UNITED SECURITY BANCSHARES - Annual Report: 2010 (Form 10-K)

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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010.

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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM               TO             .

Registrant’s telephone number, including area code    (559) 248-4943

Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in the 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

 

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o

Small reporting company x

 

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Loan Documentation – All loan documentation is prepared by a centralized loan servicing department or by legal counsel based on the terms contained in the approved Credit Authorizations.  The documentation, upon completion, is reviewed by a third party (Bank employee)  in the loan servicing department prior to forwarding to the relationship managers, who then review the documents to ensure that they have been correctly prepared in accordance with the credit approval before execution by the borrowers.

 

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Purchased Participations – The Bank independently underwrites, using the Bank’s same guidelines for direct originations, and reviews the loan documentation of participation loans originated by other lenders for acceptability.

 

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Verification of Information – The Bank, principally a commercial business lender, has not and does not make any “No Doc” or “Stated Income” loans.  In the underwriting of a commercial loan request, the Bank performs an enterprise analysis of the financial information for trends, verifies major assets and liabilities, and obtains Dun and Bradstreet Credit reports on the entities and credit bureau reports on the principals of the entity.  Regarding construction lending, the analyses have been enhanced to investigate and analyze real estate projects being financed by other lenders.

 

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The Company is not dependent on any individual customer, entity, or group of related entities for deposits nor have a significant percentage of loans to borrowers.

 

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Unsecured - Whether unsecured or secured, guarantees are usually obtained from the principals or from 3rd party guarantors if necessary for additional financial support. Unsecured loans totaled $59.3 million, $78.7 million and $91.6 million at December 31, 2010, 2009, and 2008, respectively.

 

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Additional Loans to nonaccrual borrowers. – The Bank as a general rule does not make additional loans to borrowers that are past due in principal or interest more than 90-days.  However, in selected and limited instances as part of the workout or restructure of non-performing assets, to effect repayment, additional secured advances may be made.

 

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Lending Limits – The Bank approves revolving lines of credit or loans for each borrower with terms and limits.  Consideration is given for the aggregate direct borrowing exposure of the borrower, as well as, their indirect liability, plus the indirect liability of any guarantor.  Overall, the Bank has established normal “House” lending limits at 50% of the Legal Lending Limit. The Legal Lending Limit is calculated for unsecured loans at 15% of total regulatory capital, and for secured loans at 25% of total regulatory capital. The Board of Directors must approve any borrowing relationship that exceeds the House Lending Limit.

 

	Rank	Share
Fresno County	8th	4.62%
Madera County	10th	3.98%
Kern County	14th	1.06%
Total of Fresno, Madera, Kern Counties	9th	3.34%
Santa Clara County	43rd	0.04%

 

The BHC Act requires, among other things, prior approval before acquiring, directly or indirectly, ownership or control of any voting shares of any bank, if after such acquisition it would directly or indirectly own or control more than 5% of the voting stock of that bank, unless it already owns a majority of the voting stock of that bank. The BHC Act also provides that the FRB shall not approve any acquisition that would result in or further the creation of a monopoly, or the effect of which may be substantially to lessen competition, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the probable effect in meeting the convenience and needs of the community served.

 

 

 

A bank that does not achieve and maintain the required capital levels may be issued a capital directive by the FDIC to ensure the maintenance of required capital levels.  As discussed above, the Company is required to maintain certain levels of capital, as is the Bank.  The regulatory capital guidelines as well as the actual capitalization for the Bank and the Company as of December 31, 2010 are as follows:

	Requirement to be:		December 31, 2010
	Adequately Capitalized	Well Capitalized	Company	Bank
Tier 1 leverage capital ratio	4.0%	5.0%	11.50%	11.04%
Tier 1 risk-based capital ratio	4.0%	6.0%	14.90%	14.35%
Total risk-based capital ratio	8.0%	10.0%	16.17%	15.58%

 

 

·	raised the minimum designated reserve ratio (“DDR”) which the FDIC must set each year, to 1.35 percent (from the former minimum of 1.15 percent) and removed the upper limit on the DRR (which was formerly capped at 1.5 percent) and therefore on the size of the fund;

 

·	required that the fund reserve ratio reach 1.35 percent by September 30, 2020 (rather than 1.15 percent by the end of 2016, as formerly required);

 

