UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

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

For the fiscal year ended December 31, 2006

OR

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

Commission File No. 00-30747


FIRST COMMUNITY BANCORP

(Exact Name of Registrant as Specified in Its Charter)

California

 

33-0885320

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification Number)

401 West “A” Street

 

 

San Diego, California

 

92101-7917

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (619) 233-5588


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

Securities registered pursuant to Section 12(g) of the Act: Common stock, no par value

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “Accelerated Filer and Large Accelerated Filer” in Rule 12b-2 of the Exchange Act. (check one): Large Accelerated Filer x Accelerated Filer o Non-accelerated Filer o

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

As of June 30, 2006, the aggregate market value of the voting common stock held by non-affiliates of the registrant, computed by reference to the average high and low sales prices on the Nasdaq National Market as of the close of business on June 30, 2006, was approximately $1.3 billion. Registrant does not have any nonvoting common equities.

As of February 23, 2007, there were 28,825,229 shares of registrant’s common stock outstanding, excluding 899,147 shares of unvested restricted stock and unvested performance stock.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K will be found in the Company’s definitive proxy statement for its 2007 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, and such information is incorporated herein by this reference.

 




PART I

 

 

 

 

 

ITEM 1.

 

Business

 

3

 

 

 

General

 

3

 

 

 

Strategic Evolution and Acquisition Strategy

 

4

 

 

 

Banking Business

 

6

 

 

 

Financial and Statistical Disclosure

 

10

 

 

 

Supervision and Regulation

 

10

 

 

 

Available Information

 

16

 

 

 

Forward-Looking Information

 

17

 

ITEM 1A.

 

Risk Factors

 

18

 

ITEM 1B.

 

Unresolved Staff Comments

 

22

 

ITEM 2.

 

Properties

 

22

 

ITEM 3.

 

Legal Proceedings

 

22

 

ITEM 4.

 

Submission of Matters to a Vote of Security Holders

 

23

 

PART II

 

 

 

 

 

ITEM 5.

 

Market For Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

 

24

 

 

 

Marketplace Designation, Sales Price Information and Holders

 

24

 

 

 

Dividends

 

24

 

 

 

Securities Authorized for Issuance under Equity Compensation Plans

 

26

 

 

 

Recent Sales of Unregistered Securities and Use of Proceeds

 

26

 

 

 

Repurchases of Common Stock

 

27

 

 

 

Five Year Stock Performance Graph

 

28

 

ITEM 6.

 

Selected Financial Data

 

29

 

ITEM 7.

 

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

 

30

 

 

 

Overview

 

30

 

 

 

Key Performance Indicators

 

31

 

 

 

Critical Accounting Policies

 

32

 

 

 

Results of Operations

 

36

 

 

 

Financial Condition

 

43

 

 

 

Borrowings

 

51

 

 

 

Capital Resources

 

52

 

 

 

Liquidity

 

53

 

 

 

Contractual Obligations

 

54

 

 

 

Off-Balance Sheet Arrangements

 

54

 

 

 

Recent Accounting Pronouncements

 

54

 

ITEM 7A.

 

Qualitative and Quantitative Disclosures About Market Risk

 

54

 

ITEM 8.

 

Financial Statements and Supplementary Data

 

61

 

 

 

Contents

 

61

 

 

 

Management’s Report on Internal Control Over Financial Reporting

 

62

 

 

 

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

 

63

 

 

 

Report of Independent Registered Public Accounting Firm

 

65

 

 

 

Consolidated Balance Sheets as of December 31, 2006 and 2005

 

66

 

 

 

Consolidated Statements of Earnings for the Years Ended December 31, 2006, 2005
and 2004

 

67

 

 

 

Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the Years Ended December 31, 2006, 2005 and 2004

 

68

 

 

 

Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004 

 

69

 

 

 

Notes to Consolidated Financial Statements

 

70

 

ITEM 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

106

 

ITEM 9A.

 

Controls and Procedures

 

106

 

PART III

 

 

 

 

 

ITEM 10.

 

Directors and Executive Officers of the Registrant

 

107

 

ITEM 11.

 

Executive Compensation

 

107

 

ITEM 12.

 

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

 

107

 

ITEM 13.

 

Certain Relationships and Related Transactions

 

107

 

ITEM 14.

 

Principal Accountant Fees and Services

 

107

 

PART IV

 

 

 

 

 

ITEM 15.

 

Exhibits, Financial Statement Schedules and Reports on Form 8-K

 

108

 

SIGNATURES

 

112

 

CERTIFICATIONS

 

 

 

 

2




PART I

ITEM 1. BUSINESS

General

We are a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Our principal business is to serve as a holding company for our banking subsidiary. As of December 31, 2006, our sole banking subsidiary is Pacific Western Bank, which we refer to as Pacific Western, or the Bank. As of December 31, 2005, our banking subsidiaries were Pacific Western National Bank which we also refer to as Pacific Western, and First National Bank, which we refer to as First National. As part of the previously announced plan of consolidation and conversion, Pacific Western National Bank filed an application with the California Department of Financial Institutions, or DFI, to convert from a national banking charter to a state-chartered bank under the name of Pacific Western Bank. This application was approved and the conversion of Pacific Western to a state-chartered bank occurred on September 13, 2006. Pacific Western also filed a notice with the Federal Reserve Bank of San Francisco to withdraw from membership in the Federal Reserve System and become a “nonmember” bank at the time of its conversion. Additionally, on October 26, 2006, following the completion of the acquisition of Community Bancorp Inc. and the subsequent merger of its wholly-owned subsidiary, Community National Bank, with and into First National, we completed our plan of consolidation by merging First National with and into Pacific Western, with Pacific Western as the surviving entity in an “as if” pooling transaction. All references to Pacific Western, or the Bank, prior to September 13, 2006 refer to Pacific Western National Bank, and references on or after September 13, 2006 refer to Pacific Western Bank.

On January 4, 2006, we acquired Cedars Bank, or Cedars, which was merged with and into Pacific Western. On May 9, 2006, we acquired Foothill Independent Bancorp, or Foothill. At the time of acquisition Foothill was merged with and into the First Community Bancorp and Foothill’s wholly-owned subsidiary, Foothill Independent Bank, was merged with and into Pacific Western. We refer to Pacific Western herein as the “Bank” and when we say “we”, “our” or the “Company”, we mean the Company on a consolidated basis with Pacific Western. When we refer to “First Community” or to the holding company, we are referring to the parent company on a stand-alone basis. Discussions about the Company and the Bank as of and for the year ended December 31, 2006 include Cedars, Foothill and Community Bancorp from and after their respective dates of acquisition.

Pacific Western is a full-service community bank offering a broad range of banking products and services. We accept time and demand deposits, fund loans including real estate, construction, SBA and commercial loans, and offer other business oriented banking products. Our operations are primarily located in Southern California and the Bank focuses on conducting business with small to medium size businesses and the owners and employees of those businesses in our marketplace. We also operate in Arizona and Texas through our asset-based lending division and SBA loan production offices. At December 31, 2006, the Bank’s gross loans, excluding loans held for sale, totaled $4.2 billion, of which approximately 20% were commercial loans, 79% were commercial real estate loans, including construction loans, and 1% were consumer and other loans. These percentages include some foreign loans, primarily to individuals or entities with business in Mexico, representing 2% of total loans.

We derive our income primarily from the interest received on the various loan products, fees from providing deposit services, foreign exchange services and extending credit, and interest on investment securities. Our major operating expenses are the interest paid by the Bank on deposits and borrowings, employee compensation and general operating expenses. The Bank relies on a foundation of locally generated deposits. Our Bank has a relatively low cost of funds due to a high percentage of noninterest-bearing and low cost deposits. Our operations, like those of other financial institutions operating in Southern California, are significantly influenced by economic conditions in Southern California, including the strength of the real estate market, and the fiscal and regulatory policies of the federal and state government and the regulatory authorities that govern financial institutions. See “—Supervision and

3




Regulation.” With our SBA loan production offices and asset-based lending division with operations in Arizona and Texas, we are also subject to the economic conditions affecting those markets.

We are committed to maintaining premier, relationship-based community banking in Southern California which serves the needs of small to medium-sized businesses and the owners and employees of those businesses, as well as serving the needs of growing businesses that may not yet meet the credit standards of the Bank through tightly controlled asset-based lending and factoring of accounts receivable. The strategy for serving our target markets is the delivery of a finely-focused set of value-added products and services that satisfy the primary needs of our customers, emphasizing superior service and relationships as opposed to transaction volume or low pricing.

As of December 31, 2006, our assets totaled $5.6 billion. As of February 23, 2007, we have one wholly-owned banking subsidiary, Pacific Western, with 63 branches located in Los Angeles, Orange, Riverside, San Bernardino and San Diego Counties, California. Pacific Western’s business includes its asset-based lending and accounts receivable factoring division, doing business as First Community Financial, with a loan production office in Phoenix, Arizona and marketing offices in Austin, Texas and Los Angeles and Orange Counties, California.

Strategic Evolution and Acquisition Strategy

The Company was organized on October 22, 1999 as a California corporation for the purpose of becoming a bank holding company and to acquire all the outstanding capital stock of Rancho Santa Fe National Bank, First National’s predecessor.

We have grown rapidly through a series of acquisitions. The following chart summarizes the completed acquisitions since our inception, which are described in more detail below and in Note 2 of the Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.”

Date

 

 

 

Institution/Company Acquired

May 2000

 

Rancho Santa Fe National Bank

May 2000

 

First Community Bank of the Desert

January 2001

 

Professional Bancorp, Inc.

October 2001

 

First Charter Bank

January 2002

 

Pacific Western National Bank

March 2002

 

W.H.E.C., Inc.

August 2002

 

Upland Bank

August 2002

 

Marathon Bancorp

September 2002

 

First National Bank

January 2003

 

Bank of Coronado

August 2003

 

Verdugo Banking Company

March 2004

 

First Community Financial Corporation

April 2004

 

Harbor National Bank

August 2005

 

First American Bank

October 2005

 

Pacific Liberty Bank

January 2006

 

Cedars Bank

May 2006

 

Foothill Independent Bancorp

October 2006

 

Community Bancorp Inc.

 

We have financed our acquisitions, in part, with cash raised from the sale of our common stock or from the issuance of subordinated debentures. In August and September 2005, we raised $49.0 million via the sale of 1.0 million shares of our common stock in a registered public offering, which we refer to as the 2005 offering. The proceeds of the 2005 offering were used to help fund the acquisition of First American Bank. In January 2006, we raised $109.5 million via the sale of 1.9 million shares of our common stock in a registered public offering. The proceeds of the January 2006 offering were used to provide regulatory

4




capital to support the acquisition of Cedars Bank. We have outstanding a total of $149.2 million in subordinated debentures as follows: $8.2 million issued in 2000, $10.3 million in 2002, $20.6 million issued in 2003, $61.9 million issued in 2004, and $48.2 million acquired in our acquisitions of Foothill and Community Bancorp. In December 2006, we retired $20.6 million of subordinated debentures issued in 2001. See Note 8 of the Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.” As described in more detail below, we have also financed the acquisitions with the exchange of our common stock for the stock of the target company. Below is a summary of the acquisitions which have occurred since the beginning of 2004.

First Community Financial Corporation

On March 1, 2004, we acquired First Community Financial Corporation, or FC Financial, a privately-held commercial finance company based in Phoenix, Arizona. We paid $40.0 million in cash for all of the outstanding common stock and options of FC Financial. At the time of the acquisition, FC Financial became a wholly-owned subsidiary of First National. On October 26, 2006, as part of the merger of First National with Pacific Western, FC Financial became an operating division of Pacific Western.

Harbor National Bank Acquisition

On April 16, 2004, we acquired Harbor National. We paid approximately $35.7 million in cash for all of the outstanding shares of common stock and options of Harbor National. We made this acquisition to expand our presence in Orange County, California. At the time of the acquisition, Harbor National was merged into Pacific Western.

First American Bank Acquisition

On August 12, 2005, we acquired First American Bank, or First American, based in Rosemead, California. We paid approximately $59.7 million in cash to First American shareholders, and caused First American to pay $2.6 million in cash for all outstanding options to purchase First American common stock. The aggregate deal value was approximately $62.3 million. We made this acquisition to expand our presence in Los Angeles County, California. At the time of the acquisition, First American was merged into Pacific Western.

Pacific Liberty

On October 7, 2005, we acquired Pacific Liberty Bank, or Pacific Liberty, based in Huntington Beach, California. We issued approximately 784,000 shares of our common stock to the Pacific Liberty shareholders and caused Pacific Liberty to pay $5.0 million in cash for all outstanding options to purchase Pacific Liberty common stock. The aggregate deal value was approximately $41.6 million. We made this acquisition to expand our presence in Orange County, California. At the time of the acquisition, Pacific Liberty was merged into Pacific Western.

Cedars Bank

On January 4, 2006, we acquired Cedars Bank, or Cedars, based in Los Angeles, California. We paid approximately $120.0 million in cash for all of the outstanding shares of common stock and options of Cedars. We made this acquisition to expand our presence in Los Angeles, California. At the time of the acquisition, Cedars was merged into Pacific Western. In January 2006, we issued 1,891,086 shares of common stock for net proceeds of $109.5 million. We used these proceeds to augment our regulatory capital in support of the Cedars acquisition.

5




Foothill Independent Bancorp

On May 9, 2006, we acquired Foothill Independent Bancorp, or Foothill, based in Glendora, California. We issued approximately 3,947,000 shares of our common stock to the Foothill shareholders and caused Foothill to pay $10.2 million in cash for all outstanding options to purchase Foothill common stock. The aggregate deal value was approximately $242.5 million. At the time of the acquisition, Foothill was merged with and into the Company and Foothill Independent Bank, a wholly-owned subsidiary of Foothill, was merged with and into Pacific Western. We made this acquisition to expand our presence in Los Angeles, Riverside and San Bernardino Counties of California.

Community Bancorp Inc.

On October 26, 2006, we acquired Community Bancorp Inc., or Community Bancorp, based in Escondido, California. We issued approximately 4,678,000 shares of our common stock to the Community Bancorp shareholders and caused Community Bancorp to pay $6.1 million in cash for all outstanding options to purchase Community Bancorp common stock. The aggregate deal value for financial reporting purposes was approximately $268.7 million. At the time of the acquisition, Community Bancorp was merged with and into the Company and Community National Bank, a wholly-owned subsidiary of Community Bancorp, was merged with and into First National. We made this acquisition to expand our presence in the San Diego and Riverside Counties of California.

