First Regional Bancorp 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Annual Report Pursuant to Section 13 or 15(d)
For the fiscal year ended December 31, 2008
FIRST REGIONAL BANCORP
Registrant's telephone number, including area code: (310) 552-1776
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act). Yes o No ý
Aggregate market value of Common Stock held by non-affiliates as of June 30, 2008: $45,231,073
Number of shares of Common Stock outstanding at March 6, 2009: 11,836,016
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for our 2009 Annual Meeting of Shareholders (to be filed within 120 days of fiscal year end) are incorporated by reference into Part III.
Table of Contents
Business of First Regional Bancorp
First Regional Bancorp (the "Company") maintains its principal executive offices at 1801 Century Park East, Los Angeles, California 90067. The Company was incorporated in California as Great American Bancorp on February 18, 1981 for the purpose of becoming a bank holding company and acquiring all of the outstanding common stock of First Regional Bank (the "Bank"), formerly Great American Bank, a state-chartered bank headquartered in Los Angeles (Century City), California. The reorganization of the Bank was accomplished on March 8, 1982, under the terms of a Plan of Reorganization and Merger Agreement dated October 15, 1981, providing for the merger of a Company subsidiary with the Bank, with the Bank being the surviving entity in the merger. As a result of the Bank's reorganization, the Bank's outstanding shares were exchanged on a one-for-one basis for shares of the Company's Common Stock, and the Company became the sole shareholder of the Bank. Prior to acquiring the Bank, the Company did not conduct any ongoing business activities. The Company's principal asset is the stock of the Bank and the Company's primary function is to coordinate the general policies and activities of the Bank, as well as to consider from time to time, other legally available investment opportunities. Both the Company and the Bank changed their names from Great American to First Regional in 1987 as part of an agreement with another financial institution.
Certain matters discussed in this Annual Report on Form 10-K may constitute forward-looking statements within the meaning of the Private Securities Reform Act of 1995 (the "Reform Act") and as such may involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which the Company and the Bank operate, projections of future performance, perceived opportunities in the market, and statements regarding the Company's and/or the Bank's mission and vision. The Company's and/or the Bank's actual results, performance, or achievements may differ significantly from the results, performance, or achievements expressed or implied in such forward-looking statements. The following discusses certain factors, which may affect the Company's and/or the Bank's financial results and operations and should be considered in evaluating the Company and/or the Bank.
The Company does not anticipate that its operations will be materially affected as a result of compliance with Federal, State and local environmental laws and regulations.
Business of First Regional Bank
The Bank was incorporated under the laws of the State of California on July 10, 1979, and has authorized capital of 5,000,000 shares of no par value Common Stock. The Bank commenced operations as a California-chartered bank on December 31, 1979. The Bank conducts a business-oriented wholesale banking operation, with services tailored to the needs of businesses and professionals in its service area. The Bank's main office is located in the Century City office complex in Los Angeles, California. The Bank also has Regional Offices located in the California cities of Irvine, Glendale, Santa Monica, Torrance, Encino, Hollywood, Downtown Los Angeles, Anaheim, and Westlake Village. The Bank also has a Merchant Services division located in Agoura Hills, California. The Bank has a Trust Administration Services division located in Carlsbad, California that provides administrative services for self-directed retirement plans. The Bank's customers include professionals working in the primary service areas as well as many business accounts located throughout the counties of Los Angeles, Ventura and Orange. In distinction from many other independent banks in California, the Bank's deposit business is generated by a relatively small number of accounts, although most accounts have a very high average balance.
The Bank offers a full range of lending services including commercial, real estate, and real estate construction loans. The Bank has developed a substantial portfolio of short and medium-term "mini-perm" first trust deed loans for income properties as well as specializing in construction lending for moderate-size commercial and residential projects. The Bank also offers commercial loans for commercial and industrial borrowers, which includes equipment financing as well as short-term loans. Typically, the Bank's loans are floating rate and have no prepayment penalties. Rising interest rates could lead to increased levels of loan prepayments and competitive pressure on contracted interest rates. The Bank also offers standard banking services for its customers, including telephone transfers, wire transfers, and travelers checks. The Bank accepts all types of demand, savings, and time certificates of deposit. The Bank's Merchant Services division offers credit card deposit and clearing services for retailers and other businesses that accept credit cards. Management has evaluated the Company's overall operation and determined that its business consists of three reportable business segments: (1) core bank operations, (2) the administrative services provided by the Bank's division, Trust Administration Services, and (3) Trust Services. For segment reporting financial information, see Note 19 of the Consolidated Financial Statements. The Bank formed Trust Administration Services during 1999 to provide administrative services for self-directed retirement plans. The Bank commenced offering trust services for living trusts, investment agency accounts, IRA rollovers and all forms of court-related matters in 2001. At March 13, 2009 the Bank had 288 equivalent full-time employees.
The banking business in California generally, and in the Los Angeles, Ventura and Orange County areas where the Bank is located, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major banks which have many offices operating over wide geographic areas. The Bank competes for deposits and loans principally with these major banks, but also with small independent banks located in its service areas. Among the advantages which the major banks have over the Bank are their ability to finance extensive advertising campaigns and to allocate their investment assets to regions of highest yield and demand. Many of the major commercial banks operating in the Bank's service area offer certain services, which are not offered directly by the Bank and, by virtue of their greater total capitalization, such banks have substantially higher lending limits than the Bank.
Moreover, banks generally, and the Bank in particular, face increasing competition for loans and deposits from non-bank financial intermediaries such as savings and loan associations, thrift and loan associations, credit unions, mortgage companies, insurance companies, and other lending institutions. Money market funds offer rates competitive with banks, and an increasingly sophisticated financial services industry continually develops new products for consumers that compete with banks for investment dollars. In addition, other entities (both public and private) seeking to raise capital through the issuance and sale of debt or equity securities compete with banks in the acquisition of deposits.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), enacted on September 29, 1994, provides that interstate branching and merging of existing banks is permitted beginning June 1, 1997, provided that the banks are at least adequately capitalized and demonstrate good management. The states are also authorized to enact a law to permit interstate banks to branch de novo.
On August 9, 1989, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") was signed into law. Among other things, FIRREA allows the acquisition of healthy and failed savings associations by bank holding companies, and imposes no interstate barriers on such bank holding company acquisitions. With certain qualifications, FIRREA also allows bank holding companies to merge acquired savings associations into their existing commercial bank subsidiaries; however, for a
period of five years from the date of enactment, the acquired savings association must continue as a member of, and continue to pay premiums to, the Savings Association Insurance Fund, which was created by FIRREA to replace the Federal Savings and Loan Insurance Corporation deposit insurance fund, which FIRREA abolished.
Recent legislation and economic developments have favored increased competition between different types of financial institutions for both deposits and loans, resulting in increased cost of funds to banks generally and to the Bank in particular. In order to compete with the other financial institutions in its service area, the Bank relies principally upon personal contacts by its officers, directors, founders, employees and shareholders; local promotional activity including direct mail, advertising in local newspapers and business journals; and specialized services. The Bank's promotional activities emphasize the advantages of dealing with a locally-owned and headquartered institution attuned to the particular needs of the community. In the event that a customer's loan demands exceed the Bank's lending limits, the Bank can arrange for such loans on a participation basis with its correspondent banks. The Bank also assists customers requiring services not offered by the Bank to obtain these services from its correspondent banks.
Supervision and Regulation
Banking is a complex, highly regulated industry. The primary goals of the regulatory scheme are to maintain a safe and sound banking system, protect depositors and the Federal Deposition Insurance Corporation's insurance fund, and facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress and the states have created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the financial services industry. Consequently, the growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general economic conditions, but also by the requirements of applicable state and federal statues, regulations and the policies of various governmental regulatory authorities, including the Board of Governors of the Federal Reserve System, or the FRB, the Federal Deposit Insurance Corporation, or the FDIC, and the California Department of Financial Institutions, or the DFI.
The system of supervision and regulation applicable to financial services businesses governs most aspects of the business of the Company and the Bank, including: (i) the scope of permissible business; (ii) investments; (iii) reserves that must be maintained against deposits; (iv) capital levels that must be maintained; (v) the nature and amount of collateral that may be taken to secure loans; (vi) the establishment of new branches; (vii) mergers and consolidations with other financial institutions; and (viii) the payment of dividends.
From time to time laws or regulations are enacted which have the effect of increasing the cost of doing business, limiting or expanding the scope of permissible activities, or changing the competitive balance between banks and other financial and non-financial institutions. Proposals to change the laws and regulations governing the operations of banks and bank holding companies are frequently made in Congress, in the California legislature and by various bank and other regulatory agencies. Future changes in the laws, regulations or polices that impact the Company and the Bank cannot necessarily be predicted, but they may have a material effect on the business and earnings of the Company and the Bank.
General. As a bank holding company, the Company is registered under the Bank Holding Company Act of 1956, as amended, or the BHCA, and is subject to regulation by the FRB. According to FRB policy, the Company is expected to act as a source of financial strength for the Bank, and is
subject to periodic examination by the FRB. The Company is also required to file periodic reports of its operations and any additional information regarding its activities and those of its subsidiaries, as may be required by the FRB.
The Company is also a bank holding company within the meaning of Section 3700 of the California Financial Code. Consequently, the Company and the Bank are subject to examination by, and may be required to file reports with, the DFI. Regulations have not yet been proposed or adopted or steps otherwise taken to implement the DFI's powers under this statute.
Bank Holding Company Liquidity. The Company is a legal entity, separate and distinct from the Bank. The Company has the ability to raise capital on its own behalf or borrow from external sources. The Company may also obtain additional funds from dividends paid by, and fees charged for services provided to, the Bank. However, regulatory constraints on the Bank may restrict or totally preclude the payment of dividends by the Bank to the Company.
The Company is entitled to receive dividends, when and as declared by the Bank's Board of Directors. Those dividends may come from funds legally available for those dividends, as specified and limited by the California Financial Code. Under the California Financial Code, funds available for cash dividends by a California-chartered bank are restricted to the lesser of: (i) the bank's retained earnings; or (ii) the bank's net income for its last three fiscal years (less any distributions to shareholders made during such period). With the prior approval of the DFI, cash dividends may also be paid out of the greater of: (a) the bank's retained earnings; (b) net income for the bank's last preceding fiscal year; or (c) net income or the bank's current fiscal year. In addition to these restrictions, the formal regulatory agreement which the Company is currently subject to restricts First Regional Bank from paying cash dividends to the Company without prior regulatory approval. (See "Regulatory Agreement," below).
If the DFI determines that the shareholders' equity of the bank paying the dividend is not adequate or that the payment of the dividend would be unsafe or unsound for the bank, the DFI may order the bank not to pay the dividend. Since the Bank is an FDIC insured institution, it is also possible, depending upon its financial condition and other factors, that the FDIC could assert that the payment of dividends or other payments might, under some circumstances, constitute an unsafe or unsound practice and thereby prohibit such payments.
Transactions with Affiliates. The Company and any subsidiaries it may purchase or organize are deemed to be affiliates of the Bank within the meaning of Sections 23A and 23B of the Federal Reserve Act and the FRB's Regulation W. Under Sections 23A and 23B and Regulation W, loans by the Bank to affiliates, investments by them in affiliates' stock, and taking affiliates' stock as collateral for loans to any borrower is limited to 10% of the Bank's capital, in the case of any one affiliate, and is limited to 20% of the Bank's capital, in the case of all affiliates. In addition, transactions between the Bank and other affiliates must be on terms and conditions that are consistent with safe and sound banking practices; in particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Federal Reserve Act. These restrictions also prevent a bank holding company and its other affiliates from borrowing from a banking subsidiary of the bank holding company unless the loans are secured by marketable collateral of designated amounts. The Company and the Bank are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities.
Limitations on Business and Investment Activities. Under the BHCA, a bank holding company must obtain the FRB's approval before: (i) directly or indirectly acquiring more than 5% ownership or control of any voting shares of another bank or bank holding company; (ii) acquiring all or substantially all of the assets of another bank; (iii) or merging or consolidating with another bank holding company.
The FRB may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the
target bank is located. In approving interstate acquisitions, however, the FRB must give effect to applicable state laws limiting the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institutions in the state in which the target bank is located, provided that those limits do not discriminate against out-of-state depository institutions or their holding companies, and state laws which require that the target bank have been in existence for a minimum period of time, not to exceed five years, before being acquired by an out-of-state bank holding company.
In addition to owning or managing banks, bank holding companies may own subsidiaries engaged in certain businesses that the FRB has determined to be "so closely related to banking as to be a proper incident thereto." The Company, therefore, is permitted to engage in a variety of banking-related businesses. Some of the activities that the FRB has determined, pursuant to its Regulation Y, to be related to banking are: (i) making or acquiring loans or other extensions of credit for its own account or for the account of others; (ii) servicing loans and other extensions of credit; (iii) performing functions or activities that may be performed by a trust company in the manner authorized by federal or state law under certain circumstances; (iv) leasing personal and real property or acting as agent, broker, or adviser in leasing such property in accordance with various restrictions imposed by FRB regulations; (v) acting as investment or financial advisor; (vi) providing management consulting advise under certain circumstances; (vii) providing support services, including courier services and printing and selling MICR-encoded items; (viii) acting as a principal, agent, or broker for insurance under certain circumstances; (ix) making equity and debt investments in corporations or projects designed primarily to promote community welfare or jobs for residents; (x) providing financial, banking, or economic data processing and data transmission services; (xi) owning, controlling, or operating a savings association under certain circumstances; (xii) selling money orders, travelers' checks and U.S. Savings Bonds; (xiii) providing securities brokerage services, related securities credit activities pursuant to Regulation T, and other incidental activities; and (xiv) underwriting and dealing in obligations of the U.S., general obligations of states and their political subdivisions, and other obligations authorized for state member banks under federal law.
Additionally, qualifying bank holding companies making an appropriate election to the FRB may engage in a full range of financial activities, including insurance, securities and merchant banking. The Company has not elected to qualify for these financial activities.
Federal law prohibits a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, for example, the Bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer must obtain or provide some additional credit, property or services from or to the Bank other than a loan, discount, deposit or trust services; (ii) the customer must obtain or provide some additional credit, property or service from or to the Company or any subsidiaries; or (iii) the customer must not obtain some other credit, property or services from competitors, except reasonable requirements to assure soundness of credit extended.
