As filed with the Securities and Exchange Commission on April 1, 2002.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
For the fiscal year ended December 31, 2001
or
For the transition period from ____________ to ______________
NARA BANCORP, INC.(Exact name of Registrant as specified in its charter)
3701 Wilshire BoulevardSuite 220Los Angeles, California 90010(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (213) 639-1700
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:Common Stock, par value $0.001 per share(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of the Common Stock held by non-affiliates of the Registrant based upon the closing sale price of the Common Stock on March 22, 2002, as reported on the Nasdaq National Market, was approximately $35,596,668. Shares of Common Stock held by each executive officer and director and each person owning more than 5% of the outstanding Common Stock of the Registrant have been excluded in that such persons may be deemed to be affiliates of the Registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
Number of shares outstanding of the Registrant’s Common Stock, as of March 22, 2002: 5,575,087
Portions of the Definitive Proxy Statement that will be filed in connection with the registrants Annual Meeting of Shareholders to be held on May 29, 2002 are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
Table of Contents
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PART I
Forward-Looking Information
Certain matters discussed in this Annual Report on Form 10-K may constitute forward-looking statements under Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements may involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which we operate, projections of future performance, perceived opportunities in the market and statements regarding our mission and vision. Forward-looking statements include, but are not limited to, statements preceded by, followed by or that include the word “will,” “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates” or similar expressions. Our actual results, performance or achievements may differ significantly from the results, performance or achievements expressed or implied in such forward-looking statements. For a detailed discussion of the factors that might cause such a difference, see Item 1. “ Factors That May Impact Our Business or the Value of Our Stock.”
Factors that might affect forward-looking statements include, among other things:
As a result of the above, we cannot assure you that our future results of operations or financial conditions or any other matters will be consistent with those presented in any forward-looking statements. Accordingly, we caution you not to rely on these forward-looking statements. We do not undertake, and specifically disclaim any obligation, to update these forward-looking statements, which speak only as of the date made.
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Item 1. BUSINESS
General
Nara Bancorp, Inc. (“Nara Bancorp,” on a parent-only basis, and “we” or “our” on a consolidated basis), incorporated under the laws of the State of Delaware in 2000, is a bank holding company, headquartered in Los Angeles, California, offering a full range of commercial banking and consumer financial services through its wholly owned subsidiary, Nara Bank, N.A., a national bank (“Nara Bank”). During the first quarter of 2001, Nara Bancorp became a bank holding company regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) as part of the reorganization of Nara Bank into a holding company formation.
Recent Developments
On March 8, 2002, we announced that our Board of Directors authorized the repurchase of up to 10% of the 5.57 million shares of our common stock outstanding on that date. The repurchases may be made at any time and from time to time over the next 12 months. We intend to repurchase the shares in open market transactions, including block purchases. The timing and amount of shares, if any, actually repurchased during the authorized period will be determined based on management’s discretion and will depend on market conditions. As of March 29, 2002, we had not yet repurchased any shares under the program.
On March 12, 2002, we announced that our Board of Directors declared a dividend of $0.10 per common share for the first quarter of 2002, which is payable on April 11, 2002 to stockholders of record on March 31, 2002.
On March 26, 2002, we completed a private offering of $8 million of trust preferred securities, issued as part of a pooled offering with several other financial institutions through a newly formed wholly-owned subsidiary, Nara Statutory Trust II (“Nara Trust II”), a Connecticut statutory business trust.
For the period beginning on March 26, 2002 to June 25, 2002, the trust preferred securities bear the interest rate of 5.59% per annum. For each successive period beginning on (and including) June 26, 2002, and each succeeding Interest Payment Date (March 26, June 26, September 26, and December 26 during the 30-year term), and ending on (but excluding) the next succeeding Interest Payment Date, interest rate will adjust to 3-Month LIBOR plus 3.60%. However, prior to March 26, 2007, the interest rate can not exceed 11.00%.
Nara Trust II used the proceeds from the sale of the trust preferred securities to purchase junior subordinated deferrable interest debentures of Nara Bancorp. Bancorp intends to use the proceeds for general corporate purposes. Under applicable regulatory guidelines, we expect that the trust preferred securities will qualify as Tier I Capital.
Business Overview
Nara Bancorp succeeded to the business and operations of Nara Bank upon consummation of reorganization of Nara Bank into a holding company structure, effective as of February 2, 2001. Upon consummation of the reorganization, Nara Bancorp had 5,467,942 shares of common stock outstanding, all of which were authorized for quotation on the Nasdaq National Market. Prior to the completion of the reorganization, Nara Bancorp had no material operations or assets. Nara Bancorp’s principal business is to serve as a holding company for Nara Bank and other bank or bank-related subsidiaries, which Nara Bancorp may establish or acquire. As of December 31, 2001, Nara Bancorp had 5,572,837 shares of common stock outstanding.
On March 28, 2001, Nara Bancorp, through a newly formed and wholly-owned subsidiary, Nara Bancorp Capital Trust I (“Nara Capital”), a Delaware statutory business trust, completed a private placement of $10 million of trust preferred securities, issued as part of a pooled offering with several other financial institutions.
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Our principal business activities are conducted through Nara Bank by earning interest on loans, leases and investment securities that are funded by customer deposits and other borrowings. The difference between interest received and interest paid comprises the majority of our operating earnings.
