Item
1. Business
General
Imperial
Capital Bancorp, Inc. (formerly ITLA Capital Corporation) (“ICB”) is a
diversified bank holding company headquartered in San Diego County, California
with consolidated assets of $3.6 billion, consolidated net loans of $3.1
billion, consolidated deposits of $2.2 billion and consolidated shareholders’
equity of $227.6 million as of December 31, 2007. We conduct and manage our
business principally through our wholly-owned subsidiary, Imperial Capital Bank
(the “Bank”), an institution with $3.5 billion in assets and six retail branches
located in California (Beverly Hills, Costa Mesa, Encino, Glendale, San Diego,
and San Francisco), one retail branch located in Carson City, Nevada, and one
retail branch located in Baltimore, Maryland. During 2008, we expect
to open an additional retail branch office to be located in Las Vegas,
Nevada. Our branch offices are primarily used for our deposit
services and lending business. Additionally, the Bank has 25 loan origination
offices serving the Western United States, the Southeast region, the
Mid-Atlantic region, the Ohio Valley, the Metro New York area and New England.
The Bank has been in business for 33 years. In 2005, we opened our
east coast headquarters in Times Square in New York City. This office manages
and supports our east coast real estate lending efforts.
We are
primarily engaged in:
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Originating
and purchasing real estate loans secured by income producing properties
for retention in our loan
portfolio;
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Originating
entertainment finance loans; and
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Accepting
customer deposits through the following products: certificates of
deposits, money market, passbook and demand deposit accounts. Our deposit
accounts are insured by the Federal Deposit Insurance Corporation (“FDIC”)
up to the legal limits.
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We
continuously evaluate business expansion opportunities, including acquisitions
or joint ventures with companies that originate or purchase commercial and
multi-family real estate loans, as well as other types of secured commercial
loans. In connection with this activity, we periodically have discussions with
and receive financial information about other companies that may or may not lead
to the acquisition of the company, a segment or division of that company, or a
joint venture opportunity.
Our
executive offices are located at 888 Prospect Street, Suite 110, La Jolla,
California 92037 and our telephone number at that address is (858)
551-0511.
Lending
Activities
General.
During 2007, our
core lending activities were as follows:
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Originating
and, to a lesser extent, purchasing real estate loans secured by income
producing properties, or properties under construction;
and
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Originating
entertainment finance loans.
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Income Producing Property Loans.
We originate and purchase real estate loans secured by first trust deeds
or first mortgages on commercial and multi-family real estate. Our collateral
consists primarily of the following types of properties:
•Apartments
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•Mini-storage
facilities
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•Retail
centers
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•Mobile
home parks
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•Small
office and light industrial buildings
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•Multi-family
real estate
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•Hotels
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•Other
mixed use or special purpose commercial
properties
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At
December 31, 2007, we had $2.6 billion of income producing property loans
outstanding, representing 85.6% of our total real estate loans, and 83.1% of our
gross loan portfolio. Most of our real estate borrowers are business owners,
individual investors, investment partnerships or limited liability entities. The
income producing property lending that we engage in typically involves loans to
a single borrower and is generally viewed as exposing the lender to a greater
risk of loss than one- to four-family residential lending, because repayment of
the loan generally is dependent, in large part, on the successful operation of
the property securing the loan or the business conducted on the property
securing the loan.
Income
producing property values are also generally subject to greater volatility than
residential property values. The liquidation values of income producing
properties may be adversely affected by risks generally incident to interests in
real property, such as:
•Changes
or continued weakness in general or local economic
conditions;
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•Availability
of financing for investors/owners of income producing
properties;
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•Changes
or continued weakness in specific industry segments;
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•Other
factors beyond the control of the borrower or the
lender;
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•Increases
in other operating expenses (including energy costs);
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•Increases
in interest rates, real estate and personal property tax rates;
and
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•Declines
in rental, room or occupancy rates in hotels, apartment complexes or
commercial properties;
•Declines
in real estate values;
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•Changes
in governmental rules, regulations and fiscal policies, including rent
control ordinances, environmental
legislation and taxation.
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We
originate real estate loans through our retail branches and loan origination
offices. These offices are staffed by a total of 42 loan officers. Loan officers
solicit mortgage loan brokers for loan applications that meet our underwriting
criteria, and also accept applications directly from borrowers. A majority of
the real estate loans funded by us are originated through mortgage loan brokers.
Mortgage loan brokers act as intermediaries between us and the property owner in
arranging real estate loans and earn a fee based upon the principal amount of
each loan funded.
Income
producing property loans are generally made in amounts up to 75% of the
appraised value of the property; however, multi-family loan originations may be
made at a loan to value ratio of up to 80%. Loans are generally made for terms
of between ten and 30 years, with amortization periods up to 30 years. Depending
on market conditions at the time the loan was originated, certain loan
agreements may include prepayment penalties.
The
average yield on our real estate loan portfolio was 7.39% in 2007 compared to
7.74% in 2006. A significant portion of our loan portfolio is
comprised of adjustable rate loans indexed to either six month LIBOR or the
Prime Rate, most with interest rate floors and caps below and above which the
loan’s contractual interest rate may not adjust. Approximately 49.3%
of our loan portfolio was adjustable at December 31, 2007, and approximately
46.5% of the loan portfolio as of that date was comprised of hybrid loans, which
after an initial fixed rate period of three or five years, will convert to an
adjustable interest rate for the remaining term of the loan. As of
December 31, 2007, our hybrid loans had a weighted average of 2.3 years
remaining until conversion to an adjustable rate loan. Our adjustable
rate loans generally reprice on a quarterly or semi-annual basis with increases
generally limited to maximum adjustments of 2% per year up to 5% for the life of
the loan. At December 31, 2007, approximately $2.7 billion, or 85.0%,
of our adjustable and hybrid loan portfolio contained interest rate floors,
below which the loans’ contractual interest rate may not adjust. The
inability of our loans to adjust downward can contribute to increased income in
periods of declining interest rates, and also assists us in our efforts to limit
the risks to earnings resulting from changes in interest rates, subject to the
risk that borrowers may refinance these loans during periods of declining
interest rates. At December 31, 2007, the weighted average floor
interest rate of these loans was 7.31%. At that date, approximately
$251.9 million, or 7.9%, of these loans were at the floor interest
rate. At December 31, 2007, 42.0% of the adjustable rate loans
outstanding had a lifetime interest rate cap. The weighted-average lifetime
interest rate cap on our adjustable rate loan portfolio was 11.80% at that
date. At December 31, 2007, none of the loans in our adjustable rate
loan portfolio were at their cap rate.
Total
loan production, including the unfunded portion of loans, was $1.2 billion for
the year ended December 31, 2007, as compared to $1.6 billion, for each of the
years ended December 31, 2006 and 2005. Loan production in 2007 consisted of the
origination of $721.5 million of commercial real estate loans, $331.9 million of
small balance multi-family real estate loans and $114.4 million of entertainment
finance loans, and the acquisition of $47.3 million of commercial and
multi-family real estate loans by our wholesale loan operations. In
our real estate loan purchases, we generally apply the same underwriting
criteria as loans internally originated and reserve the right to reject
particular loans from a loan pool being purchased that do not meet our
underwriting criteria. The decline in loan production in 2007 was
primarily due to a $450.4 million decrease in wholesale loan acquisitions during
the year, primarily related to a reduction in loan pools being offered in the
secondary market that met our pricing and credit requirements.
Real Estate Construction and Land
Loans.