Banking Business

The Bank is a full-service community bank that offers a broad range of banking products and services, including many types of business and personal savings and checking accounts and other commercial and consumer banking services, including foreign exchange services. We derive our income primarily from the interest received on the various loan products, fees from providing deposit services, foreign exchange services and extending credit, and interest on investment securities. The Bank originates several types of loans, including secured and unsecured commercial and consumer loans, commercial real estate mortgage loans, SBA loans and construction loans. We extend credit to customers located primarily in the counties we serve and through certain programs, we also extend credit and make commercial and real estate loans to businesses located in Mexico. Special services, including international banking services, multi-state deposit services and investment services, or requests beyond the lending limits of the Bank can be arranged through correspondent banks. The Bank issues ATM and debit cards, has a network of ATMs and offers access to ATM networks through other major service providers. Through the Bank, we provide these banking and financial services throughout Southern California to small and medium-sized businesses and the owners and employees of those businesses. We also provide asset-based lending and factoring of accounts receivable to small businesses located throughout the southwestern United States through our loan production office in Phoenix, Arizona and marketing offices in Austin, Texas and Los Angeles and Orange Counties, California.

Through the Bank, the Company concentrates its lending activities in four principal areas:

(1)   Real Estate Loans.   Real estate loans are comprised of construction loans, miniperm loans collateralized by first or junior deeds of trust on specific commercial properties and equity lines of credit. The properties collateralizing real estate loans are principally located in our primary market areas of Los Angeles, Orange, San Bernardino, Riverside and San Diego counties in California and the contiguous communities. Construction loans are comprised of loans on commercial, residential and income producing properties that generally have terms of less than two years and typically bear an interest rate that floats with the Bank’s base rate, prime rate or another established index. Miniperm loans finance the purchase and/or ownership of commercial properties, including owner-occupied and income producing properties. Miniperm loans are generally made with an amortization schedule ranging from 15 to 25 years with a lump sum balloon payment due in one to ten years. Equity lines of

6




credit are revolving lines of credit collateralized by junior deeds of trust on residential real properties. They generally bear a rate of interest that floats with the Bank’s base rate or the prime rate and have maturities of five years. From time to time, we purchase participation interests in loans originated by other financial institutions. These loans are subject generally to the same underwriting criteria and approval process as loans originated directly by us.

The Bank’s real estate portfolio is subject to certain risks, including, but not limited to (i) a possible downturn in the Southern California economy, (ii) interest rate increases, (iii) reduction in real estate values in Southern California, (iv) increased competition in pricing and loan structure, and (v) environmental risks, including natural disasters. We strive to reduce the exposure to such risks by (a) reviewing each loan request and renewal individually, (b) using a dual signature approval system for the approval of each loan request for loans over a certain dollar amount, (c) adhering to written loan policies, including, among other factors, minimum collateral requirements, maximum loan-to-value ratio requirements, cash flow requirements and personal guarantees, (d) obtaining secondary appraisals, (e) obtaining external independent credit reviews, (f) evaluating concentrations as a percentage of capital and loans, and (g) conducting environmental reviews, where appropriate. We review each loan request on the basis of our ability to recover both principal and interest in view of the inherent risks.

(2)   Commercial Loans.   Commercial loans are made to finance operations, to provide working capital, or for specific purposes, such as to finance the purchase of assets, equipment or inventory. Since a borrower’s cash flow from operations is generally the primary source of repayment, our policies provide specific guidelines regarding required debt coverage and other important financial ratios. Commercial loans include lines of credit and commercial term loans. Lines of credit are extended to businesses or individuals based on the financial strength and integrity of the borrower and generally (with some exceptions) are collateralized by short-term assets such as accounts receivable, inventory, equipment or real estate and have a maturity of one year or less. Such lines of credit bear an interest rate that floats with the Bank’s base rate, the prime rate, LIBOR or another established index. Commercial term loans are typically made to finance the acquisition of fixed assets, refinance short-term debt originally used to purchase fixed assets or, in rare cases, to finance the purchase of businesses. Commercial term loans generally have terms from one to five years. They may be collateralized by the asset being acquired or other available assets and bear interest rates which either float with the Bank’s base rate, the prime rate, LIBOR or another established index or is fixed for the term of the loan.

The Bank’s portfolio of commercial loans is subject to certain risks, including, but not limited to (i) a possible downturn in the Southern California economy, (ii) interest rate increases, (iii) deterioration of the value of the underlying collateral, and (iv) the deterioration of a borrower’s or guarantor’s financial capabilities. We strive to reduce the exposure to such risks through (a) reviewing each loan request and renewal individually, (b) using a dual signature approval system, (c) adhering to written loan policies, (d) obtaining independent credit reviews, and (e) in the case of certain commercial loans to Mexican or foreign entities, third party insurance which limits our exposure to anywhere from 20 to 30 percent of the underlying loan. In addition, loans based on short-term asset values and factoring arrangements are monitored on a daily, weekly, monthly or quarterly basis and may include lockbox or control account arrangements. In general, the Bank receives and reviews financial statements and other documents of borrowing customers on an ongoing basis during the term of the relationship and responds to any deterioration noted.

(3)   SBA Loans.   The Bank makes SBA loans through programs designed by the federal government to assist the small business community in obtaining financing from financial institutions that are given government guarantees as an incentive to make the loans. Our SBA loans fall into two categories, loans originated under the SBA’s 7a Program (“7a Loans”) and loans originated under the SBA’s 504 Program (“504 Loans”). SBA 7a Loans are commercial business loans generally made for

7




the purpose of purchasing real estate to be occupied by the business owner, providing working capital, and/or purchasing equipment, accounts receivable or inventory. SBA 504 Loans are collateralized by commercial real estate and are generally made to business owners for the purpose of purchasing or improving real estate for their use and for equipment used in their business.

SBA lending is subject to federal legislation that can affect the availability and funding of the program. From time to time, this dependence on legislative funding causes limitations and uncertainties with regard to the continued funding of such programs, which could potentially have an adverse financial impact on our business.

The Bank’s portfolio of SBA loans is subject to certain risks, including, but not limited to (i) a possible downturn in the Southern California economy, (ii) interest rate increases, (iii) deterioration of the value of the underlying collateral, and (iv) the deterioration of a borrower’s or guarantor’s financial capabilities. We strive to reduce the exposure of such risks through (a) reviewing each loan request and renewal individually, (b) using a dual signature approval system, (c) adhering to written loan policies, (d) adhering to SBA written policies and regulations, and (e) obtaining independent credit reviews. In addition, SBA loans normally require monthly installment payments of principal and interest and therefore are continually monitored for past due conditions. In general, the Bank receives and reviews financial statements and other documents of borrowing customers on an ongoing basis during the term of the relationship and responds to any deterioration noted.

(4)   Consumer Loans.   Consumer loans include personal loans, auto loans, boat loans, home improvement loans, equipment loans, revolving lines of credit and other loans typically made by banks to individual borrowers. The Bank’s consumer loan portfolio is subject to certain risks, including (i) amount of credit offered to consumers in the market, (ii) interest rate increases, and (iii) consumer bankruptcy laws which allow consumers to discharge certain debts. We strive to reduce the exposure to such risks through the direct approval of all consumer loans by (a) reviewing each loan request and renewal individually, (b) using a dual signature approval system, (c) adhering to written credit policies, and (d) obtaining external independent credit reviews.

As part of our efforts to achieve long-term stable profitability and respond to a changing economic environment in Southern California and in other areas where we operate, we constantly evaluate a variety of options to augment our traditional focus by broadening the services and products we provide. Possible avenues of growth include more branch locations, expanded days and hours of operation and new types of loan and deposit products. To date, we have not expanded into areas of brokerage, annuity, insurance or similar investment products and services and have concentrated primarily on the core businesses of accepting deposits, making loans and extending credit.

Business Concentrations

No individual or single group of related accounts is considered material in relation to our total assets or to the assets or deposits of the Bank, or in relation to the overall business of the Company. However, approximately 79% of our loan portfolio held for investment at December 31, 2006 consisted of real estate-related loans, including construction loans, miniperm loans, commercial real estate mortgage loans and commercial loans secured by commercial real estate. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Loans.” Moreover, our business activities are currently focused primarily in Southern California, with the majority of our business concentrated in Los Angeles, Riverside, Orange, San Bernardino and San Diego Counties. Consequently, our results of operations and financial condition are dependent upon the general trends in the Southern California economies and, in particular, the residential and commercial real estate markets. In addition, the concentration of our operations in Southern California exposes us to greater risk than other banking companies with a wider geographic base in the event of catastrophes, such as earthquakes, fires and floods in this region. We conduct foreign lending activities including commercial and real estate lending, consisting predominantly of loans to individuals or entities located in Mexico. All of our foreign loans are

8




denominated in U.S. dollars and most are collateralized by assets located in the United States or guaranteed or insured by businesses located in the United States. We recently decided to allow our foreign loan portfolio to repay in the ordinary course of business without making any new privately-insured foreign loans other than those under existing commitments. We also conduct asset-based lending and factoring of accounts receivable primarily in the states of Arizona, California and Texas.

Competition

The banking business in California, specifically in the Bank’s primary service areas, is highly competitive with respect to originating both loans and deposits as well as other banking and mortgage banking services. The market is dominated by a relatively small number of major banks with a large number of offices and full-service operations over a wide geographic area. Among the advantages such major banks have in comparison to the Bank is their ability to finance and engage in wide-ranging advertising campaigns and to allocate their investment assets to regions of higher yield and demand. These competitors offer certain services which we do not offer directly. In addition, by virtue of their greater total capitalization, such banks have substantially higher lending limits than we offer. Other entities, in both the public and private sectors, seeking to raise capital through the issuance and sale of debt or equity securities also compete with us for the acquisition of deposits. In recent years, increased competition has also developed from specialized finance and non-finance companies that offer wholesale finance, credit card and other consumer finance services (including on-line banking services and personal financial software). Competition for deposit and loan products remains strong from both banking and non-banking institutions and this competition directly affects the rates of those products and the terms on which they are offered to consumers and businesses.

Technological innovation continues to contribute to greater competition in domestic and international financial services markets. Technological innovation has, for example, made it possible for non-depository institutions to offer customers automated transfer payment services previously limited to traditional banking products. In addition, customers now expect a choice of several delivery systems and channels, including telephone, mail, home computer, ATMs, self-service branches and in-store branches.

Mergers between financial institutions have placed additional pressure on banks within the industry to consolidate their operations, reduce expenses and increase revenues to remain competitive. In addition, competition has intensified due to federal and state interstate banking laws, which permit banking organizations to expand geographically with fewer restrictions than in the past. These laws allow banks to merge with other banks across state lines, thereby enabling banks to establish or expand banking operations in our most significant markets. The competitive environment is also significantly affected by federal and state legislation which make it easier for non-bank financial institutions to compete with us.

Economic factors, along with legislative and technological changes, will have an ongoing impact on the competitive environment within the financial services industry. We strive to anticipate and adapt to dynamic competitive conditions, but we can make no assurance as to the effectiveness of these efforts on our future business or results of operations or as to our continued ability to anticipate and adapt to changing conditions. In order to compete with other financial services providers in our primary service areas, we attempt to use, to the fullest extent possible, the flexibility which our independent status permits, including an emphasis on specialized services, local promotional activity and personal contacts. Our Bank strives to offer highly personalized banking services. In addition, we intend to continue improving our services and banking products. We believe that through the cross-marketing of products, and our focus on tailoring our services to the needs of our customers, our Bank can distinguish itself from other community banks with which we compete based on the range of services provided and products offered. However, we can provide no assurance that we will be able to sufficiently improve our services and/or banking products or successfully compete in our primary service areas.

9




Employees

As of February 16, 2007, Pacific Western had 988 full time equivalent employees and First Community had 22 full time equivalent employees.

Financial and Statistical Disclosure

Certain of our statistical information is presented within “Item 6. Selected Financial Data,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 7A. Qualitative and Quantitative Disclosure About Market Risk.” This information should be read in conjunction with the consolidated financial statements contained in “Item 8. Financial Statements and Supplementary Data.”

Supervision and Regulation

General

The banking and financial services business in which we engage is highly regulated. Such regulation is intended, among other things, to protect depositors insured by the Federal Deposit Insurance Corporation, or FDIC, and the entire banking system. The commercial banking business is also influenced by the monetary and fiscal policies of the federal government and the policies of the Federal Reserve Bank, or FRB. The FRB implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial intermediaries subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. Indirectly, such actions may also impact the ability of non-bank financial institutions to compete with the Bank. The nature and impact of any future changes in monetary policies cannot be predicted.

The laws, regulations and policies affecting financial services businesses are continuously under review by Congress, state legislatures and federal and state regulatory agencies. From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial intermediaries. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial intermediaries are frequently made in Congress, in the California legislature and by various bank regulatory agencies and other professional agencies. Changes in the laws, regulations or policies that impact us cannot necessarily be predicted, but they may have a material effect on our business and earnings.

Bank Holding Company Regulation

As a bank holding company, First Community is registered with and subject to regulation by the FRB under the Bank Holding Company Act of 1956, as amended, or the BHCA. In accordance with FRB policy, First Community is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where it might not otherwise do so. Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance Act, the FDIC can hold any FDIC-insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to such a commonly controlled institution. Under the BHCA, we are subject to periodic examination by the FRB. We are also required to file with the FRB periodic reports of our operations and such additional information regarding the Company and its subsidiaries as the FRB may require. Pursuant to the BHCA, we are required to obtain the prior approval of the FRB before we acquire all or substantially all of the assets of any bank or ownership or control of voting shares of any bank if, after

10




giving effect to such acquisition, we would own or control, directly or indirectly, more than 5 percent of such bank.

Under the BHCA, we may not engage in any business other than managing or controlling banks or furnishing services to our subsidiaries that the FRB deems to be so closely related to banking as “to be a proper incident thereto.” We are also prohibited, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5 percent of the voting shares of any company unless the company is engaged in banking activities or the FRB determines that the activity is so closely related to banking to be a proper incident to banking. The FRB’s approval must be obtained before the shares of any such company can be acquired and, in certain cases, before any approved company can open new offices.

Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance activities and any other activity that the FRB, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. As of the date of this filing, we do not operate as a financial holding company.

