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Beverly Hills Bancorp 10-K 2008 Documents found in this filing:
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
(Mark One)
For the fiscal year ended December 31, 2007 or
For the transition period from to Commission file number 0-21845
Beverly Hills Bancorp Inc. (Exact name of registrant as specified in its charter)
(818) 223-8084 (Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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. x Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x At June 29, 2007 (the last business day of the registrant’s most recently completed second fiscal quarter), the registrant’s common stock held by non-affiliates had an aggregate market value of approximately $115,223,923 based on the closing price on that date of $7.83 per share and approximately 14,715,699 shares of common stock held by non-affiliates. As of February 29, 2008, 18,787,094 shares of common stock, par value $0.01 per share, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE None.
Table of ContentsBEVERLY HILLS BANCORP INC. AND SUBSIDIARIES FORM 10-K INDEX
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Table of ContentsFORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in such statements. All of the statements contained in this Annual Report on Form 10-K which are not identified as historical should be considered forward-looking. In connection with certain forward-looking statements contained in this Annual Report on Form 10-K and those that may be made in the future by or on behalf of the Company which are identified as forward-looking, the Company notes that there are various factors that could cause actual results to differ materially from those set forth in any such forward-looking statements. Such factors include, but are not limited to, the condition of the real estate market, interest rates, regulatory matters, the availability of pools of loans at acceptable prices, and the availability and conditions of financing for loan pool acquisitions and other financial assets. Accordingly, there can be no assurance that the forward-looking statements contained in this Annual Report on Form 10-K will be realized or that actual results will not be significantly higher or lower. Statements regarding policies and procedures are not intended, and should not be interpreted, to mean that such policies and procedures will not be amended, modified or repealed at any time in the future. The forward-looking statements have not been audited by, examined by or subjected to agreed-upon procedures by independent accountants, and no third party has independently verified or reviewed such statements. Readers of this Annual Report on Form 10-K should consider these facts in evaluating the information contained herein. The inclusion of the forward-looking statements contained in this Annual Report on Form 10-K should not be regarded as a representation by the Company or any other person that the forward-looking statements contained in this Annual Report on Form 10-K will be achieved. In light of the foregoing, readers of this Annual Report on Form 10-K are cautioned not to place undue reliance on the forward-looking statements contained herein.
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Table of ContentsITEM 1. Business General The Company Beverly Hills Bancorp Inc. (“BHBC”) is a financial holding company that conducts banking and lending operations in southern California and surrounding states primarily through its bank subsidiary, First Bank of Beverly Hills (“FBBH” or the “Bank”). The Bank is a California state-chartered commercial bank, and its primary regulator is the California Department of Financial Institutions (“DFI”). As an insured institution, the Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”). The Company was incorporated in 1996 and was known as Wilshire Financial Services Group Inc. (“WFSG”) until August 2004. References in this Form 10-K to the “Company,” “we” or “our” mean BHBC and its consolidated subsidiaries. The Company is principally a real estate lender focusing on permanent and construction loans for commercial and multifamily properties in California and other western states. In addition, the Company invests in AAA-rated and government-sponsored enterprise (“GSE”) mortgage-backed securities. The Company’s primary sources of funding are deposits and Federal Home Loan Bank (“FHLB”) advances. The administrative headquarters of BHBC and the Bank are located at 23901 Calabasas Road, Suite 1050, Calabasas, California 91302, and the main telephone number is (818) 223-8084. The Bank conducts its retail operations through its branch facility adjacent to the Company’s offices in Calabasas, California. As of December 31, 2007, the Company had 47 full-time-equivalent employees. We maintain an internet web site at www.bhbc.com and makes available our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other relevant information free of charge. Business Strategy We have adopted a “wholesale” banking strategy pursuant to which we originate assets and liabilities primarily through independent sources and maintain a low level of operating expenses with only one branch/office and a relatively low number of employees. We originate primarily adjustable rate construction and income property loans obtained from independent loan brokers, which generate higher yields and fees than single family residential loans and require lower operating costs and expenses than commercial and asset-based loans. Our assets are funded with deposits generated principally through brokers and our money desk (“wholesale deposits”), advances from the Federal Home Loan Bank of San Francisco (“FHLB advances”), repurchase agreements and other short-term borrowings. Our goal is to maximize net interest income and fee income consistent with acceptable levels of credit and interest rate risk. The objective of our present lending strategy is to provide real estate financing to a diversified customer base, representing developers, investors and owners/users. We believe we can maintain and expand our base of borrowers by providing rapid response and loan processing and tailoring our loans to meet the specific needs of our borrowers. In 2006, we expanded our product line to include construction lending for commercial and multifamily properties. Construction loans have higher margins than many other types of loans, generate fee income and create the potential for additional lending business upon completion of the construction. We originate adjustable rate loans in order to match to the extent possible the repricing periods of our liabilities. Adjustable rate loans represented 88% of our total loans at December 31, 2007. The interest rates on these loans are tied to the prime rate, LIBOR or the Constant-Maturity Treasury index and adjust with changes in the rate on a daily, monthly or quarterly basis, sometimes after an initial three to five year period at a fixed rate. At December 31, 2007, approximately 95% of our deposits were wholesale deposits. Wholesale deposit funding is a function of setting and advertising our deposit interest rates with trust departments and institutional
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Table of Contentsinvestment fund managers. We believe that although the interest rates on other borrowings and wholesale deposits may be greater than the interest rates on retail deposits of comparable maturities, the cost of generating and maintaining retail deposits is greater because of the facilities and personnel expense of those deposits. Due to uncertainty in the real estate and credit markets, we expect loan origination and purchase volumes to be substantially lower during 2008 than in prior years. We may also sell whole loans or loan participations to reduce certain real estate loan concentrations. At the same time, we anticipate the investment securities portfolio will represent a lower percentage of our total assets due to principal paydowns and fewer security purchases. In June 2007, we engaged an investment banking firm as its financial advisor to assist us in reviewing our strategic alternatives, including whether a sale of the Company would be in the best interest of the stockholders. We terminated the agreement with the investment banking firm in January 2008. Our Board of Directors continues to review the strategy and direction of the Company and our business strategy may change from time to time. Lending Activities Our lending activities involve primarily the origination and purchase of adjustable rate real estate loans. These loans include principally loans secured by commercial and multifamily properties and loans for the construction of these types of properties. Our borrowers are typically entities that operate their businesses at the properties or derive their primary source of income from their portfolio of real properties or the construction of these types of properties. We set the interest rate on any loan based on a number of factors including, but not limited to, servicing costs, risk and desirability of the credit and competitive conditions. Of our total loans outstanding, approximately 88% and 87% had adjustable rates (including loans with a fixed rate for the first three to five years which subsequently convert to adjustable rate) at December 31, 2007 and 2006, respectively. Our real estate loans are secured by real properties located throughout the United States, but primarily in California and other western states. At December 31, 2007, approximately $512 million principal amount of our real estate loans, or approximately 51% of our total portfolio, were secured by real properties in California. No more than 10% of the principal amount of our total loans was secured by real properties in any other state. We do not believe any of our residential loans have features that would cause them to be characterized as interest-only loans or loans with negative amortization and which, would give rise to any additional concentration of credit risk required to be disclosed by Financial Accounting Standards Board Statement of Position (“FSP SOP”) No. 94-6-1 “Terms of Loan Products that May Give Rise to a Concentration of Credit Risk”. Loan Policies and Procedures. We have detailed written policies and procedures for our lending activities. Our board of directors reviews and approves these policies annually. These lending policies address the types of loans we seek, our target markets, underwriting and collateral requirements, the loan terms, interest rate and yield considerations, and compliance with applicable laws and regulations. All loans are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness, including indebtedness as a guarantor. Our Officers’ Loan Committee oversees the loan approval process, including originations and purchases. The Officers’ Loan Committee reviews all loans and has loan approval authority of loan originations up to $2 million and participations and whole loan purchases up to $2 million as a pool. The Directors’ Loan Committee approves all individual loans over $2 million, up to and including $12 million, and participations and purchases over $2 million and up to and including $20 million as a pool. Loans in excess of these limits must be approved by our Board of Directors.
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Table of ContentsUnder applicable regulations, we may not make loans in excess of the regulatory legal lending limit under California law applicable to all California-chartered banks. In general, the legal limit for loans to any single borrower is equal to 25% of a bank’s unimpaired capital and surplus for amortizing loans secured by a first trust deed on real estate. As of December 31, 2007, our loan-to-one borrower limit for secured loans was approximately $35.4 million. We require a current appraisal in connection with the origination of all real estate loans. Commercial and Multifamily Lending. Our commercial and multifamily loans generally have terms of approximately 10 years and payments based on a 25- or 30-year amortization schedule, often resulting in a balloon payment at maturity. Our commercial loans are generally secured by office, retail and industrial types of properties, and our multifamily loans are secured by small- to medium –sized apartment buildings. The original principal amount of our commercial and multifamily loans ranges primarily from $2 million to $20 million. More than half of these loans had loan-to-value ratios of less than 65% of the appraised value of the property at the time of origination. These loans generally have fixed rates for the first three to five years which subsequently convert to adjustable rates. The adjustable rates are typically tied to LIBOR or the Constant-Maturity Treasury index, and adjust with changes in the rate on a daily, monthly or quarterly basis. These loans also include bridge loans secured by commercial real estate. The loans typically have terms of two to three years, and include an interest reserve, and tenant improvement or rehabilitation costs to reposition the property. Construction Lending. Our construction loans finance the construction of multifamily properties and commercial properties such as retail and industrial properties, office buildings and restaurants. Our construction loans generally have terms from one to three years and have adjustable interest rates tied to the prime rate that adjust when prime rate is changed. We do not typically originate a construction loan with a loan to value ratio in excess of 75% of the property’s estimated cost to complete as of the time of origination. We use independent due diligence/fund control specialists to perform all cost and completion analyses prior to loan funding. We also retain firms that specialize in construction loan fund control to perform all required site/progress inspections and necessary due diligence prior to loan funding, and all subsequent draw requests. Construction lending has been centered primarily in Southern California; however, we provided construction financing for a condominium development in the Tribeca area of New York, and we are a participant in two projects in Chicago, Illinois. Loans currently range from a minimum of $2 million to a maximum of $21.5 million, with an average loan size of approximately $10 million. Single-family Lending. We do not originate (or purchase) prime or sub-prime single-family mortgage loans. Our loan portfolio, however, does include fixed rate single-family mortgage loans that were purchased prior to 2002. Other Lending. Other loans include primarily “mezzanine” loans made through a non-bank subsidiary. Mezzanine loans are generally loans to single purpose entities to provide financing to purchase real estate, where the borrower needs additional “equity” to support the senior lender’s mortgage loan on the real estate. The mezzanine loan is secured by the all of the equity interests in the borrower, not the underlying real estate, and thus upon foreclosure we would acquire ownership of the entity, not the real estate. These loans have terms of one to three years, and typically bear interest at fixed or adjustable rates that are materially greater than the rates offered by us for loans secured by a first priority interest in comparable real estate, reflecting the greater risk inherent in the loans. Loan Purchases and Sales. We may from time to time purchase multifamily, commercial and construction loans or participation interests in these loans. Generally, we purchase pools of these loans, but we may occasionally purchase a single loan or a participation interest in a single loan from a financial institution. We underwrite all loans purchased (including participation interests) in accordance with our standard underwriting practices, including ratios for loan-to-value, debt service coverage, etc. We normally obtain the same information to evaluate the inherent risk in lending directly to the borrower that we would obtain in
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Table of Contentsoriginating a loan directly to the borrower. Before purchasing a participation interest in a loan, we will perform due diligence with regard to the lead lender to assess its financial capacity and overall stability. We will from time to time sell a participation interest in a loan if the total loan amount exceeds our loan to one borrower limitation or we want to mitigate our risk exposure on the loan. We retain the servicing on loans in which we sell participations. As a matter of policy, we do not subordinate our interest to the interest of the participants. We have not sold whole loans since 2004. The following table sets forth our total loan originations and purchases for the periods indicated: Loan Originations and Purchases
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Table of ContentsThe following table sets forth the composition of the Company’s portfolio of loans by type of loan as of the dates indicated. Composition of Loan Portfolio
The following table sets forth certain information at December 31, 2007 regarding the dollar amount of loans based on their contractual terms to maturity and includes scheduled payments but not potential prepayments, as well as the dollar amount of those loans which have fixed or adjustable interest rates. Loan balances have not been adjusted for unamortized discounts or premiums, deferred loan fees and the allowance for loan losses. Maturity of Loans
Scheduled contractual principal repayments do not reflect the actual maturities of mortgage loans because of prepayments and, in the case of conventional mortgage loans, due-on-sale clauses. The average life of mortgage loans, particularly fixed-rate loans, tends to increase when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when current mortgage loan rates are substantially lower than rates on existing mortgages.