Capital Adequacy. Bank holding companies must maintain minimum levels of capital under the FRB's risk-based capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.
The FRB's risk-based capital adequacy guidelines, discussed in more detail below in the section entitled "SUPERVISION AND REGULATIONFirst Regional BankRegulatory Capital Guidelines," assign various risk percentages to different categories of assets, and capital is measured as a percentage of risk assets. Under the terms of the guidelines, bank holding companies are expected to meet capital adequacy guidelines based both on total risk assets and on total assets, without regard to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual organizations. For example, the FRB's capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Moreover, any banking organization experiencing or anticipating significant growth or expansion into new activities, particularly under the expanded powers under the Gramm-Leach-Bliley Act, would be expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.
Limitations on Dividend Payments. California Corporations Code Section 500 allows the Company to pay a dividend to its shareholders only to the extent that the Company has retained earnings and, after the dividend, the Company's (i) assets (exclusive of goodwill and other intangible assets) would be 1.25 times its liabilities (exclusive of deferred taxes, deferred income and other deferred credits); and (ii) current assets would be at least equal to current liabilities.
Additionally, the FRB's policy regarding dividends provides that a bank holding company should not pay cash dividends exceeding its net income or which can only be funded in ways that weaken the bank holding company's financial health, such as by borrowing. The FRB also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations.
The Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002, or the SOX, became effective on July 30, 2002, and represents the most far reaching corporate and accounting reform legislation since the enactment of the Securities Act of 1933 and the Exchange Act of 1934. The SOX is intended to provide a permanent framework that improves the quality of independent audits and accounting services, improves the quality of financial reporting, strengthens the independence of accounting firms and increases the responsibility of management for corporate disclosures and financial statements. It is intended that by addressing these weaknesses, public companies will be able to avoid the problems encountered by several infamous companies in 2001-2002.
The SOX's provisions are significant to all companies that have a class of securities registered under Section 12 of the Exchange Act, or are otherwise reporting to the SEC (or the appropriate federal banking agency) pursuant to Section 15(d) of the Exchange Act, including the Company (collectively, "public companies"). In addition to SEC rulemaking to implement the SOX, The Nasdaq National Market has adopted corporate governance rules intended to allow shareholders to more easily and effectively monitor the performance of companies and directors. The principal provisions of the SOX, many of which have been interpreted through regulations released in 2003, provide for and include, among other things: (i) the creation of an independent accounting oversight board; (ii) auditor independence provisions that restrict non-audit services that accountants may provide to their audit clients; (iii) additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer of a public company certify financial statements; (iv) the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; (v) an increase in the oversight of, and enhancement of certain requirements relating to, audit committees of public companies and how they interact with the Company's independent auditors; (vi) requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer; (vii) requirements that companies disclose whether at least one member of the audit committee is a "financial expert' (as such term is defined by the SEC) and if not discussed, why the audit committee does not have a financial expert; (viii) expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods; (ix) a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions on
non-preferential terms and in compliance with other bank regulatory requirements; (x) disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; (xi) a range of enhanced penalties for fraud and other violations; and (xii) expanded disclosure and certification relating to an issuer's disclosure controls and procedures and internal controls over financial reporting.
As a result of the SOX, and its implementing regulations, the Company has incurred substantial cost to interpret and ensure compliance with the law and its regulations. Future changes in the laws, regulation, or policies that impact the Company cannot necessarily be predicted and may have a material effect on the business and earnings of the Company.
First Regional Bank
The Bank is extensively regulated under both federal and state law.
The Bank, as a California state chartered bank which is not a member of the Federal Reserve System, is subject to regulation, supervision, and regular examination by the DFI and the FDIC. The Bank's deposits are insured by the FDIC up to the maximum extent provided by law. The regulations of these agencies govern most aspects of the Bank's business. California law exempts all banks from usury limitations on interest rates.
Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statutes and regulations relate to many aspects of the Bank's operations, including standards for safety and soundness, reserves against deposits, interest rates payable on deposits and loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, fair lending requirements, Community Reinvestment Act activities and loans to affiliates. Further, the Bank is required to maintain certain levels of capital.
Regulatory Capital Guidelines. The federal banking agencies have established minimum capital standards known as risk-based capital guidelines. These guidelines are intended to provide a measure of capital that reflects the degree of risk associated with a bank's operations. The risk-based capital guidelines include both a definition of capital and a framework for calculating the amount of capital that must be maintained against a bank's assets and off-balance sheet items. The amount of capital required to be maintained is based upon the credit risks associated with the various types of a bank's assets and off-balance sheet items. A bank's assets and off-balance sheet items are classified under several risk categories, with each category assigned a particular risk weighting from 0% to 100%. The following table sets forth the regulatory capital guidelines and the actual capitalization levels for the Bank and the Company as of December 31, 2008:
As of December 31, 2008 and 2007, the Bank met the regulatory capital ratio requirements to be categorized as "well capitalized" under the regulatory framework for prompt corrective action, which regulatory framework applies to banks but not to bank holding companies. The ratio requirements to be categorized as "well capitalized," are as set forth in the table above. (See below, under "Regulatory Agreement" for additional information regarding the Bank's target capital ratios.)
To enhance regulatory capital and to provide liquidity, the Company, through unconsolidated subsidiary grantor trusts, issued $97.5 million (net of common stock) of trust preferred securities. These securities are currently included in our Tier I capital for purposes of determining the Company's Tier I and total risk-based capital ratios. The FRB has promulgated a modification of the capital regulations affecting trust preferred securities. Under this modification, effective March 31, 2009, the Company will be required to use a more restrictive formula to determine the amount of trust preferred securities that can be included in regulatory Tier I capital. At that time, the Company will be allowed to include in Tier I capital an amount of trust preferred securities equal to no more than 25% of the sum of all core capital elements, which is generally defined as shareholders' equity, less goodwill and any related deferred income tax liability. The regulations currently in effect through December 31, 2008, limit the amount of trust preferred securities that can be included in Tier I capital to 25% of the sum of core capital elements without a deduction for goodwill. Management has determined that the Company's Tier I capital ratios would remain above the "well-capitalized" level had the modification of the capital regulations been in effect at December 31, 2008. Management expects that the Company's Tier I capital ratios will be at or above the existing well capitalized levels on March 31, 2009, the first date on which the modified capital regulations must be applied.
Prompt Corrective Action. The federal banking agencies possess broad powers to take prompt corrective action to resolve the problems of insured banks. Each federal banking agency has issued regulations defining five capital categories: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." Under the regulations, a bank shall be deemed to be:
Banks are prohibited from paying dividends or management fees to controlling persons or entities if, after making the payment the bank would be "undercapitalized," that is, the bank fails to meet the required minimum level for any relevant capital measure. Asset growth and branching restrictions apply to "undercapitalized" banks. Banks classified as "undercapitalized" are required to submit acceptable capital plans guaranteed by their holding companies, if any. Broad regulatory authority was granted with respect to "significantly undercapitalized" banks, including forced mergers, growth restrictions, ordering new elections for directors, forcing divestiture by their holding companies, if any, requiring management changes, and prohibiting the payment of bonuses to senior management. Even more severe restrictions are applicable to "critically undercapitalized" banks, those with capital at or less than 2%. Restrictions for these banks include the appointment of a receiver or conservator. All of the
federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action.
A bank, based upon its capital levels, that 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 a hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment. At each successive lower capital category, an insured bank is subject to more restrictions. The federal banking agencies, however, may not treat an institution as "critically undercapitalized" unless its capital ratios actually warrant such treatment.
In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential enforcement actions by the federal banking agencies for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, and the issuance of removal and prohibition orders against institution-affiliated parties. The enforcement of such actions through injunctions or restraining orders may be based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.
The DFI, as the primary regulator for state-chartered banks, also has a broad range of enforcement measures, from cease and desist powers and the imposition of monetary penalties to the ability to take possession of a bank, including causing its liquidation.
During February 2009, the Bank signed an order to cease and desist with the Federal Deposit Insurance Corporation (the "FDIC") and the California Department of Financial Institutions (the "DFI") to further strengthen the Bank's operations. The agreement between First Regional Bank and its regulators is expected to help guide the Bank in addressing the impacts of today's challenging economic environment. The agreement formalizes many of the initiatives which the Bank has already adopted, and provides useful milestones for measuring the Bank's progress as it moves forward.
Under the agreement, First Regional Bank will:
As previously noted, First Regional Bank continues to maintain "well capitalized" ratios, the highest standards established by banking regulators. However, in connection with the Bank's plan to
increase its capital ratios, the Bank has agreed to maintain a minimum Tier 1 leverage ratio of 9.5% of the Bank's total assets and to maintain such ratio at 10% as of September 30, 2009. Also as a part of such plan, First Regional Bank and its parent, First Regional Bancorp, have also authorized the contribution by First Regional Bancorp, from its cash reserves, of $12 million into the Bank as additional Bank capital, which contribution was made during February 2009.
Under the prompt corrective action rules, a capital maintenance requirement prevents the Bank from accepting or renewing brokered deposits without first obtaining a waiver from the FDIC. The Bank has applied to the FDIC for permission to continue to accept certain types of brokered deposits. At December 31, 2008 and 2007, the Bank had brokered deposits of approximately $650 million and $3 million, respectively. (See "Liquidity, Sources of Funds, and Capital Resources" for additional information regarding deposits.)
In addition to the above restrictions, the agreement also restricts First Regional Bank from paying cash dividends to the Company without prior regulatory approval.
In the interest of preserving its remaining cash reserves during a challenging period, First Regional Bancorp intends to defer interest payments on its trust preferred securities for a period of one year, or until March 2010. First Regional Bancorp has the right to defer interest payments for up to five years under the indentures governing its various trust preferred securities. Under the indentures governing the Company's trust preferred securities, the Company is prohibited from taking certain actions during the period of interest deferral, such as paying dividends and repurchasing shares of the Company's stock.
First Regional Bank intends to achieve full compliance with the agreement in a timely manner. As the agreement includes many initiatives previously adopted by the Bank, the implementation of those measures has already begun. Even after the terms of the agreement have been satisfied, First Regional Bank plans to continue its efforts to further enhance the Bank's capital strength, asset quality, and operating performance.
Federal Deposit Insurance. The FDIC has implemented a risk-based assessment system in which the deposit insurance premium relates to the probability that the deposit insurance fund will incur a loss. Under the risk-based assessment system adopted by the FDIC, effective January 1, 2007, banks are categorized into one of four categories based upon supervisory and capital evaluations. In practice, the subgroup evaluations will generally be based on an institution's composite CAMELS rating assigned to it by the institution's federal supervisor at the end of its examination. The CAMELS rating system is based upon an evaluation of the five critical elements of an institution's operations: Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to risk. This rating system is designed to take into account and reflect all significant financial and operational factors financial institution examiners assess in their evaluation of an institution's performance. The following table sets forth these four Risk Categories:
Within Risk Category I, the assessment system combines supervisory ratings with other risk measures to differentiate risk. For most institutions, the assessment system combines CAMELS component ratings with financial ratios to determine an institution's assessment rate. For large institutions that have long-term debt issuer ratings, the new assessment system differentiates risk by
combining CAMELS component ratings with those ratings. For large institutions within Risk Category I, initial assessment rate determinations may be modified within limits upon review of additional relevant information. The new assessment system assess those within Risk Category I that pose the least risk a minimum assessment rate and those that pose the greatest risk a maximum assessment rate that is two basis points higher. An institution that poses an intermediate risk within Risk Category I will be charged a rate between the minimum and maximum that will vary incrementally by institution.
On February 27, 2009, the FDIC adopted final rules modifying the risk-based assessment system and setting initial base assessment rates beginning April 1, 2009. Under these new rules, risk assessments for small risk category I institutions and large risk category I institutions with no long-term debt rating will include a consideration of such institutions' adjusted brokered deposit ratio. The adjusted brokered deposit ratio affects institutions whose brokered deposits are more than 10 percent of domestic deposits and whose total assets are more than 40 percent greater than they were four years previously. The adjusted brokered deposit ratio excludes certain reciprocal deposits for institutions in Risk Category I. Brokered deposits that consist of balances swept into an insured institution are included in the adjusted brokered deposit ratio for all institutions.
Further, the new rules revised the method for calculating the assessment rate for a large risk category I institution with a long-term debt issuer rating so that it equally weights the institution's weighted average CAMELS component ratings, its long-term debt issuer ratings and the financial ratios method assessment rate. The final rule updates the uniform amount and the pricing multipliers for the weighted average CAMELS component ratings and financial ratios method. It also increases the maximum possible large bank adjustment from 0.5 basis point to 1.0 basis point.
These new rules set forth three possible adjustments to an institution's initial base assessment rate: (i) a decrease of up to five basis points for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt and, for small institutions, a portion of Tier 1 capital; (ii) an increase not to exceed 50 percent of an institution's assessment rate before the increase for secured liabilities in excess of 25 percent of domestic deposits; and (ii) for non-Risk Category I institutions, an increase not to exceed 10 basis points for brokered deposits in excess of 10 percent of domestic deposits.
Under these new rules, the FDIC adopted new initial base assessment rates as of April 1, 2009, as follows:
After applying all possible adjustments, minimum and maximum total base assessment rates for each risk category are as follows:
In addition, on February 27, 2009, the FDIC adopted an interim rule that imposes a 20 basis point emergency special assessment on all insured depository institutions on June 30, 2009. The special assessment will be collected September 30, 2009, at the same time that the risk-based assessments for the second quarter of 2009 are collected. The interim rule also permits the FDIC to impose an emergency special assessment of up to 10 basis points on all insured depository institutions whenever, after June 30, 2009, the FDIC estimates that the DIF reserve ratio will fall to a level that the FDIC believes would adversely affect public confidence or to a level close to zero or negative at the end of a calendar quarter.