·	required that, in setting assessments, the FDIC “offset the effect of requiring that the reserve ratio reach 1.35 percent by September 30, 2020 rather than 1.15 percent by the end of 2016 on insured depository institutions with total consolidated assets of less than $10,000,000,000”

 

·	eliminated the requirement that the FDIC provide dividends from the fund when the reserve ratio is between 1.35 percent and 1.5 percent; and

 

 

·	estimated operating expenses of the Deposit Insurance Fund;

·	case resolution expenditures and income of the Deposit Insurance Fund;

·	the projected effects of assessments on the capital and earnings of the institutions paying assessments to the Deposit Insurance Fund;

·	the risk factors and other factors taken into account pursuant to 12 USC 1817(b)(1); and

·	any other factors the Board may deem appropriate.

 

 

 

 

 

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a membership stock requirement with an initial cap of $25 million (100% of “membership asset value” as defined), or

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an activity based stock requirement (based on percentage of outstanding advances).

 

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Strengthen credit risk management practices of the Bank by the Bank submitting a written plan to the Federal Reserve Bank to address and include (i) the responsibility of the board of directors to establish appropriate risk tolerance guidelines and risk limits; (ii) timely and accurate identification and quantification of credit risk within the loan portfolio; (iii) strategies to minimize credit losses and reduce the level of problem assets; (iv) procedures for the on-going review of the investment portfolio to evaluate other-than temporary-impairment (“OTTI”) and accurate accounting for OTTI; (v) stress testing of commercial real estate loan and portfolio segments; and (vi) measures to reduce the amount of other real estate owned;

 

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Strengthen asset quality at the Bank by (i) not extending, renewing, or restructuring any credit to or for the benefit of any borrower, including any related interest of the borrower, whose loans or other extensions of credit were criticized in the Report of Examination or in any subsequent report of examination, without appropriate underwriting analysis, documentation, board or committee approval and certification that the board or committee reasonably believes that the extension of credit will not impair the Bank’s interest in obtaining repayment of the already outstanding credit and that the extension of credit or renewal will be repaid according to its terms, (ii) submitting to the Federal Reserve Bank an acceptable written plan designed to improve the Bank’s position through repayment, amortization, liquidation, additional collateral, or other means on each loan or other asset in excess of $1.5 million including other real estate owned that is past due as to principal or interest more than 90 days, on the Bank’s problem loan list, or were adversely classified in the Report of Examination or subsequent report of examination;

 

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Improve management of the Bank’s allowance for loan losses by (i) eliminating from its books, by charge-off or collection, all assets or portions of assets classified “loss” in the Report of Examination that have not been previously collected in full or charged off within 10 days of the Agreement, and  within 30 days from the receipt of any federal or state report of examination, charge off all assets classified “loss” unless otherwise approved in writing by the Federal Reserve Bank, (ii)  maintain a sound process for determining, documenting, and recording an adequate allowance for loan and lease losses (“ALLL”) in accordance with regulatory reporting instructions and relevant supervisory guidance, and (iii) within 60 days of the date of the Agreement,  submitting to the Federal Reserve Bank an acceptable written program for the maintenance of an adequate ALLL, including provision for a review of the ALLL by the board on at least a quarterly calendar basis and remedying any deficiency found in the ALLL in the quarter it is discovered, and the board maintaining written documentation of its review of the ALLL;

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Submit a revised business plan and budget to the Federal Reserve Bank for 2010 and subsequent calendar years that the Bank is subject to the Agreement to improve the Bank’s earnings and overall condition, which plan at a minimum provides a realistic and comprehensive budget for the remainder of calendar year 2010, and description of the operating assumptions that form the basis for, and adequately support, major projected income, expense, and balance sheet components;

 

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Not make certain distributions, dividends, and payments, specifically that (i) the Company and Bank agreeing not to declare or pay any dividends without the prior written approval of the Federal Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors (“Director”), (ii) the Company not taking any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank, and (iii) the Company and its nonbank subsidiaries not making any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank and the Director;

 

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Not incur debt or redeem stock, specifically, that except with the prior written approval of the Federal Reserve Bank, the Company each agree not to incur, increase, or guarantee any debt or purchase or redeem any shares of its stock;

 

 