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Table of ContentsMortgage-Backed and Investment Securities We invest in securities to earn positive net interest spread pending deployment into loans or other assets. The following table sets forth our holdings of mortgage-backed and other securities as of the dates indicated: Mortgage-Backed and Investment Securities
The amortized cost and fair value of our securities, by contractual maturity, are shown below as of December 31, 2007: Amortized Cost and Fair Value by Maturity
The following tables show the gross unrealized losses and fair value of our investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2007 and 2006: Unrealized Losses and Fair Values
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Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, we consider, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) our intent and ability to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. We have the ability and intent to hold the securities classified as held to maturity until they mature, at which time we expect to receive full value for the securities. Furthermore, as of December 31, 2007, we also had the ability and intent to hold the securities classified as available for sale for a period of time sufficient for a full recovery of cost. The unrealized losses are due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline. We do not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of December 31, 2007 and 2006, we believe the impairments detailed in the table above are temporary, and as a result, no impairment loss has been realized in our consolidated statements of operations. Funding Sources Our principal funding sources consist of deposits FHLB advances, short-term borrowings, repurchase agreements, and junior subordinated notes payable. The following table sets forth information relating to our deposits and borrowings at the dates indicated. Deposits and Other Borrowings
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Table of ContentsDeposits. We offer checking, NOW, money market and savings accounts and certificates of deposit generated through brokers and our money desk (“wholesale deposits”) and at our Calabasas branch. Our deposits generally are not collateralized, with the exception of $60.0 million of public fund certificates of deposit from the State of California, which are secured by mortgage-backed securities. The following table sets forth information relating to our deposits at the dates indicated. Composition of Deposits
The following table presents the sources of our deposits as of the dates indicated. Source of Deposits
Wholesale deposit funding is a function of setting and advertising our deposit interest rates with trust departments and institutional investment fund managers. The wholesale deposit marketplace (primarily certificates of deposit) consists of the following three sources of funds: (i) indirect deposits placed by independent brokers; (ii) direct wholesale deposits received from credit unions, savings associations, trust departments of banks, pension funds, insurance companies and government agencies; and (iii) Depository Trust Corporation brokered deposits, which consist of retail deposits which have been pooled into large blocks by Wall Street firms and regional brokerage houses. We use all of these sources, depending on our funding and liquidity needs.
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Table of ContentsUnder FDIC regulations, FDIC-insured institutions that are not “well-capitalized” under the prompt corrective action rules may not accept brokered deposits without the prior approval of the FDIC. In addition, we believe that if the Bank is not “well-adequately capitalized” it would have greater difficulty in obtaining certificates of deposit through our money desk or deposit brokers and may have to pay higher rates to continue to attract those deposits. Accordingly, the failure of the Bank to remain “well-capitalized” could have a material adverse effect on the Bank. We also obtain deposits through our retail branch in Calabasas, California. We compete for deposits to a large extent on the basis of rates and, therefore, could experience difficulties in attracting deposits if we could not continue to offer deposit rates at levels competitive with those of other banks and savings institutions. Accordingly, our retail deposit balances, primarily certificates of deposit, decreased during 2007 as other financial institutions offered deposit interest rates that we did not match as these rates were higher than the cost of our wholesale funding sources. The following table sets forth, by various interest rate categories, our certificates of deposit at December 31, 2007. Interest Rates for Certificates of Deposit
The following table sets forth the amount and maturities of our certificates of deposit at December 31, 2007. Maturities of Certificates of Deposit
At December 31, 2007, we had outstanding an aggregate of $583.3 million of certificates of deposit in face amounts equal to or greater than $100,000 maturing as follows: $293.5 million within three months, $207.9 million over three months through six months, $36.3 million over six months through 12 months, and $45.6 million thereafter. FHLB Advances. We obtain FHLB advances based on the security of certain of our assets, provided we have met certain standards related to our creditworthiness. FHLB advances are available to member financial institutions such as the Bank for investment and lending activities and other general business purposes. FHLB advances are made pursuant to several different credit programs (each of which has its own interest rate, which may be fixed or adjustable). We are currently authorized to obtain FHLB advances in amounts up to 45% of the Bank’s total assets measured as of each previous quarter-end and for terms of up to 10 years.
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Table of ContentsThe following table sets forth information related to our FHLB advances at and for the periods indicated: FHLB Advances
As of December 31, 2007, we had $251.0 million of FHLB advances maturing within one year, $150.0 million maturing between one and two years, $140.0 million maturing between two and three years, and $70.0 million maturing between three and four years. These advances are secured by mortgage-backed securities and loans. Short-Term Borrowings. We have a revolving line of credit with a financial institution. The credit agreement expired on November 30, 2007, and we did not have any outstanding borrowings at December 31, 2007. In January 2008, the credit agreement was amended with the borrowing line reduced from $20 million to $15 million. The revised line of credit bears interest at the 3-month LIBOR rate, plus 1.90%, and is due and payable in full on December 31, 2008. The maximum ratio of nonperforming loans to total gross loans was also increased to 3.50%. The credit is collateralized by 50% of the outstanding shares of the Bank’s common stock. We terminated the credit agreement in March 2008. Repurchase Agreements. We borrow funds under repurchase agreements that provide immediate liquidity and financing for purchases of investment securities and pools of loans. Our repurchase agreements generally have maturities up to three years. The following table sets forth certain information related to our repurchase agreements at and for the periods indicated: Repurchase Agreements
At December 31, 2007, all of our $40.0 million in repurchase agreements mature in 2008. Junior Subordinated Notes Payable. At December 31, 2007, we had outstanding $46.4 million in floating-rate junior subordinated notes payable to three wholly owned statutory business trusts. We issued the notes to the trusts in separate placements occurring in July 2002, May 2006 and December 2006. The trusts purchased the notes using the proceeds from private placements of trust preferred securities to unaffiliated third parties and from the issuance of common securities to BHBC.
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Table of ContentsThe following table presents a summary of our junior subordinated notes payable outstanding at the dates indicated: Junior Subordinated Notes Payable—Summary
In January 2008, we redeemed at par $10.3 million of the junior subordinated notes payable due in October 2032. The following table sets forth information related to our junior subordinated notes payable at and for the periods indicated: Junior Subordinated Notes Payable—Amounts and Rates
Asset Quality We are exposed to certain credit risks related to the value of the collateral that secures loans and the ability and willingness of borrowers to repay their loans. We closely monitor our loans and foreclosed real estate for potential problems on a periodic basis. Allowance for Loan Losses. We maintain an allowance for loan losses at a level believed adequate by management to absorb estimated losses inherent in the loan portfolios. The allowance is increased by provisions for loan losses charged against operations and recoveries of previously charged off loans, and is decreased by loan charge-offs. Loans are charged off when they are deemed to be uncollectible. Although we believe that we have established adequate allowances for loan losses as of December 31, 2007, the credit quality of our assets is affected by many factors beyond our control, including local and national economic conditions, and the possible existence of facts which are not known to us which adversely affect the likelihood of repayment of various loans in our loan portfolio and realization of the collateral upon a default. Accordingly, we can give no assurance that we will not sustain loan losses materially in excess of the allowance for loan losses. In addition, the FDIC and DFI, as an integral part of their examination process, periodically review our allowance for loan losses and could require additional provisions for loan losses. Material future additions to the allowance for loan losses may also be necessary due to increases in the size and changes in the composition of our loan portfolio. Increases in our provisions for loan losses would adversely affect our results of operations.
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Table of ContentsFor a complete discussion of our policies and procedures with respect to the allowance for loan losses, see “Critical Accounting Policies” in Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following table sets forth information with respect to our allowance for loan losses by category of loan at the dates indicated: Allocation of the Allowance for Loan Losses
Loan loss reserves for construction loans increased during 2007 due to specific reserves of $11.4 million for nonperforming construction loans as a result of a decrease in the fair market value of the collateral.
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Table of ContentsThe following table sets forth the activity in the allowance for loan losses during the periods indicated. Analysis of the Allowance for Loan Losses
Non-Performing Loans. It is our policy to place a loan on non-accrual status when it is over 90 days past due, or at any time when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When a loan is placed on non-accrual status, previously accrued but unpaid interest is reversed by a charge to interest income. The table below sets forth the delinquency status of our loans at the dates indicated. Loan Delinquency Experience
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Table of ContentsNonaccrual loans at December 31, 2007 were $29.9 million and increased primarily due to construction loans totaling $27.6 million. Two construction loans totaling $9.0 million were placed on nonaccrual status even though they were not delinquent 91 days or more. Loans delinquent from 31 to 60 days at December 31, 2007 included an $8.9 million construction loan and an $8.0 million participation interest in a commercial real estate loan. The $8.9 million construction loan was delinquent as it had matured and at December 31, 2007 we were negotiating an extension of the loan with the borrower. We subsequently extended the loan maturity date to June 30, 2008 and the loan is current as of March 15, 2008. The loan in which we held the participation interest was past due at December 31, 2007 as a result of a billing error in December 2007 by the lead bank. This loan was brought current by the borrower in 2008. Foreclosed Real Estate. We carry our holdings of foreclosed real estate at the lower of the net carrying value of the underlying loan or fair value less estimated costs to sell. Holding and maintenance costs related to properties are recorded as expenses in the period incurred. Declines in values of foreclosed real estate subsequent to acquisition are charged to income and recorded as a provision for losses. The following table sets forth the aggregate carrying value of our foreclosed real estate (by source of acquisition) at the dates indicated. Foreclosed Real Estate by Loan Type
Competition We compete for loans primarily with other commercial banks, mortgage companies, commercial finance companies, and savings institutions. Competition has also increased as out-of-state financial institutions have recently entered the California market. Many of our competitors have greater financial strength, marketing capability and name recognition than we do, and operate on a statewide or nationwide basis. Due to our wholesale funding strategy, we do not compete with other financial institutions for retail deposits. In order to attract wholesale deposits, primarily CDs, we have to offer interest rates comparable to those interest rates offered nationwide by other financial institutions. Supervision and Regulation Banking is a highly regulated industry. Congress and the states have enacted numerous laws that govern banks, bank holding companies and the financial services industry, and have created several largely autonomous regulatory agencies that have authority to examine and supervise banks and bank holding companies, and to adopt regulations furthering the purpose of the statutes. The primary goals of the regulatory agencies are to maintain a safe and sound banking system, to protect depositors and the FDIC insurance fund, and to facilitate the conduct of sound monetary policy. As a result, our financial condition and results of operation, and our
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Table of Contentsability to grow and engage in various business activities, can be affected not only by management decisions and general economic conditions, but the requirements of applicable federal and state laws, regulations and the policies of the various regulatory authorities. These laws, regulations and policies are often under review by Congress, state legislatures and federal and state regulatory agencies. Changes in laws, regulations and policies can materially increase in the cost of doing business, limit certain business activities or materially and adversely affect competition between banks and other financial intermediaries. While it can be predicted that changes will occur, what changes, when they will occur, and how they will impact us cannot be predicted. The following is not intended to be an exhaustive description of the statutes and regulations applicable to the business of BHBC or the Bank. The description of statutory and regulatory provisions is qualified in its entirety by reference to the particular statutory or regulatory provisions. Bank Holding Companies Bank holding companies are regulated under the Bank Holding Company Act (the “BHC Act”) and are supervised by the Federal Reserve Board (the “FRB”). Under the BHC Act, BHBC files reports of its operations and other information with the FRB, and the FRB conducts examinations of BHBC and the Bank. The BHC Act requires, among other things, the FRB’s prior approval whenever a bank holding company proposes to (i) acquire all or substantially all the assets of a bank; (ii) acquire direct or indirect ownership or control of more than 5% of the voting shares of a bank; (iii) merge or consolidate with another bank holding company; (iv) with certain exceptions, acquire more than 5% of the voting shares of any company that is not a bank; and (v) engage in any activities without the FRB’s prior approval other than managing or controlling banks and other subsidiaries authorized by the BHC Act, furnishing services to, or performing services for, its subsidiaries, or conducting a safe deposit business. The BHC Act authorizes the FRB to approve the ownership of shares in any company, the activities of which have been determined to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. Under the BHC Act and regulations adopted by the FRB, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or financing of services. The FRB may, among other things, issue cease-and-desist orders with respect to activities of bank holding companies and nonbanking subsidiaries that represent unsafe or unsound practices or violate a law, administrative order or written agreement with a federal banking regulator. The FRB can also assess civil money penalties against companies or individuals who violate the BHC Act or other federal laws or regulations, order termination of nonbanking activities by nonbanking subsidiaries of bank holding companies and order termination of ownership and control of a nonbanking subsidiary by a bank holding company. A bank holding company may become a “financial holding company” which may engage in a range of activities that are financial in nature, including insurance and securities underwriting, insurance sales, merchant banking, providing financial, investment, or economic advisory services, any activity that a bank holding company may engage in outside of the United States, and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to a financial activity, or complementary to a financial activity. The FRB is the primary regulator of financial holding companies. FDIC The Bank is subject to examination and regulation by the FDIC under the Federal Deposit Insurance Act (“FDIA”) because its deposit accounts are insured by the FDIC. The FDIC has adopted regulations which affect a broad range of the Bank’s activities, including, among other things, lending, appraisals, formation of subsidiaries, and obtaining deposits through brokers.