We originate construction and land loans for the primary purpose
of developing or rehabilitating single-family residences, condominiums, and
commercial real estate. At December 31, 2007, our construction and
land loans amounted to $421.1 million, or 13.4%, of our gross loan
portfolio. Approximately $210.3 million, or 49.9%, of our
construction and land loan portfolio consisted of new condominium or condominium
conversion loans, $106.9 million, or 25.4%, consisted of commercial and
multifamily real estate loans, $61.1 million, or 14.5%, consisted of land loans,
and $42.8 million, or 10.2%, consisted of single-family residential construction
loans. At December 31, 2007, $226.2 million, or 53.7%, of our
construction projects were located in California, $65.5 million, or 15.6%, were
for projects located in New York, $39.7 million, or 9.4%, were for projects
located in Arizona, $21.3 million, or 5.1%, were for projects located in Texas
and $19.1 million, or 4.5%, were for projects located in Florida.
Loan
commitment amounts for residential and condominium construction loans typically
range from $3.0 to $20.0 million with an average loan commitment at December 31,
2007 of $15.6 million and $7.7 million, respectively. At December 31,
2007, the unadvanced portion of residential and condominium construction loans
were $39.2 million and $105.4 million, respectively. Commercial
construction loans typically consist of mixed-use retail and other commercial
related projects. At December 31, 2007, the average loan commitment
for our commercial construction loans was $5.8 million and the unadvanced
portion of these commitments was $59.5 million. Our land loans
generally finance the acquisition and/or development of improved lots or
unimproved raw land that will be utilized in the development of single-family
tract housing. At December 31, 2007, the average loan commitment for
our land loans was $4.4 million and the unadvanced portion of these commitments
was $7.4 million.
Loans to
finance our construction projects are generally offered to experienced builders
and developers. We regularly monitor our real estate construction
loans and the economic conditions and markets where our projects are located,
including the number of unsold properties in our residential and condominium
construction loan portfolio. Maturity dates for construction loans
are largely a function of the estimated construction period of the project, and
generally do not exceed 12 to 24 months. Substantially all of our
construction loans have adjustable rates of interest based on the Prime
Rate.
Entertainment Finance Loans
.
We conduct our entertainment finance operations through ICB Entertainment
Finance (“ICBEF”), a division of the Bank. Typically, ICBEF lends to independent
producers of film and television on a senior secured basis. Collateral documents
include a mortgage of copyright, security agreements and assigned sales
contracts. Credit decisions are based in part on the creditworthiness and
reputation of the producer, the sales agent and distributors who have contracted
to distribute the films. ICBEF provides loans (with a typical term of 12 to 18
months) and letters of credit for the production of motion pictures and
television shows or series that have a predictable market worldwide, and
therefore, a predictable level of revenue arising from licensing of the
worldwide distribution rights.
ICBEF
lends to independent producers of film and television, many of which are located
in California. To a lesser extent, ICBEF also has borrowing clients outside of
the United States; however, loans are typically denominated in United States
dollars. Independent producers tend to be those producers that do not have major
studio distribution outlets for their product. Large film and television studios
generally maintain their own distribution outlets and finance their projects
with internally generated financing. In addition to funding production loans
against a number of distribution contracts, ICBEF may permit an advance,
generally not to exceed 20% of the budget amount, against its valuation of
unsold rights. ICBEF uses industry standards in the valuation of unsold rights.
ICBEF’s lending officers review the quality of the distributors and their
contracts, the budget, the producer’s track record, the script, the genre,
talent elements, the schedule of advances, and valuation of all distribution
rights when considering a new lending opportunity. Generally, ICBEF loans
require the borrower to provide a completion bond that guarantees the completion
of the film or the payoff of the outstanding balance of the loan in the event
the film is not completed. After closing, each requested advance is approved by
the bonding company on a regular basis to ensure that ICBEF is not advancing
ahead of an agreed-upon cash flow schedule. The loan documentation grants ICBEF
the right to impose certain penalties on the borrower and exercise certain other
rights, including replacing the sales agent, if sales are not consummated within
the appropriate time. Loans are repaid principally from revenue received from
distribution contracts. In many instances, the distribution contracts provide
for multiple payments payable at certain milestones (such as execution of
contract, commencement of principal photography or completion of principal
photography). The maturity date of the loan is generally six to nine months
after completion of the production. Delivery of the completed production is
typically made to the various distributors upon or after their minimum
guarantees have been paid in full. To the extent a distributor fails to make
payment upon completion of the film, or the predicted level of revenue is less
than expected, we may incur a loss if rights cannot be resold for the same
amount or other loan collateral cannot cover required loan
payments.
ICBEF
typically charges its customers an interest rate of three month LIBOR plus a
margin (exclusive of loan fees) on the outstanding balance of the loan. Loan
fees range from 0.75% to 1.50% with an additional fee up to 7.00% depending on
the unsecured amount of the production budget being financed.
At
December 31, 2007 and 2006, our entertainment finance portfolio totaled $76.3
million and $74.2 million, respectively, representing 2.4% and 2.5% of our gross
loan portfolio as of these dates. Of these amounts, approximately
$14.1 million and $10.3 million, respectively, were issued to producers
domiciled outside of the United States. The foreign loans outstanding
at December 31, 2007 were primarily issued to producers located in Australia.
Approximately $8.6 million, $5.6 million and $7.7 million of interest income was
earned during 2007, 2006 and 2005, respectively, in connection with our
entertainment finance portfolio.
Franchise
Loans
. During 2005, we closed our franchise lending operations
and sold approximately $110.0 million, or 89.0%, of the remaining loans within
this portfolio. We do not currently anticipate originating or purchasing
franchise loans in the future. Franchise loans are loans to owners of
businesses, both franchisors and franchisees, such as fast food restaurants or
gasoline retailers that are affiliated with nationally or regionally recognized
chains and brand names. Various combinations of land, building, business
equipment and fixtures may secure these loans, or they may be a general
obligation of the borrower based on an evaluation of the borrower’s business and
debt service ability. As of December 31, 2007 and 2006, our franchise loan
portfolio was $2.7 million and $9.3 million, respectively, which represented
less than one percent of our gross loan portfolio as of those
dates.
Loan Underwriting.
Initial
loan review for potential applications is performed by the Regional Directors
and Area Manager of our loan origination offices, in consultation with the Chief
Lending Officer, the Chief Operating Officer, Chief Underwriter, and the Chief
Credit Officer. Our loan underwriters are responsible for detailed reviews of
borrowers, collateral, and loan terms, and prepare a written presentation for
every loan application submitted to the real estate loan committee, which is
comprised of the following Bank officers:
•Chairman,
President, and Chief Executive Officer
•Vice
Chairman of the Board
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•Deputy
Managing Director/Director of Portfolio Management
•Deputy
Managing Director/Eastern Area Manager
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•Executive
Managing Director/Chief Credit Officer
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•Deputy
Managing Director/Western Area Manager
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•Executive
Managing Director/Chief Operating Officer
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•Deputy
Managing Director/Chief Underwriter
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•Senior
Managing Director/Chief Lending Officer
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•First
Vice President/East Coast Credit Executive
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•Managing
Director/Business Lending Credit
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The
underwriting standards for loans secured by income producing real estate
consider the borrower’s financial resources and ability to repay and the amount
and stability of cash flow, if any, from the underlying collateral, to be
comparable in importance to the loan-to-value ratio as a repayment
source.