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Correct violations of the laws by (i) the Bank immediately taking all necessary steps to correct all violations of law and regulation cited in the Report of Examination, (ii) the board of the Bank taking the necessary steps to ensure the Bank’s future compliance with all applicable laws and regulations, (iii) complying with the notice provisions of Section 32 of the FDI Act (12 U.S.C. § 1831i) and Subpart H of Regulation Y of the Board of Governors of the Federal Reserve System (12 C.F.R. §§ 225.71 et seq) prior to appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, and (iv) complying with the restrictions on indemnification and severance payments of Section 18(k) of the FDI Act (12 U.S.C. § 1828(k)) and Part 359 of the FDIC’s regulations (12 C.F.R. Part 359);

 

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Comply with the Agreement by (i) appointing a compliance committee of the Bank (“Compliance Committee”) within 10 days of the date of the Agreement to monitor and coordinate the Bank’s compliance with the provisions of the Agreement, which Compliance Committee is composed of a majority of outside directors who are not executive officers or principal shareholders of the Bank and which is to meet at least monthly and report its findings to the board of directors of the Bank, and (ii) the Company and Bank within 30 days after the end of each calendar quarter following the date of the Agreement submitting to the Federal Reserve Bank written progress reports detailing the form and manner of all actions taken to secure compliance with the Agreement and the results of such actions.

 

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a bank’s or bank holding company’s executive officers, directors and principal shareholders (i.e., in most cases, those persons who own, control or have power to vote more than 10% of any class of voting securities),

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any company controlled by any such executive officer, director or shareholder, or

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any political or campaign committee controlled by such executive officer, director or principal shareholder.

 

 

 

 

 

 

 

The Dodd-Frank Act also creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rulemaking authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as the Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators.  The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.

Many of the provisions of the Dodd-Frank Act will not take effect for at least a year, and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years.  Although the substance and scope of these regulations cannot be determined at this time, it is expected that the legislation and implementing regulations, particularly those provisions relating to the new Consumer Financial Protection Bureau, will increase the Bank’s operating and compliance costs as it is likely that the Bank’s existing regulatory agencies will adopt the same or similar consumer protections as the new Consumer Financial Protection Bureau will adopt.

 

 

 

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A new Capital Assistance Program to help ensure that our banking institutions have sufficient capital to withstand the challenges ahead, paired with a supervisory process to produce a more consistent and forward-looking assessment of the risks on banks' balance sheets and their potential capital needs.

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A new Public-Private Investment Fund on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion, to catalyze the removal of legacy assets from the balance sheets of financial institutions. This fund will combine public and private capital with government financing to help free up capital to support new lending.

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A new Treasury and Federal Reserve initiative to dramatically expand – up to $1 trillion – the existing Term Asset-Backed Securities Lending Facility (TALF) in order to reduce credit spreads and restart the securitized credit markets that in recent years supported a substantial portion of lending to households, students, small businesses, and others.

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An extension of the FDIC's Temporary Liquidity Guarantee Program to October 31, 2009. A new framework of governance and oversight to help ensure that banks receiving funds are held responsible for appropriate use of those funds through stronger conditions on lending, dividends and executive compensation along with enhanced reporting to the public.

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accelerated from 2011 to 2008 the date that the Federal Reserve Bank could pay interest on deposits of banks held with the Federal Reserve to meet reserve requirements;

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to the extent that the U. S. Treasury purchases mortgage securities as part of TARP, the Treasury shall implement a plan to minimize foreclosures including using guarantees and credit enhancements to support reasonable loan modifications, and to the extent loans are owned by the government to consent to the reasonable modification of such loans;

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limits executive compensation for executives for TARP participating financial institutions including a maximum corporate tax deduction limit of $500,000 for each of the top five highest paid executives of such institution, requiring clawbacks of incentive compensation that were paid based on inaccurate or false information, limiting golden parachutes for involuntary and certain voluntary terminations to 2.99x their average annual salary and bonus for the last five years, and prohibiting the payment of incentive compensation that encourages management to take unnecessary and excessive risks with respect to the institution;

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extends the mortgage debt forgiveness provision of the Mortgage Forgiveness Debt Relief Act of 2007 by three years (2012) to ease the income tax burden on those involved with certain foreclosures; and

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qualified financial institutions may count losses on FNMA and FHLMC preferred stock against ordinary income, rather than capital gain income.