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Table of ContentsUnder FDIC regulations, each insured depository institution is assigned to one of the following three capital groups for insurance premium purposes: “well capitalized,” “adequately capitalized” and “undercapitalized.” These capital groups are defined in the same manner as the regulations establishing the prompt corrective action system of the FDIA, as discussed under “Capital Adequacy Requirements” below. These three groups are then divided into subgroups that are based on supervisory evaluations by the institution’s primary federal regulator, resulting in nine assessment classifications. Assessment rates for BIF-insured banks range from five to seven basis points of insured deposits for well-capitalized banks with minor supervisory concerns to 43 basis points of insured deposits for undercapitalized banks with substantial supervisory concerns. The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices which are not limited to cases of capital inadequacy, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation or order or any condition imposed in writing by the FDIC. In addition, FDIC regulations provide that any insured institution that falls below a 2% minimum leverage ratio (see below) will be subject to FDIC deposit insurance termination proceedings unless it has submitted, and is in compliance with, a capital plan with its primary federal regulator and the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process if the institution has no tangible capital. The FDIC is additionally authorized by statute to appoint itself as conservator or receiver of an insured depository institution (in addition to the powers of the institution’s primary federal regulatory authority) in cases, among others and upon compliance with certain procedures, of unsafe or unsound conditions or practices or willful violations of cease and desist orders. Capital Adequacy Requirements The FRB and the FDIC have adopted similar, but not identical, “risk-based” and “leverage” capital adequacy guidelines for bank holding companies and insured banks, respectively. Under the risk-based capital guidelines, different categories of assets are assigned different risk weights, ranging from zero percent for risk-free assets (e.g., cash) to 100% for higher-risk assets (e.g., commercial loans). These risk weights are multiplied by corresponding asset balances to determine a risk-adjusted asset base. Certain off-balance sheet items, such as standby letters of credit, are added to the risk-adjusted asset base. The minimum required ratio of total capital to risk-weighted assets for both bank holding companies and insured banks is presently 8%. At least half of the total capital is required to be “Tier 1 capital,” consisting principally of common stockholders’ equity, a limited amount of perpetual preferred stock, and minority interests in the equity. The remainder, designated “Tier 2 capital,” may consist of a limited amount of subordinated debt, certain hybrid capital instruments, the remaining portion of trust preferred securities and other debt securities, preferred stock and a limited amount of the general loan loss allowance. Our junior subordinated notes are considered regulatory capital for purposes of determining BHBC’s capital ratios. In December 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46R (“FIN 46R”), “Consolidation of Variable Interest Entities,” which required companies that have issued junior subordinated notes, such as ours, to deconsolidate the related entities and restate their balance sheets. However, the Board of Governors of the Federal Reserve System (“FRB”), BHBC’s banking regulator, continues to allow inclusion of junior subordinated notes in regulatory capital following the issuance of FIN 46R. The minimum Tier 1 leverage ratio, consisting of Tier 1 capital to average adjusted total assets, is 3% for bank holding companies and insured banks that have the highest regulatory examination rating and are not contemplating significant growth or expansion. All other bank holding companies and insured banks are expected to maintain a ratio of at least 1% to 2% or more above the stated minimum. Under the prompt corrective action provisions of the FDIA, the FDIC has adopted regulations establishing five capital categories for insured banks designated as well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. If any one or more of a bank’s ratios are below the
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Table of Contentsminimum ratios required to be classified as undercapitalized, it will be classified as significantly undercapitalized, and if its ratio of tangible equity to total assets is 2% or less, it will be classified as critically undercapitalized. A bank may be reclassified by the FDIC to the next level below that determined by the criteria described above if the FDIC finds that it is in an unsafe or unsound condition or if it has received a less-than-satisfactory rating for any of the categories of asset quality, management, earnings or liquidity in its most recent examination and the deficiency has not been corrected, except that a bank cannot be reclassified as critically undercapitalized for such reasons. The FDIC may subject undercapitalized banks to a broad range of restrictions and regulatory requirements. An undercapitalized bank may not pay management fees to any person having control of the institution, nor, except under certain circumstances and with prior regulatory approval, make any capital distribution if, after doing so, it would be undercapitalized. Significantly undercapitalized banks are subject to increased monitoring by the FDIC, are restricted in their asset growth, must obtain regulatory approval for certain corporate activities, such as acquisitions, new branches and new lines of business, and, in most cases, must submit to the FDIC a plan to bring their capital levels to the minimum required in order to be classified as adequately capitalized. The FDIC may not approve a capital restoration plan unless each company that controls the bank guarantees that the bank will comply with it. Significantly and critically undercapitalized banks are subject to additional mandatory and discretionary restrictions and, in the case of critically undercapitalized institutions, must be placed into conservatorship or receivership unless the FDIC agrees otherwise. Under FRB policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to commit resources to support each such bank. In addition, a bank holding company is required to guarantee that its subsidiary bank will comply with any capital restoration plan. The amount of such a guarantee is limited to the lesser of (i) 5% of the bank’s total assets at the time it became undercapitalized or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all applicable capital standards as of the time the bank fails to comply with the capital restoration plan. A holding company guarantee of a capital restoration plan results in a priority claim to the holding company’s assets ahead of its other unsecured creditors and shareholders that is enforceable even in the event of the holding company’s bankruptcy or the subsidiary bank’s insolvency. Capital Distributions BHBC may make capital distributions (dividends in cash or property, or repurchases of capital stock) subject to the California General Corporation Law and the policies, rules and regulations of the FRB. Under the California General Corporation Law, BHBC may not pay dividends in cash or property except (i) out of positive retained earnings or (ii) if, after giving effect to the distribution, BHBC’s assets would be at least 1.25 times its liabilities and its current assets would exceed its liabilities (determined on a consolidated basis under generally accepted accounting principles). The FRB has stated that, as a matter of prudent banking, a bank holding company generally should not pay cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends, and that the prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. The ability of BHBC to continue to pay dividends will depend upon its cash resources. BHBC’s principal source of liquidity consists of proceeds received from the sale of its former loan subsidiary in 2004. In addition, the Bank paid dividends to its parent company, Wilshire Acquisitions Corporation (“WAC”), in 2006 and 2007 of $11.4 million and $19.6 million, respectively. WAC paid dividends to its parent, WFC, Inc., in 2006 and 2007 of $11.4 million and $9.6 million, respectively. WFC, Inc. paid dividends to its parent, BHBC in 2006 and 2007 of $11.4 million and $9.6 million. As a California-chartered bank, without the approval of the California DFI, the Bank may pay dividends in an amount which does not exceed the lesser of its retained earnings or its net income for the last three fiscal years. Under regulations of the FDIC, the Bank may not make a capital distribution without prior approval of the FDIC if it would be undercapitalized, significantly undercapitalized or critically undercapitalized under the prompt corrective action rules.
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Table of ContentsCommunity Reinvestment Act Banks and bank holding companies are also subject to the Community Reinvestment Act of 1977, as amended (the “CRA”). The CRA requires the Bank to ascertain and meet the credit needs of the communities it serves, including low and moderate income neighborhoods. The Bank’s compliance with CRA is reviewed and evaluated by the FDIC, which assigns the Bank a publicly available CRA rating at the conclusion of the examination. Further, an assessment of CRA compliance is also required in connection with applications for FDIC approval of certain activities, including establishing or relocating a branch office that accepts deposits or merging or consolidating with, or acquiring the assets or assuming the liabilities of, a federally regulated financial institution. An unfavorable rating may be the basis for FDIC denial of such an application, or approval may be conditioned upon improvement of the applicant’s CRA record. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the FRB will assess the CRA record of each subsidiary bank of the applicant, and such records may be the basis for denying the application. CRA regulations emphasize measurements of performance in the area of lending (specifically, a bank’s home mortgage, small business, small farm and community development loans), investment (a bank’s community development investments) and service (a bank’s community development services and the availability of its retail banking services), although examiners are still given a degree of flexibility in taking into account unique characteristics and needs of a bank’s community and its capacity and constraints in meeting such needs. The regulations also require certain levels of collection and reporting of data regarding certain kinds of loans. In the most recently completed CRA compliance examination conducted in October 2007, the Bank received a rating of “Substantial Noncompliance.” Due to the recent examination, the Bank was required to develop and submit a CRA Plan to the FDIC by March 2008 to address the performance deficiencies. The CRA Plan was submitted in March 2008. The Bank is also required to submit quarterly reports to the FDIC detailing the Bank’s progress in improving its CRA performance. To adequately address these issues, the Bank has hired a full-time CRA Officer. USA PATRIOT Act and Anti-Money Laundering Compliance The USA PATRIOT Act of 2001 and its implementing regulations significantly expanded the anti-money laundering and financial transparency laws, including the Bank Secrecy Act. The Bank has adopted comprehensive policies and procedures to address the requirements of the USA PATRIOT Act. Material deficiencies in anti-money laundering compliance can result in public enforcement actions by the banking agencies, including the imposition of civil money penalties and supervisory restrictions on growth and expansion. Such enforcement actions could also have serious reputation consequences for the Company and the Bank. The Sarbanes-Oxley Act The Company is subject to the accounting oversight and corporate governance requirements of the Sarbanes-Oxley Act of 2002. This act requires executive certification of financial presentations and increased the requirements for board audit committees and their members. The Company has also had to enhance its disclosure of controls and procedures and internal control over financial reporting. California Banking Law The Bank, as a California-chartered bank, is subject to examination, supervision and regulation by the DFI under the California Banking Law. These laws and regulations affect many aspects of the Bank’s operations, including investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, issuances of securities and other corporate governance provisions.
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Table of ContentsITEM 1A. Risk Factors We are subject to a number of business risks that may adversely impact our financial position or results of operations. These risks could make our common stock a speculative investment. We believe that the following factors represent the most significant risks to our future financial performance. We face risk from changes in interest rates. The success of our business depends, to a large extent, on our net interest income. Changes in market interest rates can affect our net interest income by affecting the spread between our interest-earning assets and interest-bearing liabilities. This may be due to the different maturities of our interest-earning assets and interest-bearing liabilities, as well as an increase in the general level of interest rates. Changes in market interest rates also affect, among other things:
Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. We face risk from possible declines in the quality of our assets. Our financial condition depends significantly on the quality of our assets. If the level of our non-performing assets rises, our results of operations and financial condition will be affected. A borrower’s ability to pay its loan in accordance with its terms can be adversely affected by a number of factors, such as a decrease in the borrower’s revenues and cash flows due to adverse changes in economic conditions or a decline in the demand for the borrower’s products and/or services. Our allowances for loan losses may be inadequate. We establish allowances for loan losses against each segment of our loan portfolio. At December 31, 2007, our allowance for loan losses equaled 2.2% of our total loans. Although we believe that we have established adequate allowances for loan losses as of December 31, 2007, the credit quality of our assets is affected by many factors beyond our control, including local and national economic conditions, and the possible existence of facts which are not known to us which adversely affect the likelihood of repayment of various loans in our loan portfolio and realization of the collateral upon a default. Accordingly, we can give no assurance that we will not sustain loan losses materially in excess of the allowance for loan losses. In addition, the FDIC and DFI, as an integral part of their examination processes, periodically review our allowance for loan losses and could require additional provisions for loan losses. Material future additions to the allowance for loan losses may also be necessary due to increases in the size and changes in the composition of our loan portfolio. Increases in our provisions for loan losses would adversely affect our financial condition and results of operations. Economic conditions may decline. Our business is strongly influenced by economic conditions in our market area (principally Southern California) as well as regional and national economic conditions. Should the economic condition in these areas
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Table of Contentsdeteriorate, the financial condition of our borrowers could weaken, which could lead to higher levels of loan defaults or a decline in the value of collateral for our loans. In addition, an unfavorable economy could reduce the demand for our loans and other products and services. We have a significant concentration of loans in California. At December 31, 2007, approximately 51% unpaid principal balance of our loans were collateralized by real estate located in California, and no more than 10% of our loans were collateralized in any other state. Because of this concentration, our financial position and results of operations have been and are expected to continue to be influenced by general trends in the California economy and its real estate market. Real estate market declines may adversely affect the values of the properties collateralizing loans. If the principal balances of our loans, together with any primary financing on the mortgaged properties, equal or exceed the value of the mortgaged properties, we could incur higher losses on sales of properties collateralizing foreclosed loans. In addition, California historically has been vulnerable to certain natural disaster risks, such as earthquakes and erosion-caused mudslides, which are not typically covered by the standard hazard insurance policies maintained by borrowers. An increasing portion of our loan portfolio consists of construction loans to developers for properties for resale to unidentified buyers. At December 31, 2007, we had outstanding construction loans to developers for multi-family and commercial properties for sale (or lease) totaling $153.2 million, representing 15.3% of our loan portfolio, and additional commitments for these projects in the amount of $100.6 million. These types of loans generally have greater risks than loans on completed residential and commercial properties. A construction loan generally does not cover the full amount of the construction costs; however, the borrower’s equity is required at loan closing. Risks include price increases, delays and unanticipated difficulties that may materially increase these costs, which are typically borne by the borrower. Further, even if completed, there is no assurance that the borrower will be able to sell the project on a timely or profitable basis, as these are closely related to real estate market conditions, which can fluctuate substantially between the start and completion of the project. If the borrower defaults prior to completion of the project, the value of the project will likely be less than the outstanding loan, and we could be required to complete construction with our own funds to minimize losses on the project. Recent negative developments in the financial industry and U.S. and global credit markets may impact our operations and results. Negative developments in the latter half of 2007 in the subprime mortgage market and the securitization markets for such loans have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing in 2008. Commercial, as well as consumer, loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Bank and bank holding company stock prices have been negatively affected as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years. As a result, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders. Liquidity risk could impair our ability to fund operations and jeopardize our financial condition. Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in