We conduct our operations through 14 branch offices and 4 loan production offices. Our headquarters is located at 3701 Wilshire Boulevard, Suite 220, Los Angeles, California 90010. Our telephone number is (213) 639-1700. In September of 2001, we opened our fourteenth office in Cerritos, California and we established our fourth loan production office in Atlanta, Georgia. The FDIC insures our deposits up to the maximum legal limits, and we are a member of the Federal Reserve System.
We offer a full range of commercial banking and consumer financial services for our customers, who typically are individuals and small- to medium-sized businesses in our market areas. We accept deposits and originate a variety of loans including commercial loans, trade finance, Small Business Administration (SBA) loans, automobile and various consumer loans. To better meet our customers’ needs, our mini-market branches generally offer extended hours from 9 a.m. to 6 p.m. Each of our branches, except for the Wilshire and Downtown Offices, operates 24-hour automated teller machines. We provide courier services to qualifying clients and have personal banking officers for our key customers to better support their banking needs. We honor merchant drafts for both VISA and MasterCard and provide debit cards services to our customers. In addition, most of our branches offer travelers’ checks, safe deposit boxes, notary public and other customary bank services. We also offer 24-hour banking by telephone. Our website at www.narabank.com features both English and Korean applications and internet banking services.
A significant amount of our operating income and net income depends on the difference between interest revenue received from interest-earning assets and interest expense paid on interest-bearing liabilities. However, interest rates are highly sensitive to many factors that are beyond our control, such as general economic conditions and the policies of various governmental and regulatory authorities, in particular those of the Federal Reserve Board. Although our business may vary with local and national economic conditions, such variations do not appear to be seasonal in nature.
Lending Activities
Our lending activity is conducted exclusively through Nara Bank. Our net loans, including loans held for sale, totaled approximately $502.1 million as of December 31, 2001, accounting for 81.6% of our total interest-earning assets of $615.5 million. At December 31, 2001, total loans consisted of: commercial loans, including lease and trade financing, of approximately $211.2 million; real estate and construction loans of approximately $251.7 million; consumer loans of approximately $46.6 million; less deferred loan fees of $650,000 and allowance for loan losses of $6.7 million. Loans are carried at face amount, less payments collected, net of deferred loan origination fees, and the allowance for loan losses. Interest on all loans is accrued daily on a simple interest basis. Loans are placed on a non-accrual basis when principal and interest on a loan is past due 90 days or more, unless a loan is both well secured and in process of collection. Once a loan is placed on non-accrual status, accrual of interest is discontinued and previously accrued interest is reversed.
The rates of interest charged on variable rate loans are set at specified increments in relation to our prime lending rate and, accordingly, vary as our prime lending rate varies. A majority of our loans (approximately 81.0% at December 31, 2001) are variable- rate loans. Although most of our variable-rate loans are secured loans, we are permitted with certain exceptions, under applicable law, to make unsecured loans to individual borrowers in aggregate amounts of up to 15% of the sum of our total capital and the allowance for loan losses, as defined for regulatory purposes. As of December 31, 2001, our lending limits were approximately $9.5 million for unsecured loans. For the purpose of lending limits, a secured loan is defined as a loan secured by readily marketable collateral having a current market value of at least 100% of the amount of the loan or extension of credit at all times. In addition to unsecured loans, we are permitted to make collateral-secured loans secured by collaterals in an additional amount up to 10% of our total capital and the allowance for loan losses.
The following table shows the composition of our loan portfolio by type of loan on the dates indicated:
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Commercial Loans
Commercial loans are made primarily for the purposes of providing working capital or financing the purchase of inventory and equipment and for other business purposes. Short term business loans (due within one year), generally are used to finance current transactions and typically provide for periodic interest payments, with principal being payable at maturity. Term loans (5 to 7 years) normally provide for monthly payments of both principal and interest. We review the credit-worthiness of our commercial borrowers on a periodic basis, and most commercial loans are collateralized by inventory, equipment and/or real estate.
We include trade financings within our commercial loan portfolio. We have established a trade finance department to serve international trade customers. This department issues and advises letters of credit for export and import businesses. It also purchases bills from export businesses at discounts and makes loans to international traders. These loans usually are collateralized with inventories and accounts receivables. As of December 31, 2001, outstanding letters of credit, including domestic letters of credit totaled $26 million.
Real Estate Loans
Our real estate loans consist primarily of loans secured by deeds of trust on commercial properties and are normally extended for short durations. It is our policy to restrict real estate loans to 70% of Nara Bank’s appraised value of the property. We offer both fixed and floating rate loans. The maturities on such loans generally are restricted to seven years (on amortizations of up to 25 years with balloon payments due at maturity).
Small Business Administration Loans
Our Small Business Administration (SBA) loans typically are made for the purpose of providing working capital, financing the purchase of equipment or inventory, financing the purchase of a business, debt refinancing, or financing the purchase or construction of owner occupied commercial property. SBA loans typically are term loans with maturities ranging from 7 to 10 years. SBA real estate loans generally are 25 years term loans with full amortization. SBA loans normally provide for floating interest rates, with monthly payments of both principal and interest.
