forth information for the three months ended December 31, 2011 with respect to repurchases by the Company of its common stock:

 

Period

   Total # of shares
Purchased
     Average price paid
per share
     Total # of shares
purchased as part
of a publicly
announced program
     Maximum # of
shares that may
yet be purchased
 

10/1/11-10/31/11

     —           —           —           0   

11/1/11-11/30/11

     —           —           —           0   

12/1/11-12/31/11

     4,906       $ 10.43         —           1,000,000   

The Company currently has a stock buyback plan, however, purchases made by the Company during the year were tax liability sales related to employee stock benefit plans and are consistent with past practices.

 

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Item 6. Selected Financial Data

SELECTED FINANCIAL AND OTHER DATA

The following table sets forth certain consolidated financial and other data of the Company at the dates and for the periods indicated. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein at Item 7 and the consolidated financial statements and notes thereto included herein at Item 8.

 

    December 31,  
    2011     2010     2009     2008     2007  
    (In thousands, except per share data)  

Selected Financial Condition Data:

         

Total assets

  $ 999,041      $ 861,621      $ 893,921      $ 876,520      $ 774,720   

Cash and cash equivalents

    44,475        59,100        34,596        19,237        21,796   

Loans receivable, net

    775,609        678,175        748,303        793,045        710,095   

Real estate owned, net

    14,692        6,562        5,680        158        —     

Securities available-for-sale

    101,616        64,790        52,304        17,565        4,367   

Bank owned life insurance

    18,451        18,151        17,932        17,565        17,042   

Other investments (interest-bearing term deposit)

    —          —          —          893        992   

FHLB stock

    6,972        8,323        9,364        9,364        6,842   

Deposits

    786,334        646,308        658,432        598,177        574,151   

Total borrowings

    20,000        75,000        135,000        175,000        111,700   

Total equity

    184,495        136,009        97,485        98,723        84,075   

Nonperforming loans

    19,254        38,830        46,172        44,219        14,132   

Nonperforming assets

    33,946        45,392        51,852        44,377        14,132   

Selected Operations Data:

         

Total interest income

    35,177        40,944        46,666        45,896        45,711   

Total interest expense

    6,037        10,788        17,976        23,021        28,847   

Net interest income

    29,140        30,156        28,690        22,875        16,864   

Provision for loan losses

    5,388        8,957        17,296        13,547        1,588   

Net interest income after provision for loan losses

    23,752        21,199        11,394        9,328        15,276   

Customer service fees

    1,473        1,336        1,383        1,579        1,573   

Net gain on sales of securities available-for-sale

    2,888        3,274        —          —          —     

Income from bank owned life insurance

    300        219        369        540        711   

Other non-interest income

    252        50        61        83        107   

Total non-interest income

    4,913        4,879        1,813        2,202        2,391   

Total non-interest expense

    31,689        22,217        15,901        13,522        14,082   

Income/(loss) before income taxes

    (3,024     3,861        (2,694     (1,992     3,585   

Income tax expense/(benefit)

    (296     1,036        (1,695     (1,463     624   

Net income/(loss)

    (2,728     2,825        (999     (529     2,961   

Dividends paid on preferred stock and discount accretion

    534        960        1,003        109        —     

Net income (loss) available to common shareholders

    (3,262     1,865        (2,002     (638     2,961   

Basic earnings/(loss) per common share

    (0.31     0.37        (0.48     (0.15     0.71   

Diluted earnings/(loss) per common share

    (0.31     0.37        (0.48     (0.15     0.70   

Selected Financial Ratios and Other Data:

         

Performance Ratios:

         

Return on assets (ratio of net income/(loss) to average total assets)

    (0.31 )%      0.32     (0.10 )%      (0.06 )%      0.38

Return on equity (ratio of net income/(loss) to average equity)

    (1.70 )%      2.69     (0.66 )%      (0.62 )%      3.54

Dividend payout ratio (ratio of dividends declared per common share to basic earnings per common share)

    n/a     67.6     n/a     n/a     104.2

Interest Rate Spread Information:

         

Average during year

    3.44     3.59     3.26     2.64     1.89

End of year

    3.34     3.56     3.34     2.75     2.18

Net interest margin(1)

    3.53     3.67     3.38     2.92     2.27

Ratio of operating expense to average total assets

    3.54     2.51     1.65     1.64     1.81

Efficiency ratio(2)

    93.06     63.41     52.13     53.92     73.13

Ratio of average interest-earning assets to average interest-bearing liabilities

    113.51     106.15     105.51     109.36     109.84

 

* Not applicable due to the net loss reported for the years ended December 31, 2011, 2009 and 2008.

