ITEM 1. BUSINESS
Alliance Bancshares California (“Bancshares”) is a bank holding company which was incorporated in February 2000. Bancshares has one bank subsidiary, Alliance Bank (the “Bank”), which it acquired on November 30, 2001. Bancshares operates exclusively through the Bank, and the capital stock of the Bank is its principal asset. The Bank is a California-chartered bank which commenced operations in 1980. Unless the context requires otherwise, references in this Form 10-K to the “Company,” “we” or “us” refers to Bancshares and its consolidated subsidiaries, including the Bank.
Our goal is to become a leading community bank serving Southern California. We are a relationship-oriented business bank targeting the borrowing, deposit and other banking needs of small to medium sized businesses, builders and professionals in Southern California. We offer secured and unsecured commercial term loans and lines of credit, construction loans for individual and tract single family homes and for commercial and multifamily properties, accounts receivable and equipment loans, SBA loans, home equity lines of credit, and equipment leasing. We often tailor our loan products to meet the specific needs of our borrowers. During the past five years, we have placed a significant emphasis on construction lending for single-family homes and commercial real estate projects. Construction loans accounted for 37% and 35% of our total loans at December 31, 2006 and 2005, respectively. We also offer a variety of deposit accounts, cash management products and other banking services.
Our principal executive offices are in Culver City, California. We have five offices as follows:
In 2006, we entered into an 84-month lease agreement for a facility comprised of approximately 5,500 square feet in Los Angeles. This facility will be our Westside Regional Banking Center. We anticipate opening this branch in the summer of 2007.
Our lending area includes six Southern California counties: Los Angeles, Orange, Riverside, San Diego, San Bernardino, and Ventura and occasionally other areas of California, Arizona and Nevada. We attract deposits principally from our customers throughout Southern California, from persons residing near our branch offices, and nationwide through our money desk and over the internet.
For financial reporting purposes, we have three reportable operating segments consisting of Regional Banking Centers, the Real Estate Industries Division, and the SBA Division. All administrative and other smaller operating divisions are combined into “Other” category. The largest business unit is the Real Estate Industries Division. This division provides financing for the acquisition, development and construction of properties. The next largest business unit is the Regional Banking Centers which provide customer sales and services. Additionally, we have the SBA Division which originates loans to small business owners that are generally guaranteed by the United States Government. See the sections captioned “Operating Segments” in the notes to consolidated financial statements.
Bancshares is registered as a bank holding company with the Federal Reserve Board (the “FRB”) and is subject to examination and regulation as a holding company by the California Department of Financial Institutions (the “California DFI”). The Bank is subject to supervision, examination and regulation by the California DFI. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) and it is a member of the Federal Home Loan Bank of San Francisco (the “FHLB”). The Bank is not a member of the FRB but does use a number of its services.
Competition
The banking business in California generally, and specifically in our market area, is highly competitive with respect to both loans and deposits, and is dominated by a number of major banks with many offices operating over a wide geographic area. Major banks have a number of competitive advantages over us, including their ability to finance wide-ranging advertising campaigns, product research and development and to allocate their investment assets to regions of highest yield and demand. These banks offer certain services (such as trust and international banking) that are not offered directly by us and, by virtue of their greater capital, they have vastly higher lending limits than we have. Other entities, both governmental and private, provide competition in the acquisition of deposits. The so-called brokerage “money market funds” also compete with us for deposits. In recent years, credit unions, which have tax advantages compared to commercial banks, have provided more competition for deposits and loans as the number of credit union members has greatly increased. In seeking to obtain customers for loans and/or deposits, we compete with other commercial banks and non-bank financial intermediaries, including savings and loan associations, insurance companies, credit unions, finance companies, investment firms and other lending or depository entities.
In order to compete with the major financial institutions in our primary service area, to the fullest extent possible, we use the flexibility that our independent status and size permits. This includes an aggressive program of personal contacts with customers and prospective customers by our officers, directors and employees. We attempt to develop and implement customized, as opposed to mass-marketed, services to meet the unique needs of particular customers. We also assist those customers requiring services not offered by us to obtain such services from other providers. When a customer requires a loan that would exceed our legal lending limit ($22.2 million for secured loans as of December 31, 2006), we may arrange for such loan on a participation basis with other financial institutions and intermediaries.
Supervision and Regulation
Banking is a highly regulated industry. Congress and the states have enacted numerous laws that govern banks, bank holding companies and the financial services industry, and have created several largely autonomous regulatory agencies which have authority to examine and supervise banks and bank holding companies, and to adopt regulations furthering the purpose of the statutes. The primary goals of the regulatory scheme are to maintain a safe and sound banking system, to protect depositors and the FDIC insurance fund, and to facilitate the conduct of sound monetary policy. As a result, the financial condition and results of operation of the Company, and its ability to grow and engage in various business activities, can be affected not only by management decisions and general economic conditions, but the requirements of applicable federal and state laws, regulations and the policies of the various regulatory authorities.
Further, these laws, regulations and policies are continuously under review by Congress, state legislatures and federal and state regulatory agencies. Changes in laws, regulations and policies can materially increase the cost of doing business, limit certain business activities or materially adversely affect competition between banks and other financial intermediaries. While it can be predicted that changes will occur, what changes, when they will occur, and how they will impact the Company cannot be predicted.
The following is not intended to be an exhaustive description of the statutes and regulations applicable to the business of Bancshares or the Bank. The description of statutory and regulatory provisions is qualified in its entirety by reference to the particular statutory or regulatory provisions.
Bank Holding Companies
Bank holding companies are regulated under the Bank Holding Company Act (the “BHC Act”) and are supervised by the FRB. Under the BHC Act, Bancshares files reports of its operations and other information with the FRB and the FRB conducts examinations of Bancshares and the Bank.
The BHC Act requires, among other things, the FRB’s prior approval whenever a bank holding company proposes to (i) acquire all or substantially all the assets of a bank; (ii) acquire direct or indirect ownership or control of more than 5% of the voting shares of a bank; (iii) merge or consolidate with another bank holding company; (iv) with certain exceptions, acquire more than 5% of the voting shares of any company that is not a bank; and (v) engage in any activities without the FRB’s prior approval other than managing or controlling banks and other subsidiaries authorized by the BHC Act, furnishing services to, or performing services for, its subsidiaries, or conducting a safe deposit business. The BHC Act authorizes the FRB to approve the ownership of shares in any company, the activities of which have been determined to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto.
Under the BHC Act and regulations adopted by the FRB, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or financing of services.
The FRB may, among other things, issue cease-and-desist orders with respect to activities of bank holding companies and nonbanking subsidiaries that represent unsafe or unsound practices or violate a law, administrative order or written agreement with a federal banking regulator. The FRB can also assess civil money penalties against companies or individuals who violate the BHC Act or other federal laws or regulations, order termination of nonbanking activities by nonbanking subsidiaries of bank holding companies and order termination of ownership and control of a nonbanking subsidiary by a bank holding company.
A bank holding company may become a “financial holding company” which may engage in a range of activities that are financial in nature, including insurance and securities underwriting, insurance sales, merchant banking, providing financial, investment, or economic advisory services, any activity that a bank holding company may engage in outside of the United States, and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to a financial activity, or complementary to a financial activity. The FRB is the primary regulator of financial holding companies.
FDIC
The Bank is subject to examination and regulation by the FDIC under the Federal Deposit Insurance Act (“FDICIA”) because its deposit accounts are insured by the FDIC under the Bank Insurance Fund (“BIF”). The FDIC has adopted regulations which affect a broad range of the Bank’s activities, including among other things lending, appraisals, formation of subsidiaries, and obtaining deposits through brokers.
Under FDIC regulations, each insured depository institution is assigned to one of three capital groups for insurance premium purposes-”well capitalized,” “adequately capitalized” and “undercapitalized”-which are defined in the same manner as the regulations establishing the prompt corrective action system of the FDIA, as
discussed under “Capital Adequacy Requirements” below. These three groups are then divided into subgroups which are based on supervisory evaluations by the institution’s primary federal regulator, resulting in nine assessment classifications. Assessment rates for BIF-insured banks range from 0% of insured deposits for well-capitalized banks with minor supervisory concerns to 0.027% of insured deposits for undercapitalized banks with substantial supervisory concerns.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices which are not limited to cases of capital inadequacy, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation or order or any condition imposed in writing by the FDIC. In addition, FDIC regulations provide that any insured institution that falls below a 2% minimum leverage ratio (see below) will be subject to FDIC deposit insurance termination proceedings unless it has submitted, and is in compliance with, a capital plan with its primary federal regulator and the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process if the institution has no tangible capital. The FDIC is additionally authorized by statute to appoint itself as conservator or receiver of an insured depository institution (in addition to the powers of the institution’s primary federal regulatory authority) in cases, among others and upon compliance with certain procedures, of unsafe or unsound conditions or practices or willful violations of cease and desist orders.
Capital Adequacy Requirements
The FRB and the FDIC have adopted similar, but not identical, “risk-based” and “leverage” capital adequacy guidelines for bank holding companies and insured banks, respectively. Under the risk-based capital guidelines, different categories of assets are assigned different risk weights, ranging from zero percent for risk-free assets (e.g., cash) to 100% for relatively high-risk assets (e.g., commercial loans). These risk weights are multiplied by corresponding asset balances to determine a risk-adjusted asset base. Certain off-balance sheet items, such as standby letters of credit, are added to the risk-adjusted asset base. The minimum required ratio of total capital to risk-weighted assets for both bank holding companies and insured banks is presently 8%. At least half of the total capital is required to be “Tier 1 capital,” consisting principally of common shareholders’ equity, a limited amount of perpetual preferred stock, and minority interests in the equity. The remainder, designated “Tier 2 capital,” may consist of a limited amount of subordinated debt, certain hybrid capital instruments, the remaining portion of trust preferred securities and other debt securities, preferred stock and a limited amount of the general loan loss allowance.
The minimum Tier 1 leverage ratio, consisting of Tier 1 capital to average adjusted total assets, is 3% for bank holding companies and insured banks that have the highest regulatory examination rating and are not contemplating significant growth or expansion. All other bank holding companies and insured banks are expected to maintain a ratio of at least 1% to 2% or more above the stated minimum.
Under the prompt corrective action provisions of the FDICIA, the FDIC has adopted regulations establishing five capital categories for insured banks designated as well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.
If any one or more of a bank’s ratios are below the minimum ratios required to be classified as undercapitalized, it will be classified as significantly undercapitalized provided that if its ratio of tangible equity to total assets is 2% or less, it will be classified as critically undercapitalized. A bank may be reclassified by the FDIC to the next level below that determined by the criteria described above if the FDIC finds that it is in an unsafe or unsound condition or if it has received a less-than-satisfactory rating for any of the categories of asset quality, management, earnings or liquidity in its most recent examination and the deficiency has not been corrected, except that a bank cannot be reclassified as critically undercapitalized for such reasons.
The FDIC may subject undercapitalized banks to a broad range of restrictions and regulatory requirements. An undercapitalized bank may not pay management fees to any person having control of the institution, nor,
except under certain circumstances and with prior regulatory approval, make any capital distribution if, after doing so, it would be undercapitalized. Significantly undercapitalized banks are subject to increased monitoring by the FDIC, are restricted in their asset growth, must obtain regulatory approval for certain corporate activities, such as acquisitions, new branches and new lines of business, and, in most cases, must submit to the FDIC a plan to bring their capital levels to the minimum required in order to be classified as adequately capitalized. The FDIC may not approve a capital restoration plan unless each company that controls the bank guarantees that the bank will comply with it. Significantly and critically undercapitalized banks are subject to additional mandatory and discretionary restrictions and, in the case of critically undercapitalized institutions, must be placed into conservatorship or receivership unless the FDIC agrees otherwise.
Under FRB policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to commit resources to support each such bank. In addition, a bank holding company is required to guarantee that its subsidiary bank will comply with any capital restoration plan. The amount of such a guarantee is limited to the lesser of (i) 5% of the bank’s total assets at the time it became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all applicable capital standards as of the time the bank fails to comply with the capital restoration plan. A holding company guarantee of a capital restoration plan results in a priority claim to the holding company’s assets ahead of its other unsecured creditors and shareholders that is enforceable even in the event of the holding company’s bankruptcy or the subsidiary bank’s insolvency.
Capital Distributions
Bancshares may make capital distributions (dividends in cash or property, or repurchases of capital stock) subject to the California General Corporation Law and the policies, rules and regulations of the FRB. Under the California General Corporation Law, Bancshares may not pay dividends in cash or property except (i) out of positive retained earnings or (ii) if, after giving effect to the distribution, Bancshares’ assets would be at least 1.25 times its liabilities and its current assets would exceed its liabilities (determined on a consolidated basis under generally accepted accounting principles). The FRB has stated that, as a matter of prudent banking, a bank holding company generally should not pay cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends, and that the prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition.
The ability of Bancshares to pay dividends will depend upon its cash resources. Bancshares’ principal source of income consists of dividends and cash distributions from the Bank. As a California-chartered bank, without the approval of the California DFI, the Bank may pay dividends in an amount which does not exceed the lesser of its retained earnings or its net income for the last three fiscal years. Under regulations of the FDIC, the Bank may not make a capital distribution without prior approval of the FDIC if it would be undercapitalized, significantly undercapitalized or critically undercapitalized under the Prompt Corrective Action Rules.