All real
estate secured loans over $3.0 million must be submitted to the loan committee
for approval. At least one loan committee member or designee must personally
conduct on-site inspections of any property involved in connection with a real
estate loan recommendation of $2.0 million or more for unstabilized properties
and $3.0 million for stabilized properties. Loans up to $750,000 may
be approved by any loan committee member. Loans of $750,000 to $2.0 million
require approval by any two members of the Bank’s loan committee, while loans in
excess of $2.0 million require approval of three loan committee members, one of
whom must be the Chief Lending Officer, and only one of whom may be from the
Loan Production Unit. Additionally, loans over $3.0 million require the approval
of the Chief Credit Officer; and individual loans over $7.5 million, loans
resulting in an aggregate borrowing relationship to one borrower in excess of
$10.0 million, and all purchased loan pools must be approved by the Executive
Committee of the Bank’s Board of Directors.
All
entertainment finance loans over $1.0 million are submitted to the business
lending loan committee for approval. All loans must be approved by
the Managing Director/Credit Risk Director and loans over $3.0 million must be
approved by the Executive Managing Director/Chief Credit
Officer. Individual loans over $7.5 million, loans resulting in an
aggregate borrowing relationship to one borrower in excess of $10.0 million, and
all purchased loan pools must be approved by the executive committee of the
Bank’s Board of Directors.
Our loans
are originated on both a non-recourse and full recourse basis and we generally
seek to obtain personal guarantees from the principals of borrowers which are
single asset or limited liability entities (such as partnerships, corporations
or trusts).
The
maximum size of a single loan made by the Bank is limited by California law to
25% of the Bank’s equity capital. At December 31, 2007, that limit was
approximately $70.0 million. Our largest combined credit extension to related
borrowers was $40.3 million at December 31, 2007. We had three other
relationships in excess of $20.0 million at December 31, 2007, with a combined
aggregate balance of $72.0 million at that date. At December 31,
2007, we had a total of 207 extensions of credit, with a combined outstanding
principal balance of $818.8 million that were over $5.0 million to a single
borrower or related borrowers. All combined extensions of credit over $5.0
million were performing in accordance with their repayment terms, with the
exception of two credit relationships aggregating $16.3 million that were on
nonaccrual status at December 31, 2007. At December 31, 2007, we had
3,334 real estate loans outstanding, with an average balance per loan of
approximately $942,000.
Servicing and Collections.
Our loan portfolio is predominantly serviced by our loan servicing
department, which is designed to provide prompt customer service, accurate and
timely information for account follow-up, financial reporting and management
review. We monitor our loans to ensure that projects are performing
as underwritten. This monitoring allows us to take a proactive approach to
addressing projects that do not perform as planned. When payments are not
received by their contractual due date, collection efforts begin on the
fifteenth day of delinquency with a telephone contact, and proceed to written
notices that progress from reminders of the borrower’s payment obligation to an
advice that a notice of default may be forthcoming. Accounts delinquent for more
than 30 days are reviewed more closely by our asset management department which
is responsible for implementing a collection or restructuring plan, or a
disposition strategy, and evaluates any potential loss exposure on the asset.
Our servicing department has received a primary servicer rating of “SBPS3” by
Fitch Ratings. Fitch rates small balance commercial mortgage primary and special
servicers on a scale of 1 to 5, with 1 being the highest rating. According to
Fitch Ratings the rating reflects the Bank’s experienced servicing management
and staff, including asset managers and its longtime experience as a small
balance commercial mortgage loan servicer. The special servicer rating was based
on our ability to work out, resolve and dispose of small balance commercial
mortgage loans and real estate owned (REO) properties.
Competition.
We face
substantial competition in all phases of our operations, including deposit
accounts and loan originations, from a variety of competitors
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Our competition for
existing and potential customers is principally from community banks, savings
and loan associations, industrial banks, real estate financing conduits,
specialty finance companies, small insurance companies, and larger banks. Many
of these entities enjoy competitive advantages over us relative to a potential
borrower in terms of a prior business relationship, wider geographic presence or
more accessible branch office locations, the ability to offer additional
services or more favorable pricing alternatives, or a lower cost of funds
structure. We attempt to offset the potential effect of these factors by
providing borrowers with higher interest rates for deposits and greater
individual attention and a more flexible and time-sensitive underwriting,
approval and funding process than they might obtain elsewhere.
Imperial
Capital Real Estate Investment Trust
During
2000, we acquired all of the equity and certain collateralized mortgage
obligations (“CMOs”) of the ICCMAC Multi-family and Commercial Trust 1999-1
(“ICCMAC Trust”) through our real estate investment trust subsidiary, Imperial
Capital Real Estate Investment Trust (“Imperial Capital REIT”). During 2004, the
CMOs were retired and the ICCMAC Trust was dissolved. The remaining outstanding
loans were contributed to Imperial Capital REIT. At December 31, 2007, Imperial
Capital REIT held net real estate loans of $1.8 million. The cash flow from
Imperial Capital REIT loan pool provides cash flow on a monthly basis to
ICB. ICB recognized $171,000 of interest income from the loans held
in Imperial Capital REIT during the year ended December 31, 2007.
Non-performing
Assets and Other Loans of Concern
At
December 31, 2007, non-performing assets totaled $57.4 million or 1.62% of total
assets. Non-performing assets consisted of $38.0 million of non-accrual loans
and $19.4 million of other real estate and other assets owned consisting of 19
properties. For additional information regarding non-performing
assets see “Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations - Credit Risk Elements”.
As of
December 31, 2007, we had loans with an aggregate outstanding balance of $27.4
million with respect to which known information concerning possible credit
problems with the borrowers or the cash flows of the properties securing the
respective loans has caused management to be concerned about the ability of the
borrowers to comply with present loan repayment terms. This known information
may result in the future inclusion of such loans in the non-accrual loan
category. All of these loans are classified as substandard pursuant to the
regulatory guidelines discussed below.
Classified
Assets
Management
uses a loan classification system consistent with the classification system used
by bank regulatory agencies to help it evaluate the risks inherent in its loan
portfolio. Loans are identified as “pass”, “substandard”, “doubtful” or “loss”
based upon consideration of all sources of repayment, underlying collateral
values, current and anticipated economic conditions, trends and uncertainties,
and historical experience. Pass loans are further divided into four additional
sub-categories, based on the type and nature of underlying collateral, as well
as the borrower’s financial strength and ability to service the debt. Underlying
collateral values for real estate dependent loans are supported by property
appraisals or evaluations. We review our loan classifications on at least a
quarterly basis. At December 31, 2007, we classified $65.4 million of loans as
“substandard”, none as “doubtful” and none as “loss” of which, $38.0 million of
these classified loans were included in the non-performing assets table in “Item
7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Credit Risk Elements”.
Funding
Sources
The
primary source of funding for our lending operations and investments are
deposits. Our deposits are federally insured by the FDIC to the
maximum extent permitted by law. At December 31, 2007 deposits
totaled $2.2 million of which approximately 86.5% were term deposits that pay
fixed rates of interest for periods ranging from 90 days to five years, 11.5%
were adjustable rate passbook accounts and adjustable rate money market accounts
with limited checking features, and 2.0% were customer demand deposit
accounts.
Our
retail checking account balance was $43.3 million at December 31, 2007. We
generally accumulate deposits by relying on renewals of term accounts by
existing depositors, participating in deposit rate surveys which promote the
rates offered by us on our deposit products, and periodically advertising in
various local market newspapers and other media. Management believes that our
deposits are a reliable funding source and that the cost of funds resulting from
our deposit gathering strategy is comparable to those of other banks pursuing a
similar strategy. However, because we compete for deposits primarily on the
basis of rates, we could experience difficulties in attracting deposits if we
could not continue to offer deposit rates at levels above those of other
financial institutions. Management also believes that any efforts to
significantly increase the size of our deposit base may require greater
marketing efforts and/or increases in deposit rates. At December 31, 2007,
$379.4 million, or 17.4% of total deposits, were brokered deposits.
