TAMALPAIS BANCORP 10-K 2010
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the transition period from to
Commission File No. 000-50878
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
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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 past 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.
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Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
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Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
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The aggregate market value of the registrant’s voting stock held by non-affiliates computed by reference to the average bid and asked prices of such stock, as of June, 30, 2009 was $17,904,461.
The number of registrant’s shares of Common Stock outstanding as of March 10, 2010 was 3,823,634.
The following documents are incorporated by reference in Part III of this Form 10-K: Items 10 through 14 of registrant’s definitive Proxy Statement for its 2010 Annual Meeting of Shareholders.
TABLE OF CONTENTS
In addition to the historical information, this Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with respect to the financial condition, results of operation and business of Tamalpais Bancorp and its subsidiaries. Actual results may differ materially from management expectations, projections and estimates. These include, but are not limited to, statements that relate to or are dependent on estimates or assumptions relating to the prospects of loan growth, capital raising transactions, credit quality, capital adequacy, liquidity, reduction of loan concentrations, diversification of the deposit base, sales of nonperforming loans, changes in securities or financial markets, and certain operating efficiencies resulting from the operations of Tamalpais Bank and Tamalpais Wealth Advisors. These forward-looking statements involve certain risks and uncertainties.
Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) regulatory actions that impact our holding company and bank subsidiary including the Order and the Directive issued with respect to our subsidiary, Tamalpais Bank, by the Federal Deposit Insurance Corporation and California Department of Financial Institutions, and the FRB Agreement between the Company and the Federal Reserve, and our ability to comply with these regulatory actions; (2) higher than expected credit losses; (3) our ability to enhance the capital ratios of the Bank and the Company; (4) our ability to diversify our loan portfolio; (5) our ability to reduce reliance on wholesale funding and generate low cost deposits from our market area; (6) competitive pressure among financial services companies increases significantly; (7) the failure to regain compliance with NASDAQ’s continued listing requirements within the grace period provided under NASDAQ rules, in which case, our shares of common stock would be delisted from the NASDAQ Capital Market; (8) changes in the interest rate environment reduce interest margins; (9) general economic conditions, internationally, nationally or in the State of California are less favorable than expected; (10) legislation or regulatory requirements, regulatory actions against us, or changes adversely affect the businesses in which the consolidated organization is or will be engaged; (11) the ability to satisfy the requirements of the Sarbanes-Oxley Act 2002 and other regulations governing internal controls; (12) decline in real estate values in the Company’s operating market areas; (13) volatility or significant changes in the equity and bond markets which can affect our ability to raise capital and the overall growth and profitability of the wealth advisors business; (14) our ability to sell nonperforming loans or sell such loans on terms acceptable to the Company; (15) changes in the quality or composition of Tamalpais Bank’s loan and investment portfolios; (16) changes in accounting principles, policies or guidelines; (17) asset/liability management risks and liquidity risks; and, (18) other risks detailed in the Company’s filings with the Securities and Exchange Commission. When relying on forward-looking statements to make decisions with respect to the Company, investors and others are cautioned to consider these and other risks and uncertainties. The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained in this report to reflect future events or developments.
Moreover, wherever phrases such as or similar to “the Company projects”, “In management’s opinion”, or “management considers” are used, such statements are as of and based upon the knowledge of management at the time made and are subject to change by the passage of time and/or subsequent events and, accordingly, such statements are subject to the same risks and uncertainties noted above with respect to forward-looking statements.
On October 28, 2008, the Board of Directors of Tamalpais Bancorp (the “Company”) elected to apply to the Board of Governors of the Federal Reserve System to become a bank holding company (“BHC”). On the same date, the Board of Directors of Tamalpais Bank (the “Bank”) elected to apply to the California Department of Financial Institutions (“CDFI”) and the Federal Deposit Insurance Corporation (“FDIC”) to convert the Bank’s charter from a California industrial bank to a California state commercial bank. On January 8, 2009, the Company received the written consent from a majority of its shareholders to amend its Articles of Incorporation to authorize a class of preferred stock.
On January 30, 2009, the Company filed amended Articles of Incorporation of the Bank with the Secretary of State of the State of California whereby the Bank converted from a California industrial bank to a California state chartered commercial bank. On January 30, 2009, the Company also notified the Federal Reserve Bank of San Francisco and the FDIC that the amendment to the Bank’s Articles of Incorporation amending the purpose clause to provide that the Bank is authorized to conduct a commercial banking business was filed with the California Secretary of State.
Accordingly, as of January 30, 2009, the Bank is now a commercial bank and the transaction by which the Company became a BHC was consummated as of that date.
As of December 31, 2009, the subsidiaries of the Company consisted of the Bank and Tamalpais Wealth Advisors (“TWA”), both of which are consolidated subsidiaries. The Company has entered into an agreement for the disposition of TWA. See “Tamalpais Wealth Advisors” of this Report. San Rafael Capital Trusts II and III (the “Trusts”) are wholly-owned unconsolidated subsidiaries which were formed during 2006 and 2007, respectively. All significant intercompany transactions and balances have been eliminated.
The Company’s outstanding equity securities consist of one class of no par value, Common Stock. The principal executive offices of the Company are located at 630 Las Gallinas Avenue, San Rafael, California, 94903, telephone number (415) 526-6400, facsimile number (415) 485-3742. The Company makes available free of charge on its website at www.tambancorp.com its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments thereto, and reports of insider transactions on Forms 3, 4, and 5 as soon as reasonably practicable after the Company, or insiders, as the case may be, file such reports with, or furnishes them to the Securities and Exchange Commission (“SEC”). Investors are encouraged to access these reports and the other information about the Company’s business on its website. The Company may also be contacted via electronic mail at firstname.lastname@example.org.
We have determined that significant additional sources of liquidity and capital will be required for us to continue operations through 2010 and beyond. We have engaged a financial advisor to explore strategic alternatives, including potential significant capital raises, to address our current and expected liquidity and capital deficiencies. However, to date we have been unable to raise additional capital and failed to meet certain deadlines to increase capital imposed by our regulators as described in more detail below. There can be no assurance that we will be able to arrange for sufficient liquidity or to raise additional capital in time to satisfy regulatory requirements and meet our obligations as they come due. In addition, our regulators are continually monitoring our liquidity and capital adequacy. Based on their assessment of our ability to continue to operate in a safe and sound manner, our regulators may take other and further action to that described below, including assumption of control of Tamalpais Bank, to protect the interests of depositors insured by the FDIC.
As we reported in our Form 8-K filed with the SEC on September 17, 2009, the Bank entered into a Stipulation and Consent (“Consent”) agreeing to the issuance of an Order to Cease and Desist (“Order”) by the Federal Deposit Insurance Corporation (“FDIC”) and the California Department of Financial Institutions (“CDFI”). Based upon our Consent, the FDIC and the CDFI jointly issued the Order on September 14, 2009.
The Order is a formal corrective action pursuant to which the Bank has agreed to address specific areas through the adoption and implementation of procedures, plans and policies designed to enhance the safety and soundness of the Bank. These affirmative actions include, among others, the implementation of a capital plan which specifies how the bank will attain and maintain a Tier I capital ratio of not less than 9% and a Total Risk-Based Capital Ratio of not less than 12% by December 31, 2009, a contingency plan in the event that the Bank has not adequately complied with the capital requirements; have and retain qualified management of the Bank, assess management and staffing needs, qualifications and performance; maintain a fully funded allowance for loan losses; reduce commercial real estate loans; review, revise and adhere to the Bank’s loan policy, develop a liquidity funds management policy; not accept, renew or roll-over brokered deposits without obtaining regulatory approval; not pay cash dividends without regulatory approval; and furnish quarterly progress reports to the FDIC and CDFI regarding its compliance with the Order.
The Order specifies certain timeframes for meeting the requirements of the Order. The Bank has established a Board Oversight committee to monitor and coordinate compliance with the Order and such remedial measures are in process. The Order will remain in effect until modified or terminated by the FDIC and the CDFI. We have not achieved the Tier I Capital or Total Risk-Based Capital Ratios required under the Order by December 31, 2009 nor have we reduced the Bank’s assets classified as “substandard” in relation to Tier I Capital plus the allowance for loan losses to not more than 100 percent by March 12, 2010. The failure to comply with the terms of the Order could result in significant enforcement actions against the Bank of increasing severity, up to and including a regulatory takeover of the Bank.
As we reported in our Form 8-K filed with the SEC on January 21, 2010, the Company entered into an agreement with the Federal Reserve Bank of San Francisco (the “Federal Reserve”) effective January 14, 2010 (the “FRB Agreement”). The FRB Agreement generally provides for the development and implementation of actions to ensure the Bank complies with the Order, and any other supervisory action taken by the Bank’s federal or state regulators. Among other things, the FRB Agreement requires the Company to:
The FRB Agreement specifies certain timeframes for meeting the requirements of the FRB Agreement. The Company has established an oversight committee to monitor and coordinate compliance with the FRB Agreement and responsive actions have been taken. The FRB Agreement will remain in effect until modified or terminated by the Federal Reserve. The failure to comply with the terms of the FRB Agreement could result in significant enforcement actions against the Company.
On March 12, 2010, the Company submitted to the FRB a written capital plan and a written statement regarding cash flow projections for 2010.
As we reported in our Form 8-K filed with the SEC on February 25, 2010, the Bank received a Supervisory Prompt Corrective Action Directive (the “Directive”) from the FDIC due to the Bank’s “significantly undercapitalized” status as of December 31, 2009 under regulatory capital guidelines.
The Directive provides that within 30 days of the effective date of the Directive (by March 21, 2010), the Bank must: (1) sell enough voting shares or obligations of the Bank so that Bank will be “adequately capitalized” under regulatory capital guidelines; and/or (2) accept an offer to be acquired by a depository institution holding company or combine with another insured depository institution. While the Company has not yet raised capital and no assurance can be given that it will be successful in its efforts to recapitalize the Bank, the Company has been, with the assistance of its investment banking firm, actively engaged in seeking additional capital from various sources.
The Directive also prohibits the Bank from: (1) paying interest on deposits in excess of prescribed limits; (2) accepting, renewing or rolling over any brokered deposits; (3) allowing its average total assets during any calendar quarter to exceed its average total assets during the preceding calendar quarter; (4) making any capital distributions or dividend payments to the Company or any affiliate of the Bank or the Company; and (5) establishing or acquiring a new branch and requires the Bank to obtain the approval of the FDIC prior to relocating, selling or disposing of any existing branch. In addition, the Directive provides that the Bank may not pay any bonus to, or increase the compensation of, any director or officer of the Bank without the prior approval of the FDIC, and the Bank must comply with Section 23A of the Federal Reserve Act without the exemption for transactions with certain affiliated institutions. Lastly the Bank may not enter into any material transaction, including any investment, expansion, acquisition, sale of assets or other similar transaction which would have a significant financial impact on the Bank without prior approval of the FDIC. The Bank was already substantially subject to each of these prohibitions prior to the issuance of the Directive, and since last year, key components of the Bank’s business strategy have included the reduction in its asset base and brokered deposits.
The failure to comply with the terms of the Directive could result in a regulatory takeover of the Bank. The Company’s principal assets are the capital stock of the Bank and it is not likely the Company would receive any recovery after such a regulatory action.
Additionally, the holding company unconditionally guarantees that the Bank will comply with the Capital Restoration Plan (“CRP”) until the FDIC notifies the Bank, in writing, that the Bank has been “adequately capitalized”, on average for four consecutive quarters. Additional undertakings by the holding company include:
The Bank was established in 1991 and is subject to primary supervision, periodic examination and regulation by the CDFI and by the FDIC as the Bank’s primary federal regulator. The Bank, now a California chartered commercial bank, has its deposits insured by the FDIC to the extent provided by law. The Bank operates seven full service branches in Marin County, located north of San Francisco, California. The Bank offers a full range of banking services targeting small-to-medium sized businesses, individuals and high-net worth consumers. The Bank seeks to focus on relationship-based community banking, providing each customer with a number of services, familiarizing itself with, and addressing itself to, customer needs. These customers demand the convenience and personal service that a local, independent financial institution can offer. The Bank attracts deposits, loans and lines of credit from small-to-medium sized businesses, not-for-profit organizations, individuals, merchants, and professionals who live and/or work in the communities comprising the Bank’s market areas.