The FDIC may seek to terminate its insurance of deposits if it finds, and then prevails in proving to an administrative law judge, at an administrative judicial hearing, that the Bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Effective November 21, 2008 and until December 31, 2009, the FDIC expanded deposit insurance limits for certain accounts under the FDIC's Temporary Liquidity Guarantee Program. Provided an institution has not opted out of the Temporary Liquidity Guarantee Program, the FDIC may (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008 and before June 30, 2009 and, (ii) will provide full FDIC deposit insurance coverage for noninterest bearing transaction deposit accounts, Negotiable Order of Withdrawal ("NOW") accounts paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts ("IOLTA") accounts held at participating FDIC-insured institutions through December 31, 2009. Coverage under the TLGP was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000. First Regional is monitoring the many programs which continue to emerge as part of the Federal government's efforts to stabilize and strengthen the nation's economy. All programs are evaluated based on their applicability to First Regional, and whether they will provide benefit to the Company and its shareholders. The Company's subsidiary, First Regional Bank, is participating in the program to provide full deposit insurance coverage of non-interest bearing deposit transaction accounts under the FDIC's Temporary Liquidity Guarantee Program. As neither the Company nor First Regional Bank anticipate issuing qualifying debt, they will not participate in the debt guarantee portion of the Temporary Liquidity Guarantee.
Money Laundering and Currency Controls. Various federal statutory and regulatory provisions are designed to enhance record-keeping and reporting of currency and foreign transactions. Pursuant to the Bank Secrecy Act, financial institutions must report high levels of currency transactions or face the imposition of civil monetary penalties for reporting violations. The Money Laundering Control Act imposes sanctions, including revocation of federal deposit insurance, for institutions convicted of money laundering.
The International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 ("IMLAFATA"), a part of the comprehensive anti-terrorism legislation, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, known as the Patriot Act. ("USA Patriot Act"). The IMLAFATA authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to banks and other financial institutions to enhance record-keeping and reporting requirements for certain financial transactions that are of primary money laundering concern. Among its other provisions, IMLAFATA requires each financial institution to: (i) establish an anti-money laundering program; (ii) establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving individuals and certain foreign banks; and (iii) avoid establishing, maintaining, administering, or managing correspondent accounts in the Untied States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, IMLAFATA contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities.
The Treasury Department's regulations implementing IMLAFATA mandate that federally-insured banks and other financial institutions establish customer identification programs designed to verify the identity of persons opening new accounts, maintain the records used for verification, and determine whether the person appears on any list of known or suspected terrorists or terrorist organizations.
Community Reinvestment Act. The CRA is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal bank regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs of their entire community, including low-and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA further requires the agencies to take a financial institution's record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions, or holding company formations.
The federal banking agencies have adopted regulations which measure a bank's compliance with its CRA obligations on a performance-based evaluation system. This system bases CRA ratings on an institution's actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. The ratings range from "outstanding" to a low of "substantial noncompliance."
The Bank had a CRA rating of "satisfactory" as of its most recent regulatory examination.
Environmental Regulation. Federal, state and local laws and regulations regarding the discharge of harmful materials into the environment may have an impact on the Bank. Since the Bank is not involved in any business that manufactures, uses or transports chemicals, waste, pollutants or toxins that might have a material adverse effect on the environment, the Bank's primary exposure to environmental laws is through its lending activities and through properties or businesses the Bank may own, lease or acquire. Based on a general survey of the Bank's loan portfolio, conversations with local appraisers and the type of lending currently and historically done by the Bank, management is not aware of any potential liability for hazardous waste contamination that would be reasonably likely to have a material adverse effect on the Company as of December 31, 2008.
Safeguarding of Customer Information and Privacy. The FRB and other bank regulatory agencies have adopted guidelines for safeguarding confidential, personal customer information. These guidelines require financial institutions to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazard to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The Bank has adopted a customer information security program to comply with such requirements.
Financial institutions are also required to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, financial institutions must provide explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, prohibits disclosing such information except as provided in the Bank's policies and procedures. The Bank has implemented privacy policies addressing these restrictions which are distributed regularly to all existing and new customers of the Bank.
USA Patriot Act. On October 26, 2001, the President signed into law comprehensive anti-terrorism legislation, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, known as the Patriot Act. The Patriot Act was designed to deny terrorists and others the ability to obtain access to the United States financial system, and has significant implications for depository institutions and other businesses involved in the transfer of money. The Patriot Act, as implemented by various federal regulatory agencies, requires financial institutions, including the Bank, to implement new policies and procedures or amend existing policies and procedures with respect to, among other matters, anti-money laundering, compliance, suspicious activity and currency transaction reporting and due diligence on customers. The Patriot Act and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB and other federal banking agencies to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or the Bank Merger Act. The Bank has augmented its systems and procedures to accomplish this. The Bank believes that the ongoing cost of compliance with the Patriot Act is not likely to be material to the Bank.
Other Aspects of Banking Law. The Bank is also subject to federal statutory and regulatory provisions covering, among other things, security procedures, insider and affiliated party transactions, management interlocks, electronic funds transfers, funds availability, and truth-in-savings. There are also a variety of federal statutes which regulate acquisitions of control and the formation of bank holding companies.
Effect of Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve's monetary policies have had, and are likely to continue to have, an important impact
on the operating results of commercial banks through the Federal Reserve's statutory power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The Federal Reserve, through its monetary and fiscal policies, affects the levels of the Bank's loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect market interest rates. From January 2001 to June 2003, the FRB decreased interest rates numerous times, reducing the overnight "Federal Funds" rate from 6.50% to 1.00%, the lowest level in four decades. From June 2004 to June 2006, the FRB reversed direction and increased rates 17 times to 5.25%. From September 2007 through December 2008, the FRB reduced rates ten times to their current level of 0.00%. The nature and timing of any future changes in such policies and their impact on us cannot be predicted. However, depending on the degree to which our interest-earning assets and interest-bearing liabilities are rate sensitive, increases in rates would have a temporary effect of increasing our net interest margin, while decreases in interest rates would have the opposite effect. In addition, adverse economic conditions, including a downturn in the local or regional economy and rising energy prices, could make a higher provision for loan losses a prudent course and could cause higher loan charge-offs, thus adversely affecting our net income or other operating costs.
Recent Regulatory Developments. In light of current conditions in the global financial markets and the global economy, regulators have increased their focus on the regulation of the financial services industry. Proposals for legislation that could substantially intensify the regulation of the financial services industry are expected to be introduced in the U.S. Congress and in state legislatures. The agencies regulating the financial services industry also frequently adopt changes to their regulations. Substantial regulatory and legislative initiatives, including a comprehensive overhaul of the regulatory system in the U.S., are possible in the months or years ahead. Any such action could have a materially adverse effect on our business, financial condition and results of operations.
Recent months have seen an unprecedented number of government initiatives designed to respond to the stresses experienced in financial markets.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008 ("EESA") was signed into law on October 3, 2008. Pursuant to EESA, the U.S. Treasury was given the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Pursuant to EESA, the U.S. Treasury established the Troubled Asset Relief Program ("TARP") and has since injected capital into many financial institutions under the TARP Capital Purchase Program ("TARP CPP"). The Company thoroughly examined the Capital Purchase Program of the Treasury's Troubled Assets Relief Program (the "TARP Capital Program"), under which the Federal government injects capital into financial institutions through the purchase of preferred stock and warrants. In November 2008, the Board determined not to seek capital under the TARP Capital Program. The Board's decision was made in recognition of the fact that the Company and First Regional Bank already exceeded all financial ratio requirements for "Well Capitalized" status, that an issuance of warrants in connection with TARP would be significantly dilutive to Company shareholders, the costs related to the preferred stock would be high, and other factors.
On October 3, 2008, the FDIC increased its insurance coverage limits on all deposits from $100,000 to $250,000 per account until December 31, 2009.
On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program ("TLGP"). The TLGP was announced by the FDIC on October 14, 2008, as an initiative to counter the system-wide crisis in the nation's financial sector. Under the TLGP, the FDIC may (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008 and before June 30, 2009 and (ii) provide full FDIC deposit insurance coverage for noninterest bearing transaction deposit accounts, Negotiable Order of Withdrawal ("NOW") accounts paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts ("IOLTA") accounts held at participating FDIC-insured institutions through December 31, 2009. Coverage under the TLGP was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000. First Regional is monitoring the many programs which continue to emerge as part of the Federal government's efforts to stabilize and strengthen the nation's economy. All programs are evaluated based on their applicability to First Regional Bank, and whether they will provide benefit to the Company and its shareholders. The Company's subsidiary, First Regional Bank, is participating in the program to provide full deposit insurance coverage of non-interest bearing deposit transaction accounts under the FDIC's Temporary Liquidity Guarantee Program. As neither the Company nor First Regional Bank anticipate issuing qualifying debt, they will not participate in the debt guarantee portion of the Temporary Liquidity Guarantee Program.
On February 10, 2009, the U.S. Treasury announced the Financial Stability Plan ("FSP"), which, among other things, proposes to establish a new Capital Assistance Program ("CAP") through which eligible banking institutions will have access to U.S. Treasury capital as a bridge to private capital until market conditions normalize, and extends the TLGP to October 31, 2009. As a complement to CAP, a new Public-Private Investment Fund on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion, was announced to catalyze the removal of legacy assets from the balance sheets of financial institutions. This proposed fund will combine public and private capital with government financing to help free up capital to support new lending. In addition, the existing Term Asset-Backed Securities Lending Facility ("TALF") would be expanded (up to $1 trillion) in order to reduce credit spreads and restart the securitized credit markets that in recent years supported a substantial portion of lending to households, students, small businesses, and others. Furthermore, the FSP proposes a new framework of governance and oversight to help ensure that banks receiving funds are held responsible for appropriate use of those funds through stronger conditions on lending, dividends and executive compensation along with enhanced reporting to the public. As of the date of this report, First Regional had not determined to seek to participate. However, First Regional will continue to monitor emerging government programs to evaluate whether such programs would be applicable to, and beneficial to, First Regional.
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 ("ARRA") was signed into law. AARA is intended to provide tax breaks for individuals and businesses, direct aid to distressed states and individuals, and infrastructure spending. In addition, ARRA imposes new executive compensation and expenditure limits on all previous and future TARP CPP recipients and expands the class of employees to whom the limits and restrictions apply. ARRA also provides the opportunity for additional repayment flexibility for existing TARP CPP recipients. Among other things, ARRA prohibits the payment of bonuses, other incentive compensation and severance to certain highly paid employees (except in the form of restricted stock subject to specified limitations and conditions), and requires each TARP CPP recipient to comply with certain other executive compensation related requirements. These provisions modify the executive compensation provisions that were included in EESA, and in most instances apply retroactively for so long as any obligation arising from financial assistance provided to the recipient under TARP remains outstanding. To the extent that the executive compensation provisions in ARRA are more restrictive than the restrictions described in the Treasury's
executive compensation guidelines already issued under EESA, the new ARRA guidelines appear to supersede those restrictions. However, both ARRA and the existing Treasury guidelines contemplate that the Secretary of the Treasury will adopt standards to provide additional guidance regarding how the executive compensation restrictions under ARRA and EESA will be applied. Because, as of the date of this report, First Regional is not a TARP CPP recipient, such provisions are not currently applicable to First Regional.
In addition, ARRA directs the Secretary of the Treasury to review previously-paid bonuses, retention awards and other compensation paid to the senior executive officers and certain other highly-compensated employees of each TARP CPP recipient to determine whether any such payments were excessive, inconsistent with the purposes of ARRA or the TARP, or otherwise contrary to the public interest. If the Secretary determines that any such payments have been made by a TARP CPP recipient, the Secretary will seek to negotiate with the TARP CPP recipient and the subject employee for appropriate reimbursements to the U.S. government (not the TARP CPP recipient) with respect to any such compensation or bonuses. ARRA also permits the Secretary, subject to consultation with the appropriate federal banking agency, to allow a TARP CPP recipient to repay any assistance previously provided to such TARP CPP recipient under the TARP, without regard to whether the TARP CPP recipient has replaced such funds from any source, and without regard to any waiting period. Any TARP CPP recipient that repays its TARP assistance pursuant to this provision would no longer be subject to the executive compensation provisions under ARRA. Because, as of the date of this report, First Regional is not a TARP CPP recipient, such provisions are not currently applicable to First Regional.
On February 18, 2009, the U.S. Treasury announced the Homeowner Affordability and Stability Plan ("HASP"), which proposes to provide refinancing for certain homeowners, to support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac, and to establish a Homeowner Stability Initiative to reach at-risk homeowners. Among other things, the Homeowner Stability Initiative would offer monetary incentive to mortgage servicers and mortgage holders for certain modifications of at-risk loans, and would establish an insurance fund designed to reduce foreclosures.
It is not clear at this time what impact EESA, the CPP, the TLGP, the FSP, AARA, HASP, or other liquidity and funding initiatives will have on the financial markets and the other difficulties described above, including the high levels of volatility and limited credit availability currently being experienced, or on the U.S. banking and financial industries and the broader U.S. and global economies. Failure of these programs to address the issues noted above could have an adverse effect on the Company and its business.
Banking is a business that depends on rate differentials. In general, the difference between the interest rate paid by a bank on its deposits and its other borrowings and the interest rate earned on its loans, securities and other interest-earning assets comprises the major source of the Bank's earnings. These rates are highly sensitive to many factors which are beyond the Bank's control and, accordingly, the earnings and growth of the Bank are subject to the influence of economic conditions generally, both domestic and foreign, including inflation, recession, and unemployment; and also to the influence of monetary and fiscal policies of the United States and its agencies, particularly the FRB. The FRB implements national monetary policy, such as seeking to curb inflation and combat recession, by:
The actions of the Federal Reserve Bank in these areas influence the growth of bank loans, investments, and deposits and also affect interest rates. The nature and timing of any future changes in the FRB's policies and their impact on the Company and the Bank cannot be predicted; however, depending on the degree to which our interest-earning assets and interest-bearing liabilities are rate sensitive, increases in rates would have a temporary effect of increasing our net interest margin, while decreases in interest rates would have the opposite effect. In addition, adverse economic conditions could make a higher provision for loan losses a prudent course and could cause higher loan charge-offs, thus adversely affecting our net income or other operating costs.
Product Development Research
The Company has not engaged in any material research activities relating to the development of new services or the improvement of existing banking services during the last three fiscal years. The officers and employees of the Bank are continually engaged in marketing activities including the evaluation and development of new services, to enable the Bank to retain a competitive position in certain service areas.
