10-K 1 a13-1177_110k.htm 10-K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

(Mark One)

 

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

 

For the fiscal year ended December 31, 2012

 

or

 

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

 

For the transition period from                   to                  

 

000-50974

(Commission File Number)

 

Bridge Capital Holdings

(Exact name of registrant as specified in its charter)

 

California

 

80-0123855

(State or other jurisdiction of

 

(I.R.S. Employer Identification Number)

incorporation or organization)

 

 

 

55 Almaden Boulevard, San Jose, CA  95113

(Address of principal executive offices, Zip Code)

 

Registrant’s telephone number, including area code:  (408) 423-8500

 

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

 

 

 

Name of each exchange

Title of each class

 

on which registered

Common Stock, no par value

 

Nasdaq Capital Market

 

Securities registered pursuant to Section 12 (g) of the Act: None

 

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

 

Bridge Capital Holdings (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 and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate be check mark whether the registrant has submitted electronically and posted on its corporate website, 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 o

 

Indicate by checkmark 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.  o

 

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

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The aggregate market value of the voting stock held by non-affiliates of Bridge Capital Holdings was $150,425,622 as of June 30, 2012.

 

As of February 27, 2013, Bridge Capital Holdings had 15,741,673 shares of common stock outstanding.

 

Documents incorporated by reference: The Company’s Proxy Statement for its 2013 Annual Meeting of Shareholders is incorporated herein by reference in Part III, Items 10 through 14.

 

 

 



 

Forward-looking Statements

 

IN ADDITION TO THE HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS CERTAIN FORWARD-LOOKING INFORMATION WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, AND WHICH ARE SUBJECT TO THE “SAFE HARBOR” CREATED BY THOSE SECTIONS. THE READER OF THIS ANNUAL REPORT SHOULD UNDERSTAND THAT ALL SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO VARIOUS UNCERTAINTIES AND RISKS THAT COULD AFFECT THEIR OUTCOME.  THE COMPANY’S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE SUGGESTED BY SUCH FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHERS, (1) COMPETITIVE PRESSURE IN THE BANKING INDUSTRY INCREASES SIGNIFICANTLY; (2) CHANGES IN THE INTEREST RATE ENVIRONMENT REDUCES MARGINS; (3) GENERAL ECONOMIC CONDITIONS, EITHER NATIONALLY OR REGIONALLY, CONTINUE TO DETERIORATE OR FAIL TO IMPROVE,  RESULTING IN, AMONG OTHER THINGS, FURTHER DETERIORATION IN CREDIT QUALITY; (4) CHANGES IN THE REGULATORY ENVIRONMENT; (5) CHANGES IN BUSINESS CONDITIONS AND INFLATION; (6) COSTS AND EXPENSES OF COMPLYING WITH THE INTERNAL CONTROL PROVISIONS OF THE SARBANES-OXLEY ACT AND OUR DEGREE OF SUCCESS IN ACHIEVING COMPLIANCE; (7) CHANGES IN SECURITIES MARKETS; (8) FUTURE CREDIT LOSS EXPERIENCE; (9) CIVIL DISTURBANCES OR TERRORIST THREATS OR ACTS, OR APPREHENSION ABOUT POSSIBLE FUTURE OCCURANCES OF ACTS OF THIS TYPE; (10) THE INVOLVEMENT OF THE UNITED STATES IN WAR OR OTHER HOSTILITIES; AND (11) THE MATTERS DISCUSSED IN THIS REPORT UNDER “ITEM 1A — RISK FACTORS” AND “ITEM 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — CRITICAL ACCOUNTING POLICIES. THEREFORE, THE INFORMATION IN THIS ANNUAL REPORT SHOULD BE CAREFULLY CONSIDERED AGAINST THESE UNCERTAINTIES AND RISKS WHEN EVALUATING THE BUSINESS PROSPECTS OF THE COMPANY.

 

FORWARD-LOOKING STATEMENTS ARE GENERALLY IDENTIFIABLE BY THE USE OF TERMS SUCH AS “BELIEVE,” “EXPECT,” “INTEND,” “ANTICIPATE,” “ESTIMATE,” “PROJECT,” “ASSUME,” “PLAN,” “PREDICT,” “FORECAST,” “IN MANAGEMENT’S OPINION,” “MANAGEMENT CONSIDERS” OR SIMILAR EXPRESSIONS.  WHEREVER SUCH PHRASES ARE USED, SUCH STATEMENTS ARE AS OF AND BASED UPON THE KNOWLEDGE OF MANAGEMENT, AT THE TIME MADE AND ARE SUBJECT TO CHANGE BY THE PASSAGE OF TIME AND/OR SUBSEQUENT EVENTS, AND ACCORDINGLY SUCH STATEMENTS ARE SUBJECT TO THE SAME RISKS AND UNCERTAINTIES NOTED ABOVE WITH RESPECT TO FORWARD-LOOKING STATEMENTS.  THE COMPANY DOES NOT UNDERTAKE, AND SPECIFICALLY DISCLAIMS ANY OBLIGATION, TO UPDATE ANY FORWARD-LOOKING STATEMENTS TO REFLECT OCCURRENCES OR UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH STATEMENTS.

 

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PART 1

 

Item 1.  Business

 

General

 

Bridge Capital Holdings (the “Company”) is a bank holding company. The Company was incorporated in the State of California on April 6, 2004 for the purpose of becoming the holding company for its subsidiary, Bridge Bank, National Association (the “Bank”). As a bank holding company, the Company is supervised by the Board of Governors of the Federal Reserve System (the “FRB”).

 

The Company acquired 100% of the voting shares of the Bank effective October 1, 2004 following approval of the Bank’s shareholders on May 20, 2004. Prior to becoming a subsidiary of the Company, the common stock of the Bank had been registered with the Comptroller of the Currency (the “Comptroller”) under the Securities and Exchange Act of 1934, as amended. After becoming the Bank’s holding company, the Company’s common stock was registered with the Securities and Exchange Commission. Filings by Bridge Capital Holdings are made with the SEC rather than the Comptroller and are available on the SEC’s website, www.sec.gov as well as on the Company’s website, www.bridgecapitalholdings.com.

 

The Bank is a national banking association chartered by the Comptroller. The Bank was organized on December 6, 2000 and commenced operations on May 14, 2001. Its headquarters office is located at 55 Almaden Boulevard, San Jose, California, 95113. It maintains two branch offices in the Silicon Valley region, and five loan production offices located throughout the U.S.

 

The Bank’s lending solutions include working capital lines of credit, structured finance (asset-based lending and factoring), 7(a) and 504 Small Business Administration (SBA) loans, commercial real estate loans, sustainable energy project financing, growth capital loans, equipment financing, letters of credit, and corporate credit cards. The bank’s depository and corporate banking services include cash and treasury management solutions, interest-bearing term deposit accounts, checking accounts, ACH payment and wire solutions, fraud protection, remote deposit capture through its Smart Deposit Express, courier services, and online banking. Additionally, the Bank’s International Banking Division serves clients operating in the global marketplace through services including foreign exchange (FX payments and hedging), letters of credit, and import/export financing.

 

The Bank attracts the majority of its loan and deposit business from the numerous small and middle market companies located in the Silicon Valley, though with an increasingly larger portion of new business from its national loan production offices. The Bank reserves the right to change its business plan at any time, and no assurance can be given that, if the Bank’s proposed business plan is followed, it will prove successful.

 

The Bank does not offer trust services, but it will attempt to make such services available to the Bank’s customers through correspondent institutions. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to applicable limits, and the Bank is a member of the Federal Reserve System.

 

In 2002, the Bank opened a full-service branch office in Palo Alto, California. Also in 2002, it established a U.S. Small Business Administration Lending Group and launched Bridge Capital Finance Group, a factoring and asset-based lending group. In 2003, the Bank opened an office in downtown San Jose. In 2005, the Bank launched its Technology Banking Group and the International Banking Group. In 2011, it launched its Energy and Infrastructure Group. In addition, the Bank operates loan production offices in San Francisco and Pleasanton, California, Dallas, Texas, Reston, Virginia and Boston, Massachusetts.

 

Deposits

 

The Bank offers a wide range of deposit accounts designed to attract small and medium size commercial businesses as well as business professionals and retail customers, including a complete line of checking and savings products, such as passbook savings, “Money Market Deposit” accounts which require minimum balances and frequency of withdrawal limitations, NOW accounts, and bundled accounts.

 

Additional deposit services include a full complement of convenience oriented services, including remote deposit capture, direct payroll and social security deposit, post-paid bank-by-mail, and Internet banking, including on-line access to account information.  However, at this time, the Bank does not open accounts through the Internet.  Any plans to offer online account opening must be approved in advance by the Comptroller.  No assurance can be given that, if applied for, such approval will be obtained.

 

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As the Bank has no automated teller machines, the Bank may refund all or a portion of the transaction charges incurred by its customers for their use of another bank’s ATM.  The majority of the Bank’s deposits are obtained from businesses located in the Bank’s primary service area.

 

Lending Activities

 

The Bank engages in a full range of lending products designed to meet the specialized needs of its customers, including commercial lines of credit and term loans, constructions loans, and equipment loans. Additionally, the Bank extends accounts receivable, factoring and inventory financing to qualified customers.  Loans are also offered through the Small Business Administration guarantee 7(a) and 504 loan programs (described below under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—FINANCIAL CONDITION AND EARNING ASSETS—Loan Portfolio”).

 

The Bank finances real estate construction projects, primarily for the construction of owner occupied and 1 to 4 unit residential developments and commercial buildings.

 

The Bank directs its commercial lending principally toward businesses whose demands for credit fall within the Bank’s lending limit.  In the event there are customers whose commercial loan demands exceed the Bank’s lending limits, the Bank seeks to arrange for such loans on a participation basis with other financial institutions.

 

The Bank also extends lines of credit to individual borrowers, and provides homeowner equity loans, home improvement loans, auto financing, credit and debit cards and overdraft/cash reserve accounts.

 

Business Hours

 

In order to attract loan and deposit business, the Bank maintains lobby hours currently between 9:00 a.m. and 5:00 p.m. Monday through Friday.

 

For additional information concerning the Bank, see Selected Financial Data under Item 6 on page 22.

 

Competition

 

The banking business in Santa Clara County, as it is elsewhere in California, is highly competitive, and each of the major branch banking institutions operating in California has one or more offices in the Bank’s service area.  The Bank competes in the marketplace for deposits and loans, principally against these banks, independent community banks, savings and loan associations, thrift and loan companies, credit unions, mortgage banking companies, and non-bank institutions such as mutual fund companies and investment brokerage firms that claim a portion of the market.

 

Larger banks may have a competitive advantage because of higher lending limits and major advertising and marketing campaigns.  They also perform services, such as trust services, discount brokerage and insurance services, which the Bank is not authorized or prepared to offer currently. The Bank has made arrangements with its correspondent banks and with others to provide such services for its customers.  For borrowers requiring loans in excess of the Bank’s legal lending limit, the Bank has offered, and intends to offer in the future, such loans on a participating basis with its correspondent banks and with other independent banks, retaining the portion of such loans which is within its lending limit.  As of December 31, 2012, the Bank’s unsecured legal lending limit to a single borrower and such borrower’s related parties was $22.6 million based on regulatory capital of $150.7 million.

 

The Bank’s business is concentrated in its service area, which primarily encompasses Santa Clara County, and also includes, to a lesser extent, the contiguous areas of Alameda, San Mateo and Santa Cruz counties.  In certain lines of business the Bank has extended beyond its primary service area.

 

In order to compete with major financial institutions in its primary service area, the Bank uses to the fullest extent possible the flexibility that is accorded by its independent status.  This includes an emphasis on specialized services, local promotional activity, and personal contacts by the Bank’s officers, directors and employees.  The Bank also seeks to provide special services and programs for individuals in its primary service area who are employed in the agricultural, professional and business fields, such as loans for equipment, furniture, and tools of the trade or expansion of practices or businesses.

 

Banking is a business that depends on interest rate differentials.  In general, the difference between the interest rate

 

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paid by the Bank to obtain its deposits and its other borrowings and the interest rate received by the Bank on loans extended to its customers and on securities held in the Bank’s portfolio comprises the major portion of the Bank’s earnings.

 

Commercial banks compete with savings and loan associations, credit unions, other financial institutions and other entities for funds.  For instance, yields on corporate and government debt securities and other commercial paper affect the ability of commercial banks to attract and hold deposits.  Commercial banks also compete for loans with savings and loan associations, credit unions, consumer finance companies, mortgage companies and other lending institutions.

 

The interest rate differentials of the Bank, and therefore its earnings, are affected not only by general economic conditions, both domestic and foreign, but also by the monetary and fiscal policies of the United States as set by statutes and as implemented by federal agencies, particularly the Federal Reserve Board.  This agency can and does implement national monetary policy, such as seeking to curb inflation and combat recession, by its open market operations in United States government securities, adjustments in the amount of interest free reserves that banks and other financial institutions are required to maintain, and adjustments to the discount rates applicable to borrowing by banks from the Federal Reserve Board (FRB).  These activities influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits.