The Bank’s deposit products include checking products for both business and personal accounts, tiered money market accounts offering a variety of access methods, tax qualified deposits accounts (e.g., IRAs), and certificates of deposit products. The Bank also offers commercial cash management products and DepositNOW Remote Deposit Capture, which is a check clearing tool that allows customers to deposit checks without going to a branch. A courier service is available to the Bank’s professional and business clients. Additionally, the Bank offers its depositors 24-hour access to their accounts by telephone and to both consumer and business accounts through its Internet banking products. The Bank’s ATM network is linked to both the STAR and PLUS networks and is also a member of the MoneyPass® nationwide network whereby customers have access to more than 24,000 surcharge-free ATMs.
The Bank’s lending programs include commercial and retail lending programs including commercial and industrial real estate loans, commercial loans to businesses including SBA loans, mortgages for multifamily real estate, revolving lines of credit and term loans, consumer loans including secured and unsecured lines of credit, land and construction lending for commercial real estate, single family residences and apartment buildings. Because of the regulatory actions as described in this Report, lending activities to borrowers have been curtailed by the Bank. The Bank is currently unable to fund any Commercial Real Estate loans as noted in the Order.
In connection with recent turmoil in the California economy and California real estate market, the Bank recorded a net loss of $37,628,000 for the fiscal year ended December 31, 2009. This loss was primarily attributable to the increases in our loan loss provision for loans sold in the fourth quarter of 2009 and for loans planned to be sold in the first quarter of 2010 subject to regulatory approval, general loan loss provision, as well as non-cash charges of $11,231,000 for the valuation allowance established against deferred tax assets due to significant doubt as to the ability of the Company to realize these deferred tax assets against positive taxable income in future years.
Nonperforming assets totaled $46,946,000 at year end 2009, up from $17,175,000 as of December 31, 2008. Small business owners and investors have seen reduced revenues due to declining economic activity, and rising unemployment has caused some borrowers to become delinquent on loan payments. Additionally, the value of land, construction and commercial real estate loans have been severely impacted by the decline in occupancy rates, rental lease rates and property values. The net loss has had a negative impact on our liquidity and capital adequacy and has resulted in actions by our regulators to restrict our operations as discussed under Regulatory Action above in this Report. See further discussion in the Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Report. In response to those regulatory actions, we have implemented a remediation plan and are pursing alternative capital and liquidity options.
Tamalpais Wealth Advisors
TWA is a registered investment advisor under the Investment Advisers Act of 1940, as amended. TWA provides investment management, financial planning and advice to high-net worth individuals, families and institutions in the Marin County and surrounding marketplace.
As we reported in our Form 8-K filed with the SEC on February 4, 2010, the Bank entered into an agreement with a San Francisco-based firm whereby the staff of TWA will be absorbed by this firm, and its clients will be referred to the firm and the Company will share revenues from the clients who migrate to the San Francsico-based firm for a period of five years. See Note 25 of this Report on Subsequent Events for TWA.
The Company is headquartered in Marin County, California, which has a population of 253,287, the second highest household income in the state and the 5th highest per capita income out of the 3,111 counties nationwide, according to data from the U.S. Census Bureau. In Marin County, the median price for a single-family home is $755,000, according to DataQuick’s December 2009 home sales report, up $80,000, or 11.9% from the same period a year ago. The per capita income is $91,483, which is the 5th highest in the nation, and household income is $83,910, which is the second highest in the State, according to data from U.S. Census Bureau. Marin County had $9.2 billion in total deposits as of June 30, 2009 and the Bank’s market share of total Marin County deposits increased from 5.14% to 5.27%, an increase of thirteen basis points for the twelve month period from June 2008 to June 2009 according to data from the FDIC (the latest data for which the information is available).
The Company’s market area consists primarily of Marin and San Francisco Counties and to a lesser degree the Greater Bay Area including Alameda, Contra Costa, San Mateo, Santa Clara, Sonoma and Napa counties. The Bank’s deposit gathering efforts are focused primarily in the Marin County communities surrounding its full service branches.
Calendar year 2009 and 2008 were challenging times not only on the national level, but within the state of California, and more specifically, the Company’s primary market area. The ongoing recession that began in the fourth quarter of 2007 has severely impacted the national, state and local housing and commercial markets. The unemployment rate in California has increased dramatically, rising to 12.3% as of December 31, 2009, up from 9.1% as of December 31, 2008. The unemployment rate in Marin County has increased from 5.5% as of December 31, 2008 to 8.0% as of December 31, 2009. Although the Company’s market areas have historically weathered economic downturns better than other areas of the State, the decline in home values, commercial property values and rising unemployment, among other factors, have affected the ability of borrowers to satisfy their financial obligations on a national, state, and local level.
The Company has adopted a business strategy of developing a business-based banking approach as a means of increasing market share in Marin County. The Company’s strategy of focusing on business owners and individuals residing in the Company’s market area and providing them with financial services and advice to help them grow and prosper incorporates a relationship-based approach to customer service and marketing. The Company has also focused its sales efforts through its Marin County based team of business banking professionals on building the balances of more profitable, noninterest bearing and lower cost transaction accounts from within our market area in order to reduce the cost of funds and dependence on brokered deposits.
Management has embarked upon several ongoing strategic initiatives to strengthen the Company’s financial position, reduce credit and funding risk, and lower the cost of funds. In the first quarter of 2009, the Bank eliminated wholesale commercial and multifamily lending through mortgage brokers, closed the loan production office in Santa Rosa, and eliminated SBA lending outside the Company’s Bay Area footprint. We believe this will allow us to focus solely on in-market customers with whom we can develop a complete banking relationship. It also allows the Company to reduce the level of wholesale funding, as loan portfolio growth will be limited to customers with whom the Bank has a deposit relationship, including low cost transaction and checking accounts. The Company believes this strategy will increase franchise value and strengthen the balance sheet. Additionally, the employees and directors of the Company maintain a high level of involvement and visibility within the community and not-for-profit sector.
The Company also added experience and depth to its credit administration team. In the fourth quarter of 2008, management hired a Chief Credit Officer with extensive in-market commercial lending experience and in the first quarter of 2009 added managers with specific experience in portfolio management and loan administration. In the second quarter of 2009, the Bank promoted Jamie Williams, who has over twenty years of experience working in the Marin County banking industry, to be Executive Vice President/Market President of the Bank. Management also obtains, from time to time, independent third party reviews and managers assistance of the loan portfolio from outside consultants who have bank regulatory or credit experience and are familiar with applicable regulatory guidelines and industry practices. All of these actions enable the Company to continue to be proactive in monitoring credit quality.
In addition, the Company is taking steps to enhance the capital position of the Bank and the Company. In this regard, the Company adopted a plan to reduce certain assets and wholesale liabilities of the Bank, control overhead once the Company has been stabilized, sell certain nonperforming and performing loans and retain earnings. The Board of Directors has suspended paying dividends on its shares of common stock and has deferred payments on the Company’s trust preferred securities to prudently manage its capital position. The Board of Directors is pursuing all alternative strategies, including raising capital, and has engaged a financial advisor.
The Bank is focused on selling performing and nonperforming loans, reducing its reliance on brokered deposits and FHLB funding and on reducing its cost of funds by acquiring small business and consumer deposits through its team of business banking professionals and through its retail branches. As a result of these efforts, the Bank sold $63.5 million in principal of performing and nonperforming loans during fiscal year 2009, FHLB borrowings have decreased $64.0 million, or 35% as of December 31, 2009 while noninterest bearing deposits increased $10.1 million, or 30.4% compared to December 31, 2008. Additionally, because of the regulatory actions as described in this Report, the Company is prohibited from any expansionary activities.
The Company’s strategy incorporates:
The Bank has ongoing programs to evaluate the adequacy of its allowance for loan losses in the current economic conditions. These programs use quantitative analysis to stress test the credit risk inherent in the loan portfolio under various default assumptions and incorporate current industry probabilities of default. In addition, the Bank has enhanced its process of evaluating nonperforming loans for impairment. This process involves, among other factors, obtaining updated appraisals, current financial statements, current credit reports, and verifying current net worth and liquidity positions of selected borrowers. The ongoing viability of businesses is also evaluated, including land and construction loans that have been impacted by the downturn in property values.
Based on the continued implementation of these processes and coupled with the increased level of nonperforming assets in fiscal year 2009, loan loss provisions are expected to remain elevated for fiscal year 2010. In addition, as updated appraisals and financial information are received on specific nonperforming assets, specific impairment charges are also likely to be recorded in fiscal year 2010 although the magnitude of these charges cannot be estimated at this time.
The banking and financial services business in California generally, and in the Company’s market area specifically, is highly competitive with respect to attracting both loan and deposit relationships. The increasingly competitive environment is a result of many factors including, but not limited to:
The Company competes for loans, deposits, investments, fee based products, and customers for financial services with commercial banks, savings and loans, credit unions, mortgage bankers, securities and brokerage companies, registered investment advisor firms, insurance firms, finance companies, mutual funds, and other non-bank financial service providers. Many of these competitors are much larger than the Company in total assets, personnel, resources and capitalization and enjoy greater access to capital markets and can offer a broader array of products and services than the Company currently offers.
As of June 30, 2009, approximately 95 banking offices with $9.2 billion in total deposits served the Marin County market. The four banking institutions with the greatest market share, Wells Fargo Bank, Bank of America, Bank of Marin and Westamerica Bank, had deposit market shares of 25.1%, 18.9%, 9.4% and 8.1%, respectively, as of June 30, 2009, the most recent date for which data is available, compared with the Bank’s share of 5.3%.
The Company also competes for depositors’ funds with money market mutual funds and with non-bank financial institutions such as brokerage firms, investment management firms and insurance companies. Among the competitive advantages held by certain of these non-bank financial institutions is the ability to finance extensive advertising campaigns, and to allocate investment assets to regions of California or other states with areas of highest demand and often, therefore, highest yield. Large commercial banks also have substantially greater lending limits than the Bank and the ability to offer certain services which are not offered directly by the Bank.
In order to compete with other financial service providers, the Company uses to the fullest extent possible the flexibility and rapid response capabilities which are accorded by its independent status. This includes an emphasis on:
As of December 31, 2009, the Company employed 72 full-time employees. The employees are not represented by a union or covered by a collective bargaining agreement. The Company believes that its employee relations are good.
There were no significant expenditures made by the Company during the last two fiscal years on material research activities relating to the development of services. The Company’s business is not seasonal. The Company intends to continue its business banking activities that have characterized the Company’s operations over the last year, subject to the restriction placed on the Company due to the Regulatory Orders.
Effect of Governmental Policies and Legislation
The commercial banking business is not only affected by general economic conditions but is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System (the “FRB”). The FRB implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States Government securities which effect short term rates such as the Fed Funds rate, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact on the Bank of any future changes in monetary policies cannot be predicted.
From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial intermediaries. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial intermediaries are frequently made in Congress, the California legislature and before various banks regulatory and other professional agencies.
Supervision and Regulation
On January 30, 2009, the Bank converted from a California industrial bank to a California chartered commercial bank, and the Company became a bank holding company under the Bank Holding Company Act of 1956, as amended, (“BHCA”).
