6. Other Statistical Disclosures

The details of the Bank's nonperforming loans and interest foregone on these loans for the past three years was discussed above under Net Interest Income, and can also be found in the footnotes to the audited financial statements presented herein.

An analysis of the Bank's nonperforming loans needs to consider the extent of the Bank's SBA lending operations. The Bank services a portfolio of $233 million in SBA loans for third party investors, of which $209 million are guaranteed loans. When a guaranteed investor loan goes into default, the Bank will repurchase the loan from the investor and file a claim for the guarantee directly with the SBA. These defaulted investor loans are reported as nonperforming loans in the Bank's portfolio during the interim period to file and process the SBA guarantee claim.

The Bank has its own portfolio of guaranteed SBA loans which has grown to $195.2 million at December 31, 1997. Between the Bank's own guaranteed loans and the third party investor servicing, the Bank will always carry some nonperforming loans subject to SBA guarantee in portfolio. The Bank does not provide for credit losses on the SBA guaranteed portion of nonperforming loans. An evaluation of the Bank's allowance for loan loss and asset quality ratios should consider the level of nonperforming assets net of the SBA guarantee. The nonperforming loans presented in the audited footnotes and the select financial data herein disclose nonperforming loans both in total and net of the guarantee.

The Bank's nonperforming loans have increased slightly from year end 1996. At December 31, 1997, nonperforming loans net of SBA guarantee have increased $429 thousand, or 29.4%, to $1.89 million from $1.46 million at December 31, 1996. As a percentage of the unguaranteed loan portfolio, nonperforming loans net of SBA guarantee were 1.0% at December 31, 1997 and .93% at December 31, 1996.

Total nonperforming assets includes nonperforming loans and real estate acquired in foreclosure, also known as other real estate owned ("OREO"). A substantial portion of the Bank's loans are secured by real estate, approximately 90% at year end 1997, and 91% at year end 1996. Most SBA loans are made with real estate collateral as a secondary source of repayment. As an SBA loan proceeds through the default and foreclosure cycle, the Bank will process and collect the SBA guarantee on the loan. Once the guarantee funds are received they are applied to the loan balance. The SBA is then essentially an investor in that loan and the Bank manages the foreclosure and OREO in the best interests of both parties. The Bank and the SBA share in the net proceeds from the OREO sale proportionately.

Balances reported by the Bank as OREO represent the reclassification of the remaining loan balance after application of the SBA guarantee funds. The Bank evaluates the appraised value for the OREO and determines the probability of loss. Any expected loss is charged to the allowance for credit loss before the loan balance is reclassified into OREO. Any loss above and beyond the estimate charged to the allowance for credit losses is charged to operations when the OREO is sold. The Bank realized net gains (losses) on the disposition of real estate acquired through foreclosure of ($75) thousand, ($48) thousand, and $2 thousand in 1997, 1996 and 1995, respectively.

At December 31, 1997, as a percentage of period end total assets, nonperforming assets net of SBA guarantee have declined to .44% from .56% at year end 1996, and .97% at December 31, 1995. The OREO component of nonperforming assets decreased 12% in 1997, to $574 thousand from $656 thousand the previous year.

The Bank accounts for impaired loans following SFAS No. 114, " Accounting by Creditors for Impairment of a Loan." Under this statement a loan is considered to be impaired when management believes it is probable that the Bank will not be able to collect all amounts due under the loan agreement, which includes both principal and interest. Impaired loans must be evaluated for potential loss based on the cash flows or collateral specific to that loan.

The impaired classification is generally made before the loans meet the traditional definition of nonperforming and usually involve special circumstances beyond the criteria for nonperforming status. As a result, the Bank's impaired loans will generally include nonperforming loans and loans expected to become nonperforming in the foreseeable near term.

At year end 1997, net of SBA guarantee, impaired loans reported by the Bank exceed nonperforming loans net of SBA guarantee by $617 thousand. This represents loans that are not yet nonperforming, but that management believes will become nonperforming early in 1998. Total impaired loans at December 31, 1997 and 1996, net of SBA guarantees, were $2.5 million and $1.7 million, respectively. The related allowance for loss against these loans was $211 thousand and $323 thousand at each respective year end. As the vast majority of these loans are real estate secured and collateral dependent under SFAS No. 114, the loss allowance is generally a function of the value of the underlying collateral. This loss allowance retains its "general" nature for purposes of regulatory risk based capital requirements.

Allowance for Credit Losses. The allowance for credit losses represents allocations for the specific purpose of absorbing losses which may occur in the Bank's loan portfolio. In determining the adequacy of the loss allowance, management considers a number of factors, one of which is the results of regulatory examinations. The Bank's loan portfolio was last examined by the California State Department of Financial Institutions in September 1997, and by the FDIC in June 1995. The allowance for credit losses reflects management's assessment of the risk and quality of the loan portfolio, which is affected by economic conditions in the geographic areas in which the Bank lends. Management believes the allowance for credit losses is adequate for the existing portfolio. However, no prediction of the ultimate level of loans charged off can be made with any certainty.