CRA
Banks and bank holding companies are also subject to the Community Reinvestment Act of 1977, as amended (the “CRA”). The CRA requires the Bank to ascertain and meet the credit needs of the communities it serves, including low and moderate income neighborhoods. The Bank’s compliance with CRA is reviewed and evaluated by the FDIC, which assigns the Bank a publicly available CRA rating at the conclusion of the examination. Further, an assessment of CRA compliance is also required in connection with applications for FDIC approval of certain activities, including establishing or relocating a branch office that accepts deposits or merging or consolidating with, or acquiring the assets or assuming the liabilities of, a federally regulated financial institution. An unfavorable rating may be the basis for FDIC denial of such an application, or approval may be conditioned upon improvement of the applicant’s CRA record. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the FRB will assess the CRA record of each subsidiary bank of the applicant, and such records may be the basis for denying the application.
In the most recently completed CRA compliance examination, conducted in 2005, the FDIC assigned the Bank a rating of “satisfactory,” the second highest of four possible ratings. CRA regulations emphasize measurements of performance in the area of lending (specifically, the bank’s home mortgage, small business, small farm and community development loans), investment (the bank’s community development investments) and service (the bank’s community development services and the availability of its retail banking services), although examiners are still given a degree of flexibility in taking into account unique characteristics and needs of the bank’s community and its capacity and constraints in meeting such needs. The regulations also require certain levels of collection and reporting of data regarding certain kinds of loans.
California Banking Law
Both Bancshares and the Bank are regulated under the California Banking Law. As a bank holding company, Bancshares must file reports with, and is subject to examination and supervision by, the California DFI. The Bank, as a California-chartered bank, is subject to examination, supervision and regulation by the California DFI. These laws and regulations affect many aspects of the Bank’s operations, including investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, issuances of securities and other corporate governance provisions.
Employees
As of December 31, 2006, we had 137 full time employees, including 79 officers. We believe that our relationship with our employees is satisfactory.
ITEM 1A.
ITEM 1A. RISK FACTORS
We face risk from changes in interest rates.
The success of our business depends, to a large extent, on our net interest income. Changes in market interest rates can affect our net interest income by affecting the spread between our interest-earning assets and interest-bearing liabilities. This may be due to the different maturities of our interest-earning assets and interest-bearing liabilities, as well as an increase in the general level of interest rates. Changes in market interest rates also affect, among other things:
•
Our ability to originate loans;
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The ability of our borrowers to make payments on their loans;
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The value of our interest-earning assets and our ability to realize gains from the sale of these assets;
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The average life of our interest-earning assets;
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Our ability to generate deposits instead of other available funding alternatives; and
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Our ability to access the wholesale funding market.
Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control.
We face risk from possible declines in the quality of our assets.
Our financial condition depends significantly on the quality of our assets. While we have developed and implemented underwriting policies and procedures to guide us in the making of loans, compliance with these policies and procedures in making loans does not guarantee repayment of the loans. If the level of our non-performing assets rises, our results of operations and financial condition will be affected. A borrower’s ability to pay its loan in accordance with its terms can be adversely affected by a number of factors, such as a decrease in the borrower’s revenues and cash flows due to adverse changes in economic conditions or a decline in the demand for the borrower’s products and/or services.
Our allowances for loan losses may be inadequate.
We establish allowances for loan losses against each segment of our loan portfolio. At December 31, 2006, our allowance for loan losses equaled 1.30% of loans. Although we believe that we have established adequate allowances for loan losses as of December 31, 2006, the credit quality of our assets is affected by many factors beyond our control, including local and national economic conditions, and the possible existence of facts which are not known to us which adversely affect the likelihood of repayment of various loans in our loan portfolio and realization of the collateral upon a default. Accordingly, we can give no assurance that we will not sustain loan losses materially in excess of the allowance for loan losses. In addition, the FDIC and California DFI, as an integral part of their examination process, periodically review our allowance for loan losses and could require additional provisions for loan losses. Material future additions to the allowance for loan losses may also be necessary due to increases in the size and changes in the composition of our loan portfolio. Increases in our provisions for loan losses would adversely affect our results of operations.
Economic conditions may worsen.
Our business is strongly influenced by economic conditions in our market area (principally, Southern California) as well as regional and national economic conditions. Should the economic condition in these areas deteriorate, the financial condition of our borrowers could weaken, which could lead to higher levels of loan defaults or a decline in the value of collateral for our loans. In addition, an unfavorable economy could reduce the demand for our loans and other products and services.
At December 31, 2006, a significant number of our loans were collateralized by real estate located in California. Because of this concentration, our financial position and results of operations have been and are expected to continue to be influenced by general trends in the California economy and its real estate market. Real estate market declines may adversely affect the values of the properties collateralizing loans. If the principal balances of our loans, together with any primary financing on the mortgaged properties, equal or exceed the value of the mortgaged properties, we could incur higher losses on sales of properties collateralizing foreclosed loans. In addition, California historically has been vulnerable to certain natural disaster risks, such as earthquakes and erosion-caused mudslides, which are not typically covered by the standard hazard insurance policies maintained by borrowers. Uninsured disasters may adversely impact our ability to recover losses on properties affected by such disasters and adversely impact our results of operations.
Our business is very competitive.
There is intense competition in Southern California and elsewhere in the United States for banking customers. We experience competition for deposits from many sources, including credit unions, insurance companies and money market and other mutual funds, as well as other commercial banks and savings institutions. We compete for loans primarily with other commercial banks, mortgage companies, commercial finance companies and savings institutions. In recent years, out-of-state financial institutions have entered the California market, which has also increased competition. Many of our competitors have greater financial strength, marketing capability and name recognition than we do, and operate on a statewide or nationwide basis. In addition, recent developments in technology and mass marketing have permitted larger companies to market loans more aggressively to our small business customers. Such advantages may give our competitors opportunities to realize greater efficiencies and economies of scale than we can. We can provide no assurance that we will be able to compete effectively against our competition.
A significant portion of our loan portfolio consists of construction loans to developers for tract projects and single homes for resale to unidentified buyers.
At December 31, 2006, we had outstanding construction loans to developers for tract projects and single homes for sale to unidentified buyers totaling $136.3 million, representing 19.1% of our loan portfolio, and additional commitments for these projects in the amount of $60.8 million. These types of loans generally have
greater risks than loans on completed homes, multifamily and commercial properties. A construction loan generally does not cover the full amount of the construction costs, so the borrower must have adequate funds to pay for the balance of the project. Price increases, delays and unanticipated difficulties can materially increase these costs. Further, even if completed, there is no assurance that the borrower will be able to sell the project on a timely or profitable basis, as these are closely related to real estate market conditions, which can fluctuate substantially between the start and completion of the project. If the borrower defaults prior to completion of the project, the value of the project will likely be less than the outstanding loan, and we could be required to complete construction with our own funds to minimize losses on the project.
Our business is heavily regulated.
Both Bancshares, as a bank holding company, and Bank, as a California-chartered FDIC insured bank, are subject to significant governmental supervision, regulation and legislation, which is intended primarily to maintain a safe and sound banking system, to protect depositors and the FDIC insurance fund, and to facilitate the conduct of sound monetary policy, and are not intended to protect bank and bank holding company shareholders. Statutes, regulations and regulatory policies affecting us may be changed at any time, and the interpretation of these statutes and regulations by examining authorities also may change. We cannot assure you that future changes in applicable statutes, regulations, legislation and policies or in their interpretation will not materially adversely affect our business.
SBA loan programs may be modified or discontinued.
In recent years we have generated significant income from fees and interest on SBA loans and gains on sales of participation interests in SBA loans. Congress or the SBA may discontinue or modify these programs at any time. Such discontinuation or modification could have a material adverse affect on our results of operations depending on our level SBA lending at the time.
One customer represents a large amount of deposits that can be withdrawn immediately, and the sudden withdrawal or material reduction of these deposits could have a material adverse affect on us.
For more than the past year, one individual has represented a number of entities that have provided a significant amount of funds to us. At December 31, 2006, these entities had provided us an aggregate of $49.9 million of deposits; and during 2006 the maximum monthly amount of funds provided by these entities at any date was $67.8 million. We provide additional collateral to this customer for the deposits in excess of the FDIC insurance limit through a $75 million letter of credit from the Federal Home Loan Bank of San Francisco. We monitor this relationship closely, and while we have no reason to believe the customer presently intends to significantly reduce or terminate the relationship, we have adequate liquidity to fund any consequential withdrawals. If we had to replace these deposits, the new deposits or borrowings might be more costly which would adversely affect our net interest income.
A significant portion of our deposits were obtained through brokers, and during 2006 almost all of these deposits were obtained through one broker.
We attract a significant amount of deposits from brokers who place certificates of deposit with their customers. As of December 31, 2006, brokered deposits were $162.4 million representing 22.7% of total deposits as compared to $125.8 million at December 31, 2005 representing 23.7% of total deposits. All except $10.0 million of our brokered deposits at December 31, 2006 were obtained through one broker. We believe that should our business discontinue with this broker, we could continue to obtain the certificates of deposit we desire through other brokers. However, we could be adversely affected because the certificates of deposit through other brokers may bear slightly higher interest rates. Further, the deposits obtained through this broker as of December 31, 2006 mature at various times through September 2011, and thus such discontinuation would not result in the immediate withdrawal of such deposits. We intend to continue its efforts to increase its levels of core deposits in an effort to decrease our reliance on money desk and brokered deposits.
If the Bank becomes less than “well capitalized” under the prompt corrective action rules, we may not accept brokered deposits without FDIC approval and may have to pay higher rates to attract deposits through our money desk.
Under FDIC regulations, banks that are not “well capitalized” under the prompt corrective action rules may not accept brokered deposits without the prior approval of the FDIC. In addition, we believe that if we are not “well capitalized”, we may have greater difficulty obtaining certificates of deposit through our money desk and may have to pay higher interest rates to continue to attract those deposits. Accordingly, the failure of the Bank to remain “well capitalized” could have a material adverse affect on us.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2.
ITEM 2. PROPERTIES
The following table sets forth information about the Bank’s lease arrangements as of December 31, 2006:
In 2006, the Bank entered into an 84-month lease agreement for a facility comprised of approximately 5,500 square feet in Los Angeles. This facility will be our Westside Regional Banking Center. We anticipate opening this office in the summer of 2007.
We believe that these facilities are adequate to meet our current space needs. However, we will continue to seek additional office space for the location of new banking offices in Southern California when opportunities to do so arise.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
As of December 31, 2006, we were not involved in any litigation other than routine litigation incidental to our business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our shareholders during the fourth quarter of 2006.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Quotations for Bancshares Common Stock are available on the NASD Over-the-Counter Bulletin Board under the symbol “ABNS.” The following table sets forth the high and low closing price for Bancshares Common Stock during the periods indicated as reported by Nasdaq. The quotations reflect inter-dealer prices, without retail mark-up, markdown or commissions, and may not reflect actual transactions.
As of March 15, 2007, there were approximately 307 holders of record of Bancshares Common Stock. Approximately 68% of Bancshares Common Stock was held in street name.
Bancshares has never paid dividends on its Common Stock. Our policy has been to accumulate retained earnings to augment our capital and increase our legal lending limits. Bancshares’ ability to pay dividends on our Common Stock is subject to the following limitations and restrictions: (i) it must meet regulatory capital requirements and other regulatory restrictions (see “Description of Business-Supervision and Regulation-Capital Distributions”); (ii) it must be current in payment of its dividends on its 7% Series A Non-Cumulative Convertible Preferred Stock and its 6.82% Series B Non-Cumulative Convertible Preferred Stock (Bancshares was current as of December 31, 2006); and (iii) it must not be in default or have elected to defer payments under its trust preferred securities.
Bancshares did not purchase any equity securities during the three months ended December 31, 2006.
The following table sets forth information concerning equity compensation plans as of December 31, 2006:
Performance Graph
The following performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporates it by reference into such filing.
The following graph compares the yearly percentage change in Alliance Bancshares California’s cumulative total shareholder return (stock price appreciation) on common stock (i) the cumulative total return of the Nasdaq Composite Market; and (ii) a published index comprised by SNL Bank and Thrift (the industry group line depicted below).
Points on the graph represent the performance as of the last business day of each of the years indicated. The graph is not necessarily indicative of future price performance.
COMPARE 5-YEAR CUMULATIVE TOTAL RETURN AMONG ALLIANCE BANCSHARES CALIFORNIA, NASDAQ MARKET INDEX AND SNL BANK & THRIFT INDEX
Alliance Bancshares California
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Certain selected consolidated financial data set forth below for the fiscal years ended December 31, 2006, 2005 and 2004 are derived from our audited consolidated financial statements included in Item 8 hereof and should be read in conjunction with those consolidated financial statements. Certain selected consolidated financial data for the fiscal years ended December 31, 2003 and 2002 are derived from previously audited financial statements that are not included herein.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We recorded net earnings of $8.0 million ($1.10 basic and $1.05 fully diluted earnings per share) for the year ended December 31, 2006, the highest net earnings in our history. This compares to net earnings of $6.2 million ($0.93 basic and $0.90 fully diluted earnings per share) in 2005 and $3.9 million ($0.78 basic and $0.61 fully diluted earnings per share) in 2004. The increase in net earnings in 2006 was due primarily to a $13.5 million increase in net interest income before provision for loan losses. Net interest income increased as a result of an increase in our net interest-earning assets and from an increase in our net interest margin. This amount was offset in part by a $1.4 million increase in the provision for loan losses due to the growth of our loan portfolio and an $8.2 million increase in general and administrative expenses related primarily to the expansion of our operations and the growth. The increase in earnings in 2005 compared to 2004 was the result of a $10.9 million increase in net interest income before provision for loan losses offset by a $1.8 million increase in provision for loan losses and a $5.1 million increase in other operating expenses. Increased net interest income for 2006, 2005, and 2004 were as a result of higher volumes of average interest earning assets for each year due to the growth of our business as well as higher yields on interest earning assets due to the increases in market interest rates.