The Bank and holding company operations are subject to extensive regulation by federal and state regulatory agencies. This regulation is intended primarily for the protection of depositors and the Bank Insurance Fund (“BIF”) and not for the benefit of shareholders. Moreover, major new legislation and other regulatory changes affecting the Company, the Bank and the financial services industry in general have occurred in the current and recent years and can be expected to occur in the future. The nature, timing and impact of new and amended laws and regulations cannot be accurately predicted. The following information describes some of the more significant laws, regulations, and policies that are applicable to the Company and the Bank, and does not purport to be complete and is qualified in its entirety by reference to all particular statutory or regulatory provisions.
Regulation and Supervision of The Company
As a bank holding company, the Company is subject to regulation and examination by the FRB under the BHCA. The Company is required to file with the FRB periodic reports and such additional information as the FRB may require.
The FRB may require the Company to terminate an activity or terminate control of or liquidate or divest certain subsidiaries, affiliates or investments if the FRB believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any bank subsidiary. The FRB also has the authority to regulate provisions of certain bank holding company debt, including the authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain FRB approval prior to purchasing or redeeming its equity securities. Further, the Company is required by the FRB to maintain certain levels of capital.
The Company is required to obtain prior FRB approval for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior FRB approval is also required for the merger or consolidation of a bank holding company with another bank holding company. Similar state banking agency approvals may also be required. Certain competitive, management, financial and other factors are considered by the bank regulatory agencies in granting these approvals.
With certain exceptions, bank holding companies are prohibited from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to subsidiaries. However, subject to prior notice or FRB approval, bank holding companies may engage in, or acquire shares of companies engaged in, those nonbanking activities determined by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
FRB regulations require that bank holding companies serve as a source of financial and managerial strength to subsidiary banks and commit resources as necessary to support each subsidiary bank. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of FRB regulations or both. The FRB’s bank holding company rating system also emphasizes risk management and evaluation of the potential impact of nondepository entities on safety and soundness.
The Company is also treated as a bank holding company under the California Financial Code. As such, the Company and its subsidiaries are subject to periodic examination by, and may be required to file reports with, the CDFI.
Directors, officers and principal shareholders of the Company have had and will continue to have banking transactions with the Bank in the ordinary course of business. Any loans and commitments to lend included in such transactions are made in accordance with applicable law, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons of similar creditworthiness, and on terms not involving more than the normal risks of collection or presenting other unfavorable features.
As previously disclosed in this Report, the Company entered into an agreement with the Federal Reserve Bank of San Francisco which provides among other things, for the development and implementation of actions to ensure the Bank complies with the Order to Cease and Desist with the FDIC and CDFI, and any other supervisory action taken by the Bank’s federal or state regulators.
Additionally, the holding company unconditionally guarantees that the Bank will comply with the Capital Restoration Plan (“CRP”) until the FDIC notifies the Bank, in writing, that the Bank has been “adequately capitalized”, on average for four consecutive quarters. Additional undertakings by the holding company include:
The Company’s securities are registered with the SEC under the Securities Exchange Act of 1934, as amended. As such, the Company is subject to the information, proxy solicitation, insider trading, corporate governance, and other requirements and restrictions of the Exchange Act.
Regulation and Supervision of The Bank
The Bank is a California state-chartered commercial bank and its deposits are insured by FDIC to the extent provided by law. The Bank is subject to primary supervision, periodic examination and regulation by the CDFI and the FDIC, as the Bank’s primary federal regulator. In general, under the California Financial Code, California banks have all the powers of a California corporation, subject to the general limitation of state bank powers under the Federal Deposit Insurance Act (“FDIA”) to those permissible for national banks. Specific federal and state laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for certain loans. The regulatory structure also gives the bank regulatory agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Furthermore, the Bank is required to maintain certain levels of capital, and is also subject to consumer protection laws.
If, as a result of an examination of the Bank, the FDIC or the CDFI should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to those regulatory agencies. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors and take possession and close and liquidate the Bank.
As previously disclosed in this Report, the Bank entered into an Order to Cease and Desist with the FDIC and CDFI effective September 14, 2009 and the Directive with the FDIC on February 19, 2010. The Order is a formal corrective action pursuant to which the Bank has agreed to address specific areas through the adoption and implementation of procedures, plans and policies designed to enhance the safety and soundness of the Bank. The failure to comply with the terms of the Order or the Directive could result in significant enforcement actions against the Bank of increasing severity, up to and including a regulatory takeover of the Bank.
Regulation of Non-banking Affiliates – TWA
TWA is registered with the SEC as an investment adviser and is subject to various regulations and restrictions imposed by those entities, as well as by various state authorities. Such regulations cover a broad range of subject matters. Rules and regulations for registered investment advisers cover such issues as sales and trading practices; use of client funds and securities; the conduct of directors, officers, and employees; record-keeping and recording; supervisory procedures to prevent improper trading on material non-public information; and qualification and licensing of sales personnel. The SEC’s risk assessment rules also apply to TWA as a registered investment adviser. These rules require a registered investment advisor to maintain and preserve records and maintain risk management policies and procedures. In addition to federal registration, state securities commissions require the registration of certain investment advisors.
Violations of federal, state and FINRA rules or regulations may result in the revocation of investment advisor licenses, imposition of censures or fines, the issuance of cease and desist orders, and the suspension or expulsion of officers and employees from the securities business firm.
Dividends and Other Transfer of Funds
Dividends from the Bank constitute the principal source of funds to the Company. The Company is a legal entity separate and distinct from the Bank. The Company’s ability to pay cash dividends is limited by California law such that shareholders of the Company may receive dividends when and as declared by the Board of Directors out of funds legally available for such purpose. With certain exceptions, a California corporation may not pay a dividend to its shareholders unless: (i) its retained earnings equal at least the amount of the proposed dividend, or (ii) after giving effect to the dividend, the corporation’s assets would equal at least 1.25 times its liabilities and, for corporations with classified balance sheets, the current assets of the corporation would be at least equal to its current liabilities or, if the average of the earnings of the corporation before taxes on income and before interest expense for the two preceding fiscal years was less than the average of the interest expense of the corporation for those fiscal years, at least equal to 1.25 times its current liabilities.
The FDIC and the CDFI have authority to prohibit the Bank from engaging in activities that, in their opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC and CDFI could assert that the payment of dividends or other payments might, under some circumstances, be an unsafe or unsound practice. Furthermore, the FDIC has established guidelines with respect to the maintenance of appropriate levels of capital by banks under its jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends which the Bank may pay. An insured depository institution is prohibited from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. The CDFI may impose similar limitations on the Bank. Under certain circumstances, dividends could be prohibited under the Trust Preferred Securities.
As a result of the Order and Directive as discussed in this Report, the Bank is not permitted to pay any cash dividend, without the prior written approval of FDIC and CDFI. As a result, the Bank currently cannot pay a dividend to the holding company.
The federal banking agencies have adopted risk-based minimum capital guidelines for bank holding companies and banks that are expected to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as commercial loans.
The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to average assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio must be 3%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above minimum guidelines and ratios.
As a result of the Order and Directive as discussed previously in this Report, our failure to remain “well capitalized” for bank regulatory purposes could result in a regulatory takeover of the Bank.
Prompt Corrective Action and Other Enforcement Mechanisms
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective federal regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements to be classified as well-capitalized or adequately capitalized. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An “undercapitalized” institution must develop a capital restoration plan.
An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized, may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. Banking agencies have also adopted regulations which mandate that regulators take into consideration: (i) concentrations of credit risk; (ii) interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position); and, (iii) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a part of the institution’s regular safety and soundness examination. In addition, the banking agencies have amended their regulatory capital guidelines to incorporate a measure for market risk. In accordance with the amended guidelines, the Company and any company with significant trading activities must incorporate a measure for market risk in its regulatory capital calculations.
As disclosed previously in this Report, the Bank received a Supervisory Prompt Corrective Action Directive from the FDIC on February 19, 2010 due to the Bank’s “significantly undercapitalized” status as of December 31, 2009 under regulatory capital guidelines.
Safety and Soundness Standards
FDICIA imposes certain specific restrictions on transactions and requires federal banking regulators to adopt overall safety and soundness standards for depository institutions related to internal control, loan underwriting and documentation and asset growth. Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, restricts the use of brokered deposits, limits the aggregate extensions of credit by a depository institution to an executive officer, director, principal shareholder or related interest, and reduces deposit insurance coverage for deposits offered by undercapitalized institutions for deposits by certain employee benefit accounts. The federal banking agencies may require an institution to submit to an acceptable compliance plan as well as have the flexibility to pursue other more appropriate or effective courses of action given the specific circumstances and severity of an institution’s noncompliance with one or more standards.
In December 2006, the FRB and FDIC issued joint guidance relating to institutions’ concentrations in commercial real estate lending. These agencies have observed that commercial real estate concentrations have been rising over the past several years and have reached levels that could create safety and soundness concerns in the event of a significant economic downturn. While these agencies are not establishing a limit on the amount of commercial real estate lending that an institution may conduct, they have established a threshold which examiners may use to identify institutions with potential concentration risk. Any institution that: (1) has experienced rapid growth in commercial real estate lending; (2) has notable exposure to a specific type of commercial real estate; or, (3) is approaching or exceeds the supervisory criteria may be identified for further examination.
Premiums for Deposit Insurance and Assessments for Examinations
The Bank’s deposits are insured by the Deposit Insurance Fund (DIF) administered by the FDIC. FDICIA established several mechanisms to increase funds to protect deposits insured by the DIF. The FDIC is authorized to assess premiums on depository institutions which are members of the DIF, and borrow from the Treasury. Any borrowings not repaid by asset sales are to be repaid through insurance premiums assessed to member institutions. Such premiums must be sufficient to repay any borrowed funds within 15 years and provide insurance fund reserves of $1.25 for each $100 of insured deposits. FDICIA also provides authority for special assessments against insured deposits.
Congress adopted the Federal Deposit Insurance Reform Act of 2005 as part of the Deficit Reduction Act of 2005 and the President signed it on February 8, 2006 and a companion bill, the Federal Deposit Insurance Reform Conforming Amendments Act of 2005, on February 15, 2006. This legislation provided for:
The FDIC has designated the DIF long-term target reserve ratio at 1.25% of insured deposits. Due to recent bank failures, the FDIC insurance fund reserve ratio has fallen below 1.15%, the statutory minimum. Effective January 1, 2009, the FDIC adopted a restoration plan that uniformly increased insurance assessments. The FDIC adopted changes to the deposit insurance assessment system beginning with the second quarter of 2009 to make the increase in assessments fairer by requiring riskier institutions to pay a larger share. Institutions would be classified into one of four risk categories. Within each category, the FDIC will be able to assess higher rates to institutions with a significant reliance on secured liabilities, which generally raises the FDIC’s loss in the event of failure without providing additional assessment revenue. The proposal also would assess higher rates for institutions with a significant reliance on brokered deposits but, for well-managed and well-capitalized institutions, only when accompanied by rapid asset growth. The proposal also would provide incentives in the form of a reduction in assessment rates for institutions to hold long-term unsecured debt and, for smaller institutions, high levels of Tier 1 capital. Together, the changes improved the way the system differentiates risk among insured institutions.
Under the EESA, adopted on October 3, 2008, certain increases in FDIC deposit insurance have also been approved, as amended. From October 3, 2009, until December 31, 2013, the amount of deposit insurance provided by the FDIC is increased from $100,000 to $250,000. This temporary increase is automatic. In November 2008, the FDIC adopted the Transaction Account Guaranty Program (“TAGP”) that provides, in exchange for additional assessments, unlimited deposit insurance on funds in noninterest-bearing transaction deposit accounts, certain attorney trust accounts, and NOW accounts paying no more than 50 basis points of interest regardless of dollar amount. Given the current deficient funded condition of the DIF and expected continued bank failures, the Bank expects premiums for deposit insurance to remain elevated. In addition, in May 2009, the FDIC imposed a special assessment of 5 basis points of each institution’s assets minus Tier 1 capital as of June 30, 2009, not to exceed 10 basis points times its assessment base for the quarter. In November 2009, the FDIC adopted a rule requiring prepayment of assessments for 2010, 2011 and 2012. This rule allows the FDIC, however, to exercise its discretion under certain circumstances to exempt an institution that is under a Cease and Desist Order to be exempt from the prepaid requirement, and thus the Bank was exempt from prepaying these assessments in 2009.