The BHCA and regulations of the FRB also impose certain constraints on the redemption or purchase by a bank holding company of its own shares of stock.

Our earnings and activities are affected by legislation, by regulations and by local legislative and administrative bodies and decisions of courts in the jurisdictions in which we and the Bank conduct business. For example, these include limitations on the ability of the Bank to pay dividends to us and our ability to pay dividends to our shareholders. It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries. Various federal and state statutory provisions limit the amount of dividends that subsidiary banks and savings associations can pay to their holding companies without regulatory approval. In addition to these explicit limitations, the federal regulatory agencies have general authority to prohibit a banking subsidiary or bank holding company from engaging in an unsafe or unsound banking practice. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice. In addition, as discussed below under “—Regulation of the Bank”, a bank holding company such as the Company is required to maintain minimum ratios of Tier 1 capital and total capital to total risk-weighted assets, as well as a minimum ratio of Tier 1 capital to total adjusted quarterly average assets as defined in such regulations.

In addition, banking subsidiaries of bank holding companies are subject to certain restrictions imposed by federal law in dealings with their holding companies and other affiliates. Subject to certain exceptions set forth in the Federal Reserve Act, a bank can make a loan or extend credit to an affiliate, purchase or invest in the securities of an affiliate, purchase assets from an affiliate, accept securities of an affiliate as collateral for a loan or extension of credit to any person or company, issue a guarantee or accept letters of credit on behalf of an affiliate only if the aggregate amount of the above transactions of such subsidiary does not exceed 10 percent of such subsidiary’s capital stock and surplus on an individual basis or 20 percent of such subsidiary’s capital stock and surplus on an aggregate basis. Such transactions must be on terms and conditions that are consistent with safe and sound banking practices. A bank holding company and its subsidiaries generally may not purchase a “low-quality asset,” as that term is defined in the Federal Reserve Act, from an affiliate. Such restrictions also prevent a holding company and its other affiliates from borrowing from a banking subsidiary of the holding company unless the loans are secured by collateral.

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The FRB has cease and desist powers over parent bank holding companies and non-banking subsidiaries where the action of a parent bank holding company or its non-financial institutions represent an unsafe or unsound practice or violation of law. The FRB has the authority to regulate debt obligations, other than commercial paper, issued by bank holding companies by imposing interest ceilings and reserve requirements on such debt obligations.

Regulation of the Bank

The Bank is extensively regulated under both federal and state law.

Pacific Western is insured by the FDIC, which currently insures non-IRA deposits of each insured bank to a maximum of $100,000 per depositor. For this protection, Pacific Western, as is the case with all insured banks, pays a quarterly statutory assessment and is subject to the rules and regulations of the FDIC. Additionally, Pacific Western is a state-chartered bank and is regulated by the DFI.

Various requirements and restrictions under federal and state law affect the operations of the Bank. Federal and state statutes and regulations relate to many aspects of the Bank’s operations, including standards for safety and soundness, reserves against deposits, interest rates payable on deposits and loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, fair lending requirements, Community Reinvestment Act activities and loans to affiliates.

Further, each of the Company and the Bank is required to maintain certain levels of capital. The FRB and the FDIC have substantially similar risk-based capital ratio and leverage ratio guidelines for banking organizations. The guidelines are intended to ensure that banking organizations have adequate capital given the risk levels of assets and off-balance sheet financial instruments. Under the guidelines, banking organizations are required to maintain minimum ratios for Tier 1 capital and total capital to risk-weighted assets (including certain off-balance sheet items, such as letters of credit). For purposes of calculating the ratios, a banking organization’s assets and some of its specified off-balance sheet commitments and obligations are assigned to various risk categories. A depository institution’s or holding company’s capital, in turn, is classified in one of three tiers, depending on type:

·       Core Capital (Tier 1).   Tier 1 capital includes common equity, retained earnings, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual stock at the holding company level, minority interests in equity accounts of consolidated subsidiaries, and qualifying trust preferred securities less goodwill, most intangible assets and certain other assets.

·       Supplementary Capital (Tier 2).   Tier 2 capital includes, among other things, perpetual preferred stock and trust preferred securities not meeting the Tier 1 definition, qualifying mandatory convertible debt securities, qualifying subordinated debt, and allowances for possible loan and lease losses, subject to limitations.

·       Market Risk Capital (Tier 3).   Tier 3 capital includes qualifying unsecured subordinated debt.

The following are the regulatory capital guidelines and the actual capitalization levels for Pacific Western and the Company as of December 31, 2006:

 

 

Adequately
Capitalized

 

Well
Capitalized

 

Pacific
Western

 

Company
Consolidated

 

 

 

(greater than or equal to)

 

Total risk-based capital ratio

 

 

8.00

%

 

 

10.00

%

 

 

12.17

%

 

 

12.18

%

 

Tier 1 risk-based capital ratio

 

 

4.00

%

 

 

6.00

%

 

 

10.93

%

 

 

10.94

%

 

Tier 1 leverage capital ratio

 

 

4.00

%

 

 

5.00

%

 

 

12.40

%

 

 

12.19

%

 

 

The Company issued subordinated debentures to trusts that were established by us or entities we have acquired, which, in turn, issued trust preferred securities, which totaled $141.0 million at December 31, 2006. This includes $43.0 million of trust preferred securities acquired in the Foothill and Community

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Bancorp acquisitions. During the fourth quarter of 2006, we also retired $20.0 million of our trust preferred securities. Our trust preferred securities are currently included in our Tier I capital for purposes of determining the Company’s Tier I and total risk-based capital ratios. The FRB, which is the holding company’s banking regulator, has promulgated a modification of the capital regulations affecting trust preferred securities. Under this modification, effective March 31, 2009, the Company will be required to use a more restrictive formula to determine the amount of trust preferred securities that can be included in regulatory Tier I capital. At that time, the Company will be allowed to include in Tier I capital an amount of trust preferred securities equal to no more than 25% of the sum of all core capital elements, which is generally defined as shareholders’ equity, less goodwill net of any related deferred income tax liability. The regulations currently in effect through December 31, 2008 limit the amount of trust preferred securities that can be included in Tier I capital to 25% of the sum of core capital elements without a deduction for goodwill. We have determined that our Tier I capital ratios would remain above the well-capitalized level had the modification of the capital regulations been in effect at December 31, 2006. We expect that our Tier I capital ratios will be at or above the existing well capitalized levels on March 31, 2009, the first date on which the modified capital regulations must be applied.

The FDIC and FRB risk-based capital guidelines are based upon the 1988 capital accord of the Basel Committee on Banking Supervision, or BIS. The BIS is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines that each country’s supervisors can use to determine the supervisory policies they apply. The BIS has been working for a number of years on revisions to the 1988 capital accord and in June 2004 released the final version of its proposed new capital framework, with an update in November 2005, or BIS II. BIS II proposes two approaches for setting capital standards for credit risk—an internal ratings-based approach tailored to individual institutions’ circumstances (which for many asset classes is itself broken into a “foundation” approach and an “advanced” or “A-IRB” approach, the availability of which is subject to additional restrictions) and a standardized approach that bases risk weightings on external credit assessments to a much greater extent than permitted in existing risk-based capital guidelines. BIS II also would set capital requirements for operational risk and refine the existing capital requirements for market risk exposures.

The U.S. banking and thrift agencies are developing proposed revisions to their existing capital adequacy regulations and standards based on BIS II. In September 2006, the agencies issued a notice of proposed rulemaking setting forth a definitive proposal for implementing BIS II in the United States that would apply only to internationally active banking organizations—defined as those with consolidated total assets of $250 billion or more or consolidated on-balance sheet foreign exposures of $10 billion or more—but that other U.S. banking organizations could elect but would not be required to apply. In December 2006, the agencies issued a notice of proposed rulemaking describing proposed amendments to their existing risk-based capital guidelines to make them more risk-sensitive, generally following aspects of the standardized approach of BIS II. These latter proposed amendments, often referred to as “BIS I-A”, would apply to banking organizations that are not internationally active banking organizations subject to the A-IRB approach for internationally active banking organizations and do not “opt in” to that approach. The comment periods for both of the agencies’ notices of proposed rulemakings expire on March 26, 2007.  The agencies have indicated their intent to have the A-IRB provisions for internationally active U.S. banking organizations first become effective in March 2009 and that those provisions and the BIS I-A provisions for others will be implemented on similar timeframes.

The Company is not an internationally active banking organization, as defined in BIS II, and has not made a determination as to whether it would opt to apply the A-IRB provisions applicable to internationally active U.S. banking organizations once they become effective.

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Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act, or FDICIA, requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. Pursuant to FDICIA, the FDIC promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under the prompt corrective action provisions of FDICIA, an insured depository institution generally will be classified as undercapitalized if its total risk-based capital is less than 8% or its Tier 1 risk-based capital or leverage ratio is less than 4%. An institution that, based upon its capital levels, is classified as “well capitalized”, “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions and prohibitions, including restrictions on growth, prohibitions on payment of dividends and restrictions on the acceptance of brokered deposits. Furthermore, if a bank is classified in one of the undercapitalized categories, it is required to submit a capital restoration plan to the federal bank regulator, and the holding company must guarantee the performance of that plan.

In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal or state banking agencies for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties. The enforcement of such actions through injunctions or restraining orders may be based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.

Hazardous Waste Clean-Up

Since we are not involved in any business that manufactures, uses or transports chemicals, waste, pollutants or toxins that might have a material adverse effect on the environment, our primary exposure to environmental laws is through our lending activities and through properties or businesses we may own, lease or acquire. Based on a general survey of the Bank’s loan portfolio, conversations with local appraisers and the type of lending currently and historically done by the Bank, we are not aware of any potential liability for hazardous waste contamination that would be reasonably likely to have a material adverse effect on the Company as of February 16, 2007.

Sarbanes-Oxley Act

On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act aims to restore the credibility lost as a result of high profile corporate scandals by addressing, among other issues, corporate governance, auditing and accounting, executive compensation and enhanced and timely disclosure of corporate information. The Nasdaq Stock Market has adopted corporate governance rules intended to allow shareholders to more easily and effectively monitor the performance of companies and directors. The principal provisions of the Sarbanes-Oxley Act, many of which have been interpreted through regulations released in 2003, provide for and include, among other things: (i) the creation of the Public Company Accounting Oversight Board; (ii) auditor independence provisions that restrict non-audit services that accountants may provide to their audit clients; (iii) additional corporate governance and

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responsibility measures, including the requirement that the chief executive officer and chief financial officer of a public company certify financial statements; (iv) the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; (v) an increase in the oversight of, and enhancement of certain requirements relating to, audit committees of public companies and how they interact with that company’s independent auditors; (vi) requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer; (vii) requirements that companies disclose whether at least one member of the audit committee is a “financial expert’ (as such term is defined by the SEC) and if not disclosed, why the audit committee does not have a financial expert; (viii) expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods; (ix) a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions on nonpreferential terms and in compliance with other bank regulatory requirements; (x) disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; (xi) a range of enhanced penalties for fraud and other violations; and (xii) expanded disclosure and certification relating to an issuer’s disclosure controls and procedures and internal controls over financial reporting.

As a result of the Sarbanes-Oxley Act, and its implementing regulations, we have incurred substantial costs to interpret and ensure compliance with the law and its regulations. Future changes in the laws, regulation, or policies that impact us cannot necessarily be predicted and may have a material effect on our business and earnings.

USA Patriot Act

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”), designed to deny terrorists and others the ability to obtain access to the United States financial system, has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act, as implemented by various federal regulatory agencies, requires financial institutions, including the Company, to implement new policies and procedures or amend existing policies and procedures with respect to, among other matters, anti-money laundering, compliance, suspicious activity and currency transaction reporting and due diligence on customers. The Patriot Act and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB, the FDIC and other federal banking agencies to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or the Bank Merger Act. The Company has augmented its systems and procedures to accomplish this. We believe that the ongoing cost of compliance with the Patriot Act is not likely to be material to the Company.

Federal Deposit Insurance

Because of favorable loss experience and a healthy reserve ratio in the Bank Insurance Fund, or the BIF, of the FDIC, well-capitalized and well-managed banks, including the Bank, have in recent years paid minimal premiums for FDIC insurance. The FDIC notified banks that beginning in 2007, it will increase the premiums for deposit insurance. Concurrently, a deposit premium refund, in the form of credit offsets, was granted to banks that were in existence on December 31, 1996 and paid deposit insurance premiums prior to that date. Pacific Western and many of our acquired institutions meet the qualifications and are eligible for the credit. The credit is to be used to offset future premiums. Because of these credits, we have no expectation of paying any deposit insurance premiums in 2007. The amount of any future premiums will depend on the BIF loss experience, legislation or regulatory initiatives and other factors, none of which we are in position to predict at this time.

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Community Reinvestment Act

The Community Reinvestment Act (“CRA”) generally requires insured depository institutions to identify the communities they serve and to make loans and investments and provide services that meet the credit needs of these communities. Furthermore, the CRA requires the FDIC to evaluate the performance of banks in helping to meet the credit needs of its communities. During these examinations, the FDIC rates such institutions’ compliance with CRA as “Outstanding,” “Satisfactory,” “Needs to Improve” or “Substantial Noncompliance.” Failure of an institution to receive at least a “Satisfactory” rating could inhibit such institution or its holding company from undertaking certain activities. The FDIC must take into account the record of performance of banks in meeting the credit needs of the entire community served, including low-and moderate-income neighborhoods. As a part of the CRA program, the Bank is subject to periodic examinations by the FDIC, and must maintain comprehensive records of its CRA activities for this purpose. The Bank received a CRA rating of “Satisfactory” as of its most recent examination.

Customer Information Security

The FRB and other bank regulatory agencies have adopted final guidelines for safeguarding confidential, personal customer information. These guidelines require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazard to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. We have adopted a customer information security program to comply with such requirements.

Privacy

The Gramm-Leach-Bliley Act of 1999 and the California Financial Information Privacy Act require financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, the statutes require explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, prohibits disclosing such information except as provided in the Bank’s policies and procedures. Pacific Western has implemented privacy policies addressing these restrictions which are distributed regularly to all existing and new customers of the Bank.