Our assets increased from $675.0 million at December 31, 2005 to $875.8 million at December 31, 2006. Loans continue to constitute the largest portion (approximately 83%) of our interest earning assets, and grew from $545.4 million at December 31, 2005 to $700.5 million at December 31, 2006. The growth of the loan portfolio is significant because not only does it represent the greatest concentration of our assets, it is also the highest yielding of our assets. Deposits increased from $531.3 million at December 31, 2005 to $716.9 million at December 31, 2006. This increase was primarily due to a $112.6 million increase in certificates of deposit primarily generated through brokers who place deposits on behalf of their customers, a result of deposit promotion campaigns conducted by the Bank, and by advertising our deposit products on the internet.
In May 2006, we completed our third offering of trust preferred securities, resulting in the issuance by Bancshares of $10.3 million of junior subordinated debentures. Bancshares has contributed all of these funds to the Bank as capital. At December 31, 2006, we had an aggregate of $27.8 million of junior subordinated debentures outstanding.
Shareholders’ equity increased from $26.9 million at December 31, 2005 to $34.3 million at December 31, 2006 primarily due to net earnings for the year.
Our allowance for loan losses was $9.2 million or 1.30% of loans at December 31, 2006 compared to $6.1 million or 1.10% of loans at December 31, 2005.
Critical Accounting Policies and Estimates
Management prepared our consolidated financial statements in conformity with accounting principles generally accepted in the United States and general industry practices. Accordingly, the consolidated financial statements require certain estimates, judgments and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. The following accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results.
Allowance for Loan Losses
The calculation of the adequacy of the allowance for loan losses (“ALL”) is based on a variety of factors, including loan classifications, migration trends and underlying cash flow and collateral values. We use a
migration analysis as part of our evaluation of the allowance for loan losses which is a method by which specific charge-offs are related to the prior life of the same loan type compared to the total loan pools in which the loan was graded. This method allows for management to use historical trends that are relative to our loan portfolio rather than use outside factors that may not take into consideration trends relative to the specific loan portfolio. In addition, this analysis takes into consideration other trends that are qualitative relative to our marketplace, demographic trends, the risk rating of our loan portfolio as discussed below, amounts and trends in non-performing assets and concentration factors.
The calculation of the adequacy of the ALL necessarily includes estimates by management applied to known loan portfolio elements. We employ a 10-point loan grading system in an effort to more accurately track the inherent quality of the loan portfolio. The 10-point system assigns a value of “1” or “2” to loans that are substantially risk free. Modest, average and acceptable risk loans are assigned point values of “3,” “4,” and “5,” respectively. Loans on the watch list are assigned a point value of “6.” Point values of “7,” “8,” “9” and “10” are assigned respectively to loans classified as special mention, substandard, doubtful and loss. As of December 31, 2006, the weighted average risk rating for our loan portfolio was 4.39, indicating an overall risk rating midway between average and acceptable. The weighted average risk rating was 4.28 at December 31, 2005.
We assess the adequacy of the ALL each calendar quarter. Classified loans (loans assigned point values of 7-10) are assigned specific reserve percentages based on point value. Loans that are not classified (loans assigned risk point values of less than 7) are subdivided into pools of similar loans by loan type and are assigned reserve percentages based on the loan type. We determine the reserve percentage by first examining actual loss history for each type of loan, then adjust that percentage by several factors including changes in lending policies; changes in national and local economic conditions; changes in experience, ability and depth of lending management and staff; changes in trend of past due and classified loans; changes in external factors such as competition and legal and regulatory requirements; and other relevant factors. Reserve estimates are totaled and any shortage is charged to current period operations and credited to the ALL while any overages would be reduced from ALL.
The ALL consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Net Interest Income
Our earnings depend largely upon our net interest income, which is the difference between the income we earn on loans and other interest earning assets and the interest we pay on deposits and borrowed funds. Net interest income is related to the rates earned and paid on and the relative amounts of interest earning assets and interest bearing liabilities. Our inability to maintain strong asset quality, capital or liquidity may adversely affect (i) our ability to accommodate desirable borrowing customers, thereby impacting growth in quality, higher-yielding earning assets; (ii) our ability to attract comparatively stable, lower-cost deposits; and (iii) the costs of wholesale funding sources.
Net interest income is related to our interest rate spread and net interest margin. The interest rate spread represents the difference between the weighted average yield on interest earning assets and the weighted average rate paid on interest bearing liabilities. Net interest margin (also called the net yield on interest earning assets) is net interest income expressed as a percentage of average total interest earning assets. Our net interest margin is affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes, and
changes in the relative amounts of interest earning assets and interest bearing liabilities. Interest rates earned and paid are affected principally by our competition, general economic conditions and other factors beyond our control such as federal economic policies, the general supply of money in the economy, legislative tax policies, governmental budgetary matters, and actions of the FRB.
2006 compared to 2005. Net interest income before provision for loan losses increased to $38.7 million in 2006 from $25.3 million for 2005. This increase was due to an increase in interest income of $28.0 million while interest expense increased by $14.5 million. The increase in interest income was due to $245.6 million increase in average interest earning assets in conjunction with a 1.29% increase in the weighted average yield on interest earning assets from 7.46% in 2005 to 8.75% in 2006. The increase in interest expense was due to a $222.1 million increase in average interest bearing liabilities in addition to a 1.19% increase in the weighted average rates paid on interest bearing liabilities from 3.25% in 2005 to 4.44% in 2006. The prime rate increased four times during 2006 causing the yield in the loan portfolio to increase to 9.61% from 8.26% in 2005.
The increase in average interest earning assets and average interest bearing liabilities is a result of the Company’s continued efforts to expand all of the Bank’s Regional Banking Centers, the continued growth of all categories of loans and investments and to favorable economic conditions. Average loans increased 50.1% to $623.7 million in 2006 from $415.5 million in 2005, with the increase occurring in all major loan categories. Average investment securities increased 39.2% to $96.2 million from $69.2 million as the Company invested in collateralized mortgage obligations, mortgage backed securities, and U.S. Government agency securities. Average interest bearing deposits increased 56.4% to $504.4 million in 2006 compared to $322.4 million during 2005.
Our interest rate spread was 4.31% for 2006 compared to 4.21% in 2005. The increase in interest rate spread was due principally to loans, our highest yielding interest-earning asset, constituting a slightly greater percentage of our average interest-earning assets in 2006 (83.0%) compared to 2005 (82.2%). In addition, average loans increased by $208.2 million while average certificates of deposit, our highest cost of deposits, increased by only $165.3 million.
Our net interest margin was 5.16% in 2006 compared to 5.00% in 2005 and continues to remain high in comparison with our interest rate spread. Our net interest margin increased by a slightly greater amount than our interest rate spread increased, primarily due to an increase in net average interest-earning assets (average interest-earning assets minus average interest-earning liabilities) from $121.2 million in 2005 to $144.7 million in 2006. This was due principally to our continued increase in average loans and the yield on our loan portfolio and particularly the increase in our construction loans during 2006 which have the highest yields in our loan portfolio. Our net interest margin was also higher in 2006 as compared to 2005 due to the repricing of our loans as compared to our deposits. A large portion of our loans which are tied to the prime rate repriced four times during 2006 due to changes in the prime rate as compared to eight times during 2005, however, approximately 50% of our certificates of deposits repriced in 2006 causing our net interest margin to increase only slightly.
2005 compared to 2004. Net interest income before provision for loan losses increased to $25.3 million in 2005 from $14.3 million for 2004. This was due to an increase in interest income of $18.4 million while interest expense increased by $7.5 million. The increase in interest income was due to a $187.6 million increase in average interest earning assets in conjunction with a 1.40% increase in the weighted average yield on interest earning assets from 6.06% in 2004 to 7.46% in 2005. The increase in interest expense was due to a $152.2 million increase in average interest bearing liabilities in addition to a 1.13% increase in the weighted average rates paid on interest bearing liabilities from 2.12% in 2004 to 3.25% in 2005. The prime rate increased eight times during 2005 causing the yield in the loan portfolio to increase to 8.26% from 7.10% in 2004.
The increase in average interest earning assets and average interest bearing liabilities is a result of the Company’s continued efforts to expand the Orange County Regional Banking Center, the San Fernando Valley Regional Banking Center and the Media District Regional Banking Center, the continued growth of all categories
of loans and investments and to favorable economic conditions. Average loans increased 75.8% to $415.5 million in 2005 from $236.3 million in 2004, with the increase occurring in all major loan categories. Average investment securities increased 24.7% to $69.2 million from $55.5 million as the Company invested in collateralized mortgage obligations, mortgage backed securities, and U.S. Government agency securities. Average interest bearing deposits increased 70.2% to $322.4 million in 2005 compared to $189.5 million during 2004.
Our interest rate spread increased from 3.94% in 2004 to 4.21% in 2005, and our net interest margin increased from 4.50% in 2004 to 5.00% in 2005. The increase in interest rate spread was due principally to loans, our highest yielding interest-earning asset, constituting a greater percentage of our average interest-earning assets in 2005 compared to 2004 (82.2% compared to 74.4%). This increase occurred notwithstanding the fact that the weighted average cost of our deposits increased slightly more than the weighted average yield on our loans and securities.
Our net interest margin was high in comparison with our interest rate spread, and increased by a greater amount than our interest rate spread increased, primarily due to an increase in net average interest-earning assets from $85.7 million in 2004 to $121.2 million in 2005. This was due principally to our continued increase in non-interest-bearing demand deposits relative to total funding sources.
Tables
The following tables present the weighted average yield on each specified category of interest earning assets, the weighted average rate paid on each specified category of interest bearing liabilities, and the resulting interest rate spread and net interest margin for the periods indicated:
ANALYSIS OF NET INTEREST INCOME
(1)
Interest income on loans includes loan fees of $4.7 million in 2006 and $3.0 million in 2005.
(2)
Loans include nonaccrual loans.
ANALYSIS OF NET INTEREST INCOME
(1)
Interest income on loans includes loan fees of $1.6 million in 2004.
(2)
Loans include nonaccrual loans.
The following tables present information concerning the change in interest income and interest expense attributable to changes in average volume and average rate during the periods indicated:
ANALYSIS OF CHANGE IN INTEREST INCOME
ANALYSIS OF CHANGE IN INTEREST INCOME
In the analysis of interest changes due to volume and rate, changes due to the volume/rate variance are allocated proportionately to both volume and rate.
Provision for Loan Losses
We made provisions for loan losses of $3.9 million for the year ended December 31, 2006 as compared to $2.5 million for 2005 and $0.8 million for 2004 primarily because of the increase in non-performing assets and the overall growth in our loans. These provisions were based on our policies and procedures for establishing the ALL. See “Asset Quality and Credit Risk Management.”
Non-Interest Income
The components of other non-interest income were as follows for the periods indicated:
Service charges and fees were $1.1 million, $0.9 million and $1.0 million in 2006, 2005 and 2004, respectively. The decrease in 2005 was due to our concerted efforts to reduce or eliminate customer overdrafts. The increase in 2006 was due to the growth of our deposits.
Net gains on sales of loans were $0.5 million, $0.7 million and $0.7 million in 2006, 2005 and 2004, respectively. Gains on sales of loans are primarily from the sale of the guaranteed portion of SBA loans. Our ability to generate gains on sales of SBA loans depends significantly on the amount of loans we can originate and market conditions. Therefore, the net gains on the sales of loans in any one period are not indicative of the gains or losses that may be realized in subsequent periods and may vary substantially from period to period. The decrease in net gains on sales of loans in 2006 was primarily attributable to a decline in the volume of loans sold.
Brokers’ fees on loans have decreased from $1.2 million in 2004 to $0.8 million in 2005 and to $0.3 million in 2006. These decreases were due primarily to a decrease in the average net premium received as well as a decrease in the volume of brokered loans. We broker loans to third parties which we do not want to originate for our own portfolio, which can occur for a variety of reasons, including the nature of the loan, the creditworthiness of the borrower, the location of the borrower or the collateral, or the specific terms requested by the borrower. The number of loans we can broker in any period is dependent upon market conditions, borrower demand and the ability to identify lenders desiring to make that type of loan. Accordingly, broker fees from loans referred to others in one period are not indicative of broker fees which may be earned in subsequent periods, and may vary substantially from period to period.
Non-Interest Expense
The components of non-interest expense were as follows for the periods indicated:
Salaries and related benefits increased from $5.5 million in 2004 to $8.1 million in 2005 or 46.8% and to $13.2 million in 2006 or 63.7%. These increases were due primarily to an increase in the number of employees in all locations and departments due to our growth. The increase in our size and profitability also resulted in an increase in incentive and bonus payments for 2006 and 2005. At year-end 2006, we employed 137 full-time employees, compared with 99 full-time employees at the end of 2005 and 74 full-time employees at the end of 2004. Additionally, in 2006, we elected to contribute a profit sharing contribution to our employees of 4% of our net income to eligible employees for a total of $320,000. We adopted the provisions of SFAS 123-R on January 1, 2006. For further information, see Notes 1 and 8 of the Notes to the Consolidated Financials Statements included in this Report.
Occupancy and equipment expense increased from $1.6 million in 2004 to $2.4 million in 2005 or 53.0% and to $3.0 million in 2006 or 26.0%. The increase in 2006 was due to increased rent expense, the amortization of leasehold improvements and the depreciation of office furniture and equipment for the new Documentation Servicing, Central Operations and Loan Servicing Departments. The increase in 2005 was due to increased rent expense, the amortization of leasehold improvements and the depreciation of office furniture and equipment primarily at the new San Fernando Valley Regional Banking Center, the new Media Center Regional Banking Center, and the new Real Estate Industries Division Office. In addition, the remodel of our headquarters office and Los Angeles Regional Banking Center space resulted in an increase in amortization and depreciation expense.