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Table of Contentsamounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact the Company’s access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole as the recent turmoil faced by banking organizations in the domestic and worldwide credit markets deteriorates. Managing reputational risk is important to attracting and maintaining customers, investors and employees. Threats to our reputation can come from many sources, including unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable or fraudulent activities of our customers. We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation. Our business is highly competitive. There is intense competition in Southern California and elsewhere in the United States for banking customers. We compete for loans primarily with other commercial banks, mortgage companies, commercial finance companies and savings institutions. In recent years, out-of-state financial institutions have entered the California market, which has also increased competition. Many of our competitors have greater financial strength, marketing capability and name recognition than we do, and operate on a statewide or nationwide basis. In addition, recent developments in technology and mass marketing have permitted larger companies to market loans more aggressively to our small business customers. Such advantages may give our competitors opportunities to realize greater efficiencies and economies of scale than we can. We can provide no assurance that we will be able to compete effectively against our competition. Our business is heavily regulated. Both BHBC, as a bank holding company, and the Bank, as a California-chartered FDIC-insured bank, are subject to significant governmental supervision, regulation and legislation, which are intended primarily to maintain a safe and sound banking system, to protect depositors and the FDIC insurance fund, and to facilitate the conduct of sound monetary policy, and are not intended to protect bank and bank holding company shareholders. Statutes, regulations and regulatory policies affecting us may be changed at any time, and the interpretation of these statutes and regulations by examining authorities also may change. We cannot provide assurance that future changes in applicable statutes, regulations, legislation and policies or in their interpretation will not materially adversely affect our business. We may not be able to fully utilize our deferred tax assets. At December 31, 2007, we had net deferred tax assets totaling $28.3 million. This amount includes $25.7 million in anticipated tax savings that would result from the future usage of $75.5 million in available federal net operating loss (NOL) carryforwards. However, the maximum amount of NOL carryforward we may utilize in any year is limited to $6.0 million, as a result of our “ownership change” within the meaning of Section 382 of the Internal Revenue Code in 2002. Therefore, to fully utilize this NOL, we must earn an average of at least $6.0 million in taxable income per year through the year ended December 31, 2020, at which date the NOL carryforward will expire. There can be no assurance that we will generate sufficient taxable income in the next 13 years to enable us to utilize all of our available NOL. If at any time it appears more likely than not that we will not be able to realize this deferred tax asset, we would be required to increase the valuation allowance against the
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Table of Contentsasset and record a corresponding charge to current earnings. This would have an adverse effect on our financial condition and results of operations. ITEM 1B. Unresolved Staff Comments None. ITEM 2. Properties The headquarters of BHBC and the Bank are located in Calabasas, California, where we lease approximately 16,500 square feet of office space pursuant to a lease agreement expiring in August 2014. This space includes our branch facility which opened in March 2005. We believe that our facilities are suitable and adequate for its present business purposes and for the foreseeable future. ITEM 3. Legal Proceedings The Company was involved in litigation with its former loan servicing subsidiary, Wilshire Credit Corporation (“WCC”), and WCC’s parent, Merrill Lynch Mortgage Capital Inc. (“Merrill Lynch”), which purchased WCC from the Company in April 2004. Beginning in June 2005, WCC demanded that the Company reimburse WCC for certain costs purportedly incurred by WCC in connection with WCC’s performance under one of its loan servicing contracts. The Company disagreed that it was liable for such costs. To resolve this dispute, in July 2005, the Company filed a complaint for declaratory relief against WCC and Merrill Lynch. The complaint sought, among other things, a declaration that the Company had no obligation to reimburse WCC for those costs, and that if such an obligation was found to exist, it was for a substantially lesser amount than that claimed by WCC. In September 2005, Merrill Lynch filed a cross-complaint against the Company alleging breach of contract. Merrill Lynch claimed that WCC had incurred and would continue to incur costs totaling approximately $3.7 million. In January 2008, a jury found that the Company had no liability to WCC and Merrill Lynch relating to the claims being litigated. The Company has contractually agreed to indemnify Merrill Lynch for claims asserted against WCC by third parties arising out of acts taken by WCC prior to its sale on April 30, 2004. The indemnity is for settlements of judgments paid and for defense costs, and is for amounts which, in the aggregate, exceed $2.0 million. Merrill Lynch has notified the Company of a number of claims that have been or are being asserted against WCC, and for which Merrill Lynch is seeking indemnity from the Company. As of December 31, 2007, the total payments and defense costs of such claims which Merrill Lynch has formally tendered to the Company were approximately $1.5 million. Although the Company expects that Merrill Lynch will demand indemnity for additional costs and expenses, it is probable that the total claims for which Merrill Lynch asserts the Company is responsible will surpass the $2.0 million threshold and this potential liability has been accrued for by the Company. The Company is a defendant in other legal actions arising from transactions conducted in the ordinary course of business. Some of these claims involve individual borrowers demanding material amounts for alleged damages. Management, after consultation with legal counsel, and based on prior experience with similar litigation, believes the ultimate liability, if any, arising from such actions will not materially affect the Company’s consolidated results of operations, financial position or cash flows. ITEM 4. Submission of Matters to a Vote of Security Holders Not applicable.
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Table of ContentsITEM 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities BHBC’s Common Stock trades under the symbol “BHBC” and is traded on the Nasdaq Global Select Market. At February 15, 2008, there were 70 holders of record of our Common Stock. The following table sets forth the range of high and low sales prices of the Common Stock and the cash dividends declared per share for the periods indicated:
BHBC has paid regular quarterly dividends of $0.125 per share, or $0.50 annually, since the second quarter of 2004. BHBC will not pay a quarterly dividend in the first quarter of 2008. Although the payment of future dividends will be evaluated and determined on a quarterly basis, dividend payments are not currently contemplated for 2008. As discussed earlier, BHBC’s ability to pay dividends is subject to regulation by California General Corporation Law and the FRB.
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Table of ContentsPERFORMANCE GRAPH The following graph shows the stockholder return on the Company’s common stock based on the market price of the common stock assuming the reinvestment of dividends, with the cumulative total returns for the S&P 500 and a peer group of other banks in California. This graph is historical only and may not be indicative of possible future performance of the common stock.
Source : SNL Financial LC, Charlottesville, VA, (434) 977-1600, www.snl.com
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Table of ContentsITEM 6. Selected Financial Data The following tables present selected financial information for the Company at the dates and for the periods indicated. The historical statements of operations and financial condition data for the five years presented have been derived from the audited consolidated financial statements of the Company. The financial data related to WCC in the Statements of Operations are presented separately under the caption “Discontinued operations.”
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Table of ContentsITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements of Beverly Hills Bancorp Inc. (“BHBC”) and the notes thereto included elsewhere in this filing. References in this filing to the “Company,” “we,” “our,” and “us” refer to Beverly Hills Bancorp Inc. and its consolidated subsidiaries, unless the context indicates otherwise. OVERVIEW Beverly Hills Bancorp Inc. is a financial holding company that conducts primarily banking and lending operations in southern California and surrounding states through its bank subsidiary, First Bank of Beverly Hills (the “Bank” or “FBBH”). Our business strategy is focused on the growth and profitability of the Bank through (1) originations and purchases of income property and construction loans and (2) investments in primarily AAA-rated and government-sponsored enterprise (“GSE”) mortgage-backed securities. The Bank is a California state chartered commercial bank, and its primary regulator is the California Department of Financial Institutions (“DFI”). As an insured institution, the Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”). Our net income for the year ended December 31, 2007 was $0.5 million, or $0.03 per diluted share, compared with $14.8 million, or $0.72 per diluted share, for the year ended December 31, 2006. The pre-tax earnings for 2007 were $24.9 million below the 2006 per-tax earnings due to a $13.4 million increase in the provision for loan losses, a $2.2 million reduction in net interest income and a goodwill impairment charge in 2007 of $3.1 million. The year 2007 results also reflect a $0.7 million increase in other operating income and a $1.6 million decrease in other operating expenses. The results for 2006 included a pre-tax gain of $8.5 million on the sale of our Beverly Hills branch. Our stockholders’ equity decreased by $7.3 million for the year ended December 31, 2007 to $148.1 million, or $7.87 book value per diluted share. This decrease was due to declared cash dividends of $9.4 million, which were offset by net earnings of $0.5 million, net after-tax unrealized gains of $1.1 million on the portfolio of available-for-sale securities, a $0.3 million increase in paid-in capital representing stock-based compensation expense, and a $0.2 million increase in paid-in-capital relating to exercise of stock options. The U.S. and global financial markets have experienced significant disruptions in recent months, due largely to a downturn in the housing market. Interest rates on many subprime mortgage loans have reset, causing borrowers to delay payments or default on their loans. The significant increase in foreclosure activity and rising interest rates during the first half of 2007 depressed housing prices further as problems in the subprime markets spread to the near-prime and prime mortgage markets. The recent housing market crisis has also forced many institutions that held large amounts of financial hybrid paper to liquidate their assets and were forced to sell them at liquidation discounts. This has created extremely unfavorable market conditions that have resulted in greater volatility, less liquidity, widening credit spreads, and has pulled back many investors from purchasing mortgage-backed securities. In light of these unprecedented challenges faced by the financial services industry, we want to reinforce that the Bank does not originate or have subprime residential mortgage loans nor does the Company hold investments backed by subprime residential mortgage loans in its available-for-sale portfolio. We have been monitoring and will continue to vigilantly monitor our loan portfolio on a loan-by-loan basis. Overall, we believe our loan portfolio is sound. We further believe that the principal and interest related to our investment portfolio are collectible in the future and that we have the financial resources and the intent to hold investment securities with unrealized losses until their market values recover to cost. CRITICAL ACCOUNTING POLICIES AND ESTIMATES This “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as disclosures included elsewhere in this Form 10-K, are based upon our consolidated financial statements, which
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Table of Contentshave been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingencies. On an ongoing basis, we evaluate the estimates used, including, but not limited to, those related to allowances for loan losses, other than temporary impairment in the market values of investment securities, the realizability of deferred tax assets, and contingencies. We base our estimates on historical experience, current conditions and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources as well as identifying and assessing our accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies involve the more significant judgments and estimates used in the preparation of the consolidated financial statements: Mortgage-Backed and Other Investment Securities Available for Sale. The Company’s mortgage-backed and other investment securities available for sale are reported at their current fair market value. The fair values of the Company’s investment securities are generally determined by quoted market prices obtained from independent external brokers or independent external pricing service providers who have experience in valuing these securities. In obtaining such valuation information from third parties, the Company has evaluated the methodologies used to develop the resulting fair values. The Company evaluates the market prices for reasonableness by comparing the market prices with prices from another independent pricing service provider. If the change in market value is considered temporary, the unrealized holding gains and losses are reported net of tax, when applicable, as a separate component of accumulated other comprehensive income in stockholders’ equity. In the event of a decline in market value, management must evaluate whether the decline is temporary in nature or other than temporary. In making this evaluation, management must consider certain factors, including (a) whether we have the ability and intent to hold the investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment, and (b) whether evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. Declines that are considered other than temporary are reflected as “Market valuation losses and impairments” in the consolidated statements of operations. Our portfolio of mortgage-backed and other investment securities available for sale represented more than 27% of our total assets as of December 31, 2007. Consequently, fluctuations in the securities’ values can have a significant impact on our financial condition and results of operations. Allowance for Loan Losses. We maintain an allowance for loan losses at a level we believe is adequate to absorb estimated losses inherent in the loan portfolios. The allowance is increased by provisions for loan losses charged against operations, recoveries of previously charged off loans, and allocations of discounts on purchased loans, and is decreased by loan charge-offs. Loans are charged off when they are deemed to be uncollectible. We use our internal asset review system to evaluate its loan portfolio and to classify loans as pass, special mention, substandard, substandard well-secured, doubtful or loss. These terms correspond to varying degrees of risk that the loans will not be collected in part or in full. The frequency at which a specific loan is subjected to internal asset review depends on the type and size of the loan and the presence or absence of other risk factors, such as delinquency and changes in collateral values. The allowance for loan losses consists of general valuation allowances (“GVAs”), which are derived from our loss migration factors and other qualitative factors. Specific valuation allowances (“SVAs”) are established for impaired loans, and are equal to the excess of the unpaid principal balance over the fair value of the collateral for each impaired loan. GVAs are based on loss migration factors that are updated each quarter. GVAs, however, consist primarily of qualitative adjustments which we evaluate after consideration of certain credit risk characteristics. These risk characteristics include, but are not limited to, the following: our historical and recent loss experience in its
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Table of Contentsportfolios; the volume, severity and trend of non-performing assets; the extent to which refinances or loan modifications are made to maintain loans in a current status; known deterioration in credit concentrations or certain classes of loans; loan to value ratios of real estate-secured loans; risks associated with specific types of collateral; the quality and effectiveness of the lending policy, loan purchase policy, internal asset review policy, charge-off, collection and recovery policies; current and anticipated conditions in the general and local economies which might affect the collectability of our asset; anticipated changes in the composition or volume of the loan portfolio; and reasonableness standards in accordance with regulatory agency policies. The evaluation of the inherent loss with respect to these risk characteristics is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio components. Apart from the qualitative adjustment, management currently maintains a risk-modeling reserve in the range of 3% to 6% of the total estimated allowance for loan losses, due to the inherent risk associated with the imprecision in estimating the allowance. To assess the adequacy of our allowance for loan losses, the portfolio is segmented into three components: impaired loans, homogeneous loans, and non-homogeneous loans.