Consumer Protection Laws and Regulations
The bank regulatory agencies are focusing greater attention on compliance with consumer protection laws and their implementing regulations. Examination and enforcement have become more intense in nature, and insured institutions have been advised to monitor carefully compliance with various consumer protection laws and their implementing regulations. The Bank is subject to many federal consumer protection statutes and regulations, including Community Reinvestment Act, Equal Credit Opportunity Act, Truth in Lending Act, Fair Housing Act, Home Mortgage Disclosure Act and Real Estate Settlement Procedures Act. Penalties under these statutes may include fines, reimbursements and other penalties. Due to heightened regulatory concern related to compliance with these and other statutes generally, the Bank may incur additional compliance costs.
The Community Reinvestment Act (“CRA”) and Fair Lending Developments
The Bank is subject to certain fair lending requirements and reporting obligations involving lending, investing and other CRA activities. CRA requires the Bank to identify the communities served by the Bank’s offices and to identify the types of credit and investments the Bank is prepared to extend within such communities including low and moderate income neighborhoods. It also requires the Bank’s regulators to assess the Bank’s performance in meeting the credit needs of its community and to take such assessment into consideration in reviewing application for mergers, acquisitions, relocation of existing branches, opening of new branches and other transactions. A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws. The federal banking agencies may take compliance with such laws and CRA in consideration when regulating and supervising other banking activities.
A bank’s compliance with its CRA obligations is determined based on a performance-based evaluation system which bases CRA ratings on an institution’s lending, service and investment performance. An unsatisfactory rating may be the basis for denying a merger application. The Bank’s latest CRA examination was completed by the FDIC and received an overall rating of outstanding in complying with its CRA obligations.
Gramm-Leach-Bliley Financial Services Modernization Act (“GLB Act”)
In November 1999, the GLB Act was enacted. The GLB Act repeals provisions of the Glass-Steagall Act which restricted the affiliation of Federal Reserve member banks with firms “engaged principally” in specified securities activities, and which restricted officer, director or employee interlocks between a member bank and any company or person “primarily engaged” in specified securities activities. In addition, the GLB Act contains provisions that expressly preempt any state law restricting the establishment of financial affiliations, primarily related to insurance. The general effect of the law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers by revising and expanding the BHCA framework to permit a holding company to engage in a full range of financial activities through a new entity known as a “financial holding company.” “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
The GLB Act provides that no company may acquire control of an insured savings association unless that company engages, and continues to engage, only in the financial activities permissible for a financial holding company, unless the company is grandfathered as a unitary savings and loan holding company. The GLB Act grandfathers any company that was a unitary savings and loan holding company on May 4, 1999 or became a unitary savings and loan holding company pursuant to an application pending on that date. The GLB Act also permits national banks to engage in expanded activities through the formation of financial subsidiaries. A national bank may have a subsidiary engaged in any activity authorized for national banks directly or any financial activity, except for insurance underwriting, insurance investments, real estate investment or development, or merchant banking, which may only be conducted through a subsidiary of a financial holding company. Financial activities include all activities permitted under new sections of the BHCA or permitted by regulation.
To the extent that the GLB Act permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. The GLB Act is intended to grant to community banks powers as a matter of right that larger institutions have accumulated on an ad hoc basis and which unitary savings and loan holding companies already possess. Nevertheless, the GLB Act may have the result of increasing the amount of competition that the Company faces from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company has.
Customer Information Security
The federal bank regulatory agencies have established standards for safeguarding nonpublic personal information about customers that implement provisions of the GLB Act (the “Guidelines”). Among other things, the Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against any anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.
Bank Secrecy Act (“BSA”)
The BSA is a tool that the U.S. government uses to fight drug trafficking, money laundering and other crimes. Under the BSA, financial institutions are required to file certain reports, including suspicious activities reports and currency transaction reports, with the Financial Crimes Enforcement Network under certain circumstances. Financial institutions are also required to have policies and procedures in place to ensure compliance with the BSA. If a financial institution fails to timely file a report or fails to implement its BSA policies and procedures, it could subject the institution to enforcement action or civil money penalties. In July 2007, federal banking regulators issued the Intercompany Statement on Enforcement of Bank Secrecy Act/Anti-Money Laundering Requirements to provide greater consistency among the agencies in enforcement decisions in BSA matters and to offer insight into the considerations that form the basis of such BSA enforcement decisions.
On October 26, 2001, the President signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001. The USA PATRIOT Act also made significant changes to BSA. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and of identifying customers when establishing new relationships and standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps:
Under the USA PATRIOT Act, financial institutions are to establish anti-money laundering programs to enhance their BSA. The USA PATRIOT Act sets forth minimum standards for these programs, including the development of internal policies, procedures, and controls, designation of a compliance officer, ongoing employee training program, and independent audit function to test the programs. Management believes that the Bank is currently in compliance with the USA PATRIOT Act.
Sarbanes-Oxley Act of 2002
On July 30, 2002, the Sarbanes-Oxley Act of 2002 (“SOX”), was signed into law to address corporate and accounting fraud. SOX establishes a new accounting oversight board that will enforce auditing standards and restricts the scope of services that accounting firms may provide to their public company audit clients. Among other things, SOX also: (i) requires chief executive officers and chief financial officers to certify to the accuracy of periodic reports filed with the SEC; (ii) imposes new disclosure requirements regarding internal controls, off-balance-sheet transactions, and pro forma (non-GAAP) disclosures; (iii) accelerates the time frame for reporting of insider transactions and periodic disclosures by public companies; and, (iv) requires companies to disclose whether or not they have adopted a code of ethics for senior financial officers and whether the audit committee includes at least one “audit committee financial expert.”
Under SOX, the SEC is required to regularly and systematically review corporate filings, based on certain enumerated factors. To deter wrongdoing, SOX: (i) subjects bonuses issued to top executives to disgorgement if a restatement of a company’s financial statements was due to corporate misconduct; (ii) prohibits an officer or director from misleading or coercing an auditor; (iii) prohibits insider trades during pension fund “blackout periods”; (iv) imposes new criminal penalties for fraud and other wrongful acts; and, (v) extends the period during which certain securities fraud lawsuits can be brought against a company or its officers. As a public reporting company, the Company was required to provide management’s report on internal control over financial reporting beginning with its 2009 Annual Report on Form 10-K. The auditor’s attestation report on internal controls over financial reporting is not required until 2010 unless there is a deferment announced during 2010. The Company has adopted a code of ethics (“Code of Ethics”) that applies to its executive officers. A copy of the Code of Ethics is filed as an exhibit hereto.
California Financial Information Privacy Act/Fair Credit Reporting Act
In 1970, the Federal Fair Credit Reporting Act (the “FCRA”) was enacted to insure the confidentiality, accuracy, relevancy and proper utilization of consumer credit report information. Under the framework of the FCRA, the United States has developed a highly advanced and efficient credit reporting system. The information contained in that broad system is used by financial institutions, retailers and other creditors of every size in making a wide variety of decisions regarding financial transactions. Employers and law enforcement agencies have also made wide use of the information collected and maintained in databases made possible by the FCRA. The FCRA affirmatively preempts state law in a number of areas, including the ability of entities affiliated by common ownership to share and exchange information freely, and the requirements on credit bureaus to reinvestigate the contents of reports in response to consumer complaints, among others.
Congress enacted the FACT Act, (“Fair and Accurate Credit Transaction Act”) of 2003, which has the effect of avoiding the sunset preemption provision of the Fair Credit Reporting Act (FCRA) that were due to expire on December 31, 2003. The President signed the FACT Act into law on December 4, 2003. In general, the FACT Act amends the FCRA and, in addition, provides that, when the implementing regulations have been issued and become effective, the FACT Act preempts elements of the California Financial Information Privacy Act. A series of regulations and announcements were promulgated during 2004, including a joint FTC/Federal Reserve announcement of effective dates for FCRA amendments, the FTC’s “Free Credit Report” rule, revisions to the FTC’s FACT Act Rules, the FTC’s final rules on identity theft and proof of identity, the FTC’s final regulation on consumer information and records disposal, and the FTC’s final summaries and notices. Regulations implementing this provision of FACT Act have a mandatory effective date of October 1, 2008. The Bank has developed and implemented a written program to detect, prevent, and mitigate identity theft for certain new and existing accounts.
Transactions between a bank and its “affiliates” are governed by Sections 23A and 23B of the Federal Reserve Act. The Federal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The FRB also issued Regulation W, which became effective on April 1, 2003, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and provides interpretative guidance with respect to affiliate transactions. Affiliates of a bank include, among other entities, the bank’s parent company and companies that are under common control with the bank. The Company is considered to be an affiliate of the Bank. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their abilities to engage in “covered transactions” with affiliates:
A “covered transaction” includes, among other things, a loan or extension of credit to an affiliate; a purchase of securities issued by an affiliate; a purchase of assets from an affiliate, with some exceptions; and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In addition, a bank and its subsidiaries may engage in certain transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. The Bank is in compliance with Regulation W.
Programs to Mitigate Identity Theft
In November 2007, federal banking agencies together with the NCUA and FTC adopted regulations under the Fair and Accurate Credit Transactions Act of 2003 to require financial institutions and other creditors to develop and implement a written identity theft prevention program to detect, prevent and mitigate identity theft in connection with certain new and existing accounts. Covered accounts generally include consumer accounts and other accounts that present a reasonably foreseeable risk of identity theft. Each institution’s program must include policies and procedures designed to: (i) identify indicators, or “red flags,” of possible risk of identity theft based; (ii) detect the occurrence of red flags; (iii) respond appropriately to red flags that are detected; and, (iv) ensure that the program is updated periodically as appropriate to address changing circumstances. The regulations include guidelines that each institution must consider and, to the extent appropriate, include in its program.
Changes to state laws and regulations (including changes in interpretation or enforcement) can affect the operating environment of bank holding companies and their subsidiaries in substantial and unpredictable ways. From time to time, various legislative and regulatory proposals are introduced. These proposals, if codified, may change banking statutes and regulations and the Company’s operating environment in substantial and unpredictable ways. If codified, these proposals could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Company cannot accurately predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon our financial condition or results of operations. It is likely, however, that the current level of enforcement and compliance-related activities of federal and state authorities will continue and potentially increase.
Readers and prospective investors in our securities should carefully consider the following risk factors as well as the other information contained in this report. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors. Any of the following risks could adversely affect our financial performance and condition.
We have consented to the issuance of a cease and desist order by our regulators and failure to comply with the terms of this order could result in significant enforcement actions.
We and our subsidiaries are regulated by several regulators, including the Federal Reserve, SEC, FDIC and California DFI. Our success is affected by state and federal regulations affecting banks and bank holding companies, and the securities markets. Banking regulations are primarily intended to protect depositors, not shareholders. The financial services industry also is subject to frequent legislative and regulatory changes and proposed changes, the effects of which cannot be predicted. Federal bank regulatory agencies and the Treasury, as well as the Congress and the President, are evaluating the regulation of banks, other financial services providers and the financial markets and such changes, if any, could require us to maintain more capital, liquidity and risk management which could adversely affect our growth, profitability and financial condition.
On September 14, 2009 the FDIC and the California DFI issued the Order to the Bank. Among other things, the Order mandates that the Bank cease and desist from certain unsafe and unsound banking practices, including operating with: management whose policies and practices are detrimental to the Bank and jeopardize the safety of its deposits; inadequate board oversight; inadequate capital in relation to the kind and quality of assets held by the Bank; an inadequate loan valuation reserve; a large volume of poor quality loans; engaging in unsatisfactory lending and collection practices; and inadequate provisions for liquidity. Specifically, the Order required that the Bank submit to the regulators a detailed capital plan to address how the Bank would achieve and thereafter maintain its Tier I capital ratio above 9% and total risk-based capital ratio above 12% by December 31, 2009; the Bank did not meet these increased capital requirements by that date. The failure to comply with the terms of the Order could result in significant enforcement actions against the Bank of increasing severity, up to and including a regulatory takeover of the Bank.
