UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-KSB

 

 

COMMISSION FILE NUMBER: 000-31977

 

CENTRAL VALLEY COMMUNITY BANCORP

(Name of small business issuer in its charter)

 

 

 

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES ý No o 

 

Check if no disclosure of delinquent filers in response to Item 405 of Regulation S-B is contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB.  o

 

State issuer’s revenues for its most recent fiscal year: $ 19,516,000

 

State the aggregate market value of the voting and non-voting common equity held by nonaffiliates computed by reference to the price at which the common equity was sold, or the average bid and asked prices of such common equity, as of March 24, 2004:  $38,501,883.

 

State the number of shares of Common Stock outstanding as of March 24, 2004: 2,625,477

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement which will be filed within 120 days after December 31, 2003, in connection with the solicitation of proxies for its 2004 Annual Meeting of Shareholders, are incorporated by reference in Items 9, 10, 11 and 12 of part III hereof.  The portions of such documents that are not incorporated by reference shall not be deemed to be filed with the Commission as part of this Form 10-KSB.

 

Transitional Small Business Disclosure Format (Check one): Yes o No ý 

 

 

TABLE OF CONTENTS

 

ITEM 1 -	DESCRIPTION OF BUSINESS.
ITEM 2 -	DESCRIPTION OF PROPERTY.
ITEM 3 -	LEGAL PROCEEDINGS.
ITEM 4 -	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
ITEM 5 -	MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
ITEM 6 -	MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
ITEM 7 -	FINANCIAL STATEMENTS.
ITEM 8 -	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
ITEM 9 -	DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
ITEM 10 -	EXECUTIVE COMPENSATION.
ITEM 11 -	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
ITEM 12 -	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
ITEM 13 -	EXHIBITS AND REPORTS ON FORM 8-K.
ITEM 14	CONTROLS AND PROCEDURES.
SIGNATURES

 

 

PART I

ITEM 1 -                                                 DESCRIPTION OF BUSINESS.

 

General

 

Central Valley Community Bancorp (the “Company”) was incorporated on February 7, 2000 as a California corporation, for the purpose of becoming the holding company for Central Valley Community Bank, formerly known as Clovis Community Bank (the “Bank”), a California state chartered bank, through a corporate reorganization.  In the reorganization, the Bank became the wholly-owned subsidiary of the Company, and the shareholders of the Bank became the shareholders of the Company.  The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Board of Governors”).

 

At December 31, 2003, the Company had one banking subsidiary, the Bank. The Company’s principal business is to provide, through its banking subsidiary, financial services in its primary market area in California. The Company serves Fresno County, Sacramento County and the surrounding area through the Bank. The Company does not currently conduct any operations other than through the Bank. Unless the context otherwise requires, references to the Company refer to the Company and the Bank on a consolidated basis. At December 31, 2003, the Company had consolidated total assets of approximately $327,930,000. See Items 6 and 7 , Management’s Discussion and Analysis or Plan of Operation and Financial Statements.

 

During 2003 and 2002, the Company approved stock repurchase plans authorizing the purchase of shares up to a total cost of $500,000, or approximately 2% and 3%, respectively, of its common stock, in each year.  As of December 31, 2003 and 2002, the Company repurchased 5,463 and 40,812 shares at a total cost of $81,000 and $483,000, respectively.

 

In January 2004, the Company approved a stock repurchase plan authorizing the purchase of shares up to a total cost of $500,000, or approximately 1% of its outstanding common stock.  The plan expires January 17, 2004.

 

As of March 24, 2004, the Company had a total of 130 employees and 99.7 full time equivalent employees, including the employees of the Bank.

 

Forward-Looking Statements

 

Certain matters discussed in this Annual Report on Form 10-KSB including, but not limited to, those described in Item 6 - Management’s Discussion and Analysis or Plan of Operation, are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements.  Such risks and uncertainties include, among others, (1) significant increases in competitive pressure in the financial services industry; (2) changes in the interest rate environment resulting in reduced margins; (3) general economic conditions, either nationally or regionally, are less favorable than expected, resulting in, among other things, a deterioration in credit quality; (4) changes in the regulatory environment; (5) fluctuations in the real estate market; (6) changes in business conditions and inflation; and (7) changes in securities markets.  Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluating the business prospects of the Company.

 

When the Company uses in this Annual Report on Form 10-KSB the words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar expressions, the Company intends to identify forward-looking statements.  Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Annual Report on Form 10-KSB.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed.  The future results and shareholder values of the Company may differ materially from those expressed in these forward-looking statements.  Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 

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The Bank

 

The Bank was organized in 1979 and commenced business as a California state chartered bank in 1980.  The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to applicable limits.  The Bank is not a member of the Federal Reserve System.

 

The Bank operates seven full-service banking offices in Clovis, Fresno, Kerman, Sacramento, and Prather, California. One of the offices is in a Save Mart Supermarket and offers extended banking hours, including Saturday and Sunday hours, for the convenience of the Bank’s customers. The Bank established a Real Estate Division in 1995 in a freestanding facility in downtown Clovis. All real estate related transactions are conducted and processed through the Real Estate Division, including interim construction loans for single family residences and commercial buildings. All types of permanent single family residential loans are also offered.

 

No new offices or locations were completed in 2003.  The Company focused on gaining the benefits of the new offices opened in 2002 and on offering competitive products and services.

 

During 2002, the Bank relocated its River Park and Fig Garden Village offices in Fresno, California to new expanded sites.  Also in 2002, the Bank also opened two new full service offices in step with its strategic plans to expand its market areas to the entire central valley area of California.  An office in the Sacramento area was opened in the first half of 2002 and in the second half of 2002, a new office located in Kerman, California was opened.

 

The Bank anticipates additional branch openings to meet the growing service needs of its customers.  The branch expansions provide the Company with opportunities to expand its loan and deposit base; however, based on past experience, management expects these new offices will initially have a negative impact on earnings until the volume of business grows to cover fixed overhead expenses.  The Bank anticipates opening a new full-service office in 2004 or 2005 in the Fresno downtown area.

 

The Bank conducts a commercial banking business, which includes accepting demand, savings and time deposits and making commercial, real estate and consumer loans. It also issues cashier’s checks, sells traveler’s checks and provides safe deposit boxes and other customary banking services. The Bank also has offered Internet Banking since 2000. Internet Banking consists of inquiry, account status, bill paying, account transfers, and cash management. The Bank does not offer trust services or international banking services and does not currently plan to do so in the near future.

 

Since August of 1995 the Bank has been a party to an agreement with Investment Centers of America, pursuant to which Investment Centers of America provides Bank customers with access to investment services.  In connection with entering into this agreement, the Bank adopted a policy intended to comply with FDIC Regulation Section 337.4, which outlines the guidelines under which an insured non-member bank may be affiliated with a company that directly engages in the sale, distribution, or underwriting of stock, bonds, debentures, notes, or other securities.

 

There have been no other significant changes in the kinds of services rendered, the principal markets for or the methods of distribution of such services during the Bank’s past three fiscal years.

 

The Bank’s operating policy since its inception has emphasized serving the banking needs of individuals and the business and professional communities in the central valley area of California.  At December 31, 2003, the Company had total loans of $186,274,000.  Total commercial and industrial loans outstanding were $55,506,000; total real estate construction, land development and other land loans outstanding were $25,232,000; total other real estate loans outstanding were $90,033,000, and total consumer installment loans outstanding were $5,117,000. The Company accepts real estate, listed and unlisted securities, savings and time deposits, automobiles, inventory, machinery and equipment as collateral for loans.

 

No individual or single group of related accounts is considered material in relation to the Bank’s assets or deposits, or in relation to the overall business of the Company. However, at December 31, 2003 approximately

 

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61.7% of the Company’s loan portfolio held for investment consisted of real estate-related loans, including construction loans, real estate mortgage loans and commercial loans secured by real estate and 29.7% consisted of commercial loans.  See Item 6 - Management’s Discussion and Analysis or Plan of Operation. The Company believes that these concentrations are mitigated by the diversification of the loan portfolio among commercial, commercial and residential construction, commercial mortgage, home equity and consumer loans. In addition, the business activities of the Company currently are mainly concentrated in Fresno County, California. Consequently, the results of operations and financial condition of the Company are dependent upon the general trends in this part of the California economy and, in particular, the residential and commercial real estate markets. In addition, the concentration of the Company’s operations in this area of California exposes it to greater risk than other banking companies with a wider geographic base in the event of catastrophes, such as earthquakes, fires and floods in this region or as a result of energy shortages in California.

 

The Company’s deposits are attracted from individual and commercial customers.  A material portion of the Company’s deposits has not been obtained from a single person or a few persons, the loss of any one or more of which would have a material adverse effect on the business of the Company.