Our SBA lending represents an important segment of our loan portfolio because of our ability to sell the guaranteed portion in the secondary market at a premium, while earning servicing fees on the sold portion over the remaining life of the loan. Thus, in addition to the yield earned on the portion of the SBA loans that we retained, we recognize income from the gains on the sales and from loan servicing on the SBA loans sold into the secondary market.
We established a separate SBA loan department to expedite our services related to SBA loans. The SBA loan department is staffed by loan officers who provide assistance to qualified individuals and existing businesses. We attained SBA Preferred Lenders status in the Los Angeles and Santa Ana districts on January 16, 1997. SBA Preferred Lender status is the highest designation awarded by the SBA and generally facilitates the marketing and approval process for new SBA loans. On February 24, 1999, we attained Preferred Lender status in the New York,
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Chicago, San Francisco, Seattle, and Spokane districts. On April 20, 2001, we also received Preferred Lender status in New Jersey, Baltimore, Washington D.C., and Atlanta.
Consumer Loans
Most of our consumer loan portfolio consists of automobile loans. Nara Bank began originating automobile loans in early 1995. Referrals from automobile dealers comprise the majority of originations of such loans. We also offer fixed-rate loans to buyers of new and previously owned automobiles who are not qualified for automobile dealers’ most preferential loan rates. During 2001, these loans increased to $35.3 million from $33.9 million at December 31, 2000 and $25.9 million at December 31, 1999.
Lines of Credit
We extend lines of credit to business customers usually on an annual review basis. Our undisbursed commercial loan commitments at December 31, 2001, 2000 and 1999 were $146.2 million, $87.9 million and $56.3 million, respectively. The following table shows our loan commitments and letters of credit outstanding at the dates indicated:
Concentrations
Loan concentrations are considered to exist when there are significant amounts of loans to a multiple number of borrowers engaged in similar activities, which would cause them to be similarly impacted by economic or other conditions. The following table describes the industry concentrations in Nara Bank’s loan portfolio, which exceeded 10% of Nara Bank’s total gross loans, including loans held for sale, as of the dates indicated:
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Other Real Estate Owned
Assets classified as other real estate owned (“OREO”) include foreclosed real estate owned by us . We had no OREO as of December 31, 2001. We owned other real estate, taken through foreclosure, in the aggregate amount of approximately $300,000 and $57,000 at December 31, 2000, and 1999, respectively. We reserved $37,000 and $13,000 at December 31, 2000 and 1999, respectively, as a valuation allowance. We incurred no OREO expense through OREO transaction in 2001. We incurred expenses of $90,748 and $16,628 and earned income of $2,893 and $906 from these properties in 2001 and 1999, respectively. The following table summarizes our OREO at the dates indicated:
Investing Activities
The main objectives of our investment strategy are to support a sufficient level of liquidity while providing a means to manage our interest rate risk, and to generate an adequate level of interest income without taking undue risks. Our investment policy permits investment in various types of securities, certificates of deposits and federal funds sold in compliance with various restrictions in the policy. Securities are classified as held-to-maturity or available-for-sale. The securities that we have the ability and intent to hold to maturity are classified as held-to-maturity securities. All other securities are classified as available-for-sale. There were no trading securities at December 31, 2001 or 2000. As of December 31, 2001, held-to-maturity securities totaled $4.3 million, compared to $15.7 million at December 31, 2000, and available-for-sale securities totaled $65.1 million at December 31, 2001, compared to $54.9 million at December 31, 2000. The decrease in held-to-maturity securities is primarily due to called agency bonds during 2001 as a result of decreases in interest rates. During 2001, a total of $36.7 million in agency securities were called and a total of $51.8 million in securities available-for-sale were purchased. From the investment portfolio, securities with amortized cost of approximately $2.5 million and $4.2 million were pledged to Federal Reserve Board as required or permitted by law at December 31, 2001 and 2000, respectively. The investment portfolio consists of government sponsored agency bonds, mortgage backed securities, bank-qualified California municipals, and corporate bonds. This investment portfolio composition reflects our investment strategy.
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The following table summarizes the maturity of securities and their pertinent weighted average yield ratios at the dates and for the periods indicated:
Deposit Activities
We attract both short-term and long-term deposits from the general public by offering a wide range of deposit products and services. Through our branch network, we provide our banking customers with money market accounts, savings and checking accounts, certificate of deposit, individual retirement accounts, business checking accounts, 24-hour automated teller machines, and internet banking and bill-pay services.
Our primary source of funds is FDIC-insured deposits. We try to match our interest-bearing liabilities with our interest-earning assets. We cover all volatile funds with liquid assets as a method to ensure adequate liquidity. Thus, we analyze our deposits’ maturities and interest rates to monitor and control the cost of funds and review the stability of the supply of funds. We believe our deposits are a stable and reliable funding source.
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When we have more funds than required for our reserve requirements or short-term liquidity needs, we sell federal funds to other financial institutions. Conversely, when we have less funds than required, we may borrow funds from both our corresponding banks and the Federal Reserve Bank, also known as the FRB. The maximum amount that we currently are authorized to borrow from our correspondent banks is $13 million on an overnight basis. The maximum amount that we may borrow from the FRB discount window is 97% of the market value of the pledged security with the FRB, which amount was $1.0 million at December 31, 2001.