Effective January 14, 2010, as a result of the Order, the Company entered into an FRB Agreement. The FRB Agreement generally provides, among other things, for the development and implementation of actions to ensure the Bank complies with the Order, and any other supervisory action taken by the Bank’s federal or state regulators. The FRB Agreement specifies certain timeframes for meeting the requirements of the FRB Agreement. Specifically, the Order required that the Bank submit to the regulators a detailed capital plan to address how the Bank would achieve and thereafter maintain its Tier 1 capital ratio above 9% and total risk-based capital ratio above 12% by December 31, 2009; the Bank did not meet those increased capital requirements by that date. The failure to comply with the terms of the FRB Agreement could result in significant enforcement actions against the Company.
The Bank’s regulatory capital position has fallen below the level necessary to be considered “well capitalized” and was categorized as “significantly undercapitalized” as of December 31, 2009. “Significantly undercapitalized” banks may not accept, renew or rollover brokered deposits or solicit deposits yielding more than 75 basis points over prevailing rates in either the Bank’s market area or the area where deposits are solicited. The Bank’s “significantly undercapitalized” status subjects it to additional regulatory restrictions that are generally consistent with the restrictions identified within the Order and include, among others, that the Bank generally may not make any capital distributions, must submit an acceptable capital restoration plan to the FDIC, may not increase its average total assets during a calendar quarter in excess of its average total assets during the preceding calendar quarter and may not establish or acquire a new branch office or sell, relocate or dispose of an existing branch without regulatory approval.
We have consented to the issuance of a Supervisory Prompt Corrective Action Directive by our regulators.
On February 19, 2010, the FDIC issued a Supervisory Prompt Corrective Action Directive (the “Directive) to the Bank due to the Bank’s “significantly undercapitalized” status as of December 31, 2009 under regulatory capital guidelines. The Directive provides that within 30 days of the effective date of the Directive (by March 21, 2010), the Bank must: (1) sell enough voting shares or obligations of the Bank so that Bank will be “adequately capitalized” under regulatory capital guidelines; and/or (2) accept an offer to be acquired by a depository institution holding company or combine with another insured depository institution. The failure to comply with the terms of the Directive could result in a regulatory takeover of the Bank.
Difficult economic and market conditions have adversely affected our industry.
Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Financial institutions have experienced decreased access to deposits and borrowings. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. We do not expect that the difficult conditions in the financial markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection with these events:
If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our business, financial condition and results of operations.
Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system. On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008, or the Emergency Economic Stabilization Act, in response to the current crisis in the financial sector. The U.S. Treasury and banking regulators have implemented a number of programs under this legislation to address capital and liquidity issues in the banking system. On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009, or the American Recovery and Reinvestment Act. There can be no assurance, however, as to the actual impact that the Emergency Economic Stabilization Act or the American Recovery and Reinvestment Act or other legislative and executive initiatives will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the Emergency Economic Stabilization Act or American Recovery and Reinvestment Act to help stabilize the financial markets and a continuation or worsening of current financial market conditions could have a material, adverse effect on our business, financial condition, results of operations, access to credit or the value of our securities.
U.S. financial markets and economic conditions could adversely affect our liquidity, results of operations and financial condition.
Recent turmoil and downward economic trends have been particularly acute in the financial sector. The cost and availability of funds may be adversely affected by illiquid credit markets and the demand for our products and services may decline as our borrowers and customers realize the impact of an economic slowdown and recession. In view of the concentration of our operations and the collateral securing our loan portfolio in the San Francisco Bay Area of California, we may be particularly susceptible to the adverse economic conditions in the state of California where our business is concentrated. In addition, the severity and duration of these adverse conditions is unknown and may exacerbate our exposure to credit risk and adversely affect the ability of borrowers to perform under the terms of their lending arrangements with us.
Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.
At December 31, 2009 and 2008, our nonperforming loans (which consist of non-accrual loans) totaled $43.4 million and $16.8 million, or 8.4% and 2.9% of the gross loans, respectively. At December 31, 2009 and 2008, our nonperforming assets (which include foreclosed real estate) were $46.9 million and $17.2 million, or 7.5% and 2.4% of total assets, respectively. In addition, we had approximately $11.5 million and $12.8 million in accruing loans that were 30-89 days delinquent at December 31, 2009 and 2008, respectively. Our nonperforming assets adversely affect our net income in various ways. Until economic and market conditions improve, we expect to continue to incur additional losses relating to an increase in nonperforming loans. We do not record interest income on non-accrual loans or other real estate owned, thereby adversely affecting our income, and increasing our loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related loan to the then fair market value of the collateral, which may result in a loss. These loans and other real estate owned also increase our risk profile and the capital our regulators believe is appropriate in light of such risks. Decreases in the value of these assets, or the underlying collateral, or in these borrowers’ performance or financial conditions, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. There can be no assurance that we will not experience further increases in nonperforming assets in the future.
Our allowance for loan losses may prove inadequate or we may be adversely affected by credit risk exposures.
For the year ended December 31, 2009, we recorded a $50.8 million provision for loan losses and charged off $35.8 million. For the year ended December 31, 2008, we recorded a $3.2 million provision for loan losses and charged off $37,000. Our business depends on the creditworthiness of our customers. We periodically review our allowance for loan losses for adequacy considering economic conditions and trends, collateral values and credit quality indicators, including past charge-off experience and levels of past due loans and nonperforming assets. We cannot be certain that our allowance for loan losses will be adequate over time to cover credit losses in our portfolio because of unanticipated adverse changes in the economy, market conditions or events adversely affecting specific customers, industries or markets, or borrower behaviors towards repaying their loans. The credit quality of our borrowers has deteriorated as a result of the economic downturn in our markets, particularly in California. Continuing deterioration in the real estate market could affect the ability of our loan customers, including our largest borrowing relationships, to service their debt, which could result in additional loan charge offs and provisions for loan losses in the future, which could have a material adverse effect on our financial condition, net income and capital. As part of the Order, the Bank has agreed to review, at least quarterly, and revise as necessary its allowance for loan losses.
During 2009, our commercial and residential real estate portfolios have continued to be affected by adverse market conditions, including reduced real estate prices and sales levels and, more generally, the entirety of our loan portfolio has been affected by the sustained economic weakness of our markets and the impact of higher unemployment rates.
Our commercial and residential real estate loans have continued to be affected adversely by the on-going deterioration in real estate prices and reduced levels of sales. More generally, all of our commercial real estate loan portfolio, especially construction, hospitality and development loans, have been affected adversely by the economic weakness of our California markets and the effects of higher unemployment rates. We may have to increase our allowance for loan losses through additional provisions for loan losses because of continued adverse changes in the economy, market conditions, and events that adversely affect our customers or markets. Our business, financial condition, liquidity, capital, and results of operations could be materially adversely affected by additional provisions for loan losses.
We are a holding company and depend on Tamalpais Bank for dividends, distributions and other payments, which are currently restricted from being paid.
We are a company separate and apart from Tamalpais Bank that must provide for our own liquidity. Substantially all of our revenues are obtained from dividends declared and paid by the Bank for which prior approval from the FDIC and California DFI and additional action by our board of directors will be necessary. As a result of the Order and the Directive, the Bank is not permitted to pay any cash dividend at this time, without the prior written approval of these regulators. As a result, the Bank cannot pay a dividend to us. Although the Bank can seek to obtain approval to pay such a dividend, the FDIC and the California DFI may choose not to provide such approval and we would not expect to be released from this prohibition until our financial performance improves significantly. Therefore, the Bank may not be able to resume payments of dividends to us in the future.
We may be subjected to negative publicity that may adversely affect our business, financial condition, liquidity and results of operations.
We may be the subject of negative news reports discussing our current financial situation and various departures of senior management as the press and others speculate about whether we will be able to continue as a going concern. These reports may have a negative impact on our business. For example, even though our deposits are insured by the FDIC, customers may choose to withdraw their deposits, and new customers may choose to do business elsewhere. In addition, we may find that our service providers will be reluctant to commit to long-term projects with us. Even if we are able to improve our current financial situation, we may be the object of negative publicity and speculation about our future.
We are subject to restrictions on the amount of interest that we can pay our customers, which could cause our deposits to decrease. Because we depend on deposits as a source of liquidity, a decrease in deposits would adversely affect our ability to continue as a going concern.
We are currently in default on our outstanding commitments to two of our lenders.
On September 3, 2009, we were notified by Pacific Coast Bankers Bank, or PCBB, that we are in default under the terms of our business loan agreements with PCBB. As a result of this default, PCBB has the option, to, among other things, declare the $5.7 million principal amount outstanding under the loan agreements immediately due and payable or foreclose on the collateral securing the loans, which includes the stock of the Bank. If PCBB were to declare a default under these loan agreements and proceed to exercise their available remedies, our business and financial conditions will be materially adversely affected.
Additionally, we are in technical default under the terms of the advances and security agreement with the Federal Home Loan Bank of San Francisco, or FHLBSF. When the holding company was unable to make its payment obligations to PCBB in the fourth quarter 2009, a cross-default provision in the agreement with the FHLBSF was triggered. As a result of this default, FHLBSF has the option to, among other things, declare the $119.1 million principal amount of advances outstanding under the advances and security agreement immediately due and payable or foreclose on the securities and loans pledged as collateral securing the advances. If FHLBSF were to declare a default under this agreement and proceed to exercise their available remedies, our business and financial condition will be materially adversely affected.
We are not currently paying dividends on our common stock and are deferring distributions on our trust preferred securities, which restricts our ability to pay cash dividends on our common stock.
We historically paid cash dividends before we suspended dividend payments on our common stock and distributions on our trust preferred securities. Future payment of cash dividends on our common stock, if any, will be subject to the prior payment of all deferred distributions on our trust preferred securities. All dividends are declared and paid at the discretion of our board of directors and are dependent upon our liquidity, financial condition, results of operations, capital requirements and such other factors as our board of directors may deem relevant. Further, distributions on our trust preferred securities are cumulative and therefore unpaid dividends and distributions will accrue and compound on each subsequent dividend payment date.
Our concentration of commercial real estate loans could result in increased loan losses.
At December 31, 2009, approximately 75.5% of our loan portfolio was concentrated in commercial real estate, or CRE, which has experienced significant deterioration as a result of economic conditions and their effect on our borrowers. The banking regulators continue to give CRE lending greater scrutiny, and banks with higher levels of CRE loans are expected to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as higher levels of allowances for possible losses and capital levels as a result of CRE lending growth and exposures. For the fiscal year 2009, we added $50.8 million of provisions for loan losses compared to $3.2 million in the fiscal year 2008, $244,000 in 2007 and $439,000 in 2006, in part reflecting collateral evaluations in response to recent changes in the market values of multifamily and commercial real estate and land collateralizing acquisition and development loans.
Further deterioration in the hospitality industry may adversely affect our results of operations.
As of December 31, 2009, approximately 15.5% of our loan portfolio was comprised of hospitality loans. Our hospitality loans are made to borrowers within the San Francisco Greater Bay Area and other regions of Northern California. We have identified hospitality loans as a higher risk concentration based on the impact of the economic conditions on the hospitality industry and supported by the rise in delinquencies and requests for payment deferments. Further deterioration in the credit quality of the hospitality loan portfolio could result in additional loan charge-offs and provisions for loan losses in the future, which could have a material adverse effect on our financial condition, net income and capital.
Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.