 

 

 

 

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Strengthen board oversight of the Bank’s management and operations;

 

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Strengthen credit risk management practices of the Bank;

 

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Strengthen asset quality at the Bank by  (i) not extending, renewing, or restructuring certain credits, and (ii) submitting to the Federal Reserve Bank an acceptable written plan designed to improve the Bank’s position through repayment, amortization, liquidation, additional collateral, or other means on each loan or other asset in excess of $1.5 million including other real estate owned that is past due as to principal or interest more than 90 days, on the Bank’s problem loan list, or were adversely classified in the Report of Examination or subsequent report of examination;

 

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Improve management of the Bank’s allowance for loan losses;

 

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Maintain sufficient capital at the Company and Bank;

 

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Submit a revised business plan and budget to the Federal Reserve Bank for 2010 and subsequent calendar years that the Bank is subject to the Agreement to improve the Bank’s earnings and overall condition;

 

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Not make certain distributions, dividends, and payments, specifically that (i) the Company and Bank agreeing not to declare or pay any dividends without the prior written approval of the Federal Reserve Bank, (ii) the Company not taking any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank, and (iii) the Company and its nonbank subsidiaries not making any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank;

 

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Not incur debt or redeem stock, specifically, that except with the prior written approval of the Federal Reserve Bank, the Company each agree not to incur, increase, or guarantee any debt or purchase or redeem any shares of its stock;

 

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Correct violations of the laws by (i) the Bank immediately taking all necessary steps to correct all violations of law and regulation cited in the Report of Examination, (ii) the board of the Bank taking the necessary steps to ensure the Bank’s future compliance with all applicable laws and regulations, (iii) complying with the notice provisions of applicable federal banking law prior to appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, and (iv) complying with the restrictions on indemnification and severance payments of federal bank law and regulations;

 

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Comply with the Agreement by (i) appointing a compliance committee of the Bank (“Compliance Committee”) within 10 days of the date of the Agreement to monitor and coordinate the Bank’s compliance with the provisions of the Agreement, which Compliance Committee is composed of a majority of outside directors who are not executive officers or principal shareholders of the Bank and which is to meet at least monthly and report its findings to the board of directors of the Bank, and (ii) the Company and Bank within 30 days after the end of each calendar quarter following the date of the Agreement submitting to the Federal Reserve Bank written progress reports detailing the form and manner of all actions taken to secure compliance with the Agreement and the results of such actions;

 

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Develop and adopt a capital plan for the California Department of Financial Institutions to maintain a ratio of tangible shareholders’ equity to total tangible assets equal to or greater than 9.5% and include in such capital plan a capital contingency plan for raising additional capital in the event of various contingencies;

 

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Maintain at the Bank a ratio of tangible shareholders’ equity to total tangible assets equal to or greater than 9.5%;

 

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Provide progress reports within 30 days after the end of each calendar quarter following the date of the Order to the California Department of Financial Institutions detailing the form and manner of all actions taken to secure compliance with the Order and Agreement and the results of such actions.

 

 

 

The Company is operating in a challenging and uncertain economic environment, including generally uncertain conditions nationally and locally in its markets. Financial institutions continue to be affected by declines in the real estate market that have negatively impacted the credit performance of construction, commercial real estate loans, and residential mortgage loans and resulted in significant write-downs of assets by many financial institutions. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. The Company retains direct exposure to the residential and commercial real estate markets, and it is affected by these events. Continued declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have an adverse affect on the Company’s borrowers or their customers, which could adversely affect the Company’s business, financial condition, results of operations and cash flows.
 

 

A prolonged national economic recession or further deterioration of these conditions in the Company’s markets could drive losses beyond that which is provided for in its allowance for credit losses and result in the following consequences:
 

	·	increases in loan delinquencies;
	·	increases in nonperforming assets and foreclosures;
	·	decreases in demand for the Company’s products and services, which could adversely affect its liquidity position; and
	·	decreases in the value of the collateral securing the Company’s loans, especially real estate, which could reduce customers’ borrowing power.

 

 

 

 

 

 

 

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larger regional and national banks and other FDIC insured depository institutions in many of the communities the Company serves;

 

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finance companies, investment banking and brokerage firms, and insurance companies that offer bank-like products;

 

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credit unions, which can offer highly competitive rates on loans and deposits because they receive tax advantages not available to commercial banks; and

 

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technology-based financial institutions including large national and super-regional banks offering on-line deposit, bill payment, and mortgage loan application services.