 

In order to attract loan and deposit business from individuals and small businesses, the Company maintains the following lobby hours at its branches:

 

Branch		Monday – Thursday		Friday		Saturday		Sunday
Clovis Main		9:00 a.m. to 4:00 p.m.		9:00 a.m. to 6:00 p.m.		None		None
Clovis Main Drive Up		8:00 a.m. to 5:30 p.m.		8:00 a.m. to 6:00 p.m.		None		None
Foothill		9:00 a.m. to 5:00 p.m.		9:00 a.m. to 6:00 p.m.		9:00 a.m. to 1:00 p.m.		None
Clovis/Herndon		10:00 a.m. to 7:00 p.m.		10:00 a.m. to 7:00 p.m.		10:00 a.m. to 5:00 p.m.		10:00 a.m. to 3:00 p.m.
Fig Garden Village		9:00 a.m. to 5:00 p.m.		9:00 a.m. to 6:00 p.m.		10:00 a.m. to 2:00 p.m.		None
Kerman		9:00 a.m. to 5:00 p.m.		9:00 a.m. to 6:00 p.m.		None		None
River Park		9:00 a.m. to 5:00 p.m.		9:00 a.m. to 6:00 p.m.		10:00 a.m. to 2:00 p.m.		None
River Park Drive Up		8:00 a.m. to 5:30 p.m.		8:00 a.m. to 6:00 p.m.		10:00 a.m. to 2:00 p.m.		None
Sacramento Private Banking		9:00 a.m. to 4:00 p.m.		9:00 a.m. to 4:00 p.m.		None		None

 

Automated teller machines operate at 6 branch locations and 2 non-branch locations 24 hours per day, seven days per week.  No automated teller machines are currently located at the Sacramento office.  The Company’s Real Estate and Small Business Administration (“SBA”) Departments maintain business hours of 8:00 A.M. to 5:00 P.M., Monday through Friday, and extended hours are available at customer request.

 

The Bank relies substantially on local promotional activity, personal contacts by its officers, directors and employees, referrals by its shareholders, extended hours, personalized service and its reputation in the communities it serves to compete effectively.

 

In Fresno County, in addition to the Company’s seven branch locations, serving the Bank’s primary service areas, as of December 31, 2003 there were 112 operating banking offices in the Company’s primary service area, which consists of the cities of Clovis, Fresno, Kerman and Prather, California, of which  65 were offices of regional and major chain banking systems and 12 were offices of other community banks. Prather does not contain any

 

3

 

banking offices other than the Company’s office. The Company’s primary service area contains 26 thrift offices. Business activity in the Company’s primary service area is oriented towards light industry, small business and agriculture.

 

In Sacramento County, in addition to the Company’s one branch, as of December 31, 2003 there were 199 operating banking offices in the Company’s primary service area of which 104 were offices of regional and major chain banking systems and 22 were offices of other community banks.  The Sacramento service area contains 56 thrift offices.

 

The banking business in California generally, and in the Company’s primary service area specifically, is highly competitive with respect to both loans and deposits, and is dominated by a relatively small number of major banks with many offices operating over a wide geographic area. Among the advantages such major banks have over the Company is their ability to finance wide-ranging advertising campaigns and to allocate their investment assets, including loans, to regions of higher yield and demand. Major banks offer certain services such as international banking and trust services which are not offered directly by the Bank but which usually can be offered indirectly through correspondent institutions. In addition, by virtue of their greater total capitalization, such banks have substantially higher lending limits than the Bank. Legal lending limits to an individual customer are limited to a percentage of a bank’s total capital accounts. As of December 31, 2003, the Bank’s legal loan limits to individual customers were $4,040,000 for unsecured loans and $6,734,000 for unsecured and secured loans combined. For borrowers desiring loans in excess of the Bank’s lending limits, the Bank makes and may, in the future, make such loans on a participation basis with other community banks taking the amount of loans in excess of the Bank’s lending limits. In other cases, the Bank may refer such borrowers to larger banks or other lending institutions.

 

Other entities, both governmental and in private industry, seeking to raise capital through the issuance and sale of debt or equity securities also provide competition for the Bank in the acquisition of deposits.  Banks also compete with money market funds and other money market instruments, which are not subject to interest rate ceilings. In recent years, increased competition has also developed from specialized finance and non-finance companies that offer wholesale finance, credit card, and other consumer finance services, including on-line banking services and personal finance software.  Competition for deposit and loan products remains strong, from both banking and non-banking firms, and affects the rates of those products as well as the terms on which they are offered to customers.

 

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

 

Mergers between financial institutions have placed additional pressure on banks to streamline their operations, reduce expenses, and increase revenues to remain competitive. In addition, competition has intensified due to federal and state interstate banking laws, which permit banking organizations to expand geographically with fewer restrictions than in the past. Such laws allow banks to merge with other banks across state lines, thereby enabling banks to establish or expand banking operations in the Company’s market. The competitive environment also is significantly impacted by federal and state legislation, which may make it easier for non-bank financial institutions to compete with the Company.

 

Clovest Corporation

 

The Bank has engaged in real estate investment and development activities since 1987 through a wholly-owned subsidiary, Clovest Corporation (“Clovest”).  On July 15, 1998 the Board of Directors approved the discontinuance of Clovest’s operations. As of December 31, 2003 and 2002, and for the years then ended, the Company’s investment in Clovest and the results of Clovest’s operations were not material.

 

4

 

Clovis Securities Corporation

 

The Bank has another wholly-owned subsidiary, Clovis Securities Corporation, which has been inactive since December 31, 1993.

 

Central Valley Community Realty,LLC

 

The Bank formed a real estate investment trust, Central Valley Community Realty, LLC (“CVCR”) in 2002.  The trust invests in the Bank’s real estate related assets.  CVCR, as a real estate investment trust, is afforded certain tax advantages which reduce state income tax expense. Refer to Item 6, Management’s Discussion and Analysis or Plan of Operations for further discussion on CVCR.

 

Statistical Disclosure

 

This information should be read in conjunction with the consolidated financial statements and the notes thereto and the Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are included in items 6 and 7 of this annual report.

 

Distribution Of Average Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential

 

Table A sets forth the Company’s average consolidated balance sheets for the years ended December 31, 2003, 2002 and 2001 and an analysis of interest rates and the interest rate differential for the years then ended. Table B sets forth the changes in interest income and interest expense in 2003 and 2002 resulting from changes in volume and changes in rates.

 

Investment Portfolio

 

The book value of investment securities at December 31, 2003, 2002 and 2001 and the book value, maturities and weighted average yield of investment securities at December 31, 2003 are set forth in Table C.

 

Loan Portfolio

 

The composition of the loan portfolio at December 31, 2003, 2002, 2001, 2000, and 1999 is summarized in Table D.

 

Maturities and sensitivity to changes in interest rates in the loan portfolio at December 31, 2003 are summarized in Table E.

 

Table F shows the composition of non-accrual, past due and restructured loans at December 31, 2003, 2002, 2001, 2000, and 1999. Set forth in the text accompanying Table F is a discussion of the Company’s policy for placing loans on non-accrual status.

 

Summary Of Loan Loss Experience

 

Table G sets forth an analysis of loan loss experience as of and for the years ended December 31, 2003, 2002, 2001, 2000, and 1999.

 

Set forth in the text accompanying Table G is a description of the factors which influenced management’s judgment in determining the amount of the additions to the allowance charged to operating expense in each fiscal year, a table showing the allocation of the allowance for credit losses to the various types of loans in the portfolio, as well as a discussion of management’s policy for establishing and maintaining the allowance for credit losses.

 

Deposits

 

Table H sets forth the average amount of and the average rate paid on major deposit categories for the years ended December 31, 2003, 2002, and 2001.

 

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Table I sets forth the maturity of time certificates of deposit of $100,000 or more at December 31, 2003.

 

Return On Equity And Assets

 

Table J sets forth certain financial ratios for the years ended December 31, 2003, 2002, and 2001.

 

6

 

Table A

 

DISTRIBUTION OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS’
EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL

 

The following table sets forth consolidated average assets, liabilities and shareholders’ equity; interest income earned and interest expense paid; and the average yields earned or rates paid thereon for the years ended December 31, 2003, 2002 and 2001. The average balances reflect daily averages except non-accrual loans, which were computed using quarterly averages.

 

		2003								2002								2001
(Dollars in Thousands)		Average Balance			Interest Income/ Expense			Average Rates Earned		Average Balance			Interest Income/ Expense			Average Rates Earned		Average Balance			Interest Income/ Expense			Average Rates Earned
ASSETS:
Interest-earning deposits in other banks		$	500		$	11		2.20	%	$	175		$	5		2.86	%	$	100		$	3		3.00	%
Investment securities:
Taxable		67,238			1,981			2.95	%	50,974			2,629			5.16	%	55,059			3,475			6.31	%
Non-taxable (1)		15,842			754			4.76	%	10,136			512			5.05	%	8,665			479			5.53	%
Total investment securities		83,080			2,735			3.29	%	61,110			3,141			5.14	%	63,724			3,954			6.20	%
Federal funds sold		17,642			185			1.05	%	12,826			195			1.52	%	6,502			240			3.69	%
Total securities		100,722			2,920			2.90	%	73,936			3,336			4.51	%	70,226			4,194			5.97	%
Loans (2)(3)		174,057			12,039			6.92	%	147,956			11,195			7.57	%	112,092			10,380			9.26	%
Total interest-earning assets (1)		275,279			$	14,970		5.44	%	222,067			$	14,536		6.55	%	182,418			$	14,577		7.99	%
Less allowance for credit losses		(2,398		)						(2,390		)						(2,241		)
Non-accrual loans		651								698								442
Cash and due from banks		18,364								14,988								13,932
Premises and equipment		3,082								2,719								1,896
Other assets		10,906								10,866								10,075
Total average assets		$	306,384							$	248,948							$	206,522

 