FDIC insurance premiums have increased substantially in 2009 already and we expect to pay significantly higher FDIC premiums in the future. Market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. The FDIC adopted a revised risk-based deposit insurance assessment schedule on February 27, 2009, which raised deposit insurance premiums. On May 22, 2009, the FDIC also implemented a five basis point special assessment of each insured depository institution’s assets minus Tier 1 capital as of September 30, 2009, but no more than 10 basis points times the institution’s assessment base for the second quarter of 2009, to be collected on September 30, 2009. Additional special assessments may be imposed by the FDIC for future periods. We participate in the FDIC’s Temporary Liquidity Guarantee Program, or TLG, for noninterest-bearing transaction deposit accounts. Banks that participate in the TLG’s noninterest-bearing transaction account guarantee will pay the FDIC an annual assessment of 10 basis points on the amounts in such accounts above the amounts covered by FDIC deposit insurance. To the extent that these TLG assessments are insufficient to cover any loss or expenses arising from the TLG program, the FDIC is authorized to impose an emergency special assessment on all FDIC-insured depository institutions. The FDIC has authority to impose charges for the TLG program upon depository institution holding companies, as well. These changes will cause the premiums and TLG assessments charged by the FDIC to increase. In addition, in November 2009, the FDIC enacted regulation to require banks to prepay three years of premiums by the end of 2009. Since the Bank is under a Cease and Desist order, the prepayment of the premiums is not applicable to the Bank. However, these actions could significantly increase our noninterest expense in 2010 and for the foreseeable future.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and disruption for more than a year. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial condition or performance. If current levels of market disruption and volatility continue or worsen, we may experience adverse effects, which may be material, on our ability to maintain or access capital and on our business, financial condition and results of operations.
Liquidity risks could affect 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 amounts adequate to finance or capitalize our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Pursuant to terms of the Directive, the FDIC must approve material transactions, which could affect our ability to sell loans to increase liquidity. Our liquidity, on a parent only basis, is adversely affected by the inability of receiving dividends from the Bank, based on its current capital position. If our holding company is unable to receive dividends from the Bank, it may be unable to service its own obligations, which would adversely affect our business and financial condition. Our ability to borrow could also be impaired by factors that are not specific to us, such as further disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.
We are required to maintain capital to meet regulatory requirements, and if we fail to maintain sufficient capital, whether due to losses, an inability to raise additional capital or otherwise, our financial condition, liquidity and results of operations, as well as our regulatory requirements, would be adversely affected.
Both we and the Bank must meet regulatory capital requirements and maintain sufficient liquidity. The Order requires, among other things, that the Bank submit a capital plan that will ensure that it achieves and maintains a Tier 1 capital ratio of at least 9% and a total risk-based capital ratio of at least 12%. We have not met these increased capital requirements. Our ability to raise additional capital will depend on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry and market condition, and governmental activities, many of which are outside our control, and on our financial condition and performance. Accordingly, we cannot assure you that we will be able to raise additional capital or on terms acceptable to us. If we fail to meet these capital and other regulatory requirements, our financial condition, liquidity and results of operations would be materially and adversely affected.
Our cost of funds may increase as a result of general economic conditions, FDIC insurance assessments, interest rates and competitive pressures.
Our cost of funds may increase as a result of general economic conditions, FDIC insurance assessments, interest rates and competitive pressures. We have historically utilized deposits obtained out of our market area. As of December 31, 2009, we had wholesale deposits through deposit brokers of $92.0 million (18.9% of deposits) and through non-brokered wholesale sources of $121.7 million (25.0% of deposits). These deposits, some of which were certificates of deposit of $100,000 or more, were obtained for generally longer terms than can be acquired through retail sources as a means to control interest rate risk or were acquired to fund all short term differences between loan and deposit growth rates. However, based on the amount of wholesale funds maturing in each month, we may not be able to replace all wholesale deposits with retail deposits upon maturity. As a result of the Order, the Bank is no longer permitted to accept new or renew maturing brokered deposits unless it receives the prior approval of the FDIC and the California DFI. Our financial flexibility could be severely constrained if we are unable to renew our wholesale funding or if adequate financing is not available in the future at acceptable rates of interest. We may not have sufficient liquidity to continue to fund new loan originations, and we may need to liquidate loans or other assets unexpectedly in order to repay obligations as they mature.
Our profitability and liquidity may be affected by changes in interest rates and economic conditions.
Our profitability depends upon net interest income, which is the difference between interest earned on assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Net interest income will be adversely affected if market interest rates change such that the interest we pay on deposits and borrowings and our FDIC deposit insurance assessments increase faster than the interest earned on loans and investments. Interest rates, and consequently our results of operations, are affected by general economic conditions and fiscal and monetary policies may materially affect the level and direction of interest rates. From September 2004 to mid-2006, the Federal Reserve raised the federal funds rate from 1.0% to 5.25%. Since then, beginning in September 2007, the Federal Reserve decreased the federal funds rates by 100 basis points to 4.25% over the remainder of 2007, and has since reduced the target federal funds rate by an additional 400 basis points to a range between zero to 25 basis points beginning in December 2008. Decreases in interest rates generally increase the market values of fixed-rate, interest-bearing investments and loans held, and increase the values of loan sales and mortgage loan activities. However, the production of mortgages and other loans and the value of collateral securing our loans, are dependent on demand within the markets we serve, as well as interest rates. The levels of sales, as well as the values of real estate in our markets, have declined. Declining rates reflect efforts by the Federal Reserve to stimulate the economy, but may not be effective, and thus may negatively affect our results of operations and financial condition, liquidity and earnings.
Our future success is dependent on our ability to compete effectively in highly competitive markets.
We operate in the highly competitive markets of Marin County and the Greater Bay Area including San Francisco, Alameda, Contra Costa, San Mateo, Santa Clara, Sonoma and Napa counties of California. Our future growth and success will depend on our ability to compete effectively in these markets. We compete for loans, deposits and other financial services in geographic markets with other local, regional and national commercial banks, thrifts, credit unions and mortgage lenders. Many of our competitors offer products and services different from us, and have substantially greater resources, name recognition and market presence than we do, which benefits them in attracting business. Larger competitors may be able to price loans and deposits more aggressively than we can, and have broader customer and geographic bases to draw upon.
We may not be able to attract and retain skilled people.
Our success depends in large part on our ability to attract and retain key people and there are a limited number of qualified persons with knowledge of and experience in the banking industry in our market. Furthermore, recent demand for skilled finance and accounting personnel among publicly traded companies has increased the importance of attracting and retaining these people. Competition for the best people can be intense and we may not be able to hire people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding and other transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems, losses of depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by other institutions. We could experience increases in deposits and assets as a result of other banks’ difficulties or failure, which would increase the capital we need to support such growth.
We are subject to internal control reporting requirements that increase compliance costs and failure to comply timely could adversely affect our reputation and the value of our securities.
We are required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as rules and regulations adopted by the SEC, the Public Company Accounting Oversight Board and NASDAQ. In particular, we are required to include management and, beginning with our annual report on Form 10-K for the year ending December 31, 2010, independent auditor attestation reports on internal controls as part of our annual report on Form 10-K pursuant to Section 404 of the Sarbanes-Oxley Act. We expect to continue to spend significant amounts of time and money on compliance with these rules. Our failure to track and comply with the various rules may materially adversely affect our reputation, ability to obtain the necessary certifications to financial statements, and the value of our securities.
Technological changes affect our business, and we may have fewer resources than many competitors to invest in technological improvements.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to serving clients better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs. Our future success will depend, in part, upon our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in operations. We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services. Many competitors have substantially greater resources to invest in technological improvements.
We may raise additional capital, which could have a dilutive effect on the existing holders of our common stock and adversely affect the market price of our common stock.
In order to comply with the Order and Directive, we may increase our capital resources by issuing additional common stock or preferred stock. Some of these issues, were they to occur, could substantially dilute the value of our common stock. Because our decision to issue securities in future public or private transactions may be influenced by market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing, or nature of our future offerings. In addition, market conditions could require us to accept less favorable terms for the issuance of securities in the future.
In addition, we face significant regulatory and other governmental risk as a financial institution, and it is possible that capital requirements and directives could in the future require us to change the amount or composition of our current capital, including common equity. In this regard, we note that we were not one of the 19 institutions required to conduct a forward-looking capital assessment, or “stress test,” in conjunction with the Federal Reserve and other federal bank supervisors, pursuant to the Supervisory Capital Assessment Program, a complement to the U.S. Treasury’s Capital Assistance Program, which makes capital available to financial institutions as a bridge to private capital in the future. However, the stress assessment requirements under the Capital Assistance Program or similar requirement could be extended or otherwise impact financial institutions beyond the 19 participating institutions, including us. As a result, our regulators have required us to raise additional capital. There could also be market perceptions regarding the need to raise additional capital, whether as a result of public disclosures that were made regarding the Capital Assistance Program stress test methodology or otherwise, and, regardless of the outcome of the stress tests or other stress case analysis, such perceptions could have an adverse effect on the price of our common stock.
Our independent registered public accountants have expressed substantial doubt about our ability to continue as a going concern.
In their audit report for the year ended December 31, 2009, our independent registered public accountants have stated that certain matters raise substantial doubt about our ability to continue as a going concern. We have been significantly and negatively impacted by the events and conditions impacting the banking industry. We and the industry have been adversely affected by rising unemployment, declining real estate and financial asset prices, and rising delinquency and loss rates on loans. These in turn have caused significant losses, reduced our capital materially, and had other follow-on consequences. There is the potential for these events to impact our on-going access to liquidity sources. In addition, some of our on-going operations, particularly our ability to continue to access our traditional funding sources, are impacted by our regulatory capital ratios and regulatory standing. Should management be unable to execute on its plans, including restoring and maintaining its capital ratios at amounts that would result in its ratios being sufficient to be declared “well capitalized,” there could be a doubt on our ability to remain a going concern. Our audited financial statements were prepared under the assumption that we will continue our operations on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. Our financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. If we cannot continue as a going concern, our shareholders will lose some or all of their investment in the Company.
The following table sets forth information relating to each of the Company’s offices as of December 31, 2009:
The Company is involved in various claims and legal proceedings arising out of the ordinary course of business. Management is of the opinion, based on its review with counsel of the development of such matters to date, that the ultimate disposition of such matters will not materially affect the consolidated financial position or results of operations of the Company.
On November 25, 2009, the Company received the written consent from shareholders holding a majority of its outstanding common stock to the proposed amendment (the “Share Amendment”) to the Company’s Articles of Incorporation to increase its authorized shares of common stock. As of November 25, 2009, 2,082,824 shares of common stock (54.47% of the 3,823,634 shares entitled to vote) voted to consent to the Share Amendment, 1,027,771 shares (26.88% of shares entitled to vote) voted to withhold consent, and 6,312 shares (0.17% shares entitled to vote) abstained.
On November 25, 2009, the Company received the written consent from shareholders holding a majority of its outstanding common stock to permit (but not require) the board of directors of the Company to amend its Articles of Incorporation to effect a reverse stock split (the “Reverse Stock Split”) of the Company’s Common Stock at any time prior to November 4, 2010, by a ratio of not less than one-for-two and not more than one-for-ten with the exact ratio to be set at a whole number within this range as determined by the board of directors in its sole discretion. As of November 25, 2009, 2,738,062 shares of common stock (71.61% of the 3,823,634 shares entitled to vote) voted to consent to the Reverse Stock Split, 372,533 shares (9.74% of shares entitled to vote) voted to withhold consent, and 6,312 shares (0.17% shares entitled to vote) abstained.
ITEM 5 – MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUERS PURCHASE OF EQUITY SECURITIES>
The Company’s common stock is traded on the NASDAQ Capital Market under the symbol TAMB.
At February 27, 2010, 3,823,634 shares of the Company’s common stock, no par value were outstanding. The following table sets forth, for the periods indicated, the range of high and low trade prices per share of the Company’s common stock.