 

Supervision and Regulation

 

General

 

The Company and the Bank are subject to extensive regulation under both federal and state law.  This regulation is intended primarily for the protection of depositors, the deposit insurance fund, and the banking system as a whole, and not the protection of shareholders of the Company.  Set forth below is a summary description of some of the significant laws and regulations applicable to the Company and the Bank.  The description is qualified in its entirety by reference to the applicable laws and regulations.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act

 

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted. The Dodd-Frank Act is intended to effect a fundamental restructuring of federal banking regulation. The Dodd-Frank Act is expected to have a significant impact on the Company’s business operations as its provisions take effect. The numerous rules and regulations that have been adopted and are yet to be adopted under Dodd-Frank are likely to significantly impact the Company’s operations and compliance costs, such as changes in FDIC assessments, the permitted payment of interest on demand deposits and projected enhanced consumer compliance requirements. Among the provisions of Dodd-Frank that could affect us are the following:

 

·      The creation of a Financial Services Oversight Counsel to identify emerging systemic risks and improve interagency cooperation;

 

·      The establishment of strengthened capital and liquidity requirements for banks and bank holding companies, including minimum leverage and risk-based capital requirements no less than the strictest requirements in effect for depository institutions as of the date of enactment.  Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets;

 

·      The requirement that bank holding companies serve as a source of financial strength for their depository institution subsidiaries;

 

·      Enhanced regulation of financial markets, including the derivative and securitization markets, and the elimination of certain proprietary trading activities by banks (the “Volcker Rule”);

 

·      A permanent increase of the previously implemented temporary increase of FDIC deposit insurance to $250,000;

 

·      Authorization for financial institutions to pay interest on business checking accounts;

 

·      Changes in the calculation of FDIC deposit insurance assessments, such that the assessment base will no longer be the institution’s deposit base, but instead will be its average consolidated total assets less its average tangible equity;

 

·      The elimination of remaining barriers to de novo interstate branching by banks;

 

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·      Expanded restrictions on transactions with affiliates and insiders under Section 23A and 23B of the Federal Reserve Act and lending limits for derivative transactions, repurchase agreements, and securities lending and borrowing transactions;

 

·      Provisions that affect corporate governance and executive compensation at most United States publicly traded companies, including (i) stockholder advisory votes on executive compensation, (ii) executive compensation “clawback” requirements for companies listed on national securities exchanges in the event of materially inaccurate statements of earnings, revenues, gains or other criteria, (iii) enhanced independence requirements for compensation committee members, and (iv) giving the SEC authority to adopt proxy access rules which would permit stockholders of publicly traded companies to nominate candidates for election as director and have those nominees included in a company’s proxy statement; and

 

·      The creation of a Bureau of Consumer Financial Protection, which is authorized to promulgate and enforce consumer protection regulations relating to bank and non-bank financial products and which and which may examine and enforce its regulations on banks with more than $10 billion in assets.

 

Emergency Economic Stabilization Act and American Recovery and Reinvestment Act

 

On October 3, 2008, Congress adopted the Emergency Economic Stabilization Act (“EESA”), including a Troubled Asset Relief Program (“TARP”).  TARP gave the United States Treasury Department (“Treasury”) authority to deploy up to $700 billion into the financial system for the purpose of improving liquidity in capital markets.  On October 14, 2008, Treasury announced plans to direct $250 billion of this authority into preferred stock investments in banks and bank holding companies through a Capital Purchase Program (“CPP”).

 

In December of 2008, the Company elected to participate in the CPP by issuing to Treasury $23,864,000 in preferred stock and a warrant to purchase 396,412 shares of common stock at an exercise price of $9.03 per share. Treasury’s preferred stock earned cumulative dividends at the rate of 5% for the first five years and 9% thereafter.  On March 16, 2011, the Company completed its redemption of the preferred stock in its entirety. On April 20, 2011, the Company announced that it had repurchased the warrant issued to Treasury.

 

Bank Holding Company Act

 

The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  As a bank holding company, the Company is subject to examination and supervision by the FRB and is subject to limitations on the kinds of businesses in which it can engage directly or through subsidiaries.  While the Company may manage or control banks, it is generally prohibited from acquiring direct or indirect ownership or control of more than five percent of any class of voting shares of an entity engaged in non-banking activities, unless the FRB finds such activities to be “so closely related to banking” as to be deemed “a proper incident thereto” within the meaning of the BHCA.  As a bank holding company, the Company may not acquire more than five percent of the voting shares of any domestic bank without the prior approval of (or, for “well managed” companies, prior written notice to) the FRB.

 

The BHCA includes minimum capital requirements for bank holding companies.  See the section titled “Regulation and Supervision — Regulatory Capital Requirements”.  Under certain conditions, the FRB may conclude that certain actions of a bank holding company, such as the payment of a cash dividend, would constitute an unsafe and unsound banking practice.

 

Change in Bank Control

 

The BHCA and the Change in Bank Control Act of 1978, as amended, together with regulations of the FRB and the Comptroller, require that, depending on the particular circumstances, either FRB approval must be obtained or notice must be furnished to the Comptroller and not disapproved prior to any person or company acquiring “control” of a company that controls a bank, such as the Company, or a national bank, such as the Bank, subject to exemptions for some transactions.  Control is conclusively presumed to exist if an individual or company (i) acquires 25% or more of any class of voting securities of the bank or (ii) has the direct or indirect power to direct or cause the direction of the management and policies of the Bank, whether through ownership of voting securities, by contract or otherwise; provided that no individual will be deemed to control the bank solely on account of being director, officer or employee of the Bank.  Control is presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the company has registered securities under Section 12 of the Exchange Act or no other person will own a greater percentage of that class of voting securities immediately after the transaction.

 

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Securities Exchange Act of 1934

 

The Company’s common stock is registered under the Securities Exchange Act of 1934, as amended (“Exchange Act”). This registration requires ongoing compliance with the Exchange Act and its periodic filing requirements, as well as a wide range of federal and state securities laws. Under the Exchange Act and the SEC’s rules, the Company must electronically file periodic and current reports as well as proxy statements with the SEC.  The Company electronically files the following reports with the SEC: Form 10-K (Annual Report), Form 10-Q (Quarterly Report), Form 8-K (Current Report), and Schedule 14A (Information Required in Proxy Statement).  The Company may prepare additional filings as required.  The SEC maintains an Internet site, http://www.sec.gov, at which all forms filed electronically may be accessed.  Our SEC filings are also available on our website at http://www.bridgebank.com.

 

Sarbanes-Oxley Act

 

The Sarbanes-Oxley Act of 2002 implemented legislative reforms intended to address corporate and accounting fraud.  In addition to the establishment of an accounting oversight board to enforce auditing, quality control and independence standards, the law restricts provision of both auditing and consulting services by accounting firms.  To ensure auditor independence, any non-audit services being provided to an audit client require pre-approval by the company’s audit committee members.  In addition, the audit partners assigned to the company must be rotated every five years.  The act requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate the certification requirement.  Under the act legal counsel are required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself.

 

The act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company’s financial statements for the purpose of rendering the financial statement’s materially misleading. The act requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by both management and the external auditors in the annual report to stockholders.  In addition, the act requires that each financial report required to be prepared in accordance with (or reconciled to) accounting principles generally accepted in the United States and filed with the SEC reflect all material correcting adjustments that are identified by a “registered public accounting firm” in accordance with accounting principles generally accepted in the United States and the rules and regulations of the SEC.

 

The Company’s chief executive officer and chief financial officer are each required to certify that the Company’s quarterly and annual reports do not contain any untrue statement of a material fact.  The rules have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the Company’s internal controls; they have made certain disclosures to the Company’s auditors and the audit committee of the Board of Directors about the Company’s internal controls; and they have included information in the Company’s quarterly and annual reports about their evaluation and whether there have been significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation.

 

Regulation of the Bank

 

The Bank is regulated and supervised by the Comptroller and is subject to periodic examination by the Comptroller.  Deposits of the Bank’s customers are insured by the FDIC up to the maximum limit of $250,000.  As an FDIC- insured bank, the Bank is subject to certain regulations of the FDIC.  As a national bank, the Bank is a member of the Federal Reserve System and is also subject to the regulations of the FRB.

 

The regulations of the Comptroller, the FDIC and the FRB govern most aspects of the Bank’s business and operations, including but not limited to limiting the nature and amount of investments and loans which may be made, regulating the issuance of securities, restricting the payment of dividends and regulating bank expansion and bank activities. The Bank also is subject to the requirements and restrictions of various consumer laws and regulations.

 

Statutes, regulations and policies affecting the banking industry are frequently under review by Congress and by the federal bank regulatory agencies that are charged with supervisory and examination authority over banking institutions.  Changes in the banking and financial services industry are likely to occur in the future.  Some of the changes may create opportunities for the Bank to compete in financial markets with less regulation.  However, these changes also may create new competitors in geographic and product markets which have historically been limited by law to insured depository institutions such as the Bank.  Changes in the statutes, regulations, or policies that affect the

 

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Bank cannot necessarily be predicted and may have a material effect on the Bank’s business and earnings.  In addition, the regulatory agencies which have jurisdiction over the Bank have broad discretion in exercising their supervisory powers.

 

The Comptroller can pursue an enforcement action against the Bank for unsafe and unsound practices in conducting its business, or for violations of any law, rule or regulation or provision, any consent order with any agency, any condition imposed in writing by the agency, or any written agreement with the agency.  During periods of economic stress, regulatory oversight can be expected to increase and regulatory agencies become more aggressive in responding to concerns and trends identified in examinations.  One result of this heightened activity is an increase in the issuance of enforcement actions.  Enforcement actions may include the imposition of a conservator or receiver, cease-and-desist orders and written agreements, the termination of insurance of deposits, the imposition of civil money penalties and removal and prohibition orders against institution-affiliated parties.  See “Supervision and Regulation — Potential Enforcement Actions and Supervisory Agreements.”

 

In addition to the regulation and supervision outlined above, banks must be prepared for judicial scrutiny of their lending and collection practices.  For example, some banks have been found liable for exercising remedies which their loan documents authorized upon the borrower’s default.  This has occurred in cases where the exercise of those remedies was determined to be inconsistent with the previous course of dealing between the bank and the borrower.  As a result, banks must exercise caution, incur expense and face exposure to liability when dealing with delinquent loans.

 

Capital Adequacy Requirements

 

Federal regulations establish guidelines for calculating “risk-adjusted” capital ratios.  These guidelines, which apply to banks and bank holding companies, establish a systematic approach of assigning risk weights to bank assets and commitments, making capital requirements more sensitive to differences in risk profiles among banking organizations.  For these purposes, “Tier 1” capital consists of common equity, non-cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries and excludes goodwill.  “Tier 2” capital consists of cumulative perpetual preferred stock, limited-life preferred stock, mandatory convertible securities, subordinated debt and (subject to a limit of 1.25% of risk-weighted assets) general loan loss reserves.  In calculating the relevant ratio, a bank’s assets and off-balance sheet commitments are risk-weighted; thus, for example, generally loans are included at 100% of their book value while assets considered less risky are included at a percentage of their book value (20%, for example, for inter-bank obligations and Government Agency securities, and 0% for vault cash and U.S. Government securities).  Under these regulations, to be considered adequately capitalized, banks and bank holding companies are required to maintain a risk-based capital ratio of 8%, with Tier 1 risk-based capital (primarily shareholders’ equity) constituting at least 50% of total qualifying capital or 4% of risk-weighted assets.

 

The risk-based capital ratio focuses principally on broad categories of credit risk, and may not take into account many other factors that can affect a bank’s financial condition.  These factors include overall interest rate risk exposure; liquidity, funding and market risks; the quality and level of earnings; concentrations of credit risk; certain risks arising from nontraditional activities; the quality of loans and investments; the effectiveness of loan and investment policies; and management’s overall ability to monitor and control financial and operating risks, including the risk presented by concentrations of credit and nontraditional activities.  The Comptroller has addressed many of these areas in related rule-making proposals. In addition to evaluating capital ratios, an overall assessment of capital adequacy must take account of each of these other factors including, in particular, the level and severity of problem and adversely classified assets. For this reason, the final supervisory judgment on a bank’s capital adequacy may differ significantly from the conclusions that might be drawn solely from the absolute level of the bank’s risk-based capital ratio.  The Comptroller has stated that banks generally are expected to operate above the minimum risk-based capital ratio.  Banks contemplating significant expansion plans, as well as those institutions with high or inordinate levels of risk, are required to hold capital consistent with the level and nature of the risks to which they are exposed.

 

Further, the banking agencies have adopted modifications to the risk-based capital regulations to include standards for interest rate risk exposures.  Interest rate risk is the exposure of a bank’s current and future earnings and equity capital arising from movements in interest rates.  While interest rate risk is inherent in a bank’s role as a financial intermediary, it introduces volatility to bank earnings and to the economic value of the bank.  The banking agencies have addressed this problem by implementing changes to the capital standards to include a bank’s exposure to declines in the economic value of its capital due to changes in interest rates as a factor that the banking agencies consider in evaluating an institution’s capital adequacy.  Bank examiners consider a bank’s historical financial performance and its earnings exposure to interest rate movements as well as qualitative factors such as the adequacy of a bank’s internal interest rate risk management.

 

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Under certain circumstances, the Comptroller may determine that the capital ratios for a national bank must be maintained at levels that are higher than the minimum levels required by the guidelines.  A national bank that does not achieve and maintain required capital levels may be subject to supervisory action by the Comptroller through the issuance of a capital directive to ensure the maintenance of required capital levels.

 

The federal banking agencies, including the Comptroller, have adopted regulations implementing a system of prompt corrective action under the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”).  The regulations establish five capital categories with the following characteristics:  (1) “Well capitalized,” consisting of institutions with a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater and a leverage ratio of 5.0% or greater and which are not operating under an order, written agreement, capital directive or prompt corrective action directive; (2) “Adequately capitalized,” consisting of institutions with a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital of 4.0% or greater and a leverage ratio of 4.0% or greater and which do not meet the definition of a “well capitalized” institution; (3) “Undercapitalized,” consisting of institutions with a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or a leverage ratio of less than 4.0%; (4) “Significantly undercapitalized,” consisting of institutions with a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%; and (5) “Critically undercapitalized,” consisting of institutions with a ratio of tangible equity to total assets that is equal to or less than 2.0%.