 

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     December 31,  
     2011     2010     2009     2008     2007  
     (In thousands)  

Quality Ratios:

          

Non-performing assets to total assets

     3.40     5.27     5.80     4.33     1.82

Allowance for loan losses to non-performing loans(3)

     66.38     37.70     28.33     48.33     44.16

Allowance for loan losses to gross loans(3)

     1.62     2.12     1.72     2.26     0.87

Capital Ratios:

          

Equity to total assets at end of year

     18.47     15.79     10.91     11.26     10.85

Average equity to average assets

     17.90     11.87     15.72     10.45     10.71

Other Data:

          

Number of full-service offices

     9        6        6        6        6   

 

(1) Net interest income divided by average interest-earning assets.
(2) Efficiency ratio represents noninterest expense as a percentage of net interest income plus noninterest income.
(3) The allowance for loan losses at December 31, 2011, 2010, 2009, 2008 and 2007 was $12.8 million, $14.6 million, $13.1 million, $18.3 million and $6.2 million, respectively.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Management Overview

This overview of management’s discussion and analysis highlights selected information in the financial results of the Company and may not contain all of the information that is important to you. For a more complete understanding of trends, commitments, uncertainties, liquidity, capital resources and critical accounting policies and estimates, you should carefully read this entire document. Each of these items could have an impact on the Company’s financial condition and results of operations.

First PacTrust Bancorp, Inc. is a savings and loan holding company that owns one thrift institution, Pacific Trust Bank. As a unitary thrift holding company, First PacTrust Bancorp, Inc. activities are limited to banking, securities, insurance and financial services-related activities. Pacific Trust Bank is a federally chartered stock savings bank, in continuous operation since 1941 as a successful financial institution. The Company is headquartered in Irvine, California, a suburb of San Diego, California, and has nine full service and four limited service banking offices primarily serving residents of San Diego, Los Angeles, Orange and Riverside Counties in California. The Company’s geographic market for loans and deposits is principally San Diego, Los Angeles, Orange and Riverside counties.

On November 1, 2010, the Company completed a private placement of common stock to select institutional and other accredited investors providing the Company with aggregate gross proceeds of $60.0 million. In connection with the private placement the Company issued warrants that are exercisable for a total of 1,635,000 shares of non-voting Common Stock at an exercise price of $11.00 per share. The private placement enabled the Company to repurchase the 19,300 shares of Fixed Rate Cumulative Perpetual Preferred Stock Series A that was issued to the U.S. Department of Treasury on November 21, 2008 pursuant to the “TARP”, Troubled Asset Relief Program’s Capital Purchase Program. The Company redeemed the $19.3 million of Series A Preferred Stock that had been issued to the U.S. Treasury on December 15, 2010. In January 2011, the Company repurchased 280,795 warrants with a strike price of $10.31 which were issued to the United States Department of the Treasury in connection with TARP. These warrants were purchased for $1.0 million, or $3.58 per warrant. The Company raised additional capital in several transactions during 2011. In June 2011, the Company completed an underwritten public offering of its common stock, as well as a concurrent offering of common stock to several existing investors of the Company, that resulted in aggregate gross proceeds of $28.2 million (including shares sold in connection with the underwriters’ partial exercise of their overallotment option in July 2011). In August 2011, the Company received a preferred stock investment of $32.0 million from the U.S. Department of the Treasury pursuant to the Small Business Lending Fund Program.

The Company’s principal business consists of attracting retail deposits from the general public and investing these funds and other borrowings in loans primarily secured by first mortgages on owner-occupied, one-to four-family residences and commercial real estate loans in San Diego, Los Angeles, Orange and Riverside counties, California. During 2005, the Company introduced a new lending product called the “Green Account”, a fully transactional flexible mortgage account. The Company originated $61.7 million in Green Account loans in 2011. At December 31, 2011, one- to four-family residential mortgage first trust deed loans totaled $546.8 million, or 69.5% of our gross loan portfolio including the portion of the Company’s Green Account home equity loan portfolio that are first trust deeds. If the home equity Green Account loans in first position are excluded, total one- to four-family residential mortgage loans totaled $323.5 million, or 41.09% of our gross loan portfolio.

The Company continues to develop strong deposit relationships with customers by providing quality service while offering a variety of competitive deposit products. During 2007, the Company introduced commercial deposit accounts and had a total of $183.5 million of commercial deposit accounts at December 31, 2011. Net core deposits including checking, savings and money market deposit accounts “MMDA” accounts increased by $42.1 million, while total net deposits increased $140.0 million during 2011 due primarily to increased MMDA accounts and certificate of deposit accounts as the Bank further expanded its branch network during the year.