Professional fees increased from $0.4 million in 2004 to $0.8 million in 2005 or 78.7% and to $1.5 million or 92.5% in 2006. The increases in 2005 and 2006 were primarily due to the increase in consulting fees related to the Document Servicing and Loan Servicing Departments and to personnel development expenses.
Data processing expenses increased from $0.6 million in 2004 to $0.8 million in 2005 or 31.5% and remained relatively stable at $0.8 million in 2006. The increase in 2005 was consistent with our growth in assets and the number of customers. The stability of data processing expense in 2006 was due to our loan servicing and documentation no longer being performed by a third party vendor.
Other operating expenses increased from $2.5 million in 2004 to $3.6 million in 2005 or 46.9% and to $5.3 million at in 2006 or 45.9%. The increase in 2006 was primarily due to software licenses and employment costs in conjunction with the expansion of our space for the Document Servicing, Central Operations and Loan Servicing Departments. The increase in 2005 was due in part to increases in training costs as well as the growth in assets and personnel associated with the new regional banking centers.
FINANCIAL CONDITION
Regulatory Capital
At December 31, 2006, Bancshares’ and the Bank’s Tier 1 capital, which is comprised of shareholders’ equity as modified by certain regulatory adjustments which includes a percentage of junior subordinated debentures, were $70.5 million and $79.3 million, respectively. Our Tier 1 capital increased during 2006 as a result of net earnings. At December 31, 2006, Bancshares and the Bank met all applicable regulatory and capital requirements and the Bank was “well capitalized” as defined under prompt corrective action rules.
The following table sets forth the regulatory standards for well-capitalized and adequately capitalized institutions and the capital ratios for Bancshares and the Bank as of the date indicated:
REGULATORY CAPITAL
At December 31, 2006
Liquidity
Our objective in managing our liquidity is to maintain cash flow adequate to fund our operations and meet obligations and other commitments on a timely and cost effective basis. We manage to this objective through the selection of asset and liability maturity mixes. Our liquidity position is enhanced by our ability to raise additional funds as needed through available borrowings, accessing deposits nationwide through our money desk and/or brokered deposits or selling or participating a greater percentage of our construction and real estate loans through our correspondent network of other banks.
Deposits provide most of our funds. This relatively stable and low-cost source of funds has, along with our preferred stock and shareholders’ equity, provided 86% of funding for average total assets during both 2006 and 2005.
Secondary sources of liquidity include borrowing arrangements with the FRB and the FHLB. Borrowings from the FRB are short-term and must be collateralized by pledged securities. As a member of the FHLB system, the Bank may obtain advances from the FHLB pursuant to various credit programs offered from time to time. Credit limitations are based on the assessment by the FHLB of the Bank’s creditworthiness, including an adequate level of net worth, reasonable prospects of future earnings, sources of funds sufficient to meet the scheduled interest payments, lack of financial or managerial deficiencies and other factors. Such advances may be obtained pursuant to several different credit programs, and each program has its own rate, commitment fees and range of maturities. Funds borrowed from the FHLB must be collateralized either by pledged securities or by assignment of notes and may be for terms of a few days to several years. As of December 31, 2006, we had $50.0 million outstanding FHLB advances and available borrowings of $8.0 million. We had no outstanding borrowings from the FRB.
We also have liquidity as a net seller of overnight funds at a level that will cushion at least in part any unexpected increase in demand for funds or decrease in funds deposited. During 2006, we had an average balance of $26.0 million in overnight funds sold representing 5.15% of total average deposits.
Time Deposits and Investment Securities
We invest in time deposits with other financial institutions and investment securities principally to (i) generate interest income pending the ability to deploy those funds in loans meeting our lending strategies; (ii) increase net interest income where the rates earned on such investments exceed the related cost of funds, consistent with the management of interest rate risk; and (iii) provide sufficient liquidity in order to maintain cash flow adequate to fund our operations and meet obligations and other commitments on a timely and cost efficient basis.
Our time deposit investments generally have terms of less than three years and are generally in amounts of $100,000 or less. Historically, our investment securities consist principally of U.S. Government Agency securities, collateralized mortgage obligations, mortgage-backed securities and corporate bonds with an expected weighted average life of less than three years.
Our present strategy is to stagger the maturities of our time deposit investments and investment securities to meet our overall liquidity requirements. The weighted average maturity of investment securities was 3.0 years at December 31, 2006 compared to 2.7 years at December 31, 2005. At December 31, 2006, we classified all our investment securities as held to maturity, as we intend to hold the securities to maturity.
The following table provides certain information regarding our time deposits at the dates indicated.
TIME DEPOSITS
The following table provides certain information regarding our investment securities at the dates indicated. Expected maturities will differ from contractual maturities, particularly with respect to collateralized mortgage obligations and mortgage backed securities, because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. We held no tax-exempt securities in 2006 or 2005.
INVESTMENT SECURITIES
The amortized cost and estimated fair values of securities held to maturity at December 31, 2006 and 2005 are as follows:
The following table lists securities which have an aggregate book value in excess of 10% of the Company’s capital at December 31, 2006 which were issued by one issuer:
Lending Activities
Our present lending strategy is to attract small to mid-sized businesses, builders and professionals by offering a variety of commercial loan products and a full range of banking services coupled with highly personalized service. We offer secured and unsecured commercial term loans and revolving lines of credit, commercial and multi-family real estate loans, construction loans for individual and tract single-family homes, commercial and multi-family properties, land development loans, SBA loans and home equity lines of credit. We often tailor our loan products to meet the specific needs of our borrowers. Our lending area includes all six Southern California counties (Los Angeles, Orange, Riverside, San Diego, San Bernardino, and Ventura) and occasionally other areas of California and other states.
The following table sets forth the composition of our loan portfolio at the dates indicated (excluding loans held for sale):
LOAN PORTFOLIO COMPOSITION
A further breakdown of the construction loan portfolio at the dates indicated follows:
CONSTRUCTION LOAN PORTFOLIO COMPOSITION
At December 31, 2006, we had undisbursed construction loan commitments of $160.5 million.
Of our total loans outstanding at December 31, 2006, 58% were due in one year or less, 20% were due in 1-5 years and 22% were due after 5 years. As is customary in the banking industry, loans can be renewed by mutual agreement between the borrower and us. Because we are unable to estimate the extent to which our borrowers will renew their loans, the following table is based on contractual maturities.
LOAN MATURITIES
Under applicable regulations, we may not make loans in excess of our legal lending limit. In general, this limit is 25% of our total regulatory capital for secured loans and 15% of our total regulatory capital for unsecured loans. Our legal lending limits at December 31, 2006 were $22.2 million for secured loans and $13.3 million for unsecured loans. If a borrower requests a loan in excess of our legal lending limit, we may originate the loan with the participation of one or more other lenders. Historically, we have not subordinated our retained interest in these loans to the participation interest and have retained the servicing rights for the loans, for which we receive a servicing fee from the participants. At December 31, 2006, we were servicing $175 million in participated loans, including $98 million in construction loans, $59 million in SBA loans and $18 million in real estate loans, as compared with $128 million in participated loans at the end of 2005, including $45 million of construction loans, $60 million in SBA loans and $23 million in real estate loans.
Of our total loans outstanding, approximately 85% and 83% had adjustable rates at December 31, 2006 and 2005, respectively. Our adjustable rate loans generally have interest rates tied to the prime rate and adjust with changes in the rate on a daily, monthly or quarterly basis. The following table sets forth the amount of our loans due after one year which have fixed and adjustable rates at the dates indicated:
FIXED/ADJUSTABLE RATE LOANS
(Loans due after one year)
We from time to time refer or sell certain commercial real estate loans to third parties and receive a broker fee if and when the loan funds.
Commercial Loans. We offer a variety of commercial loans, including secured and unsecured term loans and revolving lines of credit, equipment loans, accounts receivable loans and Small Business Administration (“SBA”) loans. Loans other than term loans generally have adjustable rates; term loans may have fixed or adjustable rates. We underwrite secured term loans and revolving lines of credit primarily on the basis of the borrower’s cash flow and the ability to service the debt, although we rely on the liquidation of the underlying collateral as a secondary payment source, where applicable. As a result, if the borrower defaults and we foreclose on the assets, we may not be able to recover the full amount of the loan.
SBA loans are designed for small business owners and are generally guaranteed, in part, up to 75% by the United States Government. SBA loans are structured with longer maturities and generally more liberal collateral requirements than conventional commercial loans. The SBA defines a “small business” generally as independently owned and operated and not dominant within its industry and within defined asset and income limitations. SBA loans may have fixed or adjustable rates and maximum loan maturities range from seven to 25 years depending on the intended use of loan proceeds. We have historically sold to third parties the SBA-guaranteed portion of our SBA loans. We originated $29 million and $31 million of SBA loans in 2006 and 2005, respectively. At December 31, 2006, we had $30 million of SBA loans outstanding, and we were servicing an additional $59 million of SBA loans.
Construction Loans. We make loans to finance the acquisition, development and/or construction of individual and tract single-family residences and multifamily and commercial properties. Loans to finance the construction of individual single-family residences may be made to borrowers for their primary residence or developers who build for sale to unidentified third parties.
Our construction loans generally have terms from 12 to 18 months and bear interest at adjustable rates. The loan-to-value ratio of our construction loans generally does not exceed 75% of the estimated value of the project upon completion. We require the borrower to have equity in the project (generally 15% of the acquisition, development and construction costs) in connection with each construction loan. Construction loans to developers for tract projects require repayment from the proceeds of unit sales at a rate greater than pro-rata based on the ratio of the loan amount to project costs including an interest reserve. We generally require personal guarantees
from corporate or other entity borrowers. We disburse construction loan proceeds through a bonded fund control company which is required to carefully monitor disbursements based on the project budget and percent completion or through our construction loan disbursement section. We require a current appraisal in connection with each of our construction loans.
We also make land development loans to borrowers who demonstrate the experience and expertise in successful land planning, zoning and lot development. These loans are typically made with the expectation that we will provide financing for the construction loan. The land development loans generally have a maturity of 12 to 18 months.
During 2006, we have significantly increased the amount of construction loans, both in dollar amounts and as a percentage of our total loans. This increase in loans is partially due to projects which were delayed due to the near record rainfall in Southern California during the first part of 2005 as well as a continued demand for construction loan financing.
Real Estate Loans. Our real estate loans include fixed and adjustable rate loans secured by primarily commercial properties. These loans generally have terms of ten years or less and payments based on a 15-to-25 year amortization schedule, often resulting in a balloon payment at maturity. The original principal amount of the real estate loans in our loan portfolio at December 31, 2006 generally did not exceed 65% to 75% of the appraised value of the property at the time of origination (or the lesser of the appraised value or the purchase price for the property if the loan is made to finance the purchase of the property). We require a current appraisal in connection with each real estate loan originated. Generally, our real estate loan borrowers are single-asset, limited liability companies or operate their businesses at the properties.
Other Loans. We offer other types of loans, including home equity lines of credit. Home equity lines of credit generally have adjustable rates and provide the borrower with a line of credit in an amount which generally does not exceed 80% of the appraised value of the borrower’s residence, net of senior debt, at the time of origination.
Asset Quality and Credit Risk Management
We assess and manage credit risk on an ongoing basis through diversification guidelines, lending limits, credit review and approval policies and internal monitoring. We have a Board of Directors Loan Workout Committee which meets quarterly to review, monitor and establish the plan of action for all criticized assets and review the adequacy of the allowance for loan losses (“ALL”). As part of the control process, an independent credit review firm regularly examines our loan portfolio and other credit processes. In addition to this credit review process, our loan portfolio is subject to examination by the FDIC and the California DFI in the normal course of business. Underlying trends in the economic and business cycle will influence credit quality. We seek to manage and control our risk through diversification of the portfolio by type of loan, industry concentration and type of borrower.
The credit quality of our loans will be influenced by underlying trends in the economic cycle, particularly in Southern California, and other factors which are beyond our control. Accordingly, no assurance can be given that we will not sustain loan losses that in any particular period are sizable in relation to the ALL. Additionally, subsequent evaluation of the loan portfolio, in light of factors then prevailing, by our regulators and us, may indicate a requirement for increases in the ALL through charges to the provision for loan losses.
Non-Performing Assets
Non-performing assets consist of non-performing loans and other real estate owned (“OREO”). Non-performing loans are (i) loans which have been placed on non-accrual status; (ii) loans which are contractually past due 90 days or more with respect to principal or interest, have not been restructured or placed on non-accrual status, and are accruing interest; and (iii) troubled debt restructurings (“TDRs”). OREO is comprised of real estate acquired in satisfaction of loans either through foreclosure or deed in lieu of foreclosure.
The following table sets forth information about non-performing assets at the dates indicated:
NON-PERFORMING ASSETS
Subsequent to December 31, 2006, we have experienced an increase in non-performing loans. We believe that this may be in part due to delayed payoffs on construction projects impacted by a declining demand in the housing industry. Based on our review of the underlying collateral, cash flows and other factors, we believe that the allowance for loan losses at December 31, 2006 is adequate. However, no assurance can be given that future provisions for loan losses will not be necessary.
Non-accrual Loans. Non-accrual loans are those loans for which we have discontinued accrual of interest because there exists reasonable doubt as to the full and timely collection of either principal or interest. It is our present policy that a loan will be placed on non-accrual status if either principal or interest payments are past due generally in excess of 90 days unless the loan is both well secured and in process of collection, or if full collection of interest or principal becomes uncertain, regardless of the time period involved.