 

The regulations establish procedures for the classification of financial institutions within the capital categories, for filing and reviewing capital restoration plans required under the regulations, and for the issuance of directives by the appropriate regulatory agency, among other matters.  See “Supervision and Regulation — Prompt Corrective Action” for additional discussion regarding regulations.

 

An institution that is less than well-capitalized cannot accept brokered deposits without the consent of the FDIC.  The appropriate federal banking agency, after notice and an opportunity for a hearing, is authorized to treat a well capitalized, adequately capitalized or undercapitalized insured depository institution as if it had a lower capital-based classification if it is in an unsafe and unsound condition or engaging in an unsafe and unsound practice.  Thus, an adequately capitalized institution can be subjected to the restrictions (described below) that are imposed on undercapitalized institutions (provided that a capital restoration plan cannot be required of the institution), and an undercapitalized institution can be subjected to the restrictions (also described below) applicable to significantly undercapitalized institutions.  See “Supervision and Regulation — Prompt Corrective Action” for additional discussion regarding federal banking agency supervision.

 

An insured depository institution cannot make a capital distribution (as broadly defined to include, among other things, dividends, redemptions and other repurchases of stock), or pay management fees to any person or persons that control the institution, if it would be undercapitalized following the distribution.  However, a federal banking agency may (after consultation with the FDIC) permit an insured depository institution to repurchase, redeem, retire or otherwise acquire its shares if (i) the action is taken in connection with the issuance of additional shares or obligations in at least an equivalent amount and (ii) the action will reduce the institution’s financial obligations or otherwise improve its financial condition.  An undercapitalized institution is generally prohibited from increasing its average total assets, and is also generally prohibited from making acquisitions, establishing new branches, or engaging in any new line of business except under an accepted capital restoration plan or with the approval of the FDIC.  In addition, a federal banking agency has authority with respect to undercapitalized depository institutions to take any of the actions it is required to or may take with respect to a significantly undercapitalized institution (as described below) if it determines “that those actions are necessary to carry out the purpose” of FDICIA.

 

The federal banking agencies have adopted a joint agency policy statement indicating that the adequacy and effectiveness of a bank’s interest rate risk management process and the level of its interest rate exposures are critical factors in the agencies’ evaluation of the bank’s capital adequacy.

 

At December 31, 2012, the Company and the Bank have capital ratios that place them in the “well capitalized” category. See Footnote 16 to the Bank’s Financial Statements included under Item 8 of this Annual Report.

 

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Basel Accords

 

The current risk-based capital guidelines that apply to the Company and the Bank are based upon the 1988 capital accord (referred to as “Basel I”) of the International Basel Committee on Banking Supervision (the “Basel Committee”), a committee of central banks and bank supervisors and regulators from the major industrialized countries.  The Basel Committee develops broad policy guidelines for use by each country’s supervisors in determining the supervisory policies they apply.

 

A new framework and accord, referred to as Basel II, evolved from 2004 to 2006 out of the efforts to revise capital adequacy standards for internationally active banks. Basel II emphasized internal assessment of credit, market and operational risk and supervisory assessment and market discipline. The Company was not required to comply with Basel II and elected not to apply the Basel II standards.

 

In 2010 and 2011, the Basel Committee finalized proposed reforms on capital and liquidity, generally referred to as Basel III, to reconsider regulatory capital standards, supervisory and risk-management requirements and additional disclosures to further strengthen the Basel II framework in response to the worldwide economic downturn.  Basel III provides for increases in the minimum Tier 1 common equity ratio and the minimum requirement for the Tier 1 capital ratio. Basel III additionally includes a “capital conservation buffer” on top of the minimum requirement designed to absorb losses in periods of financial and economic distress; and an additional required countercyclical buffer percentage to be implemented according to a particular nation’s circumstances.  These capital requirements are further supplemented under Basel III by a non-risk-based leverage ratio.  Basel III also reaffirms the Basel Committee’s intention to introduce higher capital requirements on securitization and trading activities.

 

Implementation of Basel III in the United States will require regulations and guidelines by United States banking regulators, which may differ in significant ways from the recommendations published by the Basel Committee. The new Basel III capital standards were scheduled to be phased in from January 1, 2013 until January 1, 2019 but United States banking regulators have delayed the adoption of final rules implementing these standards. It is unclear how smaller banking organizations in the United States will be subject to these regulations and guidelines.  The Basel III standards, if adopted, could lead to significantly higher capital requirements, higher capital charges and more restrictive leverage and liquidity ratios. The standards would, among other things:

 

·  Impose more restrictive eligibility requirements for Tier 1 and Tier 2 capital;

 

·  Increase the minimum Tier 1 common equity ratio to 4.5%, net of regulatory deductions, and introduce a capital conservation buffer of an additional 2.5% of common equity to risk-weighted assets, raising the target minimum common equity ratio to 7.0%;

 

·  Increase the minimum Tier 1 capital ratio to 8.5% inclusive of the capital conservation buffer;

 

·  Increase the minimum total capital ratio to 10.5% inclusive of the capital conservation buffer;

 

·  Introduce a countercyclical capital buffer of up to 2.5% of common equity or other fully loss absorbing capital for periods of excess credit growth; and

 

·  Introduces a non-risk adjusted Tier 1 leverage ratio of 3.0%, based on a measure of total exposure rather than total assets, and new liquidity standards.

 

Deposit Insurance Coverage and Premiums

 

The Bank is a member of the Deposit Insurance Fund (the “DIF”), which is administered by the FDIC.  Deposits at the Bank are insured by the FDIC up to applicable limits.

 

The FDIC assesses deposit insurance premiums on each FDIC-insured institution quarterly based on annualized rates.  A depository institutions’ FDIC insurance premium assessment rate is adjusted for risk and is based on its capital, supervisory ratings and other factors.  Under FDIC regulations, the assessment base against which deposit insurance premiums are calculated is the depository institution’s average total consolidated assets less the institution’s average tangible equity.  Assessment rates on this assessment base initially range from 5 to 35 basis points.  After potential adjustment for certain risk elements, the assessments rates range from 2.5 to 45 basis points.

 

The Dodd-Frank Act increased the minimum reserve ratio (the ratio of the net worth of the DIF to estimated insured deposits) from 1.15% of estimated deposits to 1.35% of estimated deposits (or a comparable percentage of the asset-based assessment base described above).  The Dodd-Frank Act requires the FDIC to offset the effect of the increase in the minimum reserve ratio when setting assessments for insured depository institutions with less than $10 billion in total consolidated assets, including the Bank. The FDIC has until September 30, 2020 to achieve the new minimum reserve ratio of 1.35%.

 

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FDIC insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. For the quarterly period ended December 31, 2009, the Financing Corporation assessment equaled 1.02 basis points for each $100 in domestic deposits.  These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.

 

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.  It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital.

 

Prompt Corrective Action

 

The federal banking agencies, including the Comptroller, have adopted regulations implementing a system of prompt corrective action under FDICIA.  The regulations establish five capital categories:  (1) ”well capitalized,”; (2) ”adequately capitalized,”; (3) ”undercapitalized,” ; (4) ”significantly undercapitalized,”; and (5) ”critically undercapitalized,”  See “Capital Adequacy Requirements” above for a discussion of the features of each capital category.

 

The FDIC has authority: (a) to request that an institution’s primary regulatory agency (in the case of the Bank, the Comptroller) take enforcement action against it based upon an examination by the FDIC or the agency, (b) if no action is taken within 60 days and the FDIC determines that the institution is in an unsafe and unsound condition or that failure to take the action will result in continuance of unsafe and unsound practices, to order that action be taken against the institution, and (c) to exercise this enforcement authority under “exigent circumstances” merely upon notification to the institution’s primary regulatory agency.  This authority gives the FDIC the same enforcement powers with respect to any institution and its subsidiaries and affiliates as the primary regulatory agency has with respect to those entities.

 

An undercapitalized institution is required to submit an acceptable capital restoration plan to its primary federal bank regulatory agency.  The banking agency may not accept a capital restoration plan unless the agency determines, among other things, that the plan “is based on realistic assumptions, and is likely to succeed in restoring the institution’s capital” and “would not appreciably increase the risk . . . to which the institution is exposed.”

 

FDICIA provides that the appropriate federal regulatory agency must require an insured depository institution that is significantly undercapitalized, or that is undercapitalized and either fails to submit an acceptable capital restoration plan within the time period allowed by regulation or fails in any material respect to implement a capital restoration plan accepted by the appropriate federal banking agency, to take one or more of the following actions:  (a) sell enough shares, including voting shares, to become adequately capitalized; (b) merge with (or be sold to) another institution (or holding company), but only if grounds exist for appointing a conservator or receiver; (c) restrict specified transactions with banking affiliates as if the “sister bank” exception to the requirements of Section 23A of the Federal Reserve Act did not exist; (d) otherwise restrict transactions with bank or non-bank affiliates; (e) restrict interest rates that the institution pays on deposits to “prevailing rates” in the institution’s “region”; (f) restrict asset growth or reduce total assets; (g) alter, reduce or terminate activities; (h) hold a new election of directors; (i) dismiss any director or senior executive officer who held office for more than 180 days immediately before the institution became undercapitalized, provided that in requiring dismissal of a director or senior executive officer, the agency must comply with procedural requirements, including the opportunity for an appeal in which the director or officer will have the burden of proving his or her value to the institution; (j) employ “qualified” senior executive officers; (k) cease accepting deposits from correspondent depository institutions; (l) divest non-depository affiliates which pose a danger to the institution; (m) be divested by a parent holding company; and (n) take any other action which the agency determines would better carry out the purposes of the prompt corrective action provisions.

 

In addition to the foregoing sanctions, without the prior approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to any senior executive officer or increase the rate of compensation for a senior executive officer without regulatory approval.  If an undercapitalized institution has failed to submit or implement an acceptable capital restoration plan the appropriate federal banking agency is not permitted to approve the payment of a bonus to a senior executive officer.

 

Not later than 90 days after an institution becomes critically undercapitalized, the institution’s primary federal bank regulatory agency must appoint a receiver or a conservator, unless the agency, with the concurrence of the FDIC, determines that the purposes of the prompt corrective action provisions would be better served by another course of

 

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action.  Any alternative determination must be documented by the agency and reassessed on a periodic basis.  Notwithstanding the foregoing, a receiver must be appointed after 270 days unless the FDIC determines that the institution has positive net worth, is in compliance with a capital plan, is profitable or has a sustainable upward trend in earnings, and is reducing its ratio of non-performing loans to total loans, and unless the head of the appropriate federal banking agency and the chairperson of the FDIC certify that the institution is viable and not expected to fail.

 

The FDIC is required, by regulation or order, to restrict the activities of critically undercapitalized institutions.  The restrictions must include prohibitions on the institution’s doing any of the following without prior FDIC approval:  entering into any material transactions not in the usual course of business, extending credit for any highly leveraged transaction; engaging in any “covered transaction” (as defined in Section 23A of the Federal Reserve Act) with an affiliate; paying “excessive compensation or bonuses”; and paying interest on “new or renewed liabilities” that would increase the institution’s average cost of funds to a level significantly exceeding prevailing rates in the market.

 

Potential Enforcement Actions and Supervisory Agreements

 

Under federal law, national banks and their institution-affiliated parties may be the subject of potential enforcement actions by the Comptroller for unsafe and unsound practices in conducting their businesses, or for violations of any law, rule or regulation or provision, any consent order with any agency, any condition imposed in writing by the agency or any written agreement with the agency.  During periods of economic stress, regulatory oversight can be expected to increase and regulatory agencies become more aggressive in responding to concerns and trends identified in examinations.  One result of this heightened activity is an increase in the issuance of enforcement actions.  Enforcement actions may include the imposition of a conservator or receiver, cease-and-desist orders and written agreements, the termination of insurance of deposits, the imposition of civil money penalties and removal and prohibition orders against institution-affiliated parties.

 

Payment of Dividends

 

The Company - Historically the Company has not paid dividends but has retained earnings to support growth.  The ability of the Company to make dividend payments is subject to statutory and regulatory restrictions.  Under California law, a California corporation such as the Company may make a distribution to its shareholders if the corporation’s retained earnings equal at least the amount of the proposed distribution.  In the event sufficient retained earnings are not available for the proposed distribution, a California corporation may nevertheless make a distribution to its shareholders if, giving effect to the distribution, the value of the corporation’s assets would equal or exceed the value of its liabilities plus the amount of shareholder preferences, if any.

 

The primary source of funds for payment of any dividends by the Company to its shareholders will be the receipt of dividends and management fees from the Bank.  FDIC policies generally allow cash dividends to be paid only from net operating income, and do not permit dividends to be paid until an appropriate allowance for loans and lease losses has been established and overall capital is adequate.  See “Supervision and Regulation — Capital Adequacy Requirements” for additional discussion regarding capital adequacy.

 

The Bank - The Board of Directors of a national bank may declare the payment of dividends depending upon the earnings, financial condition and cash needs of the bank and general business conditions.  A national bank may not pay dividends from its capital.  All dividends must be paid out of net profits then on hand, after deducting losses and bad debts.  The approval of the Comptroller is required for the payment of dividends if the total of all dividends declared by the bank in any calendar year would exceed the total of its net profits of that year combined with its retained net profits of the two preceding years, less any required transfers to surplus or a fund for the retirement of any preferred stock.

 

In addition to the above requirements, guidelines adopted by the Comptroller set forth factors which are to be considered by a national bank in determining the payment of dividends.  A national bank, in assessing the payment of dividends, is to evaluate the bank’s capital position, its maintenance of an adequate allowance for loan and lease losses, and the need to revise or develop a comprehensive capital plan.