 

 

 

 

 

 

 

		Closing Prices								Volume
Quarter		High				Low
4th Quarter 2010		$	4.91			$	3.45				821,000
3rd Quarter 2010		$	4.51			$	3.54				409,000
2nd Quarter 2010		$	4.82			$	3.53				598,000
1st Quarter 2010		$	5.18			$	4.28				616,000
4th Quarter 2009		$	5.60			$	2.50				975,000
3rd Quarter 2009		$	6.00			$	4.10				1,377,400
2nd Quarter 2009		$	9.57			$	4.35				2,427,600
1st Quarter 2009		$	11.81			$	4.72				979,600

 

 

Purchases of Equity Securities by Affiliates and Associated Purchasers

 

 

 

 

 

 

 

 

	Period Ending
Index	12/31/05	12/31/06	12/31/07	12/31/08	12/31/09	12/31/10
United Security Bancshares	100.00	161.41	104.27	82.28	32.53	28.93
Russell 2000	100.00	118.37	116.51	77.15	98.11	124.46
Russell 3000	100.00	115.71	121.66	76.27	97.89	114.46
SNL Bank $500M-$1B Index	100.00	113.73	91.14	58.40	55.62	60.72

			December 31,
(in thousands except per share data and ratios)			2010				2009				2008				2007				2006
Summary of Year-to-Date Earnings:
Interest income and loan fees			$	32,490			$	35,676			$	45,147			$	57,156			$	47,356
Interest expense				4,589				7,327				14,938				20,573				14,175
Net interest income				27,901				28,349				30,209				36,583				33,181
Provision for credit losses				12,475				13,375				9,526				6,231				880
Net interest income after
Provision for credit losses				15,426				14,974				20,683				30,372				32,301
Noninterest income				5,939				6,305				8,343				9,681				9,031
Noninterest expense				29,020				27,966				23,351				22,215				19,937
(Loss) income before taxes on income				(7,655	)			(6,687	)			5,675				17,818				21,395
Taxes on income				(3,216	)			(2,150	)			1,605				6,561				8,035
Net (loss) income			$	(4,439	)		$	(4,537	)		$	4,070			$	11,257			$	13,360
Per Share Data:
Net (loss) income – Basic			$	(0.34	)		$	(0.35	)		$	0.31			$	0.85			$	1.07
Net (loss) income – Diluted			$	(0.34	)		$	(0.35	)		$	0.31			$	0.85			$	1.06
Average shares outstanding – Basic				13,003,840				13,003,840				13,047,046				13,173,466				12,531,258
Average shares outstanding - Diluted				13,003,840				13,003,840				13,050,752				13,211,849				12,661,524
Cash dividends paid			$	0.00			$	0.00			$	0.26			$	0.50			$	0.43
Financial Position at Period-end:
Total assets			$	678,210			$	693,235			$	761,077			$	771,715			$	678,314
Total net loans and leases				424,526				492,692				531,788				583,625				489,764
Total deposits				557,466				561,660				508,486				634,617				587,127
Total shareholders' equity				73,270				75,821				79,610				82,431				66,042
Book value per share			$	5.63			$	6.07			$	6.37			$	6.55			$	5.51
Selected Financial Ratios:
Return on average assets				(0.63	%)			(0.62	%)			0.52	%			1.47	%			2.04	%
Return on average shareholders' equity				(5.67	%)			(5.77	%)			4.93	%			13.73	%			20.99	%
Average shareholders' equity to average assets				11.06	%			10.71	%			10.60	%			10.73	%			9.70	%
Allowance for credit losses as a percentage
of total nonperforming loans				35.19	%			29.57	%			25.24	%			45.99	%			57.50	%
Net charge-offs to average loans				2.24	%			1.85	%			0.93	%			0.77	%			0.05	%
Allowance for credit losses as a percentage  of period-end loans				3.75	%			2.96	%			2.12	%			1.26	%			0.88	%
Dividend payout ratio				0.00	%			0.00	%			80.12	%			56.39	%			39.16	%

 

 

 

 

 

 

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Asset quality continued to deteriorate as adversely classified assets increased over four consecutive target and full-scope examinations conducted from 2006 through the June 2009 exam. The dollar volume of adversely classified assets increased by 16.7% during the six months prior to the exam to $142.1 million at the June 2009 examination.