When a loan is placed on non-accrual status, all interest previously accrued but uncollected is reversed against current period operating results. Income on such loans is then recognized only to the extent that cash is received and, where the ultimate collection of the carrying amount of the loan is probable, after giving consideration to the borrower’s current financial condition, historical repayment performance and other factors. Accrual of interest is resumed only when (i) principal and interest are brought fully current, and (ii) such loan is either considered, in management’s judgment, to be fully collectible or otherwise well secured and in the process of collection.
Non-accrual loans at December 31, 2006 increased to $5.9 million from $0.7 million at December 31, 2005. Non-accrual loans at December 31, 2006 consisted of four loans secured by various types of collateral including real estate and accounts receivables or partially guaranteed by the SBA, all of which are considered to be well secured. Subsequent to December 31, 2006 a $1.0 million non-accrual loan was paid in full.
Interest income of $122,000, $900, and $81,800 was recorded on non-accrual loans in 2006, 2005, and 2004, respectively; the additional interest income that would have been recorded on non-accrual loans, if the loans had not been on non-accrual status, would have been $281,600, $2,300, and $83,500 for 2006, 2005, and 2004, respectively. Interest payments received on non-accrual loans are applied to principal unless there is no doubt as to ultimate full repayment of principal, in which case the interest payment is recognized as interest income. Interest income not recognized on non-accrual loans reduced the net yield on earning assets less than 0.1% for 2006, 2005 and 2004.
Loans Contractually Past Due 90 or More Days. Loans contractually past due 90 or more days are those loans which have become contractually past due at least 90 days with respect to principal or interest. Interest accruals may be continued for loans that have become contractually past due 90 days when such loans are well secured and in the process of collection, and, accordingly, management has determined such loans to be fully collectible as to both principal and interest.
For this purpose, a loan is considered well secured if the collateral has a realizable value in excess of the amount of principal and accrued interest outstanding and/or is guaranteed by a financially capable party. A loan is considered to be in the process of collection if collection of the loan is proceeding in due course either through legal action or through other collection efforts which management reasonably expects to result in repayment of the loan or its restoration to a current status in the near future.
We had $0.2 million in loans which were contractually past due 90 or more days and still accruing interest at December 31, 2006. We had no loans contractually past due 90 or more days and still accruing interest at December 31, 2005.
TDRs. A TDR is a loan for which we have, for economic or legal reasons related to a borrower’s financial difficulties, granted a concession to the borrower we would not otherwise consider. We may make modifications of loan terms to alleviate the burden of the borrower’s near-term cash flow requirements in order to help the borrower to improve its financial condition and eventual its ability to repay the loan.
At December 31, 2005, we had a $570,900 loan which had been classified as a TDR. This troubled debt restructuring loan was charged off during the second quarter of 2006 due to financial difficulties of the borrower.
Other Real Estate Owned. We carry OREO at the lesser of our recorded investment or the fair value less selling costs. We periodically revalue OREO properties and charge other expenses for any further write-downs. We had no OREO in 2006 or 2005.
Impaired Loans
An impaired loan is a loan which management determines is probable that we will be unable to collect all principal and interest amounts due according to the contractual terms of the loan agreement. Impaired loans can include non-performing loans, although not all impaired loans will be non-performing loans.
We determine impaired loans by a periodic evaluation on an individual loan basis. At December 31, 2006 and 2005, we had classified $4.5 million and $2.0 million, respectively, of our loans as impaired. As of December 31, 2006, we had established specific reserves of $0.6 million on $6.0 million of impaired loans. As of December 31, 2005, we had established specific reserves of $0.2 million on $0.8 million of impaired loans. In 2006, we collected $1.3 million on impaired loans, of which $1.2 million was credited to principal outstanding and $0.1 million was recognized as interest income. In 2005, we collected $8.8 million on impaired loans, of which $8.4 million was credited to principal outstanding and $0.4 million was recognized as interest income. The average balance of impaired loans was $6.3 million in 2006 and $6.5 million in 2005. Subsequent to December 31, 2006 a $1.0 million impaired loan was paid in full.
Allowance for Loan Losses (“ALL”)
The ALL consists of specific, general and unallocated components. The specific component relates to loans that are classified as either special mention, substandard, doubtful or loss including impaired loans (rated 7, 8, 9, or 10 in our loan grading system). The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect our estimate of probable losses. The unallocated component of the ALL reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
We make periodic credit reviews of the loan portfolio and consider current economic conditions, historical credit loss experience and other factors in determining the adequacy of the ALL. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. Although we use the best information available to make these estimates, future
adjustments to the ALL may be necessary due to economic, operating, regulatory and other conditions that may be beyond our control. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our ALL and such agencies may require us to recognize additions to the allowance based on judgments different from those of management.
The following table presents at the dates indicated the composition of our allocation of our ALL for credit to specific loan categories:
ALLOWANCE FOR LOAN LOSSES
ALLOWANCE FOR LOAN LOSSES
The following table presents an analysis of changes in the allowance for loan losses during the periods indicated:
CHANGES IN ALLOWANCES FOR LOAN LOSSES
Off-Balance Sheet Credit Commitments and Contingent Obligations
We enter into or issue financial instruments with off-balance sheet credit risk in the normal course of business to meet the financing needs of our customers. In 2006, these included undisbursed commitments to extend credit, standby letters of credit and financial guarantees. Our exposure to credit loss in the event of non-performance by customers is represented by the contractual amount of the instruments. We use the same credit underwriting policies in entering into these commitments and contingent obligations as we do for loans. When deemed necessary, we obtain collateral supporting those commitments.
Commitments to extend credit are agreements to lend up to a specific amount to a customer as long as there is no violation of any condition in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since we expect some commitments to expire without being drawn upon, the total commitment amounts do not necessarily represent future loans. At December 31, 2006, we had undisbursed loan commitments of $306.4 million.
Standby letters of credit and financial guarantees are conditional commitments issued to secure the financial performance of a customer to a third party. These are issued primarily to support public and private borrowing arrangements. The credit risk involved in issuing a letter of credit for a customer is essentially the same as that involved in extending a loan to that customer. We hold certificates of deposit and other collateral of at least 100% of the notional amount as support for letters of credit for which we deem collateral to be necessary. At December 31, 2006, we had outstanding standby letters of credit and financial guarantees with a potential $80.2 million of obligations, all of which will mature at various dates through 2011.
Deposits
We attract deposits from our borrowers, from customers in the vicinity of our four branches in Southern California, through a “money desk” which attracts deposits telephonically throughout the United States, by advertising our deposit products on the internet and from brokers. We offer non-interest bearing checking accounts and a variety of interest bearing accounts, including money market accounts, savings accounts, and certificates of deposit with maturities ranging from 90 days to three years.
The following table sets forth the amount of certificates of deposit of $100,000 and over maturing within certain intervals at the date indicated:
MATURITY DISTRIBUTION OF CERTIFICATES OF DEPOSIT OF $100,000 AND OVER
The following table sets forth information concerning the amount of deposits from various sources at the dates indicated:
(1) All except approximately $10.0 million of brokered deposits were arranged by one broker for over 1,600 different depositors as of December 31, 2006.
Our money desk attracts primarily certificates of deposit from institutional investors nationwide by telephone. We also engage brokers to place certificates of deposit with their customers. During 2006, the certificates of deposits obtained through our money desk or deposit brokers generally had maturities ranging from six months to nine years. We limit the amount of money desk and brokered deposits that are scheduled to mature in any one calendar month. In addition, we have historically maintained an appropriate level of liquidity specifically to counter any concurrent deposit reduction that might occur.
We have established relationships with several brokers that will place certificates of deposit for us. When we desire to use these brokers to place certificates of deposit, we generally advise all of them of the amount and maturities of the certificates of deposit we want to place, and place the certificates of deposit through the broker offering the lowest interest rates. Notwithstanding this procedure, all except $10.0 million of our brokered deposits at December 31, 2006 were obtained through one broker. We believe that should our business
discontinue with this broker, we could continue to obtain the certificates of deposit we desire through other brokers. However, we could be adversely affected because the certificates of deposit through other brokers may bear relatively higher interest rates. Further, the deposits obtained through this broker as of December 31, 2006 mature at various times through September 2011, and thus such discontinuation would not result in the immediate withdrawal of such deposits. We intend to continue our efforts to increase our levels of core deposits in an effort to decrease our reliance on money desk and brokered deposits.
In recent years, the interest rates on certificates of deposit we have obtained through brokers generally have been lower than the interest rates then offered through our money desk or to local customers for certificates of deposit with comparable maturities. We believe this is due to the highly competitive nature of Southern California market for deposits and, in particular, the difficulty smaller banks with several branch offices have in competing for deposits with larger banks, savings associations and credit unions with multiple offices.
Under FDIC regulations, banks that are not “well capitalized” under the prompt corrective action rules may not accept brokered deposits without the prior approval of the FDIC. In addition, we believe that if we are not “well capitalized”, we will have greater difficulty obtaining certificates of deposit through our money desk and may have to pay higher interest rates to continue to attract those deposits. Accordingly, the failure of the Bank to remain “well capitalized” could have a material adverse affect on us.
The following table shows by specified deposit category the dollar amount of deposits from the single largest depositor or intermediary and from the five largest depositors and/or intermediaries at the date indicated:
CONCENTRATION OF DEPOSITS
At December 31, 2006
(1)
Includes $152.4 million and $125.8 million obtained through one broker for over 1,600 and 1,300 different depositors for 2006 and 2005, respectively.
Note: One depositor appeared in more than one category with total deposits of $49.9 million.
At December 31, 2006, one customer represented a number of entities that provide us funds through deposits which exceed the FDIC insurance limits. We provide security for these funds through a letter of credit issued by the FHLB of San Francisco for $75 million. Most of these deposits can be withdrawn upon demand without penalty. In 2006, the maximum month-end amount of funds provided by entities controlled by this individual at any date was $67.8 million and at December 31, 2006 the aggregate amount of these deposits was $49.9 million. We monitor this relationship closely, and while we have no reason to believe the customer presently intends to significantly reduce or terminate the relationship, we have adequate liquidity to fund any consequential withdrawals. If we had to replace these deposits, the new deposits or borrowings might be more costly which would adversely affect our net interest income.
Borrowed Funds
FHLB Advances. At December 31, 2006, we had $50 million in advances from the FHLB which were collateralized by certain qualifying loans with a carrying value of $228.4 million and various investment
securities with an amortized cost of $11.0 million. The advances mature on various dates between 2008 and 2010. Advances totaling $10.0 million bear interest at a weighted average fixed rate of 5.31% and advances totaling $40.0 million bear interest at a rate of the prime lending rate less a weighted average rate of 2.81% (5.44% at December 31, 2006). Interest is payable monthly, quarterly or semi-annually with principal and any accrued interest due at maturity.
The following table provides additional information concerning the FHLB advances:
Junior Subordinated Debentures. In October 2002, Bancshares issued $7,217,000 of junior subordinated debentures to Alliance Bancshares California Capital Trust I, a Delaware business trust that was formed for the exclusive purpose of issuing trust preferred securities to provide additional regulatory capital. This capital has a relatively low cost as interest payments on the debentures are deductible for income tax purposes. The Trust purchased the debentures with the proceeds of the sale of its common trust securities to Bancshares for $217,000 and trust preferred securities for $7,000,000. The subordinated debentures and trust preferred securities have generally identical terms, including that they mature in 2032, are redeemable at the Bancshare’s option commencing October 2007 at par, and require quarterly distributions/interest payments at a rate which adjusts quarterly at the three-month LIBOR rate plus 3.45% (the rate was 8.82% at December 31, 2006).
In February 2005, Bancshares issued $10,310,000 of junior subordinated debentures to Alliance Bancshares California Capital Trust II, a Delaware business trust that was formed for the exclusive purpose of issuing trust preferred securities to provide additional regulatory capital. The Trust purchased the debentures with the proceeds of the sale of its common trust securities to Bancshares for $310,000 and trust preferred securities for $10,000,000. The subordinated debentures and trust preferred securities have generally identical terms, including that they mature in 2034, are redeemable at Bancshare’s option commencing February 2010 at par, and require quarterly distributions/interest payments at a rate which adjusts quarterly at the three-month LIBOR rate plus 1.90% (the rate was 7.27% at December 31, 2006).
In May 2006, Bancshares issued $10,310,000 of junior subordinated debentures to Alliance Bancshares California Capital Trust III, a Delaware business trust that was formed for the exclusive purpose of issuing trust preferred securities to provide additional regulatory capital. The Trust purchased the debentures with the proceeds of the sale of its common trust securities to Bancshares for $310,000 and trust preferred securities in a private placement for $10,000,000. The subordinated debentures and trust preferred securities have generally identical terms, including that they mature in 2036, are redeemable at Bancshare’s option commencing June 2011 at par, and require quarterly distributions/interest payments at a rate which adjusts quarterly at the three-month LIBOR rate plus 1.50% (the rate was 6.87% at December 31, 2006).
Bancshares has unconditionally guaranteed distributions on, and payments on liquidation and redemption of, all issues of the trust preferred securities.
Securities Sold Under Agreements to Repurchase. One customer represents a number of entities that have deposit accounts that greatly exceed the FDIC deposit insurance limit. To provide additional security for these borrowings, in fiscal year 2006 through September 22, 2006, we swept the funds in these deposit accounts that exceeded the FDIC insurance limit into overnight repurchase agreements. These repurchase agreements were in essence overnight borrowings by us collateralized by certain of our investment securities that were held by an independent third party financial institution that can cause the securities to be liquidated upon default. During the nine months ended September 30, 2006, the average daily balance of these repurchase agreements was $47.5
million. On September 22, 2006, we entered into a new arrangement to provide security for these funds through a letter of credit issued by the FHLB of San Francisco up to $75 million. See “Deposits.” As a result, at December 31, 2006, we have no securities sold under agreements to repurchase with this customer and the accounts are classified as deposits.