 

The Comptroller also has broad authority to prohibit a national bank from engaging in banking practices which it considers to be unsafe or unsound.  It is possible, depending upon the financial condition of the national bank in question and other factors, that the Comptroller may assert that the payment of dividends or other payments by a bank is considered an unsafe or unsound banking practice and therefore, implement corrective action to address such a practice.

 

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Accordingly, the future payment of cash dividends by the Company will not only depend upon the Bank’s earnings during any fiscal period but will also depend upon the assessment of its Board of Directors of capital requirements and other factors, including dividend guidelines and the maintenance of an adequate allowance for loan and lease losses.

 

Community Reinvestment Act

 

Pursuant to the Community Reinvestment Act (the “CRA”) of 1977, the federal regulatory agencies that oversee the banking industry are required to use their authority to encourage financial institutions to help meet the credit needs of the local communities in which such institutions are chartered, consistent with safe and sound banking practices.  When conducting an examination of a financial institution such as the Bank, the agencies assess the institution’s record of meeting the credit needs of its entire community, including low- and moderate- income neighborhoods.  This record is taken into account in an agency’s evaluation of an application for creation or relocation of domestic branches or for merger with another institution.  Failure to address the credit needs of a bank’s community may also result in the imposition of certain other regulatory sanctions, including a requirement that corrective action be taken.

 

Transactions with Affiliates

 

Sections 23A and 23B of the Federal Reserve Act and the FRB’s Regulation W limit transactions between a bank and its affiliates and limit a bank’s ability to transfer to its affiliates the benefits arising from the bank’s access to insured deposits, the payment system and the discount window and other benefits of the Federal Reserve system.  The statute and regulation impose quantitative and qualitative limits on the ability of a bank to extend credit to, or engage in certain other transactions with, an affiliate (and a non-affiliate if an affiliate benefits from the transaction).  However, certain transactions that generally do not expose a bank to undue risk or abuse the safety net are exempted from coverage under Regulation W.

 

Tying Arrangements and Transactions with Affiliated Persons

 

A bank is prohibited from tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services.  For example, with some exceptions, a bank may not condition an extension of credit on a promise by its customer to obtain other services provided by it, its holding company or other subsidiaries (if any), or on a promise by its customer not to obtain other services from a competitor.

 

Directors, officers and principal shareholders of the Bank, and the companies with which they are associated, may have banking transactions with the Bank in the ordinary course of business.  Any loans and commitments to loan included in these transactions must be made in compliance with the requirements of applicable law, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons of similar creditworthiness, and on terms not involving more than the normal risk of collectability or presenting other unfavorable features.

 

USA PATRIOT Act

 

Pursuant to USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to establish anti-money laundering programs and sets forth minimum standards for these programs.  The Bank has adopted comprehensive policies and procedures to address the requirements of the USA PATRIOT Act, and management believes that the Bank is currently in compliance with the Act.

 

Consumer Laws and Regulations

 

The Bank must also comply with consumer laws and regulations that are designed to protect consumers in transactions with banks.  While the list is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act and the Fair Credit Reporting Act among others.  These laws and regulations mandate disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans.  The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing regulatory compliance and customer relations efforts.

 

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Exposure to and Management of Risk

 

The federal banking agencies examine banks and bank holding companies with respect to their exposure to and management of different categories of risk.  Categories of risk identified by the agencies include legal risk, operational risk, market risk, credit risk, interest rate risk, price risk, foreign exchange risk, transaction risk, compliance risk, strategic risk, credit risk, liquidity risk, and reputation risk.  This examination approach causes bank regulators to focus on risk management procedures, rather than simply examining every asset and transaction.  This approach supplements rather than replaces existing rating systems based on the evaluation of an institution’s capital, assets, management, earnings and liquidity.

 

Safety and Soundness Standards

 

Federal banking regulators have adopted guidelines prescribing standards for safety and soundness.  The guidelines create standards for a wide range of operational and managerial matters including (a) internal controls, information systems, and internal audit systems; (b) loan documentation; (c) credit underwriting; (d) interest rate exposure; (e) asset growth; (f) compensation and benefits; and (g) asset quality and earnings.  Although meant to be flexible, an institution that falls short of the guidelines’ standards may be requested to submit a compliance plan or be subjected to regulatory enforcement actions.

 

Impact of Government Monetary Policy

 

The earnings of the Bank are and will be affected by the policies of regulatory authorities, including the Federal Reserve.  An important function of the Federal Reserve is to regulate the national supply of bank credit.  Among the instruments used to implement these objectives are open market operations in U.S. Government securities, changes in reserve requirements against bank deposits, and changes in the discount rate which banks pay on advances from the Federal Reserve System.  These instruments are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates on loans or interest rates paid for deposits.  The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.  The effect, if any, of such policies upon the future business earnings of the Bank cannot be predicted.

 

Legislation and Proposed Changes

 

From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions.  Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress and before various bank regulatory agencies.  For example, certain proposals to substantially revise the structure of regulation of financial services are under consideration.  No prediction can be made as to the likelihood of any major changes or the impact that new laws or regulations might have on the Company or the Bank.

 

Conclusion

 

It is impossible to predict with any certainty the competitive impact the laws and regulations described above will have on commercial banking in general and on the business of the Company in particular, or to predict whether or when any of the proposed legislation and regulations described above will be adopted.  It is anticipated that banking will continue to be a highly regulated industry.  Additionally, there has been a continued lessening of the historical distinction between the services offered by financial institutions and other businesses offering financial services, and the trend toward nationwide interstate banking is expected to continue.  As a result of these factors, it is anticipated banks will experience increased competition for deposits and loans and, possibly, further increases in their cost of doing business.

 

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Item 1A.  Risk Factors

 

RISK FACTORS

 

Readers and prospective investors in our securities should carefully consider the following risk factors as well as the other information contained or incorporated by reference in this report.

 

The risks and uncertainties described below are not the only ones facing us.  Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors.

 

If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Company’s securities could decline significantly, and you could lose all or part of your investment.

 

General Business Risks

 

Continued or worsening general economic or business conditions, particularly in California where our business is concentrated, could have an adverse effect on our business, results of operations and financial condition.

 

Our operations, loans and the collateral securing our loan portfolio are concentrated in the State of California. Our success depends upon the business activity, population, income levels, deposits and real estate activity in this market. As a result, we may be particularly susceptible to the adverse economic conditions in California, and the San Bay Area of Northern California in particular.

 

Since late 2007, the United States and the State of California in particular have experienced difficult economic conditions. Weak economic conditions are characterized by, among other indicators, deflation, increased levels of unemployment, fluctuations in debt and equity capital markets, increased delinquencies on mortgage, commercial and consumer loans, residential and commercial real estate price declines and lower home sales and commercial activity. All of those factors are generally detrimental to our business.

 

In addition, our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more complex by these difficult market and economic conditions. Adverse economic conditions could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations.

 

While some economic trends have shown signs of improving in recent months, we cannot be certain that market and economic conditions will substantially improve in the near future. Recent and ongoing events at the state, national and international levels continue to create uncertainty in the economy and financial markets and could adversely impact economic conditions in our market area. A worsening of these conditions would likely exacerbate the adverse effects of the recent market and economic conditions on us and our customers. As a result, we may experience additional increases in foreclosures, delinquencies and customer bankruptcies as well as more restricted access to funds. Any such negative events may have an adverse effect on our business, financial condition, results of operations and stock price. Moreover, because of our geographic concentration, we are less able to diversify our credit risks across multiple markets to the same extent as regional or national financial institutions.

 

Poor economic conditions in the Northern California real estate market may cause us to suffer higher default rates on our loans and decreased value of the assets we hold as collateral.

 

The majority of our assets and deposits were generated in Northern California. At December 31, 2012, approximately 30% of our loan portfolio was secured by real property in Northern California. During 2012, the real estate market in Northern California showed signs of stabilization and some improvement, as evidenced by increasing prices and increased transaction volume, and decreased foreclosure rates. These improvements follow an extended period of deterioration and there is no certainty that improvements will continue, or that we not might return to further deterioration in the real estate market.  Further deterioration may result in an increase in the level of our nonperforming loans, particularly commercial real estate loans. When real estate prices decline, the value of real estate collateral securing our loans is reduced. As a result, we may experience greater charge-offs and, similarly, our ability to recover on defaulted loans by foreclosing and selling the real estate collateral may be diminished and, as a result, we are more likely to suffer losses on defaulted loans. If this real estate trend in our market areas continues or worsens, the result could be reduced income, increased expenses, and less cash available for lending and other activities, which could

 

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have a material and adverse effect on our financial condition and results of operations.

 

We may suffer losses in our loan portfolio despite strict adherence to underwriting practices.

 

We attempt to mitigate the risks inherent in extending credit by adhering to specific underwriting practices, managed by credit professionals. Although we believe that our underwriting criteria is appropriate for the various kinds of loans we fund, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in the Bank’s allowance for loan losses. If our underwriting practices prove to be ineffective, we may incur losses in our loan portfolio, which could have a material and adverse effect on our financial condition and results of operations.

 

Bank regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses. While we believe that our allowance for loan losses is currently adequate to cover potential losses, we cannot guarantee that future increases to the allowance for loan losses may not be required by regulators or other third party loan review or financial audits. Any of these occurrences could materially and adversely affect our financial condition and results of operations.

 

We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.

 

Competition for qualified employees in the banking industry is intense, and there are limited numbers of qualified persons with knowledge of, and experience in, the California community banking industry. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and business development and technical personnel, and upon the continued contributions of our management and personnel.  If we fail to attract and retain the necessary personnel, our financial condition and results of operations may be materially and adversely affected.

 

We face limits on our ability to lend and the limitation may increase.

 

Our legal lending limit as of December 31, 2012 was approximately $22.6 million. Accordingly, the size of the loans which we can offer to potential customers is less than the size of loans which many of our competitors with larger lending limits can offer. Our lending limit affects our ability to seek relationships with the area’s larger and more established businesses. We cannot be assured of any success in attracting or retaining customers seeking larger loans or that we can engage in participations of those loans on terms favorable to us. Moreover, to the extent that we incur losses and do not obtain additional capital, our lending limit, which depends upon the amount of our capital, will decrease, which could have a material and adverse effect on our financial condition and results of operations.

 

Market and Interest Rate Risks

 

Changes in interest rates could reduce income and cash flow

 

The Company’s income and cash flow depend to a great extent on the difference between the interest earned on loans and investment securities, and the interest paid on deposits and other borrowings (the “interest rate spread”). We cannot control or prevent changes in the level of interest rates.  They fluctuate in response to general economic conditions and the policies of various governmental and regulatory agencies, in particular, the FRB. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the purchase of investments, the generation of deposits and the rates received on loans and investment securities and paid on deposits and other liabilities.  See “Item 7a Quantitative and Qualitative Disclosures About Market Risk” is incorporated by reference in this paragraph.

 

Recent decreases in market interest rates have caused the Company’s interest rate spread to decline significantly, which reduces revenue and net income.  Sustained low levels of market interest rates will likely continue to put pressure on our profitability.  Any material reduction in interest rate spread could have a material adverse effect on our business, profitability and financial position.

 

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, capital offerings 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 attractive to us, could be impaired by factors that impact us specifically or the financial services industry in general.  Factors that could detrimentally impact our access to liquidity sources

 

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include a reduction in the level of business activity due to a market downturn or adverse regulatory action against us, or a decrease in depositor or investor confidence in us.  Further, as a business bank, a significant portion of our deposits are raised from companies in amounts that exceed levels covered by FDIC insurance.  In addition, our ability to borrow could also be impaired by factors that are not specific to us, such as the severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole as the recent turmoil faced by banking in the domestic and worldwide credit markets deteriorates.

 

Risks Related to the nature and geographical location of Bridge Capital Holdings’ business

 

Bridge Capital Holdings’ invests in loans that contain inherent credit risks that may cause us to incur losses

 

In our business as a lender, we face the risk that borrowers may fail to pay their loans when due.  If borrower defaults cause large aggregate losses, it could have a material adverse impact on our business, profitability and financial condition.  We closely monitor the markets in which we conduct our lending operations and attempt to adjust our strategy to control exposure to loans with higher credit risk.  Asset reviews are performed using grading standards and criteria similar to those employed by bank regulatory agencies.  We have established an evaluation process designed to determine the adequacy of our allowance for loan losses.  While this process uses historical and other objective information, the classification of loans and the forecasts and establishment of loan losses are dependent to a great extent on our subjective assessment based upon our experience and judgment.  During 2008 and 2009, the rapid deterioration of real estate values prompted us to take substantial charges and provisions to the allowance for loan losses.  We can provide no assurance that the credit quality of our loans will not deteriorate in the future and that such deterioration will not adversely affect the Company and that our allowance for loan losses will be adequate to absorb actual losses in the future.

 

Bridge Capital Holdings’ operations are concentrated geographically in California, and poor economic conditions in California may cause us to incur losses.

 

Substantially all of Bridge Capital Holdings’ business is located in California. Bridge Capital Holdings’ financial condition and operating results will be subject to changes in economic conditions in California. A significant and prolonged downturn in the California economy could adversely affect financial institutions doing business in California, such as the Company. Economic conditions in California are subject to various uncertainties at this time, including the decline in the technology sector, the California state government’s budgetary difficulties and continuing fiscal difficulties.  The Company will be subject to changes in economic conditions. We can provide no assurance that conditions in the California economy will not deteriorate in the future and that such deterioration will not adversely affect Bridge Capital Holdings.