Available Information

We maintain an Internet website at www.firstcommunitybancorp.com, and a website for Pacific Western at www.pacificwesternbank.com. At www.firstcommunitybancorp.com and via the “Investor Relations” link at the Bank’s website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, as soon as reasonably practicable after such forms are electronically filed with, or furnished to, the SEC. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room, located at 450 Fifth Street, NW, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. You may obtain copies of the Company’s filings on the SEC site. These documents may also be obtained in print upon request by our shareholders to our Investor Relations Department.

We have adopted a written code of ethics that applies to all directors, officers and employees of the Company, including our principal executive officer and senior financial officers, in accordance with

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Section 406 of the Sarbanes-Oxley Act of 2002 and the rules of the Securities and Exchange Commission promulgated there under. The code of ethics, which we call our Code of Business Conduct and Ethics, is available on our corporate web site, www.firstcommunitybancorp.com in the section entitled “Corporate Governance.” In the event that we make changes in, or provide waivers from, the provisions of this code of ethics that the SEC requires us to disclose, we intend to disclose these events on our corporate web site in such section. In the Corporate Governance section of our corporate web site, we have also posted the charters for our Audit Committee and our Compensation, Nominating and Governance Committee, as well as our Corporate Governance Guidelines. In addition, information concerning purchases and sales of our equity securities by our executive officers and directors is posted on our web site.

Our Investor Relations Department can be contacted at First Community Bancorp, 275 N. Brea Blvd., Brea, CA 92821, Attention: Investor Relations, telephone 714-671-6800, or via e-mail to investor-relations@firstcommunitybancorp.com.

(All website addresses given in this document are for information only and are not intended to be an active link or to incorporate any website information into this document.)

Forward-Looking Information

This Annual Report on Form 10-K contains certain forward-looking information about the Company, which statements are intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact are forward-looking statements. Such statements involve inherent risks and uncertainties, many of which are difficult to predict and are generally beyond the control of the Company. We caution readers that a number of important factors could cause actual results to differ materially from those expressed in, implied or projected by, such forward-looking statements. Risks and uncertainties include, but are not limited to:

·       planned acquisitions and relative cost savings from completed acquisitions cannot be realized or realized within the expected time frame;

·       revenues are lower than expected;

·       credit quality deterioration which could cause an increase in the provision for credit losses;

·       competitive pressure among depository institutions increases significantly;

·       the integration of acquired businesses costs more, takes longer or is less successful than expected;

·       the possibility that personnel changes will not proceed as planned;

·       the cost of additional capital is more than expected;

·       a change in the interest rate environment reduces interest margins;

·       asset/liability repricing risks and liquidity risks;

·       general economic conditions, either nationally or in the market areas in which the Company does or anticipates doing business, are less favorable than expected;

·       the economic and regulatory effects of the continuing war on terrorism and other events of war, including the war in Iraq and related disturbances in the Middle East;

·       legislative or regulatory requirements or changes adversely affect First Community Bancorp’s business;

·       changes in the securities markets; and

·       regulatory approvals for announced or future acquisitions cannot be obtained on the terms expected or on the anticipated schedule.

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If any of these risks or uncertainties materializes or if any of the assumptions underlying such forward-looking statements proves to be incorrect, First Community Bancorp’s results could differ materially from those expressed in, implied or projected by, such forward-looking statements. First Community Bancorp assumes no obligation to update such forward-looking statements. For additional information concerning risk and uncertainties related to us and our operations, please refer to Items 1 through 7A of this Annual Report.

ITEM 1A. RISK FACTORS

Ownership of our common stock involves risk. You should carefully consider, in addition to the other information set forth herein, the following risk factors.

Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance.

Changes in the interest rate environment may reduce our profits. It is expected that we will continue to realize income from the differential or “spread” between the interest earned on loans, securities and other interest earning assets, and interest paid on deposits, borrowings and other interest bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest earning assets and interest bearing liabilities. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. We cannot assure you that we can minimize our interest rate risk. In addition, while an increase in the general level of interest rates may increase our net interest margin and loan yield, it may adversely affect the ability of certain borrowers with variable rate loans to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially and adversely affect our net interest spread, asset quality, loan origination volume and overall profitability.

We face strong competition from financial services companies and other companies that offer banking services which could negatively affect our business.

We conduct our banking operations primarily in Southern California. Increased competition in our market may result in reduced loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. Many competitors offer the same banking services that we offer in our service area. These competitors include national banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including without limitation, savings and loan institutions, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, our competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and ATMs and conduct extensive promotional and advertising campaigns.

Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits, and range and quality of products and services provided, including new technology driven products and services. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances enable more companies to provide financial services. We also face competition from out-of-state financial intermediaries that have opened low-end production offices or that solicit deposits in our market areas. If we are unable to attract and retain banking customers, we may be unable to continue our loan growth and level of deposits and our results of operations and financial condition may otherwise be adversely affected.

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Changes in economic conditions, in particular an economic slowdown in Southern California, could materially and negatively affect our business.

Our business is directly impacted by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which are beyond our control. A deterioration in economic conditions, whether caused by national or local concerns, in particular an economic slowdown in Southern California, could result in the following consequences, any of which could hurt our business materially: loan delinquencies may increase; problem assets and foreclosures may increase; demand for our products and services may decrease; low cost or noninterest bearing deposits may decrease; and collateral for loans made by us, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans. These circumstances may lead to an increase in nonaccrual and classified loans, which generally results in a provision for credit losses and in turn reduces the Company’s net earnings. The State of California continues to face fiscal challenges, the long-term effects of which on the State’s economy cannot be predicted.

A downturn in the real estate market could negatively affect our business.

A downturn in the real estate market could negatively affect our business because a significant portion (approximately 79% as of December 31, 2006) of our loans is secured by real estate. Our ability to recover on defaulted loans by selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans. Substantially all of our real property collateral is located in Southern California. If there is a significant decline in real estate values, especially in Southern California, the collateral for our loans would provide less security. Real estate values could be affected by, among other things, an economic slowdown, an increase in interest rates, earthquakes and other natural disasters particular to California.

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

We currently depend heavily on the services of our chairman, John Eggemeyer, our chief executive officer, Matthew Wagner, and a number of other key management personnel. The loss of Mr. Eggemeyer’s or Mr. Wagner’s services or that of other key personnel could materially and adversely affect our results of operations and financial condition. Our success also depends, in part, on our ability to attract and retain additional qualified management personnel. Competition for such personnel is strong in the banking industry and we may not be successful in attracting or retaining the personnel we require.

We are subject to extensive regulation which could adversely affect our business.

Our operations are subject to extensive regulation by federal and state governmental authorities, and we are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Because our business is highly regulated, the laws, rules and regulations applicable to us are subject to regular modification and change. There are currently proposed laws, rules and regulations that, if adopted, would impact our operations. There can be no assurance that these proposed laws, rules and regulations, or any other laws, rules or regulations, will not be adopted in the future, which could (i) make compliance much more difficult or expensive, (ii) restrict our ability to originate, broker or sell loans or accept certain deposits, (iii) further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold by us, or (iv) otherwise adversely affect our business or prospects for business. Additionally, in order to conduct certain activities, including acquisitions, we are required to obtain regulatory approval.  There can be no assurance that any required approvals can be obtained, or obtained without conditions or on a timeframe acceptable to us. For more information, please see the section entitled “Item 1. Business—Supervision and Regulation” above.

19




We are exposed to transactional, currency and legal risk related to our foreign loans that is in addition to risks we face on loans to U.S. based borrowers.

A portion of our loan portfolio is represented by credit we extend and loans we make to businesses located outside the United States, predominantly in Mexico. These loans, which include commercial loans, real estate loans and credit extensions for the financing of international trade, are subject to risks in addition to risks we face with our loans to businesses located in the United States including, but not limited to, currency risk, transaction risk, country risk and legal risk. While these loans are denominated in U.S. dollars, the ability of the borrower to repay may be affected by fluctuations in the borrower’s home country currency relative to the U.S. dollar. Additionally, while most of our foreign loans are insured by U.S.-based institutions, guaranteed by a U.S.-based entity, or collateralized with U.S.-based assets or real property, our ability to collect in the event of default is subject to a number of conditions, as well as deductibles and co-payments with respect to insurance, and we may not be successful in obtaining partial or full repayment or reimbursement from the insurers. Furthermore, foreign laws may restrict our ability to foreclose on, take a security interest in, or seize collateral located in the foreign country.

We are exposed to risk of environmental liabilities with respect to properties to which we take title.

In the course of our business, we may own or foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.

Our ability to pay dividends is restricted by law and contractual arrangements and depends on capital distributions from the Bank which are subject to regulatory limits.

Our ability to pay dividends to our shareholders is subject to the restrictions set forth in California law. In addition, our ability to pay dividends to our shareholders is restricted in specified circumstances under indentures governing the trust preferred securities we have issued and under the revolving credit agreement to which we are a party. See “Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters—Dividends” in Part II of this Annual Report for more information on these restrictions. We cannot assure you that we will meet the criteria specified under California law or under these agreements in the future, in which case we may reduce or stop paying dividends on our common stock.

The primary source of our income from which we pay dividends is the receipt of dividends from the Bank.

The availability of dividends from the Bank is limited by various statutes and regulations. It is possible, depending upon the financial condition of the Bank and other factors, that the Board of Governors of the Federal Reserve System, the FDIC and/or the DFI could assert that payment of dividends or other payments is an unsafe or unsound practice. In the event the Bank is unable to pay dividends to us, it is likely that we, in turn, would have to reduce or stop paying dividends on our common stock. Our failure to pay dividends on our common stock could have a material adverse effect on the market price of our common stock. See “Item 1. Business—Supervision and Regulation” above for additional information on the regulatory restrictions to which we and the Bank are subject.

20




Only a limited trading market exists for our common stock which could lead to price volatility.

Our common stock was designated for quotation on the Nasdaq National Market in June 2000 and trading volumes since that time have been modest. The limited trading market for our common stock may cause fluctuations in the market value of our common stock to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market of our common stock. In addition, even if a more active market in our common stock develops, we cannot assure you that such a market will continue or that shareholders will be able to sell their shares.

Our allowance for credit losses may not be adequate to cover actual losses.

In accordance with accounting principles generally accepted in the United States, we maintain an allowance for loan losses to provide for loan defaults and non-performance and a reserve for unfunded loan commitments, which when combined, we refer to as the allowance for credit losses. Our allowance for credit losses may not be adequate to cover actual credit losses, and future provisions for credit losses could materially and adversely affect our operating results. Our allowance for credit losses is based on prior experience, as well as an evaluation of the risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed current estimates. Our federal and state regulators, as an integral part of their examination process, review our loans and allowance for credit losses. While we believe that our allowance for credit losses is adequate to cover current losses, we cannot assure you that we will not further increase the allowance for credit losses or that regulators will not require us to increase this allowance. Either of these occurrences could materially and negatively affect our earnings. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of this Annual Report for more information.

Our acquisitions may subject us to unknown risks.

We have completed 18 acquisitions since May 2000, including the acquisition of two bank subsidiaries around which the Company was initially formed.  Certain events may arise after the date of an acquisition, or we may learn of certain facts, events or circumstances after the closing of an acquisition, that may affect our financial condition or performance or subject us to risk of loss. These events include, but are not limited to: litigation resulting from circumstances occurring at the acquired entity prior to the date of acquisition; loan downgrades and credit loss provisions resulting from underwriting of certain acquired loans determined not to meet our credit standards; personnel changes that cause instability within a department; delays in implementing new policies or procedures, or the failure to apply new policies or procedures; and, other events relating to the performance of our business. Acquisitions involve inherent uncertainty and we cannot determine all potential events, facts and circumstances that could result in loss, or give assurances that our investigation or mitigation efforts will be sufficient to protect against any such loss.

Concentrated ownership of our common stock creates a risk of sudden changes in our share price.

As of February 23, 2007, directors and members of our executive management team owned or controlled approximately 10.7% of our common stock, excluding shares that may be issued to executive officers upon vesting of restricted and performance stock awards and exercise of stock options. Investors who purchase our common stock may be subject to certain risks due to the concentrated ownership of our common stock. The sale by any of our large shareholders of a significant portion of that shareholder’s holdings could have a material adverse effect on the market price of our common stock. In addition, the registration of any significant amount of additional shares of our common stock will have the immediate effect of increasing the public float of our common stock and any such increase may cause the market price of our common stock to decline or fluctuate significantly.

21




Our largest shareholder is a registered bank holding company and the activities and regulation of such shareholder may affect the permissible activities of the Company.

Castle Creek Capital, LLC, which we refer to as Castle Creek, is controlled by our chairman, John M. Eggemeyer, and beneficially owned approximately 6.4% of the Company as of February 23, 2007. Castle Creek is a registered bank holding company under the BHCA and is regulated by the FRB. Under FRB guidelines, holding companies must be a “source of strength” for their subsidiaries. See “Item 1. Business—Supervision and Regulation—Bank Holding Company Regulation” above for more information. Regulation of Castle Creek by the FRB may adversely affect the activities and strategic plans of the Company should the FRB determine that Castle Creek or any other company in which Castle Creek has invested has engaged in any unsafe or unsound banking practices or activities. While we have no reason to believe that the FRB is proposing to take any action with respect to Castle Creek that would adversely affect the Company, we remain subject to such risk.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

As of February 23, 2007, we had a total of 94 properties consisting of 63 branch offices, one annex office, 4 operations centers, 10 loan offices, and 16 other properties of which 11 are subleased. We own 8 locations and the remaining properties are leased. All properties are located in Southern California except for the annex office used by Pacific Western’s asset-based lending division, which is located in Phoenix, Arizona. Pacific Western operates through 63 branches and its principal office is located at 401West A Street, San Diego, CA 92101-7917.

For additional information regarding properties of the Company and Pacific Western, see “Item 8. Financial Statements and Supplementary Data.”

ITEM 3. LEGAL PROCEEDINGS

On June 8, 2004, the Company was served with an amended complaint naming First Community and Pacific Western as defendants in a class action lawsuit filed in Los Angeles Superior Court pending as Gilbert et. al v. Cohn et al, Case No. BC310846 (the “Gilbert Litigation”). A former officer of First Charter Bank, N.A. (“First Charter”), which the Company acquired in October 2001, was also named as a defendant. That former officer left First Charter in May of 1997 and later became a principal of Four Star Financial Services, LLC (“Four Star”), an affiliate of 900 Capital Services, Inc. (“900 Capital”).