When we increase the allowance for loan losses, we record a corresponding increase to the provision for loan losses in the statement of operations. The DFI and FDIC, as part of their examination process, periodically review our allowance for losses and the carrying values of our assets. There can be no assurance that the DFI or FDIC will not require additional reserves following future examinations. Income Taxes. At December 31, 2007 we had a total gross deferred tax asset of $36.2 million. This asset represents the tax effect of future deductible or taxable amounts and is attributable to net operating loss carryforwards and also to temporary differences between amounts that have been recognized in the financial statements and amounts that have been recognized in our income tax returns. In accounting for the deferred tax assets, we apply SFAS No. 109, Accounting for Income Taxes, which requires, among other things, that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. As of December 31, 2007, we evaluated the positive and negative evidence regarding the future realization of the deferred tax assets. Pursuant to this evaluation, we concluded that the available objective positive evidence regarding our ability to generate future federal taxable income substantially outweighed the available objective negative evidence regarding future federal taxable income. We also concluded that the objective negative evidence regarding the ability to generate certain future state taxable income outweighed the available objective positive evidence regarding certain future state taxable income, due primarily to the curtailment of our operations in the state of Oregon following the sale of WCC. As a result, we believe it is more likely than not that a substantial amount of our deferred tax asset will be realized in future years. Consequently, we believe that as of
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Table of ContentsDecember 31, 2007, that the only valuation allowance required is approximately $7.9 million related to net operating loss carryforwards in Oregon and certain other states. As portions of the deferred tax asset are realized and the valuation allowance is reduced, the related benefits, to the extent they related to our post-reorganizational period, are recorded as a deferred tax benefit in our consolidated statements of operations. As benefits relating to our pre-reorganizational period are realized, they are recorded as a direct increase to stockholders’ equity. The net deferred tax asset of $28.3 million is reported as an asset in our consolidated statement of financial condition as of December 31, 2007. However, there can be no assurance that the amount, if any, that we ultimately realize will not differ materially from our assessment. We adopted the provisions of FIN No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), on January 1, 2007. FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. Pursuant to FIN 48, we examine our financial statements, income tax provision, and federal and state income tax returns and analyze our tax positions, including permanent and temporary differences, as well as the major components of income and expense to determine whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. There was no effect on the financial statements upon adoption of FIN 48. We did not have any unrecognized tax benefits as a result of uncertainty at or during the year ended December 31, 2007. It is our policy to record any penalties or interest arising from the application of federal or state income taxes as other expense. There were no penalties or interest paid during the year ended December 31, 2007. Newly Issued Accounting Standards. For a discussion of new accounting pronouncements and their expected impact on the Company’s consolidated financial statements, refer to Note 1—“Recent Accounting Pronouncements” in the accompanying Notes to the Consolidated Financial Statements included elsewhere in this report.
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Table of ContentsRESULTS OF OPERATIONS—2007 COMPARED TO 2006 Interest Income A significant portion of our consolidated earnings arises from net interest income, which is the difference between interest income earned and interest expense incurred. Net interest income is affected by the relative amount of interest-earning assets and interest-bearing liabilities and the degree of mismatch in the maturity and repricing characteristics of interest-earning assets and interest-bearing liabilities. The following table sets forth, for the periods indicated, information regarding the total amount of our income from interest-earning assets and the resulting average yields, the interest expense associated with interest-bearing liabilities, expressed in dollars and rates, and the net interest spread and net interest margin. (The interest income and expense amounts in the table below are consolidated, but reflect primarily the results of our banking operations.) Information is based on monthly balances during the indicated periods. Interest-Earning Assets and Interest-Bearing Liabilities
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Table of ContentsThe following table describes the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected our interest income and expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior rate), (ii) changes in rate (change in rate multiplied by prior volume) and (iii) total change in rate and volume. Changes attributable to both volume and rate have been allocated proportionately to the change due to volume and the change due to rate. Changes in Net Interest Income
Our net interest income was $30.8 million for 2007, compared with $33.0 million for 2006. This decrease was due to a decline in our net interest margin, as average interest earning assets in 2007 were approximately $146.6 million above the average interest earning assets in 2006. Our net interest margin was 2.01% for 2007, compared with 2.38% for 2006. The 37 basis point decline in the margin was primarily the result of the increase in market interest rates during 2006 and the first half of 2007. Our balance sheet is structured such that our interest bearing liabilities reprice more frequently than our interest earning assets. This liability-sensitive balance sheet generally results in a declining net interest margin as interest rates rise. Our weighted average cost of interest bearing liabilities increased by 75 basis points to 5.10% for the year ended December 31, 2007, compared with 4.35% for the year ended December 31, 2006. This increase in the cost of funds compares with a 36 basis point increase in our interest-earning assets yield from 6.47% for 2006 to 6.73% for 2007. Our cost of funds also increased in 2007 as we became more dependent on wholesale deposits and FHLB advances than retail deposits. During 2007, the maturity terms of our FHLB advances and brokered CDs were generally less than one year. We expect the margin compression to be lessened as market interest rates declined in the fourth quarter of 2007 and into 2008. Interest income on mortgage-backed securities was $23.2 million for 2007, compared with $18.5 million for 2006. The increase in 2007 reflects both an increase in yields and a higher average earning-asset balance.
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Table of ContentsAlthough the balance of our mortgage-backed securities at the end of 2007 was lower than the prior year-end, the average balance for 2007 was $70.2 million above the 2006 average balance. The higher average balance in 2007 was due to security purchases of $197.6 million in 2006. The average yield on mortgage-backed securities increased 29 basis points from 4.94% for 2006 to 5.23% for 2007. The higher average yield resulted from the 2006 security purchases occurring in a rising interest rate environment. The higher interest rate environment also reduced the premium amortization as the expected lives of the securities were extended. Interest income on loans was $78.2 million for 2007, compared with $67.5 million for 2006. This increase was due primarily to a 44-basis point increase in the weighted-average yield on our loans and an $86.1 million increase in average loan balances from 2006 to 2007. The increase in the average balances was due to substantial loan originations and purchases in the fourth quarter of 2006 which did not fully affect the yearly average loan balances until 2007. The average loan yield increased during 2007 as market interest rates increased, and loans with initial fixed rates for three or five years reached the initial rate reset date and converted to fully adjustable loans. The yield was also enhanced by the increase in construction and land loans which generally have higher margins and loans fees than permanent commercial real estate and multifamily mortgage loans. Interest expense on deposits was $38.6 million for 2007, compared with $31.7 million for 2006. This increase was due to both a 69-basis point increase in the average cost of our interest-bearing deposits and a $39.3 million increase in the average balance of interest-bearing deposits during the year. The higher average cost of funds in 2007 was mainly due to an increase in market interest rates, which raised our cost of deposits as we increased our reliance on wholesale deposits in the fourth quarter of 2006 after the sale of the Beverly Hills branch. We began utilizing FHLB advances as our primary funding source during 2007 due to its lower funding cost as compared with brokered CDs. The proportion of CDs to total interest-bearing deposits increased to an average of 98.7% for 2007, compared with an average of 92.1% for 2006. Interest expense on repurchase agreements and FHLB advances totaled $29.2 million for 2007, compared with $20.6 million for 2006. This increase was due to a higher market interest rates and an increased utilization of FHLB advances during 2007. Due to the increase in market interest rates during 2006 and the first half of 2007, the cost of our repurchase agreements increased by 128 basis points, from 3.53% in 2006 to 4.81% in 2007, and the cost of our FHLB advances increased by 76 basis points, from 3.96% to 4.72% over the same periods. Average FHLB advances increased by $95.4 million from 2006 to 2007, as FHLB advances were the primary funding source in 2007 due to their lower cost relative to brokered CDs. The average balance of repurchase agreements declined by $3.5 million from 2006 to 2007 as we effected no repurchase agreement transactions during 2007. Interest expense on our junior subordinated notes payable was $4.0 million 2007, compared with $2.8 million for 2006. This increase in interest expense was primarily due to a $12.7 million increase in average borrowing balances during 2007. The average balance was higher in 2007 due to a $20.6 million note issued in May 2006 and a $5.2 million note issued in December 2006. Although the 3-month LIBOR rate declined in the fourth quarter of 2007, the average cost of the junior subordinated notes payable in 2007 was 41 basis points higher than the average cost for the prior year as the 3-month LIBOR rate increased throughout 2006. Provision for Loan Losses Provision for losses on loans is charged to operations to maintain an allowance for losses on the loan portfolio at a level that we believe is adequate based on an evaluation of the inherent risks in the portfolio. Our evaluation is based on an analysis of the loan portfolio, historical loss experience, credit concentrations, current economic conditions and trends, the effects of interest rate changes on collateral values, and other relevant factors. Specific reserves are established for impaired loans when the fair value of the collateral for each impaired loan is less than the unpaid principal balance of the loan. We currently intend to maintain an unallocated allowance in the range of 3% to 6% of the estimated allowance for loan losses, excluding specific reserves, due to the inherent risk associated with the imprecision in estimating the allowance.
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Table of ContentsWe recorded a provision for loan losses of $14.4 million for 2007, compared with a provision for loan losses of $957,000 for 2006. The increase in the provision primarily reflects specific reserves totaling $11.4 million for nonperforming construction loans due to a decrease in the fair market value of the collateral. Other Income Our other income was $2.3 million for 2007, compared with $10.0 million for 2006. Other income for 2006 included an $8.5 million pre-tax gain on the sale of our Beverly Hills branch. FHLB stock dividend income increased $220,000 to $1.6 million as we increased our holdings of FHLB stock. Stock in the FHLB at December 31, 2007 and 2006 was $31.9 million and $29.0 million, respectively. Other income for 2007 also included $400,000 pursuant to a settlement agreement with a former officer. Other Expenses Compensation and employee benefits expense totaled $7.2 million for 2007, compared with $7.1 million for 2006. This increase was due primarily to stay bonus expense of $803,000 in 2007. In June 2007, the Company approved stay bonus agreements totaling $2.1 million for certain executive officers and employees. These employees are entitled to receive the stay bonus payment if they are employees either 60 days after a change in control (as defined in the agreement) or on December 31, 2008. Accordingly, the stay bonus payments are being accrued on a straight-line basis to December 2008. Our legal expenses declined by $1.0 million from 2006 to $581,000 for 2007. In 2006, we incurred significant litigation-related costs in connection with our disputes with a former officer of the Company, and our former loan servicing subsidiary, Wilshire Credit Corporation, and its parent company, Merrill Lynch. The Company did not incur a similar level of legal costs in 2007 as the matter with the former officer was resolved in 2006. We did not incur significant costs in our dispute with WCC during 2007 as this matter went to trial in 2008. In January 2008, a jury found that the Company had no liability to WCC and Merrill Lynch relating to the claims being litigated. Occupancy expenses were $600,000 for 2007, compared with $930,000 for 2006. The reduction in expense from 2006 was due to the sale of the Beverly Hills branch in November 2006. Real estate owned expenses declined by $566,000 from 2006 to 2007. Writedowns on properties acquired through foreclosure totaled $289,000 in 2007, and included $266,000 on a multi-family property in Texas. We also incurred $166,000 in operating expenses for the foreclosed properties. Expenses for 2006 included an $865,000 writedown on the Texas multi-family property. We evaluate goodwill for impairment on an annual basis. Our evaluation as of March 31, 2007 indicated that no impairment existed. Due to the significant decline in the price of our common stock during the fourth quarter of 2007, we reevaluated goodwill for impairment at year-end. We concluded that the fair value of the Company was below the carrying value and that goodwill was impaired. Accordingly, the goodwill of $3.1 million was written-off in 2007. Other general and administrative expenses were $1.8 million for 2007, compared with $1.4 million for 2006. Marketing and business travel costs for 2007 declined $172,000 from the prior year as the Company generally focused its lending efforts on direct loan originations in California rather than nationwide loan originations and purchases. Expenses in 2006 included a bonus payment to our legal counsel for work completed on a legal matter and costs associated with the 2006 stock tender offer.
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Table of ContentsRESULTS OF OPERATIONS—2006 COMPARED TO 2005 Our net interest income was $33.0 million for 2006, compared with $39.1 million for 2005. This decrease was due primarily to a decline in our net interest margin, as the net interest earning assets in 2006 were comparable to those in 2005. Our net interest margin was 2.38% for 2006, compared with 2.94% for 2005. This decline in the margin was primarily the result of the increase in market interest rates from 2005 to 2006. Because our interest bearing liabilities reprice more frequently than our interest earning assets, our net interest margin tends to decrease as interest rates rise. As a result, our weighted average cost of interest bearing liabilities increased by 118 basis points to 4.35% for the year ended December 31, 2006, compared with 3.17% for the year ended December 31, 2005. In contrast, our yield on interest-earning assets increased by only 54 basis points, to 6.37% for 2006 compared with 5.83% for 2005. We anticipate that the net interest margin may narrow further in future periods if the treasury yield remains relatively flat. In addition, the sale of the Beverly Hills branch may cause a reduction in the net interest margin, due to our reduced retail presence and our increasing reliance on higher-costing brokered deposits. Interest income on mortgage-backed securities was $18.5 million for 2006, compared with $14.8 million for 2005. The increase in 2006 reflects both an increase in yields and a higher average earning-asset balance. The higher yields, which were precipitated by rising market interest rates, extended the expected lives of the securities and reduced the amortization of premiums. As a result, our yield on mortgage-backed securities increased by 54 basis points, from 4.40% for 2005 to 4.94% for 2006. The increase in the average investment balance from 2005 to 2006 reflects our purchase of $117.9 million in mortgage-backed securities in the second quarter of 2006, in addition to an increase in mortgage-backed securities throughout 2005. Interest income on loans was $67.5 million for 2006, compared with $60.9 million for 2005. This increase was due primarily to a 58-basis point increase in the weighted-average yield on our loans, from 6.41% for 2005 to 6.99% for 2006, reflecting the continuing increase in market interest rates. Our adjustable-rate loans (including loans with an initial fixed rate for 3 or 5 years which subsequently convert to adjustable-rate) comprised between 85-88% of our total loans for 2006, and therefore our portfolio was highly sensitive to interest rate fluctuations. The higher yield in 2006 was also a result of our expansion into construction loans, which had a weighted-average yield of 9.31% for the year. To a lesser extent, the increase in loan interest income was due to a $16.3 million increase in the average balance of loans from 2005 to 2006. This increase in average loan volume reflects the moderate growth in our loan portfolio throughout 2005 (the effects of which are realized in future periods) and loan portfolio acquisitions in the second and fourth quarters of 2006. Interest expense on deposits was $31.7 million for 2006, compared with $17.6 million for 2005. This increase was due to both a 134-basis point increase in the average cost of our interest-bearing deposits (from 3.13% for 2005 to 4.47% for 2006) and a significant increase in the average balance of deposits during the year. The higher average cost of funds in 2006 was largely due to the continuing increase in market interest rates, which raised the cost of deposits as maturing certificates of deposit (CDs) were replaced with higher-costing CDs. In addition, the proportion of CDs to total deposits increased to an average of 92.1% for 2006, compared with an average of 80.3% for 2005. We have increasingly utilized deposits as our primary funding source in 2006 and raised a significant volume of wholesale CDs, resulting in a $144.8 million increase in the average balance of interest-bearing deposits over 2005. Interest expense on repurchase agreements and FHLB advances totaled $20.6 million for 2006, compared with $19.2 million for 2005. This increase was due to the higher market interest rates in 2006. As a result, the cost of our repurchase agreements increased by 36 basis points, from 3.17% in 2005 to 3.53% in 2006, and the cost of our FHLB advances increased by 90 basis points, from 3.06% to 3.96% over the same periods. The effects of the higher rates more than offset a decline in the average balance of borrowings. The average volume or repurchase agreements and FHLB advances declined by $70.5 million and $26.2 million, respectively, from 2005 to 2006, as we increasingly utilized CDs as our primary funding source in 2006.