 

The markets in which Bridge Capital Holdings operates are subject to the risk of earthquakes and other natural disasters

 

Most of the properties of Bridge Capital Holdings are located in California. Also, most of the real and personal properties which currently secure the Company’s loans are located in California. California is a state which is prone to earthquakes, brush fires, flooding and other natural disasters. In addition to possibly sustaining damage to its own properties, if there is a major earthquake, flood or other natural disaster, Bridge Capital Holdings faces the risk that many of its borrowers may experience uninsured property losses, or sustained job interruption and/or loss which may materially impair their ability to meet the terms of their loan obligations. A major earthquake, flood or other natural disaster in California could have a material adverse effect on Bridge Capital Holdings’ business, financial condition, results of operations and cash flows.

 

Substantial competition in the California banking market could adversely affect us

 

Banking is a highly competitive business. We compete actively for loan, deposit, and other financial services business primarily in California. Our competitors include a large number of state and national banks, thrift institutions and credit unions, as well as many financial and non-financial firms that offer services similar to those offered by us. Other competitors include large financial institutions that have substantial capital, technology and marketing resources. Such large financial institutions may have greater access to capital at a lower cost than us, which may adversely affect our ability to compete effectively.

 

17



 

Regulatory Risks

 

Restrictions on dividends and other distributions could limit amounts payable to us

 

Various statutory provisions restrict the amount of dividends our subsidiaries can pay to us without regulatory approval. In addition, if any subsidiary of ours were to liquidate, that subsidiary’s creditors will be entitled to receive distributions from the assets of that subsidiary to satisfy their claims against it before we, as a holder of an equity interest in the subsidiary, will be entitled to receive any of the assets of the subsidiary.

 

Adverse effects of, or changes in, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us

 

We are subject to significant federal and state regulation and supervision, which is primarily for the benefit and protection of our customers and not for the benefit of investors. In the past, our business has been materially affected by these regulations. This trend is likely to continue in the future. Laws, regulations or policies, including accounting standards and interpretations currently affecting us and our subsidiaries, may change at any time. Regulatory authorities may also change their interpretation of these statutes and regulations.  During periods of economic stress, regulatory oversight can be expected to increase and regulatory agencies become more aggressive in responding to concerns and trends identified in examinations.  Such a regulatory response may effect, among other things, growth rates, business mix,  capital levels and payment of dividends Therefore, our business may be adversely affected by any future changes in laws, regulations, policies or interpretations or regulatory approaches to compliance and enforcement, including legislative and regulatory reactions to the current credit crisis, the terrorist attack on September 11, 2001 and future acts of terrorism, and major U.S. corporate bankruptcies and reports of accounting irregularities at U.S. public companies.

 

As noted above, on October 3, 2008, President Bush signed into law the EESA, which evolved from the U.S. Treasury’s initial proposal in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. This was followed by the ARRA on February 17, 2009 and the Dodd-Frank Act on July 21, 2010.  Each of these laws mandate significantly increased supervisory activities and many new studies and regulations.  We can give no assurance as to what form additional regulations, particularly those required by the Dodd-Frank Act, might take or whether and when they could become effective.

 

Additionally, our business is affected significantly by the fiscal and monetary policies of the federal government and its agencies. We are particularly affected by the policies of the Federal Reserve Board, which regulates the supply of money and credit in the U.S. Under long-standing policy of the Federal Reserve Board and the Dodd-Frank Act, a bank holding company is required to act as a source of financial strength for its subsidiary banks. As a result of that requirement, we may be required to commit financial and other resources to our subsidiary bank in circumstances where we might not otherwise do so. Among the instruments of monetary policy available to the Federal Reserve Board are (a) conducting open market operations in U.S. government securities, (b) changing the discount rates of borrowings by depository institutions, and (c) imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the Federal Reserve Board may have a material effect on our business, results of operations and financial condition.

 

See “Supervision and Regulation — Legislation and Proposed Changes” for additional discussion regarding adverse effects of, or changes in, banking or other laws and regulations and governmental fiscal or monetary policies.

 

Systems, Accounting and Internal Control Risks

 

The accuracy of the Company’s judgments and estimates about financial and accounting matters will impact operating results and financial condition

 

The Company makes certain estimates and judgments in preparing its financial statements.  The quality and accuracy of those estimates and judgments will have an impact on the Company’s operating results and financial condition. See “Critical Accounting Policies and Estimates” in this report and the information referred to in that discussion.

 

The Company’s information systems may experience an interruption or breach in security

 

The Company relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s customer relationship management and systems. There can be no assurance that any such failures, interruptions or security

 

18



 

breaches will not occur or, if they do occur, that they will be adequately corrected by the Company. The occurrence of any such failures, interruptions or security breaches could damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny, or expose the Company to litigation and possible financial liability, any of which could have a material adverse effect on the Company’s financial condition and results of operations.

 

The Company’s controls and procedures may fail or be circumvented

 

Management regularly reviews and updates the Company’s internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.

 

Item 1B.  Unresolved Staff Comments

 

None.

 

Item 2.  Properties

 

The Company’s principal executive office and a full service banking office are located at 55 Almaden Boulevard, City of San Jose, County of Santa Clara, State of California.  The office consists of approximately 42,337 square feet on three floors of an eight-story office building.  24,767 square feet of the space was originally sublet from a prior tenant in a sublease which commenced December 26, 2003 and terminated December 31, 2006.  The sublease provided for an initial base rent of $28,730 with annual escalations to $45,819 in the final year of the sublease.  The Bank has entered into a direct lease with the landlord, which commenced immediately following the expiration of the sublease term on January 1, 2007 for 120 months ending on December 31, 2016.  The direct lease provides for an initial twelve-month period of reduced rent followed by a base rent of $47,305 beginning on January 1, 2008 and increasing 3.0% on each anniversary date thereafter.  The Bank has also entered into an additional direct lease with the landlord to occupy 17,570 square feet, which commenced November 1, 2006 and terminates on December 31, 2016.  The direct lease provides for an initial twelve-month period with no rent followed by an initial base rent of $36,897 with annual escalations to $48,142 in the final year of the lease.  The foregoing description is qualified by reference to the lease agreement dated November 1, 2006 Exhibit 10.3 to this Report.

 

An additional full service banking office is located at 525 University Avenue, City of Palo Alto, County of Santa Clara, State of California.  The office consists of approximately 6,495 square feet located in Suite 31 in the building known as the Palo Alto Office Center.  The Lease is an amendment to a lease which ended November 30, 2006 and is for a term of 86 months commencing on February 1, 2007 and ending on January 31, 2014.  The Lease provides for a base rent of $29,228 through the first anniversary of the lease date.  Effective with the first anniversary date the lease payments will be adjusted by a factor that is tied to the Consumer Price Index.  The foregoing description is qualified by reference to the lease agreement dated October 15, 2001 attached as exhibit 10.2 to this Report and the amendment to this lease agreement dated March 9, 2006 exhibit 10.5 to this Report.

 

In addition, the Bank operates loan production offices in San Francisco and Pleasanton, California, Dallas, Texas, Reston, Virginia and Boston, Massachusetts.

 

Item 3.  Legal Proceedings

 

The Company is not a defendant in any material pending legal proceedings and no such proceedings are known to be contemplated.  No director, officer, affiliate, more than 5.0% shareholder of the Company or any associate of these persons is a party adverse to the Company or has a material interest adverse to the Company in any material legal proceeding.

 

Item 4.  Mine Safety Disclosures

 

Not applicable.

 

19



 

PART II

 

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

 

The Company’s Common Stock trades on the Nasdaq Capital Market under the symbol “BBNK”.  The following table summarizes those trades of which the Company has knowledge, setting forth the high and low sales prices for the periods indicated.

 

 

 

Sales Price of

 

 

 

Common Stock (1)

 

Three Months Ended

 

Low

 

High

 

 

 

 

 

 

 

March 31, 2011

 

$

8.60

 

$

9.42

 

June 30, 2011

 

$

9.34

 

$

11.75

 

September 30, 2011

 

$

9.18

 

$

11.99

 

December 31, 2011

 

$

9.11

 

$

11.40

 

 

 

 

 

 

 

March 31, 2012

 

$

10.39

 

$

13.46

 

June 30, 2012

 

$

13.30

 

$

16.20

 

September 30, 2012

 

$

14.85

 

$

16.29

 

December 31, 2012

 

$

13.75

 

$

15.88

 

 


(1) Prices represent the actual trading history on the Nasdaq Capital Market.  Additionally, since trading in the Company’s common stock is limited, the range of prices stated is not necessarily representative of prices which would result from a more active market.

 

The Company had 1,204 common shareholders of record as of December 31, 2012.

 

The Company’s shareholders are entitled to receive dividends, when and as declared by its Board of Directors, out of funds legally available, subject to statutory, regulatory, and contractual restrictions.  See “Supervision and Regulation — Payment of Dividends” for additional discussion regarding dividends.  A California corporation such as Bridge Capital Holdings generally may make a distribution to its shareholders if the corporation’s retained earnings equal at least the amount of the proposed distribution, or, alternatively, to the extent that its assets exceed its liabilities plus Shareholder preferences, if any.

 

In a policy statement, the FRB has advised bank holding companies that it believes that payment of cash dividends in excess of current earnings from operations is inappropriate and may be cause for supervisory action.  Additionally, the Dodd-Frank requirement that holding companies are expected to provide a source of managerial and financial strength to their subsidiary banks potentially restricts a bank holding company’s ability to pay dividends.

 

The Company has not declared dividends on its common stock since inception of the Bank’s existence.  In the future, the Company may consider cash and stock dividends, subject to the restrictions on the payment of cash dividends as described above, depending upon the level of earnings, management’s assessment of future capital needs and other factors considered by the Board of Directors.

 

The following chart reflects the total return performance of the Company’s common stock for the years ended December 31, 2012, 2011, 2010, 2009, and 2008.

 

20



 

 

 

 

Period Ending

 

Index

 

12/31/07

 

12/31/08

 

12/31/09

 

12/31/10

 

12/31/11

 

12/31/12

 

Bridge Capital Holdings

 

100.00

 

18.62

 

33.75

 

40.50

 

48.42

 

72.44

 

NASDAQ Composite

 

100.00

 

60.02

 

87.24

 

103.08

 

102.26

 

120.42

 

SNL Western Bank

 

100.00

 

97.37

 

89.41

 

101.31

 

91.53

 

115.50

 

 

21



 

Item 6.  Selected Financial Data

 

The following table presents certain consolidated financial information concerning the business of the Company.  This information should be read in conjunction with the Financial Statements and the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained elsewhere herein.

 

 

 

As of and for the year ended

 

 

 

December 31,

 

(dollars in thousands, except per share data)

 

2012

 

2011

 

2010

 

2009

 

2008

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

62,787

 

$

50,694

 

$

45,188

 

$

44,572

 

$

58,692

 

Interest expense

 

2,195

 

2,256

 

3,071

 

6,763

 

13,827

 

Net interest income

 

60,592

 

48,438

 

42,117

 

37,809

 

44,865

 

Provision for credit losses

 

3,950

 

2,600

 

4,700

 

9,200

 

31,520

 

Net interest income after provision for credit losses

 

56,642

 

45,838

 

37,417

 

28,609

 

13,345

 

Other income

 

12,984

 

9,930

 

6,849

 

10,312

 

9,971

 

Other expenses

 

46,212

 

42,424

 

39,720

 

38,071

 

36,318

 

Income before income taxes

 

23,414

 

13,344

 

4,546

 

850

 

(13,002

)

Income taxes

 

9,610

 

5,497

 

1,955

 

(585

)

(5,661

)

Net income (loss)

 

$

13,804

 

$

7,847

 

$

2,591

 

$

1,435

 

$

(7,341

)

Preferred Dividends

 

 

200

 

1,955

 

4,203

 

152

 

Net income (loss) available to common shareholders

 

$

13,804

 

$

7,647

 

$

636

 

$

(2,768

)

$

(7,493

)

 

 

 

 

 

 

 

 

 

 

 

 

Per Share Data:

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per share

 

$

0.96

 

$

0.54

 

$

0.06

 

$

(0.42

)

$

(1.15

)

Diluted earnings (loss) per share

 

0.92

 

0.52

 

0.06

 

(0.42

)

(1.15

)

Book value per common share

 

9.32

 

8.55

 

8.16

 

7.81

 

8.51

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Balance sheet totals:

 

 

 

 

 

 

 

 

 

 

 

Assets

 

$

1,343,585

 

$

1,161,033

 

$

1,029,731

 

$

844,067

 

$

947,596

 

Loans, net

 

885,575

 

740,696

 

634,557

 

558,977

 

679,451

 

Deposits

 

1,162,548

 

998,675

 

847,946

 

705,046

 

777,245

 

Shareholders’ equity

 

146,747

 

129,513

 

142,303

 

109,314

 

112,490

 

 

 

 

 

 

 

 

 

 

 

 

 

Average balance sheet amounts:

 

 

 

 

 

 

 

 

 

 

 

Assets

 

$

1,206,691

 

$

1,047,141

 

$

897,140

 

$

868,166

 

$

831,958

 

Loans, net

 

805,560

 

641,894

 

573,173

 

593,352

 

671,065

 

Deposits

 

1,023,625

 

884,683

 

751,119

 

719,001

 

725,952

 

Shareholders’ equity

 

138,366

 

128,128

 

114,624

 

110,447

 

67,551

 

 

 

 

 

 

 

 

 

 

 

 

 

Selected Ratios:

 

 

 

 

 

 

 

 

 

 

 

Return on average equity

 

9.98

%

6.12

%

2.26

%

1.30

%

-10.87

%

Return on average assets

 

1.14

%

0.75

%

0.29

%

0.17

%

-0.88

%

Efficiency ratio

 

62.81

%

72.68

%

81.12

%

79.12

%

66.23

%

Total risk based capital ratio

 

15.23

%

16.06

%

20.87

%

19.45

%

16.90

%

Net chargeoffs (recoveries) to average gross loans

 

0.31

%

-0.06

%

0.85

%

1.92

%

3.14

%

Allowance for loan losses to total gross loans

 

2.20

%

2.43

%

2.39

%

2.78

%

2.65

%

Average equity to average assets

 

11.47

%

12.24

%

12.78

%

12.72

%

8.12

%

 

22



 

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

 

In addition to the historical information, this annual report contains certain forward-looking information within the meaning of Section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended, and which are subject to the “Safe Harbor” created by those sections.  The reader of this annual report should understand that all such forward-looking statements are subject to various uncertainties and risks that could affect their outcome.  The Company’s actual results could differ materially from those suggested by such forward-looking statements.  Such risks and uncertainties include, among others, (1) competitive pressure in the banking industry increases significantly; (2) changes in interest rate environment reduces margin; (3) general economic conditions, either nationally or regionally are less favorable than expected, resulting in, among other things, a deterioration in credit quality; (4) changes in the regulatory environment; (5) changes in business conditions and inflation; (6) costs and expenses of complying with the internal control provisions of the Sarbanes-Oxley Act and our degree of success in achieving compliance; (7) changes in securities markets; (8) future credit loss experience; (9) civil disturbances of terrorist threats or acts, or apprehension about possible future occurrences of acts of this type; and (10) the involvement of the United States in war or other hostilities.  Therefore, the information in this annual report should be carefully considered when evaluating the business prospects of the Company.