Distribution of Assets, Liabilities and Shareholders' Equity
The following table shows the yearly average balances of the Company's assets, liabilities, and shareholders' equity for each of the past three years:
Interest Rates and Interest Differential
The following table sets forth the average balances outstanding for major categories of interest earning assets and interest bearing liabilities and the average interest rates earned and paid thereon:
The following table shows the net interest earnings and the net yield on average interest earning assets:
The following table sets forth changes in interest income and interest expense. The net change as shown in the column "Net Increase (Decrease)" is segmented into the change attributable to variations
in volume and the change attributable to variations in interest rates. Non-performing loans are included in average loans.
The following table shows the fair value of the investment securities portfolio at December 31, 2008 and 2007:
The maturity schedule and weighted average yields of debt securities at December 31, 2008 is as follows:
The loan portfolio consisted of the following at December 31:
Loan Maturities and Interest Rates
The following table shows the amounts of total loans outstanding as of December 31, 2008, which, based on remaining scheduled payments of principal, are due in one year or less, more than one year but less than five years, more than five years but less than ten years, and ten years or more. The amount due for each interval is classified according to whether the interest rate floats in response to changes in interest rates or is fixed.
Aggregate maturities of loan balances which are due (in thousands):
The current policy is to cease accruing interest on commercial, real estate and installment loans which are past due as to principal or interest 90 days or more, except that in certain circumstances interest accruals are continued on loans deemed by management to be fully collectible.
The following table shows the principal amount of non-performing loans:
Performing assets that are considered impaired due to concerns with the economic climate consist of the following:
Except as may have been included in the above tables, at December 31, 2008, there were no loans, the terms of which had been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration of the financial position of the borrower or which would be classified as restructured debt in a troubled loan situation.
Summary of Loan Loss Experience
The following table provides information concerning changes in the allowance for loan losses and loans charged off and recovered:
The Bank has historically evaluated the adequacy of its allowance for loan losses on an overall basis rather than by specific categories of loans. In determining the adequacy of the allowance for loan losses, management considers such factors as historical loan loss experience, known problem loans, evaluations made by bank regulatory authorities, assessment of economic conditions and other appropriate data to identify the risks in the loan portfolio.
For the purposes of this report, the allowance for loan losses has been allocated to the major categories of loans as set forth in the following table. The allocations are estimates based upon
historical loss experience and management judgment. The allowance for loan losses should not be interpreted as an indication that charge-offs will occur in these amounts or proportions, or that the allocation indicates future charge-off trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories, since even in this allocation is an unallocated portion, and, as previously stated, the total allowance is applicable to the entire portfolio (dollar amounts in the following table are in thousands).
The average amounts of deposits for the years indicated are summarized below.
The maturity schedule of time certificates of deposit of $100,000 or more at December 31, 2008 is as follows:
Selected Financial Ratios
The following table sets forth the ratios of net income to average total assets and to average shareholders' equity, and average shareholders' equity to average total assets.
Our internet site can be found at www.firstregional.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports can be found through our internet site as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Copies of the Company's filings with the SEC may also be obtained directly from the SEC's website at www.sec.gov.
Our financial and operating results, and an investment in First Regional Bancorp common stock, are subject to a number of factors, many of which are outside the Company's control. These factors include the following:
Economic conditions could adversely affect the Company's liquidity.
The banking industry, including First Regional, has long focused on the importance of liquidity. The current economic environment has had an uneven impact on First Regional's liquidity. On the one hand, demands upon First Regional's liquidity sources have declined in a number of respects. For one, loan demand in general has slowed. For another, First Regional remains highly selective in its loan production, particularly in light of deteriorating conditions in some real estate markets. On the other hand, First Regional has found that loan payoffs have slowed, as a result of declining real estate sales and a tightened credit market for the long-term financing that has historically been accessed by our borrowers to refinance properties. In addition, First Regional has undisbursed commitments for existing loans, which results in ongoing demand for funding even with highly constrained new loan production. In order to effectively manage its liquidity, First Regional has recently increased deposits from previously underutilized sources, such as institutional time deposits. The Company has done this as part of a plan to reduce First Regional's outstanding Federal Home Loan Bank borrowing levels so as to hold this source available as a reserve fund of liquidity.
As previously noted, First Regional Bank continues to maintain "well capitalized" ratios, the highest standards established by banking regulators. However, in February 2009, First Regional Bank entered into a formal agreement with the FDIC and California Department of Financial Institutions, pursuant to which the Bank has agreed to increase its capital ratios. Under regulatory "prompt corrective action" rules, the existence of a capital component in a formal agreement results in a "well capitalized" institution being treated as "adequately capitalized" for purposes of rules governing brokered deposits. As a result, First Regional must seek and obtain a waiver from the FDIC prior to issuing or renewing any brokered deposits. As a result, First Regional Bank expects that most brokered deposits previously issued will run off as they mature over the next two years. First Regional has, however, applied for a waiver for certain types of deposits deemed "brokered deposits" by regulators.
First Regional also maintains other supplemental sources of liquidity, including marketable assets, credit lines with correspondent banks, and access to the Federal Reserve's discount window. Nevertheless, there is a risk that if loan repayments continue to slow, and/or First Regional's traditional deposit levels are reduced, the Company may need to utilize these supplemental liquidity sources, which could have an adverse impact on First Regional's financial condition and/or results of operations.
There is a limited and volatile trading market for the Company common stock.
The Company's common stock is traded on the Nasdaq National Market under the symbol "FRGB." However, there is a limited trading market for the Company's common stock, with an average trading volume of approximately 73,000 shares per trading day.
In addition, the Company's stock has suffered from a very significant decline over the past two years. While the Company's stock had previously traded at a significant multiple of the Company's
book value, the stock currently trades at less than 10% of book value. This may be due to several factors, including the recent concerns about banks and financial institutions generally, the status of the U.S. and world economies, the significant drop in real estate valuations, extreme credit tightening throughout the financial system, as well as the Company's recent financial results, including its loss of approximately $23 million for 2008. The Company does not believe that recent stock prices are meaningfully reflective of the company's underlying value. Accordingly, an investment in First Regional stock is subject to these risks, and there can be no assurance that a holder of the Company's common stock, particularly of large blocks, will have the ability to dispose of such shares in a liquid or stable market or that a more active trading market for the Company's common stock will develop or will be sustained.
While the Company's book value exceeded $12 per share as of December 31, 2008, the Company's common stock has recently been trading below $1. The Company's common stock is listed on the Nasdaq Global Select Market. One of Nasdaq's continued listing requirements is that a listed company have a minimum bid price of $1. Due to current extraordinary market conditions, in October 2008, Nasdaq suspended the rules requiring a minimum $1 closing bid price, with such rules initially scheduled to be reinstated January 2009. In January 2009, Nasdaq extended its suspension of such rules until April 20, 2009. It is expected that, in light of continued extraordinary market conditions, Nasdaq will continue to be flexible concerning such rules. However, there can be no assurance that Nasdaq will further extend the suspension of such rules, or that the closing bid price of the Company's common stock will rise above $1. Should Nasdaq fail to further extend the suspension of such rule, and the closing bid price of the Company's common stock fails to rise above $1, then Nasdaq could give the Company notice of noncompliance with such rule and require the Company to regain compliance within a timeframe determined by Nasdaq. The Company would then have the opportunity to devise a plan to regain compliance within such timeframe. Should the Company thereafter fail to timely regain compliance with such rule, the Company's common stock would be at risk of being delisted by Nasdaq, after which the stock would trade in over the counter (OTC) markets.
If a significant number of borrowers, guarantors and related parties fail to perform as required by the terms of their loans, we will sustain losses.
A significant source of risk for us arises from the possibility that losses will be sustained if a significant number of our borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans and guaranties. While First Regional Bank has historically enjoyed very low levels of nonperforming assets, during 2008, these levels rose in response to declining economic conditions, declining real estate values, tightening credit markets and other factors. First Regional Bank has undertaken to enhance its underwriting and credit monitoring procedures and credit policies, in an effort to better manage and reduce our exposure to such risks. Nevertheless, these policies and procedures may not prevent unexpected losses that could materially and adversely affect our results of operations.
We are highly dependent on real estate and events that negatively impact the real estate market could hurt our business.
A significant portion of our loan portfolio is dependent on real estate. At December 31, 2008, real estate served as the principal source of collateral with respect to approximately 88% of our loan portfolio. Declines in the value of real estate have adversely affected the quality of certain of First Regional's loans, including collateral value and, in a number of cases, the borrower's financial condition. This has, in turn, required First Regional to make substantial loan loss provisions during 2008, which has resulted in First Regional's loss of approximately $23 million for 2008. Further declines in real estate values will likely further adversely affect the value of the real estate securing both our loans and the real estate we own, and will likely require additional loan loss provisions. Such provisions would likely adversely impact our results of operations.
In addition, acts of nature, including earthquakes, fires, landslides and floods, which may cause uninsured damage and other loss of value to real estate, may also negatively impact our financial condition. This is particularly significant in light of the fact that most of the real estate that makes up the collateral of our real estate secured loans is located in Southern California, where the risk of such acts of nature is relatively high.
Failure to comply with the provisions of First Regional Bank's formal agreement with its regulators could adversely affect the Bank.
During February 2009, the bank signed an order to cease and desist with the Federal Deposit Insurance Corporation (the "FDIC") and the California Department of Financial Institutions (the "DFI") to further strengthen the Bank's operations. The agreement between First Regional Bank and its regulators is expected to help guide the Bank in addressing the impacts of today's challenging economic environment. The agreement formalizes many of the initiatives which the Bank has already adopted, and provides useful milestones for measuring the Bank's progress as it moves forward.
Under the agreement, First Regional Bank will:
As previously noted, First Regional Bank continues to maintain "well capitalized" ratios, the highest standards established by banking regulators. However, in connection with the Bank's plan to increase its capital ratios, effective February 23, 2009, the Bank specifically agreed to maintain a minimum Tier 1 leverage ratio of 9.5% of the Bank's total assets and to maintain such ratio at 10% as of September 30, 2009. Also as a part of such plan, First Regional Bank and its parent, First Regional Bancorp, have also authorized the contribution by First Regional Bancorp, from its cash reserves, of $12 million into the Bank as additional Bank capital, which contribution was made during February 2009.
First Regional intends to achieve full compliance with the agreement in a timely manner. As the agreement includes many initiatives previously adopted by the Bank, the implementation of those measures has already begun. Even after the terms of the agreement have been satisfied, First Regional plans to continue its efforts to further enhance the Bank's capital strength, asset quality, and operating performance. In an effort to enhance its capital ratios, First Regional Bank intends to shrink the size of the Bank by several hundreds of million dollars. However, First Regional Bank has found that the pace of loan payoffs has slowed significantly, as a result of slower sales of completed construction projects and the tightening of credit markets historically accessed by our borrowers to refinance stabilized real estate projects. First Regional also intends to sell certain assets as a part of its effort to shrink the Bank. However, there can be no assurance that such efforts will be successful at prices acceptable to the Bank. Should the Bank fail to comply with the terms of its formal agreement with its regulators,
this may result in further enforcement action by the Bank's regulators, which may adversely affect the results or financial condition of the Bank.
The Bank is subject to certain risks associated with borrower and industry concentrations.
Certain customers of the Bank control various separate legal entities representing, in the aggregate, significant borrowing concentrations; including as much as $126 million, or 56% of the Bank's capital, as of December 31, 2008. While each individual loan is separately and independently underwritten, and while the majority of such loans are secured by commercial real property, these borrowing concentrations nevertheless present certain risks.
In that regard, bank regulatory agencies have issued a number of public statements about risks related to borrower and industry concentrations, in particular with respect to loans secured by commercial real estate. Regulators have proposed guidance to banks addressing such risks. The costs of implementing and managing such policies, procedures and controls is currently unknown, but could adversely affect our financial and operating results.
In certain cases, multiple loans across a borrower relationship has become impaired after the controlling principal has suffered an adverse change in such borrower's financial condition. In some of these cases, the Bank has suffered defaults across multiple loans in a borrower concentration. As a part of the Bank's action plan to comply with the terms of the Bank's February 2009 formal agreement with its regulators, the Bank has devised a plan to reduce borrower concentrations over time. In anticipation of this requirement, First Regional Bank's Board adopted a policy to reduce borrower concentrations to no more than 25% of capital by the end of 2009. However, there can be no assurance that the Bank will succeed in reducing all borrower concentrations in accordance with the Bank's action plan by the target dates for such action. Failure to do so could adversely affect the results of operations or financial condition of First Regional Bank.
Economic conditions in the Southern California area could adversely affect our operations.
Our banking operations are concentrated primarily in Los Angeles, Orange and Ventura Counties. As a result of this geographic concentration, our results of operations depend largely upon economic conditions in these areas. Deterioration in economic conditions in our market area could have a material adverse impact on the quality of our loan portfolio and the demand for our commercial banking products and services, which in turn may have a material adverse effect on our results of operations.
We are dependent on the continued services of key members of management.
The Company's continued success depends on the retention, recruitment and continued contributions of key members of management. Key member's of the Company's and the Bank's management include H. Anthony Gartshore, our President and Chief Executive Officer, Thomas E. McCullough, our Corporate Secretary and Executive Vice President and Chief Operating Officer of the Bank, and other officers with key positions and/or who have relationships with customers of the Bank. The loss of such key personnel could have an adverse affect on the Company's growth and profitability, and many of these persons would be difficult or impossible to replace. The competition for qualified personnel is intense. The loss of services of members of the Company's key personnel could have a material adverse effect on the Company's business, financial condition and results of operations.
We face strong competition from financial service companies and other companies that offer banking services that could hurt our business.
The banking business in California, generally, and in the Los Angeles, Orange and Ventura County areas where the Bank's operations are centered, specifically, is highly competitive with respect to both loans and deposits and is dominated by major banks, both domestic and foreign, which have many offices operating over wide geographic areas. The Bank competes for deposits and loans principally
with these major banks, but also with small independent banks located in its service areas. Among the advantages which the major banks have over the Bank are their ability to finance extensive advertising campaigns and to allocate their investment assets to regions of highest yield and demand. Many of the major commercial banks operating in the Bank's service area offer certain services that are not offered directly by the Bank and, by virtue of their greater total capitalization, such banks have substantially higher lending limits than the Bank. In addition, the Bank faces direct competition from newly chartered banks, which are formed from time to time in the Bank's service area.