At December 31, 1997, the Bank's allowance for credit losses was $2.15 million and represents .56% of the loan portfolio carrying value, and 1.14% of the entire portfolio not guaranteed by the SBA. This credit loss allowance is considerably above the Bank's industry peer group. At December 31, 1996, the Bank's allowance for credit losses was $2.3 million and represented .78% of the portfolio carrying value, and 1.44% of the portfolio not guaranteed by the SBA, compared to .98% of carrying value, and 1.6% of all unguaranteed loans at December 31, 1995. The percentage of net loans charged off to average loans outstanding has declined for the past three years, from .46% in 1995 to .17% in 1996 and .14% in 1997.

The following table presents the provisions for credit losses, recovery on loans previously charged off, and the amount of the allowance for credit losses for the past five years.

Analysis of Allowance for Credit Losses
(dollars in thousands)

(1) Net charge-off coverage ratio is the ending allowance for credit losses divided by net charge-offs for the year.

Allocation of Allowance for Credit Losses
(dollars in thousands)

Deposits. Total deposits at December 31, 1997 were $512.1 million, up $166.9 million from $345.2 million at December 31, 1996. This 48.3% increase follows an increase of $74.6 million, or 27.6%, in 1996 over 1995. In 1997, the Bank achieved increases in all categories of deposits except savings accounts. Demand deposits increased $41.7 million to $105.3 million, interest bearing transaction accounts increased $20.6 million to $57.6 million, and time certificates of deposit increased $110 million to $193.3 million. Savings accounts declined $6.9 million in 1997 to $145.1 million, as some of the Bank's savings accounts migrated into time deposits. Most of the 1997 increase in deposits, 66% of the total increase, came in time deposits.

Rates offered on certificates of deposit in 1997 were extremely competitive. The average rate on certificates of deposit for 1997 was 5.66%, up from 5.43% in 1996. The Bank was successful in acquiring deposits from various public entities in 1997 and at December 31, 1997 held $28.7 million in these deposits, of which $14.9 million were in certificates of deposit. The Bank had no significant public deposits at December 31, 1996.

The Bank defines core deposits as all deposits without a fixed maturity date. Core deposits at December 31, 1997 were $318.8 million, or 62% of total deposits. Core deposits at December 31, 1996 were $262 million, or 76% of total deposits.

The Bank had $2.6 million in brokered deposits at year end 1997. Of these brokered deposits, $682 thousand were in accounts of $100 thousand or more. None of these deposits have a remaining maturity in excess of nine months. At December 31, 1996, the Bank had $4.4 million in brokered certificates of deposit. Certificates of deposit in excess of $100 thousand were $80.8 million at year end 1997, or 15.8% of total deposits. This compares to $28.7 million at year end 1996, or about 8.3% of total deposits. Except for the brokered CD's discussed above, substantially all of these certificate accounts are held by depositors in the Bank's service area.

Average deposits for 1997 increased $134.4 million, or 45.4% over 1996. Savings and certificate accounts represented 71% of the total average deposits in 1997, compared to 67% in 1996. The following table presents the Bank's average deposits and the average rate paid for each category of deposit for the periods indicated.

Average Deposit Information
(dollars in thousands)

The maturity distribution of time certificates of deposit in denominations of $100 thousand or more is presented in the following table.

Certificates of Deposit for $100 Thousand or More
(dollars in thousands)

Fair Value of Financial Instruments. Loans guaranteed by the SBA typically command a premium price in the secondary market. These are variable rate loans at a spread over the prevailing prime rate, real estate secured, and guaranteed by a federal agency. SBA guaranteed loans have a premium yield over treasury and agency securities with similar maturities. Management believes the Bank's portfolio of SBA guaranteed loans represents considerable unrealized fair value relative to its book carrying value. At December 31, 1997 the Bank had $195.2 million in SBA guaranteed loans at a book carrying value of $197.1 million. The book value represents a 1% premium over par value. At December 31, 1996 the Bank had $131.3 million in SBA guaranteed loans at a book carrying value of $132.6 million, which also represents a 1% premium over par.