On April 18, 2005, the plaintiffs filed the second amended class action complaint. The second amended complaint alleged that the former officer of First Charter improperly induced several First Charter customers to invest in 900 Capital or affiliates of 900 Capital and further alleges that Four Star, 900 Capital and some of their affiliated entities perpetuated their fraud upon investors through various accounts at First Charter, First Community and Pacific Western with those banks’ purported knowing participation in and/or willful ignorance of the scheme. The key allegations in the second amended complaint dated back to the mid-1990s and the second amended complaint alleged several counts for relief including aiding and abetting, conspiracy, fraud, breach of fiduciary duty, relief pursuant to the California Business and Professions Code, negligence and relief under the California Securities Act stemming from an alleged fraudulent scheme and sale of securities issued by 900 Capital and Four Star. In disclosures provided to the parties, plaintiffs have asserted that the named plaintiffs have suffered losses well in excess of $3.85 million, and plaintiffs have asserted that “losses to the class total many tens of millions of dollars.” On June 15, 2005, we filed a demurrer to the second amended complaint, and on August 22, 2005, the

22




Court sustained our demurrer as to each of the counts therein, granting plaintiffs leave to amend on four of the six counts, and dismissing the other counts outright.

On August 12, 2005, the Company was notified by Progressive Casualty Insurance Company (“Progressive”), its primary insurance carrier with respect to the Gilbert Litigation that Progressive had determined that, based upon the allegations in the second amended complaint filed in the Gilbert Litigation, there was no coverage with respect to the Gilbert Litigation under the Company’s insurance policy with Progressive. Progressive also notified the Company that it was withdrawing its agreement to fund defense costs for the Gilbert Litigation and reserving its right to seek reimbursement from the Company for any defense costs advanced pursuant to the insurance policy. Through December 31, 2005, Progressive had advanced to the Company approximately $690,000 of defense costs with respect to the Gilbert Litigation.

On August 12, 2005, Progressive filed an action in federal district court for declaratory relief, currently pending as Progressive Casualty Insurance Company, etc., v. First Community Bancorp, etc., et al., Case No. 05-5900 SVW (MAWx) (the “Progressive Litigation”), seeking a declaratory judgment with respect to the parties’ rights and obligations under Progressive’s policy with the Company. On October 11, 2005, the Company filed in federal court a motion to dismiss or stay the Progressive Litigation.

In November 2005, along with certain other defendants, we reached an agreement in principle with respect to the Gilbert Litigation. That agreement is reflected in a written Stipulation of Settlement dated February 9, 2007, which has been executed by all the parties to that settlement. The settlement is subject to approval by the Los Angeles Superior Court and a certain level of participation in the settlement by class members. Assuming all conditions to final consummation of the settlement are met, First Community’s contribution to the settlement will be $775,000, which was accrued in 2005.

While we believe that this settlement, if finalized, will end our exposure to the underlying claims by participating class members, we cannot be certain that all conditions to the settlement will be satisfied or that we will not be subject to further claims by parties related to the same claims who did not participate in the settlement.

In connection with the Gilbert Litigation settlement, we also reached a settlement with Progressive Casualty Insurance Co. in the Progressive Litigation. The settlement with Progressive, which includes an additional contribution by Progressive under First Community’s policy toward the settlement of the Gilbert Litigation and a dismissal by Progressive of any claims against First Community for reimbursement, is contingent upon the consummation of the Gilbert Litigation settlement.

In the ordinary course of our business, we are party to various other legal actions, which we believe are incidental to the operation of our business. Although the ultimate outcome and amount of liability, if any, with respect to these other legal actions to which we are currently a party cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is not likely to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to the shareholders of the Company, through the solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 2006.

23




PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Marketplace Designation, Sales Price Information and Holders

On June 1, 2000, our common stock was designated for quotation on the Nasdaq National Market® and trades under the symbol “FCBP.” The following table summarizes the high and low sale prices for each quarterly period ended since January 1, 2005 for our common stock, as quoted and reported by the Nasdaq National Market:

 

 

Sales Prices

 

 

 

High

 

Low

 

Quarter Ended

 

 

 

 

 

2005:

 

 

 

 

 

First quarter

 

$

46.20

 

$

39.00

 

Second quarter

 

$

48.95

 

$

41.18

 

Third quarter

 

$

51.62

 

$

45.50

 

Fourth quarter

 

$

57.30

 

$

45.07

 

2006:

 

 

 

 

 

First quarter

 

$

61.65

 

$

53.95

 

Second quarter

 

$

61.35

 

$

55.02

 

Third quarter

 

$

59.52

 

$

51.87

 

Fourth quarter

 

$

58.11

 

$

51.30

 

 

As of February 16, 2007, the closing price of our common stock on Nasdaq was $54.42 per share. As of that date, we believe, based on the records of our transfer agent, that there were approximately 2,650 record holders of our common stock.

Dividends

Our ability to pay dividends to our shareholders is subject to the restrictions set forth in the California General Corporation Law, or the CGCL. The CGCL provides that a corporation may make a distribution to its shareholders if the corporation’s retained earnings equal at least the amount of the proposed distribution. The CGCL further provides that, in the event that sufficient retained earnings are not available for the proposed distribution, a corporation may nevertheless make a distribution to its shareholders if it meets two conditions: (i) the corporation’s assets equal at least 11¤4 times its liabilities and (ii) the corporation’s current assets equal at least its current liabilities or, alternatively, if the average of the corporation’s earnings before taxes on income and interest expense for the two preceding fiscal years was less than the average of the corporation’s interest expense for such fiscal years, the corporation’s current assets equal at least 11¤4 times its current liabilities. Our ability to pay dividends is also subject to certain other limitations. See “Item 1. Business—Supervision and Regulation” in Part I of this Annual Report on Form 10-K.

Our primary source of income is the receipt of dividends from the Bank. The availability of dividends from the Bank is limited by various statutes and regulations. It is possible, depending upon the financial condition of the bank in question, and other factors, that either the FRB, the FDIC or the DFI could assert that payment of dividends or other payments is an unsafe or unsound practice. In addition, our ability to pay dividends is limited by certain provisions of our credit agreement with U.S. Bank, N.A. This agreement provides that we may not declare or pay any dividend on the Company’s common stock in any quarter if an Event of Default (as defined in the agreement) has occurred or will occur as a result of such payment. In addition, the agreement prevents us from paying a dividend in the event we no longer own 100% of Pacific

24




Western. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity” and Note 18 of the Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.”

Our ability to pay dividends is also limited by certain covenants contained in the indentures governing trust preferred securities issued by us or entities that we have acquired, and the debentures underlying the trust preferred securities. Generally the indentures provide that if an Event of Default (as defined in the indentures) has occurred and is continuing, or if we are in default with respect to any obligations under our guarantee agreement which covers payments of the obligations on the trust preferred securities, or if we give notice of any intention to defer payments of interest on the debentures underlying the trust preferred securities, then we may not, among other restrictions, declare or pay any dividends (other than a dividend payable by the Bank to the holding company) with respect to our common stock. See Note 8 of the Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.”

Holders of our common stock are entitled to receive dividends declared by our Board of Directors out of funds legally available under the laws of the State of California, subject to the rights of holders of any preferred stock of the Company that may be issued in the future. Since January 1, 2005 we have declared the following quarterly dividends:

Record Date

 

Pay Date

 

Amount per Share

 

February 15, 2005

 

February 28, 2005

 

 

$

0.22

 

 

May 16, 2005

 

May 31, 2005

 

 

$

0.25

 

 

August 16, 2005

 

August 31, 2005

 

 

$

0.25

 

 

November 16, 2005

 

November 30, 2005

 

 

$

0.25

 

 

February 16, 2006

 

February 28, 2006

 

 

$

0.25

 

 

May 16, 2006

 

May 31, 2006

 

 

$

0.32

 

 

August 16, 2006

 

August 30, 2006

 

 

$

0.32

 

 

November 16, 2006

 

November 30, 2006

 

 

$

0.32

 

 

February 16, 2007

 

February 28, 2007

 

 

$

0.32

 

 

 

We believe that the Company will be able to continue paying quarterly dividends, however we can provide no assurance that we will continue to declare dividends on a quarterly basis or otherwise. The declaration of dividends by the Company is subject to the discretion of our Board of Directors. Our Board of Directors will take into account such matters as general business conditions, our financial results, capital requirements, contractual, legal and regulatory restrictions on the payment of dividends by us to our shareholders or by our subsidiary to the holding company, and such other factors as our Board of Directors may deem relevant. See “Item 1. Business—Regulation and Supervision,” in Part I of this Annual Report on Form 10-K for a discussion of potential regulatory limitations on the holding company’s receipt of funds from the Bank.

25




Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of December 31, 2006, regarding securities issued and to be issued under our equity compensation plans that were in effect during fiscal 2006:

 

 

Plan Category

 

Number of
Securities to be
Issued Upon
Exercise of
Outstanding
Options, Warrants
and Rights

 

Weighted-
Average
Exercise Price
of
Outstanding
Options,
Warrants
and Rights

 

Number of
Securities
Remaining
Available for
Future Issuance
Under Equity
Compensation
Plans (Excluding
Securities Reflected
in Column (a))

 

 

 

 

 

(a)

 

(b)

 

(c)

 

Equity compensation plans approved by security
holders

 

The First Community
Bancorp 2003 Stock
Incentive Plan
(1)

 

 

135,373

(2)

 

 

$

20.78

 

 

 

916,196

(3)

 

Equity compensation plans not approved by security holders

 

None

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


(1)           The First Community Bancorp 2003 Stock Incentive Plan (the “Incentive Plan”) was last approved by the shareholders of the Company at our 2004 Annual Meeting of Shareholders and amended at our 2006 Annual Meeting of Shareholders.

(2)           Amount represents outstanding options only and does not include the 750,014 shares of unvested restricted and performance stock awarded since 2003 and outstanding as of December 31, 2006 with an exercise price of zero.

(3)           The total number of shares of common stock that have been approved for issuance pursuant to awards granted or which may be granted in the future under the Incentive Plan is 3,500,000 shares. In addition to options issued under the Incentive Plan, the number of securities remaining available for future issuance has been reduced by 1,134,122 shares which represents the sum of the number of unvested shares of restricted and performance stock awards outstanding at December 31, 2006 and the number of vested shares of restricted and performance stock as of December 31, 2006. In February 2007, the Company granted 208,300 of performance and restricted stock awards reducing the shares remaining available for issuance under the Incentive Plan to 707,896.

Recent Sales of Unregistered Securities and Use of Proceeds

During the past three years, the Company has issued unregistered debt securities through one offering of trust preferred securities. The details of the offering are set forth below:

 

 

 

 

 

 

Consideration

 

Exemption

 

Terms of

 

 

 

Securities Sold

 

 

 

Date
Offering
Completed

 

Underwriters or
Other
Purchasers

 

Aggregate
OfferingPrice

 

Underwriting
Discounts/
Commissions

 

from
Registration
Claimed

 

Conversion
or
Exercise

 

Use of
Proceeds

 

 

 

(In thousands)

 

Trust Preferred Securities

 

 


2/5/2004

 

 

 

Cohen Bros. & Co./ Friedman, Billings, Ramsey & Co., Inc.

 

 


61,856

 

 

 


300

 

 

 


(1


)

 

 


N/A

 

 


Acquisition
financing

 


(1)           The securities were sold in a private placement. We are informed by the initial purchasers that the securities were resold in transactions exempt from registration pursuant to Rule 144A under the Securities Act of 1933, as amended, to qualified institutional buyers as such term is defined in Rule 144A and in accordance with the procedures set forth in such Rule.

26




Additional information regarding the offering of our debt securities and the trust preferred securities is set forth in Note 8 of the Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.”

Repurchases of Common Stock

Through the Company’s Directors Deferred Compensation Plan, or the DDCP, participants in the plan may reinvest deferred amounts in the Company’s common stock. The Company has the discretion whether to track purchases of common stock as if made, or to fully fund the DDCP via purchases of stock with deferred amounts. Purchases of Company common stock by the rabbi trust of the DDCP are considered repurchases of common stock by the Company since the rabbi trust is an asset of the Company. Actual purchases of Company common stock via the DDCP are made through open market purchases pursuant to the terms of the DDCP, which includes a predetermined formula and schedule for the purchase of such stock in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934. Pursuant to the terms of the DDCP, generally purchases are actually made or deemed to be made in the open market on the 15th of the month (or the next trading day) following the day on which deferred amounts are contributed to the DDCP, beginning March 15 of each year. Listed in the table below are the purchases made by the DDCP for the fourth quarter of 2006:

 

 

Total Shares
Purchased

 

Average
Price Paid
Per Share

 

Shares Purchased As Part of a
Publicly-Announced
Program

 

Maximum
Shares Still
Available for
Repurchase

 

October 1 - October 31, 2006

 

 

 

 

 

 

 

 

N/A

 

 

 

N/A

 

 

November 1 - November 30, 2006

 

 

 

 

 

 

 

 

N/A

 

 

 

N/A

 

 

December 1 - December 31, 2006

 

 

6,433

 

 

 

$

53.20

 

 

 

N/A

 

 

 

N/A

 

 

 

 

 

6,433

 

 

 

$

53.20

 

 

 

 

 

 

 

 

 

 

 

On May 3, 2006, our Board of Directors authorized the repurchase of up to one million shares of the Company’s common stock over the next twelve months, subject to market conditions and corporate and regulatory requirements. Through February 7, 2007, we repurchased 277,600 shares. The stock repurchase program may be limited or terminated at any time without prior notice. Listed in the table below are the purchases made by the Company as of February 7, 2007:

 

 

Total Shares
Purchased

 

Average
Price Paid
Per Share

 

Shares Purchased As Part of a
Publicly-Announced
Program

 

Maximum
Shares Still
Available for
Repurchase

 

October 1 - October 31, 2006

 

 

 

 

 

 

 

 

 

 

 

1,000,000

 

 

November 1 - November 30, 2006

 

 

100,000

 

 

 

$

53.26

 

 

 

100,000

 

 

 

900,000

 

 

December 1 - December 31, 2006

 

 

 

 

 

 

 

 

 

 

 

900,000

 

 

Fourth quarter total

 

 

100,000

 

 

 

$

53.26

 

 

 

100,000

 

 

 

 

 

 

January 1 - January 31, 2007

 

 

89,900

 

 

 

$

52.87

 

 

 

89,900

 

 

 

810,100

 

 

February 1 - February 7, 2007

 

 

87,700

 

 

 

$

54.37

 

 

 

87,700

 

 

 

722,400

 

 

 

 

 

277,600

 

 

 

$

53.48

 

 

 

277,600

 

 

 

 

 

 

 

27




Five-Year Stock Performance Graph

The following chart compares the yearly percentage change in the cumulative shareholder return on our common stock based on the closing price during the five years ended December 31, 2006, with (1) the Total Return Index for the NASDAQ Stock Market (U.S. Companies) and (2) the Total Return Index for NASDAQ Bank Stocks. This comparison assumes $100 was invested on December 31, 2001, in our common stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends. First Community’s total cumulative return was 186.8% over the five year period ending December 31, 2006 compared to 24.2% and 66.1% for the NASDAQ Composite and NASDAQ Bank Stocks.