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		2003								2002									2001
(Dollars in Thousands)		Average Balance			Interest Income/ Expense			Average Rates Paid		Average Balance				Interest Income/ Expense			Average Rates Paid		Average Balance			Interest Income/ Expense			Average Rates Paid
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Deposits:
Savings and negotiable orders of withdrawal		$	57,282		$	115		0.20	%	$	47,936			$	168		0.35	%	$	40,126		$	263		0.66	%
Money market accounts		72,720			659			0.91	%	52,414				817			1.56	%	45,397			1,366			3.01	%
Time certificates of deposit, Under $100,000		47,118			1,032			2.19	%	38,847				1,074			2.76	%	35,458			1,646			4.64	%
Time certificates of deposit, $100,000 and over		13,675			198			1.45	%	14,251				334			2.34	%	16,365			840			5.13	%
Total interest-bearing deposits		190,795			2,004					153,448				2,393			1.56	%	137,346			4,115			3.00	%
Other borrowed funds		8,230			286			3.48	%	11,277				335			2.97	%	532			22			4.14	%
Federal funds purchased		—			—			—		18				0			1.09	%	14			1			7.14	%
Total interest-bearing Liabilities		199,025			$	2,290		1.15	%	164,743				$	2,728		1.66	%	137,892			$	4,138		3.00	%
Non-interest bearing deposits		79,364								59,181									45,843
Other liabilities		2,511								2,420									2,606
Shareholders’ equity		25,484								22,604									20,181
Total liabilities and Shareholders’ equity		$	306,384							$	248,948								$	206,522
Interest income and average rate earned on earning assets  (1)					$	14,970		5.44	%					$	14,536		6.55	%				$	14,577		7.99	%
Interest expense and average interest cost related to interest- bearing liabilities					2,290			1.15	%					2,728			1.66	%				4,138			3.00	%
Net interest income and margin(4)					$	12,680		4.61	%					$	11,808		5.32	%				$	10,439		5.72	%

 

(1)                                  Not computed on a tax equivalent basis.

(2)                                  Loan interest income includes loan fees of  $721 in 2003; $755 in 2002; and, $648 in 2001 (dollars in thousands).

(3)                                  Average loans do not include non-accrual loans.

(4)                                  Net interest margin is computed by dividing net interest income by total average interest-earning assets.

 

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Table B

 

VOLUME AND RATE ANALYSIS

 

The following table sets forth, for the years indicated, a summary of the changes in interest earned and interest paid resulting from changes in asset and liability volumes and changes in rates.  The change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of absolute dollar amounts of change in each.

 

		Year Ended December 31
		2003 Compared to 2002									2002 Compared to 2001
(In Thousands)		Volume			Rate			Net			Volume			Rate			Net
Increase (decrease) due to changes in:
Interest income:
Interest-earning deposits in other banks		$	7		$	(1	)	$	6		$	2		$	(0	)	$	2
Investment securities:
Taxable		1,884			(2,532		)	(648		)	(244		)	(602		)	(846		)
Non-taxable (1)		270			(28		)	242			67			(34		)	33
Total investment securities		2,154			(2,560		)	(406		)	(177		)	(636		)	(813		)
Federal funds sold		(55		)	45			(10		)	(114		)	69			(45		)
Loans		1,639			(795		)	844			1,903			(1,088		)	815
Total earning assets(1)		3,745			(3,311		)	434			1,614			(1,655		)	(41		)
Interest expense:
Deposits:
Savings and negotiable orders of withdrawal		637			(848		)	(211		)	359			(1,003		)	(644		)
Certificates of deposit under $100,000		(1,684		)	1,642			(42		)	177			(749		)	(572		)
Certificates of deposit $100,000 and over		(13		)	(123		)	(136		)	(97		)	(409		)	(506		)
Total deposits		(1,060		)	671			(389		)	439			(2,161		)	(1,722		)
Federal funds purchased		(1		)	1			0			0			(1		)	(1		)
Other borrowed funds		(132		)	83			(49		)	317			(4		)	313
Total interest bearing liabilities		(1,193		)	755			(438		)	756			(2,166		)	(1,410		)
Net interest income (1)		$	4,938		$	(4,066	)	$	872		$	858		$	511		$	1,369

 

(1) Not computed on a tax equivalent basis.

 

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Table C

 

INVESTMENT PORTFOLIO

 

The book value of investment securities at December 31, 2003, 2002 and 2001 is set forth in the following table. At December 31, 2003, the Bank held no investment securities from any issuer which totaled over 10% of the Company’s shareholders’ equity.

 

		Book Value at December 31
Available for Sale (In Thousands)		2003			2002			2001
U.S. Treasury securities and obligations of other U.S. government agencies and corporations		$	11,123		$	10,619		$	8,477
Mortgage-backed securities		55,490			44,421			35,675
Obligations of states and political subdivisions		19,947			16,629			12,440
Federal Home Loan Mortgage Corporation stock		-0-			-0-			1,019
Corporate bonds		-0-			974			967
Other securities		7,632			2,348			265
Total Available-for-Sale Securities		$	94,192		$	74,991		$	58,843

 

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The book value, maturities and weighted average yield of investment securities at December 31, 2003 are summarized in the following table.

 

Maturing
(Dollars in Thousands)		In one year or less					After one through five years					After five through ten years					After ten years					Total
Available for Sale		Amount			Yield(1)		Amount			Yield(1)		Amount			Yield(1)		Amount			Yield(1)		Amount			Yield(1)
Obligations of other U.S.Government agencies and corporations		$	1,002		2.25	%	$	8,170		4.37	%	—			—		$	1,951		5.88	%	$	11,123		4.45	%
Mortgage-backed securities		—			—		654			4.78	%	$	7,047		5.32	%	47,789			3.71	%	55,490			3.92	%
Obligations of states & political subdivisions		—			—		2,563			2.74	%	4,670			4.72	%	12,714			3.90	%	19,947			4.32	%
Other securities		7,632			.94	%	—			—		—			—		—			—		7,632			.94	%
Total Available for Sale		$	8,634		1.09	%	$	11,387		4.03	%	$	11,717		5.08	%	$	62,454		3.81	%	$	94,192		3.83	%

 

(1)  Not computed on a tax equivalent basis.

 

11

 

Table D

 

LOAN PORTFOLIO

 

The composition of the loan portfolio at December 31, 2003, 2002, 2001, 2000 and 1999 is summarized in the table below.

 

(In Thousands)		2003			2002			2001			2000			1999
Commercial and industrial		$	55,506		$	66,580		$	51,718		$	36,614		$	38,374
Real estate
Construction, land development & other land loans		25,232			21,736			27,462			12,829			8,253
Other		90,033			57,498			41,858			33,534			25,544
Loans to finance agricultural production or other loans to farmers		10,714			3,978			1,159			941			610
Installment loans to individuals for household, family and other personal expenditures		5,117			5,581			5,517			7,371			5,918
Leases					3,828			5,656			4,612			2,260
Other		320			13			302			385			545
Subtotal		186,922			159,214			133,672			96,286			81,504
Unearned income		(648		)	(488		)	(401		)	(266		)	(251		)
Subtotal		186,274			158,726			133,271			96,020			81,253
Allowance for credit losses		(2,225		)	(2,433		)	(2,474		)	(2,047		)	(2,236		)
Total (1)		183,849			$	156,293		$	130,797		$	93,973		$	79,017

 

(1)Includes non-accrual loans of:

 

 

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Table E

 

LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES

 

The following table presents information concerning loan maturities and sensitivity to changes in interest rates of the indicated categories of the Company’s loan portfolio, as well as loans in those categories maturing after one year that have fixed or floating interest rates at December 31, 2003.

 

Maturity Distribution of Loans(1): (In Thousands)		One Year or Less			After One Through Five Years			After Five Years			Total
Real estate construction		$	19,043		$	5,492		$	697		$	25,232
Other real estate		57,701			13,693			18,638			90,032
Commercial and industrial		55,308			9,634			965			65,907
Installment		2,539			1,196			1,382			5,117
		$	134,591		$	30,015		$	21,682		$	186,288
Sensitivity to Changes in Interest Rates:
Loans with Fixed Interest Rates					$	21,677		$	21,021
Loans with Floating Interest Rates					8,338			661
Total					$	30,015		$	21,682

 

(1)Does not include non-accrual loans of $634.

 

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Table F

 

COMPOSITION OF NON-ACCRUAL, PAST DUE AND RESTRUCTURED LOANS

 

A summary of non-accrual, restructured and past due loans at December 31, 2003, 2002, 2001, 2000, and 1999 is set forth below:

 

		December 31
(Dollars in Thousands)		2003			2002			2001			2000			1999
Non-accrual		$	634		$	466		$	1,109		$	205		$	3,617
Accruing loans past due 90 days or more		-0-			-0-			-0-			—0—			—0—
Restructured loans		-0-			615			627			—0—			145
		$	634		$	1,081		$	1,736		$	205		$	3,762
Non-accrual loans to total loans		0.3		%	0.3		%	0.8		%	0.2		%	4.5		%

 

The Company’s consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans. Interest income from non-accrual loans is recorded only if collection of principal in full is not in doubt and when and if received.

 

Loans are placed on non-accrual status and any accrued but unpaid interest income is reversed and charged against income when the payment of interest or principal is ninety days or more past due. Loans in the non-accrual category are treated as non-accrual loans even though the Company may ultimately recover all or a portion of the interest due. These loans return to accrual status when the loan becomes contractually current and future collectibility of amounts due is reasonably assured. At December 31, 2003, the Company had $634,000 in non-accrual loans.  One manufacturing relationship represented 66.3% of the total non-accrual loans.