For
information concerning overall deposits outstanding during the periods indicated
and the rates paid thereon, see “Item 7. Management’s Discussion and Analysis of
Financial Condition and Results of Operations — Net Interest
Income”.
The Bank
also uses advances from the Federal Home Loan Bank or FHLB of San Francisco and
borrowings from other unaffiliated financial institutions as funding sources.
FHLB advances are collateralized by pledges of qualifying cash equivalents,
investment securities, mortgage-backed securities and loans. At December 31,
2007, FHLB advances outstanding totaled $1.0 billion, and the remaining
available borrowing capacity, based on the loans and securities pledged as
collateral, totaled $415.6 million, net of the $13.2 million of additional FHLB
Stock that we would be required to purchase to support the additional
borrowings. Additionally, the Bank has a $30.0 million repurchase agreement
borrowing from an unaffiliated financial institution that is secured by
mortgage-backed securities. As of December 31, 2007, we had an available
borrowing capacity under the Federal Reserve Bank of San Francisco credit
facility of $178.5 million. We also had available $131.0 million of
uncommitted, unsecured lines of credit with four unaffiliated financial
institutions, and a $37.5 million revolving credit facility with an unaffiliated
financial institution. See “Item 8. Financial Statements and
Supplementary Data — Notes to Consolidated Financial Statements — Notes 7, 8,
and 9”.
Regulation
As a bank
holding company, ICB is regulated by the Board of Governors of the Federal
Reserve System (the “Federal Reserve Board” or “FRB”). As a California-chartered
commercial bank, the Bank is regulated by the California Department of Financial
Institutions (the “DFI”) and the Federal Deposit Insurance Corporation (the
“FDIC”).
Holding
Company Regulation
Bank
holding companies are subject to comprehensive regulation by the Federal Reserve
Board under the Bank Holding Company Act of 1956, and the regulations of the
Federal Reserve Board. As a bank holding company, ICB is required to file
reports with the Federal Reserve Board and provide such additional information
as the Federal Reserve Board may require. ICB and its non-bank subsidiaries are
also subject to examination by the Federal Reserve Board. The Federal Reserve
Board has extensive enforcement authority over bank holding companies,
including, among other things, the ability to assess civil money penalties, to
issue cease and desist or removal orders and to require that a bank holding
company divest subsidiaries, including its bank subsidiaries. In general,
enforcement actions may be initiated for violations of law and regulation as
well as unsafe or unsound practices.
Under
Federal Reserve Board policy, a bank holding company must serve as a source of
strength for its subsidiary banks. Under this policy, the Federal Reserve Board
may require, and has required in the past, bank holding companies to contribute
additional capital to undercapitalized subsidiary banks.
Under the
Bank Holding Company Act of 1956, a bank holding company must obtain Federal
Reserve Board approval before, among other matters:
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acquiring,
directly or indirectly, ownership or control of any voting shares of
another bank or bank holding company if, after the acquisition, it would
own or control more than 5% of these shares (unless it already owns or
controls a majority of these
shares);
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acquiring
all or substantially all of the assets of another bank or bank holding
company; or
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merging
or consolidating with another bank holding
company.
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This
statute also prohibits a bank holding company, with certain exceptions, from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company which is not a bank or bank holding company, or from
engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non-bank activities
which have been identified as activities closely related to the business of
banking or managing or controlling banks. Companies that qualify as financial
holding companies may also engage in securities, insurance and merchant banking
activities.
Dividends
. The Federal
Reserve Board has issued a policy statement on the payment of cash dividends by
bank holding companies, which expresses the Federal Reserve Board’s view that a
bank holding company should pay cash dividends only to the extent that its net
income for the past year is sufficient to cover both the cash dividends and a
rate of earnings retention that is consistent with the bank holding company’s
capital needs, asset quality and overall financial condition. Furthermore, under
its source of strength doctrine, the Federal Reserve Board expects a bank
holding company to serve as a source of financial strength for its bank
subsidiaries, which could limit the ability of a holding company to pay
dividends if a bank subsidiary did not have sufficient capital.
Repurchase or Redemption of Equity
Securities.
A bank holding company is required to give the Federal
Reserve Board prior written notice of any purchase or redemption of its
outstanding equity securities if the gross consideration for the purchase or
redemption, when combined with the net consideration paid for all such purchases
or redemptions during the preceding 12 months, is equal to 10% or more of its
consolidated net worth. The Federal Reserve Board may disapprove such a purchase
or redemption if it determines that the proposal would constitute an unsafe or
unsound practice or would violate any law, regulation, Federal Reserve Board
order, or any condition imposed by, or written agreement with, the Federal
Reserve Board. This notification requirement does not apply to any company that
meets the well-capitalized standard for bank holding companies, has a safety and
soundness examination rating of at least a “2” and is not subject to any
unresolved supervisory issues.
Regulatory Capital
Requirements
.
The
Federal Reserve has established risk-based measures and a leverage measure of
capital adequacy for bank holding companies.
The
risk-based capital standards are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among banks and bank
holding companies, to account for off-balance-sheet exposure, and to minimize
disincentives for holding liquid assets. Assets and off-balance-sheet items,
such as letters of credit and unfunded loan commitments, are assigned to broad
risk categories, each with appropriate risk weights. The resulting capital
ratios represent capital as a percentage of total risk-weighted assets and
off-balance-sheet items.
The
minimum ratio of total capital to risk-weighted assets is 8.0%. Total capital
consists of two components, Tier 1 capital and Tier 2 capital. Tier 1 capital
generally consists of common shareholders’ equity, including retained earnings,
noncumulative perpetual preferred stock, certain trust preferred securities and
minority interest in equity accounts of fully consolidated subsidiaries, less
goodwill and other specified intangible assets. Tier 1 capital must equal at
least 4.0% of risk-weighted assets. Tier 2 capital generally consists of
subordinated debt and other hybrid capital instruments, other preferred stock, a
limited amount of loan loss reserves and a limited amount of unrealized holding
gains on equity securities. The total amount of Tier 2 capital is limited to
100% of Tier 1 capital. At December 31, 2007, our ratio of total capital to
risk-weighted assets was 11.3% and our ratio of Tier 1 capital to risk-weighted
assets was 9.7%.
In
addition, the Federal Reserve has established minimum leverage ratio guidelines
for bank holding companies. These guidelines provide for a minimum ratio of Tier
1 capital to average assets, less goodwill and other specified intangible
assets, of 3.0% for certain bank holding companies that meet specified criteria,
including having the highest regulatory rating and implementing the Federal
Reserve’s risk-based capital measure for market risk. All other bank holding
companies generally are required to maintain a leverage ratio of at least
4.0%. At December 31, 2007, ICB’s
required leverage ratio
was 4.0% and its actual leverage ratio was 8.4%.
ICB
currently is deemed “well capitalized” under the Federal Reserve Board capital
requirements. To be well capitalized, a bank holding company must have a ratio
of total capital to risk weighted assets of at least 10% and a ratio of Tier 1
capital to risk weighted assets of at least 6.0%.
Failure
to meet capital guidelines could subject a bank or bank holding company to a
variety of enforcement remedies, including issuance of a capital directive, the
termination of deposit insurance by the FDIC, a prohibition on accepting
brokered deposits, and other restrictions on its business. As described below,
significant additional restrictions can be imposed on FDIC-insured depository
institutions that fail to meet applicable capital requirements.