GRAPHIC

 

 

Period Ending

 

Index

 

 

 

12/31/01

 

12/31/02

 

12/31/03

 

12/31/04

 

12/31/05

 

12/31/06

 

First Community Bancorp

 

 

$

100

 

 

$

166.02

 

$

186.01

 

$

224.57

 

$

291.96

 

$

286.78

 

NASDAQ Composite

 

 

  100

 

 

69.66

 

99.71

 

113.79

 

114.47

 

124.20

 

NASDAQ Bank Index

 

 

  100

 

 

59.14

 

89.11

 

103.85

 

130.57

 

166.05

 

 

28




ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth certain of our financial and statistical information for each of the years in the five-year period ended December 31, 2006. This data should be read in conjunction with our audited consolidated financial statements as of December 31, 2006 and 2005, and for each of the years in the three-year period ended December 31, 2006, and related Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.”

 

 

At or for the Years Ended December 31,

 

 

 

2006

 

2005

 

2004

 

2003

 

2002

 

 

 

(In thousands, except per share amounts and percentages)

 

Results of Operations(1):

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

301,597

 

$

183,352

 

$

140,147

 

$

112,881

 

$

83,903

 

Interest expense

 

59,640

 

22,917

 

14,417

 

12,647

 

14,156

 

NET INTEREST INCOME

 

241,957

 

160,435

 

125,730

 

100,234

 

69,747

 

Provision for credit losses

 

9,600

 

1,420

 

465

 

300

 

 

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES

 

232,357

 

159,015

 

125,265

 

99,934

 

69,747

 

Noninterest income

 

16,466

 

13,778

 

17,221

 

19,637

 

12,684

 

Noninterest expense

 

121,455

 

87,302

 

81,827

 

65,820

 

54,302

 

EARNINGS BEFORE INCOME TAXES AND EFFECT OF ACCOUNTING CHANGE

 

127,368

 

85,491

 

60,659

 

53,751

 

28,129

 

Income taxes

 

51,512

 

35,125

 

24,296

 

21,696

 

11,217

 

NET EARNINGS BEFORE CUMULATIVE
EFFECT OF ACCOUNTING CHANGE

 

75,856

 

50,366

 

36,363

 

32,055

 

16,912

 

Cumulative effect on prior years (to December 31, 2005) of changing the method of accounting for stock-based compensation forfeitures

 

142

 

 

 

 

 

NET EARNINGS

 

$

75,998

 

$

50,366

 

$

36,363

 

$

32,055

 

$

16,912

 

Share Data:

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share (EPS):

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

3.23

 

$

3.05

 

$

2.34

 

$

2.08

 

$

1.64

 

Diluted

 

3.21

 

2.98

 

2.27

 

2.02

 

1.58

 

Dividends declared per share

 

1.21

 

0.97

 

0.85

 

0.68

 

0.54

 

Book value per share(2)

 

$

39.42

 

$

27.30

 

$

22.98

 

$

21.24

 

$

20.68

 

Shares outstanding at the end of the year(2)

 

29,636

 

18,347

 

16,268

 

15,893

 

15,297

 

Average shares outstanding for basic EPS

 

23,476

 

16,536

 

15,521

 

15,382

 

10,302

 

Average shares outstanding for diluted EPS

 

23,680

 

16,894

 

15,987

 

15,868

 

10,692

 

Ending Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Assets

 

$

5,553,323

 

$

3,226,411

 

$

3,049,453

 

$

2,429,981

 

$

2,120,004

 

Time deposits in financial institutions

 

501

 

90

 

702

 

311

 

1,041

 

Investments

 

120,128

 

239,354

 

269,507

 

432,318

 

325,858

 

Loans held for sale

 

173,319

 

 

 

 

 

Loans, net of unearned income

 

4,189,543

 

2,467,828

 

2,118,171

 

1,595,837

 

1,424,396

 

Allowance for credit losses

 

61,179

 

32,971

 

29,507

 

25,752

 

24,294

 

Intangible assets

 

788,510

 

323,188

 

256,955

 

221,956

 

188,050

 

Deposits(3)

 

3,685,733

 

2,405,361

 

2,432,390

 

1,949,669

 

1,738,621

 

Borrowings

 

499,000

 

160,300

 

90,000

 

53,700

 

1,223

 

Subordinated debentures

 

149,219

 

121,654

 

121,654

 

59,798

 

39,178

 

Common shareholders’ equity

 

1,168,328

 

500,778

 

373,876

 

337,563

 

316,292

 

Selected Financial Ratios:

 

 

 

 

 

 

 

 

 

 

 

Dividend payout ratio

 

37.69

%

32.55

%

37.33

%

33.42

%

34.18

 

Shareholders’ equity to assets at period end

 

21.04

 

15.52

 

12.26

 

13.89

 

14.92

 

Return on average assets

 

1.72

 

1.68

 

1.35

 

1.41

 

1.14

 

Return on average equity

 

9.13

 

12.10

 

10.36

 

9.84

 

9.66

 

Average equity/average assets

 

18.88

 

13.90

 

13.04

 

14.29

 

11.78

 

Net interest margin

 

6.67

 

6.37

 

5.58

 

5.24

 

5.41

 


(1)             Operating results of acquired companies are included from the respective acquisition dates. See Note 2 of the Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.”

(2)             Includes 750,014 shares, 405,831 shares, 585,416 shares and 460,000 shares of unvested restricted and performance stock outstanding at December 31, 2006, 2005, 2004 and 2003.

(3)             2004 includes a short-term $365 million interest-bearing deposit received on December 31, 2004.

29




ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This section should be read in conjunction with the disclosure regarding “Forward-Looking Statements” set forth in “Item 1. Business—Forward-Looking Statements”, as well as the discussion set forth in “Item 1. Business—Certain Business Risks” and “Item 8. Financial Statements and Supplementary Data.”

Overview

We are a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Our principal business is to serve as a holding company for our banking subsidiary. As of December 31, 2006, our sole banking subsidiary is Pacific Western Bank, which we refer to as Pacific Western, or the Bank. As of December 31, 2005, our banking subsidiaries were Pacific Western National Bank which we also refer to as Pacific Western, and First National Bank, which we refer to as First National. As part of our announced plan of consolidation and conversion, Pacific Western National Bank, filed an application with the California Department of Financial Institutions, or DFI, to convert from a national banking charter to a state-chartered bank under the name of Pacific Western Bank. This application was approved and the conversion of Pacific Western to a state-chartered bank occurred on September 13, 2006. Pacific Western also filed a notice with the Federal Reserve Bank of San Francisco to withdraw from membership in the Federal Reserve System and become a “nonmember” bank at the time of its conversion. Additionally, on October 26, 2006, following the completion of the acquisition of Community Bancorp Inc. and the subsequent merger of its wholly-owned subsidiary, Community National Bank, with and into First National, we completed our plan of consolidation by merging First National with and into Pacific Western, with Pacific Western as the surviving entity in an “as if” pooling transaction. All references to Pacific Western, or the Bank, prior to September 13, 2006 refer to Pacific Western National Bank, and references on or after September 13, 2006 refer to Pacific Western Bank.

On January 4, 2006, we acquired Cedars Bank, or Cedars, which was merged with and into Pacific Western. On May 9, 2006, we acquired Foothill Independent Bancorp, or Foothill, which was merged with and into the First Community Bancorp and Foothill’s wholly-owned subsidiary, Foothill Independent Bank, was merged with and into Pacific Western. When we say “we”, “our” or the “Company”, we mean the Company on a consolidated basis with Pacific Western. When we refer to “First Community” or to the holding company, we are referring to the parent company on a standalone basis. Discussions about the Company and the Bank as of and for the year ended December 31, 2006 include Cedars, Foothill and Community Bancorp from and after their respective dates of acquisition.

Pacific Western is a full-service community bank offering a broad range of banking products and services. We accept time and demand deposits, fund loans including real estate, construction, SBA and commercial loans, and offer other business oriented banking products. Our operations are primarily located in Southern California and the Bank focuses on conducting business with small to medium size businesses and the owners and employees of those businesses in our marketplace. Through our asset-based lending division and SBA loan production offices we also operate in Arizona and Texas. At December 31, 2006, the Bank’s gross loans, excluding loans held for sale, totaled $4.2 billion of which approximately 20% were commercial loans, 79% were commercial real estate loans, including construction loans, and 1% were consumer and other loans. These percentages include some foreign loans, primarily to individuals or entities with business in Mexico, representing 2% of total loans.

The Bank competes actively for deposits, and we tend to solicit noninterest-bearing deposits. In managing the top line of our business, we focus on loan growth and loan yield, deposit cost, and net interest margin, as net interest income accounts for 94% of our net revenues (net interest income plus noninterest income).

30




Key Performance Indicators

Among other factors, our operating results depend generally on the following:

The Level of Our Net Interest Income

Net interest income is the excess of interest earned on our interest-earning assets over the interest paid on our interest-bearing liabilities. Our primary interest-earning assets are loans and investment securities. Our primary interest-bearing liabilities are deposits, borrowings, and subordinated debentures. We attempt to increase our net interest income by maintaining a high level of noninterest-bearing deposits. At December 31, 2006, approximately 43% of our deposits were noninterest-bearing. We have borrowing capacity under various credit lines which we use for liquidity needs such as funding loan demand, managing deposit flows and interim acquisition financing. Some of our long-term borrowings are matched to our asset-based loan portfolio and other fixed-rate loans. During the latter half of 2006, we extended the term on $200 million of our borrowings to take advantage of pricing opportunities such extended terms offered. Net proceeds from our other long-term borrowings, consisting of subordinated debentures, were used to fund certain of our acquisitions. Our general policy is to price our deposits in the bottom half or third-quartile of our competitive peer group, resulting in deposit products that bear interest rates at somewhat lower yields. While our deposit balances will fluctuate depending on deposit holders’ perceptions of alternative yields available in the market, we attempt to minimize these variances by attracting a high percentage of noninterest-bearing deposits, which have no expectation of yield.

Loan Growth

We generally seek new lending opportunities in the $500,000 to $5 million range, try to limit loan maturities for commercial loans to one year, for construction loans up to 18 months, and for commercial real estate loans up to ten years, and to price lending products so as to preserve our interest spread and net interest margin. We sometimes encounter strong competition in pursuing lending opportunities such that potential borrowers obtain loans elsewhere at lower rates than those we offer.

The Magnitude of Credit Losses

We stress credit quality in originating and monitoring the loans we make and measure our success by the level of our nonperforming assets and the corresponding level of our allowance for credit losses. Our allowance for credit losses is the sum of our allowance for loan losses and our reserve for unfunded loan commitments. Provisions for credit losses are charged to operations as and when needed for both on and off balance sheet credit exposure. Loans which are deemed uncollectible are charged off and deducted from the allowance for loan losses. Recoveries on loans previously charged off are added to the allowance for loan losses. During 2006, we made provisions for credit losses totaling $9.6 million in response to an increase in nonaccrual loans, the credit quality of an acquired portfolio, our analysis of current market conditions related to real estate loans, and organic loan growth.

We review our loans periodically to determine whether there has been any deterioration in credit quality stemming from economic conditions or other factors which may affect collectibility of our loans. Changes in economic conditions, such as increases in the general level of interest rates and negative conditions in borrowers’ businesses, could negatively impact our customers and cause us to adversely classify loans and increase portfolio loss factors. Once an acquisition is completed we further review the acquired loans under our underwriting standards. These reviews could result in downgrades of acquired loans to adversely classified status. Because adversely classified loans require an allowance for credit losses, increases in classified loans generally result in increased provisions for credit losses. Because we have a concentration in real estate loans, any deterioration in the real estate markets may negatively impact our borrowers and could lead to increased provisions for credit losses. Approximately 79% of our

31




gross loans are real estate related with construction loans and real estate mortgage loans representing 22% and 57%, respectively, of gross loans.

The Level of Our Noninterest Expense

Our noninterest expense includes fixed and controllable overhead, the major components of which are compensation, occupancy, data processing, professional fees and communications. We measure success in controlling such costs through monitoring of the efficiency ratio. We calculate the efficiency ratio by dividing noninterest expense by the sum of net interest income and noninterest income. Accordingly, a lower percentage reflects lower expenses relative to income. The consolidated efficiency ratios have been as follows:

Quarterly Period in 2006

 

 

 

Ratio

 

First

 

 

47.2

%

 

Second

 

 

45.7

%

 

Third

 

 

45.5

%

 

Fourth

 

 

49.5

%

 

 

During the fourth quarter of 2006 we completed the Community Bancorp acquisition and systems integration, incurred reorganization costs of $1.4 million, and sold investment securities at a loss of $2.3 million. These items increased the fourth quarter efficiency ratio by 336 basis points.

Additionally, our operating results have been influenced significantly by acquisitions. The seven acquisitions we completed from March 1, 2004 through December 31, 2006 added approximately $3.2 billion in assets. Our assets at December 31, 2006 totaled approximately $5.6 billion. Our noninterest expenses have increased for all periods presented because of our acquisitions. However, our expense control programs and merger integration routines enabled us to improve our efficiency ratio. In addition to driving down our efficiency ratio during 2006, we have steadily improved this ratio over the last 3 years.

Critical Accounting Policies

The following discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, and the notes thereto, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable; however, actual results may differ significantly from these estimates and assumptions which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and on our results of operations for the reporting periods.

Our significant accounting policies and practices are described in Note 1 to the Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.” The accounting policies that involve significant estimates and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities, are considered critical accounting policies. We have identified our policies for the allowance for credit losses, the fair value of financial instruments, and the carrying values of goodwill, other intangible assets and deferred tax assets as critical accounting policies.