The following table sets forth information for the periods indicated regarding the balances of our deposits by category.
Borrowing Activities
On September 31, 1999, we issued five-year subordinated capital notes in the aggregate amount of $4.3 million with a stated interest rate of 9 percent, maturing on September 30, 2004. Interest on the notes is payable quarterly and no scheduled payments of principal are due prior to maturity. We may redeem the notes prior to their maturity as of, or after, September 30, 2002. The notes qualify as Tier 2 risk-based capital under the Office of the Comptroller of the Currency guidelines for assessing regulatory capital. For the total risk-based capital ratio, the amount of notes that qualify as capital is reduced as those notes approach maturity. At December 31, 2001, $1.7 million, which represents 40% of the total outstanding amount of the notes, qualified as risk-based capital.
During 2000, we established a lending line with the FHLB of San Francisco. Advances may be obtained from the FHLB of San Francisco to supplement our supply of lendable funds. Advances from the FHLB of San Francisco typically are secured by a pledge of mortgage loans and/or qualified securities, with a market value at least equal to outstanding advances. At December 31, 2001, we had a $5.0 million advance outstanding, collateralized with securities pledged by Nara Bank. The borrowing has a seven-year, fixed-rate term.
On March 28, 2001, through our subsidiary, Nara Capital Trust I, we completed a private placement of $10 million of trust preferred securities, issued as part of a pooled offering with several other financial institutions.
The trust preferred securities bear a 10.18% fixed rate of interest payable semi-annually and maturing June 8, 2031. Nara Capital used the proceeds from the sale of the trust preferred securities to purchase junior subordinated deferrable interest debentures issued by Nara Bancorp. The net proceeds from the trust preferred securities will be used to accommodate stock repurchase program that was approved by the Board of Directors as described in “Recent Developments” section of this report. Pending deployment of the funds for the repurchase program, we have invested the proceeds in federal fund overnight accounts. Under applicable regulatory guidelines, the trust preferred securities qualify as Tier I Capital.
Competition
The banking and financial services industry generally, and in our market areas specifically, including California and New York City, is highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. We compete for loans, deposits, and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other non-bank financial service providers. Many of these competitors are much larger in total assets and capitalization, have greater access to
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capital markets and offer a broader range of financial services than we do. In addition, recent federal legislation may have the effect of further increasing the pace of consolidation within the financial services industry. See “Item 1. Business — Supervision and Regulation — Financial Services Modernization Legislation.”
Economic Conditions, Government Policies and Legislation
Our profitability, like most financial institutions, primarily depends on interest rate differentials. In general, the difference between the interest rates paid on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received on our interest-earning assets, such as loans extended to our clients and securities held in our investment portfolio, comprise the major portion of our earnings. These rates are highly sensitive to many factors that are beyond our control, such as inflation, recession and unemployment. The impact that future changes in domestic and foreign economic conditions might have on our performance cannot be predicted.
Our business also is influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System (the “FRB”). The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) through its open-market operations in U.S. Government securities by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments, and deposits and also affect interest rates earned on interest-earning assets and paid on interest-bearing liabilities. The nature and impact on Nara Bancorp and Nara Bank any of our future changes in monetary and fiscal policies cannot be predicted.
From time to time, legislation, as well as regulations, 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 services providers. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies, and other financial institutions and financial services providers are frequently made in the U.S. Congress, in the state legislatures, and before various regulatory agencies. This legislation may change banking statutes and the operating environment of Nara Bancorp and its subsidiaries in substantial and unpredictable ways. If enacted, such 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 financial condition or results of operations of us or any of our subsidiaries. See “Item 1. Business - Supervision and Regulation.”
Supervision and Regulation
Bank holding companies and banks are extensively regulated under both federal and state law. This regulation is intended primarily for the protection of depositors and the deposit insurance fund and not for the benefit of our stockholders. Set forth below is a summary description of the material laws and regulations, which relate to our operations. The description is qualified in its entirety by reference to the applicable laws and regulations.
Nara Bancorp
As a registered bank holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHCA”). We are required to file with the FRB periodic reports and such additional information as the FRB may require pursuant to the BHCA. The FRB may conduct examinations of our subsidiaries and us.
The FRB may require that we terminate an activity or terminate control of or liquidate or divest ourselves of certain subsidiaries or affiliates when the FRB believes the activity or the control of the subsidiary or affiliate
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constitutes a significant risk to the financial safety, soundness or stability of any of our banking subsidiaries. The FRB also has the authority to regulate provisions of certain bank holding company debt, including the authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, we must file written notice and obtain approval from the FRB prior to purchasing or redeeming our equity securities.
Further, we are required by the FRB to maintain certain levels of capital. See “Capital Standards.”
We are required to obtain the prior approval of the FRB for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior approval of the FRB is also required if we merge or consolidate with another bank holding company. We are prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to our subsidiaries. However, subject to the prior approval of the FRB, we may engage in any, or acquire shares of companies engaged in, activities that are deemed by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident there to.
Under FRB regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the FRB’s policy that a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB’s regulations or both.
We are also a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, we and our subsidiaries are subject to examination by, and may be required to file reports with, the California Department of Financial Institutions.
Our securities are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As such, we are subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Exchange Act.
Nara Bank, N.A.