 

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The Company’s results of operations are dependent primarily on net interest income, which is the difference between interest income on earning assets such as loans and securities, and interest expense paid on liabilities such as deposits and borrowings. The Company’s net interest income, which is primarily driven by interest income on residential first mortgage loans, decreased by $1.0 million for the year ended December 31, 2011. The decline in interest rate levels experienced throughout the year negatively impacted loan interest income, but, positively contributed to a significant reduction in the Company’s cost of funds. The Company’s net interest margin declined by 14 basis points from 3.67% for the year ended December 31, 2010 to 3.53% for the year ended December 31, 2011 as a result of lower than planned loan origination volumes during the first half of 2011, which caused the reduction in the Company average loan balance for the year, and the sale of previously impaired higher yielding investment securities. The delay in loan origination volumes was due to the re-launching of the Company’s single family lending business and building of the commercial real estate lending platform.

The past year represented to be a challenging operating environment, as witnessed by the continued instability and high levels of foreclosures in the housing market coupled with continued high but declining levels of unemployment. Reduced availability of commercial and consumer credit have negatively affected the performance of consumer and commercial credit and resulted in write-downs of assets by financial institutions. As a result, the Company continues to have elevated levels of provisions for loan losses and non-performing loans, however improvement was seen in 2011. The Company experienced a decrease of $11.4 million in non-performing assets (including other real estate owned) over the prior year while the provision for loan losses decreased $3.6 million over the prior year. Other real estate owned increased during the year, as the Company has continued to work out its problem loans. The Company expects that the economic pressures on consumers and businesses and a lack of confidence in the financial markets may continue to adversely affect the Company’s results of operations in the coming year. Future earnings of the Company are inherently tied to changes in interest rate levels, the relationship between short and long term interest rates, credit quality, and economic trends. If short term interest rates continue to decrease, the Company’s interest expense on deposits will likely decrease at a faster pace than the interest income received on earning assets due to the relatively shorter term repricing characteristics of the Company’s deposits than the maturity or repricing characteristics of its loan portfolio. Conversely, if short term interest rates rise in the future interest expense paid on the Company’s deposits would increase at a faster pace than the interest income received on interest-earning assets which could negatively impact the Company’s results of operations over the short term. The Company currently intends to continue to focus on the origination of adjustable rate loan products while securing longer term deposits and borrowings.

In addition to striving for retail deposit growth, the primary on-going business focus will be continued improvement in customer service and origination of commercial real estate loan production. Future growth will be managed to ensure sound capital ratios are maintained while talking advantage of income enhancement opportunities. Given the current economic environment and resulting high non-performing loan balances, the Company will continue to focus on the timely resolution of non-performing assets. This will be coupled with efforts to further improve our efficiency ratio through controlling operating expenses, as well as exploring potential new sources of noninterest income.

The following is a discussion and analysis of the Company’s financial position and results of operations and should be read in conjunction with the information set forth in Item 7A, Quantitative and Qualitative Disclosures about Market Risk, and the consolidated financial statements and notes thereto appearing under Item 8 of this report.

Comparison of Financial Condition at December 31, 2011 and December 31, 2010

The Company’s total assets increased by $137.4 million, or 15.9%, to $999.0 million at December 31, 2011 from $861.6 million at December 31, 2010 due primarily to an increase in the net loans receivable balance of $97.4 million, an increase in the balance of securities available-for-sale of $36.8 million, an increase of $8.1 million in other real estate owned assets, an increase of $7.5 million in other assets, and an increase of $4.2 million in premises and equipment, net. The increase in total assets was partially reduced by a decrease in total cash and cash equivalents of $14.6 million.

 

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Loans receivable, net of valuation allowances, increased by $97.4 million, or 14.4%, to $775.6 million at December 31, 2011 from $678.2 million at December 31, 2010. This increase was the result of loan originations and loan purchases during the year. For the year ended December 31, 2011, loan production including advances drawn during the year was $199.1 million compared to $97.9 million for the year ended December 31, 2010. The loan production was primarily attributable to growth in the Company’s commercial real estate loans which totaled $76.3 million and the Company’s transactional flexible Green Account loan product which totaled $61.7 million. At December 31, 2011, the Company had a total of $382.0 million in interest-only mortgage loans and $23.4 million in loans with potential for negative amortization. At December 31, 2010, the Company had a total of $423.4 million in interest-only mortgage loans, and $32.1 million in loans with potential for negative amortization. Negatively amortizing and interest-only loans could pose a higher credit risk because of the lack of principal amortization and potential for negative amortization. However, management believes these risks are mitigated through the Company’s loan terms and underwriting standards, including its policies on loan-to-value ratios. The Company has not originated negatively amortizing loans since March, 2006.