 

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Below investment grade investment securities classified substandard at the previous examination totaling $9.1 million increased to $17.1 million at the June 2010 examination, representing 18.6% of tier 1 capital and reserves as of March 31, 2009. The classified investment securities are comprised of three private-label residential mortgage backed securities that are below investment grade as graded by a national rating agency, were divided between $16.9 million in substandard and $163,000 in loss. The portion listed as loss represented the amount identified as other-than-temporary-impairment (OTTI) and had been recognized as loss as of March 31, 2009.

 

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During the June 2009 examination, it was the opinion of the Federal Reserve Bank that the Bank's methodology related to the allowance for loan and leases losses was flawed, leading the Federal Reserve Bank to conclude that additional provisions were required to raise reserves to an appropriate level. In addition, weaknesses in the ALLL policy were identified and needed to be addressed, which included improvements in documentation related to identification and analysis of loans under SFAS No. 114 and SFAS No. 5, and more detailed justification for the qualitative factors used in the ALLL process. During the six months ended June 30, 2010, several large lending relationships to developers in the San Joaquin Valley deteriorated significantly, requiring an additional $1.8 million in ALLL. In addition, during that period, the Bank experienced increases in other problem loans or potentially problem loans including nonaccrual loans and special mention loans, and real estate valuations continued to decline. Regulators required an increase in the reserves as calculated by the Federal Reserve Bank using a model they call the “Atlanta Model.” The Atlanta Model calculated an estimated range of allowance for loan losses using a blend of national, regional, and local peer bank data. The reserve calculated by the Bank for June 30, 2009 under GAAP included additions to ALLL required for increases in adversely classified and special mention loans experienced during the first half of 2009, and although at the lower range of ALLL as estimated by the Federal Reserve, corresponded favorably with the Federal Reserves’ “Atlanta Model”. The reserve adjustment required for the second quarter of 2009 totaled $6.8 million bringing the ALLL level to $15.8 million (including reserve for unfunded commitments) at June 30, 2009. The ALLL findings of the Federal Reserve Bank included recommendations to better align actual practices with the regulatory governing policy as well as to provide a more specific framework for analyzing, determining, and supporting the factors used in the ALLL methodology.

 

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Earnings performance declined as of June 30, 2009, due in large part to the additional $6.8 million provision recorded for the second quarter ($8.2 million year-to-date) resulting in a net loss for the Company of $4.8 million for the six months ended June 30, 2009. Earnings for the period were also adversely impacted by: a goodwill impairment loss of $3.0 million (pre-tax and net); year-to-date pre-tax impairment losses of $403,000 on the real estate mortgage-backed securities; year-to-date pre-tax operating expenses and impairment losses of $1.3 million related to other real estate owned through foreclosure.

 

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Although the Bank’s Tier 1 leverage capital, Tier 1 risk-based capital, and total risk-based capital ratios remained above regulatory Prompt Corrective Action guidelines of adequately capitalized banks at 10.8%, 11.3%, and 12.6%, respectively, at June 30, 2009, the Federal Reserve concluded that capital levels were less than adequate to support the Bank's high risk profile resulting primarily from the continued decline in asset quality. At the June 2009 examination adversely classified assets were in excess of 150.0% of Tier 1 capital and reserves.

 

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The Bank's liquidity position had tightened since the last examination and was considered marginal at the June 2009 examination. The Bank's tight liquidity position was the result of low levels of liquid assets, high percentage of investment securities pledged against borrowing lines, and higher levels of wholesale borrowings including $64.0 million borrowed from the Federal Home Loan Bank line and $71.3 million borrowed from the Federal Reserve Bank discount window. Brokered deposits total $99.3 million, 19.4% of total deposits at June 30, 2009, and compared unfavorably with the peer group at 6.3%.

 

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The Federal Reserve concluded in the June 2009 examination that oversight by the Board of Directors and senior management was not adequate given the escalating risk profile of the Bank's activities Although the severe economic downturn was a significant factor in the decline in asset quality, the Board of Directors and senior management were deemed responsible for implementing a business strategy which allowed concentrations in higher-risk speculative residential construction lending. The Board of Directors and senior management had taken measures to maintain asset quality, capital, earnings, and liquidity, but had had not responded in a timely manner to the rapidly changing real estate conditions. As of March 31, 2009, the concentration in construction and land development loans represented high levels in relation to equity capital and reserves, although the exposures were declining over the prior few years. For example, management increased the ALLL in the second quarter of 2009, ordered new appraisals on property remargined collateral on loans, and was seeking sources for new equity capital. In addition, several transactions to reduce or restructure problem assets were in process. However, these actions had not resulted in material tangible improvements in the overall condition of the Bank as of the June 2009 examination. In addition, the June 2009 examination identified nine technical violations of Regulation Y Subpart B that deal with the failure to obtain the prescribed appraisals or evaluations on loan extensions or renewals. These violations of law were subsequently remedied.