Nara Bank, as a national banking association, is subject to primary supervision, examination, and regulation by the Office of the Comptroller of the Currency. To a lesser extent, Nara Bank is also subject to regulations of the Federal Deposit Insurance Corporation as administrator of the Bank Insurance Fund and the FRB. If, as a result of an examination of Nara Bank, the Office of the Comptroller of the Currency should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of Nara Bank’s operations are unsatisfactory or that Nara Bank or its management is violating or has violated any law or regulation, various remedies are available to the Office of the Comptroller of the Currency. 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 Nara Bank, to assess civil monetary penalties, and to remove officers and directors. The Federal Deposit Insurance Corporation has similar enforcement authority, in addition to its authority to terminate Nara Bank’s deposit insurance in the absence of action by the Office of the Comptroller of the Currency and upon a finding that Nara Bank is in an unsafe or unsound condition, is engaging in unsafe or unsound activities, or that its conduct poses a risk to the deposit insurance fund or may prejudice the interest of its depositors.
Various requirements and restrictions under the laws of the United States and the State of California affect the operations of Nara Bank. Federal and California statutes and regulations relate to many aspects of Nara Bank’s operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices and new products
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and services. Further, Nara Bank is also required to maintain certain minimum levels of capital. See “Capital Standards.”
During 2001, Nara Bank and its board of directors negotiated and on, February 20, 2002,they signed a Stipulation and Consent to the Issuance of a Consent Order (the “Consent Order”) with the Office of the Comptroller of the Currency (the “OCC”) pursuant to 12 U.S.C. 1818. Nara Bank, without admitting to any allegations, entered into the Consent Order in connection with alleged deficiencies relating to the lack of sufficient internal controls, procedures and inadequate compliance with the Bank Secrecy Act. Management is taking all necessary steps to comply with the Consent Order and the Bank Secrecy Act, including, but not limited to, the implementation of new IT systems and the expansion of the employee training program.
The Consent Order requires, among other matters, that Nara Bank:
If we fail to comply with the terms of the Consent Order, the OCC could:
In addition, if we violate the Consent Order, the FDIC may initiate a termination of insurance proceeding against us. If any of these penalties or actions were to occur, they would materially and adversely affect our business and operations.
USA Patriot Act of 2001
On October 26, 2001, President Bush signed the USA Patriot Act of 2001 (the “Patriot Act”). Enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. on September 11, 2001, the Patriot Act is intended to strengthen U.S law enforcement’s and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including:
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We are not able to predict the impact such law will have on our financial condition or results of operations at this time.
Financial Services Modernization Legislation
General. On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 also referred to as the FSMA. The FSMA repeals the two affiliation provisions of the Glass-Steagall Act: Section 20, which restricted the affiliation of Federal Reserve Member Banks with firms “engaged principally” in specified securities activities; and Section 32, which restricts officer, director, or employee interlocks between a member bank and any company or person “primarily engaged” in specified securities activities. In addition, the FSMA also contains provisions that expressly preempt any state law restricting the establishment of financial affiliations, primarily related to insurance. The general effect of the law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework to permit a holding company system to engage in a full range of financial activities through a new entity known as a financial holding company.
The law also:
We do not believe that the FSMA will have a material adverse effect on operations in the near-term. However, to the extent that it permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. The FSMA is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that we face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than we do.
Financial Holding Companies. Bank holding companies that elect to become a financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or are incidental or complementary to activities that are financial in nature. “Financial in nature” activities include:
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Prior to filing a declaration of its election to become a financial holding company, all of the bank holding company’s depository institution subsidiaries must be well capitalized, well managed, and, except in limited circumstances, in compliance with the Community Reinvestment Act.
Failure to comply with the financial holding company requirements could lead to divestiture of subsidiary banks or require all activities of such company to conform to those permissible for a bank holding company. No FRB approval is required for a financial holding company to acquire a company (other than a bank holding company, bank or savings association) engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the FRB:
A bank holding company that is not also a financial holding company can only engage in banking and such other activities determined by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
We are not currently a Financial Holding Company. Management has not determined at this time whether it will seek an election to become a Financial Holding Company.
Merchant Banking Restrictions. While the BHCA generally prohibits bank holding companies from owning more than 5 percent of the voting stock of non-financial companies, with limited exceptions, the FSMA authorizes merchant banking activities. Permissible merchant banking investments are defined as investments that meet two important requirements:
In addition, there are limits on bank funding of portfolio companies owned by the bank’s parent holding company, transactions between the bank and portfolio companies and on cross-marketing activities between banks and portfolio companies owned by the same financial holding company. However, current rules do not prevent a depository institution from marketing the shares of private equity funds controlled by an affiliated financial holding company, and does not apply to situations in which the financial holding company owns less than 5 percent of the voting shares of the portfolio company.
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Furthermore, in December 2001, federal regulators adopted new capital requirements for merchant banking activities. The rule employs a sliding scale based on each banking organization’s aggregate equity investments in non-financial entities and Tier 1 capital, requiring banks or holding companies to hold regulatory capital equal to:
The first 15% of investments that banking companies make through small-business investment companies, also known as SBICs, is exempt, however, the sliding scale applies for any such investments over 15%.