Moreover, banks generally, and the Bank in particular, face increasing competition for loans and deposits from non-bank financial intermediaries such as savings and loan associations, thrift and loan associations, credit unions, mortgage companies, insurance companies, and other lending institutions. Money market funds offer rates competitive with, or higher than those of, banks, and an increasingly sophisticated financial services industry continually develops new products for businesses and consumers that compete with banks for investment dollars. In addition, other entities (both public and private) seeking to raise capital through the issuance and sale of debt or equity securities compete with banks in the acquisition of deposits.
Increasing levels of competition in the banking and financial services businesses may reduce our market share or cause the prices we charge for our services to fall. Our results may differ in future periods depending upon the nature or level of competition.
We are subject to government regulation that could limit or restrict our activities, which in turn could adversely impact our operations.
The financial services industry is regulated extensively. Federal and state regulation is designed primarily to protect consumers and the deposit insurance funds, rather than our shareholders. These regulations can sometimes impose significant limitations on our operations. In addition, these regulations are constantly evolving and may change significantly over time.
In recent years, banking regulators have indicated that, unless a bank is in full compliance with applicable regulations deemed to be of particular importance, including Bank Secrecy Act ("BSA"), Anti-Money Laundering and the Community Reinvestment Act ("CRA"), requests for approvals for new types of activities, including branching, may be subject to increased scrutiny, temporarily delayed or outright denied.
At the conclusion of an examination by the FDIC and DFI of the Bank in 2007, the FDIC expressed concern regarding a previously unidentified BSA concern relating to the Bank's program of providing custodial services to individual retirement accounts (IRAs) administered by non-bank third parties. The FDIC requested that the Bank enter into a cease and desist order, principally addressing the Bank's BSA duties in connection with such third party administered retirement accounts. While the Bank questioned the need for such a cease and desist order, the Bank concluded that it was advisable for the Bank to enter into, rather than undertake a formal challenge to, the requested cease and desist order. While the bank believes it fully complied with this Cease and Desist Order, no assurance can be given that the FDIC will not require further action if the Bank fails to comply with the terms of the cease and desist order or otherwise fails to correct the deficiencies identified.
We are subject to certain risks associated with public company regulation.
New laws and regulations or changes in existing laws and regulations or repeal of existing laws and regulations may adversely impact our business. We have incurred substantial costs to interpret and ensure compliance with applicable laws and regulations, including the Sarbanes-Oxley Act of 2002 and its implementing regulations. The Company cannot be certain of the effect, if any, of the foregoing legislation on the business of the Company. Future changes in the laws, regulations, or policies that impact the Company cannot necessarily be predicted and may have a material effect on the business
and earnings of the Company. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects economic conditions for the Company.
Our business is subject to interest rate risk and changes in interest rates may adversely affect our performance and financial condition.
Our earnings are impacted by changing interest rates, which are unpredictable and beyond our control. Changes in interest rates impact the demand for new loans, the credit profile of our borrowers, the rates received on loans and securities and rates paid on deposits and borrowings. The difference between the rates received on loans and securities and the rates paid on deposits and borrowings is known as interest rate spread. Given our current volume and mix of interest-bearing liabilities and interest-earning assets, we would expect our interest rate spread to increase if interest rates rise and, conversely, to decline if interest rates fall. Recent trends in interest rates may not continue and/or may reverse. Also, competitive pressures on both the pricing of loans and on the cost of deposits can have the effect of compressing our net interest margin, making it difficult for us to sustain or enhance our net income in the future. We believe our current level of interest rate sensitivity is reasonable, particularly in light of currently prevailing historically low interest rates. Nevertheless, significant fluctuations in interest rates may have an adverse effect on our business, financial condition and results of operations.
Risks Related to the Retirement Plan Administration Business
The Bank's Trust Administration Services Division provides administrative, record-keeping and other services for self-directed retirement plans and accounts for which the Bank serves as sponsor and custodian. Recently, both the banking and securities regulatory authorities have increased their scrutiny of the retirement plan industry. This enhanced scrutiny arises from a number of governmental concerns, including investment scams directed at members of the United States' increasing population of seniors and the potential abuse of retirement accounts to support terrorism financing, money laundering and tax-avoidance schemes.
While the Bank's involvement in the retirement plan industry is limited to providing custodial and other ministerial services for modest fees, the Bank is sensitive to this enhanced industry-wide scrutiny. For this reason, the Bank is currently strengthening its risk management program for its retirement plan business. As a result of increased risk management and screening procedures, and the corresponding paperwork burden imposed on customers, expenses related to this business will rise and, at the same time, the Bank may lose certain existing or prospective customers. This may, in turn, lead to a decline in the profitability of the Trust Administration Services Division. While the Company does not expect these developments to have a material adverse effect on the Company's financial condition or results of operations, the Bank may be required to take further action if the risk management policies and procedures currently being implemented are later deemed insufficient to address the on-going regulatory concerns.
Our performance is dependent on our maintaining a high quality of service for our customers, and will be impaired by a decline in our quality of service.
Our continued successful performance is dependent on our maintaining a high quality of service for our customers. As we continue to grow, it may become increasingly difficult to maintain high service quality for our customers. This could cause a decline in our performance and growth with respect to net income, deposits, assets and other benchmarks.
Our internal operations are subject to a number of risks.
We are subject to certain operations risks, including, but not limited to, data processing system failures and errors, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. We maintain a system of internal controls to mitigate against such occurrences and
maintain insurance coverage for such risks that are insurable, but should such an event occur that is not prevented or detected by our internal controls and uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on our business, financial condition or results of operations.
We are exposed to risk of environmental and other liabilities with respect to properties to which we take title.
In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental or other liabilities with respect to these properties. We may be held liable to a governmental entity or to third persons for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, in the event we become the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.
The interests of our controlling shareholders may differ from yours.
The Company's directors, executive officers and their related interests have voting control or beneficial ownership of approximately 39% of its outstanding shares (including shares issuable to them upon exercise of vested stock options). In particular, Jack A. Sweeney, the Company's Founder and Chairman Emeritus, has voting control or beneficial ownership of approximately 29% of the Company's outstanding common stock (including shares issuable to him upon exercise of vested stock options). The interests of these controlling shareholders may differ from yours. Because of this beneficial ownership and voting power, our controlling shareholders may have the power to substantially control any matter presented to shareholders for a vote, including with respect to the election of directors or other material transactions, such as a future issuance of securities, a potential acquisition of, or take-over proposal made by, another company. As a result, these controlling shareholders may cause the defeat of a proposal you support, or cause the approval of a proposal you oppose.
Provisions in the Company's bylaws may delay or prevent an acquisition of the Company, which could decrease the value of its common stock.
The Company has in place various types of protections which would make it difficult for a company or investor to buy the Company without the approval of the Company's board of directors. These provisions include the elimination of cumulative voting and the classification of the Board of Directors into two or three classes, depending on the number of directors.
The Bank's head office is located on the ground, second, fourth and eighth floors of an office building located at 1801 Century Park East, Los Angeles, California. The Bank has leased approximately 19,734 square feet of office space under a lease which expires on February 28, 2013. The total monthly rental for the premises is $60,569 subject to annual 3% adjustments and adjustments for increases in property taxes and other operating costs. An equivalent of eight months of rent was abated during various months during 2003 and 2004, the first 2 years of the lease; the Bank is deferring recognition of this amount and is amortizing it evenly over the lease term. The lease was amended in August 2003 to include an additional 5,450 square feet of office space on the ground floor at a monthly
rental of $10,425 subject to annual adjustments and adjustments for increases in property taxes and other operating costs. The lease was amended in December 2004 to include an additional 3,820 square feet of office space on the second floor at a monthly rental of $7,067 subject to annual adjustments and adjustments for increases in property taxes and other operating costs. The lease was amended in September 2005 to include an additional 2,597 square feet of office space on the second floor at a monthly rental of $4,960 subject to annual adjustments and adjustments for increases in property taxes and other operating costs. The lease was amended in February 2006 to include an additional 2,453 square feet of office space on the second floor at a monthly rental of $5,691 subject to annual adjustments and adjustments for increases in property taxes and other operating costs. The lease was amended in December 2006 to include an additional 5,409 square feet of office space on the fourth floor at a monthly rental of $16,314 subject to annual adjustments and adjustments for increases in property taxes and other operating costs.
The Bank's Merchant Services division is located at 28632 Roadside Drive, Suite 155, Agoura Hills, California. The premises consist of approximately 2,799 square feet which are provided under a lease which expires on October 31, 2012. The total monthly rental is $6,744, subject to annual adjustments of 3% and various operating costs.
The Bank also leases an office to house its Irvine Regional Office located at 19100 Von Karman Avenue, Irvine, California. The premises consists of approximately 4,837 square feet and is provided under a lease which expires April 30, 2011 at a monthly rental of $14,027 subject to annual adjustments plus a proportionate share of the building's operating costs.
The Bank also leases an office located at 501 Santa Monica Boulevard, Suite 403, Santa Monica, California to house its Santa Monica Regional Office. The premises consisting of approximately 5,635 square feet are provided under a lease which expires July 31, 2012 at a rental of $18,426 per month, subject to annual adjustments and various operating costs.
The Bank's South Bay Regional Office is located at 990 West 190th Street, Suite 440, and 970 West 190th Street, Suite 400, Torrance, California. The premises consist of approximately 12,909 square feet which are provided under a lease which expires on June 30, 2013. The total monthly rental is $26,722, subject to annual adjustments and various operating costs.
The Bank also leases an office located at 5950 La Place Court, Suite 160, Carlsbad, California to house Trust Administration Services. The premises consisting of approximately 12,722 square feet are provided under a lease, which expires May 31, 2009 at a rental of $23,387 per month, subject to annual adjustments and various operating costs.
The Bank's Glendale Regional Office is located at 655 North Central Avenue, Suite 1500, Glendale, California. The premises consist of approximately 7,771 square feet which are provided under a lease which expires in December 2012. The total monthly rental is $19,793, subject to annual adjustments and various operating costs.
The Bank also leases an office located at 16830 Ventura Blvd, Suite 202, Encino, California to house the Encino Regional Office. The premises consisting of approximately 2,980 square feet are provided under a lease, which expires August 31, 2010 at a rental of $7,001 per month, subject to annual adjustments and various operating costs.
The Bank's Hollywood Regional Office is located at 7083 Hollywood Boulevard, Hollywood, California. The premises consisting of approximately 2,141 square feet are provided under a lease, which expires in November 2009 at a rental of $6,637 per month, subject to annual adjustments and various operating costs.
The Bank also leases an office located at 2535 Townsgate Road, Suite 300, Westlake Village, California to house the Ventura County Regional Office. The premises consisting of approximately
4,061 square feet are provided under a lease which expires August 31, 2013 at a rental of $12,017 per month, subject to annual adjustments and various operating costs.
The Bank also leases an office located at 515 South Flower Street, Suite 1200, Los Angeles, California to house the downtown Los Angeles Regional Office. The premises consisting of approximately 6,475 square feet are provided under a lease which expires in October 2014 at a rental of $17,010 per month, subject to annual adjustments and various operating costs.
The Bank also leases an office located at 2400 East Katella, Suite 460, Anaheim, California to house the Orange County Regional Office. The premises consisting of approximately 4,021 square feet are provided under a lease which expires in May 2012 at a rental of $11,861 per month, subject to annual adjustments and various operating costs.
In the normal course of business, the Company and the Bank are involved in litigation. Management does not expect the ultimate outcome of any pending litigation to have a material adverse effect on the Company's financial position or results of operations.
During the fourth quarter of 2008, no matters were submitted to a vote of the Company's shareholders.
The common stock of First Regional Bancorp is traded on The Nasdaq Global Market under the trading symbol FRGB. Quotations are carried either daily or weekly by newspapers throughout the nation including The Wall Street Journal and the Los Angeles Times and are carried daily on internet-based financial reports such as www.Bloomberg.com and www.Yahoo.com. As of March 11, 2009, there were approximately 1,500 shareholders of the Company's common stock. The following table summarizes the quotations reported by Nasdaq of First Regional Bancorp's common stock.
On July 30, 2007, the Company announced that its Board of Directors had approved and adopted a share repurchase program authorizing the Company to repurchase up to 1,000,000 shares, or
approximately 8%, of its outstanding common stock through July 30, 2008. The repurchase program authorizes the Company to purchase shares from time to time in the open market, depending on market price and other considerations. The timing of purchases and the prices to be paid are at the discretion of management. All repurchased shares are expected to be retired. The repurchase program is intended to be structured to conform with the safe harbor provisions of Securities and Exchange Commission Rule 10b-18.
Repurchases of the Company's securities during 2008 and 2007 are as follows:
The Company has not paid any cash dividends and it is the Company's Board of Directors' intention that no cash dividends be declared by the Company during this stage of the Company's development. The Board of Directors intends to retain earnings to increase the Company's capital. Cash dividends will be paid only when it is prudent to do so and when the Company's performance justifies such action.
The Company is a legal entity separate and distinct from its subsidiaries, and has not engaged in any activities other than acting as a holding company. Accordingly, the Company's principal source of funds, including funds available for payment of cash dividends to its shareholders, have and will consist of dividends paid and other funds advanced to the Company by its subsidiaries. As described below, statutory and regulatory requirements impose limitations on the amounts of dividends payable by the Bank to the Company and on extensions of credit by the Bank to the Company.
Holders of the Company's common stock are entitled to receive dividends as and when declared by the Board of Directors out of funds legally available therefore under the laws of the State of California. Under California law, the Company would be prohibited from paying dividends unless: (1) its retained earnings immediately prior to the dividend payment equals or exceeds the amount of the dividend; or (2) immediately after giving effect to the dividend (i) the sum of the Company's assets would be at least equal to 125% of its liabilities, and (ii) the current assets of the Company would be at least equal to its current liabilities, or, if the average of its earnings before taxes on income and before interest expense for the two preceding fiscal years was less than the average of its interest expense for the two preceding fiscal years, at least 125% of its current liabilities.