 

Critical Accounting Policies

 

Our accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note 1 to the Consolidated Financial Statements. Our most complex accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies involving significant management valuation judgments.

 

Allowance for Loan Losses

 

The allowance for loan losses is a valuation allowance for probable incurred loan losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors.  Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

 

The allowance generally consists of specific and general reserves.  Specific reserves generally relate to loans that are individually classified as impaired, but may also relate to loans that in management’s opinion exhibit negative credit characteristics or trends suggesting potential future loss exposure greater than historical loss experience would suggest. It is currently the Bank’s practice to immediately charge-off any identified financial loss pertaining to impaired loans when management believes the uncollectibility of the loan is confirmed, therefore specific reserves are uncommon.  A loan is impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Loans, for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are generally considered troubled debt restructurings and classified as impaired.

 

Commercial and real estate loans are individually evaluated for impairment.  Generally Accepted Accounting Principles specify that if a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.  Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.  However, it is currently the Bank’s practice to immediately charge-off any identified financial loss pertaining to impaired loans when management believes the uncollectibility of the loans has been confirmed.

 

23



 

Substandard loans are individually evaluated for impairment.  Generally Accepted Accounting Principles specify that if a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using an appropriate discount rate or at the fair value of collateral if repayment is expected solely from the collateral.  Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. See Note 4 to the consolidated financial statements for additional information on substandard loans.

 

Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using an appropriate discount rate at inception.  If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral.  For troubled debt restructurings that subsequently default, the Bank determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.  See Note 4 to the financial statements for additional information on troubled debt restructurings.

 

General reserves cover non-impaired loans and are based on historical loss rates for each portfolio segment, adjusted for the effects of qualitative or environmental factors that are likely to cause estimated loan losses as of the evaluation date to differ from the portfolio segment’s historical loss experience. Qualitative factors include consideration of the following: changes in lending policies and procedures; changes in economic conditions, changes in the nature and volume of the portfolio; changes in the experience, ability and depth of lending management and other relevant staff; changes in the volume and severity of past due, nonaccrual and other adversely graded loans; changes in the loan review system; changes in the value of the underlying collateral for collateral-dependent loans; concentrations of credit and the effect of other external factors such as competition and legal and regulatory requirements.

 

Portfolio segments identified by the Bank include commercial, real estate construction, land, real estate other, factoring and asset-based lending, SBA, and consumer loans.  Relevant risk characteristics for these portfolio segments generally include debt service coverage, loan-to-value ratios and financial performance on non-consumer loans and credit scores, debt-to income, collateral type and loan-to-value ratios for consumer loans.

 

Sale of SBA Loans

 

The Company has the ability and the intent to sell all or a portion of certain SBA loans in the loan portfolio and, as such, carries the saleable portion of these loans at the lower of aggregate cost or fair value.  At December 31, 2012 and December 31, 2011, the fair value of SBA loans exceeded aggregate cost and therefore, SBA loans were carried at aggregate cost.

 

In calculating gain on the sale of SBA loans, the Bank performs an allocation based on the relative fair values of the sold portion and retained portions of the loan.  The Company assumptions are validated by reference to external market information.

 

Investment Securities

 

Our securities are classified as either available-for-sale or held-to-maturity. The fair value of most securities classified as available-for-sale is based on quoted market prices. If quoted market prices are not available, fair values are extrapolated from the quoted prices of similar instruments. Held-to maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts.

 

Supplemental Employee Retirement Plan

 

The Company has entered into supplemental employee retirement agreements with certain executive and senior officers.  The measurement of the liability under these agreements includes estimates involving life expectancy, length of time before retirement, and expected benefit levels.  Should these estimates prove materially wrong, we could incur additional or reduced expense to provide the benefits.

 

Deferred Tax Assets

 

Our deferred tax assets are explained in Note 8 to the Consolidated Financial Statements. The Company has sufficient taxable income from current and prior periods to support our position that the benefit of our deferred tax assets will be realized.  As such, we have provided no valuation allowance against our deferred tax assets.

 

24



 

Operating Results

 

The Company reported net operating income of $13.8 million for the year ended December 31, 2012 representing an increase of $6.0 million, compared to net income of $7.8 million for the same period one year ago.  For the year ended December 31, 2012, the Company reported earnings per diluted share of $0.92 compared to $0.52 for the year ended December 31, 2011, which included preferred dividend payments of $200,000.  The Company retired the preferred stock issued under TARP in March of 2011 and, as a result, no longer has any preferred dividend payments.  For the year ended December 31, 2010, the Company reported net operating income of $2.6 million.  Net income available to common shareholders was reduced by preferred dividends of $2.0 million resulting in earnings per diluted share of $0.06 for the year ended December 31, 2010.

 

The increase in earnings during 2012 compared to 2011 resulted primarily from an increase in interest income related to loans and investment securities, warrant income and other non-interest income, offset in part by an increase in non-interest expense related to supporting growth and investments in new initiatives.  The increase in earnings during 2011 compared to 2010 resulted primarily from an increase in interest income related to loans and investment securities, and a decrease in provision for loan losses, an increase in non-interest income related to international fee income and a gain on sale of SBA loans, offset in part by an increase in non-interest expense related to supporting growth and investments in new initiatives.  See the specific sections below for details regarding these changes.

 

25



 

Net Interest Income and Margin

 

Net interest income is the principal source of the Company’s operating earnings.  Net interest income is affected by changes in the nature and volume of earning assets held during the year, the rates earned on such assets and the rates paid on interest-bearing liabilities.  The following table shows the composition of average earning assets and average funding sources, average yields and rates, and the net interest margin for the three years ended December 31, 2012, 2011 and 2010.

 

 

 

Year Ended December 31,

 

 

 

2012

 

2011

 

2010

 

 

 

 

 

Interest

 

 

 

 

 

Interest

 

 

 

 

 

Interest

 

 

 

 

 

Average

 

Income/

 

Yields/

 

Average

 

Income/

 

Yields/

 

Average

 

Income/

 

Yields/

 

(dollars in thousands)

 

Balance

 

Expense

 

Rates

 

Balance

 

Expense

 

Rates

 

Balance

 

Expense

 

Rates

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning assets (2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans (1)

 

$

827,691

 

$

56,122

 

6.8

%

$

660,614

 

$

45,352

 

6.9

%

$

590,334

 

$

42,071

 

7.1

%

Investment securities

 

235,892

 

6,461

 

2.7

%

216,870

 

5,068

 

2.3

%

134,349

 

2,733

 

2.0

%

Federal funds sold

 

86,735

 

203

 

0.2

%

109,134

 

255

 

0.2

%

112,940

 

263

 

0.2

%

Interest bearing deposits

 

331

 

1

 

0.3

%

998

 

19

 

1.9

%

5,775

 

121

 

2.1

%

Total earning assets

 

1,150,649

 

62,787

 

5.5

%

987,616

 

50,694

 

5.1

%

843,398

 

45,188

 

5.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

22,946

 

 

 

 

 

22,392

 

 

 

 

 

18,792

 

 

 

 

 

All other assets (3)

 

33,096

 

 

 

 

 

37,133

 

 

 

 

 

34,950

 

 

 

 

 

TOTAL

 

$

1,206,691

 

 

 

 

 

$

1,047,141

 

 

 

 

 

$

897,140

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand

 

$

5,834

 

2

 

0.0

%

$

6,205

 

4

 

0.1

%

$

 6,079

 

6

 

0.1

%

Savings

 

311,712

 

900

 

0.3

%

326,546

 

884

 

0.3

%

306,461

 

1,223

 

0.4

%

Time

 

38,933

 

187

 

0.5

%

36,876

 

208

 

0.6

%

58,285

 

736

 

1.3

%

Other

 

29,057

 

1,106

 

3.8

%

20,217

 

1,160

 

5.7

%

17,622

 

1,106

 

6.3

%

Total interest-bearing Liabilities

 

385,536

 

2,195

 

0.6

%

389,844

 

2,256

 

0.6

%

388,447

 

3,071

 

0.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

667,146

 

 

 

 

 

515,056

 

 

 

 

 

380,295

 

 

 

 

 

Accrued expenses and other liabilities

 

15,643

 

 

 

 

 

14,113

 

 

 

 

 

13,775

 

 

 

 

 

Shareholders’ equity

 

138,366

 

 

 

 

 

128,128

 

 

 

 

 

114,623

 

 

 

 

 

TOTAL

 

$

1,206,691

 

 

 

 

 

$

1,047,141

 

 

 

 

 

$

897,140

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income and margin

 

 

 

$

60,592

 

5.3

%

 

 

$

48,438

 

4.9

%

 

 

$

42,117

 

5.0

%

 


1)     Includes amortization of loan fees of $9.4 million for 2012, $5.7 million for 2011 and $4.1 million for 2010.  Nonperforming loans have been included in average loan balances.

 

2)    Interest income is reflected on an actual basis, not on a fully taxable equivalent basis.  Yields are based on amortized cost.

 

3)     Net of average allowance for loan losses of $19.2 million and average deferred loan fees of $2.9 million for 2012, average allowance for loan losses of $16.9 million and average deferred loan fees of $1.8 million for 2011, and average allowance for loan losses of $15.6 million and $1.5 million for 2010, respectively.

 

Interest differential is affected by changes in volume, changes in rates and a combination of changes in volume and rates. Volume changes are caused by changes in the levels of average earning assets and average interest bearing deposits and borrowings.  Rate changes result from changes in yields earned on assets and rates paid on liabilities.  Changes not solely attributable to volume or rates have been allocated to the rate component.

 

26



 

The following table shows the effect on the interest differential of volume and rate changes for the years ended December 31, 2012, 2011 and 2010:

 

 

 

Year Ended December 31,

 

 

 

2012 vs. 2011

 

2011 vs. 2010

 

 

 

Increase (decrease)

 

Increase (decrease)

 

 

 

due to change in

 

due to change in

 

 

 

Average

 

Average

 

Total

 

Average

 

Average

 

Total

 

(dollars in thousands)

 

Volume

 

Rate

 

Change

 

Volume

 

Rate

 

Change

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

11,329

 

$

(559

)

$

10,770

 

$

4,825

 

$

(1,544

)

$

3,281

 

Investment securities

 

521

 

872

 

1,393

 

1,928

 

407

 

2,335

 

Federal funds sold

 

(52

)

0

 

(52

)

(9

)

1

 

(8

)

Other

 

(2

)

(16

)

(18

)

(91

)

(11

)

(102

)

Total interest income

 

11,795

 

298

 

12,093

 

6,654

 

(1,148

)

5,506

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand

 

(0

)

(2

)

(2

)

0

 

(2

)

(2

)

Savings

 

(43

)

59

 

16

 

55

 

(394

)

(339

)

Time

 

10

 

(31

)

(21

)

(121

)

(407

)

(528

)

Other

 

336

 

(390

)

(54

)

149

 

(95

)

54

 

Total interest expense

 

303

 

(364

)

(61

)

84

 

(898

)

(815

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in net interest income

 

$

11,492

 

$

662

 

$

12,154

 

$

6,570

 

$

(250

)

$

6,321

 

 

Net interest income was $60.6 million in 2012, comprised of $62.8 million in interest income and $2.2 million in interest expense.  Net interest income was $48.4 million in 2011, comprised of $50.7 million in interest income and $2.3 million in interest expense.  The increase of $12.2 million in net interest income in 2012, comprised of an increase in interest income of $12.1 million combined with a decrease of $61,000 in interest expense, was primarily attributable to an increase in average earning assets as a result of loan growth.

 

Net interest income was $42.1 million in 2010, comprised of $45.2 million in interest income and $3.1 million in interest expense.  The increase of $6.3 million in net interest income in 2011, comprised of an increase in interest income of $5.5 million combined with a decrease of $815,000 in interest expense, was primarily attributable to an increase in average earning assets combined with a decrease in average non-performing loans and a lower cost of funds.

 

The net interest margin (net interest income divided by average earning assets) was 5.27% for the year ended December 31, 2012, as compared to 4.90% for the year ended December 31, 2011 and 4.99% for 2010. The increase in net interest margin in 2012 was primarily due to increased balance sheet leverage, a more favorable mix in average earning assets, and increased recurring loan fees related to overall growth of the loan portfolio. The positive impact on the net interest margin from increased loan fees for the twelve months ended December 31, 2012 compared to the same period one year ago was 24 basis points. The Company’s loan-to-deposit ratio, a measure of leverage, averaged 80.9% during the twelve months ended December 31, 2012, which represented an increase compared to an average of 74.7% for the same period in 2011.