 

 

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The June 2009 examination indicated that risk management practices needed improvement. Management information systems needed to be redesigned and implemented to more accurately measure fundamental exposures, such as the ongoing credit risk posed by the residential construction and land development loan portfolio and the emerging liquidity risks. The Bank needed to continue its efforts to address and reduce the increasing volume of problem assets. While the loan grading process showed improvement over the prior several examinations, the ALLL methodology was identified as flawed in the June 2009 examination. While the Board of Directors and management made some progress to address the findings of the June 2009 examination, management needed to make further progress on improving several key areas to identify, measure, monitor, and control the exposures presented by credit, liquidity, market, operational, reputation, and legal risks.

 

 

 

 

·

Plan to Strengthen Board Oversight – Includes actions that the Board of Directors will take to improve the Bank’s condition, and maintain effective control and supervision over the Bank’s operations including credit risk management, liquidity, and earnings. Also includes the Board’s responsibility to monitor adherence to policies and procedures and applicable laws and regulations, and lists information and reports that will enable the Board to perform this oversight function.

·

Plan to Strengthen Credit Risk Management Practices – includes the responsibility of Board to establish appropriate risk tolerance guidelines and limits, timely and accurate identification and quantification of credit risk, strategies to minimize credit losses and reduce the level of problem assets, procedures for the ongoing review of the investment portfolio to evaluate other-than-temporary-impairment, stress testing for commercial real estate loans and portfolio segments, and measures to reduce the levels of other real estate owned.

·

Plan to Improve Adversely Classified Assets – Includes specific plans and strategies to improve the Bank’s asset position through repayment, amortization, liquidation, additional collateral, or other means on each loan, relationship, or other asset in excess of $1.5 million including OREO, that are past due more than 90 days as of the date of the written agreement.

·

Plan for Maintenance of Adequate Allowance for Loan Losses – Includes policies and procedures to ensure adherence to the Bank’s revised ALLL methodology, provides for periodic reviews of the methodology as appropriate, and provides for review of ALLL by the Board at least quarterly.

·

Capital Plan – Includes guidelines and trigger points to ensure sufficient capital is maintained at the Bank and the Company, and that capital ratios are maintained at a level deemed appropriate under regulatory guidelines given the level of classified assets, concentrations of credit, ALLL, current and projected growth, and projected retained earnings. Also contains contingency strategies to obtain additional capital as required to fulfill future capital requirements.

·

Plan to Improve Liquidity Position – Includes measures to enhance the monitoring, measurement, and reporting of the Bank’s liquidity to the Board, a timetable to reduce the Bank’s reliance on brokered deposits and other wholesale funding, and specific liquidity targets and parameters to meet contractual obligations and unanticipated demands.

·

Contingency Funding Plan – Includes adverse scenario planning, and identifies and quantifies available sources of liquidity for each scenario.

·

Earnings Plan and Budget – Includes a revised business plan for the remainder of 2010, including operating assumptions that support for projected income, expense, and balance sheet components.

 

 

·

Develop and adopt a capital plan to maintain a ratio of tangible shareholders’ equity to total tangible assets equal to or greater than 9.5% and include in such capital plan a capital contingency plan for raising additional capital in the event of various contingencies;

 

·

Maintain a ratio of tangible shareholders’ equity to total tangible assets equal to or greater than 9.5%

 

·

Maintain an adequate allowance for loan losses and remedy any deficiency in the allowance for loan losses in the calendar quarter in which it is discovered; and

 

·

Not establish any new branches or other offices without the prior written consent of the Commissioner of the California Department of Financial Institutions

 

·

Provide progress reports within 30 days after the end of each calendar quarter following the date of the Order to the California Department of Financial Institutions detailing the form and manner of all actions taken to secure compliance with the Order and Agreement and the results of such actions.