32




Allowance for Credit Losses

The allowance for loan losses and the reserve for unfunded loan commitments when combined are referred to as the allowance for credit losses. The allowance for loan losses is reported as a reduction of outstanding loan balances and the reserve for unfunded loan commitments is included within other liabilities. On December 31, 2004, we reclassified to other liabilities our reserve for unfunded loan commitments which was previously included with the allowance for loan losses. When we determined the amount of our allowance for loan losses applicable to the real estate loan portion of our portfolio, we included both real estate loan balances and real estate loan commitments because the commitments related to loans which existed and the commitment amounts were expected to be disbursed. We followed this practice through September 30, 2005. At December 31, 2005, we decided to use commitments for all categories of loans in determining our reserve for unfunded loan commitments. Accordingly, we reclassified from the allowance for loan losses to the reserve for unfunded loan commitments the commitment reserve related to real estate loans that was previously included in the allowance for loan losses prior to December 31, 2005. Generally, as loans are funded, the amount of the commitment reserve applicable to such funded loans will be transferred from the reserve for unfunded loan commitments to the allowance for loan losses based on our reserving methodology. The accompanying balance sheets and the allowance for loan losses tables included in Note 5 of the Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data” and within Management’s Discussion and Analysis of Financial Condition and Results of Operations reflect the reclassification.

We maintain an allowance for loan losses at an amount which we believe is sufficient to provide adequate protection against losses inherent in the loan portfolio at the balance sheet date. Our periodic evaluation of the adequacy of the allowance is based on such factors as our past loan loss experience, known and inherent risks in the portfolio, adverse situations that have occurred but are not yet known that may affect the borrowers’ ability to repay, the estimated value of underlying collateral, and economic conditions. As we utilize information currently available to evaluate the allowance for loan losses, the allowance for loan losses is subjective and may be adjusted in the future depending on changes in economic conditions or other factors.

The methodology we use to estimate the amount of our allowance for credit losses is based on both objective and subjective criteria. While some criteria are formula driven, other criteria are subjective inputs included to capture environmental and general economic risk elements which may trigger losses in the loan portfolio, and to account for the varying levels of credit quality in the loan portfolios of the entities we have acquired, that have not yet been captured in our objective loss factors.

Specifically, our allowance methodology contains four elements: (a) amounts based on specific evaluations of impaired loans; (b) amounts of estimated losses on several pools of loans categorized by type; (c) amounts of estimated losses for loans adversely classified based on our loan review process; and (d) amounts for environmental and general economic factors that indicate probable losses were incurred but were not captured through the other elements of our allowance process.

Impaired loans are identified at each reporting date based on certain criteria and individually reviewed for impairment. Allowance amounts for these loans are based upon the fair value of the loan’s collateral if the loan is collateral dependent or the present value of cash flows, discounted at the loan’s effective interest rate, if the loan is not collateralized.

Our non-impaired loan portfolio is broken down into several pools for purposes of determining allowance amounts by pool and within those pools for adversely classified loans. The pools we currently evaluate are: real estate construction, real estate other, commercial collateralized, commercial unsecured, consumer, foreign, asset-based, and factoring. The allowance amounts for loans not adversely classified are determined using historical loss rates developed through a migration analysis. The allowance amounts for

33




adversely classified loans are also determined through migration analysis adjusted for historical loss rates on similarly classified loans.

Finally, in order to ensure our allowance methodology is incorporating recent trends and economic conditions, we apply environmental and general economic factors to our allowance methodology including: credit concentrations; delinquency trends; economic and business conditions; external factors such as fuel and building materials prices, the effects of adverse weather, and hostilities; the quality of lending management and staff; lending policies and procedures; loss and recovery trends; nature and volume of the portfolio; nonaccrual loan trends; other adjustments for items not covered by other factors; problem loan trends; and quality of loan review.

Based on our methodology and its components, management believes the resulting allowance for credit losses is adequate and appropriate for the risk identified in the Company’s loan portfolio.

The Company’s determination of the allowance for loan losses is sensitive to the assigned credit risk ratings and inherent loss rates at any given point in time. Therefore, we perform a sensitivity analysis to provide insight regarding the impact of adverse changes in risk ratings may have on our allowance for loan losses. The sensitivity analysis does not imply any expectation of future deterioration in our loans’ risk ratings and it does not necessarily reflect the nature and extent of future changes in the allowance for loan losses due to the numerous quantitative and qualitative factors considered in determining our allowance for loan losses. At December 31, 2006, in the event that 1 percent of our loans were downgraded from the pass to substandard category within our current allowance methodology, the allowance for loan losses would have increased by approximately $10.6 million. Given current processes employed by the Company, management believes the risk ratings and inherent loss rates currently assigned are appropriate. It is possible that others, given the same information, may at any point in time reach different reasonable conclusions that could be material to the Company’s financial statements.

Although we have established an allowance for loan losses that we consider adequate, there can be no assurance that the established allowance for loan losses will be sufficient to offset losses on loans in the future. Management also believes that the reserve for unfunded loan commitments is adequate. In making this determination, we use the same methodology for the reserve for unfunded loan commitments as we do for the allowance for loan losses and consider the same qualitative factors, as well as an estimate of the probability of drawdown of the commitments correlated to their credit risk rating. Please see “—Financial Condition—Allowance for Credit Losses” and Notes 1(h) and 5 of the Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data” for more information.

Goodwill and Other Intangible Assets

As a result of our acquisition activity, goodwill and core deposit and customer relationship intangible assets have been added to our balance sheet. Goodwill, a long-lived asset, is evaluated for impairment at least annually. We conduct an impairment analysis to evaluate the carrying value of goodwill as of June 30th each year. Core deposit and customer relationship intangibles arising from acquisitions are being amortized over their estimated useful lives of up to 10 years.

The process of evaluating goodwill for impairment requires us to make several assumptions and estimates. We begin the valuation process by identifying the reporting units related to the goodwill. We identified one reporting unit, banking operations, in relation to our goodwill asset. If our impairment analysis indicates that the fair value of our reporting unit is less than its carrying amount, then we will have to writedown the amount of goodwill we carry on our balance sheet through a charge to our earnings.

Our impairment analysis estimated the value of our reporting unit using three methods: an income approach which is a discounted cash flow model, a market comparison approach, and a market transaction approach. Each of these valuation methods include several assumptions, including forecasts of future

34




earnings of our reporting unit, discount rates, market trends and market multiples of companies engaged in similar lines of business. If any of the assumptions used in the valuation of our goodwill change over time, the estimated value assigned to our goodwill could differ significantly, including a decrease in the value of goodwill which would result in a charge to our earnings. The most significant element in the goodwill evaluation is the level of our earnings. If our earnings were to decline and cause our market capitalization to decline also, the market value of our Company may not support the carrying value of goodwill. The goodwill for our one reporting unit was last evaluated for impairment as of June 30, 2006, and no impairment was identified.

The calculation and subsequent amortization of core deposit and customer relationship intangible assets also requires several assumptions including, among other things, the estimated cost to service deposits acquired, discount rates, estimated attrition rates and useful lives. If the value of the core deposit intangible or the customer relationship intangible is determined to be less than the carrying value in future periods, a writedown would be taken through a charge to our earnings. The most significant element in either intangible evaluation is the attrition rate of the acquired deposits or loans. If such attrition rate were to accelerate from that which we expected, the intangible may have to be reduced by a charge to earnings. The attrition rate related to deposit flows or loan flows is influenced by many factors, the most significant of which are alternative yields available to customers and the level of competition from other financial institutions and financial services companies.

Deferred Income Tax Assets

Our deferred income tax assets arise from mainly two items: (1) differences in the dates that items of income and expense enter into our reported income and taxable income and (2) net operating loss carryforwards. Deferred tax assets are established for these items as they arise based on our judgments that they are realizable. From an accounting standpoint, we determine whether a deferred tax asset is realizable based on the historical level of our taxable income and estimates of our future taxable income. In most cases, the realization of the deferred tax asset is based on our future profitability. If we were to experience either reduced profitability or operating losses in a future period, the realization of our deferred tax assets would be questionable. In such an instance, we could be required to increase the valuation reserve on our deferred tax assets by charging earnings.

35




Results of Operations

Earnings Performance

We analyze our performance based on net earnings determined in accordance with accounting principles generally accepted in the United States. The comparability of financial information is affected by our acquisitions. Operating results include the operations of acquired entities from the dates of acquisition. FC Financial ($106 million in assets) was acquired in March 2004, Harbor National ($198 million in assets) was acquired in April 2004, First American ($286 million in assets) was acquired in August 2005, Pacific Liberty ($183 million in assets) was acquired in October 2005, Cedars ($489 million in assets) was acquired in January 2006, Foothill ($892 million in assets) was acquired in May 2006, and Community Bancorp ($1 billion in assets) was acquired in October of 2006. The following table presents net earnings and summarizes per share data and key financial ratios:

 

 

For the Years Ended
December 31,

 

 

 

2006

 

2005

 

2004

 

 

 

(Dollars in thousands,
except share data)

 

Net earnings

 

$

75,998

 

$

50,366

 

$

36,363

 

Profitability measures:

 

 

 

 

 

 

 

Basic earnings per share

 

$

3.23

 

$

3.05

 

$

2.34

 

Diluted earnings per share

 

$

3.21

 

$

2.98

 

$

2.27

 

Return on average assets

 

1.72

%

1.68

%

1.35

%

Return on average equity

 

9.13

%

12.10

%

10.36

%

Dividend payout ratio

 

37.69

%

32.55

%

37.33

%

 

The 51% increase in net earnings during 2006 as compared to 2005 is due to higher net interest income from acquisitions and organic loan growth, tempered by an increased credit loss provision, loss on sale of securities, increased compensation and general expenses from our acquisitions, and reorganization charges. Our net interest income increased 51% during 2006 when compared to 2005 due largely to a $1.2 billion increase in our average loans over 2005. Noninterest income was $2.6 million higher for 2006 compared to 2005 and is due mostly to increased service charges and fees for deposits, which are attributed to increased deposit volumes from our acquisitions, and increased fee income related to other services such as letters of credit and foreign exchange. Noninterest income for 2006 also included a $2.3 million loss on sale of securities and a $642,000 gain related to the recognition of a discount upon the repayment of an acquired loan; there were no such items in 2005. The increase in noninterest expenses for 2006 when compared to 2005 was a result of a combination of acquisitions, business growth, and recording reorganization charges of $1.8 million in 2006. Our branch network has expanded through our acquisitions and we have 63 offices as of February 2007.

Net Interest Income

Net interest income, which is our principal source of income, represents the difference between interest earned on assets and interest paid on liabilities. Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Net interest income is affected by changes in both interest rates and the volume of average interest-earning assets and interest-bearing liabilities. The following table presents, for the periods indicated, the distribution of average assets, liabilities and shareholders’ equity, as well as interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities.

36




Analysis of Average Balances, Yields and Rates

 

 

For the Years Ended December 31,

 

 

 

2006

 

2005

 

2004

 

 

 

Average
Balance

 

Interest
Income/
Expense

 

Yields
and
Rates

 

Average
Balance

 

Interest
Income/
Expense

 

Yields
and
Rates

 

Average
Balance

 

Interest
Income/
Expense

 

Yields
and
Rates

 

 

 

(Dollars in thousands)

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, net of unearned income(1)(2)

 

$

3,394,123

 

$

292,069

 

 

8.61

%

 

$

2,231,975

 

$

174,202

 

 

7.80

%

 

$

1,897,755

 

$

130,175

 

 

6.86

%

 

Investment securities(2)

 

228,031

 

9,200

 

 

4.03

%

 

248,471

 

7,900

 

 

3.18

%

 

324,156

 

9,584

 

 

2.96

%

 

Federal funds sold

 

6,491

 

297

 

 

4.58

%

 

39,117

 

1,245

 

 

3.18

%

 

29,206

 

354

 

 

1.21

%

 

Other earning assets

 

826

 

31

 

 

3.75

%

 

198

 

5

 

 

2.53

%

 

1,560

 

34

 

 

2.18

%

 

Total interest-earning assets

 

3,629,471

 

301,597

 

 

8.31

%

 

2,519,761

 

183,352

 

 

7.28

%

 

2,252,677

 

140,147

 

 

6.22

%

 

Noninterest-earning
assets

 

778,323

 

 

 

 

 

 

 

473,024

 

 

 

 

 

 

 

437,893

 

 

 

 

 

 

 

Total assets

 

$

4,407,794

 

 

 

 

 

 

 

$

2,992,785

 

 

 

 

 

 

 

$

2,690,570

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest checking

 

$

246,569

 

$

423

 

 

0.17

%

 

$

190,846

 

$

116

 

 

0.06

%

 

$

185,255

 

$

114

 

 

0.06

%

 

Money market

 

890,400

 

17,753

 

 

1.99

%

 

719,372

 

6,494

 

 

0.90

%

 

668,881

 

3,716

 

 

0.56

%

 

Savings

 

132,130

 

222

 

 

0.17

%

 

97,144

 

179

 

 

0.18

%

 

82,101

 

102

 

 

0.12

%

 

Time deposits

 

436,669

 

14,821

 

 

3.39

%

 

226,538

 

4,298

 

 

1.90

%

 

257,930

 

3,192

 

 

1.24

%

 

Total interest-bearing deposits

 

1,705,768

 

33,219

 

 

1.95

%

 

1,233,900

 

11,087

 

 

0.90

%

 

1,194,167

 

7,124

 

 

0.60

%

 

Borrowings and subordinated
debentures

 

435,640

 

26,421

 

 

6.06

%

 

227,376

 

11,830

 

 

5.20

%

 

172,459

 

7,293

 

 

4.23

%

 

Total interest-bearing liabilities

 

2,141,408

 

59,640

 

 

2.79

%

 

1,461,276

 

22,917

 

 

1.57

%

 

1,366,626

 

14,417

 

 

1.05

%

 

Non interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

1,387,919

 

 

 

 

 

 

 

1,072,071

 

 

 

 

 

 

 

933,418

 

 

 

 

 

 

 

Other liabilities

 

46,444

 

 

 

 

 

 

 

43,352

 

 

 

 

 

 

 

39,608

 

 

 

 

 

 

 

Total liabilities

 

3,575,771

 

 

 

 

 

 

 

2,576,699

 

 

 

 

 

 

 

2,339,652

 

 

 

 

 

 

 

Shareholders’ equity

 

832,023

 

 

 

 

 

 

 

416,086

 

 

 

 

 

 

 

350,918

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

4,407,794

 

 

 

 

 

 

 

$

2,992,785

 

 

 

 

 

 

 

$

2,690,570

 

 

 

 

 

 

 

Net interest income

 

 

 

$

241,957

 

 

 

 

 

 

 

$

160,435

 

 

 

 

 

 

 

$

125,730

 

 

 

 

 

Net interest spread

 

 

 

 

 

 

5.52

%

 

 

 

 

 

 

5.71

%

 

 

 

 

 

 

5.17

%

 

Net interest margin

 

 

 

 

 

 

6.67

%

 

 

 

 

 

 

6.37

%

 

 

 

 

 

 

5.58

%

 


(1)             Includes nonaccrual loans and loan fees.