Bank
Regulation — California Law
The
regulations of the DFI govern most aspects of the Bank’s businesses and
operations, including, but not limited to, the scope of its business,
investments, the nature and amount of any collateral for loans, the issuance of
securities, the payment of dividends, bank expansion and bank activities. The
DFI’s supervision of the Bank includes comprehensive reviews of all aspects of
the Bank’s business and condition, and the DFI possesses broad remedial
enforcement authority to influence the Bank’s operations, both formally and
informally.
Bank
Regulation — Federal Law
The FDIC,
in addition to the DFI, broadly regulates the Bank. As an insurer of deposits,
the FDIC issues regulations, conducts examinations, requires the filing of
reports, and generally supervises the operations of institutions to which it
provides deposit insurance. The FDIC is also the federal agency charged with
regulating state-chartered banks that are not members of the Federal Reserve
System, such as the Bank. Insured depository institutions, and their
institution-affiliated parties, may be subject to potential enforcement actions
by the FDIC and the DFI for unsafe or unsound practices in conducting their
businesses or for violations of any law, rule, regulation or any condition
imposed in writing by the agency or any written agreement with the agency.
Management is not aware of any pending or threatened enforcement actions against
the Bank.
Regulatory Capital Requirements.
Federally-insured, state-chartered banks such as the Bank are required to
maintain minimum levels of regulatory capital as specified in the FDIC’s capital
maintenance regulations. The FDIC also is authorized to impose capital
requirements in excess of these standards on individual banks on a case-by-case
basis.
The Bank
is required to comply with three separate minimum capital requirements: a “tier
1 capital ratio” and two “risk-based” capital requirements. “Tier 1 capital”
generally includes common shareholders’ equity, including retained earnings,
qualifying noncumulative perpetual preferred stock and any related surplus, and
minority interests in the equity accounts of fully consolidated subsidiaries,
less intangible assets, other than properly valued purchased mortgage servicing
rights up to certain specified limits and less net deferred tax assets in excess
of certain specified limits.
Tier 1 Capital Ratio.
FDIC
regulations establish a minimum 3.0% ratio of tier 1 capital to total average
assets for the most highly-rated state-chartered, FDIC-supervised banks. All
other FDIC supervised banks must maintain at least a 4.0% tier 1 capital ratio.
At December 31, 2007, the Bank’s required minimum tier 1 capital ratio was 4.0%
and its actual tier 1 capital ratio was 8.3%.
Risk-Based Capital Requirements.
The risk-based capital requirements generally require the Bank to
maintain a minimum ratio of tier 1 capital to risk-weighted assets of at least
4.0% and a minimum ratio of total risk-based capital to risk-weighted assets of
at least 8.0%. To calculate the amount of capital required, assets are placed in
one of four categories and given a percentage weight (0%, 20%, 50% or 100%)
based on the relative risk of the category. For example, United States Treasury
Bills and Ginnie Mae securities are placed in the 0% risk category. Fannie Mae
and Freddie Mac securities are placed in the 20% risk category, loans secured by
one-to four-family residential properties and certain privately-issued
mortgage-backed securities are generally placed in the 50% risk category, and
commercial and consumer loans and other assets are generally placed in the 100%
risk category. In addition, certain off-balance-sheet items are converted to
balance sheet credit equivalent amounts and each amount is then assigned to one
of the four categories.
For
purposes of the risk-based capital requirements, “total capital” means tier 1
capital plus supplementary or tier 2 capital, so long as the amount of
supplementary or tier 2 capital that is used to satisfy the requirement does not
exceed the amount of tier 1 capital. Tier 2 capital includes cumulative and
certain other perpetual preferred stock, mandatory convertible subordinated debt
and perpetual subordinated debt, mandatory redeemable preferred stock,
intermediate-term preferred stock, mandatory convertible subordinated debt and
subordinated debt, the allowance for loan losses up to a maximum of 1.25% of
risk-weighted assets and a limited amount of unrealized holding gains on
securities. At December 31, 2007 the Bank’s required minimum tier 1 risk-based
and total capital ratios were 4.0% and 8.0% respectively and its actual was 9.6%
and 10.9%, respectively.
The
federal banking agencies have adopted regulations specifying that the agencies
will include, in their evaluation of a bank’s capital adequacy, an assessment of
the exposure to declines in the economic value of the bank’s capital due to
changes in interest rates. The FDIC and the other federal banking agencies have
also promulgated final amendments to their respective risk-based capital
requirements which identify concentration of credit risk and certain risks
arising from nontraditional activities, and the management of such risk, as
important factors to consider in assessing an institution’s overall capital
adequacy. The FDIC may require higher minimum capital ratios based on certain
circumstances, including where the institution has significant risks from
concentration of credit or certain risks arising from nontraditional
activities.
Prompt Corrective Action
Requirements.
The FDIC has implemented a system requiring regulatory
sanctions against state-chartered banks that are not adequately capitalized,
with the sanctions growing more severe the lower the institution’s capital. The
FDIC has established specific capital ratios for five separate capital
categories: “well capitalized”, “adequately capitalized”, “undercapitalized”,
“significantly undercapitalized”, and “critically
undercapitalized”.
An
institution is treated as “well capitalized” if its total risk based capital
ratio is 10.0% or more, its tier 1 risk-based ratio is 6.0% or more, its tier 1
capital ratio is 5.0% or greater, and it is not subject to any order or
directive by the FDIC to meet a specific capital level. The Bank exceeded these
requirements at December 31, 2007.
The FDIC
is authorized and, under certain circumstances, required to take certain actions
against institutions that are not at least adequately capitalized. Any such
institution must submit a capital restoration plan and, until such plan is
approved by the FDIC, may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not make
capital distributions. The capital restoration plan must include a
limited guaranty by the institution’s holding company. In addition,
the FDIC must appoint a receiver or conservator for an institution, with certain
limited exceptions, within 90 days after it becomes “critically
undercapitalized”.
The FDIC
is also generally authorized to reclassify an institution into a lower capital
category and impose the restrictions applicable to such category if the
institution is engaged in unsafe or unsound practices or is in an unsafe or
unsound condition.
Deposit
Insurance.
The Bank’s deposits are insured up to applicable
limits by the Deposit Insurance Fund, or DIF, which is administered by the FDIC.
The FDIC insures deposits up to the applicable limits and this insurance is
backed by the full faith and credit of the United States government. As insurer,
the FDIC imposes deposit insurance premiums and is authorized to conduct
examinations of and to require reporting by institutions insured by the FDIC. It
also may prohibit any institution insured by the FDIC from engaging in any
activity determined by regulation or order to pose a serious risk to the
institution. The FDIC also has the authority to initiate enforcement actions
against insured institutions and may terminate the deposit insurance if it
determines that an institution has engaged in unsafe or unsound practices or is
in an unsafe or unsound condition.
Under
regulations effective January 1, 2007, the FDIC adopted a new risk-based premium
system that provides for quarterly assessments based on an insured institution's
ranking in one of four risk categories based upon supervisory and capital
evaluations. Well-capitalized institutions (generally those with capital
adequacy, asset quality, management, earnings and liquidity, or "CAMELS"
composite ratings of 1 or 2) are grouped in Risk Category I and assessed for
deposit insurance at an annual rate of between five and seven basis points. The
assessment rate for an individual institution is determined according to a
formula based on a weighted average of the institution's individual CAMEL
component ratings plus either five financial ratios or, in the case of an
institution with assets of $10.0 billion or more, the average ratings of its
long-term debt. Institutions in Risk Categories II, III and IV are assessed at
annual rates of 10, 28 and 43 basis points, respectively. This assessment for
the year ended December 31, 2007 was approximately $1.0 million and was offset
by a one-time credit assessment allocated to member institutions under the
Federal Deposit Insurance Reform Act of 2005. As of December 31, 2007, the
remaining assessment credit available to offset our future deposit insurance
assessment was $34,000.