In November 2006, we entered into a repurchase agreement in the amount of $20.0 million. This agreement is collateralized by various collateral mortgage obligations and mortgage-backed securities with an amortized cost of $24.1 million. Interest is payable on a quarterly basis and adjusts quarterly at the rate of the three-month LIBOR minus 1.00% (the rate was 4.37% at December 31, 2006) until November 2008 at which time it converts to a fixed rate of 4.54%. The agreement has a maturity date of November 2016 and is callable by the holder at any time after November 7, 2008.
Contractual obligations
The following table summarizes the aggregate contractual obligations as of December 31, 2006:
Deposits represent non-interest bearing and interest bearing demand, money market, savings, NOW, certificates of deposits, brokered and all other deposits held by the Company.
FHLB advances represent the amounts that are due to the Federal Home Loan Bank. These borrowings have variable interest rates except for one $10 million advance which has a fixed rate of interest.
The junior subordinated debentures are held by three trust subsidiaries that purchased the debentures with the proceeds from the sale of trust preferred securities. The debentures and the trust preferred securities have substantially identical terms, including that they mature in 30 years from issuance and are redeemable five years after the date of issuance.
Securities sold under agreements to repurchase is a repurchase agreement which has a variable rate of three-month LIBOR minus 1.00% until November 2008 at which time it converts to a fixed rate of 4.54%. The agreement has a maturity date of 2016 and is callable by the holder at any time after November 2008.
Operating leases represent the total minimum lease payments under noncancelable operating leases.
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Based on our business, market risk is primarily limited to interest rate risk which is the impact that changes in interest rates would have on future earnings. Interest rate risk, including interest rate sensitivity and the repricing characteristics of assets and liabilities, is managed by our Management Asset Liability Committee and reported to the Board of Directors. The principal objective of our asset/liability management is to maximize net interest income within acceptable levels of risk established by policy. Interest rate risk is measured using financial modeling techniques, including stress tests, to measure the impact of changes in interest rates on future earnings. Net interest income, the primary source of earnings, is affected by interest rate movements. Changes in interest rates have lesser impact the more that assets and liabilities reprice in approximately equivalent amounts at basically the same time intervals. Imbalances in these repricing opportunities at any point in time constitute interest sensitivity gaps, which is the difference between interest sensitive assets and interest sensitive liabilities. These static measurements do not reflect the results of any projected activity and are best used as early indicators of potential interest rate exposures.
An asset sensitive gap means an excess of interest sensitive assets over interest sensitive liabilities, whereas a liability sensitive gap means an excess of interest sensitive liabilities over interest sensitive assets. In a changing rate environment, a mismatched gap position generally indicates that changes in the income from interest earning assets will not be completely proportionate to changes in the cost of interest bearing liabilities, resulting in net interest income volatility. This risk can be reduced by various strategies, including the administration of liability costs and the reinvestment of asset maturities.
The following table sets forth the distribution of our rate-sensitive assets and liabilities at the date indicated:
RATE SENSITIVITY
At December 31, 2006
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Alliance Bancshares California:
We have audited the accompanying consolidated balance sheets of Alliance Bancshares California and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of earnings, shareholders’ equity and cash flows for each of the three years ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alliance Bancshares California and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standard No. 123 (revised 2004), Share-Based Payment in 2006 and changed its method of accounting for stock-based compensation.
/s/ MCGLADREY & PULLEN, LLP
Pasadena, California
March 30, 2007
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF EARNINGS
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the Three Years Ended December 31, 2006
The accompanying notes are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006
1. Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of Alliance Bancshares California (“Bancshares”), its wholly owned subsidiary Alliance Bank (the “Bank”) and Lexib Realcorp, an inactive wholly owned subsidiary of the Bank. Bancshares is a bank holding company which was incorporated in 2000 in the State of California. The Bank is a commercial bank incorporated in 1979 in the State of California. The Bank is chartered by the California Department of Financial Institutions and its deposit accounts are insured by the Federal Deposit Insurance Corporation up to the maximum amount under the terms allowed by the federal regulations. The Bank conducts its financial services primarily in the six Southern California counties: Los Angeles, Orange, Riverside, San Diego, San Bernardino, and Ventura and occasionally other areas of California and other states. References in these Notes to the “Company” refer to Bancshares and its consolidated subsidiary.
Bancshares has three additional wholly owned subsidiaries, Alliance Bancshares California Capital Trust I, which it formed in 2002, and Alliance Bancshares California Capital Trust II, which it formed in 2005, and Alliance Bancshares California Capital Trust III, which it formed in 2006 (collectively known as the “Trusts”) to issue trust preferred securities. These subsidiaries are not consolidated as a result of the implementation of FIN 46R. As a result, the accompanying consolidated balance sheets include the investment in the Trusts of $837,000 in other assets.
The accounting and reporting policies of the Bank and the Company conform to accounting principles generally accepted in the United States of America and general practices within the banking industry.
The following are descriptions of the more significant of those policies:
A. Principles of Consolidation
The consolidated financial statements include the accounts of Bancshares, the Bank and the Bank’s wholly owned subsidiary. All material intercompany accounts and transactions have been eliminated.
B. Reclassifications
Certain amounts for 2005 have been reclassified to conform to the 2006 presentation. These reclassifications had no change to shareholders’ equity, net earnings or earnings per share.
C. Securities Held to Maturity
The Company classifies as held-to-maturity those debt securities that the Company has the positive intent and ability to hold to maturity. Securities held-to-maturity are accounted for at cost and adjusted for amortization of premiums and accretion of discounts. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. For mortgage-backed securities (“MBS”), the amortization or accretion is based on estimated average lives of the securities. The lives of these securities can fluctuate based on the amount of prepayments received on the underlying collateral of the securities.
D. Loans Held for Sale
Loans held for sale are those loans the Company has the intent to sell in the foreseeable future. They are carried at the lower of aggregate cost or market. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Gains and losses on sales of loans are recognized at settlement dates and are determined by the difference between the sales proceeds and the carrying value of the loans after allocating costs to servicing rights retained. All sales are made without recourse.
E. Loans
Loans receivable that management has the intent and the ability to hold for the foreseeable future or until maturity or pay-off are stated at the amount of unpaid principal, reduced by net deferred loan fees and costs and an allowance for loan losses. Interest is accrued daily on the outstanding balances. Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loan’s yield using the effective interest method. The Company amortizes these amounts over the contractual life of the loan.
The Company determines a loan to be delinquent when payments have not been made according to contractual terms, typically evidenced by nonpayment of a monthly installment by the due date. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. All interest accrued but not collected for loans that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
A substantial portion of the Company’s loan portfolio is secured by real estate in Southern California. A significant downturn in the value of such real estate could have an adverse effect on the recorded investment in such loans.
F. Allowance for Loan Losses
The allowance for loan losses is based on estimates and ultimate losses may vary from current estimates. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in results of operations in the periods in which they become known. The allowance is increased by provisions for loan losses charged to expense. The balance of a loan deemed uncollectible is charged against the allowance for loan losses when management believes that collectibility of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.
Management makes periodic credit reviews of the loan portfolio and considers current economic conditions, historical credit loss experience and other factors in determining the adequacy of the allowance. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. Although management uses the best information available to make these estimates, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions that may be beyond the Company’s control. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful, substandard or special mention. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
Also included in the allowance for loan losses are provisions for loans that have declined in value and which management has determined to be impaired. Management deems a loan to be impaired when it is probable, based on current information and events, that the Company will be unable to collect all principal and interest amounts due according to the contractual terms of the loan agreement. Impaired loans are measured on an individual basis for commercial and construction loans based upon the present value of expected future cash flows discounted at the loan’s effective rate, or, as a practical expedient, at the loan’s observable market price or the fair value of the
collateral if the loan is collateral-dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses.
For impaired loans, the accrual of interest is discontinued on a loan when management believes, after considering collection efforts and other factors, that the borrower’s financial condition is such that collection of interest is doubtful. Cash collections on impaired loans are generally credited to the loan receivable balance, and no interest income is recognized on those loans until the principal balance has been collected.
G. Loan Sales and Servicing
The Company originates loans to customers under a SBA program that provides for SBA guarantees of generally 75% of the principal amount of each loan. The Company routinely sells the guaranteed portion of these loans to third parties and retains the unguaranteed portion of the loans. Transfers of loans held for sale in which the Company surrenders control over those loans are accounted for as a sale to the extent that consideration, other than beneficial interests in the transferred loans, is received in exchange. For loans sold, the Company allocates the carrying value of such loans between the portion sold and the portion retained, based upon estimates of their relative fair value at the time of sale. The difference between the adjusted carrying value and the face amount of the portion retained is amortized to interest income over the life of the related loan using the interest method.
Servicing assets are recognized when loans are sold with servicing retained. Servicing assets are amortized in proportion to and over the period of estimated future net servicing income. The fair value of servicing assets are estimated by discounting the future cash flows at estimated future current market rates for the expected life of the loans. The Company uses industry prepayment statistics in estimating the expected life of the loan. Management periodically evaluates servicing assets for impairment. For purposes of measuring impairment, the rights are stratified based on original term to maturity. The amount of impairment recognized is the amount by which the servicing asset for a stratum exceeds its fair value. There was no impairment of servicing assets identified as of December 31, 2006.
The aggregate principal balance of SBA loans serviced for others was $59.4 million and $60.0 million at December 31, 2006 and 2005, respectively.
H. Federal Home Loan Bank Stock
The Bank, as a member of the Federal Home Loan Bank (“FHLB”) system, is required to maintain an investment in the capital stock of the FHLB in an amount equal to the greater of 1% of its outstanding home loans or 5% of advances from the FHLB. No ready market exists for the FHLB stock and it has no quoted market value. The total amount of FHLB stock included in other assets was $2.9 million at December 31, 2006 and 2005.
I. Redeemable Preferred Stock
The Company classifies redeemable preferred stock as mezzanine capital if it is redeemable either at the option of the Company and a majority of the Board of Directors of the Company owns the stock, or at the option of the holder.
J. Equipment and Leasehold Improvements
Equipment and leasehold improvements are carried at cost less accumulated depreciation and amortization. Depreciation is computed on the straight-line method over the estimated useful life of the asset. Amortization is computed on the straight-line method over the useful life of the leasehold improvement or the term of the lease, whichever is shorter. Equipment and leasehold improvements are reviewed for impairment periodically and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.
K. Basic and Diluted Earnings per Share
We account for EPS in accordance with SFAS No. 128 “Earnings Per Share”. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The diluted EPS computation does not include the anti-dilutive effect of 103,700 and 51,000 options for the years ended December 31, 2006 and 2005, respectively. There were no anti-dilutive options for the year ended December 31, 2004.
L. Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash, non-interest earning deposits and federal funds sold. Generally, federal funds are sold for one-day periods.
M. Time Deposits with Other Financial Institutions
Time deposits with other financial institutions have an original maturity of three months to three years and are carried at cost at December 31, 2006.
N. Income Taxes
The Company accounts for income taxes on the asset and liability method under which deferred tax liabilities (assets) are determined based on the differences between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Annual deferred tax expense (benefit) is equal to the change in the deferred tax liability (asset) account from the beginning to the end of the year. A current tax asset or liability is recognized for the estimated taxes refundable or payable for the current year. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax asset will not be realized.
O. Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses.
P. Equity Compensation Plans
The Company has two stock-based employee compensation plans, which are described more fully in Note 8.
Prior to January 1, 2006, the Company accounted for stock-based awards to employees and directors using the intrinsic value method, in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Accordingly, no compensation expense was recognized in the consolidated financial statements for employee and director stock options for the periods prior to January 1, 2006 as all options granted under the Plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123-R, Share-Based Payment (“SFAS 123-R”), using the modified-prospective-transition method. Under that transition method, compensation cost recognized for the year ended December 31, 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested as of December 31, 2006. Results for prior periods have not been restated.
In conjunction with the Company’s adoption of the fair value recognition provisions of SFAS 123-R, the Company also elected to adopt FASB Staff Position No. 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards, which is used to calculate the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123-R.
As a result of adopting SFAS 123-R on January 1, 2006, the net income for year ended December 31, 2006, was $209,800 lower and basic and diluted net income per share for the year ended December 31, 2006 were $0.03 lower than if the Company continued to account for stock-based compensation under APB Opinion No. 25. Prior to the adoption of SFAS 123-R, the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Consolidated Statements of Cash Flows. SFAS 123-R requires the cash flows related to the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. The Company had excess tax benefits of $143,400 resulting from exercise of non-qualified stock options for the year ended December 31, 2006.
The following table illustrates the effect on net income and earnings per share had the Company accounted for stock-based compensation in accordance with SFAS 123-R. For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes-Merton option pricing formula and amortized to expense over the options’ vesting periods.
Q. Fair Value of Financial Instruments
The financial statements include various estimated fair value information. Such information, which pertains to the Company’s financial instruments, does not purport to represent the aggregate net fair value of the Company. Further, the fair value estimates are based on various assumptions, methodologies and subjective considerations, which vary widely among different financial institutions and which are subject to change. The following methods and assumptions were used by the Company:
Cash and cash equivalents: The carrying amounts of cash and short-term instruments approximate fair values.
Time deposits with other financial institutions: The carrying amounts of time deposits with other financial institutions approximate fair values.
Securities: Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Loans held for sale: The fair value of loans held for sale is based on dealer quotes.
Loans receivable, accrued interest receivable and off-balance sheet instruments: For variable-rate loans and off-balance-sheet instruments that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. The fair values for other loans and off-balance-sheet instruments are estimated using discounted cash flow analyses. The carrying amount of accrued interest receivables approximates its fair value.