 

Interest income on non-accrual loans that would have been recognized in the year ended December 31, 2003 if the loans had been current in accordance with their original terms totaled $27,000. No income was recognized on these loans for the year ended December 31, 2003.

 

In 2002, 2001, and 1999, the Company had one (1) restructured loan in the principal amount of $615,000, $627,000, and $145,000, respectively. At December 31, 2003 and 2000 the Company had no restructured loans.  See Note 3 of the Notes to Consolidated Financial Statements of the Company included under Item 7 - Financial Statements for information concerning the Company’s recorded investment in loans for which an impairment has been recognized. Impaired loans are identified from internal credit review reports, past due reports, overdraft listings, and regulatory reports of examination. Borrowers experiencing problems such as operating losses, marginal working capital, inadequate cash flow or business interruptions which jeopardize collection of the loan are also reviewed for possible impairment classification.

 

When a loan is classified as impaired, the net fair value (i.e., the measure of the impaired loan) is computed based on the present value of expected future cash flows discounted at the loan’s effective interest rate.  Alternatively, if the loan is collateral dependent, impairment is measured based on the fair value or market price of the collateral.  If the net fair value of the impaired loan is less than the recorded investment in the loan, then the resulting impairment amount is recognized through the use of a valuation allowance with a corresponding charge to the provision for credit losses.  A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (including both principal and interest) in accordance with the contractual terms of the loan agreement.

 

As of December 31, 2003, the Company had no loans where known information abut possible credit problems of borrowers caused management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as non-accrual loans.

 

14

 

Table G

 

SUMMARY OF LOAN LOSS EXPERIENCE

 

The following table summarizes loan loss experience as of and for the years ended December 31, 2003, 2002, 2001, 2000 and 1999. 

 

(Dollars in Thousands)		2003			2002			2001			2000			1999
Loans outstanding at December 31,		$	186,922		$	159,214		$	133,672		$	96,286		$	81,504
Average loans outstanding during period		$	174,708		$	148,654		$	112,534		$	85,968		$	77,234
Allowance for credit losses:
Balance at beginning of year		$	2,433		$	2,474		$	2,047		$	2,236		$	2,949
Deduct loans charged-off:
Commercial and industrial		(172		)	(289		)	(342		)	(146		)	(1,561		)
Real estate – construction		-0-			-0-			-0-			-0-			-0-
Real estate – other		-0-			-0-			-0-			(868		)	-0-
Loans to finance agricultural and other loans to farmers		-0-			-0-			-0-			-0-			(845		)
Loans to individuals for household, family and other personal expenditures		(45		)	(63		)	(49		)	(128		)	(103		)
Other		-0-			-0-			-0-			-0-			(24		)
Total loans charged-off		(217		)	(352		)	(391		)	(1,142		)	(2,533		)
Add recoveries of loans charged off:
Commercial and industrial		167			275			122			271			447
Real estate – construction		-0-			-0-			-0-			-0-			-0-
Real estate – other		9			-0-			37			-0-			53
Loans to finance agricultural and other loans to farmers		-0-			-0-			9			591			-0-
Loans to individuals for household, family and other personal expenditures		33			36			28			41			50
Total recoveries		209			311			196			903			550
Net charge-offs		(8		)	(41		)	(195		)	(239		)	(1,983		)
Add provision charged to operating expense		-0-			-0-			622			50			1,270
Balance at end of year		$	2,425		$	2,433		$	2,474		$	2,047		$	2,236
Allowance for credit losses as a percentage of outstanding loan balance		1.30		%	1.53		%	1.85		%	2.13		%	2.74		%
Net charge-offs to average loans outstanding		0.01		%	0.03		%	0.17		%	0.28		%	2.57		%

 

15

 

Managing credits identified through the risk evaluation methodology includes developing a business strategy with the customer to mitigate Company losses.  Management continues to monitor these credits with a view to identifying as early as possible when, and to what extent, additional provisions may be necessary.

 

The allowance for credit losses is reviewed at least quarterly by the Board of Directors Audit/Compliance Committee and by the Board of Directors. Reserves are allocated to loan portfolio segments using percentages which are based on both historical risk elements such as delinquencies and losses and predictive risk elements such as economic, competitive and environmental factors. The Company has adopted the specific reserve approach to allocate reserves to each adversely graded asset, as well as to each impaired asset for the purpose of estimating potential loss exposure. Although the allowance for credit losses is allocated to various portfolio categories, it is general in nature and available for the loan portfolio in its entirety. Additions may be required based on the results of independent loan portfolio examinations, regulatory agency examinations, or the Company’s own internal review process. Additions are also required when, in management’s judgment, the reserve does not properly reflect the potential loss exposure.

 

The Company made no additions to the allowance for credit losses in 2003 and 2002 due mainly to decreased levels of risk-rated loans and increased recoveries on previously charged-off loans.

 

The provision for credit losses was $622,000 in 2001.  The 2001 provision primarily related to the Company’s increase in non-accrual loans, which totaled $1,109,000 at December 31, 2001 compared to $205,000 at December 31, 2000, as well as a 30.9% increase in loan volume during 2001. The 2000 provision for credit losses of $50,000 reflected management’s evaluation of deterioration primarily in one commercial borrowing relationship. In 1999, the provision for credit losses of $1,270,000 reflected the deterioration of four borrowing relationships.

 

16

 

Using the criteria on the previous page, the allocation of the allowance for credit losses is set forth below:

 

		2003					2002					2001					2000					1999
(Dollars in Thousands)		Amount			Percent of Loans in Each Category to Total Loans		Amount			Percent of Loans in Each Category to Total Loans		Amount			Percent of Loans in Each Category to Total Loans		Amount			Percent of Loans in Each Category To Total Loans		Amount			Percent of Loans in Each Category To Total Loans
Commercial and industrial		$	717		29.6	%	$	985		40.7	%	$	1,345		54.4	%	$	877		42.8	%	$	1,060		47.1	%
Real estate construction		249			10.3	%	85			3.5	%	141			5.7	%	272			13.3	%	75			10.1	%
Real estate - other		777			32.0	%	1,039			42.5	%	370			15.0	%	712			34.8	%	845			31.3	%
Loans to finance agricultural and other loans to farmers		540			22.3	%	159			6.5	%	380			15.3	%	20			1.0	%	5			.8	%
Loans to individuals for household, family and other personal expenditures and other loans		85			3.5	%	58			2.4	%	62			2.5	%	158			7.7	%	146			7.3	%
Lease contracts		3			.1	%	—			—		—			—		—			—		23			2.8	%
Year 2000 for all loan types		—			—		—			—		—			—		—			—		81			N/A
Other		47			1.9	%	40			1.6	%	—			—		8			0.4	%	1			.6	%
Non-specific reserve		7			.3	%	67			2.8	%	176			7.1	%	—			—		—			N/A
		$	2,425				$	2,433				$	2,474				$	2,047				$	2,236

 

Loans are charged to the allowance for credit losses when the loans are deemed uncollectible.  It is the policy of management to make additions to the allowance so that it remains adequate to cover all potential loan charge-offs that exist in the portfolio at that time.

 

17

 

Table H

 

DEPOSITS

 

The Company has no known foreign deposits. The following table sets forth the average amount of and the average rate paid on certain deposit categories which were in excess of 10% of average total deposits for the years ended December 31, 2003, 2002 and 2001.

 

		(Dollars in Thousands)
		2003						2002					2001
		Balance			Rate			Balance			Rate		Balance			Rate
Savings and negotiable orders of withdrawal		$	130,002		$	0.60		$	100,350		0.98	%	$	85,523		1.90	%
Time certificates of deposit, under $100,000		47,118			2.19		%	$	38,847		2.76	%	$	35,458		4.64	%
Non-interest bearing demand		79,364			N/A			$	59,181		N/A		$	45,843		N/A
Total deposits		$	270,159					$	212,629				$	183,189

 

Table I

 

TIME DEPOSITS

 

The following table sets forth the maturity of time certificates of deposit and other time deposits of $100,000 or more at December 31, 2003.

 

 

Table J

 

FINANCIAL RATIOS

 

The following table sets forth certain financial ratios for the years ended December 31, 2003, 2002 and 2001.

 

 

18

 

SUPERVISION AND REGULATION

 

GENERAL

 

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

 

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

 

BANK HOLDING COMPANY REGULATION

 

The Company, as a bank holding company, is subject to regulation under the BHC Act, and is subject to the supervision and examination of the Board of Governors. Pursuant to the BHC Act, the Company is required to obtain the prior approval of the Board of Governors before it may acquire all or substantially all of the assets of any bank, or ownership or control of voting shares of any bank if, after giving effect to such acquisition, the Company would own or control, directly or indirectly, more than 5 percent of such bank.

 

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

 

The BHC Act and regulations of the Board of Governors also impose certain constraints on the redemption or purchase by a bank holding company of its own shares of stock.

 

The Company’s earnings and activities are affected by legislation, by actions of its regulators, and by local legislative and administrative bodies and decisions of courts in the jurisdictions in which the Company and the Bank conduct business. For example, these include limitations on the ability of the Bank to pay dividends to the Company and the ability of the Company to pay dividends to its shareholders. It is the policy of the Board of Governors that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries. Various

 

19

 

federal and state statutory provisions limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval. In addition to these explicit limitations, the federal regulatory agencies are authorized to prohibit a banking subsidiary or bank holding company from engaging in an unsafe or unsound banking practice. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

 

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

 

A holding company and its banking subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or provision of services. For example, with certain exceptions a bank may not condition an extension of credit on a customer obtaining other services provided by it, a holding company or any of its other bank affiliates, or on a promise by the customer not to obtain other services from a competitor.