The FDIC
also collects assessments against the assessable deposits of insured
institutions to service the debt on bonds issued during the 1980s to resolve the
thrift bailout. Our expense related to this assessment for the year
ended December 31, 2007 was $250,000.
Community Reinvestment Act and Fair
Lending Requirements.
Federal banking agencies are required to evaluate
the record of financial institutions in meeting the credit needs of their local
communities, including low and moderate income neighborhoods. In its most recent
examination, the FDIC rated the Bank “satisfactory” in complying with its
Community Reinvestment Act obligations. The Bank is also subject to
certain fair lending (nondiscrimination) requirements. In addition to
substantial penalties and corrective measures that may be required for a
violation of certain fair lending laws, the federal banking agencies take
compliance with such laws into account when regulating and supervising other
activities such as mergers and acquisitions.
Fiscal and Monetary Policies.
Our business and earnings are affected significantly by the fiscal and
monetary policies of the federal government and its agencies. We are
particularly affected by the policies of the Federal Reserve Board, which
regulates the supply of money and credit in the United States. Among the
instruments of monetary policy available to the Federal Reserve Board are (a)
conducting open market operations in United States government securities; (b)
changing the discount rates of borrowings of depository institutions, (c)
imposing or changing reserve requirements against depository institutions’
deposits, and (d) imposing or changing reserve requirements against certain
borrowings by banks and their affiliates. These methods are used in varying
degrees and combinations to directly affect the availability of bank loans and
deposits, as well as the interest rates charged on loans and paid on deposits.
The policies of the Federal Reserve Board may have a material effect on our
business, results of operations and financial condition.
Federal
Reserve Board regulations require the Bank to maintain non-interest earning
reserves against the Bank’s transaction deposit accounts. Currently,
the first $8.5 million of otherwise reservable balances are exempt from the
reserve requirement, a 3% reserve requirement applies to balances over $9.3
million up to $43.9 million and a 10% reserve requirement applies to balances
over $43.9 million. The Bank was in compliance with these
requirements as of December 31, 2007.
Privacy
Provisions.
Banking regulators, as required under the
Gramm-Leach-Bliley Act (“GLB Act”), have adopted rules limiting the ability of
banks and other financial institutions to disclose nonpublic information about
consumers to nonaffiliated third parties. The rules generally require disclosure
of privacy policies to consumers and, in some circumstances, allow consumers to
prevent disclosure of certain personal information to nonaffiliated third
parties. The privacy provisions of the GLB Act affect how consumer information
is transmitted through diversified financial services companies and conveyed to
outside vendors.
The State
of California has adopted The California Financial Information Privacy Act
(“CFPA”), which took effect in 2004. The CFPA requires a financial
institution to provide specific information to a consumer related to the sharing
of that consumer’s nonpublic personal information. A consumer may 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 requires that
permission from the consumer be obtained by a financial institution prior to
sharing such information. These provisions are more restrictive than the privacy
provisions of the GLB Act.
In
December 2003, the U.S. Congress adopted, and President Bush signed, the Fair
and Accurate Transactions Act (the “FACT Act”). In 2005, federal courts
determined that the provisions of the CFPA limiting shared information with
affiliates are preempted by provisions of the GLB Act, the FACT Act and the Fair
Credit Reporting Act.
International Money Laundering
Abatement and Financial Anti-Terrorism Act of 2001.
President
Bush signed the USA Patriot Act of 2001 into law in October 2001. This act
contains the International Money Laundering Abatement and Financial
Anti-Terrorism Act of 2001 (the “IMLAFA”). The IMLAFA substantially broadened
existing anti-money laundering legislation and the extraterritorial jurisdiction
of the United States, imposes new compliance and due diligence obligations,
creates new crimes and penalties, compels the production of documents located
both inside and outside the United States, and clarifies the safe harbor from
civil liability to customers. The U.S. Treasury Department has issued a number
of regulations implementing the USA Patriot Act that apply certain of its
requirements to financial institutions such as the Bank. The regulations impose
obligations on financial institutions to maintain appropriate policies,
procedures and controls to detect, prevent and report money laundering and
terrorist financing. The increased obligations of financial institutions,
including us, to identify their customers, watch for and report suspicious
transactions, respond to requests for information by regulatory authorities and
law enforcement agencies, and share information with other financial
institutions, requires the implementation and maintenance of internal
procedures, practices and controls which have increased, and may continue to
increase, our costs and may subject us to liability.
Enforcement
and compliance-related activity by government agencies has increased. Money
laundering and anti-terrorism compliance are among the areas receiving a high
level of focus in the present environment.
Future Legislation.
Various
legislation, including proposals to change substantially the financial
institution regulatory system, is from time to time introduced in Congress. This
legislation may change banking statutes and our operating environment in
substantial and unpredictable ways. If enacted, this legislation could increase
or decrease the cost of doing business, limit or expand permissible activities
or affect the competitive balance among banks, savings associations, credit
unions, and other financial institutions. We cannot predict whether any of this
potential legislation will be enacted and, if enacted, the effect that it, or
any implementing regulations, would have on our business, results of operations
or financial condition.
Employees
As of
December 31, 2007, we had 268 employees. Management believes that its relations
with employees are satisfactory. We are not subject to any collective bargaining
agreements.
Segment
Reporting
Financial
and other information regarding our operating segments is contained in Note 17
to our audited consolidated financial statements included in Item 8 of this
report.
Internet
Website
We
maintain a website with the address www.imperialcapitalbancorp.com. The
information contained on our website is not included as a part of, or
incorporated by reference into, this Annual Report on Form 10-K. Other than an
investor’s own Internet access charges, we make available free of charge through
our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K, and amendments to these reports, as soon as
reasonably practicable after we have electronically filed such material with, or
furnished such material to, the Securities and Exchange Commission.
Item
1A. Risk Factors
An investment in
our common stock is subject to risks inherent in our business. Before
making an investment decision, you should carefully consider the risks and
uncertainties described below together with all of the other information
included in this report. In addition to the risks and uncertainties
described below, other
risks and
uncertainties not currently known to us or that we currently deem to be
immaterial also may materially and adversely affect our business, financial
condition and results of operations.
The value or
market price of our common stock could decline due to any of these identified or
other risks, and you could lose all or part of your
investment.
Fluctuations
in interest rates could reduce our profitability and affect the value of our
assets.
Like
other financial institutions, we are subject to interest rate
risk. Our primary source of income is net interest income, which is
the difference between interest earned on loans and investments and the interest
paid on deposits and borrowings. We expect that we will periodically
experience imbalances in the interest rate sensitivities of our assets and
liabilities and the relationships of various interest rates to each
other. Over any defined period of time, our interest-earning assets
may be more sensitive to changes in market interest rates than our
interest-bearing liabilities, or vice versa. In addition, the
individual market interest rates underlying our loan and deposit products may
not change to the same degree over a given time period. In any event,
if market interest rates should move contrary to our position, our earnings may
be negatively affected. In addition, loan volume and quality and
deposit volume and mix can be affected by market interest
rates. Changes in levels of market interest rates could materially
adversely affect our net interest spread, asset quality, origination volume and
overall profitability.