Commitments to extend credit and standby letters of credit: The carrying amounts of commitments to extend credit and standby letters of credit approximate fair value as the instruments predominately have adjustable rates and are short term in nature.
Deposit liabilities: The fair values estimated for transactional deposit accounts (interest and non-interest checking, savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of the aggregate expected monthly maturities on time deposits.
Accrued interest payable: The carrying amount of accrued interest payable approximates its fair value.
Borrowings: Fair value for FHLB advances, junior subordinated debentures and securities sold under agreements to repurchase are estimated using rates currently available for similar borrowings with similar credit risk and for the remaining maturities. The carrying amount of these borrowings approximates their fair value.
R. Securities Sold Under Agreements to Repurchase
We periodically enter into repurchase agreements in which the Company acquires funds which are immediately available by selling securities and simultaneously agreeing to repurchase the same or similar securities after a specified time at a given price (repurchase agreements). Fixed coupon repurchase agreements are treated as financing activities. Accordingly, the securities underlying the agreements remain in the securities balance, and the obligations to repurchase securities sold are reflected as a liability.
S. Advertising Costs
Advertising costs are expensed as incurred.
T. Operating Segments
SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for the way that public businesses report information about operating segments in annual and interim financial statements and establishes standards for related disclosures about an enterprise’s products and services, geographic areas, and major customers.
In accordance with the provisions of SFAS No. 131, reportable segments have been determined based upon the Company’s internal management and profitability reporting system, which is organized based on lines of business. The reportable segments for the Company are the Regional Banking Centers, the Real Estate Industries Division, the Small Business Administration (SBA), and Other. The Regional Banking Centers segment is comprised of the Bank’s four regional banking centers which provide a wide range of credit products and banking services primarily to small to medium sized businesses, executives, and professionals. The Real Estate Industries Division is comprised of real estate lending, including construction loans for commercial buildings, condominium and apartment projects, multifamily properties, and single-family subdivisions as well as commercial real estate loans. The SBA segment provides credit products that are in part guaranteed by the U.S. government and are made to qualified small business owners for the purpose of accessing capital for operations, acquisitions, and inventory or debt management. The segment entitled “Other” incorporates all remaining business units such as the Company’s corporate office, administrative and treasury functions, as well as other
types of products and services such as asset-based lending, investment securities, money desk certificates of deposit and brokered deposits.
The management accounting policies and processes utilized in compiling segment financial information are highly subjective and, unlike financial accounting, are not based on authoritative guidance similar to generally accepted accounting principles. As a result, reported segment results are not necessarily comparable with similar information reported by other financial institutions.
The Company does not allocate provisions for loan losses, general and administrative expenses, or income taxes to the business segments. In addition, the Company allocates internal funds transfer pricing to the segments using a methodology that charges users of funds interest expense and credits providers of funds interest income with the net effect of this allocation being recorded in administration. Since the Company derives substantially all of its revenues from interest and noninterest income, and interest expense is our most significant expense, the Company reports the net interest income (interest income less interest expense), which includes the effect of internal funds transfer pricing, and noninterest income for each of these segments as shown in the following table for the years ended December 31, 2006, 2005 and 2004.
The following table also shows the assets allocated to each of these segments as of December 31, 2006 and 2005.
Note: Overhead expenses are not allocated for costs from administration departments to operating segments.
U. Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position 13-2 (FSP 13-2) “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction.” This guidance applies to all transactions classified as leveraged leases in accordance with SFAS 13, Accounting for Leases. It requires the projected timing of income tax cash flows generated by a leveraged lease transaction to be reviewed annually or more frequently if events or changes in circumstances indicate that a change in timing has occurred or is projected to occur. If the projected timing of the income tax cash flows is revised, the rate of return and the allocation of income to positive investment years shall be recalculated from the inception of the lease. This guidance shall be applied to fiscal years beginning after December 15, 2006. The Company does not expect the adoption of FSP 13-2 to have a material effect on the Company’s consolidated financial statements.
The FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109. It prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the impact of the Interpretation on its consolidated financial statements.
SFAS No. 156, Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140, among other requirements, requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in the situations described in the standard. Essentially, all separately recognized servicing assets and servicing liabilities are to be initially measured at fair value, if practical. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. Early adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not issued financial statements. The Company does not expect the adoption of this Statement to have a material impact on its financial position, results of operations and cash flows.
In September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability. It also emphasizes that fair value is a market-based measurement not an entity specific measurement. SFAS 157 expands disclosures about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition. The disclosures focus on the inputs used to measure fair value and for recurring fair value measurements using significant unobservable inputs, the effect of the measurements on earnings for the period. The Company does not expect the adoption of SFAS 157 to have a material effect on the Company’s consolidated financial statements.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”(“SAB 108”). SAB 108 provides guidance on how to evaluate prior period financial statement misstatements for purposes of assessing their materiality in the current period, including both the carryover and reversing effects of prior year misstatements, using both a “rollover” and “iron curtain” approach. If the prior period effect is material to the current period, then the prior period is required to be corrected. Correcting prior year financial statements would not require an amendment of prior year financial statements, but such corrections would be made the next time the company files the prior year financial statements. Upon adoption, SAB 108 allows a one-time transitional cumulative effect adjustment to retained earnings for corrections of prior period misstatements required under this statement. SAB 108 is effective for fiscal years beginning after November 15, 2006. The Company does not expect the adoption of SAB 108 to have a material effect on the Company’s consolidated financial position or results of operations.
In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of SFAS 115.” SFAS 159 permits an entity to choose to measure financial instruments and certain other items at fair value. Most of the provisions of SFAS 159 are elective; however, the amendment to SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available for sale or trading securities. For financial instruments elected to be accounted for at fair value, an entity will report the unrealized gains and losses in earnings. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company does not expect the adoption of SFAS 159 to have an effect on the Company’s consolidated financial statements as the Company does not have available for sale or trading investments.
2. Balances at the Federal Reserve Bank
The Federal Reserve Board regulations may require that the Company maintain reserves in the form of cash on hand and deposit balances with the Federal Reserve Bank depending on the Company’s level of deposits. There was no balance required to be maintained with the Federal Reserve Bank at December 31, 2006. The reserve balance required to be maintained at the Federal Reserve Bank was $193,000 at December 31, 2005.
3. Securities Held to Maturity
The amortized cost and estimated fair value of securities held to maturity at December 31, 2006 and 2005 were as follows:
The amortized cost and estimated fair value of investment securities at December 31, 2006 by contractual maturities are shown in the following table. Expected maturities will differ from contractual maturities, particularly with respect to collateralized mortgage obligations and mortgage backed securities, because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The Company had no tax-exempt securities for the years ended December 31, 2006, 2005 or 2004.
At December 31, 2006, securities with an amortized cost of $37.0 million were pledged at the Federal Reserve to secure a discount line, at Citigroup Global Markets, Inc. to secure a structured repurchase agreement and at the FHLB to secure a letter of credit and various advances. At December 31, 2005, securities with an amortized cost of $55.3 million were pledged at the Federal Reserve to secure a discount line and at Wells Fargo Bank to secure repurchase agreements with one of the Bank’s depositors.
Unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in an unrealized loss position, at December 31, 2006 and 2005 are summarized as follows:
The Company’s analysis of these securities and the unrealized losses was based on the following factors: i) the length of the time and the extent to which the market value has been less than cost; ii) the financial condition and near-term prospects of the issuer; iii) the intent and ability of the Company to retain its investment in a security for a period of time sufficient to allow for any anticipated recovery in market value; and iv) general market conditions which reflect prospects for the economy as a whole, including interest rates and sector credit spreads.
The Company’s corporate bonds consist primarily of securities issued by General Motors Acceptance Corporation and Ford Motor Credit Company. These securities were rated as less than investment grade at December 31, 2006. Because these securities mature within the next two and one-half years, the Company believes that it will fully recover its principal investment and does not consider these investments to be other than temporarily impaired at December 31, 2006 or 2005.
Additionally, at December 31, 2006, approximately 50% of the collateral mortgage obligations and mortgage backed securities were issued by U.S. government agencies that guarantee payment of principal and interest of the underlying mortgage and we believe we will fully recover the principal investment on these securities. The remaining collateral mortgage obligations and mortgage backed securities were rated “AAA” by either Standard & Poor’s or Moody’s, as of December 31, 2006 and, therefore, the Company does not consider these investments to be other than temporarily impaired.
4. Loans
The composition of loans at the dates indicated was as follows:
The Company originates commercial, construction, real estate loans and home equity lines of credit primarily to small to mid-sized businesses, builders and professionals located in Southern California. The amount of collateral obtained, if deemed necessary by the Company, is determined in accordance with the Company’s underwriting criteria. During 2006, the Company has significantly increased the volume and dollar amounts of its loans in all categories.
At December 31, 2006 and 2005, qualifying loans with an outstanding balance of $228.4 million and $119.1 million, respectively, were pledged to secure advances and a letter of credit at the FHLB.
An analysis of the activity in the allowance for loan losses for the years at the dates indicated is as follows:
Loans on which the accrual of interest had been discontinued amounted to $5.9 million at December 31, 2006 and $0.7 million at December 31, 2005. If interest on those loans had been accrued, such income would have approximated $281,600 and $2,300 for 2006 and 2005, respectively. Additionally, we had $0.2 million in loans which were more than 90 days past due and still accruing interest at December 31, 2006. There were no loans more than 90 days past due and still accruing interest at December 31, 2005.
The following is a summary of the information pertaining to impaired loans at the dates indicated:
5. Equipment and Leasehold Improvements
The amount of depreciation and amortization included in operating expenses was $1.2 million, $0.9 million and $0.4 million, for 2006, 2005 and 2004, respectively, and was based on the following estimated useful asset lives:
Equipment and leasehold improvements at the dates indicated consisted of the following:
6. Income Taxes
The provision (benefit) for income taxes for the dates indicated consisted of the following:
As a result of the following items, the total provision (benefit) for income taxes for the dates indicated was different from the amount computed by applying the statutory U.S. federal income tax rate to earnings before income taxes:
Deferred tax assets and liabilities at the dates indicated consisted of the following:
7. Earnings Per Share
Basic and diluted earnings per share for the years ended December 31 are computed as follows:
8. Stock Options
The Company’s 1996 Combined Incentive and Non-Qualified Stock Option Plan (“1996 Plan”) provides for the issuance of up to 800,000 shares of the Company’s common stock upon exercise of incentive and non-qualified options. The 2005 Equity Incentive Plan (the “2005 Plan”), provides for the issuance of up to 450,000 shares of the Company’s common stock upon the exercise of incentive and non-qualified options, as restricted stock grants, or upon exercise of stock appreciation rights. To date, no restricted stock grants or stock appreciation rights have been issued under the 2005 Plan.
Both Plans provide that each option must have an exercise price not less than the fair market value of the stock at the date of grant and have a term not to exceed ten years (five years with respect to options granted to employees holding 10% or more of the voting stock of the Company). Options vest in various increments of not less frequently than 20% per year. The 1996 Plan expired in February 2006, although options remain outstanding under that Plan.
At December 31, 2006, compensation expense related to non-vested stock option grants aggregated to $1.4 million and is expected to be recognized as follows:
The Company uses the Black-Scholes option valuation model to determine the weighted average fair value of options. The Company utilizes assumptions on expected life, risk-free rate, expected volatility, and dividend yield to determine such values. If grants were to occur, the expected life of options would be derived from historical data on employee exercise and post-vesting termination behavior. The risk-free rate would be based on treasury instruments in effect at the time of grant whose terms are consistent with the expected life of the Company’s stock options. Expected volatility would be based on historical volatility of the Company’s stock. The dividend yield would be based on historical experience and expected future changes. The Company has not historically paid dividends on its common stock.
The following table summarizes the weighted average assumptions used for stock options granted for the years presented:
The following table summarizes the share option activity under the Plans for the periods indicated:
The weighted-average grant-date fair value of options granted was $7.77, $7.29 and $4.42 for 2006, 2005, and 2004, respectively. The total intrinsic value of options exercised during the year ended 2006, 2005 and 2004 was $1.2 million, $1.1 million and $0.4 million, respectively. SFAS 123R requires an estimate of forfeitures be used in the calculation. The Company estimates its forfeiture rates based on its historical experience.
The Company has a policy of issuing new shares to satisfy share option exercises.
9. Employee Benefit Plans
The Company’s 1996 Combined Incentive and Non-Qualified Stock Option Plan (“1996 Plan”) and the 2005 Equity Incentive Plan (the “2005 Plan”) are fully described in Note 8 above.
As of December 31, 2006, under the 1996 Plan, 484,600 shares had been issued, and options to purchase 295,300 shares were outstanding. Under the 2005 Plan, no shares had been issued, and options to purchase 129,700 shares were outstanding and 320,300 shares remained available for future options.
The fair value of each option grant is estimated on the grant date by using the Black-Scholes option-pricing model with the following assumptions used for options granted in 2006 and 2005: average risk-free interest rate of 4.9% and 4.27%, respectively; expected lives ranging from 4 to 6.5 years for 2006 and 5 to 10 years for 2005; and the estimated volatility of Company’s common stock of 42% and 38%, respectively.
The Company has an employee retirement savings plan that qualifies as a 401(k) savings plan for federal income tax purposes. The terms of the plan require the Company to contribute one dollar to the plan for every dollar contributed by eligible employees up to a maximum of 5% of each employee’s gross salary. For the years ended December 31, 2006, 2005 and 2004, the Company contributed approximately $453,000, $290,000 and $175,000, respectively. The profit sharing provision of the 401(k) savings plan provides for a discretionary contribution to be made to each eligible employee. The Company elected to contribute 4% of net income ($320,000) for the year ended December 31, 2006.