 

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

 

The Company is also a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by the Department of Financial Institutions (“DFI”).

 

Further, the Company is required by the Board of Governors to maintain certain capital levels. See “Capital Standards.”

 

REGULATION OF THE BANK

 

Banks are extensively regulated under both federal and state law. The Bank, as a California state-chartered bank, is subject to primary supervision, regulation and periodic examination by the DFI and the FDIC. The Bank is not a member of the Federal Reserve System, but is nevertheless subject to certain regulations of the Board of Governors.

 

If, as a result of an examination of a bank, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the bank’s operations are unsatisfactory or that the bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate the bank’s deposit insurance, which for a California chartered bank would result in a revocation of the bank’s charter. The DFI has many of the same remedial powers.

 

The Bank is a member of the FDIC, which currently insures customer deposits in each member bank to a maximum of $100,000 per depositor. For this protection, the Bank is subject to the rules and regulations of the FDIC, and, as is the case with all insured banks, may be required to pay a semi-annual statutory assessment.

 

20

 

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, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, fair lending requirements, Community Reinvestment Act activities, and loans to affiliates.

 

PAYMENT OF DIVIDENDS

 

THE COMPANY

 

The shareholders of the Company are entitled to receive dividends when and as declared by its Board of Directors, out of funds legally available, subject to the dividends preference, if any, on preferred shares that may be outstanding, and also subject to the restrictions of the California Corporations Code. At December 31, 2003, the Company had no outstanding shares of preferred stock.

 

The principal source of cash revenue to the Company is dividends received from the Bank. The Bank’s ability to make dividend payments to the Company is subject to state and federal regulatory restrictions.

 

THE BANK

 

Dividends payable by the Bank to the Company are restricted under California law to the lesser of the Bank’s retained earnings, or the Bank’s net income for the latest three fiscal years, less dividends paid during that period, or, with the approval of the DFI, to the greater of the retained earnings of the Bank, the net income of the Bank for its last fiscal year or the net income of the Bank for its current fiscal year.

 

In addition to the regulations concerning minimum uniform capital adequacy requirements described below, the FDIC has established guidelines regarding the maintenance of an adequate allowance for credit losses. Therefore, the future payment of cash dividends by the Bank will generally depend, in addition to regulatory constraints, upon the Bank’s earnings during any fiscal period, the assessment of the Board of Directors of the capital requirements of the Bank and other factors, including the maintenance of an adequate allowance for credit losses.

 

CAPITAL STANDARDS

 

The Board of Governors, the FDIC and other federal banking agencies have issued risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets, and transactions, such as letters of credit and recourse arrangements, which are reported as off-balance-sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off-balance-sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. government securities, to 100% for assets with relatively higher credit risk, such as business loans.

 

A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk-adjusted assets and off-balance-sheet items. The regulators measure risk-adjusted assets and off-balance-sheet items against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists of common stock, retained earnings, noncumulative perpetual preferred stock and minority interests in certain subsidiaries, less most other intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. Since December 31, 1992, the federal banking agencies have required a minimum ratio of qualifying total capital to risk-adjusted assets and off-balance-sheet items of 8%, and a minimum ratio of Tier 1 capital to risk-adjusted assets and off-balance-sheet items of 4%.

 

In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to average total assets, referred to as the leverage ratio. For a banking

 

21

 

organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is 3%. It is improbable, however, that an institution with a 3% leverage ratio would receive the highest rating by the regulators since a strong capital position is a significant part of the regulators’ rating. For all banking organizations not rated in the highest category, the minimum leverage ratio is at least 100 to 200 basis points above the 3% minimum. Thus, the effective minimum leverage ratio, for all practical purposes, is at least 4% or 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.

 

A bank that does not achieve and maintain the required capital levels may be issued a capital directive by the FDIC to ensure the maintenance of required capital levels. As discussed above, the Company and the Bank are required to maintain certain levels of capital. The regulatory capital guidelines as well as the actual capitalization for the Bank and the Company on a consolidated basis as of December 31, 2003 follow:

 

		REQUIREMENT				ACTUAL
		ADEQUATELY CAPITALIZED		WELL CAPITALIZED		BANK		COMPANY
Total risk-based capital ratio		8.0	%	10.0	%	12.3	%	12.8	%
Tier 1 risk-based capital ratio		4.0	%	6.0	%	11.2	%	11.7	%
Tier 1 leverage capital ratio		4.0	%	5.0	%	7.5	%	7.8	%

 

RECENT LEGISLATION

 

SARBANES-OXLEY ACT

 

On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 implementing legislative reforms intended to address corporate and accounting fraud.  In addition to the establishment of a new accounting oversight board which will enforce auditing, quality control and independence standards and will be funded by fees from all publicly traded companies, the bill restricts provision of both auditing and consulting services by accounting firms.  To ensure auditor independence, any non-audit services being provided to an audit client will require pre-approval by the company’s audit committee members.  In addition, the audit partners must be rotated.  The Act requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the Securities and Exchange Commission (“SEC”), subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement.  In addition, under the Act, legal counsel will be required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself.

 

Longer prison terms and increased penalties will also be applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company’s financial statements are now subject to disgorgement if such restatement was due to corporate misconduct.  Executives are also prohibited from insider trading during retirement plan “blackout” periods, and loans to company executives are restricted.  The Act accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations.  Directors and executive officers must also provide information for most changes in ownership in their company’s securities within two business days of the change.

 

The Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company’s financial statements for the purpose of rendering the financial statements materially misleading.  The Act also requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to stockholders.  In addition, the Act requires that

 

22

 

each financial report required to be prepared in accordance with (or reconciled to) accounting principles generally accepted in the United States of America and filed with the SEC reflect all material correcting adjustments that are identified by a “registered public accounting firm” in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the SEC.

 

Effective August 29, 2002, as directed by Section 302(a) of Sarbanes-Oxley, the Company’s chief executive officer and chief financial officer are each required to certify that the Company’s Quarterly and Annual Reports do not contain any untrue statement of a material fact.  The rules have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the Company’s internal controls; they have made certain disclosures to the Company’s auditors and the audit committee of the Board of Directors about the Company’s internal controls; and they have included information in the Company’s Quarterly and Annual Reports about their evaluation and whether there have been significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation.

 

USA PATRIOT ACT

 

In the wake of the tragic events of September 11th, on October 26, 2001, the President signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001.  The USA PATRIOT Act also made significant changes to the Bank Secrecy Act.  Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and of identifying customers when establishing new relationships and standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps:

 

*To conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;

 

*To ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;

 

* To ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and

 

*To ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.

 

Under the USA PATRIOT Act, financial institutions are to establish anti-money laundering programs to enhance their Bank Secrecy Act program.  The USA PATRIOT Act sets forth minimum standards for these programs, including:

 

* The development of internal policies, procedures, and controls;

 

* The designation of a compliance officer;

 

* An ongoing employee training program; and

 

* An independent audit function to test the programs.

 

Bank management believes that the Bank is currently in compliance with the Act.

 

FINANCIAL SERVICES MODERNIZATION LEGISLATION

 

On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act. This legislation eliminated many of the barriers that have separated the

 

23

 

insurance, securities and banking industries since the Great Depression. The federal banking agencies (the Board of Governors, FDIC and the Office of the Comptroller of the Currency) among others, continue to draft regulations to implement the Gramm-Leach-Bliley Act.  The Gramm-Leach-Bliley Act is the result of a decade of debate in the Congress regarding a fundamental reformation of the nation’s financial system. The law is subdivided into seven titles, by functional area.

 

The major provisions of the Gramm-Leach-Bliley Act are:

 

FINANCIAL HOLDING COMPANIES AND FINANCIAL ACTIVITIES. Title I establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHC Act framework to permit a holding company system to engage in a full range of financial activities through qualification as a new entity known as a financial holding company.

 

Final regulations adopted by the FDIC in January 2001, in the form of amendments to Part 362 of the FDIC rules and regulations, provide the framework for subsidiaries of state nonmember banks to engage in financial activities that the Gramm-Leach-Bliley Act permits national banks to conduct through a financial subsidiary.

 

Activities permissible for financial subsidiaries of national banks, and, pursuant to Section 362 of the FDIC rules and regulations, also permissible for financial subsidiaries of state nonmember banks, include, but are not limited to, the following:  (a) Lending, exchanging, transferring, investing for others, or safeguarding money or securities; (b) Insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker for purposes of the foregoing, in any State; (c) Providing financial, investment, or economic advisory services, including advising an investment company; (d) Issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly; and (e) Underwriting, dealing in, or making a market in securities.

 

SECURITIES ACTIVITIES. Title II narrows the exemptions from the securities laws previously enjoyed by banks and creates a new, voluntary investment bank holding company.  The Board of Governors and the SEC continue to work together to draft rules governing certain securities activities of banks.

 

INSURANCE ACTIVITIES. Title III restates the proposition that the states are the functional regulators for all insurance activities, including the insurance activities of federally-chartered banks, and bars the states from prohibiting insurance activities by depository institutions.

 

PRIVACY. Under Title V, federal banking regulators were required to adopt rules that have limited the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. Federal banking regulators issued final rules on May 10, 2000 to implement the privacy provisions of Title V. Under the rules, financial institutions must provide:

 

* initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates;

 

* annual notices of their privacy policies to current customers; and

 

* a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.