We
principally manage interest rate risk by managing our volume and mix of our
earning assets and funding liabilities. In a changing interest rate
environment, we may not be able to manage this risk effectively. If
we are unable to manage interest rate risk effectively, our business, financial
condition and results of operations could be materially harmed.
Changes
in the level of interest rates also may negatively affect our ability to
originate loans, the value of our assets and our ability to realize gains from
the sale of our assets, all of which ultimately affect our
earnings.
An
increase in loan prepayments may adversely affect our
profitability.
Prepayment
rates are affected by customer behavior, conditions in the real estate and other
financial markets, general economic conditions and the relative interest rates
on our fixed-rate and adjustable-rate mortgage loans and mortgage-backed
securities. Changes in prepayment rates are therefore difficult for us to
predict.
We
recognize our deferred loan origination costs and premiums paid in originating
these loans by adjusting our interest income over the contractual life of the
individual loans. As prepayments occur, the rate at which net deferred loan
origination costs and premiums are expensed accelerates. The effect of the
acceleration of deferred costs and premium amortization may be mitigated by
prepayment penalties paid by the borrower when the loan is paid in full within a
certain period of time which varies between loans. If prepayment occurs after
the period of time when the loan is subject to a prepayment penalty, the effect
of the acceleration of premium and deferred cost amortization is no longer
mitigated.
We may
not be able to reinvest prepayments on loans or mortgage-backed securities at
rates comparable to the prepaid instrument particularly in periods of declining
interest rates.
An
inadequate allowance for loan losses would reduce our earnings.
We are
exposed to the risk that our borrowers will be unable to repay their loans
according to their terms and that any collateral securing the payment of their
loans will not be sufficient to assure full repayment. Credit losses are
inherent in the lending business and could have a material adverse effect on our
operating results. Volatility and deterioration in the economy may also increase
our risk for credit losses. We evaluate the collectibility of our loan portfolio
and provide an allowance for loan losses that we believe is adequate based upon
such factors as:
•
|
|
the
risk characteristics of various classifications of
loans;
|
•
|
|
general
portfolio trends relative to asset and portfolio
size;
|
•
|
|
potential
credit and geographic
concentrations;
|
•
|
|
delinquency
trends and nonaccrual levels;
|
•
|
|
historical
loss and recovery experience and risks associated with changes in
economic, social and business
conditions;
|
•
|
|
the
amount and quality of the
collateral;
|
•
|
|
the
views of our regulators; and
|
|
•
|
|
the
underwriting standards in effect when the loan is
made.
|
If our
evaluation is incorrect and borrower defaults cause losses exceeding our
allowance for loan losses, our earnings could be materially and adversely
affected. We cannot assure you that our allowance will be adequate to cover loan
losses inherent in our portfolio. We may experience losses in our loan portfolio
or perceive adverse trends that require us to significantly increase our
allowance for loan losses in the future, which would also reduce our earnings.
In addition, the Bank’s regulators, as an integral part of their examination
process, may require us to make additional provisions for loan
losses.
Our
income producing property loans involve higher principal amounts and expose us
to a greater risk of loss than one-to-four family residential
loans.
At
December 31, 2007, we had $2.6 billion of loans secured by commercial and
multi-family real estate, representing 85.6% of our total real estate loans and
83.1% of our gross loan portfolio. The income generated from the
operation of the property securing the loan is generally considered by us to be
the principal source of repayment on this type of loan. A significant
portion of the income producing property lending in which we engage typically
involves larger loans to a single borrower and is generally viewed as exposing
the lender to a greater risk of loss than one-to-four family residential lending
because these loans generally are not fully amortizing over the loan period, but
have a balloon payment due at maturity. A borrower’s ability to make
a balloon payment typically will depend on being able to either refinance the
loan or timely sell the underlying property. Income producing
property values are also generally subject to greater volatility than
residential property values. The liquidation values of income producing
properties may be adversely affected by risks generally incident to interests in
real property, such as:
•
|
|
changes
or continued weakness in general or local economic
conditions;
|
•
|
|
changes
or continued weakness in specific industry
segments;
|
•
|
|
declines
in real estate values;
|
•
|
|
declines
in rental, room or occupancy rates in hotels, apartment complexes or
commercial properties;
|
•
|
|
increases
in other operating expenses (including energy
costs);
|
•
|
|
the
availability of refinancing at lower interest rates or better loan
terms;
|
•
|
|
changes
in governmental rules, regulations and fiscal policies, including rent
control ordinances, environmental legislation and
taxation;
|
•
|
|
increases
in interest rates, real estate and personal property tax rates,
and
|
•
|
|
other
factors beyond the control of the borrower or the
lender.
|
We
generally originate and acquire income producing property loans primarily to be
held in our portfolio to maturity. Because the resale market for this
type of loan is less liquid than the well-established secondary market for
residential loans, should we decide to sell our income producing property loans,
we may incur losses on any sale.
The
unseasoned nature of many of the loans we originated as part of our small
balance multi-family real estate loan platform, along with our limited
experience in originating loans nationwide, may lead to additional provisions
for loan losses or charge-offs, which would hurt our profits.
The
national expansion of our real estate loan platform and, in particular, our
small balance multi-family real estate loans has led to an increase in the
number of these types of loans in our portfolio. Many of these loans are
unseasoned and have not been subjected to unfavorable economic
conditions. We have limited experience in originating loans outside
the State of California and as a result do not have a significant payment
history pattern with which to judge future collectibility. At December 31, 2007,
$1.7 billion, or 56.2%, of our real estate secured loans were secured by
properties located outside the state of California. As a result, it is difficult
to predict the future performance of this portion of our real estate loan
portfolio. These loans may have delinquency or charge-off levels
above our historical experience, which could adversely affect our
profitability.
Our
construction loans are based upon estimates of costs and value associated with
the complete project. These estimates may be inaccurate.
We
originate construction loans for income producing properties, as well as for
single family home construction. At December 31, 2007, construction
and land loans totaled $421.1 million, or 13.4% of gross loans
receivable. Residential, including condominium, construction loans
consisted of $253.1 million, or 8.0% of our total loan portfolio at December 31,
2007. Construction lending involves additional risks because funds
are advanced upon the security of the project, which is of uncertain value prior
to its completion. There are also risks associated with the timely
completion of the construction activities for their allotted costs, as a number
of factors can result in delays and cost overruns, and the time needed to
stabilize income producing properties or to sell residential tract
developments. Because of the uncertainties inherent in estimating
construction costs, as well as the market value of the completed project and the
effects of governmental regulation of real property, it is relatively difficult
to evaluate accurately the total funds required to complete a project and the
related loan-to-value ratio. This type of lending also typically
involves higher loan principal amounts and is often concentrated with a small
number of builders. As a result, construction loans often involve the
disbursement of substantial funds with repayment dependent, in part, on the
success of the ultimate project and the ability of the borrower to sell or lease
the property or refinance the indebtedness, rather than the ability of the
borrower or guarantor to repay principal and interest. If our
appraisal of the value of the completed project proves to be overstated, we may
have inadequate security for the repayment of the loan upon completion of
construction of the project and may incur a loss.
A
slowdown in the commercial and residential real estate markets may have a
negative impact on earnings and liquidity position.