10. Certificates of Deposit
The aggregate amount of the certificates of deposit in denominations of $100,000 or more at December 31, 2006 and 2005 was approximately $247.9 million and $183.4 million, respectively. Interest expense on such deposits was approximately $10.0 million in 2006 and $3.5 million in 2005.
The approximate scheduled maturities of certificates of deposit at December 31, 2006 was as follows:
Time deposits included in IRA accounts have been excluded from the above maturities.
Our money desk attracts primarily certificates of deposit from institutional investors nationwide by telephone. We also engage brokers to place certificates of deposit for their customers. Certificates of deposit include amounts arranged through a single intermediary totaled 43.5% and 51.5% of all certificates of deposit at December 31, 2006 and 2005, respectively. The weighted average interest rate on brokered certificates of deposit at December 31, 2006 and 2005 was 4.49% and 4.21%, respectively.
11. Commitments, Contingencies and Financial Instruments with Off-Balance Sheet Risk
Lease Commitments. The Company entered into noncancelable operating leases relating to its corporate headquarters and Los Angeles Regional Banking Centers through January 2010, it’s Orange County Regional Banking Center through November 2007, its San Fernando Valley Regional Banking Center through February 2012, its Media Center Regional Banking Center through September 2009 and its Real Estate Industries Division Office through May 2008. In addition, the Company entered into a new noncancelable operating lease through March 2014 for its Westside Regional Banking Center to be opened in the summer of 2007. The future minimum lease payments under the six leases as of December 31, 2006 are as follows:
Certain lease agreements provide for scheduled rent increases during the lease term. Such “stepped” rent expense is recorded on a straight line basis over the respective terms of the leases. Rent expense for the years ended December 31, 2006, 2005, and 2004 totaled approximately $1.4 million, $1.1 million, and $0.9 million, respectively.
Legal Contingencies. The Company is subject to various claims and lawsuits which arise in the ordinary course of business. The Company does not anticipate any material losses with respect to any claims or lawsuits existing at December 31, 2006.
Financial Instruments with Off-Balance Sheet Risk. The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The Company had the following financial instruments as of December 31, 2006:
Commitments to extend credit are agreements to lend up to a specified amount to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon the extension of credit, is based on
management’s credit evaluation of the counterparty. Collateral held varies, but may include assignment of deposits and assignment of real estate interests. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. All standby letters of credit existing at December 31, 2006 will mature at various dates through 2011. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds certificates of deposit and other collateral of at least 100% of the notional amount as support for letters of credit for which collateral is deemed necessary.
12. Parent Company Only Condensed Financial Statements
The condensed parent company financial statements of Bancshares follow:
Condensed Balance Sheets
Condensed Statements of Earnings
Condensed Statements of Cash Flows
13. Fair Value of Financial Instruments
The estimated fair value of the Company’s financial instruments at the dates indicated was as follows:
Commitments to extend credit and letters of credit are written at current market rates. The Company does not anticipate any interest rate or credit factors that would affect the fair value of commitments or letters of credit outstanding at December 31, 2006.
14. Redeemable Preferred Stock
On December 31, 2005, Bancshares issued 667,096 shares of a newly created 6.82% Series B Non-Cumulative Preferred Stock (the “Series B Preferred”) at $17.00 per share for total proceeds of $11.3 million. The Series B Preferred is entitled to noncumulative dividends at an annual rate of $1.16 per share payable quarterly, has a liquidation preference of $17.00 per share plus declared and unpaid dividends, and has no voting rights except as required by law. Each share of Series B Preferred converts into one share of common stock at any time at the option of the holder and automatically if the market price of the common stock exceeds $22.00 per share for 60 consecutive trading days after September 30, 2010. Bancshares has the right to redeem the Series A Preferred for $17.00 per share plus declared and unpaid dividends at any time on or after September 30, 2013.
On March 31, 2004, Bancshares issued 733,050 shares of a newly created 7% Series A Non-Cumulative Convertible Preferred Stock (the “Series A Preferred”) at $10.50 per share for total proceeds of $7.7 million. The Series A Preferred is entitled to noncumulative dividends at an annual rate of $0.735 per share payable semi-annually, has a liquidation preference of $10.50 per share plus declared and unpaid dividends, and has no voting rights except as required by law. Each share of Series A Preferred converts into one share common stock at any time at the option of the holder and automatically if the market price of the common stock exceeds $16.00 per share for 60 consecutive trading days after December 31, 2008. Bancshares has the right to redeem the Series A Preferred for $10.50 per share plus declared and unpaid dividends at any time on or after December 31, 2012.
The Company has classified the Series A Preferred and Series B Preferred as mezzanine capital in its consolidated balance sheets. This classification is because the Series A Preferred and the Series B Preferred are redeemable at the option of the Company and a majority of the Board of Directors of the Company own shares of the Series A Preferred and the Series B Preferred.
15. Shareholders’ Equity
During 2005, Bancshares issued 100,000 shares of common stock for $1.05 per share upon exercise of warrants. There were no warrants exercised in 2006 or outstanding at December 31, 2006.
16. Related Party Transactions
A member of the Company’s Board of Directors is also a partner of a law firm that provides legal services to the Company. Fees paid to such law firm for the years ended December 31, 2006, 2005, and 2004 totaled $1,500, $2,600, and $7,800, respectively.
The Company has had, and may be expected to have in the future, banking transactions in the ordinary course of business with directors, significant shareholders, principal officers, their immediate families and affiliated companies in which they are principal shareholders (commonly referred to as related parties). In management’s opinion, these loans and transactions were on the same terms as those for comparable loans and transactions with non-related parties.
An analysis of the activity with respect to loans to directors and executive officers for the year ended 2006 is as follows:
None of these loans were past due, considered impaired or on nonaccrual at December 31, 2006.
17. Regulatory Capital
Bancshares and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. If Bancshares or the Bank fail to meet minimum capital requirements, regulators can initiate certain actions that could have a material effect on the Company’s financial statements. The regulations require Bancshare and the Bank to meet specific capital adequacy guidelines that involve quantitative measures of the Bancshare and the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting principles. The Bancshares’s and the Bank’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital to average assets (as defined). As of December 31, 2006, the Company and the Bank met all applicable capital adequacy requirements.
As of December 31, 2006, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. Prompt corrective action does not apply to bank holding companies. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that regulatory notification that management believes have changed the institution’s category.
The Bancshares and the Bank’s actual capital amounts and ratios as of December 31, 2006 and 2005 were as follows:
The Company has no formal dividend policy for its common shares, and dividends are paid solely at the discretion of the Company’s Board of Directors subject to compliance with regulatory requirements. There are also certain regulatory limitations on the payment of cash dividends by banks.
18. Debt Arrangements
As of December 31, 2006, the Bank had $50.0 million in advances from the FHLB of San Francisco. The advances are collateralized by certain qualifying loans with a carrying value of $228.4 million and various investment securities with an amortized cost of $11.0 million that have been pledged to secure the advances at December 31, 2006. The advances mature on various dates between 2008 and 2010. Advances totaling $10.0 million bear interest at a weighted average fixed rate of 5.31% and advances totaling $40.0 million bear interest at a rate of the prime lending rate less a weighted average rate 2.81% or 5.44% at December 31, 2006. Interest is payable monthly or quarterly with principal and any accrued interest due at maturity.
The following table provides additional information concerning the FHLB advances:
19. Securities Sold under Agreements to Repurchase.
One customer represents a number of entities that have deposit accounts that greatly exceed the FDIC deposit insurance limit. To provide additional security for these borrowings, in fiscal year 2006 through September 22, 2006, we swept the funds in these deposit accounts that exceeded the FDIC insurance limit into overnight repurchase agreements. These repurchase agreements were in essence overnight borrowings by the Company collateralized by certain of securities that were held by an independent third party financial institution that could cause the securities to be liquidated upon default. For 2006, the average daily balance of these repurchase agreements was $47.5 million and the maximum monthly amount of funds provided by these entities at any date was $67.8 million. On September 22, 2006, the Company entered into a new arrangement to provide security for these funds through a letter of credit issued by the FHLB of San Francisco for $75 million. As a result, at December 31, 2006, the Company had no securities sold under agreements to repurchase with this customer and the accounts are classified as deposits.
On November 7, 2006, the Company entered into a repurchase agreement in the amount of $20.0 million. This agreement is collateralized by various collateral mortgage obligations and mortgage-backed securities with an amortized cost of $24.1 million. Interest is payable on a quarterly basis and adjusts quarterly at the rate of the three-month LIBOR minus 1.00% (the rate was 4.37% at December 31, 2006) until November 2008 at which time it converts to a fixed rate of 4.54%. The agreement has a maturity date of November 2016 and is callable by the holder at any time after November 7, 2008.
20. Junior Subordinated Debentures
In October 2002, Bancshares issued $7.2 million of junior subordinated debentures to Alliance Bancshares California Capital Trust I, a Delaware business trust that was formed for the exclusive purpose of issuing trust preferred securities to provide additional regulatory capital. This capital has a relatively low cost as interest payments on the debentures are deductible for income tax purposes. The Trust purchased the debentures with the proceeds of the sale of its common trust securities to Bancshares for $217,000 and trust preferred securities for $7.0 million. The subordinated debentures and trust preferred securities have generally identical terms, including that they mature in 2032, are redeemable at the Company’s option commencing October 2007 at par, and require quarterly distributions/interest payments at a rate which adjusts quarterly at the three-month LIBOR rate plus 3.45% (the rate was 8.82% at December 31, 2006).
In February 2005, Bancshares issued $10.3 million of junior subordinated debentures to Alliance Bancshares California Capital Trust II, a Delaware business trust that was formed for the exclusive purpose of issuing trust preferred securities to provide additional regulatory capital. The Trust purchased the debentures with the proceeds of the sale of its common trust securities to Bancshares for $310,000 and trust preferred securities for $10.0 million. The subordinated debentures and trust preferred securities have generally identical terms, including that they mature in 2034, are redeemable at the Company’s option commencing December 2009 at par, and require quarterly distributions/interest payments at a rate which adjusts quarterly at the three-month LIBOR rate plus 1.90% (the rate was 7.27% at December 31, 2006).
In May 2006, Bancshares issued $10.3 million of junior subordinated debentures to Alliance Bancshares California Capital Trust III, a Delaware business trust that was formed for the exclusive purpose of issuing trust preferred securities to provide additional regulatory capital. The Trust purchased the debentures with the proceeds of the sale of its common trust securities to Bancshares for $310,000 and trust preferred securities in a private placement for $10.0 million. The subordinated debentures and trust preferred securities have generally identical terms, including that they mature in 2036, are redeemable at the Company’s option commencing June 2011 at par, and require quarterly distributions/interest payments at a rate which adjusts quarterly at the three-month LIBOR rate plus 1.50% (the rate was 6.87% at December 31, 2006).
Bancshares has unconditionally guaranteed distributions on, and payments on liquidation and redemption of, all issues of the trust preferred securities.
21. Quarterly Financial Data (Unaudited)
Summarized quarterly financial data follows:
22. Subsequent event
Subsequent to December 31, 2006, we have experienced an increase in non-performing loans. We believe that this may be in part due to delayed payoffs on construction projects impacted by a declining demand in the housing industry. Based on our review of the underlying collateral, cash flows and other factors, we believe that the allowance for loan losses at December 31, 2006 is adequate. However, no assurance can be given that future provisions for loan losses will not be necessary.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) that are designed to assure that information required to be disclosed in our Securities Exchange Act of 1934 reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide reasonable assurance only of achieving the desired control objectives, and management necessarily is required to apply its judgment in weighting the costs and benefits of possible new or different controls and procedures. Limitations are inherent in all control systems, so no evaluation of controls can provide absolute assurance that all control issues and any fraud within the company have been detected.
As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this report the Company, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of that date.
During the quarter ended December 31, 2006, there was no significant change in our internal controls over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934, as amended) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The information under the captions “Election of Directors-Information About the Nominees, and-Board Committees-Audit Committee” and “Other Information-Executive Officers,-Compliance with Section 16(a) Beneficial Ownership Reporting and-Code of Ethics” in our definitive proxy statement for the 2007 annual meeting of shareholders (the “Proxy Statement”) is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information under the subcaptions “Other Information-Executive Compensation,” and “Election of Directors-Compensation of Directors,” in the Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information under the captions “Other Information-Security Ownership of Principal Shareholders, Directors and Executive Officers” in the Proxy Statement is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information under the captions “Other Information-Transactions with Related Persons” and “Election of Directors-Director Independence” in the Proxy Statement is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information under the captions “Ratification of Selection of Independent Auditor” in the Proxy Statement is incorporated herein by reference.
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
See attached index to exhibits, which is incorporated herein by reference.
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
(1)
Filed with the Securities and Exchange Commission (“SEC”) as an exhibit to the Alliance Bancshares California’s Registration Statement on Form S-4EF filed in May 2002 and incorporated herein by reference.
(2)
Incorporated by reference to Form 10-KSB for the year ended December 31, 2001.
(3)
Incorporated by reference to Form 10-KSB for the year ended December 31, 2002.
(4)
Incorporated by reference to Form S-8 filed on June 17, 2003.
(5)
Incorporated by reference to Form 10-QSB for the quarter ended March 31, 2004.
(6)
Incorporated by reference to Form 10-KSB for the year ended December 31, 2003.
(7)
Incorporated by reference to Form 10-QSB for the quarter ended March 31, 2005.
(8)
Incorporated by reference to Form S-8 filed on July 26, 2005
(9)
Incorporated by reference to Form 10-Q for the quarter ended June 30, 2006.
(10)
Incorporated by reference to Form 10-KSB for the year ended December 31, 2005.