The Bank estimates the fair value of its SBA guaranteed portfolio at December 31, 1997 to be $216.8 million, or a premium over par value of about 11%. At year end 1996 the estimated value of the guaranteed portfolio was $143.1 million, representing a premium over par value of about 9%. Each percentage point of premium or discount is multiplied by 100 and added or subtracted from a base par value of 100 to express the value of financial instruments in terms of market prices. At year end 1997 the Bank's guaranteed loans had a fair market price of 111 and a book price of 101. The unrealized fair value was about 10 points, or $19.7 million. At December 31, 1996 the portfolio had a fair market price of 109 and a book price of 101, and the unrealized fair value was about 8 points, or $10.5 million. In relative terms, the value of the Bank's SBA guaranteed loans has increased 2 points between 1997 and 1996. In absolute dollars, the unrealized fair value has increased $9.2 million.

The fair value of SBA guaranteed loans is based on representative market prices for loan sales structured for the maximum servicing spread. At year end 1997, relative to 1996, the market pricing for variable rate SBA loans with interest rate caps improved 58 basis points, and the market pricing for uncapped loans declined 15 basis points. This had a favorable impact on the fair value of the Bank's portfolio, as two-thirds of the portfolio loans are capped variable rate loans.

In December 1997, the Bank consummated its first sale of unguaranteed SBA loans. Based on the bid prices received for this sale, the Bank estimates the fair value of its unguaranteed portfolio to be at a premium to par value of about 4.375%. The unguaranteed loans are carried on the books at a discounted value of about 97.125% of par. The unrealized fair value of the unguaranteed loans is about 7.25% or $10.6 million. Prior to executing a sale of unguaranteed loans, the Bank estimated fair value using conservative discounted cash flow methods and reported fair value at a slight discount to par.

7. Quantitative and Qualitative Disclosures about Market Risk.

The Bank manages interest rate risk by measuring the differences in rate sensitive assets and liabilities over their expected repricing periods. On a monthly basis the Bank projects the impact on earnings from the maturity and repricing of these assets and liabilities over a range of possible interest rate and reinvestment assumptions. The differences in rate sensitive assets and liabilities, commonly know as gaps, are managed at levels that keep the potential impact on earnings within acceptable policy relative to the analysis assumptions.

Management places emphasis on the one year gap and maintains the ability to control liability pricing in reaction to market changes in interest rates. Marketing efforts for time certificates of deposit focus on maturities of one year or less. Rates offered on these deposits offer only marginal incentives for longer maturities and the Bank does not generally offer time deposits for maturities greater than three years. The Bank's investment portfolio is entirely US treasury and agency securities with little or no credit risk. Investment portfolio maturities are rarely longer than the latest maturity in the Bank's time deposit liabilities.

Quantitative disclosures. The table below presents the expected cash flows for the Bank's rate sensitive assets and liabilities based on contractual maturities. Weighted average interest rates are calculated using the contractual rates as of December 31, 1997. Balances presented are the face amount of the related instruments without accounting adjustments. None of the Bank's financial instruments are held for trading.

The Bank's SBA loan portfolio is very homogeneous in characteristics of collateral, original maturity and amortization schedules. Expected cash flows for SBA loans include regular amortization and prepayments based on historical experience and industry prepayment statistics, without reinvestment. Cash flows for nonaccrual SBA guaranteed loans are reported in 1998 at contractual interest rates reflecting the timing for the processing and collection of the guaranteed principal and interest. Cash flows for nonaccrual unguaranteed SBA loans are reported according to contractual maturity at zero yield without amortization.

The Bank's portfolio of other commercial and homeowners association loans does not have the same homogeneous characteristics. These loans carry a variety of original maturities and amortization methods, and the Bank does not have reasonable estimates for prepayment speeds. Other loans are reported according to contractual maturities without consideration for amortization and prepayments.

Cash flows for deposit accounts without stated maturities are based on the average life of the type of account.

Principal Amount Maturing In:
(dollars in thousands)

The table does not reflect cash flows related to $46 million in commitments to fund loans and standby letters of credit as of December 31, 1997. The extent to which customers will actually draw on these commitments is unknown and therefore the commitments do not represent actual cash requirements and the timing and amounts of actual cash flows are uncertain. The character of these loan commitments is much the same as the Bank's actual loan portfolio. The vast majority of commitments are for variable rate loans indexed to the prevailing prime lending rate.

The table also does not include cash flows related to the servicing fees expected on the Bank's portfolio serviced for third party investors. At December 31, 1997 the Bank had a servicing portfolio of SBA loans of $233 million at an average servicing fee of 1.61%. About 75% to 80% of the present value of this cash flow has been recognized by the Bank and capitalized in the balance sheet as servicing assets and interest only strips. These assets are indirectly exposed to interest rate risk to the extent that fluctuations in the prime lending rate influence the level of prepayments experienced with the portfolio. The character of the Bank's servicing portfolio mirrors the SBA loans in the Bank's asset portfolio. These loans are real estate secured, variable rate loans indexed to the prime lending rate. Prepayment speeds on these loans have historically been influenced more by general economic conditions and competitive alternate loan products than interest rate cycles.