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Table of ContentsInterest expense on our junior subordinated notes payable was $2.8 million for 2006, compared with $1.5 million for 2005. This increase reflects both higher average borrowing balances and higher rates in 2006. In May 2006 we issued $20.6 million of junior subordinated notes payable to fund our anticipated stock repurchase, and in December 2006 we issued an additional $5.2 million. This new debt increased the average liability balance for 2006 by $13.1 million over the average balance for 2005. These new notes and our earlier notes, issued in July 2002, bear interest at a premium over LIBOR, and therefore generate higher interest expense in periods of rising rates. Consequently, the average cost of our junior subordinated notes payable increased by 102 basis points from 2005 to 2006. Provision for Loan Losses We recorded a provision for loan losses of $957,000 for 2006, compared with net recaptures of loan loss reserves of $41,000 for 2005. The increase in the provision for 2006 was due primarily to a change in the composition of our loan portfolio. In 2006, we expanded our product line to include construction loans, and also saw a substantial increase in our loans secured by land. Because these categories of loans carry more risk than commercial and multifamily real estate loans, we increased our reserves accordingly to provide for possible estimated losses. Other Income Our other income was $10.0 million for 2006, compared with $1.8 million for 2005. The increase in 2006 was due to the $8.5 million pre-tax gain on the sale of our Beverly Hills branch in the fourth quarter. In addition, our other income for 2005 included a one-time gain of $404,000 resulting from our payoff of a participation liability to a co-investor, which previously shared in the returns generated by certain loan portfolios. Other Expenses Compensation and employee benefits expense totaled $7.1 million for 2006, compared with $6.8 million for 2005. This increase was due primarily to a $347,000 increase in bonus expense in 2006. These higher bonuses included incentive bonuses paid to our Chief Executive Officer pursuant to our stock repurchase and sale of the Beverly Hills branch and a signing bonus paid to a new executive. Our legal expenses declined by $469,000 from 2005 to 2006. This decrease was due to the reversal of $746,000 in expenses previously accrued on behalf of a former officer after we received a favorable ruling from an arbitrator in May 2006. We continued to incur litigation-related costs in connection with our disputes with our former loan servicing subsidiary, WCC, and its parent company, Merrill Lynch. Other professional fees increased by $425,000 from 2005 to 2006. This increase was largely due to $177,000 in consulting fees relating to our stock repurchase in 2006. In addition, on an ongoing basis we incur consulting fees in connection with our information systems, which we began outsourcing in the fourth quarter of 2005. Regulatory assessments were $145,000 for the year ended December 31, 2006, compared with $338,000 for the year ended December 31, 2005. The decrease in 2006 was due to the Bank’s conversion to a state charter in September 2005. Because the DFI assesses its annual fee effective July 1, the Bank did not incur such fees in 2006 until the third quarter. Our regulatory assessments in 2005 included fees paid to the Bank’s former regulator, the Office of Thrift Supervision, for the first three quarters of the year. We did not incur amortization expense related to our core deposit intangible because this asset had been amortized in full as of June 30, 2005. We recorded amortization expense of $129,000 on this asset through the first six months of 2005.
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Table of ContentsOur directors expenses declined by $132,000 from the year ended December 31, 2005 to the year ended December 31, 2006. These decreases were due primarily to the reduction in the size of our board of directors from ten members to seven in August 2005. Real estate owned, net was $984,000 for the year ended December 31, 2006, compared with a credit of $187,000 for the year ended December 31, 2006. The increase in 2006 was due to an $865,000 a provision for loss on a multifamily property which was acquired through foreclosure. CHANGES IN FINANCIAL CONDITION General At December 31, 2007, our total assets were $1.5 billion, a decrease of $123.7 million, or 7.6%, from total assets at December 31, 2006. This decrease was due to an increased level of loan payoffs and paydowns that more than offset new loan originations. We also reduced the level of investment securities purchases in 2007, as compared with prior years. The following discussion summarizes the significant changes in our financial condition for 2007. Mortgage-Backed and Other Securities Available for Sale Our portfolio of mortgage-backed securities available for sale decreased by $47.0 million during the year ended December 31, 2007. This increase was due primarily to purchases of securities of $34.9 million, offset by principal repayments of $83.5 million. Our purchases included $24.9 million in GSE mortgage-backed securities with a weighted-average yield of 6.04% and $10.0 million in AAA-rated mortgage-backed securities with a weighted-average yield of 6.05%. In 2007, we significantly reduced our investment purchases due to the narrow spreads to our cost of funds and increased volatility in the mortgage markets. Our mortgage-backed securities recovered approximately $1.8 million of their previously-recorded unrealized holding losses during 2007. This increase in market value was a result of the decline in treasury yields as the Federal Reserve Bank began decreasing interest rates in the third quarter of 2007. As of December 31, 2007, the net unrealized holding losses on our mortgage-backed securities totaled $2.2 million. The balance of our other investment securities available for sale (consisting of trust preferred securities and mutual funds) declined by $2.0 million during the year ended December 31, 2007, primarily as a result of repayments. Loans Our portfolio of loans, net of discounts and allowances, decreased by $61.9 million for the year ended December 31, 2007 to a total of $979.9 million at year-end. The loan portfolio declined in 2007 as loan originations and purchases of $256.4 million were more than offset by loan repayments and sales of $303.5 million. Loan repayments increased in 2007 as certain borrowers were able to obtain lower-cost refinancing from third parties. Our loan origination activity did not increase in 2007 due to our conservative loan pricing and concerns regarding real estate valuations and general economic conditions. Real Estate Owned Real estate owned decreased by $533,000 during 2007. During 2007, we acquired $1.3 million of new properties through foreclosure. These acquisitions were offset by sales of $1.6 million and valuation writedowns of $289,000. Real estate owned at December 31, 2007 consisted of one property with a fair value of $44,000. Deposits Deposits decreased by $213.4 million during 2007. This decrease was due to a reduction in brokered CDs during 2007. We generally replaced maturing brokered CDs with FHLB advances due to their lower cost for
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Table of Contentscomparable maturity terms. The weighted average interest cost of our deposits was 4.88% at December 31, 2007, compared with 4.82% at December 31, 2006. The average cost of deposits increased during 2007 due to our reliance on wholesale deposits and the need to offer competitive market interest rates for these deposits. At December 31, 2007, CDs comprised 96.4% of our total deposits, compared with 96.7% at December 31, 2006. Short-Term Borrowings Short-term borrowings decreased by $20.0 million during the year ended December 31, 2007. At December 31, 2007, we had no outstanding borrowings under a revolving line of credit with another financial institution. The line of credit agreement expired on November 30, 2007, but was amended in January 2008 to expire on December 31, 2008. The line of credit amount was reduced in January 2008 from $20 million to $15 million. This borrowing line bears interest at the 3-month LIBOR rate, plus 1.90%, adjusting quarterly. The maximum ratio on nonperforming loans to total gross loans was also increased to 3.50%. The credit is collateralized by 50% of the outstanding shares of the Bank’s common stock. We terminated the credit agreement in March 2008. Repurchase Agreements Repurchase agreements did not change at any time during the year ended December 31, 2007. The weighted-average cost of our repurchase agreements was 4.81% at December 31, 2007 and December 31, 2006. We did not enter into any new repurchase agreements during 2007, as our funding requirements were met with new brokered CDs and FHLB advances. FHLB Advances FHLB advances increased by $114.7 million during the year ended December 31, 2007. This increase reflects $595.0 million in new advances, partially offset by matured advances of $480.3 million. The FHLB advances were our primary funding source during 2007 as the advances generally had a lower cost than brokered CDs. The FHLB has authorized a borrowing limit for total FHLB advances of 45% of the Bank’s total assets as of the previous quarter-end. As of December 31, 2007, we had FHLB borrowing availability of $76.5 million. Junior Subordinated Notes Payable to Trusts The amount of our junior subordinated notes payable to trusts did not change at any time during 2007. The weighted-average cost of these notes was 7.58% at December 31, 2007 and 7.88% at December 31, 2006. The interest rates for the notes are at various spreads to 3-month LIBOR and reset quarterly. In January 2008, we redeemed at par $10.3 million of the notes due in 2032. Stockholders’ Equity Our stockholders’ equity decreased by $7.3 million for the year ended December 31, 2007 to $148.1 million, or $7.87 book value per diluted share. This decrease was due to declared cash dividends of $9.4 million, which were offset by net earnings of $0.5 million, net after-tax unrealized gains of $1.1 million on the portfolio of available-for-sale securities, a $0.3 million increase in paid-in capital representing stock-based compensation expense, and a $0.2 million increase in paid-in-capital relating to exercise of stock options. Off-Balance Sheet Arrangements We are a party to financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments include debt obligations and commitments to extend credit and involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet.
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Table of ContentsAt December 31, 2007, we had outstanding commitments to extend credit of $150.4 million. These commitments expose us to credit risk in excess of amounts reflected in the consolidated financial statements. We receive collateral to support loans and commitments to extend credit for which collateral is deemed necessary. As of December 31, 2007, we did not have an allowance for unfunded loan commitments. LIQUIDITY AND CAPITAL RESOURCES Liquidity is the measurement of an entity’s ability to meet potential cash requirements, including ongoing commitments to repay borrowings, originate loans, fund investments, purchase pools of loans, and make payments for general business purposes. Our sources of liquidity include deposits, FHLB advances (up to 45% of the Bank’s total assets as of the previous quarter-end), repurchase agreements, repayments of loans and mortgage-backed securities, and net interest income. We manage our liquidity on a daily basis, and our Board of Directors periodically reviews our liquidity. This process is intended to ensure the maintenance of sufficient funds to meet our operating needs. Based on our current and expected asset size, capital levels, and organizational infrastructure, we believe there will be sufficient available liquidity to meet our operating needs. At December 31, 2007, we had $629.1 million of CDs. Scheduled maturities of CDs during the 12 months ending December 31, 2008 and thereafter amounted to $582.5 million and $46.6 million, respectively. Wholesale deposits generally are more responsive to changes in interest rates than core deposits, and thus are more likely to be withdrawn by the investor upon maturity as changes in interest rates and other factors are perceived by investors to make other investments more attractive. Management continues its effort to reduce our exposure to interest rate changes by utilizing funding sources whose repricing characteristics more closely match those of our interest-earning assets. We are party to various contractual financial obligations, including repayment of borrowings, operating lease payments and commitments to extend credit. The table below presents the Company’s future financial obligations (principal and interest payments) outstanding as of December 31, 2007: Contractual Obligations
With the exception of the operating leases, employment contracts and loan commitments, the expected obligations presented above include anticipated interest accruals based on the current respective contractual terms. The amounts for the three issuances of junior subordinated notes are based on the assumption that the notes will be repaid in full at their respective maturities in July 2032, June 2036 and March 2037. However, the notes may be repaid in full or in part at par commencing in July 2007, June 2011 and March 2012, respectively, and quarterly thereafter.