Securities classified as available-for-sale of $101.6 million at December 31, 2011 increased $36.8 million from December 31, 2010. Municipal and private label mortgage-backed securities totaling $129.0 million were purchased during the twelve months ended December 31, 2011. In addition, the Company sold securities for $62.8 million and recognized a net gain on sale of $2.9 million during the period. As interest rates fell to historic low levels which resulted in increases in market prices for its securities, the Company took the opportunity to divest several of its private label residential mortgage-backed securities that had been purchased in early 2011 and earlier periods.

Cash and cash equivalents decreased $14.6 million to $44.5 million, or 24.7% at December 31, 2011 from $59.1 million at December 31, 2010. Cash and cash equivalents were reduced by an increase in net loan receivable balances of $97.4 million, maturing FHLB advances totaling $55.0 million and investment purchases (net of sales during the period) totaling $66.2 million. Cash and cash equivalents were increased by an increase in time and core deposits of $140.0 million, the completion of the common stock offering with net proceeds totaling $27.0 million and $31.9 million of net proceeds received from the issuance of preferred stock to the U.S. Treasury related to participation in their Small Business Loan Fund Program.

Premises and equipment of $10.6 million at December 31, 2011 increased $4.2 million from December 31, 2010 as a direct result of newly acquired buildings in La Jolla and San Marcos, California to serve as additional branches for the Company in 2011.

Total deposits increased by $140.0 million, or 21.7%, to $786.3 million at December 31, 2011 from $646.3 million at December 31, 2010. Money market accounts increased $99.0 million, certificate of deposits increased $97.9 million, and interest bearing demand accounts increased $23.7 million. Growth was achieved primarily from the opening of three new branches during the period as well as the formation of new customer relationships and the attraction of additional funds from existing customers. The Bank completed the opening of a new branch in La Jolla, California in early March, a new branch in San Marcos, California during June, 2011, and a new branch in Century City (Los Angeles), California in November, 2011. The Company expects to open two additional branch locations in Santa Monica, California and Tustin, California in the first quarter of 2012.

During 2011, the Company had $55.0 million of long term FHLB advances mature resulting in a 73.3% decrease in total FHLB advances to $20.0 million at December 31, 2011 from $75.0 million at December 31, 2010. The remaining $20.0 million of advances have an average current yield of 1.79% and mature in 2012. The maturing advances have been replaced by deposits. The Company anticipates increasing the use of FHLB advances in the near term as part of its funding plan for asset growth.

Total shareholders’ equity increased $48.5 million, or 35.6% to $184.5 million at December 31, 2011 from $136.0 million at December 31, 2010. The increase was primarily due to the net proceeds of $31.9 million from the issuance of preferred stock related to the Small Business Lending Fund in August, 2011 and net proceeds of $27.0 million from the common stock offering in June, 2011. Additionally, total shareholders’ equity was decreased due to the payment of dividends to holders of common stock of $4.4 million, a $3.5 million decline in the fair value of securities available-for-sale, net of tax (primarily due to security sales during the period), a net loss of $2.7 million, and the payment of preferred stock dividends of $534 thousand.

 

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Average Balances, Net Interest Income, Yields Earned and Rates Paid

The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Also presented is the weighted average yield on interest-earning assets, rates paid on interest-bearing liabilities, net interest margin and the resultant net interest spread at December 31, 2011. No tax equivalent adjustments were made. All average balances are monthly average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.

 

     At December 31,
2011
    2011     2010     2009  
     Average
Yield/
Cost
    Average
Balance
    Interest      Average
Yield/
Cost
    Average
Balance
    Interest      Average
Yield/
Cost
    Average
Balance
    Interest      Average
Yield/
Cost
 
     (Dollars in thousands)  

INTEREST-EARNING ASSETS

                       

Loans receivable(1)

     4.37   $ 681,956      $ 30,997         4.55   $ 709,306      $ 35,439         5.00   $ 780,127      $ 42,312         5.42

Securities(2)

     3.06     82,307        3,963         4.81     63,734        5,289         8.30     39,941        4,266         10.68

Other interest-earning assets(3)

     0.42     60,130        217         0.36     49,485        216         0.44     28,141        88         0.31
    

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     4.03     824,393        35,177         4.27     822,525        40,944         4.98     848,209        46,666         5.50
    

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

BOLI and non-interest earning assets(4)

       69,754             63,079             115,708        
    

 

 

        

 

 

        

 

 

      

Total assets

     $ 894,147           $ 885,604           $ 963,917        
    

 

 

        

 

 

        

 

 

      

INTEREST-BEARING LIABILITIES