The overall credit quality of our
construction loan portfolio is impacted by trends in commercial and residential
real estate prices. We continually monitor changes in key regional and national
economic factors because changes in these factors can impact our construction
loan portfolio and the ability of our borrowers to repay their
loans. Across the United States over the past year, commercial and
residential real estate markets have experienced significant adverse
trends, including accelerated price depreciation. These conditions
led to significant increases in loan delinquencies and credit losses, as well as
increases in loan loss provisions, which in turn have had a negative affect
on earnings for many banks across the country. Likewise, we have also
experienced loan delinquencies in our construction loan
portfolio. The current slowdown in commercial and residential real
estate markets may continue to negatively impact real estate values and the
ability of our borrowers to liquidate properties. Despite reduced
sales prices, the lack of liquidity in the commercial and residential real
estate markets and tightening of credit standards within the banking industry
may continue to diminish all sales, further reducing our borrowers’ cash flows
and weakening their ability to repay their debt obligations to us. As
a result, we may experience a further negative material impact on our earnings
and liquidity positions.
Our
real estate lending also exposes us to the risk of environmental
liabilities.
In the
course of our business, we may foreclose and take title to real estate, and
could be subject to environmental liabilities with respect to these properties.
We may be held liable to a governmental entity or to third persons for property
damage, personal injury, investigation and clean-up costs incurred by these
parties in connection with environmental contamination, or may be required to
investigate or clean up hazardous or toxic substances, or chemical releases at a
property. The costs associated with investigation or remediation activities
could be substantial. In addition, as the owner or former owner of a
contaminated site, we may be subject to common law claims by third parties based
on damages and costs resulting from environmental contamination emanating from
the property. If we ever become subject to significant environmental
liabilities, our business, financial condition and results of operations could
be materially and adversely affected.
Repayment
of our entertainment finance loans is primarily dependent on revenues from
distribution contracts.
Through
ICBEF, we originate entertainment finance loans to independent producers of film
and television on a senior secured basis. Although these loans are
typically collateralized by a mortgage of copyright, security agreements and
assigned sales contracts, the primary source of repayment is the revenue
received by the borrower from the licensing of distribution
rights. For this reason, our credit decisions are based in part on
the creditworthiness and reputation of the producer, sales agent and
distributors who have contracted to distribute the films. In many
instances, the distribution contracts provide for multiple payments payable at
certain milestones (such as execution of contract, commencement of principal
photography or completion of principal photography). The maturity date of the
loan is generally six to nine months after completion of the
production. To the extent a distributor fails to make payment upon
completion of the film, or the predicted level of revenue is less than expected,
we may incur a loss if rights cannot be resold for the same amount or other loan
collateral cannot cover required loan payments.
Negative
events in certain geographic areas, particularly California, could adversely
affect us.
Although
we have significantly increased the geographic diversification of our loan
portfolio since commencing our national expansion, our real estate loans remain
heavily concentrated in the State of California, with approximately 43.8% of our
real estate loans as of December 31, 2007 secured by collateral and made to
borrowers in that state. In addition, as of that date, approximately
5.6%, 4.3%, 3.4%, 4.4% and 11.1% of our real estate loans were secured by
collateral and made to borrowers in the States of Arizona, Florida, Georgia, New
York and Texas, respectively. We have no other state geographic concentration of
loans in excess of three percent of our total gross loan portfolio. A worsening
of economic conditions in California or in any other state in which we have a
significant concentration of borrowers could have a material adverse effect on
our business, by reducing demand for new financings, limiting the ability of
customers to repay existing loans, and impairing the value of our real estate
collateral and real estate owned properties. Real estate values are affected by
various other factors, including changes in general or regional economic
conditions, governmental rules or policies and natural disasters such as
earthquakes, tornados and hurricanes.
Our
wholesale funding sources may prove insufficient to replace deposits and support
our future growth.
We must
maintain sufficient funds to respond to the needs of depositors and
borrowers. As a part of our liquidity management, we use a number of
funding sources in addition to core deposit growth and repayments and maturities
of loans and investments. These sources include brokered certificates of
deposit, repurchase agreements, federal funds purchased and Federal Home Loan
Bank advances. Adverse operating results or changes in industry
conditions could lead to an inability to replace these additional funding
sources at maturity. Our financial flexibility will be severely
constrained if we are unable to maintain our access to funding or if adequate
financing is not available to accommodate future growth at acceptable interest
rates. Finally, if we are required to rely more heavily on more
expensive funding sources to support future growth, our revenues may not
increase proportionately to cover our costs. In this case, our
profitability would be adversely affected.
Competition
with other financial institutions could adversely affect our
profitability.
The
banking and financial services industry is very competitive. Legal and
regulatory developments have made it easier for new and sometimes unregulated
competitors to compete with us. Consolidation among financial service providers
has resulted in fewer very large national and regional banking and financial
institutions holding a large accumulation of assets. These institutions
generally have significantly greater resources, a wider geographic presence or
greater accessibility. Our competitors sometimes are also able to offer more
services, more favorable pricing or greater customer convenience than we do. In
addition, our competition has grown from new banks and other financial services
providers that target our existing or potential customers. As consolidation
continues among large banks, we expect additional institutions to try to exploit
our market.
Technological
developments have allowed competitors including some non-depository
institutions, to compete more effectively in local markets and have expanded the
range of financial products, services and capital available to our target
customers. If we are unable to implement, maintain and use such technologies
effectively, we may not be able to offer products or achieve cost-efficiencies
necessary to compete in our industry. In addition, some of these competitors
have fewer regulatory constraints and lower cost structures.
We
rely heavily on the proper functioning of our technology.
We rely
on our computer systems, and outside sources providing technology, for much of
our business, including recording our assets and liabilities. If our computer
systems or outside technology sources fail, are not reliable or there is a
breach of security, our ability to maintain accurate financial records may be
impaired, which could materially affect our operations and financial
condition.
We
are dependent upon the services of our management team.
We are
dependent upon the ability and experience of a number of our key management
personnel who have substantial experience with our operations, the financial
services industry and the markets in which we offer our services. It is possible
that the loss of the services of one or more of our senior executives or key
managers would have an adverse effect on our operations. Our success also
depends on our ability to continue to attract, manage and retain other qualified
personnel as we grow. We cannot assure you that we will continue to attract or
retain such personnel.
Terrorist
activities could cause reductions in investor confidence and substantial
volatility in real estate and securities markets.
It is
impossible to predict the extent to which terrorist activities may occur in the
United States or other regions, or their effect on a particular security issue.
It is also uncertain what affects any past or future terrorist activities and/or
any consequent actions on the part of the United States government and others
will have on the United States and world financial markets, local, regional and
national economics, and real estate markets across the United States. Among
other things, reduced investor confidence could result in substantial volatility
in securities markets, a decline in general economic conditions and real estate
related investments and an increase in loan defaults. Such unexpected losses and
events could materially affect our results of operations.
We
are subject to extensive regulation that could restrict our activities and
impose financial requirements or limitations on the conduct of our
business.
Bank
holding companies and California-charted commercial banks operate in a highly
regulated environment and are subject to supervision and examination by federal
and state regulatory agencies. We are subject to the Bank Holding Company Act of
1956, as amended, and to regulation and supervision by the FRB. Imperial Capital
Bank is subject to regulation and supervision by the FDIC, and DFI. The cost of
compliance with regulatory requirements may adversely affect our results of
operations or financial condition. Federal and state laws and regulations govern
numerous matters including: changes in the ownership or control of banks and
bank holding companies; maintenance of adequate capital and the financial
condition of a financial institution; permissible types, amounts and terms of
extensions of credit and investments; permissible non-banking activities; the
level of reserves against deposits; and restrictions on dividend
payments.
The FDIC
and DFI possess cease and desist powers to prevent or remedy unsafe or unsound
practices or violations of law by banks subject to their regulation, and the FRB
possesses similar powers with respect to bank holding companies. These and other
restrictions limit the manner in which we may conduct our business and obtain
financing.