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Table of ContentsDFI regulations require each California-chartered bank to maintain adequate liquidity to assure safe and sound operation. It is the Bank’s responsibility to establish a liquidity policy that sets minimum liquidity requirements. As of December 31, 2007, the Bank was in compliance with its liquidity policy. REGULATORY CAPITAL REQUIREMENTS Bank holding companies, such as BHBC, and FDIC-insured banks, such as FBBH, are required to meet certain minimum regulatory capital requirements. At December 31, 2007, BHBC and FBBH met all applicable regulatory capital requirements and FBBH was “well capitalized,” as defined under applicable regulations. The following table sets forth the regulatory standards for well capitalized and adequately capitalized institutions and capital ratios for BHBC and FBBH at December 31, 2007: Regulatory Capital Ratios
In addition to the requirements shown in the above table, FBBH is required by the DFI to maintain a ratio of tangible stockholder’s equity to total tangible assets of at least 8.0% for the first three years following the effective date of the charter conversion, or through August 31, 2008. As of December 31, 2007, the Bank was in compliance with the DFI’s requirement. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Managing risk is an essential part of successfully operating a financial services company. The most prominent risk exposures are credit quality, interest rate sensitivity and liquidity. Credit quality risk is the risk of not collecting interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of net interest income as the result of changes in interest rates. Rate movements can affect the repricing of assets and liabilities differently, as well as their market values, and also can affect the ability of the borrower to repay. Liquidity risk is the possible inability to fund obligations to depositors, investors and borrowers. Asset and Liability Management It is our objective to attempt to control risks associated with interest rate movements. In general, management’s strategy is to limit our exposure to earnings volatility and variations in the value of assets and liabilities as interest rates change over time. Our asset and liability management strategy is formulated and monitored by the board and management asset/liability committees (collectively, “ALCO”) which reviews,
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Table of Contentsamong other things, the sensitivity of our assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses (including those attributable to hedging transactions), purchase activity, and maturities of investments and borrowings. ALCO establishes rate sensitivity tolerances (within regulatory guidelines) which are approved by our Board of Directors, and coordinates with our Board with respect to overall asset and liability composition. ALCO is authorized to utilize off-balance sheet financial techniques to assist in the management of interest rate risk. These techniques include interest rate swap agreements, pursuant to which the parties exchange the difference between fixed-rate and floating-rate interest payments on a specified principal amount (referred to as the “notional amount”) for a specified period without the exchange of the underlying principal amount. We regularly monitor the interest rate sensitivity of our portfolios of interest-earning assets and interest-bearing liabilities in conjunction with the current interest rate environment. When new pools of loans or securities are acquired, we will assess the incremental change in our sensitivity to interest rates. In addition, ALCO also regularly reviews interest rate risk by forecasting the impact of alternative interest rate environments on the interest rate sensitivity of Net Portfolio Value (“NPV”), which is defined as the net present value of an institution’s existing assets, liabilities and off-balance sheet instruments. ALCO further evaluates such impacts against the maximum tolerable change in interest income that is authorized by our Board of Directors. The following table quantifies the potential changes in our net portfolio value at December 31, 2007, should interest rates increase or decrease by 100 to 300 basis points, assuming the yield curves of the rate shocks will be parallel to each other. Interest Rate Sensitivity of Net Portfolio Value
In determining net portfolio value, we make various assumptions, including, but not limited to, prepayment speeds on our assets and the discount rates to be used. We review our assumptions regularly and adjust them when we deem appropriate based on current and future expected market conditions. We believe that the assumptions (including prepayment assumptions) we use to evaluate the vulnerability of our operations to changes in interest rates approximate actual experience and consider them reasonable. However, the interest rate sensitivity of our assets and liabilities and the estimated effects of changes in interest rates on NPV could vary substantially if different assumptions were used or actual experience differs from the historical experience on which they are based.
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Table of ContentsAnother tool used to identify and manage our interest rate risk profile is the static gap analysis. Interest sensitivity gap analysis measures the difference between the assets and liabilities repricing or maturing within specific time periods. The following table summarizes the scheduled maturities or repricing of the Company’s assets and liabilities based on their contractual terms as of December 31, 2007.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk See Item 7—Qualitative and Quantitative Disclosures About Market Risk—Asset and Liability Management—of Part II of this Report. ITEM 8. Financial Statements and Supplementary Data See Item 15 of Part IV of this Report. ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not Applicable.
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Table of ContentsITEM 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, our CEO and CFO concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s Exchange Act filings. MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2007. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the above evaluation, our management has concluded that, as of December 31, 2007, we did not have any material weaknesses in our internal control over financial reporting and our internal control over financial reporting was effective. The independent registered public accounting firm of Deloitte & Touche LLP, as auditors of Beverly Hills Bancorp Inc.’s consolidated financial statements, has issued an attestation report on the effectiveness of management’s internal control over financial reporting based on criteria established in Internal Control— Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Changes in Internal Control Over Financial Reporting There was no change in our internal control over financial reporting during our fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Beverly Hills Bancorp Inc. Calabasas, California We have audited the internal control over financial reporting of Beverly Hills Bancorp Inc. and subsidiaries (the “Company”) as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
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Table of ContentsWe have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2007 of the Company and our report dated March 17, 2008 expressed an unqualified opinion on those financial statements. /s/ Deloitte & Touche LLP Los Angeles, California March 17, 2008 Not Applicable.
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Table of ContentsITEM 10. Directors and Executive Officers of the Registrant Directors Larry B. Faigin, age 65, was appointed to the Board of Directors in June 1999 and has been Chairman since September 1999. In addition, Mr. Faigin has been a director of FBBH since April 2001. Mr. Faigin has been the Chief Executive Officer of the Company since August 2005 and the Chief Executive Officer and President of FBBH since June 2006. From December 2005 to June 2006, Mr. Faigin was the Bank’s Executive Vice President of Development. From 2003 to 2005, Mr. Faigin was President and Chief Executive Officer of China Housing Partners, LLC, a residential developer in China. Previously, he was President and Chief Executive Officer of GreenPark Remediation, LLC, a company that specializes in acquiring environmentally impacted land and remediating and improving the property for further development. Howard Amster, age 60, has been a director of the Company since November 2001 and a director of FBBH since October 2001. Mr. Amster is a professional real estate operator and also is a principal of Ramat Securities Ltd., a Cleveland-based investment firm. Mr. Amster also is a director of Horizon Group Properties, Inc., and Astrex Inc. Stephen P. Glennon, age 63, has been a director of the Company since December 1999 and a director of FBBH since April 2001. Mr. Glennon is a retired financial executive. He was the Company’s Chief Executive Officer from September 1999 to May 2004 and its Chief Financial Officer from April 2003 to May 2004. Robert H. Kanner, age 60, has been a director of the Company and FBBH since January 2002. Mr. Kanner has been Chairman of the Board of Pubco Corporation, a manufacturer and marketer of computer printer supplies and specialized construction products, since 1987. Kathleen L. Kellogg, age 54, has been a director of the Company since August 2005 and a director of FBBH since October 2001. Ms. Kellogg has been President of her own independent consulting company since 2000. Ms. Kellogg also is a director of First General Bank, and is a Trustee of the San Marino Schools Foundation. William D. King, age 66, has been a director of the Company since May 2004 and a director of FBBH since April 2001. He has been Chairman of the Board of FBBH since December 2002. Mr. King is a retired Chairman and Chief Executive Officer of Aviation Distributors, Inc. John J. Lannan, age 61, has been a director of the Company since May 2004 and a director of FBBH since June 2003. Mr. Lannan has been a Principal with Brentwood Partners, Inc., a real estate financing firm specializing in institutional equity and mezzanine debt placement, since 1998. Executive Officers Craig W. Kolasinski, age 45, has been employed by FBBH since 2001. He has been Executive Vice President of Business Development of FBBH since November 2006. Previously, from April 2006 to November 2006, he was Executive Vice President and Chief Lending Officer and also held that position from October 2001 to February 2005. From February 2005 to April 2006, he served as Executive Vice President and Chief Credit Officer. Bryce W. Miller, age 45, has been employed by the Bank since 2000. He has been Executive Vice President and Chief Administrative Officer of FBBH since January 2007. Previously, he served as Senior Vice President, Technology and Compliance (February 2003 to January 2007) and Vice President and Information Services Manager (July 2001 through February 2003) and Vice President and Controller (June 2000 through June 2001). Takeo K. Sasaki, age 39, joined the Company in July 2001. He has been Chief Financial Officer of BHBC since February 2005, an Executive Vice President of BHBC since January 2007, and Chief Financial Officer of
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Table of Contentsthe Bank since 2003. Mr. Sasaki served as Senior Vice President of the Bank from February 2003 through January 2007 and Vice President and Controller of the Bank from July 2001 to February 2003. Annette J. Vecchio, age 57, has been employed by the Bank since 1985. She has been Executive Vice President and Chief Credit Officer of the Bank since April 2006 and served as the Bank’s Senior Vice President and Portfolio Manager from March 2002 to April 2006. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires a company’s directors and executive officers, and beneficial owners of more than 10% of the common stock of such company, to file with the Securities and Exchange Commission initial reports of ownership and periodic reports of changes in ownership of the company’s securities. To the knowledge of the Company, no director, officer, or beneficial owner of more than 10% of the Company’s Common Stock failed to timely furnish reports required of such person by Section 16(a) on Forms 3, 4 and 5 during the year ended December 31, 2007. Code of Ethics Beverly Hills Bancorp Inc. has adopted a written code of ethics that applies to all employees and members of the Board of Directors. A copy of the Company’s code of ethics is available on the Company’s web site at www.bhbc.com. Audit Committee The Audit Committee of the Board of Directors consists of William D. King (Chairman), Robert H. Kanner and Kathleen L. Kellogg. All of the Audit Committee members are non-employee directors who are independent within the listing standards of the Nasdaq Stock Market and the Securities Exchange Act of 1934. The Board of Directors has determined that Mr. King is a financial expert as defined in Item 407(d)(5)(ii) of Regulation S-K. ITEM 11. Executive Compensation Compensation Discussion and Analysis Overview The Company’s executive compensation program is designed to attract, retain, and motivate highly competent executives and to focus the interests of the executives on objectives that enhance stockholder value. The Company seeks to attain these goals by structuring the executives’ compensation so that a portion of each executive’s pay is a function of that executive’s performance for the year, and a portion is tied to the overall profitability of the Company. Process The Company’s Board of Directors has overall responsibility for the Company’s compensation policies and procedures. The Board of Directors has delegated to its Compensation Committee the responsibility to review and recommend all employment contracts and compensation arrangements, including salaries, bonuses, programs and benefits, for executive officers. All actions of the Compensation Committee pertaining to executive compensation must be submitted to the Board of Directors for approval. The CEO generally makes recommendations to the Compensation Committee and participates in discussions with the Compensation Committee regarding the form and amount of compensation for executive officers other than himself. He may also discuss with the Compensation Committee his expectations for his own
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Table of Contentscompensation. The CEO does not participate in Board or Compensation Committee deliberations regarding his own compensation and abstains from voting on any matters regarding his own compensation. Elements of Executive Compensation The principal elements of the Company’s executive compensation program are base salary, performance bonuses, stock-based compensation, long-term incentives and other benefits. The Company does not utilize a specific formula to determine the allocation of each element of compensation for its executives. However, the Company does attempt to provide each executive with a number of incentives to improve individual performance as it relates to the objectives of the Company. Consequently, the executive officers’ total compensation is typically weighted heavily toward bonuses and incentive compensation. Base Salary. Base salaries for the Company’s executives are intended to reflect the scope of each executive’s responsibilities, the success of the Company, and contributions of each executive toward the Company’s attainment of its objectives. In setting the base salary for an executive officer, the Board and Compensation Committee may consider some or all of the following factors: the executive officer’s current base salary, the base salaries of the Company’s other executive officers, base salaries of executive officers of other financial institutions, the scope of the executive officer’s duties and responsibilities (and changes in the scope of such responsibilities), and the executive officer’s performance. Performance Bonuses. The Company historically considers performance bonuses for its executive officers on an annual basis. Factors that affect the amount the bonus for any executive officer may include some or all of the following: the individual officer’s performance generally; the individual executive officer’s achievement of specific goals; the financial performance of the Company; and the executive officer’s overall compensation. The Company does not have a policy addressing whether the executives’ bonuses would be adjusted in the event the Company’s financial statements are later restated. Stock Based Compensation. The Company from time to time grants stock-based compensation, such as stock options and stock appreciation rights (“SARs”), to its executive officers. These forms of compensation are intended to provide further incentive for the executive officers to contribute towards meeting the Company’s goals by (i) aligning part of the executives’ compensation with the overall performance of the Company and (ii) encouraging the executives to remain with the Company at least through the vesting period of the award (typically three to five years). The Company has two stock plans, the 1999 Equity Participation Plan (the “1999 Plan”) and the 2002 Equity Participation Plan (the “2002 Plan”). Both the 1999 Plan and the 2002 Plan were approved by the shareholders of the Company. Under these plans, the Company may grant stock options and other forms of stock-based compensation. The exercise prices of awards granted under these plans may not be less than the fair value of the underlying shares on the date of grant. In the past two years, the Company has also granted SARs outside these plans. These SARs are payable in cash only. Long-Term Incentives. The Company has from time to time entered agreements with its executive officers to induce them to remain with the Company and to provide them with protection in the event of adverse changes in their employment conditions. Other Benefits. Executive officers may participate in various employee benefits offered to employees generally, including medical, dental and vision insurance coverage and the Company’s matching contributions to its 401(k) plan. The Company may also from time to time provide other benefits to specific executive officers, such as use of a Company automobile or an automobile allowance.