Prior to the consummation of the 1982 reorganization of the Bank, the Bank did not pay any cash dividends to its shareholders. It is the Bank's Board of Directors' current intention to retain most of the Bank's earnings to increase its capital, although the Bank may pay cash dividends to the Company as its current sole shareholder subject to regulation and when deemed prudent. The Bank paid dividends to the Company of $10,000,000, $26,000,000 and $0 in 2008, 2007 and 2006, respectively.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2008 regarding equity compensation plans under which equity securities of the Company were authorized for issuance.
Restrictions on Transfer of Funds to the Company by the Bank
The Company is a legal entity separate and distinct from the Bank. It is anticipated that the Company may eventually receive sufficient income to fund its operating expenses through the payment of management fees by its subsidiaries. However, if the Company requires significant amounts of cash, including funds available for the payment of dividends and extraordinary operating expenses, such funds initially will be received as dividends paid by the Bank. Subject to the regulatory restrictions described below, future cash dividends by the Bank to the Company also will depend upon Management's assessment of the Bank's future capital requirements, contractual restrictions and other factors.
In addition, there are statutory and regulatory limitations on the amount of dividends which may be paid to the Company by the Bank. Under California law, funds available for cash dividend payments by a bank are restricted to the lesser of: (i) retained earnings or (ii) the bank's net income for its last three fiscal years (less any distributions to shareholders made during such period). Cash dividends may also be paid out of net income for a bank's last preceding fiscal year upon the prior approval of the California Commissioner of Financial Institutions, without regard to retained earnings or net income for its last three fiscal years. If the Commissioner of Financial Institutions finds that the shareholders' equity of a bank is not adequate or that the payment of a dividend would be unsafe or unsound for the bank, the Commissioner may order the bank not to pay any dividend to its shareholders.
Moreover, in a policy statement adopted in November, 1985, the Federal Reserve Board advised banks and bank holding companies that payment of cash dividends in excess of current earnings from operations is inappropriate and may be cause for supervisory action. As a result of this new policy, banks and their holding companies may find it difficult to pay dividends out of retained earnings from historical periods prior to the most recent fiscal year or to take advantage of earnings generated by extraordinary items such as sales of buildings, other large assets, or business segments in order to generate profits to enable payment of future dividends.
Under the Financial Institutions Supervisory Act, the FDIC also has authority to prohibit a bank from engaging in business practices which the FDIC considers to be unsafe or unsound. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC could assert that the payment of dividends or other payments might under some circumstances be such an unsafe or unsound practice.
In addition, the Bank is subject to certain restrictions imposed by federal law on any extensions of credit to the Company or other affiliates, investments in stock or other securities thereof, and taking of such securities as collateral for loans. Such restrictions prevent the Company and such other affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts.
The summary information presented below should be read in conjunction with the Notes to Consolidated Financial Statements, which accompany the Company's financial statements as described below.
The balances of selected balance sheet components as of December 31 of each of the past five years were as follows:
The Company's operating results are summarized as follows for the twelve-month periods ending December 31 of each of the following years:
The number of shares outstanding (net of unearned ESOP shares) was 11,834,000 in 2008, 11,890,000 in 2007, 12,200,000 in 2006, 12,111,000 in 2005 and 11,976,000 in 2004.
All share and per share information have been retroactively adjusted to reflect the three-for-one stock split approved by the Board of Directors on July 20, 2006. All shareholders of record on July 31, 2006, received two additional shares of common stock for each share held by them at that date. In connection with the stock split, the authorized number of shares was increased from 50 million to 150 million, effective August 21, 2006.
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.
First Regional Bancorp's financial results for both the year and the fourth quarter ended December 31, 2008 reflect higher loan loss provisions due to the continuing economic recession, the Company reported operating losses for both the fourth quarter and the full year. Core earnings (before loan loss provisions and taxes) declined from earlier periods but remained substantial.
The net loss for the quarter ended December 31, 2008 was $11.0 million, equal to 93 cents per diluted share, compared to net income for the fourth quarter of 2007 of $7.9 million, equal to 62 cents per diluted share. For the full year 2008, the Company recorded a net loss of $23.6 million, or $2.00 per diluted share, versus 2007 net income of $33.6 million, equal to $2.59 per diluted share.
At December 31, 2008, total assets were $2.465 billion, compared to $2.174 billion one year earlier. Total deposits grew to $2.130 billion from $1.721 billion a year earlier, and net loans rose to $2.257 billion from $2.020 billion at December 31, 2007. The increase in loans was the result of a decline in loan payoffs due to slower sales of completed condominium units and the ongoing funding of previously approved construction loan commitments. At the end of 2008, equity totaled $150.1 million. As First Regional has no "intangible" assets on its books, all of the Company's equity is tangible. First Regional continues to exceed all financial ratio requirements under applicable regulations for "Well Capitalized" status, the highest level established by banking regulators.
Reflecting the impact of the economic downturn, in the fourth quarter of 2008 First Regional made a $27.4 million provision to its loan loss reserve and charged off a total of $20.9 million in loans. These transactions brought the loan loss reserve to $61.3 million, or 2.64% of gross loans, at December 31, 2008. Nonperforming assets as of the same date totaled $120.7 million, or 5.19% of gross loans plus other real estate owned, compared to $10.5 million at December 31, 2007.
Clearly, these are challenging times for the nation and for financial institutions, and obviously, our results have been adversely affected by these difficult conditions. The impact of the economic climate on real estate values has been of particular concern. Our 2008 loan loss provisions reflect our ongoing review of our loan portfolio, and our current assessment of collateral values and borrower performance. It should be emphasized that the vast majority of our loan portfolio continues to be well secured and to perform as agreed. Nonetheless, our nonperforming assets increased in the fourth quarter of 2008. First Regional is continuing its long-standing practice of confronting challenges fully, directly, and realistically. We do not hesitate to place loans on non-accrual status (rendering them "nonperforming" by definition) as part of our enhanced collection program. Most of our nonperforming assets are secured by real estate, and thus our risk of loss is mitigated by the value of the underlying collateral even in a declining market. Reflecting the economic environment in which we now operate, we remain highly selective on loan transactions. While we believe we are dealing effectively with our problem loans, the economic future remains unclear, and additional loan loss provisions will be made if warranted based on our ongoing analysis of First Regional's loan portfolio performance and economic conditions in general.
First Regional's long-standing emphasis on capital strength has enabled us to deal realistically with the economic environment while maintaining "well capitalized" capital ratios, the highest standard established by banking regulators. Moreover, our core earnings (before loan loss provisions and taxes), though reduced, remain substantial despite the decline in operating margins in 2008 due to the Federal Reserve's actions to reduce interest rates in an attempt to stimulate the economy.
During February 2009, the Bank signed an order to cease and desist with the FDIC and DFI to further strengthen the Bank's operations. The agreement between First Regional Bank and its regulators is expected to help guide the Bank in addressing the impacts of today's challenging economic environment. The agreement formalizes many of the initiatives, which the Bank has already adopted, and provides useful milestones for measuring the Bank's progress as it moves forward.
As we move forward, we will continue to benefit from our skilled and experienced management and our capable and professional staff. These members of the First Regional team have shown the talent and experience to confront the challenges and to capitalize on the opportunities that will doubtless arise as the economy and the credit markets return to health. We will continue to provide our clients with our unmatched level of service and the efficient, cost-effective operation they have come to expect.
While we foresee many challenges, we remain confident regarding the future. The current environment continues to require difficult measures, but we are committed to taking those actions as necessary steps in enhancing value over time for First Regional's shareholders.
First Regional Bancorp, a bank holding company (the "Company"), and one of its subsidiaries, First Regional Bank, primarily serve Southern California through their branches. First Regional Bancorp has six other subsidiaries, First Regional Statutory Trust III, First Regional Statutory Trust IV, First Regional Statutory Trust V, First Regional Statutory Trust VI, First Regional Statutory Trust VII and First Regional Statutory Trust VIII, that exist for the sole purpose of issuing Trust Securities and investing the proceeds thereof in junior subordinated deferrable debentures issued by the Company and engaging in certain other limited activities; see Note 7 of the Consolidated Financial Statements. The following discussion and analysis relates primarily to the Bank and its three reportable business segments consisting of core bank operations, the administrative services provided by the Bank's division, Trust Administration Services(TAS), and the Bank's Trust Services Division. For segment reporting financial information see Note 19 of the Consolidated Financial Statements.
Core Bank OperationsThe principal business activities of this segment are attracting funds from the general public and originating real estate and commercial loans for small and midsize businesses in Southern California. This segment's primary sources of revenue are interest income from loans and investment securities, and fees earned in connection with loans and deposits. This segment's principal expenses consist of interest paid on deposits, personnel, and other general and administrative expenses. The Bank's Core Bank Operations also include the Bank's Merchant Services Division, which provides credit card and ACH processing for Merchants.
Administrative ServicesThe principal business activity of this segment is providing administrative services for self-directed retirement plans. The primary source of revenue for this segment is fee income from self-directed accounts. The segment's principal expenses consist of personnel, rent, data processing, and other general and administrative expenses.
Trust ServicesThe principal business activity of this segment is providing trust services for living trusts, investment agency accounts, IRA rollovers, and all forms of court-related matters. The primary source of revenue for this segment is fee income. The segment's principal expenses consist of personnel, data processing, professional fees, and other general and administrative expenses.
Average assets in 2008 were $2,386,189,000 compared to $2,059,903,000 in 2007, compared to $1,940,575,000 in 2006. As was the case in 2007 and 2006, the Company's asset growth in 2008 was funded by an increase in deposits. The Company generated a net loss of $23,641,000 in 2008 compared to net income of $33,610,000 in 2007 and net income of $38,336,000 in 2006.
Distribution of Assets, Liabilities and Shareholders' Equity
The following table shows the yearly average balances of the Company's assets, liabilities, and shareholders' equity for each of the past three years:
Critical Accounting Policies
Allowance For Loan Losses
Accounting for the allowance for loan losses involves significant judgments and assumptions by management which have a material impact on the carrying value of net loans. Management considers this accounting policy to be a critical accounting policy. The judgments and assumptions used by management are based on historical data and management's view of the current economic environment as described in "Loan Portfolio and Provision for Loan Losses".
We generally cease to accrue interest on any loan with respect to which the loan's contractual payments are more than 90 days delinquent, as well as loans classified substandard for which interest payment reserves were established from loan funds rather than borrower funds. In addition, interest is not recognized on any loan for which management has determined that collection of our investment in the loan is not reasonably assured. A non-accrual loan may be restored to accrual status when delinquent principal and interest payments are brought current, the loan is paying in accordance with its payment terms and future monthly principal and interest payments are expected to be collected.
Properties acquired through foreclosure, or deed in lieu of foreclosure, are transferred to the other real estate owned portfolio and carried at the lower of cost or estimated fair value less the estimated
costs to sell the property. The fair value of the property is based upon a current appraisal. The difference between the fair value of the real estate collateral and the loan balance at the time of transfer is recorded as a loan charge-off if fair value is lower. Subsequent to foreclosure, management periodically performs valuations and the property is carried at the lower of carrying value or fair value, less costs to sell. The determination of a property's estimated fair value includes revenues projected to be realized from disposal of the property less construction and renovation costs.
Other Real Estate Owned
Other real estate owned is recognized when a property collateralizing a loan is foreclosed upon or otherwise acquired by the Bank in satisfaction of the loan. Other real estate owned is recorded at the lower of outstanding loan balance or estimated fair value. Reductions in value at the time of foreclosure are charged against the allowance for loan losses. Allowances are recorded to provide for estimated declines in fair value and costs to sell subsequent to the date of acquisition.
Stock Based Compensation
The Company has two nonqualified employee stock option plans that are more fully described in Note 12 of the notes to the consolidated financial statements. On January 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment, using the modified prospective method. SFAS No. 123R requires companies to account for stock options using the fair value method, which generally results in compensation expense recognition. Prior to January 1, 2006, the Company accounted for its fixed stock options using the intrinsic-value method, as prescribed in Accounting Principles Board Opinion No. 25. Accordingly, no stock option expense was recorded in periods prior to January 1, 2006. The modified prospective method requires application of the new Statement to new awards and to awards modified, repurchased or cancelled after the required effective date. Accordingly, prior-period amounts have not been restated. Commencing with 2006, stock compensation cost is comprised of costs related to share-based awards granted prior to, but not yet vested as of January 1, 2006, based upon the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, which will be recognized as the requisite services are rendered after January 1, 2006 and costs related to all share-based awards granted subsequent to January 1, 2006 based upon the grant date fair value estimated in accordance with the provisions of SFAS No. 123R.
Investment securities available for sale are reported in the accompanying consolidated balance sheets at fair value, and the net unrealized gain or loss on such securities (unless other-than-temporary) is reported as a separate component of shareholders' equity. The fair values of the investment securities are generally determined by reference to quoted market prices obtained from independent external brokers or independent external pricing service providers who have experience in valuing these securities. In obtaining such valuation information from third parties, the Company has evaluated the methodologies used to develop the resulting fair values.
Premiums and discounts on debt securities are amortized or accreted as adjustments to interest income using the level-yield method. Realized gains and losses on sales of securities are determined on a specific identification basis and reported in earnings.
At each reporting date, management assesses whether there are any "other-than-temporary" impairments to investment securities. Such impairment is required to be recognized in current earnings rather than other comprehensive income or loss. In assessing impairment, the severity and duration of the loss and the financial wherewithal of the issuers of the securities is considered, as well as the ability and positive intent of the Company to hold the securities until their fair values recover, which may be maturity.
Net Interest Income
Net interest income is the excess of interest income earned on interest-earning assets over interest expense incurred on interest-bearing liabilities. Interest income or expense are determined by the average volume of interest-bearing assets or liabilities, and the average rate of interest earned or paid on those assets or liabilities. As was the case during 2007, in 2008 the Company's continued growth efforts resulted in an increase in interest earning assets, including loans. The Bank's core loan portfolio increased by 12% during 2008. Although net interest income decreased primarily due to the Federal Reserve's series of rate decreases, it was mitigated by an increase in the loan portfolio. The deposit growth was centered in time deposits, while there was a decline in non-interest bearing and money market deposits and a slight decline in savings deposits. Average time deposits increased in 2008 as compared to the prior year. Interest expense for the year 2008 decreased primarily due to a decrease in interest rates during the period.