 

Compliance with these rules was mandatory after July 1, 2001.  The Company and the Bank were in full compliance with the rules as of or prior to their respective effective dates.

 

SAFEGUARDING CONFIDENTIAL CUSTOMER INFORMATION.  Under Title V, federal banking regulators are required to adopt rules requiring financial institutions to implement a program to protect confidential customer information. In January 2000, the federal banking agencies adopted guidelines requiring financial institutions to establish an information security program.

 

The Bank implemented a security program appropriate to its size and complexity and the nature and scope of its operations prior to the July 1, 2001 effective date of the regulatory guidelines, and since initial implementation

 

24

 

has, as necessary, updated and improved that program.

 

COMMUNITY REINVESTMENT ACT SUNSHINE REQUIREMENTS. The federal banking agencies have adopted final regulations implementing Section 711 of Title VII of the Gramm-Leach-Bliley Act , the Sunshine Requirements. The regulations require nongovernmental entities or persons and insured depository institutions and affiliates that are parties to written agreements made in connection with the fulfillment of the institution’s CRA obligations to make available to the public and the federal banking agencies a copy of each agreement.  Neither the Company nor the Bank is a party to any agreement that would be the subject of reporting pursuant to the CRA Sunshine Requirements.

 

The Company continues to evaluate the strategic opportunities presented by the broad powers granted to bank holding companies that elect to be treated as financial holding companies. In the event that the Company determines that access to the broader powers of a financial holding company is in the best interests of the Company, its shareholders and the Bank, the Company will file the appropriate election with the Board of Governors.

 

The Company and the Bank intend to comply with all provisions of the Gramm-Leach-Bliley Act and all implementing regulations as they become effective.

 

CONSUMER PROTECTION LAWS AND REGULATIONS

 

The bank regulatory agencies are focusing greater attention on compliance with consumer protection laws and their implementing regulations. Examination and enforcement have become more intense in nature, and insured institutions have been advised to monitor carefully compliance with such laws and regulations. The Bank is subject to many federal consumer protection statutes and regulations, some of which are discussed below.

 

The Community Reinvestment Act (“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 regulatory agencies, in examining insured depository institutions, to assess a bank’s record of helping meet the credit needs of its 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, mergers or acquisitions, or holding company formations. The agencies use the CRA assessment factors in order to provide a rating to the financial institution. The ratings range from a high of “outstanding” to a low of “substantial noncompliance.”  The Bank was last examined for CRA compliance by its primary regulator, the FDIC, as of December 2003.

 

The Equal Credit Opportunity Act (“ECOA”) generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.

 

The Truth in Lending Act (“TILA”) is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology to express rates and payments, including the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule, among other things.

 

The Fair Housing Act (“FH Act”) regulates many practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status. A number of lending practices have been found by the courts to be, or may be considered, illegal under the FH Act, including some that are not specifically mentioned in the FH Act itself.

 

The Home Mortgage Disclosure Act (“HMDA”) grew out of public concern over credit shortages in certain urban neighborhoods and provides public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The HMDA also includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes.

 

Finally, the Real Estate Settlement Procedures Act (“RESPA”) requires lenders to provide borrowers with

 

25

 

disclosures regarding the nature and cost of real estate settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Penalties under the above laws may include fines, reimbursements and other penalties.

 

Due to heightened regulatory concern related to compliance with the CRA, TILA, FH Act, ECOA, HMDA and RESPA generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in its local community.

 

CALIFORNIA FINANCIAL INFORMATION PRIVACY ACT/FAIR CREDIT REPORTING ACT

 

In 1970, the federal Fair Credit Reporting Act (the “FCRA”) was enacted to insure the confidentiality, accuracy, relevancy and proper utilization of consumer credit report information.  Under the framework of the FCRA, the United States has developed a highly advanced and efficient credit reporting system.  The information contained in that broad system is used by financial institutions, retailers and other creditors of every size in making a wide variety of decisions regarding financial transactions.  Employers and law enforcement agencies have also made wide use of the information collected and maintained in databases made possible by the FCRA.  The FCRA affirmatively preempts state law in a number of areas, including the ability of entities affiliated by common ownership to share and exchange information freely, and the requirements on credit bureaus to reinvestigate the contents of reports in response to consumer complaints, among others.

 

The California Financial Information Privacy Act, which was enacted in 2003, requires a financial institution to provide specific information to a consumer related to the sharing of that consumer’s nonpublic personal information.  The Act would allow a consumer to direct the financial institution not to share his or her nonpublic personal information with affiliated or nonaffiliated companies with which a financial institution has contracted to provide financial products and services, and would require that permission from each such consumer be acquired by a financial institution prior to sharing such information.  These provisions are much more restrictive than the privacy provisions of the Financial Services Modernization Act, and would require the Bank to adopt new policies, procedures and disclosure documentation if implemented as enacted.  The cost of complying with this legislation is not predictable at this time.

 

Congress enacted the FACT Act, (Fair and Accurate Credit Transaction Act) of 2003, which will have the effect of avoiding the sunset preemption provision of the Fair Credit Reporting Act (FCRA) that were due to expire on December 31, 2003.  The President signed the FACT Act into law on December 4, 2003.  In general, the FACT Act amends the FCRA and, in addition, provides that, when the implementing regulations have been issued and become effective, the FACT Act will preempt elements of the California Financial Information Privact Act.   The FACT Act requires the Board of Governors and the Federal Trade Commission to issue final regulations within nine months of the effectiveness of the FACT Act, and that thos regulations must become effective within six months of issuance.  The provisions of the regulations that will implement the FACT Act, and the timing of their effect on the Bank, cannot be determined at this time.

 

CHECK 21 ACT

 

On December 22, 2003, the Board of Governors approved a proposed rule to amend Regulation CC and its commentary to implement the Check Clearing for the 21^st Century Act (Check 21 Act).  The Check 21 Act was enacted on October 28, 2003 and becomes effective on October 28, 2004.

 

To facilitate check truncation and electronic check exchange, the Check 21 Act authorizes a new negotiable instrument called a “substitute check” and provides that a properly prepared substitute check is the legal equivalent of the original check for all purposes.  A substitute check is a paper reproduction of the original check that can be processed just like the original check.  The Check 21 Act does not require any bank to create substitute checks or to accept checks electronically.  The Board’s proposed amendments: 1) set forth the requirements of the Check 21 Act that apply to banks; 2) provide a model disclosure and model notices relating to substitute checks; and 3) set forth bank indorsement and identification requirements for substitute checks.  The proposed amendments also clarify some existing provisions of the rule and commentary.

 

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The Bank has been imaging its customers’ checks since 2000 and anticipates that Check 21 Act will have limited impact on the Bank.  The Act provides for “paperless” clearing of transit items which may provide some cost savings in transportation costs.

 

Recent Accounting Pronouncements

 

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123.  This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  The transition guidance and annual disclosure provisions of SFAS No.  148 are effective for fiscal years ending after December 15, 2002.  The interim disclosure provisions are effective for financial reporting containing financial statements for interim periods beginning after December 15, 2002.  Because the Company accounts for the compensation cost associated with its stock option plans under the intrinsic value method, the alternative methods of transition will not apply to the Company.  The additional disclosure requirements of the statement are included in these financial statements.  In management’s opinion, the adoption of this Statement did not have a material impact on the Company’s consolidated financial position or results of operations.

 

On April 30, 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities.  This Statement amends and clarifies the accounting for derivative instruments by providing guidance related to circumstances under which a contract with a net investment meets the characteristics of a derivative as discussed in SFAS No. 133.  The Statement also clarifies when a derivative contains a financing component.  The Statement is intended to result in more consistent reporting for derivative contracts and must be applied prospectively for contracts entered into or modified after June 30, 2003, except for hedging relationships designated after June 30, 2003.  In management’s opinion, adoption of this Statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

 

Other

 

Other legislation which has been or may be proposed to the United States Congress and the California Legislature and regulations which may be proposed by the Board of Governors, FDIC and the DFI may affect the business of the Company and the Bank.  It cannot be predicted whether any pending or proposed legislation or regulations will be adopted or the effect such legislation or regulations may have upon the business of the Company and the Bank.

 

Other Information Concerning the Company

 

The Company holds no material patents, trademarks, licenses, franchises or concessions.

 

No expenditures were made by the Company during its last two fiscal years on material research activities relating to the development of services or the improvement of existing services.

 

Based upon present business activities, compliance with Federal, State and local provisions regulating discharge of materials into the environment will have no material effects upon the capital expenditures, earnings and competitive position of the Company.

 

The business of the Company is not seasonal.  The Company intends to continue with the same basic commercial banking activities that have characterized the Bank’s operations since its inception.

 

Available Information

The Company is subject to certain of the informational requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore the Company files reports and other information with the Securities and Exchange Commission (the “Commission”). These reports and other information may be inspected and copied at the public reference facilities of the Commission located at 450 Fifth Street, N. W., Washington, D. C. 20549.  Information regarding the Commission can be obtained by calling 1-800-SEC-0330. Such reports and other information may also be accessed electronically at the Commission’s home page on the Internet at http://www.sec.gov.

 

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ITEM 2 -                                                 DESCRIPTION OF PROPERTY.