(2)             Yields on loans and securities have not been adjusted to a tax-equivalent basis because the impact is not material.

Our net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a “volume change,” as well as changes in the yields earned on interest-earning assets and rates paid on deposits and borrowed funds, referred to as a “rate change.” The change in interest income/expense attributable to volume reflects the change in volume multiplied by the prior year’s rate and the change in interest income/expense attributable to rate reflects the change in rates multiplied by the prior year’s volume. The changes in interest income and expense which are not attributable specifically to either volume or rate are allocated ratably between the two categories. The following table presents, for the years indicated, changes in interest income and expense and the amount of change attributable to changes in volume and rates.

37




Analysis of Net Interest Income Changes

 

 

2006 Compared to 2005

 

2005 Compared to 2004

 

 

 

Total
Increase

 

Increase (Decrease)
Due to

 

Total
Increase

 

Increase (Decrease)
Due to

 

 

 

(Decrease)

 

Volume

 

Rate

 

(Decrease)

 

Volume

 

Rate

 

 

 

(Dollars in thousands)

 

Loans, net of unearned income

 

$

117,867

 

$

98,474

 

$

19,393

 

 

$

44,027

 

 

$

24,698

 

$

19,329

 

Investment securities

 

1,300

 

(691

)

1,991

 

 

(1,684

)

 

(2,365

)

681

 

Federal funds sold

 

(948

)

(1,336

)

388

 

 

891

 

 

154

 

737

 

Other earning assets

 

26

 

23

 

3

 

 

(29

)

 

(34

)

5

 

Total interest income

 

118,245

 

96,470

 

21,775

 

 

43,205

 

 

22,453

 

20,752

 

Interest checking

 

307

 

42

 

265

 

 

2

 

 

3

 

(1

)

Money market

 

11,259

 

1,851

 

9,408

 

 

2,778

 

 

299

 

2,479

 

Savings

 

43

 

60

 

(17

)

 

77

 

 

21

 

56

 

Time deposits

 

10,523

 

5,686

 

4,837

 

 

1,106

 

 

(427

)

1,533

 

Borrowings and subordinated debentures

 

14,591

 

9,819

 

4,772

 

 

4,537

 

 

1,602

 

2,935

 

Total interest expense

 

36,723

 

17,458

 

19,265

 

 

8,500

 

 

1,498

 

7,002

 

Net interest income

 

$

81,522

 

$

79,012

 

$

2,510

 

 

$

34,705

 

 

$

20,955

 

$

13,750

 

 

2006 compared to 2005

The increase in net interest income in 2006 over 2005 was due primarily to an increase in both loan volume and loan yield. Loan volume increased due to loan growth, both from acquisitions and organic growth. Our net interest income is impacted by the significant amount of noninterest-bearing demand deposits in our balance sheet. We endeavor to acquire and maintain demand deposits which averaged $1.4 billion during 2006, or 45% of total average deposits. Maintaining this high percentage of noninterest-bearing demand deposits to total deposits contributed to our overall cost of deposits being 1.07% for 2006 compared to 0.48% for 2005.

Loans increased $1.2 billion during 2006 including organic growth of $259.3 million. During 2006 average loans represented 94% of the total average interest-earning assets compared to 89% for 2005. Maintaining a high concentration of average loans to average interest-earning assets is a key factor in increasing interest income and maintaining our net interest margin, since loan yields are usually higher than yields on investment securities. The yield on average loans increased 81 basis points during 2006. In response to the market interest rate changes made by the Federal Reserve Bank our base lending rate increased to 8.25% at December 31, 2006 from 7.25% at December 31, 2005. Approximately 45% of our loan portfolio is eligible to reprice immediately as our base lending rate changes.

Interest expense increased in 2006 compared to 2005 due largely to an increase in the cost of our interest-bearing liabilities and, to a lesser extent, from the increase in amounts borrowed to fund loan growth. Interest-bearing deposit costs increased 105 basis points to 1.95% in 2006 compared to 2005, as a result of the higher-cost deposit bases of the banks we acquired and upward adjustments we made in rates offered on money market and certain time deposits in response to competition. The costs for borrowings and subordinated debentures also increased in 2006 as they have repriced in the higher interest rate environment. Our acquisitions, selective deposit repricing and the upward repricings of our borrowings resulted in a 122 basis point increase in the cost of our interest-bearing liabilities for 2006 compared to 2005.

38




2005 compared to 2004

The growth in net interest income and the 79 basis point increase in out net interest margin for 2005 compared to 2004 was largely a result of higher average loan balances and increased loan yields, offset by higher funding costs.

Net interest income increased $34.7 million mostly as a result of the $334.2 million increase in average loans for 2005 compared to 2004. Interest earned on average loans increased $44.0 million in 2005 when compared to 2004; this increase was due mainly to increased average loans from both organic growth and acquisition activity coupled with increased yields. Organic loan growth totaled $121.1 million for 2005. In addition, average loans represented 89% of the total average earning-assets compared to 84% for 2004. The yield on average loans was 94 basis points higher for 2005 when compared to 2004 and was related to escalating market interest rates.

Interest expense increased in 2005 compared to 2004 due largely to an increase in the cost of our interest-bearing liabilities and, to a lesser extent, from the increase in amounts borrowed to fund loan growth, deposit flows and acquisitions. The increase in market interest rates contributed to both the increase in our deposit costs and the upward repricing of our borrowings. The cost of all our deposits increased 15 basis points to 0.48% for 2005 compared to 2004. The cost of our interest-bearing liabilities increased 52 basis points to 1.57% for 2005 compared to 2004.

Provision for Credit Losses

The amount of the provision for credit losses in each year is a charge against earnings in that year. The provisions for credit losses are based on our reserve methodology and reflect our judgments about the adequacy of the allowance for loan losses and the reserve for unfunded loan commitments. In determining the amount of the provision, we consider certain quantitative and qualitative factors including our historical loan loss experience, the volume and type of lending we conduct, the results of our credit review process, the amounts of classified, criticized and nonperforming assets, regulatory policies, general economic conditions, underlying collateral values, off-balance sheet exposures, and other factors regarding collectibility and impairment. To the extent we experience, for example, increased levels of documentation deficiencies, adverse changes in collateral values, or negative changes in economic and business conditions which adversely affect our borrowers, our classified loans may increase. Increases in our classified loans generally result in provisions for credit losses.

We made provisions for credit losses totaling $9.6 million during 2006, $1.4 million during 2005 and $465,000 during 2004. The 2006 provision for credit losses was composed of an $8.0 million addition to the allowance for loan losses and a $1.6 million addition to the reserve for unfunded loan commitments. The 2005 provision for credit losses was composed of a $1.3 million addition to the allowance for loan losses and $75,000 added to the reserve for unfunded loan commitments. Net loans charged-off in 2006 increased by $230,000 to $1.4 million when compared to 2005.

The second quarter of 2006 provision for credit losses was made in response to an increase in nonaccrual loans, the credit quality of an acquired portfolio, our analysis of current market conditions related to real estate loans, and organic loan growth. Our integration procedures and internal credit review indicated that the underlying credit quality of certain of the Cedars-acquired loans was deficient compared to our standards. As a result, we adversely classified certain Cedars-acquired loans in accordance with our criteria. The actions we took to reduce these classified loans were successful and the number and dollar amount of classified loans has been reduced. The provision for 2005 was in response to loan growth and the level of nonaccrual loans. During 2005, foreign loans totaling $9.5 million were placed on nonaccrual; by the end of 2005, these loans were either repaid, charged off or returned to accrual status. The provision for 2004 was in response to loan growth.

39




The allowance for credit losses was $61.2 million, or 1.46% of loans, net of unearned income, at December 31, 2006, and $33.0 million, or 1.34% of loans, net of unearned income, at the end of 2005. The allowance for loan losses totaled $52.9 million at December 31, 2006 and $27.3 million at the end of 2005.

Increased provisions for credit losses may be required in the future based on loan and unfunded commitment growth and based on the effect of changes in economic conditions, such as the level of interest rates and real estate values, have on the ability of borrowers to repay their loans. See “—Critical Accounting Policies,” “—Financial Condition—Allowance for Credit Losses,” and Note 5 of the Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.”

Noninterest Income

The following table sets forth the details of noninterest income for the years indicated. The columns titled “Increase (Decrease)” set forth the year-over-year changes between 2006 and 2005 and between 2005 and 2004.

 

 

For the Years Ended December 31,

 

 

 

2006

 

Increase
(Decrease)

 

2005

 

Increase
(Decrease)

 

2004

 

 

 

(Dollars in thousands)

 

Noninterest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

$

8,835

 

 

$

2,468

 

 

$

6,367

 

 

$

(1,931

)

 

$

8,298

 

Other commissions and fees

 

6,420

 

 

2,240

 

 

4,180

 

 

183

 

 

3,997

 

Gain on sale of loans

 

 

 

(596

)

 

596

 

 

(1,208

)

 

1,804

 

Gain (loss) on sale of securities

 

(2,332

)

 

(2,287

)

 

(45

)

 

(39

)

 

(6

)

Increase in cash surrender value of life insurance

 

2,205

 

 

577

 

 

1,628

 

 

(270

)

 

1,898

 

Other income

 

1,338

 

 

286

 

 

1,052

 

 

(178

)

 

1,230

 

Total noninterest income

 

$

16,466

 

 

$

2,688

 

 

$

13,778

 

 

$

(3,443

)

 

$

17,221

 

 

2006 compared to 2005

Noninterest income increased $2.7 million to $16.5 million for 2006 compared to 2005. The increases in noninterest income categories result largely from increased service charges and fees for deposits, which are attributed to an increase in deposit volumes from our acquisitions, and increased fee income related to other services such as letters of credit and foreign exchange.

During 2006 we sold approximately $103 million in securities yielding 3.52% at a loss of approximately $2.3 million in an effort to reduce our reliance on borrowed funds and to improve net interest income. The proceeds from the sale were used to reduce overnight borrowings that were costing 5.35%. The loss on sale of securities of $45,000 in 2005 related to the write-off of the remaining balance of an interest-only strip initially recorded at the time of a loan sale.

Income from the cash surrender value of life insurance policies increased for 2006 when compared to 2005. This increase is due to additions to our life insurance policy investments due to our acquisition activity and the income from all of our life insurance policies. The income is recognized as an appreciation of the cash surrender value of life insurance policies. It is noncash income and not subject to income tax. The tax-equivalent yield for our life insurance policies was 5.92% during 2006 compared to 5.18% during 2005. Our crediting rate, or yield for our life insurance policies, changes quarterly and is determined by the performance of the underlying investments. In addition, the increase in the overall yield is due in part to the policies acquired in the Foothill acquisition.

40




Other income includes a $642,000 gain related to the recognition of a discount upon the pay-off of an acquired loan; there was no such item in 2005.

2005 compared to 2004

Noninterest income decreased $3.4 million to $13.8 million for 2005 compared to $17.2 million in 2004. This decrease results largely from lower service charges on deposit accounts which declined due to the effect increased market interest rates had on fee income on business accounts. Fees received for “not-sufficient-funds” also declined $470,000 as we worked to reduce our overdraft exposure in relation to certain customers.

Gain on sale of loans declined $1.2 million. The 2004 balance includes a gain of $975,000 on the sale of an acquired charged-off loan; there was no such item in 2005. The remaining gain on sale of loans resulted from the sale of $6.8 million of SBA loans in both 2005 and 2004.

Income from cash surrender value of life insurance policies declined for 2005 when compared to 2004 due to a decline in the tax-equivalent yield. The tax-equivalent yield for our life insurance policies was 5.18% during 2005 compared to 6.38% during 2004. The decline in the yield on our life insurance policies results mostly from a decline in the market performance on the securities portfolio underlying the life insurance policies.

Other income includes fees related to loan referral programs for SBA loans and single family mortgages totaling $480,000 for 2005 compared to $792,000 for 2004; these fees decreased mostly as a result of lower volumes in the single family mortgage program.

Noninterest Expense

The following table sets forth the details of noninterest expense for the years indicated. The columns titled “Increase (Decrease)” set forth the year-over-year changes between 2006 and 2005 and between 2005 and 2004.

 

 

For the Years Ended December 31,

 

 

 

2006

 

Increase
(Decrease)

 

2005

 

Increase
(Decrease)

 

2004

 

 

 

(Dollars in thousands)

 

Noninterest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation

 

$

65,505

 

 

$

16,882

 

 

$

48,623

 

 

$

3,403

 

 

$

45,220

 

Occupancy

 

15,296

 

 

4,563

 

 

10,733

 

 

275

 

 

10,458

 

Furniture and equipment

 

4,034

 

 

1,304

 

 

2,730

 

 

(193

)

 

2,923

 

Data processing

 

6,317

 

 

1,448

 

 

4,869

 

 

86

 

 

4,783

 

Other professional services

 

5,072

 

 

524

 

 

4,548

 

 

422

 

 

4,126

 

Business development

 

1,591

 

 

403

 

 

1,188

 

 

(63

)

 

1,251

 

Communications

 

3,103

 

 

1,110

 

 

1,993

 

 

(16

)

 

2,009

 

Insurance and assessments

 

2,121

 

 

406

 

 

1,715

 

 

68

 

 

1,647

 

Intangible asset amortization

 

6,688

 

 

3,081

 

 

3,607

 

 

354

 

 

3,253

 

Reorganization charges

 

1,822

 

 

1,822

 

 

 

 

 

 

 

Other

 

9,906

 

 

2,610

 

 

7,296

 

 

1,139

 

 

6,157

 

Total noninterest expense

 

$

121,455

 

 

$

34,153

 

 

$

87,302

 

 

$

5,475

 

 

$

81,827

 

Efficiency ratio