Interest Rates and Interest Differential
The following table sets forth the average balances outstanding for major categories of interest earning assets and interest bearing liabilities and the average interest rates earned and paid thereon:
The following table shows the net interest earnings and the net yield on average interest earning assets:
The following table sets forth changes in interest income and interest expense. The net change as shown in the column "Net Increase (Decrease)" is segmented into the change attributable to variations in volume and the change attributable to variations in interest rates. Non-performing loans are included in average loans.
objective of these policies is to manage the Company's interest rate sensitivity and limit the fluctuations of net interest income resulting from interest rate changes. The table which follows in section 7A indicates the repricing or maturity characteristics of the major categories of the Bank's assets and liabilities as of December 31, 2008, and thus the relative sensitivity of the Bank's net interest income to changes in the overall level of interest rates.
Other Operating Income
Other operating income increased for 2008 to $12,165,000, versus $11,421,000 in 2007 and $8,307,000 for the year 2006. Trust Administration Services (TAS), the Bank's division that provides administrative services to self-directed retirement plans, had revenue that totaled $2,332,000 during 2008 and $2,464,000 during 2007 and $2,428,000 during 2006. The Bank's merchant services operation, which provides credit card deposit and clearing services to retailers and other credit card accepting businesses, had revenue that totaled $1,568,000 in 2008, $1,103,000 in 2007 and $1,458,000 in 2006. The Bank's trust services department, which provides trust services for living trusts, investment agency accounts, IRA rollovers, and all forms of court-related matters had revenue that totaled $2,219,000 in 2008, $2,084,000 in 2007 and $1,632,000 in 2006. During the first quarter of 2008, the Company realized a gain of $2,758,000 on the redemption of restricted stock in VISA, Inc. During the fourth quarter of 2007, the company realized a gain of $2,455,000 on the redemption of restricted stock in MasterCard International.
Loan Portfolio and Provision for Loan Losses
The loan portfolio consisted of the following at December 31, 2008 and 2007:
The Bank offers a full range of lending services including commercial, real estate, and real estate construction loans. The Bank has developed a substantial portfolio of short and medium-term "mini-perm" first trust deed loans for income properties as well as specializing in construction lending for moderate-size commercial and residential projects. The Bank also offers commercial loans for commercial and industrial borrowers, which includes equipment financing as well as short-term loans. Typically the Bank's loans are floating rate and have no prepayment penalties.
Interest-only loans allow interest-only payments for a fixed period of time. The loans generally mature at the end of the interest only period and require a balloon payment. At December 31, 2008 and 2007 we had $1,042,205,000 and $976,808,000 of short and medium-term "mini-perm" first trust deed loans for income properties with interest only payments that have a balloon payment at loan maturity. The Bank does not offer residential mortgage products, negative amortization loans, "option-ARMs", or sub-prime loan products.
Provision for Loan Losses
The allowance for loan losses is intended to reflect the known and unknown risks which are inherent in a loan portfolio. The adequacy of the allowance for loan losses is continually evaluated in light of many factors, including loan loss experience and current economic conditions The allowance for loan losses is increased by provision for loan losses, and is decreased by net charge-offs. Management believes the allowance for loan losses as of December 31, 2008 is adequate in relation to both existing and potential risks in the loan portfolio.
The Bank has historically evaluated the adequacy of its allowance for loan losses on an overall basis rather than by specific categories of loans. In determining the adequacy of the allowance for loan losses, management considers such factors as historical loan loss experience, known problem loans, evaluations made by bank regulatory authorities, assessment of economic conditions and other appropriate data to identify the risks in the loan portfolio.
The first major element includes a detailed analysis of the loan portfolio in two phases. The first phase is conducted in accordance with SFAS No. 114, "Accounting by Creditors for the Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a LoanIncome Recognition and Disclosures." Individual loans are reviewed to identify loans for impairment. A loan is impaired when principal and interest are deemed uncollectable in accordance with the original contractual terms of the loan. Impairment is measured as either the expected future cash flows discounted at each loan's effective interest rate, the fair value of the loan's collateral if the loan is collateral dependent, or an observable market price of the loan (if one exists). Upon measuring the impairment, the Bank will ensure an appropriate level of allowance is present or established.
Central to the first phase and the Bank's credit risk management is its loan risk rating system. The originating credit officer assigns borrowers an initial risk rating, which is based primarily on a thorough analysis of each borrower's financial capacity in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit administration personnel. Credits are monitored by line and credit administration personnel for deterioration in a borrower's financial condition, which would impact the ability of the borrower to perform under the contract. Credits undergo a quarterly loan review and a periodic review by the regulators. Risk ratings are adjusted as necessary.
Based on the risk rating system specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicates the probability that a loss has been incurred. Management performs a detailed analysis of these loans, including, but not limited to, cash flows, appraisals of the collateral, conditions of the marketplace for liquidating the collateral and assessment of the guarantors. Management then determines the inherent loss potential and allocates a portion of the allowance for losses as a specific allowance for each of these credits.
The second phase is conducted by evaluating or segmenting the remainder of the loan portfolio into groups or pools of loans with similar characteristics in accordance with SFAS No. 5, "Accounting for Contingencies". In this second phase, groups or pools of homogeneous loans are reviewed to determine a portfolio allowance. Additionally groups of non-homogeneous loans, such as construction loans, are also reviewed to determine a portfolio allowance. The risk assessment process in this case emphasizes trends in the different portfolios for delinquency, loss, and other-behavioral characteristics of the subject portfolios.
The second major element in the Bank's methodology for assessing the appropriateness of the allowance consists of management's considerations of all known relevant internal and external factors that may affect a loan's collectibility. This includes management's estimates of the amounts necessary for concentrations, economic uncertainties, the volatility of the market value of collateral, and other
relevant factors. The relationship of the two major elements of the allowance to the total allowance may fluctuate from period to period.
The allowance for loan losses is increased by provisions which are charged to operating expense and is reduced by loan charge offs. Any subsequent recoveries of charged off loans are added back into the allowance. Based on ongoing analysis of the risks presented by the loan portfolio, in 2008 provisions of $93,367,000 were made to the reserve for loan losses, $55,156,000 in loans were charged off, and $20,000 in loans previously charged off were recovered. In 2007 provisions of $2,622,000 were made to the reserve for loan losses, $741,000 in loans were charged off, and $94,000 in loans previously charged off were recovered. By way of comparison, in 2006 provisions of $4,328,000 were made to the reserve for loan losses, $1,028,000 in loans were charged off, and $100,000 in loans previously charged off were recovered. These transactions brought the balance of the allowance for loan losses at the end of 2008 to $61,336,000 (or 2.7% of total loans), compared to the 2007 balance of $22,771,000 (or 1.1% of total loans), and compared to $20,624,000 (or 1.1% of total loans) at December 31, 2006.
Loans are determined to be impaired when it is determined probable that the bank will be unable to collect all the contractual interest and principal payments as scheduled in the loan agreement. Impaired loans include both non-performing and performing assets. Per banking industry convention, non-performing assets consist of loans past due 90 or more days and still accruing interest, loans on non-accrual status, and other real estate owned ("OREO"). As of December 31, 2008, the Company had $18,540,000 in loans past due 90 or more days which were still accruing interest and $9,611,000 in other real estate owned. The Company's non-performing assets as of December 31, 2008, which consist of loans on non-accrual status, loans past due 90 days or more and still accruing interest and other real estate owned, were as follows:
Performing assets that are considered impaired due to concerns with the economic climate consist of the following:
Thus, at December 31, 2008 the Company has identified non-performing and performing loans totaling $215,190,000 which it concluded were impaired. These loans are principally secured by real estate or other guarantees. The Company's policy is generally to discontinue the accrual of interest income on non-performing impaired loans, and to recognize income on such loans only after the loan principal has been repaid in full. The Company has established a loss reserve for each of the performing and non-performing impaired loans, which at December 31, 2008 totaled $32,264,000 for the loans as a group.
Other real estate owned includes properties acquired through foreclosure. At December 31, 2008, the Company had five OREO properties acquired during the last six months of the year. In comparison, the Company had no OREO properties at December 31, 2007.
In 2007, the Company identified loans having an aggregate average balance of $324,000 which it concluded were impaired under SFAS No. 114. In contrast, during 2006, the Company identified loans having an aggregate average balance of $545,000 which it concluded were impaired under SFAS No. 114. The Company's policy is generally to discontinue the accrual of interest income on impaired loans, and to recognize income on such loans only after the loan principal has been repaid in full, and to establish a specific loss reserve for each of the loans which at December 31, 2008 and 2007 totaled $32,264,000 and $20,000, respectively, for the loans as a group.
Total operating expenses decreased to $56,227,000 in 2008 from $58,580,000 in 2007 and $46,043,000 in 2006. Included in other operating expenses during 2008 is a reversal of a litigation accrual of $2,232,000 further described below. While the total expense figures increased after accounting for the reversal, primarily due to increases in overall bank growth, most components continue to be moderated by the effects of an ongoing program of expense control.
Salaries and related benefits expense decreased in 2008, to $34,002,000 from a 2007 total of $36,373,000 and increased from $30,130,000 in 2006. Occupancy expense rose in 2008, to $3,908,000 from $3,640,000 in 2007 and a 2006 total of $2,797,000; the increases reflect the rent paid on the additional space at the various facilities which house the Bank's headquarters and many of the regional offices. Other expenses decreased slightly in 2008 after rising in both 2007 and 2006. Other expenses totaled $18,317,000 in 2008 compared to $18,567,000 in 2007, which was increased from $13,116,000 in 2006. Other expenses in 2008 include professional services of $2,471,000, a slight decrease from the prior years when professional services were $2,510,000 for 2007 and $2,065,000 in 2006; these expenses primarily relate to audit and accounting fees due to the more extensive regulatory requirements applicable to larger companies. Data processing fees increased in 2008 to $1,774,000 compared to $1,691,000 in 2007 and $1,369,000 in 2006. The FDIC assessment increased to $2,058,000 in 2008, compared to $1,236,000 in 2007 and $177,000 in 2006. Loan valuation and OREO expenses increased
to $1,406,000 in 2008 compared to $27,000 in 2007 and $0 in 2006. Equipment expense increased to $1,895,000 during 2008 from $1,665,000 during 2007 and $1,356,000 for 2006. Telephone and postage expense decreased to $828,000 during 2008 from $944,000 during 2007 and $863,000 for 2006. Customer courier service decreased during 2008 to $831,000 compared to $912,000 during 2007 and increased from $768,000 for 2006. The increases in data processing fees and equipment expense relate primarily to the growth of the bank. Directors fees increased due to increased corporate regulations and were $379,000 in 2008, $315,000 in 2007, and $303,000 in 2006. Most of the remaining categories of other expense, generally remained stable (with the exception of the special reserves in 2007 noted below).
During the fourth quarter of 2007, the Company's subsidiary, First Regional Bank, recorded a charge of $2,232,000 for its share of contingent liabilities relating to settlement of lawsuits by Visa Inc. This charge was reversed in the first quarter of 2008 after the successful completion of the Visa Inc. IPO, where a portion of the proceeds from the IPO funded an escrow account expected to be used for litigation settlement/claims, reducing all other operating expenses.
During the year ended December 31, 2005, the issuer's subsidiary, First Regional Bank, recorded a charge of $1,033,000 reflected in other expense to add to a special reserve in connection with the termination of certain business operations of the Bank's Merchant Services division. The $1,033,000 reserve represents approximately 65% of an amount, approximately $1.59 million that the Bank had been carrying as a receivable due from an outside service provider which arose in connection with the Bank's former engagement in the business of supplying cash to ATM machines, which activity was terminated in 2004. While the Bank believed that it was entitled to the entire amount due of approximately $1.59 million, the Bank established the reserve due to the uncertain and protracted timing of collection. As of December 31, 2006, all but $555,000 of this receivable had previously been reserved against. During 2007, the Bank entered into a full and final settlement of litigation related to an account receivable arising out of the Bank's Merchant Services Division. The Bank recovered $388,500 from the defendant in full settlement of the matter, which resulted in a charge of approximately $166,500, or $87,000 after tax during 2007.
The combined effects of the activity described above resulted in income (loss) before taxes (benefit) of $(43,035,000) in 2008, a decrease from $58,030,000 in 2007, and a decrease from $66,428,000 in 2006. In 2008, the Company recorded tax benefits of $19,394,000. The Company recorded tax provisions of $24,420,000 and $28,092,000 during 2007 and 2006, respectively. As a result, the Company generated net loss of $23,641,000 in 2008, compared to net income of $33,610,000 in 2007, and versus net income of $38,336,000 in 2006.
The Company has various financial obligations, including contractual obligations that may require future cash payments. Further discussion of the nature of each obligation is included in Notes 7, 8, 9, 13 and 14 of the Notes to Consolidated Financial Statements.
The following table presents, as of December 31, 2008, significant fixed and determinable contractual obligations to third parties by payment date:
Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements
The following table shows the amounts and expected maturities of significant commitments as of December 31, 2008. Further discussion on these commitments is included in Note 8 of the Notes to Consolidated Financial Statements.
Commitments to extend credit do not necessarily represent future cash requirements, as these commitments may experience.
Liquidity, Sources of Funds, and Capital Resources
Liquidity management involves our ability to meet cash flow requirements arising from fluctuations in deposit levels and demands of daily operations, which include funding of securities purchases, providing for customers' credit needs and ongoing repayment of borrowings. Our liquidity is actively managed on a daily basis and reviewed periodically by the Asset/Liability Committee and the Board of Directors. This process is intended to ensure the maintenance of sufficient funds to meet the needs of the Bank, including adequate cash flow for off-balance sheet instruments.
Our primary sources of liquidity are derived from financing activities which include the acceptance of customer and brokered deposits, federal funds facilities, advances from the Federal Home Loan Bank of San Francisco, and issuances of long-term debt. These funding sources are augmented by payments of principal and interest on loans, the routine liquidation of securities from the available-for-sale portfolio and securitizations of loans. Primary uses of funds include withdrawal of and interest payments on deposits, originations and purchases of loans, purchases of investment securities, and payment of operating expenses.