 

(a)  Properties

 

		OWNED		LEASED		TOTAL
FULL SERVICE BRANCHES
Main Deposit Branch 600 Pollasky Avenue, Clovis, CA		1				1
Foothill Branch, Prather, CA		1				1
Kerman Branch, Kerman, CA				1		1
River Park Branch, Northeast Fresno, CA				1		1
Fig Garden Branch, Northwest Fresno, CA				1		1
Supermarket Branch, Clovis, CA				1		1
Sacramento Private Banking, Gold River, CA				1		1

 

OTHER FACILITIES:
Accounting and Information Services Department 536 Woodworth, Clovis, CA		1				1
Real Estate Department and Loan Servicing 795 Pollasky Avenue, Clovis, CA				1		1
Training Facility 630 Pollasky Avenue, Clovis, CA				1		1
Executive Administration Office 642 Pollasky Avenue, Clovis, CA				1
SBA Department 624 Pollasky Avenue, Clovis CA				1		1
Total		3		9		12

 

Title to the properties described as owned in the above table is held by the Bank with no liens or encumbrances.  All of the property described as leased is leased directly from independent parties.   Management considers the terms and conditions of each of the existing leases to be in the aggregate favorable to the Company.

 

(b)          Investment Policies

 

For a description of the Company’s policies (all of which may be changed without a vote of the Company’s security holders) and the limitations on the percentage of assets which may be invested in any one investment, or type of investment with respect to: (1) investments in real estate or interests in real estate; (2) investments in real

 

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estate mortgages; and (3) securities of or interests in persons primarily engaged in real estate activities, reference is made hereunder to the information presented above under “Item 1. Description of Business”.

 

(c)          Description of Real Estate and Operating Data

 

Inapplicable.  None of the net book values of the properties listed above represent 10% or more of total assets of the Company as of December 31, 2003.

 

ITEM 3 -                                                 LEGAL PROCEEDINGS.

 

Neither the Company nor the Bank is a party to, nor are any of their properties the subject of, any material pending legal proceedings other than ordinary, routine litigation incidental to the Company’s and the Bank’s businesses, nor are any of such proceedings known to be contemplated by government authority.

 

No director, officer, affiliate, more than 5% shareholder of the Company or the Bank or any associate of these persons is a party adverse to the Company or the Bank or has a material interest adverse to the Company or the Bank in any material legal proceeding.

 

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

 

None.

 

PART II

 

ITEM 5 -                                                 MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

 

The Company’s common stock is listed for trading on the Nasdaq SmallCap Market under the ticket symbol CVCY.  As of February 28, 2004, the Company had approximately 600 shareholders of record.

 

The following table summarizes bid quotations for the Company’s common stock for the periods presented, as the Company’s common stock was not listed on the Nasdaq SmallCap Market prior to March 5, 2004.  The prices indicated may not necessarily represent actual transactions.  Bid information has been obtained from The Seidler Companies Inc., which makes a market in the Company’s common stock.

 

		Bid Quotations of the Company’s Common Stock
Quarter Ended		Low Bid			High Bid
March 31, 2002		$	10.25		$	11.50
June 30, 2002		$	11.40		$	11.75
September 30, 2002		$	11.43		$	11.88
December 31, 2002		$	14.75		$	14.95
March 31, 2003		$	13.50		$	14.75
June 30, 2003		$	14.55		$	17.00
September 30, 2003		$	16.80		$	18.60
December 31, 2003		$	18.10		$	21.50

 

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The Company paid a $0.10 and $0.05 per share cash dividend in 2003 and 2002, respectively.   On January 6, 2003, the Company effected a two-for-one stock split.

 

Inquiries regarding Central Valley Community Bancorp’s accounting, internal accounting controls or auditing concerns should be directed to Steven D. McDonald, chairman of the Board of Directors’ Audit Committee, at steve.mcdonald@cvcb.com.

 

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ITEM 6 -                                                 MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

 

Management’s discussion and analysis should be read in conjunction with the Company’s audited Consolidated Financial Statements, including the Notes thereto, at pages 39 through 75 herein.

 

Certain matters discussed in this report constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  All statements contained herein that are not historical facts, such as statements regarding the Company’s current business strategy and the Company’s plans for future development and operations, are based upon current expectations. These statements are forward-looking in nature and involve a number of risks and uncertainties.  Such risks and uncertainties include, but are not limited to (1) significant increases in competitive pressure in the banking industry; (2) the impact of changes in interest rates, a decline in economic conditions at the international, national or local level on the Company’s results of operations, the Company’s ability to continue its internal growth at historical rates, the Company’s ability to maintain its net interest margin, and the quality of the Company’s earning assets; (3) changes in the regulatory environment; (4) fluctuations in the real estate market; (5) changes in business conditions and inflation; (6) changes in securities markets.  Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluating the business prospects of the Company.

 

When the Company uses in this Annual Report on Form 10-KSB the words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar expressions, the Company intends to identify forward-looking statements.  Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Annual Report on Form 10-KSB.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed.  The future results and shareholder values of the Company may differ materially from those expressed in these forward-looking statements.  Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 

INTRODUCTION:

 

Central Valley Community Bancorp (OTC:CVCY) (the “Company”) was incorporated on February 7, 2000.  The formation of the holding company offered the Company more flexibility in meeting the long-term needs of customers, shareholders, and the communities it serves.  The Company currently has one bank subsidiary.  The Company’s market area includes the entire central valley area from Sacramento, California to Bakersfield, California.  To garner public acceptance beyond the Clovis-Fresno area, the Company made a decision in the first half of 2002 to change the name of its one subsidiary, Clovis Community Bank, to Central Valley Community Bank (the “Bank”).

 

During 2003, the Company focused on gaining the benefits of the new offices opened in 2002 and assuring competitive products and services to our clients while adjusting to the many new laws and regulations that affect the banking industry.  Identity theft, terrorism, and the resulting compliance requirements are of utmost importance to the Company.  No new branches or relocations were undertaken in 2003. During 2002, the Bank relocated its River Park and Fig Garden Offices in Fresno, California to new expanded sites and opened an office in Kerman, California and a private banking facility in Sacramento, California.

 

The Bank anticipates additional branch openings to meet the growing service needs of its customers through establishment of new branches or bank or branch acquisitions.   The Company anticipates opening a full service retail office in the Fresno downtown area in late 2004 or early 2005.  Branch expansions provide the Company with

 

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opportunities to expand its loan and deposit base; however, based on past experience, management expects these new offices will initially have a negative impact on earnings until the volume of business grows to cover fixed overhead expenses.

 

In 2002, the Bank formed a real estate investment trust, Central Valley Community Realty, LLC  (CVCR).  The trust invests in the Bank’s real estate related assets and provides an alternative means to potentially generate additional capital.  The REIT offered preferred stock to private investors, to raise capital for its subsidiary bank in accordance with the laws and regulations in effect at the time.  Additionally, CVCR, as a real estate investment trust, is afforded certain tax advantages which may reduce state income tax expense.  However, no assurance can be given that the Company will be successful in accomplishing these objectives.  (Refer to INCOME TAXES for further discussion of CVCR.)

 

ECONOMIC CONDITIONS

 

The local economy benefited from growth in housing and construction fueled by record low long term interest rates and demand for new housing and refinance activity.  The Central Valley experienced significant appreciation in home and real estate values during 2003 while remaining relatively inexpensive compared to other major cities in the State.  Agriculture improved in most sectors with good weather and some improvement in crop prices.   The impact of the Mad Cow disease on the cattle industry is yet unknown, but will likely have an impact on cattle prices.  Fresno County continues to have one of the highest unemployment rates in California.

 

OVERVIEW

 

In 2003, the Company reported its highest earnings in the Company’s history.  The Company had net income of  $3,372,000 in 2003 compared to $2,784,000 in 2002.  The primary contributors to the increase in net income during 2003 were a 7.4% increase in net interest income, and a 7.9% increase in non-interest income which was partially offset by a 3.1% increase in non-interest expenses. An increase in gain on sale of investments of $479,000 was the major contributor to the increase in non-interest income.

 

Average earning assets for 2003 were $275,279,000 compared to $222,067,000 for 2002.  The major contributor to the increase in average earning assets was the 17.5% increase in average loans and a 36.2% increase in average investments which were the result of the 27.1% growth in deposits.  Loan and deposit growth are discussed in more detail below.

 

Average assets increased 23.1% in the periods under review.  Return on average assets (ROA) and return on average equity (ROE) for the past two years are reflected in the following table.

 

 

Similar to most of the banking industry, the Company’s net interest margin continues to be challenged by the impact of twelve consecutive decreases in the Federal funds interest rate by the Federal Open Market Committee (FOMC) in the past three years.  Managing the decrease in loan yields and the effective rates paid on deposits have become increasingly difficult as deposit rates may be near the bottom of consumer tolerance.  While the Company’s loan volume increased 17.5% in the periods under review, interest income from loans only increased 7.5%.  For additional information, please see Market Risk for further discussion of the Bank’s interest rate position.

 

The following table sets forth average assets, liabilities, and shareholders’ equity; interest income earned and interest expense paid; and the average yields earned or rates paid thereon for the years 2003 and 2002.  The average balances reflect daily averages except non-accrual loans that were computed using month-end averages.  Net interest margin is calculated by dividing net interest income by average interest earning assets and not computed on a taxable equivalent basis.