Expanded Bank Activities. The FSMA also permits national banks to engage in expanded activities through the formation of financial subsidiaries. A national bank may have a subsidiary engaged in any activity authorized for national banks directly or any financial activity, except for insurance underwriting, insurance investments, real estate investment or development, or merchant banking, which may only be conducted through a subsidiary of a financial holding company. Financial activities include all activities permitted under new sections of the BHCA or permitted by regulation.
A national bank seeking to have a financial subsidiary, and each of its depository institution affiliates, must be “well-capitalized,” “well-managed” and in compliance with the Community Reinvestment Act. The total assets of all financial subsidiaries may not exceed the lesser of 45% of a bank’s total assets, or $50 billion. A national bank must exclude from its assets and equity all equity investments, including retained earnings, in a financial subsidiary. The assets of the subsidiary may not be consolidated with the bank’s assets. The bank must also have policies and procedures to assess financial subsidiary risk and protect the bank from such risks and potential liabilities.
Privacy. Under the FSMA, federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. Pursuant to these rules, effective July 1, 2001, financial institutions must provide:
These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. It is not possible at this time to assess the impact of the privacy provisions on our financial condition or results of operations.
Dividends and Other Transfers of Funds
Dividends from Nara Bank constitute the principal source of income to Nara Bancorp. Nara Bancorp is a legal entity separate and distinct from Nara Bank. Nara Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends to Nara Bancorp. Under such restrictions, the amount available for payment of dividends to Nara Bancorp by Nara Bank totaled $12 million at December 31, 2001. In addition, the California Department of Financial Institutions and the FRB have the authority to prohibit Nara Bank from paying dividends, depending upon Nara Bank’s financial condition, if such payment is deemed to constitute an unsafe or unsound practice.
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Transactions with Affiliates
Nara Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, Nara Bancorp or other affiliates, the purchase of, or investments in, stock or other securities thereof, the taking of such securities as collateral for loans, and the purchase of assets of Nara Bancorp or other affiliates. Such restrictions prevent Nara Bancorp and such other affiliates from borrowing from Nara Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by Nara Bank to or in Nara Bancorp or to or in any other affiliate are limited, individually, to 10.0% of Nara Bank’s capital and surplus (as defined by federal regulations), and such secured loans and investments are limited, in the aggregate, to 20.0% of Nara Bank’s capital and surplus (as defined by federal regulations). California law also imposes certain restrictions with respect to transactions involving Nara Bancorp and other controlling persons of Nara Bank. Additional restrictions on transactions with affiliates may be imposed on Nara Bank under the prompt corrective action provisions of federal law. See “Item 1. Business — Supervision and Regulation — Prompt Corrective Action and Other Enforcement Mechanisms.”
Capital Standards
The federal banking agencies have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk federal banking agencies, to 100% for assets with relatively high credit risk.
The guidelines require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 4%. 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.
The following table presents the amounts of regulatory capital and the capital ratios for Nara Bank, compared to its minimum regulatory capital requirements as of December 31, 2001.
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In addition, federal banking regulators may set capital requirements higher than the minimums described above for financial institutions whose circumstances warrant it. For example, a financial institution experiencing or anticipating significant growth may be expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets.
Predatory Lending
The term “predatory lending,” much like the terms “safety and soundness” and “unfair and deceptive practices,” is far-reaching and covers a potentially broad range of behavior. As such, it does not lend itself to a concise or a comprehensive definition. But typically predatory lending involves at least one, and perhaps all three, of the following elements:
On December 14, 2001, FRB amended its regulations aimed at curbing such lending. Compliance is not mandatory until October 1, 2002. The rule significantly widens the pool of high-cost home-secured loans covered by the Home Ownership and Equity Protection Act of 1994, a federal law that requires extra disclosures and consumer protections to borrowers. The following triggers coverage under the act:
In addition, the regulation bars loan flipping by the same lender or loan servicer within a year. Lenders also will be presumed to have violated the law — which says loans shouldn’t be made to people unable to repay them — unless they document that the borrower has the ability to repay. Lenders that violate the rules face cancellation of loans and penalties equal to the finance charges paid.
We are unable at this time to determine the impact of these rule changes and potential state action in this area on our financial condition or results of operation.
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Prompt Corrective Action and Other Enforcement Mechanisms
Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios. Each federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At December 31, 2001, Nara Bank and Nara Bancorp exceeded the required ratios for classification as “well capitalized.”
An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment.
In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators 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. Finally, pursuant to an interagency agreement, the FDIC can examine any institution that has a substandard regulatory examination score or is considered undercapitalized — without the express permission of the institution’s primary regulator.
Safety and Soundness Standards
The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset growth, (v) earnings, and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution should: (i) conduct periodic asset quality reviews to identify problem assets, (ii) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses, (iii) compare problem asset totals to capital, (iv) take appropriate corrective action to resolve problem assets, (v) consider the size and potential risks of material asset concentrations, and (vi) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk. These new guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves.
Premiums for Deposit Insurance
Through the Bank Insurance Fund (BIF), the FDIC insures the deposits of Nara Bank up to prescribed limits for each depositor. The amount of FDIC assessments paid by each BIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based on the institution’s capitalization risk category and supervisory subgroup category. An institution’s capitalization risk category is based on the FDIC’s determination of whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. An institution’s supervisory subgroup category is based on the FDIC’s assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required.