During the years ended December 31, 2008, 2007, and 2006, we experienced net cash inflows from operating activities of $39.0 million, $40.2 million, and $41.0 million, respectively. Net cash inflows from operating activities reflects the $93.4 million loan loss provision recorded during 2008. Net cash inflows from operating activities during 2007 and 2006 were primarily due to net income earned during the year.
Net cash outflows from investing activities totaled $335.4 million, $229.6 million, and $153.3 million during 2008, 2007, and 2006, respectively. Net cash outflows from investing activities for 2008, 2007 and 2006 were due primarily to the growth in our loan portfolio. These activities were partially offset by repayments, maturities and net sales proceeds from investment securities.
We experienced net cash inflows from financing activities of $311.3 million during the year ended December 31, 2008, primarily due to the net increase in deposits. As a result of the turbulence in the banking sector, we experienced a notable growth in deposit products that afford greater deposit insurance coverage to deposit customers during the second half of 2008. As of December 31, 2008, time deposits within the CDARS program increased to $77.6 million, compared to $2.9 million at December 31, 2007. The CDARS program allows customers with deposits in excess of FDIC-insured limits to obtain full coverage on time deposits through a network of banks within the CDARS program. Cash from financing activities were partially offset by net decreases in federal funds purchased and FHLB advances.
During 2007, a net decrease in deposits, proceeds from federal funds purchased, and proceeds from the issuance of subordinated debentures accounted for net cash inflows from financing activities totaling $122.0 million. These factors were partially offset by purchases of treasury shares related to our Board-approved share repurchase program, and a decrease in Federal Home Loan Bank advances. During 2006, net cash inflows from financing activities amounting to $220.3 million were primarily due to net increases in deposits and proceeds from issuance of subordinated debentures.
Total liquid assets (cash and due from banks, investment securities, and federal funds sold) totaled $86,259,000 and $71,790,000 (or 4.0% and 4.2% of total deposits) at December 31, 2008 and 2007, respectively. In addition, at December 31, 2008, some $16.3 million of the Bank's total assets consisted of government guaranteed loans which represent a source of liquidity due to the active secondary markets which exist for these assets. The Company did not sell loan participation interests during 2008 and 2007. Participations of loans originated by the Bank represent an additional source of liquidity for the bank. The ratio of net loans (including government guaranteed loans) to deposits was 106.0% and 117.4% at the end of 2008 and 2007, respectively.
The Bank is a member of the Federal Home Loan Bank of San Francisco (FHLB), which provides an additional source for short and long-term funding. Borrowings from the FHLB were $60,000,000 at the end of 2008 and were secured by loans available as collateral at the FHLB. As of December 31, 2008, the Bank has additional borrowing capacity at the Federal Home Loan Bank of $418,094,000.
The Bank has available lines of credit totaling $19,000,000 from certain financial institutions.
The Bank's established TAS, a division that provides administrative services to self-directed retirement plans. Deposits held for TAS clients by the Bank represent approximately 5% and 7% of the Bank's total deposits as of December 31, 2008 and 2007.
The Company continues to maintain a strong and prudent capital position. Total shareholders' equity was $150,147,000 and $174,619,000 as of December 31, 2008 and 2007, respectively. The
Company's capital ratios for those dates in comparison with regulatory capital requirements were as follows:
The "regulatory requirement" listed represents the level of capital required for Adequately Capitalized status.
In addition, bank regulators have risk-adjusted capital guidelines which assign risk weighting to assets and off-balance sheet items and place increased emphasis on common equity. The Company's risk adjusted capital ratios for the dates listed in comparison with the risk adjusted capital requirements were as follows:
The Company meets all applicable capital standards at December 31, 2008 and believes that it will continue to meet all applicable capital standards.
During 1998, the Company established an Employee Stock Ownership Plan consisting of 450,000 shares of First Regional common stock acquired in market transactions or directly from First Regional Bancorp at an average price of $3.16 per share. This Plan helps build the capital base of First Regional Bank and provides its employees with a powerful incentive to achieve further improvements in First Regional's operating performance.
During 2008 and 2007, the Company repurchased 115,000 and 384,000 shares of its outstanding common stock at a total cost of $1,977,000 and $8,435,000. During 2006, the Company did not repurchase any shares of its outstanding common stock.
In 2001, 2002, 2004, 2005, 2006 and 2007 the Company issued $5,000,000, $7,500,000, $27,500,000, $20,000,000, $30,000,000, $5,000,000 and $15,000,000 respectively, in cumulative preferred capital securities through subsidiary organizations that were formed for that purpose. In addition to the issuance of junior subordinated deferrable debentures, the Trusts also issued common stock to the Company which is recorded along with the junior subordinated deferrable debentures. The Company then invested most of the net proceeds of the security sales in the Bank as additional paid-in capital to support the Bank's future growth.
The Company contributed the majority of the net proceeds of the above described capital transactions to First Regional Bank to support its continued growth. The remaining proceeds were and will be used for general corporate purposes in the effort to continue to promote the future growth of the Company.
At December 31, 2008 and 2007, the Bank had brokered deposits of approximately $650 million and $3 million, respectively. The growth in First Regional's time deposits reflects the Company's decision to increase deposits obtained from under-represented sources such as time deposits. Historically, the Company has not competed aggressively for such deposits, since the cost of time deposits is typically higher than the costs of the Company's other funding sources. In the second quarter of 2008, however, the Company made the decision to seek more time deposits in order to reduce the utilization of supplemental funding sources (such as advances from the Federal Home Loan Bank) in order to hold such supplemental sources in reserve to deal with possible future funding needs. The Bank continued this program through January 2009. The increase in time deposit was accomplished by quoting more competitive interest rates than had previously been the Company's practice, and while the cost of the deposits is higher than the supplemental funding sources which they replaced, the rates paid remained at the low end of the market for such deposits. Under the prompt corrective action rules, a capital maintenance requirement prevents the Bank from accepting or renewing brokered deposits without first obtaining a waiver from the FDIC. The Bank has applied to the FDIC for permission to continue to accept certain types of brokered deposits.
Recent Accounting Pronouncements
SFAS No. 157In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which provides a definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value measurements. The standard applies when GAAP requires or allows assets or liabilities to be measured at fair value, and therefore, does not expand the use of fair value in any new circumstance. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an arm's length transaction between market participants in the markets where we conduct business. SFAS 157 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices available in active markets and the lowest priority to data lacking transparency. The level of the reliability of inputs utilized for fair value calculations drives the extent of disclosure requirements of the valuation methodologies used under the standard. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. The provisions of SFAS 157 should be applied prospectively, except for certain financial instruments for which the standard should be applied retrospectively. The adoption of this guidance has not had a material impact to the Company's financial condition and results of operations.
SFAS No. 159In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115. SFAS No. 159 would allow the Company a one-time irrevocable election to measure certain financial assets and liabilities on the balance sheet at fair value and report the unrealized gains and losses on the elected items in earnings at each subsequent reporting date. This Statement requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company's choice to use fair value on its earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company has elected not to measure any new financial instruments at fair value, as permitted in SFAS No. 159, but to continue recording its financial instruments in accordance with current practice.
SFAS No. 141(R)In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (SFAS 141(R)), which replaces FASB Statement No. 141, Business Combinations. SFAS 141(R) establishes principles and requirements for how an acquiring company (1) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree, (2) recognizes and measures the goodwill acquired in the business combination
or a gain from a bargain purchase, and (3) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for business combinations occurring on or after the beginning of the fiscal year beginning on or after December 15, 2008. SFAS 141(R), effective for the Company on January 1, 2009, applies to all transactions or other events in which the Company obtains control in one or more businesses. Management will assess transactions on a case-by-case basis as they occur.
SFAS No. 160In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statementsan Amendment of ARB No. 51. This Statement requires that non-controlling or minority interests in subsidiaries be presented in the consolidated statement of financial position within equity, but separate from the parents' equity, and that the amount of the consolidated net income attributable to the parent and to the non-controlling interest be clearly identified and presented on the face of the consolidated statement of income. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. Management does not expect this guidance to have a material effect on the Company's financial condition and results of operations.
FAS No. 140-3In February 2008, the FASB issued FASB Staff Position FAS No. 140-3, Accounting for Transfers of Financial Assets and Repurchase Financing Transactions ("FSP No. 140-3"), which provides a consistent framework for the evaluation of a transfer of a financial asset and subsequent repurchase agreement entered into with the same counterparty. FSP FAS No. 140-3 provides guidelines that must be met in order for an initial transfer and subsequent repurchase agreement to not be considered linked for evaluation. If the transactions do not meet the specified criteria, they are required to be accounted for as one transaction. This FSP is effective for fiscal years beginning after November 15, 2008, and shall be applied prospectively to initial transfers and repurchase financings for which the initial transfer is executed on or after adoption. The Company does not expect this guidance to have a material effect on its financial condition, results of operations, or cash flows.
FSP EITF 03-06-1In June 2008, the FASB issued FSP EITF 03-06-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. FSP EITF 03-06-1 requires all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends to be considered participating securities and requires entities to apply the two-class method of computing basic and diluted earnings per share. This FSP is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company is currently evaluating the impact that this FSP will have on the Company's consolidated financial statements.
FSP SFAS 157-3In October 2008, the FASB issued FSP SFAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active. FSP SFAS 157 157-3 clarified the application of SFAS 157 in an inactive market. It demonstrated how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP SFAS 157-3 was effective upon issuance. The adoption of this guidance did not have a material effect on the Company's financial condition, results of operations, or cash flows.
FSP FAS 140-4 and FIN 46(R)-8In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, "Disclosures by Public Entities (Enterprises) About Transfers of Financial Assets and Interests in Variable Interest Entities". This disclosure-only FSP improves the transparency of transfers of financial assets and an enterprise's involvement with variable interest entities (VIEs), including qualifying special-purpose entities (QSPEs). The disclosures required by this FSP are intended to provide greater transparency to financial statement users about a transferor's continuing involvement with transferred financial assets and an enterprise's involvement with variable interest entities and qualifying SPEs. This FSP shall be effective for the first reporting period ending after December 15, 2008, with earlier application encouraged, and shall be applied for each annual and interim reporting period thereafter. The adoption of this guidance did not have a material impact to the Company's consolidated financial statements.
The impact of inflation on the Company differs significantly from other industries, since virtually all of its assets and liabilities are monetary. During periods of rising inflation, companies with net monetary assets will always experience a reduction in purchasing power. Inflation continues to have an impact on salary, supply, and occupancy expenses, but the rate of inflation in general and its impact on these expenses in particular has remained moderate in recent years.
Since customer deposits are the Company's principal funding source outside of its capital, management has attempted to match rates of its deposits with its investment and loan portfolios as part of its liquidity and asset and liability management policies. The objective of these policies is to manage the Company's interest rate sensitivity and limit the fluctuations of net interest income resulting from interest rate changes. The table which follows indicates the repricing or maturity characteristics of the major categories of the Bank's assets and liabilities as of December 31, 2008, and thus the relative sensitivity of the Bank's net interest income to changes in the overall level of interest rates.
As the table indicates, the vast majority of the Company's assets are either floating rate or, if fixed rate, have short maturities. Since the yields on these assets quickly adjust to reflect changes in the overall level of interest rates, there are no significant unrealized gains or losses with respect to the Company's assets, nor is there much likelihood of large realized or unrealized gains or losses developing in the future.
The Bank's investment portfolio continues to include high quality, low risk securities, principally U.S. Treasury and Government Sponsored Enterprise debt securities. The balance of the Bank's investment portfolio contains investments that qualify for CRA investment status. A gain of $2,758,000 and no losses were recorded on securities sales during 2008. In comparison, no gains and $29,000 losses were recorded on securities sales during 2007. No gains or losses were recorded on securities for 2006. As of December 31, 2008 the Bank's investment portfolio contained $523,000 in gross unrealized gains and $0 in gross unrealized losses, for a net unrealized gain net of tax benefit of $303,000. As of December 31, 2007, the Bank's investment portfolio contained gross unrealized gains of $290,000 and gross unrealized losses of $32,000, for a net unrealized gain net of tax benefit of $150,000. Because the Company's holdings of securities are intended to serve as a source of liquidity should conditions warrant, the securities have been classified by the Company as "available for sale," and thus unrealized gains and losses have no effect on the Company's income statement.
See "Item 15. Exhibits, Financial Statement Schedules" below for financial statements filed as part of this report.
The Company has not had any change in accountants during the two most recent fiscal years or any subsequent interim period. The Company has not had any disagreements with its accountants on accounting and financial disclosure issues.
Disclosure Controls and Procedures
As of December 31, 2008, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e) and 15d-15(e). Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective as of December 31, 2008.
Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Management's Annual Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rules 13a-15(f) under the Securities Exchange Act of 1934. The Company's internal control over financial reporting is designed to provide reasonable
assurance to the Company's management and board of directors regarding the preparation and fair presentation of published financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2008. In making this assessment, management used the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment, we concluded, as of December 31, 2008, the Company's internal control over financial reporting is effective based on those criteria.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2008 that have materially affected or is reasonably likely to materially affect our internal control over financial reporting.
the Board of Directors and Shareholders of
We have audited the internal control over financial reporting of First Regional Bancorp and subsidiaries (the "Company") as of December 31, 2008, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established to Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2008 of the Company and our report dated March 16, 2009 expressed an unqualified opinion on those financial statements.
/s/ DELOITTE & TOUCHE LLP
The information required by this part (Items 10, 11, 12, 13 and 14) will be included in the definitive proxy statement to be filed by the Company within 120 days of fiscal year end pursuant to Section 14 of the Act. Such information is hereby incorporated by reference in accordance with Rule G(3) of the General Instructions to Form 10-K.
List of Documents filed as a part of this report:
See Index to Financial Statements which is part of this Form 10-K.
See Index to Exhibits which is part of this Form 10-K
(Exhibits are listed by numbers corresponding to the Exhibit Table in Item 601 of Regulation S-K)
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
All other financial statement schedules are omitted because they are not applicable, not material or because the information is included in the financial statements or the notes.
the Board of Directors and Shareholders of
We have audited the accompanying consolidated balance sheets of First Regional Bancorp and subsidiaries (the "Company") as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of First Regional Bancorp and subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 16, 2009 expressed an unqualified opinion on the Company's internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
See notes to consolidated financial statements.