 

		YTD Average				YTD Average				YTD Average
		12/31/10				12/31/09				12/31/08
Loans			80.42	%			84.66	%			84.11	%
Investment securities			10.16	%			13.31	%			14.41	%
Interest-bearing deposits in other banks			0.40	%			0.93	%			1.40	%
Interest-bearing deposits in FRB			4.18	%			0.51	%			0.00	%
Federal funds sold			4.84	%			0.59	%			0.08	%
Total earning assets			100.00	%			100.00	%			100.00	%
NOW accounts			12.78	%			8.80	%			7.92	%
Money market accounts			23.57	%			22.68	%			22.89	%
Savings accounts			7.20	%			6.86	%			7.50	%
Time deposits			47.22	%			39.94	%			42.51	%
Other borrowings			7.16	%			19.44	%			16.84	%
Trust Preferred Securities			2.07	%			2.28	%			2.34	%
Total interest-bearing liabilities			100.00	%			100.00	%			100.00	%

 

 

 

 

 

 

 

 

(in thousands)	December 31, 2010	December 31, 2009	December 31, 2008
Provision for credit losses during period	$12,475	$13,375	$9,526
Allowance as % of nonperforming loans	35.19%	29.57%	25.24%
Nonperforming loans as % total loans	10.63%	9.99%	8.39%
Restructured loans as % total loans	5.65%	5.13%	--

 

 

 

 

 

 

 

						2010												2009												2008
		Average								Yield/				Average								Yield/				Average								Yield/
(Dollars in thousands)		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
Assets:
Interest-earning assets:
Loans (1)		$	490,421			$	29,502				6.02	%		$	534,830			$	31,197				5.83	%		$	582,500			$	39,669				6.81	%
Investment Securities – taxable			60,696				2,794				4.60	%			82,865				4,298				5.19	%			98,330				5,170				5.26	%
Investment Securities – nontaxable (2)			1,246				58				4.65	%			1,252				58				4.63	%			1,452				68				4.68	%
Interest on deposits in other banks			2,457				41				1.67	%			5,905				117				1.90	%			9,680				222				2.29	%
Interest on deposits in FRB			25,519				59				0.23	%			3,227				3				0.09	%			0				0				0.00	%
Federal funds sold and reverse repos			29,506				36				0.12	%			3,708				3				0.08	%			549				18				3.28	%
Total interest-earning assets			609,845			$	32,490				5.33	%			631,787			$	35,676				5.65	%			692,511			$	45,147				6.52	%
Allowance for credit losses			(13,825	)											(12,639	)											(8,729	)
Noninterest-bearing assets:
Cash and due from banks			16,815												15,301												20,785
Premises and equipment, net			12,950												13,731												14,981
Accrued interest receivable			2,105												2,405												2,779
Other real estate owned			37,089												34,345												9,434
Other assets			42,708												49,153												46,122
Total average assets		$	707,687											$	734,083											$	777,883
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
NOW accounts		$	62,779			$	128				0.20	%		$	45,189			$	176				0.39	%		$	42,988			$	223				0.52	%
Money market accounts			115,752				1,434				1.24	%			116,522				2,214				1.90	%			124,202				2,963				2.39	%
Savings accounts			35,336				139				0.39	%			35,228				219				0.62	%			40,699				482				1.18	%
Time deposits			231,876				2,516				1.09	%			205,261				3,583				1.75	%			230,746				8,420				3.65	%
Other borrowings			35,181				124				0.35	%			99,877				804				0.80	%			91,368				2,116				2.32	%
Trust Preferred securities			10,172				248				2.44	%			11,692				331				2.83	%			12,710				734				5.77	%
Total interest-bearing liabilities			491,096			$	4,589				0.93	%			513,769			$	7,327				1.43	%			542,713			$	14,938				2.75	%
Noninterest-bearing liabilities:
Noninterest-bearing			133,458												134,925												144,772
Accrued interest payable			318												623												1,131
Other liabilities			4,556												6,147												6,782
Total average liabilities			629,428												655,464												695,398
Total average shareholders' equity			78,259												78,619												82,485
Total average liabilities and
Shareholders' equity		$	707,687											$	734,083											$	777,883
Interest income as a percentage
of average earning assets											5.33	%											5.65	%											6.52	%
Interest expense as a percentage
of average earning assets											0.75	%											1.17	%											2.16	%
Net interest margin											4.58	%											4.49	%											4.36	%