FDIC-insured depository institutions pay an assessment rate equal to the rate assessed on deposits insured by the Savings Association Insurance Fund (“SAIF”).
The assessment rate currently ranges from zero to 27 cents per $100 of domestic deposits. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis. An increase in the assessment rate could
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have a material adverse effect on our earnings, depending on the amount of the increase. The FDIC is authorized to terminate a depository institution’s deposit insurance upon a finding by the FDIC that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency. The termination of deposit insurance for Nara Bank could have a material adverse effect on our earnings, depending on the collective size of the particular institutions involved.
All FDIC-insured depository institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds, commonly referred to as FICO bonds, were issued to capitalize the Federal Savings and Loan Insurance Corporation. The FDIC established the FICO assessment rates effective for the fourth quarter of 2001 at approximately $0.0184 per $100 of assessable deposits. The FICO assessments are adjusted quarterly to reflect changes in the assessment bases of the FDIC’s insurance funds and do not vary depending on a depository institution’s capitalization or supervisory evaluations.
Interstate Banking and Branching
The BHCA permits bank holding companies from any state to acquire banks and bank holding companies located in any other state, subject to certain conditions, including certain nationwide and state imposed concentration limits. The establishment of new interstate branches is also possible in those states with laws that expressly permit it. Interstate branches are subject to certain laws of the states in which they are located. Competition may increase further as banks branch across state lines and enter new markets.
Community Reinvestment Act and Fair Lending Developments
We are subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low- and moderate-income neighborhoods. A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws. The federal banking agencies may take compliance with such laws and CRA obligations into account when regulating and supervising other activities. Furthermore, financial institutions are subject to annual reporting and public disclosure requirements for certain written agreements that are entered into between insured depository institutions or their affiliates and nongovernmental entities or persons that are made pursuant to, or in connection with, the fulfillment of the CRA.
A bank’s compliance with its CRA obligations is based a performance-based evaluation system, which bases CRA ratings on an institution’s lending service and investment performance. When a bank holding company applies for approval to acquire a bank or other bank holding company, the FRB will review the assessment of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application.
Federal Reserve System
The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW, and Super NOW checking accounts) and non-personal time deposits. At December 31, 2001, Nara Bank was in compliance with these requirements.
Employees
As of December 31, 2001, we had 264 full-time equivalent employees. Our employees are not represented by a union or covered by a collective bargaining agreement. We have entered into a written employment agreement with Benjamin B. Hong, President and Chief Executive Officer. Management believes that its relations with its employees are good. See Item 4(a) below for a list of executive officers.
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Factors That May Impact Our Business or the Value of Our Stock
Set forth below are certain factors that may affect our financial results and operations, which you should consider when evaluating our business and prospects.
Failure to comply with our Consent Order with the Office of the Comptroller of the Currency written agreement could adversely affect our business.
If we fail to comply with the terms of the Consent Order, OCC could:
Deterioration of economic conditions in Southern California, New York or Korea could adversely affect our loan portfolio and reduce the demand for our services. We focus our business primarily in Korean communities in Southern California and in the greater New York City metropolitan area. A deterioration in economic conditions in our market areas could have a material adverse impact on the quality of our business. An economic slowdown in California or New York could have the following consequences, any of which could reduce our net income:
Loan loss reserves may not cover actual loan losses. If our actual loan losses exceed the amount we have reserved for probable losses, it will hurt our business. We try to limit the risk that borrowers will fail to repay loans by carefully underwriting the loans. Losses nevertheless occur. We create reserves for estimated loan losses in our accounting records. We base these allowances on estimates of the following:
A downturn in the real estate market could seriously impair our loan portfolio.As of December 31, 2001, approximately 48% of the value of our loan portfolio consisted of loans secured by various types of real estate. If
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real estate values decline significantly, especially in California or New York, higher vacancies and other factors could harm the financial condition of our borrowers, the collateral for our loans will provide less security, and we would be more likely to suffer losses on defaulted loans.
Changes in interest rates affect our profitability. Changes in prevailing interest rates may hurt our business. We derive our income mainly from the difference or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. In general, the wider the spread, the more we earn. When market rates of interest change, the interest we receive on our assets and the interest we pay on our liabilities will fluctuate. This can cause decreases on our spread and can greatly affect our income. In addition, interest rate fluctuation can affect how much money we may be able to lend. For example, when interest rates rise, loan originations tend to decrease.
If we lose key employees, our business may suffer. If we lost key employees temporarily or permanently, it could hurt our business. We could be particularly hurt if our key employees went to work for competitors. Our future success depends on the continued contributions of existing senior management personnel.
Environmental laws could force us to pay for environmental problems. The cost of cleaning up or paying damages and penalties associated with environmental problems could increase our operating expenses. When a borrower defaults on a loan secured by real property, we often purchase the property in foreclosure or accept a deed to the property surrendered by the borrower. We may also take over the management of commercial properties whose owners have defaulted on loans. We also lease premises where our branches and other facilities are located and where environmental problems may exist. Although we have lending, foreclosure and facilities guidelines intended to exclude properties with an unreasonable risk of contamination, hazardous substances may exist on some of the properties that we own, lease, manage or occupy. We may face the risk that environmental laws could force us to clean up the properties at our expense. It may cost much more to clean a property than the property is worth. We also could be liable for pollution generated by a borrower’s operations if we take a role in managing those operations after a default. We may find it difficult or impossible to sell contaminated properties.