The Company’s closing price on December 31, 2009 was $0.84 per share, compared to the closing price one year earlier of $8.47 per share.
On March 12, 2010, we received a letter from the NASDAQ Stock Market notifying us that our shares of Common Stock no longer meet NASDAQ’s continued listing requirement under Listing Rule 5550(a)(2), or the Bid Price Rule, because the bid price for the Common Stock has closed below $1.00 per share for 30 consecutive business days. Pursuant to Listing Rule 5810(c)(3)(A), we have 180 days, until September 8, 2010, to regain compliance with the Bid Price Rule. If, prior to September 8, 2010, the bid price of the Common Stock closes at $1.00 per share, or higher, for at least 10 consecutive business days, NASDAQ will notify us that the matter will be closed.
If compliance with the Bid Price Rule cannot be established prior to September 8, 2010, our Common Stock will be subject to delisting from the NASDAQ Capital Market. We may, however, be eligible for an additional 180-day grace period if we satisfy the initial listing standards (with the exception of the Bid Price Rule) for listing on the NASDAQ Capital Market. We are evaluating our options following receipt of the notification and intend to take appropriate actions in order to retain the listing of our Common Stock on the NASDAQ Stock Market.
The Company initiated a cash dividend program in 2004. The Board of Directors evaluates the payment of dividends on a quarterly basis. The shareholders of the Company will be entitled to receive dividends when and as declared by its Board of Directors, out of funds legally available, subject to the dividend preference, if any, on preferred shares that may be outstanding and also subject to the restrictions of the California General Corporation Law. There are no preferred shares outstanding at this time. There is no assurance, however, that any dividends will be paid since they are dependent upon earnings, cash balances, financial condition, asset quality, and capital requirements of the Company and its subsidiaries as well as general economic conditions. See “Supervision and Regulation – Dividends and Other Transfer of Funds.” See also Note 14 to the Consolidated Financial Statements.
In January 2007, the Board of Directors declared a 7% stock dividend payable on February 14, 2007 to shareholders of record on January 31, 2007. Cash was paid in lieu of issuing fractional shares. Earnings per share amounts and information with respect to stock options have been restated for all years presented to reflect the stock dividend.
The Company declared cash dividends of $0.045 per share in May and August 2007, respectively, and increased to $0.05 per share in November 2007. The Company declared cash dividends of $0.06 per share in January 2009 and November 2008, up from $0.05 per share in January 2008 and $0.055 per share in May and August 2008. On July 13, 2009, the Company announced that the Board of Directors had decided to suspend declaring quarterly dividends on its common stock.
The Company historically has been dependent on the payment of cash dividends from the Bank as the main source of liquidity to service its commitments and pay dividends to shareholders and other obligations. As noted earlier in this Report, the Order, Directive and the FRB Agreement prohibits the Bank from paying cash dividends to the Company without the prior written consent of the FDIC and the CDFI and the FRB. The inability of the Bank to pay dividends to the Company, absent other sources of funds, has, and is likely to continue to, adversely affect the liquidity of the Company.
No shares of common stock were purchased during the fiscal year ended December 31, 2009 and our repurchase plan was terminated.
Securities Authorized for Issuance Under Equity Compensation Plans>
The following table summarizes information as of December 31, 2009 with respect to equity compensation plans. All plans have been approved by the shareholders.
The following table sets forth selected financial condition and results of operations data as of, and for the years ended, December 31, 2009, 2008, 2007, 2006 and 2005. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein and the consolidated financial statements and notes thereto included herein.
Earnings per share, book value per share and common shares outstanding have been adjusted for the January 2007 7% stock dividend.
This Management Discussion and Analysis should be read in conjunction with the accompanying consolidated financial statements which have been prepared assuming we will continue as a going concern. As discussed in the report of our independent registered public accountants, because of our obligations under the written agreements with our regulators, including among other things, restoring and maintaining our capital levels at amounts that would result in our capital ratios being sufficient for us to be considered well capitalized, our independent accountants believe there is substantial doubt about our ability to continue as a going concern. Management’s plans concerning these matters are discussed in the “Business - Company Strategy.” The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.
In January 2007, the Board of Directors declared a 7% stock dividend. Earnings per share and book value per share amounts have been restated for prior periods to reflect the stock dividend.
In September 2007, the Company received Board of Director approval to repurchase up to 5% of the share of the Company’s common stock over the next twelve months from the approval date in the open market. The repurchase plan represents approximately 200,649 of the Company’s then-outstanding shares as of July 28, 2007, as reported on the Company’s Form 10-Q filed with the Securities and Exchange Commission (“SEC”) on August 10, 2007. As of December 31, 2008, the Company repurchased 196,216 shares at prices ranging from $11.65 to $13.00 for a total cost of $2.5 million.
For discussion of stock dividends and share repurchases, see Note 19 of the Notes to Consolidated Financial Statements.
Critical Accounting Policies
The accounting policies are integral to understanding the results reported. The most complex accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. The Company has established detailed policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of the current accounting policies involving significant management valuation judgments.
Allowance for Loan Losses
The allowance for loan losses represents management’s best estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged-off, net of recoveries. The Company evaluates the allowance for loan loss on a quarterly basis and believes that the allowance for loan loss is a “critical accounting estimate” because it is based upon management’s assessment of various factors affecting the collectability of the loans, including current and projected economic conditions, past credit experience, delinquency status, the value of the underlying collateral, if any, and a continuing review of the portfolio of loans and commitments. Management also obtains, from time to time, independent third party reviews and management assistance of the loan portfolio from outside consultants who have bank regulatory or credit experience and are familiar with applicable regulatory guidelines and industry practices.
The Bank determines the appropriate level of the allowance for loan losses, primarily on an analysis of the various components of the loan portfolio, including an analysis of all significant credits on an individual basis. The Bank segments the loan portfolios into as many components as practical. Each component would normally have similar characteristics, such as risk classification, past due status, type of loan, industry or collateral. The Bank analyzes the following components of the portfolio and provides for them in the allowance for loan losses:
No assurance can be given that the Company will not sustain loan losses that are sizable in relation to the amount reserved, or that subsequent evaluations of the loan portfolio will not require an increase in the allowance. Prevailing factors in association with the methodology may include improvement or deterioration of individual commitments or pools of similar loans, or loan concentrations.
Available-for-sale securities are required to be carried at fair value. This is a “critical accounting estimate” in that the fair value of a security is based on quoted market prices or if quoted market prices are not available, fair values are extrapolated from the quoted prices of similar instruments. Adjustments to the available-for-sale securities fair value impact the consolidated financial statements by increasing or decreasing assets and shareholders’ equity.
Any loan that management determines will not be held-to-maturity is classified as held-for-sale and are valued at fair value. The fair value of loans held-for-sale is determined based upon an analysis of investor quoted pricing inputs.
Supplemental Employee Retirement Plan
The Company has entered into supplemental employee retirement agreements with certain executive officers. The liability is based on estimates involving life expectancy, length of time before retirement, appropriate discount rate, forfeiture rates and expected benefit levels. Should these estimates prove materially different from actual results, the Company could incur additional or reduced future expense.
Deferred Tax Assets
Deferred income taxes reflect the estimated future tax effects of temporary differences between the reported amount of assets, liabilities, revenue and expense for financial reporting purposes and such amounts as measured by tax laws and regulations. The Company uses an estimate of future earnings to assess whether the benefit of the deferred tax assets will be realized. If future pre-tax income is forecasted to be negative or less than the amount of the deferred tax assets within the tax years to which they may be applied, the deferred tax assets may not be fully realized and, in such cases, a deferred tax valuation allowance is recorded to reduce the deferred tax assets to the amounts estimated to be realizable.
The Company recognizes compensation expense in an amount equal to the fair value of share-based payments such as stock options granted to employees. The Company records compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that were outstanding on January 1, 2006 and for all awards granted after that date as they vest. The fair value of each option is estimated on the date of grant and amortized over the service period using an option pricing model. Critical assumptions that affect the estimated fair value of each option include expected stock price volatility, dividend yield, option life and the risk-free interest rate.
Effective January 1, 2008, the Company adopted enhanced disclosures about financial instruments carried at fair value. These disclosures establish a hierarchical framework associated with the level of observable pricing scenarios utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of the observable pricing scenario. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of observable pricing and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no observable pricing and a higher degree of judgment utilized in measuring fair value. Observable pricing scenarios are impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.
For a description of the recent pronouncements applicable to the Company, see Note 2 to the Consolidated Financial Statements included in this report.
The Company reported on a consolidated basis a net loss of $37,628,000 for 2009 as compared to net income of $4,829,000 for 2008, a decrease of $42,457,000, or 879.3%. Diluted loss per share was $9.84 for the twelve months ended December 31, 2009 as compared to diluted earnings per share of $1.26 for the twelve months ended December 31, 2008, a decrease of 880.2%.
Results for the fiscal year 2009 were negatively impacted by the substantial increase in the provision for loan losses recorded for loans sold in the fourth quarter of 2009 and for loans planned to be sold in the first quarter of 2010 subject to regulatory approval, general loan loss provision, as well as non-cash charges of $11.2 million for the valuation allowance established against the deferred tax asset due to the significant doubt as to the ability of the Company to realize those deferred tax assets against positive taxable income in future years. The ongoing and deepening recession has caused a continuing decline in real estate values and has reduced the liquidity and net worth of businesses and consumers in the Company’s market area. The loan loss provision in the year ended December 31, 2009 was $50,846,000, as compared to $3,191,000 for the prior year.
The allowance for loan losses as a percent of total loans held for investment was increased to 5.03% as of December 31, 2009, up from 1.37% as of December 31, 2008 to better position the Company to manage through a prolonged economic downturn.
Net interest income before provision for loan losses of $23,316,000 increased $8,000 from the same period last year. The Bank increased total deposits 5.8% over the last twelve months and increased noninterest-bearing deposits to $43,362,000, up 30.4% over the last twelve months. The success in generating low-cost deposits was one of the factors for net interest income increasing for the year.
In 2008, the Federal Reserve lowered its Federal funds rate (the rate at which banks may borrow from each other) by two hundred basis points resulting in lower deposit rates being offered by the Bank, which positively affected the interest margin. However, the variable rate loans adjusted downward with the decline in the Prime Rate, subject to any contractual floor rates. Even though these changes resulted in improvements to the net interest margin in the year ended December 31, 2009 as compared to the prior year, these improvements were more than offset by the increase in nonperforming assets, which decreased the yield of the loan portfolio for the respective periods. The slight increase in net interest income was more than offset by the increase in loan loss provisions related to substandard and nonperforming loans, an $11.2 million valuation reserve established against the deferred tax assets and by the $5.1 million increase in noninterest expense in 2009 as compared to the prior year.
The decrease in net income and fully diluted earnings per share for 2009 over the same period in 2008 was primarily the result of the following:
Partially offsetting the increase in the provision for loan losses, decreases in interest income, increases in noninterest expense and decreases in noninterest income, which had negative impacts on net income, were decreases in interest expense, which had positive impacts on net income as follows:
There were $59,985,443 in Loans held-for-sale at December 31, 2009, and none for the same period in 2008. There were $2,498,130, $1,219,382 and $12,021,000 carrying value of loans held-for-sale at December 31, 2009, that were sold in January, February and March 2010, respectively. Additionally, there were $3,264,458 principal balance of loans not classified as held-for-sale at December 31, 2009, that were sold in March 2010. The first quarter of 2010 sales of the loans classified as held-for-sale and the sale of the other loans resulted in a net pre-tax gain on sale of $705,647. See Note 25 of this report for further discussion.