 

The decrease in net interest margin in 2011 was primarily due to decreased balance sheet leverage and a less favorable mix in average earning assets, partially offset by increased loan fees related to growth in the factoring and asset-based lending portfolio. The positive impact on the net interest margin from increased loan fees for the twelve months ended December 31, 2011 compared to the same period in 2010 was 9 basis points. The Company’s loan-to-deposit ratio averaged 74.7% during the twelve months ended December 31, 2011 compared to 78.6% for the same period in 2010.

 

Interest Income

 

For the year ended December 31, 2012, the Company reported interest income of $62.8 million, an increase of $12.1 million or 23.9% over $50.7 million reported in 2011.  The increase in interest income primarily reflects an increase in average earning assets in addition to an increase in the average yield on investment securities.  Average earning assets were $1.151 billion for the year ended December 31, 2012, an increase of $163.0 million, or 16.5%, over $987.6 million for the year ended December 31, 2011.  The increase in average earning assets reflects an increase in the average loan portfolio of $167.1 million over $660.6 million in 2011, and an increase in the average securities portfolio

 

27



 

of $19.0 million from $216.9 million in 2011.  The average yield on earning assets was 5.46% for the year ended December 31, 2012 compared to 5.13% for the year ended December 31, 2011 primarily due to a higher rate of interest earned on investment securities during 2012, more favorable mix of average earning assets, as well as a higher yield on investment securities. This was partially offset by lower rates of interest earned on all other earning assets.

 

For the year ended December 31, 2011, the Company reported interest income of $50.7 million, an increase of $5.5 million or 12.2% over $45.2 million reported in 2010.  The increase in interest income primarily reflects an increase in average earning assets.  Average earning assets were $987.6 million for the year ended December 31, 2011 an increase of $144.2 million, or 17.1%, over $843.4 million for the year ended December 31, 2010.  The increase in average earning assets reflects an increase in the average loan portfolio of $70.3 million over $590.3 million in 2010, and an increase in the average securities portfolio of $82.5 million from $134.3 million in 2010.  The average yield on earning assets was 5.13% for the year ended December 31, 2011 compared to 5.36% for the year ended December 31, 2010 due to a higher rate of interest earned on securities instruments during 2011, and a decrease in the rate of interest earned on the loan portfolio during 2011.  The decrease in the rate of interest earned on the loan portfolio was partially offset by a decrease in average non-performing loans during the year, as well as increased loan fees related to loan recoveries and growth in the factoring and asset based lending portfolio.

 

Interest Expense

 

Interest expense was $2.2 million for the year ended December 31, 2012, which represented a decrease of $61,000 or 2.7% compared to $2.3 million for the year ended December 31, 2011.  The decrease in interest expense primarily reflects a lower level of interest bearing liabilities combined with a lower interest rates paid on deposits in 2012 compared to 2011.  The average yield on interest-bearing liabilities was 0.57% for the period ended December 31, 2012 compared to 0.58% for the period ended December 31, 2011. Average interest-bearing liabilities were $385.5 million for the year ended December 31, 2012, a decrease of $4.3 million or 1.1% from $389.8 million for the year ended December 31, 2011.

 

Average interest bearing deposits were $356.5 million for the year ended December 31, 2012, which represented 34.8% of total average deposits and was a decrease of $13.1 million, or 3.6%, from $369.6 million at December 31, 2011, representing 41.8% of total average deposits for the year.

 

Other (non-deposit) interest bearing liabilities are primarily comprised of junior subordinated debt securities issued by the Company and other borrowings.  The junior subordinated debt is intended to supplement capital requirements of the Company at a rate of interest that is fixed for five years.  Other borrowings during the year was comprised of short borrowings. Other interest bearing liabilities averaged $29.1 million and $20.2 million in the years ended December 31, 2012 and 2011, respectively.

 

Interest expense was $2.3 million for the year ended December 31, 2011, which represented a decrease of $815,000 or 26.5% compared to $3.1 million for the year ended December 31, 2010.  The decrease in interest expense primarily reflects the lower interest rates paid on deposits in 2011 compared to 2010.  The average yield on interest-bearing liabilities was 0.58% for the period ended December 31, 2011 compared to 0.78% for the period ended December 31, 2010. Average interest-bearing liabilities were $389.8 million for the year ended December 31, 2011, an increase of $1.4 million or 0.4% from $388.4 million for the year ended December 31, 2010.

 

Average interest bearing deposits were $369.6 million for the year ended December 31, 2011, which represented 41.8% of total average deposits and was a decrease of $1.2 million, or 0.3%, from $370.8 million at December 31, 2010, representing 49.4% of total average deposits for the year.

 

Other (non-deposit) interest bearing liabilities are primarily comprised of junior subordinated debt securities issued by the Company and other borrowings.  The junior subordinated debt is intended to supplement capital requirements of the Company at a rate of interest that is fixed for five years.  Other interest bearing liabilities averaged $20.2 million and $17.6 million in the years ended December 31, 2011 and 2010, respectively.

 

Credit Risk and Provision for Loan losses

 

The Company maintains an allowance for loan losses which is based, in part, on the Company’s loss experience, the impact of economic conditions within the Company’s market area and, as applicable, the State of California and/or national macroeconomic conditions, the value of underlying collateral, loan performance, and inherent risks in the loan portfolio. The allowance is reduced by charge-offs and increased by provisions for loan losses charged to operating expense and recoveries of previously charged-off loans.  Based on management’s evaluation of such risks, the Company provided $4.0 million, $2.6 million, and $4.7 million to the allowance for loan losses in 2012, 2011 and 2010,

 

28



 

respectively. During 2012, the Bank had $3.1 million in charge offs, and had recoveries of $0.6 million as compared to $2.9 million in charge offs and recoveries of $3.3 million in 2011.  During 2010, the Bank had $8.2 million in charge offs and $3.0 million in recoveries.  The allowance for loan losses was $19.9 million representing 2.20% of total loans at December 31, 2012, as compared to $18.5 million representing 2.43% of total loans at December 31, 2011, and $15.5 million representing 2.39% of total loans at December 31, 2010.

 

Management is of the opinion that the allowance for loan losses is maintained at a level adequate for known and unidentified losses inherent in the portfolio.  However, although the Company is seeing a lower incidence of new problem assets, as well as a consistent reduction of carrying values through continued payments by borrowers on loans that have been placed on non-accrual, should circumstances change and management determines that the collectibility of any of these credits becomes unlikely, there could be an adverse effect on the level of the allowance for loan losses and the Company’s future profitability.

 

See “Allowance for Loan Losses” for additional discussion regarding the allowance for loan losses and nonperforming assets.

 

Non-interest Income

 

The following table sets forth the components of other income and the percentage distribution of such income for the years ended December 31, 2012, 2011 and 2010:

 

 

 

Year Ended December 31,

 

 

 

2012

 

2011

 

2010

 

(dollars in thousands) 

 

Amount

 

Percent

 

Amount

 

Percent

 

Amount

 

Percent

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

$

3,354

 

25.8

%

$

2,876

 

29.0

%

$

2,417

 

35.3

%

International fee income

 

2,646

 

20.4

%

2,488

 

25.1

%

1,785

 

26.1

%

Gain on sale of SBA loans

 

1,850

 

14.2

%

1,743

 

17.6

%

 

0.0

%

Warrant income

 

1,422

 

11.0

%

392

 

3.9

%

36

 

0.5

%

Net gain on sale of OREO

 

1,056

 

8.1

%

421

 

4.2

%

1,011

 

14.8

%

SBA loan servicing fee income

 

514

 

4.0

%

411

 

4.1

%

380

 

5.5

%

Increase in value-bank owned life insurance

 

422

 

3.3

%

388

 

3.9

%

392

 

5.7

%

Net gain on sale of securities

 

323

 

2.5

%

438

 

4.4

%

165

 

2.4

%

Other non-interest income

 

1,397

 

10.7

%

773

 

7.9

%

663

 

9.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

12,984

 

100.0

%

$

9,930

 

100.0

%

$

6,849

 

100.0

%

 

Non-interest income totaled $13.0 million in 2012, an increase of $3.1 million or 30.8% over $9.9 million in 2011.  Non-interest income of $9.9 million in 2011 represented an increase of $3.1 million or 45.0% over $6.8 million in 2010.  Non-interest income generally consists primarily of service charge income on deposit accounts, international fee income, gain on sales of OREO and gains recognized on sales of SBA loans.  The increase in non-interest income during the year ending December 31, 2012 was primarily attributable to an increase in warrant income. Additionally, non-interest income benefited during 2012 by increased gains on sale of OREO and service charges on deposit account.

 

The increase in non-interest income during the year ending December 31, 2011 was primarily attributable to an increase in gains on sales of SBA loans of $1.7 million during 2011. The company did not sell any SBA loans in 2010. Additionally, non-interest income benefited during 2011 by increased service charges on deposit accounts and increased international fee income.

 

For the year ended December 31, 2012 service charge income on deposit accounts was $3.4 million, representing an increase of $478,000, or 16.6%, compared to $2.9 million for the same period one year ago.  The service charge income on deposit accounts for 2011 compared to $2.4 million in 2010, representing an increase of $459,000 or 19.0%. The increase in 2012 and 2011 was attributable to an increase in deposit accounts and deposit related analysis charges.

 

29



 

The Company generates international fee income on spot contracts (binding agreements for the purchase or sale of currency for immediate delivery and settlement) and forward contracts (a contractual commitment for a fixed amount of foreign currency on a future date at an agreed upon exchange rate) in connection with client’s cross-border activities. The transactions incurred are during the ordinary course of business and are not speculative in nature.  The Company recognizes income on a cash basis at the time of contract settlement in an amount equal to the spread created by the exchange rate charged to the client versus the actual exchange rate negotiated by the Company in the open market.  During 2012, the Company recognized $2.6 million in international fee income, representing an increase of $158,000, or 6.4%, compared to $2.5 million for the same period one year ago.  The international fee income for 2011 compared to $1.8 million in 2010, representing an increase of $703,000, or 39.4%.  The increase in international fee income in both 2012 and 2011 was primarily caused by an increase in client demand for international services as a result of the recovering economic environment.

 

Revenue from sales of SBA loans is dependent on the Company’s decision to sell versus retain loans as well as consistent origination and funding of new loan volumes, the timing of which may be impacted by (1) increased competition from other lenders; (2) the relative attractiveness of SBA borrowing to other financing options; (3) adjustments to programs by the SBA; (4) changes in activities of secondary market participants and; (5) other factors.  During 2012, the Company recognized $1.9 million in gains on sale of SBA loans, representing an increase of $107,000 or 6.1% over the prior year.  The Company recognized $1.7 million in gains on sales of SBA loans in 2011 compared to 2010 where the company did not recognize any gains on sales of SBA loans.

 

During 2012, the Company recognized $1.4 million in warrant income. This represented an increase of $1.0 million or 262.8% over $392,000 in 2011. Income from warrants is inherently event-driven and the contributions from warrants largely reflect the economic environment of IPOs and M&A activity.  Compared to $36,000 in 2010, the increase in 2011 represents $356,000 or 988.9%.

 

During 2012, 2011, and 2010, the Company recognized $1.1 million, $421,000, and $1.0 million, respectively, in gains on the sale of OREO properties. During the year ending December 31, 2012, the Company recognized $1.6 million as a result of the successful resolution of “other real estate owned” properties and legacy problem loans that were originated prior to the economic downturn.

 

The Company earns a servicing fee on all SBA loans sold.  During 2012, $514,000 in SBA loan servicing income was recognized compared to $411,000 for the prior year, reflecting an increase of $103,000 or 25.1%. The $411,000 recognized in 2011 also represents an increase of $31,000 or 8.2% over $380,000 in 2010.

 

The Company recognized gains on the sale of securities of $323,000 during the twelve months ended December 31, 2012 which represents a decrease of $115,000 or 26.3% compared to $438,000 during 2011.  During 2010 the Company recognized $165,000 in gain on the sale of securities. Compared to 2010, the increase in gains on the sale of securities in 2011 represented $273,000 or 165.5%.

 

30



 

Non-interest Expenses

 

The components of other expense as a percentage of average assets are set forth in the following table for the years ended December 31, 2012, 2011 and 2010:

 

 

 

Year Ended December 31,

 

 

 

2012

 

2011

 

2010

 

(dollars in thousands) 

 

Amount

 

Percent

 

Amount

 

Percent

 

Amount

 

Percent

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

$

30,308

 

2.5

%

$

24,606

 

2.3

%

$

21,292

 

2.4

%

Occupancy

 

3,441

 

0.3

%

3,296

 

0.3

%

3,343

 

0.4

%

Data processing

 

3,257

 

0.3

%

3,046

 

0.3

%

2,913

 

0.3

%

Marketing

 

2,060

 

0.2

%

1,571

 

0.2

%

1,012

 

0.1

%

Director/Shareholder expenses

 

1,277

 

0.1

%

1,158

 

0.1

%

1,273

 

0.1

%

Professional services

 

1,206

 

0.1

%

2,667

 

0.3

%

2,106

 

0.2

%

Deposit services/supplies

 

989

 

0.1

%

954

 

0.1

%

909

 

0.1

%

OREO expense

 

174

 

0.0

%

1,140

 

0.1

%

1,975

 

0.2

%

Assessments

 

879

 

0.1

%

1,717

 

0.2

%

2,500

 

0.3

%

Furniture and equipment

 

552

 

0.0

%

505

 

0.0

%

699

 

0.1

%

Other

 

2,069

 

0.2

%

1,764

 

0.2

%

1,698

 

0.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

46,212

 

3.8

%

$

42,424

 

4.1

%

$

39,720

 

4.4

%

 

Non-interest expenses were $46.2 million in 2012 as compared to $42.4 million in 2011 and $39.7 million in 2010.  Non-interest expense increased approximately $3.8 million in 2012 compared to 2011.  This increase was primarily attributable to increased salaries and benefits, marketing costs and data processing expense. Overall, trends in non-interest expenses in 2012 reflect a lower level of expense related to problem asset valuation and resolution and higher expenses related to supporting growth and investments in new initiatives.