 

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CENTRAL VALLEY COMMUNITY

SCHEDULE OF AVERAGE BALANCES AND AVERAGE YIELDS AND

(Dollars In Thousands)

 

		FOR THE TWELVE MONTHS ENDED December 31, 2003								FOR THE TWELVE MONTHS ENDED December 31, 2002
		AVERAGE BALANCE			INTEREST			AVERAGE INTEREST RATE		AVERAGE BALANCE			INTEREST			AVERAGE INTEREST RATE
ASSETS
Interest-earning deposits in other		$	500		$	11		2.20	%	$	175		$	5		2.86	%
Securities
Taxable securities		67,238			1,981			2.95	%	50,974			2,629			5.16	%
Non-taxable		15,842			754			4.76	%	10,136			512			5.05	%
Total investment		83,080			2,735			3.29	%	61,110			3,141			5.14	%
Federal funds sold		17,642			185			1.05	%	12,826			195			1.52	%
Total		100,722			2,920			2.90	%	73,936			3,336			4.51	%
Loans		174,057			12,039			6.92	%	147,956			11,195			7.57	%
Total interest-earning		275,279			14,970			5.44	%	222,067			14,536			6.55	%
Allowance for credit		(2,398		)						(2,390		)
Non-accrual loans		651								698
Cash and due from banks		18,364								14,988
Premises		3,082								2,719
Other non-earning		10,906								10,866
Total average assets		$	306,384		$	14,970				$	248,948		$	14,536
LIABILITIES AND SHAREHOLDERS’
Interest-bearing liabilities:
Savings and NOW		$	57,282		$	115		0.20	%	$	47,936		$	168		0.35	%
Money market		72,720			659			0.91	%	52,414			817			1.56	%
Time certificates of deposit, under		47,118			1,032			2.19	%	38,847			1,074			2.76	%
Time certificates of deposit, $100,000 and		13,675			198			1.45	%	14,251			334			2.34	%
Total interest-bearing		190,795			2,004			1.05	%	153,448			2,393			1.56	%
Other borrowed funds		8,230			286			3.48	%	11,277			335			2.97	%
Federal funds purchased		—			—			—		18			—			1.09	%
Total interest-bearing		199,025			2,290			1.15	%	164,743			2,728			1.66	%
Non-interest bearing demand		79,364								59,181
Other liabilities		2,511								2,420
Shareholders’ equity		25,484								22,604
Total average liabilities and shareholders’		$	306,384		$	2,290				$	248,948		$	2,728
Interest income and rate earned on average earning					$	14,970		5.44	%				$	14,536		6.55	%
Interest expense and interest cost related average interest-bearing					2,290			1.15	%				2,728			1.66	%
Net interest income and net interest					$	12,680		4.61	%				$	11,808		5.32	%

 

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The Company’s net interest margin decreased 71 basis points in 2003.  The net interest margin in 2003 was 4.61% compared to 5.32% in 2002.  The decrease can be partially attributed to the declining interest rate environment and the fact that assets generally reprice more quickly than liabilities. West Coast prime rate declined 25 basis points in 2003 and 50 basis points in 2002, from 4.25% at December 31, 2002 to 4.00% at December 31, 2003.

 

The effective rate on interest bearing liabilities in 2003 was 1.15% compared to 1.66% in 2002. The Federal funds rate decreased 25 basis points in June 2003 and 50 basis points in November 2002.  Refer to “Schedule of Average Balances and Average Yields and Rates”.  However, as stated above, the Bank may not be able to reduce the rates paid on deposits further.  Customers may seek alternative avenues to increase yields on their investments and accept higher risks than those associated with traditional products offered by financial institutions.

 

Non-interest bearing deposits provide fairly inexpensive funding for loans and offer the opportunity for the Company to enhance and strengthen its net interest margin.  However, with deposit rates at historical lows, the advantages of this funding source are not as significant as in times of higher market interest rates.  Average non-interest bearing deposits increased 34.1% from 2002 to 2003. New business relationships were the major contributor to this increase.

 

Total average deposits increased 27.1% in 2003.  No one relationship represented more than 4% of total deposits at December 31, 2003.

 

COMPANY LINES OF BUSINESS

 

The Company’s market focus is lending to small to medium size commercial businesses offering both commercial and real estate loans.  The Company also offers retail consumer loan products.  These loans offer diversification as to industries and types of business, thus reducing exposure in any one industry concentration.  The Company offers both fixed and floating interest rate loans and typically obtains collateral in the form of real estate, business equipment, deposit accounts, and accounts receivable, but looks to business cash flow as its primary source of repayment.

 

The Company also offers Small Business Administration (SBA) loans, and agricultural lending as well. While the Company has approximately 5.0%of total loans as Section 7(a) SBA loans, it believes the recent cuts in grants and reduced loan limit will have limited affect as the Company’s main strength is in SBA 504 loans which have not been affected.   For the fourth year, Central Valley Community Bank has been honored as the number one SBA 504 lender in Fresno, Kings and Madera counties.  Agricultural loans increased 226% in 2003 due in part to the addition of the Kerman Office.  Agricultural loans were 5.7% of total loans in 2003 compared to 2.1% in 2002.

 

As of December 31, 2003, in management’s judgment, a concentration of loans existed in commercial loans and real estate-related loans.  At that date, commercial and real estate-related loans represented 29.7% and 61.7% of gross total loans, respectively. Similar concentrations existed as of December 31, 2002 with commercial and real estate-related loans representing 32.4% and 62.0% of total loans, respectively. No one borrower had aggregate credit commitments exceeding 4.0% of the loan portfolio at December 31, 2003.

 

Although management believes the loans within these concentrations have no more than the normal risk of collectibility, a substantial decline in the performance of the economy in general or a decline in real estate values in the Company’s primary market area, in particular, could have an adverse impact on collectibility, increase the level of real estate-related nonperforming loans, or have other adverse effects which alone or in the aggregate could have a material adverse effect on the financial condition of the Company.

 

Deposits are the Company’s main source of funding for loans.  As a result of the market focus on small and medium businesses, deposits from these businesses and their corresponding relationships are significant contributors to this funding resource.  The Company also offers numerous retail consumer deposit products and services to meet the needs of its customers.

 

The Company offers a variety of deposit accounts having a range of interest rates and terms.  The

 

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Company’s deposits consist of savings, demand deposits, and certificate of deposit accounts.  The flow of deposits is influenced significantly by general economic conditions, changes in the money market, prevailing interest rates and competition.  The Company’s deposits are obtained primarily from the geographic area in which its offices are located.  The Company relies primarily on customer service and long-standing relationships with customers to attract and retain these deposits.  The Company does not currently have any brokered deposits, and based on historical experience, management believes it will continue to retain a large portion of its time deposit accounts at maturity.  Management’s Assets and Liability Committee (ALCO) meets regularly to discuss economic conditions, competition, community needs, and set competitive rates and fees.

 

COMPANY’S SOURCE OF INCOME

 

Net interest income is the Company’s primary source of revenue.  Net interest income is the difference between the interest income received on interest-earning assets and the interest expense paid on interest-bearing liabilities.  Net interest income is primarily affected by two factors, the volume and mix of interest-earning assets and interest-bearing liabilities and the interest rates earned on those assets and paid on the liabilities.

 

Results of Operations

 

Net income for 2003 increased $588,000 as compared to 2002.  The increase in net income in 2003 resulted primarily from an increase in net interest income as increases in non-interest income and non-interest expense largely offset each other.  The increase in non-interest income was mainly attributable to the increase in gain on sale of investments in 2003.  The increase in non-interest expense can be mainly attributed to increases in salaries and employee benefits from 2002 to 2003.

 

INTEREST INCOME FROM LOANS

 

Interest income from loans increased 7.5%, or $844,000, in 2003 as average total loan volumes increased  $26,054,000 for 2003 compared to 2002.

 

The increase in the average loan volume can be attributed to the continued success of the Company’s strategic plan to build its core business with the introduction of new products, seasoned commercial bankers, and strong emphasis on business development and customer retention activities.  The current low rate environment has also offered opportunities for many small businesses to make capital improvements.  The successes of new offices and the expansion into the Sacramento market have also contributed to the increase in volume.  However, no assurances can be given that this level of loan growth will continue.  At December 31, 2003 and 2002, SBA loans were $20,506,000 and $16,697,000, respectively. Agricultural and agricultural related loans increased $7,429,000 in the periods under review.  Refer to Provision for Credit Losses below for discussion regarding risk and risk assessments of loans.

 

The Company continued to purchase loans from other financial institutions and brokers during 2003 which also contributed to the 2003 volumes.  Loans purchased in 2003 totaled $27,417,000 compared to $20,139,000 in 2002.

 

The Company’s loan to deposit ratio at December 31, 2003 was 64.1% compared to 64.4% at December 31, 2002.  The relatively unchanged status can be mainly attributed to the $44,228,000 increase in deposits compared to the $27,548,000 increase in loans in 2003.

 

NON-ACCRUAL LOANS

 

A loan is classified as non-accrual when 1) it is maintained on a cash basis because of deterioration in the financial condition of the borrower, 2) payment in full of principal or interest is not expected, or 3) principal or interest has been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection.

 

Average non-accrual loans for 2003 were $651,000 compared to $698,000 for 2002.  At December 31, 2003, the Company had $634,000 in +non-accrual loans compared to $466,000 at December 31, 2002.

 

A summary of non-accrual, restructured, and past due loans at December 31, 2003 and 2002 is set forth

 

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below. The Company had no restructured or past due loans at December 31, 2003 or 2002. Management can give no assurance that non-accrual and other non-performing loans will not increase in the future.

 

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