The Company began to manage down the size of its balance sheet during the third quarter 2009 to improve liquidity, the funding mix and manage capital resources. As of December 31, 2009, consolidated total assets were $629,729,000 as compared to $703,390,000 at December 31, 2008, which represents a decrease of $73,661,000, or 10.5%. As of December 31, 2009, there were annual decreases in investment securities of $10,431,000, or 15.5%, and net loans receivable of $148,797,000, or 25.5%. The decrease in investment securities was primarily due to pay downs in the held-to-maturity securities and $19,599,000 of available-for-sale securities which were sold in 2009 as compared to $4,259,000 in 2008. The decrease in loans was primarily attributable to the sale of loans sold during the fiscal year 2009 as well as $75 million principal amount of loans reclassified to Held-for-Sale classification. During the third quarter 2009, the Company sold approximately $19.8 million in loans at par value and during the fourth quarter 2009, the Company sold approximately $37,432,000 million in principal amount of certain nonperforming loans. In connection with this sale, the Company received proceeds of approximately $23,903,000 million and incurred a pre-tax charge of approximately $4,735,000 million to its fourth quarter earnings. The proceeds from the sale were primarily used to reduce outstanding borrowings. These decreases were partially offset by an increase in Federal funds sold of $15,001,000 from December 31, 2008 to December 31, 2009 and was primarily due to the Bank bolstering its on-balance sheet liquidity. As of December 31, 2009, other real estate owned increased by $3,170,000, or 760.3%, and other assets increased by $10,425,000, or 138.5% as compared to December 31, 2008. The increase in other assets was primarily due to an increase in the income taxes receivable which resulted from the large taxable loss during the fiscal year 2009 as compared to the same period in the prior year.
As of December 31, 2009, consolidated total liabilities were $629,968,000 as compared to $666,017,000 at December 31, 2008, which represents a decrease of 5.4%. Contributing to the decrease in liabilities during the fiscal year 2009 was an increase in noninterest-bearing deposits of $10,102,000, or 30.4% and certificates of deposits of $47,224,000, or 18.1%, partially offset by decreases in money market and savings deposits of $27,846,000, or 17.8% and decrease in FHLB advances of $64,000,000, or 35.0% as compared to December 31, 2008. FHLB advances decreased as the growth in deposits and loans which were sold during 2009 enabled us to pay down these borrowings. The Bank is reducing its reliance on FHLB borrowings but when necessary the FHLB borrowings are used to hedge interest rate risk in the loan and investment portfolios and mature evenly on a monthly basis.
Shareholders’ equity decreased $37,612,000, or 100.6% to $(239,000) at December 31, 2009 as compared to $37,373,000 at December 31, 2008. This was attributable to a net loss of $37,628,000, share-based compensation expense of $232,000, cash dividends declared of $229,000 and an unrealized security holding loss of $174,000 partially offset by an unrealized gain on a cash flow hedge of $187,000.
As of December 31, 2009, TWA had approximately $349.3 million in assets under management as compared to $254.0 million for the same period prior year. The increase was primarily due to increases in the institutional fixed income portfolio and market appreciation.
For the twelve months ended December 31, 2009, the Company’s return on average assets (“ROA”) was (5.39)% compared to 0.76% for the same period in 2008. The ROA was negative primarily due to the high loan loss provisions and large deferred tax asset valuation allowance in fiscal year 2009. The Company’s return on average equity (“ROE”) was (115.17)% for the twelve months ended December 31, 2009 compared to 13.74% for the same period last year. The Company’s ROE was negative due to the extremely large loss that the Company posted in fiscal year 2009.
The Bank is focusing on lowering the cost of funds and improving the core funding mix by generating low cost deposits through the Marin County based team of business banking professionals and paying off wholesale funding sources.
Summary of Quarterly Results of Operations>
The following table below sets forth the results of operations for the four quarters of 2009 and 2008.
Net Interest Income
Net interest income is the difference between the interest earned on loans, investments and other interest earning assets and the interest expense on deposits and other interest bearing liabilities, and is the most significant component of the Company’s revenue.
Net interest income is impacted by changes in general market interest rates and by changes in the amounts and composition of interest earning assets and interest bearing liabilities. Comparisons of net interest income are frequently made using net interest margin and net interest rate spread. Net interest margin is expressed as net interest income divided by average earning assets. Net interest rate spread is the difference between the average rate earned on total interest earning assets and the average rate incurred on total interest bearing liabilities. Both of these measures are reported on a taxable equivalent basis. Net interest margin is the higher of the two because it reflects interest income earned on assets funded with non-interest bearing sources of funds, which includes demand deposits and stockholders’ equity.
The average balance of nonperforming loans is included in the average balance of loans. Because nonperforming loans do not accrue income, an increase in nonperforming loans will result in a decrease in loan and asset yields.
As of December 31, 2009 compared to 2008, interest earned on interest-bearing assets declined faster than costs of interest bearing liabilities resulting in a thirty four basis point decrease in the net interest margin and thirty basis point decrease in the net interest spread. As of December 31, 2008 compared to 2007, rates paid on interest-bearing liabilities declined faster than yields on earning assets, resulting in a twenty nine basis point increase in net interest margin. The following table presents average daily balances of assets, liabilities, and shareholders’ equity during 2009, 2008 and 2007, along with total interest income earned and expense paid, and the average yields earned or rates paid thereon and the net interest margin for the years ended December 31, 2009, 2008 and 2007.
TAMALPAIS BANCORP AND SUBSIDIARIES
Average Balance Sheets (Unaudited)
(1) Yields on securities and certain loans have been adjusted upward to a “fully taxable equivalent” (“FTE”) basis in order to reflect the effect of income which is exempt from federal income taxation at the current statutory tax rate.
(2) The yields for securities were computed using the average amortized cost and therefore do not give effect for changes in fair value.
(3) Loans, net of unearned income, include non-accrual loans but do not reflect average reserves for possible loan losses.
(4) Savings deposits include Money Market accounts.
(5) Net interest spread is the interest differential between total interest earning assets and total interest-bearing liabilities.
(6) Net interest margin is the net yield on average interest earning assets.
In 2009, the Bank’s net interest income before the provision for loan losses increased $8,000 over 2008 primarily due to a decrease in interest expense attributable to the decline in cost of funds partially offset by lower loan yields that were a result of nonperforming loans. The decrease of $3,187,000 in interest income on interest earning assets was primarily due to a decline in interest income on the loan portfolio. In 2008, the Bank’s net interest income before provision for loan losses increased $5,749,000 as compared to the same period in 2007. The increase was primarily attributable to a decrease in the cost of deposits related to interest bearing liabilities in addition to an increase in interest income on the loan portfolio driven by higher loan balances.
2009 Compared to 2008
The Bank’s yield on average interest earning assets decreased to 5.92% as of December 31, 2009 from 7.03% as of December 31, 2008 as a result of the following.
For the twelve months ended December 31, 2009, the Bank’s Net Interest Margin (“NIM”) was 3.45%, a decrease from the NIM of 3.79% for the same period in 2008. The decrease in the NIM in 2009 as compared to the same period of the prior year is primarily attributable to the Bank’s lower cost of funds in response to ongoing decreases in the Federal funds rates and discount rates resulting in lower funding costs and an improved funding mix which was more than offset by lower loan yields in a declining interest rate environment and interest foregone on non-accrual loans. The Bank’s yield on average interest earning assets decreased from 7.03% for 2008 to 5.92% for the year ended 2009 as a result of the factors described below.
The yield on the loan portfolio decreased one hundred and three basis points from 7.40% in 2008 to 6.37% for the year ended December 31, 2009 which is primarily attributable to the non-recognition of accrued interest income for the large balance of nonperforming loans during 2009 as well as the effect of competitive pressures on rates offered by the Bank due to decreases in interest rates implemented by the Federal Reserve Board in 2008. The yield on the Bank’s Federal funds sold decreased to 0.29% for 2009 from 1.76% in 2008. The decrease in the yields on loans and Federal Funds sold is the result of the Federal Reserve decreasing the Federal funds interest rate in 2008 as discussed previously. The average balance of investment securities – taxable in 2009 of $60,629,000 which represents an increase of $9,023,000 from 2008, had a decrease in yield from 4.71% in 2008 to 4.22% in 2009. Again, the decrease in yield was a function of purchasing more securities with lower yields than the yields on securities that matured or had balance reductions. Other investments yield decreased to 0.26% in 2009 from 3.71% in 2008. The yield on interest bearing deposits in other financial institutions decreased fifty-five basis points in 2009 as compared to 2008. The yield on investment securities for municipal securities increased from 5.54% in 2008 to 5.66% for the year ended December 31, 2009.
The rate paid on average interest bearing liabilities decreased from 3.48% to 2.67% when comparing 2009 to the same period a year ago. The rate paid on savings deposits decreased from 2.37% in 2008 to 1.28% in 2009 and the rate paid on time deposits decreased from 3.67% in 2008 to 2.58% in 2009. These decreases are primarily attributable to the result of the previously discussed changes in market interest rates due to actions taken by the Federal Reserve in 2008. The rate on other borrowings decreased eleven basis points for 2009 as compared to the same period in the prior year. The rate paid on junior subordinated debentures increased sixty-five basis points in the 2009 period when compared to 2008, and the rate paid on adjustable-rate long term debt of $6 million decreased fifty-two basis points in 2009 as compared to the same period a year ago.
2008 Compared to 2007
In 2008, the Bank’s NIM was 3.79%, an increase of 8.3% from the NIM of 3.50% in 2007. The increase in the NIM in 2008 as compared to the same period prior year is primarily attributable to the Bank’s lower cost of funds in response to ongoing decreases in the Federal funds rates and discount rates resulting in lower funding costs partially offset by lower loan yields in a declining interest rate environment.
The Bank’s yield on average interest earning assets decreased to 7.03% as of December 31, 2008 from 7.79% as of December 31, 2007 as a result of the following.
The yield on the loan portfolio decreased eighty two basis points from 8.22% in 2007 to 7.40% in 2008 which is primarily a result of the growth in loans held in the portfolio partially offset by the effect of competitive pressures on rates offered by the Bank as a result of a decrease in the interest rates implemented by the Federal Reserve Board in 2008. The yield on the loan originations were lower and maturities and paydowns of loans were at higher yields. The yield on the Bank’s Federal funds sold decreased to 1.76% in 2008 from 5.15% in 2007. The decrease in the yield for the Federal funds sold is the result of the Federal Reserve decreasing the Federal funds interest rate (the interest rate banks charge each other for short term borrowings) in 2008 by two hundred basis points. The yield on the investment securities – taxable in 2008 remained relatively unchanged as compared to the same period for 2007. The yield on other investments decreased to 3.71% in 2008 from 5.48% in 2007. The yield on interest bearing deposits in other financial institutions increased eighteen basis points from 2008 as compared to 2007.
The rate paid on average interest bearing liabilities decreased from 4.64% to 3.48% when comparing 2008 versus 2007. The rate paid on saving deposits decreased from 4.14% to 2.37% from 2007 as compared to 2008 and the rate paid on time deposits decreased one hundred forty six basis points from 5.13% to 3.67% from 2007 as compared to 2008. These decreases are primarily attributable to the result of the previously discussed decreases in market interest rates originating from actions taken by the Federal Reserve in 2008. The rate on other borrowings decreased twenty four basis points from 2008 as compared to 2007. The junior subordinated rate paid on debentures decreased from 7.42% to 4.75% at 2008 when compared to 2007. The decrease in the interest rate paid on debentures is attributable to the Company obtaining an issuance of $10 million in new trust preferred securities that bears a floating interest rate of three-month LIBOR plus 1.44% as compared to the Company’s existing securities which bore a floating interest rate of three-month LIBOR plus 3.65% which was redeemed with proceeds of the new issuance. New long term debt for $6 million was obtained in 2008 which had an average cost of 5.31%
Analysis of Volume and Rate Changes on Net Interest Income and Expenses>
The following sets forth changes in interest income and interest expense for each major category of average interest-earning assets and interest-bearing liabilities, and the amount of change attributable to volume and rate changes for the periods indicated. Changes not solely attributable to volume or rate have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the changes in each.