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Table of ContentsEmployment Agreements Larry Faigin. Mr. Faigin is employed pursuant to an Employment Agreement dated March 7, 2006. Under the Employment Agreement, Mr. Faigin is entitled to a base salary of $275,000 for 2006, $285,000 for 2007, $295,000 for 2008, and an amount to be agreed upon each year thereafter, but in no event less than his base salary in the prior year. The base salaries for Mr. Faigin were set at levels the Compensation Committee believed were approximately the average of base salaries of chief executive officers of similar-sized banks in Southern California at the time the parties entered into the Employment Agreement. The Employment Agreement contemplates that each year the Company and Mr. Faigin will negotiate in good faith to establish an incentive compensation plan for him for the year. The Company may terminate Mr. Faigin’s employment at any time with or without cause. If the Company terminates Mr. Faigin’s employment without cause, or Mr. Faigin terminates his employment under circumstances constituting “good reason,” Mr. Faigin will be entitled to a continuation of base salary and benefits until the later to occur of two years from the date of termination or December 31, 2008. “Good reason” includes, among other things, a change of control of the Company, the failure of the Board of Directors to nominate Mr. Faigin as a director, or the appointment of any officer senior to Mr. Faigin. Mr. Faigin may terminate his employment at any time upon 60 days’ written notice. In July 2007 the Company and Mr. Faigin amended his Employment Agreement. The amendment provides that Mr. Faigin will be entitled to receive a stay bonus equal to 150% of his base salary if he is an employee either 60 days after a change in control or on December 31, 2008. He is also entitled to this payment if the Company terminates his employment without cause or he terminates his employment for good reason prior to December 31, 2008. The Board approved this amendment because in June 2007 the Company engaged an investment banking firm as its financial advisor to assist the Company in reviewing its strategic alternatives, including whether a sale of the Company would be in the best interests of the stockholders. The Board approved similar arrangements with the other executive officers. The Board determined that these arrangements were advisable and in the best interests of the Company and its stockholders as they would motivate Mr. Faigin and the other executive officers to remain with the Company notwithstanding the uncertainty about their future employment should the Company become involved in negotiations for a sale of the Company. Eric Rosa. Mr. Rosa was employed pursuant to an Employment Agreement dated October 31, 2006. Mr. Rosa’s Employment Agreement provided for a base salary of $250,000 per year, a signing bonus of $150,000, 30,000 SARS payable in cash, and discretionary performance bonuses. Mr. Rosa was entitled to severance equal to continuation of his base salary through December 31, 2008 if prior to that date the Company terminated his employment without cause or he terminated his employment for good reason. Mr. Rosa’s employment terminated in January 2008, and he did not receive any severance under his Employment Agreement in connection with such termination. 2007 Compensation The following discusses the compensation paid or awarded for 2007 to the Chief Executive Officer, the Chief Financial Officer and each other Named Executive Officer. Base Salary. In fiscal 2007, the Compensation Committee utilized the DFI’s Annual Executive Officer & Director Compensation Survey to assist in determining whether to adjust base salaries. In general, the Compensation Committee sets base salaries within the peer group average for comparable positions. The base salaries for Mr. Faigin and Mr. Rosa were determined pursuant to their respective Employment Agreements. Ms. Vecchio’s base salary was increased in May 2006 in connection with her promotion to Chief Credit Officer and her base salary did not change in 2007 because the Board believed her base salary was appropriate. Mr. Kolasinski’s base salary was not increased due to his stay bonus agreement pursuant to which he would receive stay bonuses if he remained in employment with the Company through January 1, 2008.
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Table of ContentsMr. Sasaki’s base salary was increased from $150,000 to $200,000 to reflect additional responsibilities in 2007 and to bring his base salary to a level more comparable to other executive officers of the Company and peer averages for chief financial officers of similar-sized banks. Performance Bonuses. Mr. Faigin’s Employment Agreement provides that each year he and the Company will negotiate in good faith to establish an incentive compensation plan for him. Mr. Faigin’s plan for 2007 provided that he would receive a bonus ranging from $150,000 to $500,000 based on the Company’s consolidated earnings excluding extraordinary or unusual events, satisfactory ratings from regulatory examinations and internal audits and absence of regulatory restrictions on dividends. Mr. Faigin’s bonus could be zero if the above criteria were not met. The earnings condition did not include quantitative target levels, and no weights or amounts were assigned to any component of the bonus. Based on the Company’s results of operations for the year, Mr. Faigin did not receive a performance bonus for 2007. None of the named executive officers other than Mr. Faigin had specific individual goals upon which their performance bonuses for 2007 were based. Their performance bonuses for 2007 were lower than in prior years because the Company’s results of operations were not as good as in the prior several years and because they (with the exception of Mr. Kolasinski) received stay bonus agreements entitling them to stay bonuses for remaining employed by the Company through December 31, 2008 (see Long-Term Incentives below). Based on these factors, Mr. Sasaki received a cash bonus of $55,000 for 2007 and Ms. Vecchio received a cash bonus of $40,000. Mr. Kolasinski did not receive a cash bonus for 2007 because he received a stay bonus payment of $150,000 in January 2008, and Mr. Rosa did not receive a performance bonus for 2007 as his employment terminated prior to the consideration of bonuses by the Compensation Committee. Stock-Based Compensation. In January 2007, the Company granted SARs with respect to 30,000 shares to Mr. Rosa as required by his Employment Agreement. The SARs terminated upon termination of Mr. Rosa’s employment in January 2008. The SARs were exercisable at $7.80 per share (the fair market value of the common stock on the date of grant), were payable in cash only, and were to vest in three equal annual installments of 10,000 shares beginning January 25, 2008. In June 2007, the Company granted SARs with respect to 400,000 shares to Mr. Faigin. The SARs are exercisable at $7.86 per share, are payable in cash only and expire on September 27, 2008. These SARs were granted at the time the Company engaged an investment banking firm as its financial advisor to assist the Company in reviewing its strategic alternatives. The Board granted the SARS in order to provide further incentive for Mr. Faigin to remain with the Company through the consummation of a potential sale. In this regard, the Board considered that his existing stock options have an exercise price of $10.50 per share, and thus Mr. Faigin would be unlikely to realize any financial benefit from the options in the event of a sale of the Company within the next one to two years, given the then current market price of the common stock. For this reason, the Company set an expiration date for the SARs of 15 months from the grant date, instead of a more typical three to five years. Long-Term Incentives. The Company has entered into various other agreements with its named executive officers to induce them to remain with the Company and to provide them with protection in the event of adverse changes in their employment conditions. In 2004 the Company entered into a stay bonus agreement with Craig Kolasinski. This agreement provided that Mr. Kolasinski would receive a cash bonus of $300,000 if he remained as an employee through January 1, 2007 and an additional cash bonus of $150,000 if he remained as an employee through January 1, 2008. Mr. Kolasinski would receive a prorated portion of these bonuses if his employment terminated prior to these dates due to death, disability, termination by the Company without cause or termination by Mr. Kolasinski for good reason. Because Mr. Kolasinski remained employed by the Company through January 1, 2008, he received both stay bonuses.
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Table of ContentsAs discussed above, in June 2007 the Company engaged an investment banking firm as its financial advisor to assist the Company in reviewing its strategic alternatives, including whether a sale of the Company would be in the best interests of the stockholders. Because of this, the Board approved amendments to existing change of control agreements for Messrs. Sasaki and Rosa and Ms. Vecchio and provided stay bonus agreements to these executive officers. In addition, as discussed above, the Company amended Mr. Faigin’s Employment Agreement to provide a stay bonus. The Board effected these changes to encourage these executive officers to remain as employees in this period of uncertainty regarding their future employment. Each amended change of control agreement provides that, in the event of a change in control of the Company or Bank, the executive officer would be entitled to receive a severance payment if at any time following the execution of a definitive agreement for a change of control and one year after a change in control either of the following occurs: (i) the executive’s employment is involuntarily terminated by the Company or the Bank for any reason other than cause or death or disability or (ii) the executive officer terminates his or her employment for “good reason”, as defined in the change of control agreement. The amount of the severance payment for each executive is a multiple of his or her base salary less any stay bonus received by the executive. The multiple is three for Ms. Vecchio and Mr. Rosa, and two and one-half for Mr. Sasaki. Mr. Rosa’s change of control agreement terminated in January 2008 upon termination of his employment. Each stay bonus agreement provides that the executive officer will be entitled to receive a stay bonus payment if the executive is an employee either 60 days after a change in control (as defined in the agreement) or on December 31, 2008. The amount of the stay bonus for Mr. Rosa and Ms. Vecchio would be equal to their annual base salary, and the amount of the stay bonus for Mr. Sasaki would be equal to 18 months’ base salary. Mr. Rosa received his stay bonus in connection with the termination of his employment in January 2008. The Company also has a change of control agreement with Mr. Kolasinski. This agreement was amended in February 2008 to be in the form of the amended change of control agreement provided to the other executive officers in 2007. The amount of the severance payment for Mr. Kolasinski is his annual base salary. Compensation Committee Report The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with the Company’s management. Based on such review and discussions, the Compensation Committee recommended to the board of directors that the Compensation Discussion and Analysis be included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, for filing with the Securities and Exchange Commission. COMPENSATION COMMITTEE Robert H. Kanner, Chair Howard Amster Kathleen L. Kellogg
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Table of ContentsSummary Compensation Table The following table sets forth the total compensation paid or accrued by the Company for services rendered during the year ended December 31, 2007 to (i) the principal executive officer, (ii) the principal financial officer and (iii) each of the three other most highly compensated executive officers of the Company who were serving as executive officers at December 31, 2007 (the “Named Executive Officers”). Summary Compensation Table
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Table of ContentsGrants of Plan-Based Awards The following table provides information concerning option awards granted by the Company during the year ended December 31, 2007 to named executive officers. Grants of Plan-Based Awards
Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards Mr. Faigin’s employment agreement provided for a base salary of $285,000 for the year 2007. In July 2007 the Company and Mr. Faigin amended his Employment Agreement. The amendment provides that Mr. Faigin will be entitled to receive a stay bonus equal to 150% of his base salary if he is an employee either 60 days after a change in control or on December 31, 2008. He is also entitled to this payment if the Company terminates his employment without cause or he terminates his employment for good reason prior to December 31, 2008. Mr. Faigin’s Employment Agreement provides that each year he and the Company will negotiate in good faith to establish an incentive compensation plan for him. Mr. Faigin’s plan for 2007 provided that he would receive a bonus ranging from $150,000 to $500,000 based on the Company’s consolidated earnings excluding extraordinary or unusual events, satisfactory ratings from regulatory examinations and internal audits and absence of regulatory restrictions on dividends. Mr. Faigin’s bonus could be zero if the above criteria were not met. The earnings condition did not include quantitative target levels, and no weights or amounts were assigned to any component of the bonus. Based on the Company’s results of operations for the year, Mr. Faigin did not receive a performance bonus for 2007. Mr. Faigin’s SARs are exercisable at $7.86 per share and payable in cash only. They were vested upon issuance and expire on September 27, 2008. Mr. Rosa’s SARs are exercisable at $7.80 per share and payable in cash only. His SARs vest in three equal annual installments of 10,000 shares beginning January 25, 2008, and expire on January 25, 2012.
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Table of ContentsOutstanding Equity Awards at Fiscal Year-End The following table sets forth the outstanding equity awards at December 31, 2007 for the Named Executive Officers. Outstanding Equity Awards at Fiscal Year-End
Option Exercises The following table presents the number and value of shares received upon the exercise of options during 2007 for the Named Executive Officers. Option Exercises
Potential Payments Upon Termination or Change in Control Mr. Faigin’s employment agreement provides that if he is terminated by the Company without cause or he resigns for “Good Reason” (as defined in the agreement, which includes a change in control of the Company), he would be entitled to receive a continuation of his base salary and benefits as provided for in his employment agreement for two years following the change in control. This agreement requires that for two years following his termination, Mr. Faigin shall comply with certain provisions, including, but not limited to (1) a covenant not to participate in a business that is in competition with the Company and (2) a covenant not to offer employment to any person still employed by the Company. In addition, in the event Mr. Faigin is terminated without cause or there is a change in control of the Company, all of his unexercised stock options would immediately vest and become exercisable. The Company has change of control agreements with Ms. Vecchio and Messrs. Sasaki and Rosa. The change of control agreement provides that, in the event of a change in control of the Company or Bank, the executive officer would be entitled to receive a severance payment if at any time following the execution of a definitive agreement for a change of control and one year after a change in control either of the following occurs: (i) the executive’s employment is involuntarily terminated by the Company or the Bank for any reason other than cause or death or disability or (ii) the executive officer terminates his or her employment for “good reason”, as defined in the change of control agreement. The amount of the severance payment for each executive is a multiple of his or her base salary less any stay bonus received by the executive. The multiple is three for Ms. Vecchio and Mr. Rosa, and two and one-half for Mr. Sasaki. Mr. Rosa’s change of control agreement terminated in January 2008 upon termination of his employment.
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Table of ContentsEach stay bonus agreement provides that the executive officer will be entitled to receive a stay bonus payment if the executive is an employee either 60 days after a change in control (as defined in the agreement) or on December 31, 2008. The amount of the stay bonus for Mr. Rosa and Ms. Vecchio would be equal to their annual base salary, and the amount of the stay bonus for Mr. Sasaki would be equal to 18 months’ base salary. Mr. Rosa received his stay bonus in connection with the termination of his employment in January 2008. The Company also has a change of control agreement with Mr. Kolasinski. This agreement was amended in February 2008 to be in the form of the amended change of control agreement provided to the other executive officers in 2007. The amount of the severance payment for Mr. Kolasinski is his annual base salary. The following table summarizes the potential payments to the Company’s named executive officers upon their termination, assuming such termination occurred on December 31, 2007 and such termination did not follow a change of control (see table following this table). Termination Payments and Benefits
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