 

Non-interest expense increased approximately $2.7 million in 2011 compared to 2010.  This increase was primarily attributable to increased salaries and benefits, marketing costs and professional services.  Non-interest expenses measured as a percentage of average assets were 3.8% in 2012, 4.1% in 2011 and 4.4% in 2010.

 

Salaries and related benefits was the largest component of the Bank’s non-interest expense.  Salaries and benefits were $30.3 million for the year ended December 31, 2012 as compared to $24.6 million and $21.3 million for the years ended December 31, 2011 and 2010, respectively.  The Bank had 207 full time equivalent employees (FTE) at December 31, 2012 as compared to 193 FTE at December 31, 2011 and 170 FTE at December 31, 2010.  The increase in salaries and related benefits in 2012 compared to 2011 and 2010 was primarily attributable to the increase in headcount to support growth and new initiatives, increased stock based compensation due to long term retention awards granted in the third quarter of 2012, and an increase in commissions and incentive compensation directly related to increased loan and deposit production.

 

Occupancy expense for the year ended December 31, 2012 was $3.4 million and compared to $3.3 million during 2011, which represents an increase of $145,000 or 4.4%.  Occupancy expense for the year ended December 31, 2011 represented a decrease of approximately $47,000 over $3.3 million from 2010.

 

The Company contracts with third-party vendors for most data processing needs and to support technical infrastructure.  Data processing expense in 2012 was $3.3 million which represented an increase of approximately $211,000 over $3.0 million one year earlier.  Data processing expense in 2011 represented an increase of approximately $133,000 over $2.9 million one year earlier.  The increase in data processing in both years was primarily due to an increase in deposit transaction volumes.

 

Legal and professional expenses were $1.2 million for the year ended December 31, 2012, which represents a $1.5 million decrease compared to $2.7 million one year earlier.  Legal and professional expenses were $2.1 million for the year ended December 31, 2010.  The decrease in legal fees in 2012 was primarily a result of reduced non-performing assets. The increase in legal and professional expenses in 2011 was primarily due to the early redemption of Series C preferred shares and repurchase of the related warrant, as well as legal fees associated with the active management of one non-real estate credit exposure.  The elevated legal and professional expenses in 2010 was primarily attributed to legal fees associated with a $30.0 million private placement of common stock as well as legal fees resulting from elevated levels of non-performing assets.

 

Regulatory assessments related to participation in the Transaction Guarantee Program as well as FDIC insurance pertaining to deposit balances, totaled $879,000 for the year ended December 31, 2012, compared to $1.7 million for the year ended December 31, 2011 and $2.5 million in 2010.

 

31



 

Other real estate owned (OREO) expense for the year ended December 31, 2012 was $174,000, which represents a decrease of $966,000 compared to $1.1 million for the same period one year earlier.  December 31, 2011 OREO expense reflects a decrease of $835,000 from $2.0 million in 2010. The decrease in 2012 and 2011 reflects the consistent decline in non-performing assets since 2010.

 

The Company’s efficiency ratio, the ratio of non-interest expenses to revenues, was 62.81% for the twelve months ended December 31, 2012, compared to 72.68% and 81.12% for the twelve months ended December 31, 2011 and December 31, 2010, respectively.  As pressure continues on net interest margins and net asset growth, management of operating expenses will continue to be a priority.

 

Income Taxes

 

The Company’s effective tax rate was 41.0% for the year ended December 31, 2012, 41.2% for the year ended December 31, 2011 and 43.0% for the year ended December 31, 2010.  See Note 8 to the consolidated financial statements for additional information on income taxes.

 

32



 

Quarterly Income

 

The unaudited income statement data of the Company, in the opinion of management, includes all normal and recurring adjustments necessary to state fairly the information set forth herein.  The results of operations are not necessarily indicative of results for any future period.  The following table shows the Company’s unaudited quarterly income statement data for the years 2012, 2011, and 2010.

 

 

 

Three Months Ended

 

(dollars in thousands, except share amounts)

 

March 31

 

June 30

 

September 30

 

December 31

 

Year Ended December 31, 2012:

 

 

 

 

 

 

 

 

 

Interest income

 

$

15,325

 

$

15,090

 

$

15,970

 

$

16,402

 

Interest expense

 

479

 

549

 

573

 

594

 

Net interest income

 

14,846

 

14,541

 

15,397

 

15,808

 

Provision for credit losses

 

1,750

 

500

 

200

 

1,500

 

Other income

 

2,542

 

2,972

 

3,785

 

3,685

 

Other expense

 

11,077

 

11,358

 

11,584

 

12,193

 

Income before income taxes

 

4,561

 

5,655

 

7,398

 

5,800

 

Income taxes

 

1,854

 

2,346

 

3,034

 

2,376

 

Net income

 

$

2,707

 

$

3,309

 

$

4,364

 

$

3,424

 

Preferred dividends

 

 

 

 

 

Net income available to common shareholders

 

$

2,707

 

$

3,309

 

$

4,364

 

$

3,424

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - basic

 

$

0.19

 

$

0.23

 

$

0.30

 

$

0.24

 

Earnings per share - diluted

 

$

0.18

 

$

0.22

 

$

0.29

 

$

0.23

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31, 2011:

 

 

 

 

 

 

 

 

 

Interest income

 

$

11,710

 

$

12,301

 

$

13,180

 

$

13,503

 

Interest expense

 

652

 

535

 

529

 

540

 

Net interest income

 

11,058

 

11,766

 

12,651

 

12,963

 

Provision for credit losses

 

750

 

0

 

1,250

 

600

 

Other income

 

2,546

 

1,511

 

3,257

 

2,616

 

Other expense

 

10,237

 

10,205

 

10,923

 

11,059

 

Income before income taxes

 

2,617

 

3,072

 

3,735

 

3,920

 

Income taxes

 

1,047

 

1,286

 

1,532

 

1,633

 

Net income

 

$

1,570

 

$

1,786

 

$

2,203

 

$

2,287

 

Preferred dividends

 

200

 

0

 

0

 

0

 

Net income available to common shareholders

 

$

1,370

 

$

1,786

 

$

2,203

 

$

2,287

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - basic

 

$

0.10

 

$

0.13

 

$

0.15

 

$

0.16

 

Earnings per share - diluted

 

$

0.09

 

$

0.12

 

$

0.15

 

$

0.16

 

 

FINANCIAL CONDITION AND EARNING ASSETS

 

As of December 31, 2012, total assets were $1.3 billion, gross loans were $908.6 million and deposits were $1.2 billion. Assets increased $182.6 million, or 15.7%, from $1.2 billion at December 31, 2011.  Gross loans increased $146.6 million, or 19.2%, from $762.0 million at December 31, 2011.  Deposits increased $163.9 million, or 16.4%, from $998.7 million at December 31, 2011.

 

As of December 31, 2011, total assets were $1.2 billion, gross loans were $762.0 million and deposits were $998.7 million. Assets increased $131.3 million, or 12.8%, from $1.0 billion at December 31, 2010.  Gross loans increased $110.5 million, or 17.0% from $651.5 million at December 31, 2010.  Deposits increased $150.7 million, or 17.8%, from $847.9 million at December 31, 2010.

 

33



 

Federal Funds Sold

 

Federal funds sold were $113.8 million at December 31, 2012 as compared to $106.7 million at December 31, 2011.  The Company’s investment in federal funds sold reflects the Company’s current strategy of deploying other earning assets primarily in federal funds sold to address the potential volatility of deposit balances and to accommodate projected loan growth.

 

The average balance of federal funds sold was $86.7 million in 2012 and $109.1 million in 2011.  These balances represented 8.5% and 12.3% of average deposits for 2012 and 2011, respectively.  They are maintained primarily for the short-term liquidity needs of the Bank.

 

Securities

 

Investment securities are classified as either available for sale or held to maturity.  Any unrealized gain or loss on investment securities available for sale is reflected in the carrying value of the security and reported net of income taxes in the equity section of the balance sheet.  Held-to maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. The pre-tax unrealized gain on securities available for sale at December 31, 2012 and 2011 was $2.9 million and $1.6 million, respectively.

 

The following table shows the composition of the securities portfolio at December 31, 2012 and 2011.

 

 

 

As of December 31,

 

 

 

2012

 

2011

 

 

 

Amortized

 

Fair

 

Amortized

 

Fair

 

(dollars in thousands)

 

Cost

 

Value

 

Cost

 

Value

 

Securities available for sale

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

U.S. government agency securities

 

$

12,976

 

$

13,112

 

$

14,873

 

$

15,014

 

Mortgage backed securities

 

208,058

 

210,919

 

181,226

 

183,138

 

Corporate Bonds

 

25,559

 

25,674

 

26,294

 

25,859

 

Municipal Bonds

 

2,436

 

2,262

 

 

 

Total debt securities

 

249,029

 

251,967

 

222,393

 

224,011

 

 

 

 

 

 

 

 

 

 

 

Total securities available for sale

 

$

249,029

 

$

251,967

 

$

222,393

 

$

224,011

 

 

 

 

 

 

 

 

 

 

 

Securities held to maturity

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

Mortgage backed securities

 

15,237

 

15,606

 

16,256

 

16,604

 

Total debt securities

 

15,237

 

15,606

 

16,256

 

16,604

 

 

 

 

 

 

 

 

 

 

 

Total securities held to maturity

 

$

15,237

 

$

15,606

 

$

16,256

 

$

16,604

 

 

 

 

 

 

 

 

 

 

 

Total investment securities

 

$

264,266

 

$

267,573

 

$

238,649

 

$

240,615

 

 

34



 

The maturities and yields of the debt securities included in the investment portfolio at December 31, 2012 and December 31, 2011 are shown in the table below.  There were no equity securities in 2012 and 2011.

 

 

 

 

 

Due in one year

 

Due after one year

 

Due greater than

 

 

 

 

 

or less

 

through five years

 

five years

 

 

 

 

 

 

 

Weighted

 

 

 

Weighted

 

 

 

Weighted

 

 

 

Amortized

 

 

 

Average

 

 

 

Average

 

 

 

Average

 

(dollars in thousands)

 

Cost

 

Amount

 

Yield

 

Amount

 

Yield

 

Amount

 

Yield

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2012:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government agencies

 

$

12,976

 

$

 

0.0

%

$

2,001

 

0.9

%

$

10,975

 

2.1

%

Mortgage backed securities

 

223,295

 

6,754

 

1.9

%

41,276

 

2.2

%

175,265

 

3.1

%

Corporate bonds

 

25,559

 

10,347

 

1.9

%

14,227

 

2.0

%

985

 

3.3

%

Municipal bonds

 

2,436

 

 

2.1

%

 

2.0

%

2,436

 

2.6

%

Total debt securities

 

$

264,266

 

$

17,101

 

1.9

%

$

57,504

 

2.1

%

$

189,661

 

3.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government agencies

 

$

14,873

 

$

 

0.0

%

$

5,002

 

1.3

%

$

9,871

 

2.6

%

Mortgage backed securities

 

197,482

 

1,500

 

2.7

%

49,453

 

2.1

%

146,529

 

3.3

%

Corporate bonds

 

26,294

 

5,627

 

2.1

%

16,690

 

2.0

%

3,977

 

3.0

%

Total debt securities

 

$

238,649

 

$

7,127

 

2.2

%

$

71,145

 

2.0

%

$

160,377

 

3.2

%

 

35



 

Loan Portfolio

 

The following table shows the Company’s loans by type and their percentage distribution at December 31, 2012, 2011, 2010, 2009, and 2008.

 

 

 

As of December 31,

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

436,293

 

$

330,348

 

$

269,034

 

$

253,776

 

$

301,024

 

Real estate construction

 

35,501

 

47,213

 

40,705

 

20,601

 

98,105

 

Land loans

 

8,973

 

6,772

 

9,072

 

12,763

 

23,535

 

Real estate other

 

139,931

 

157,446

 

138,633

 

149,617

 

134,767

 

Factoring and asset based

 

195,343

 

142,482

 

122,542

 

66,660

 

55,761

 

SBA

 

87,375

 

73,336

 

67,538

 

67,629

 

77,043

 

Other

 

5,163

 

4,431

 

4,023

 

5,395

 

9,371

 

Total gross loans

 

908,579

 

762,028

 

651,547

 

576,441

 

699,606

 

Unearned fee income

 

(3,056

)

(2,792

)

(1,444

)

(1,452

)

(1,601

)

Total loan portfolio

 

$

905,523

 

$

759,236

 

$

650,103

 

$

574,989

 

$

698,005

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

48.0

%

43.4

%

41.3

%

44.0

%

43.0

%

Real estate construction

 

3.9

%

6.2

%

6.2

%

3.6

%

14.0

%

Land loans

 

1.0

%

0.9

%

1.4

%

2.2

%

3.4

%

Real estate other

 

15.4

%

20.7

%

21.3

%

26.0

%

19.3

%

Factoring and asset based

 

21.5

%

18.7

%

18.8

%

11.6

%

8.0

%

SBA

 

9.6

%

9.6

%

10.4

%

11.7

%

11.0

%

Other