We are exposed to the risks of natural disasters. A significant portion of our operations is concentrated in Southern California. California is in an earthquake-prone region. A major earthquake could result in material loss to us. A significant percentage of our loans are and will be secured by real estate. Many of our borrowers could suffer uninsured property damage, experience interruption of their businesses or lose their jobs after an earthquake. Those borrowers might not be able to repay their loans, and the collateral for such loans could decline significantly in value. Unlike a bank with operations that are more geographically diversified, we are vulnerable to greater losses if an earthquake, fire, flood or other natural catastrophe occurs in Southern California.
An increase in non-performing assets would reduce our income and increase our expenses. If the level of non-performing assets rises in the future, it could adversely affect our operating results. Non-performing assets are mainly loans on which the borrowers are not making their required payments. Non-performing assets also include loans that have been restructured to permit the borrower to have smaller payments and real estate that has been acquired through foreclosure of unpaid loans. To the extent that assets are non-performing, we have less cash available for lending and other activities.
Governmental regulation may impair our operations or restrict our growth. We are subject to significant governmental supervision and regulation. These regulations are intended primarily for the protection of depositors. Statutes and regulations affecting our business may be changed at any time, and the interpretation of these statutes and regulations by examining authorities may also change. Within the last several years Congress and the President have passed and enacted significant changes to these statutes and regulations. There can be no assurance that such changes to the statutes and regulations or in their interpretation will not adversely affect our business. Nara Bank is subject to regulation and examination by the Comptroller of the Currency. In addition to governmental supervision and regulation, Nara Bank is subject to changes in other federal and state laws, including changes in tax laws, which could materially affect the banking industry. Nara Bancorp is subject to the rules and regulations of the Federal Reserve Board. If we fail to comply with federal and state bank regulations, the regulators may limit our activities or growth, fine us or ultimately put us out of business. Banking laws and regulations change from time to time. Bank regulations can hinder our ability to compete with financial services companies that are not regulated or are less regulated.
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Federal and state bank regulatory agencies regulate many aspects of our operations. These areas include:
Our stock price may be volatile, which could result in substantial losses for our stockholders. The market price of our common stock could be subject to wide fluctuations in response to a number of factors, including:
Future offerings of debt securities, which would be senior to our common stock upon liquidation, or equity securities, which would dilute our existing stockholders and may be senior to our common stock for the purposes of dividend distributions, may adversely affect the market price of our common stock. In the future, we may attempt to increase our capital resources by making additional offerings of debt or equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings by us may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Our preferred stock, if issued, would have a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock or diluting their stock holdings in us.
Accounting Matters
Statement of Financial Accounting Standards (“SFAS”) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125, was issued in September 2000 and revises the standards for accounting for securitizations and other transfers of financial assets
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and collateral and requires certain disclosures, but it carries over most of the provisions of SFAS No. 125 without reconsideration. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The statement is effective for recognition and reclassification of collateral and for disclosures related to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of SFAS No. 140 did not have a material impact on our results of operations, financial position or cash flows.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations completed after June 30, 2001 and also specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill and those acquired intangible assets that are required to be included in goodwill. SFAS No. 142 will require that goodwill no longer be amortized, but instead tested for impairment at least annually. Additionally, SFAS No. 142 will require recognized intangible assets be amortized over their respective estimated useful lives and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, as replaced by SFAS No. 144. Any recognized intangible asset determined to have an indefinite useful life will not be amortized, but instead tested for impairment until its life is determined to no longer be indefinite. We adopted the provisions of SFAS No. 141 and SFAS No. 142 on January 1, 2002. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized until December 31, 2001.
During the first quarter of fiscal year 2002, we will evaluate our existing intangible assets and goodwill and make any necessary reclassifications in order to conform with the new requirements in accordance with SFAS No. 141. Upon the adoption of SFAS No. 142, we will be required to reassess the useful lives and residual values of all intangible assets and make any necessary amortization period adjustments by March 31, 2002. Although we have commenced our evaluation, no final conclusion has been reached.
Furthermore, in connection with the transitional impairment evaluation, SFAS No. 142 will require us to perform an assessment of whether there is an indication that goodwill is impaired as of January 1, 2002. The transitional assessment, which is required to be completed by June 30, 2002, will consist of (1) identify our reporting units, (2) determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets to those reporting units, and (3) determine the fair value of each reporting unit. If the carrying value of any reporting unit exceeds its fair value, then detailed fair values for each of the assigned assets (excluding goodwill) and liabilities will be determined to calculate the amount of goodwill impairment, if any. Such impairment evaluation is to be completed as soon as possible, but no later than December 31, 2002. Any transitional impairment loss resulting from the adoption will be recognized as the effect of a change in accounting principle in our consolidated statement of income. We are evaluating the impact of the adoption of these standards and have not yet fully determined the effect of adoption on our financial position, results of operations and cash flows.
We also carry negative goodwill, the amount of the fair values of assets acquired and liabilities assumed exceeds the cost of an acquired company, of $4,192,334 at December 31, 2001. In accordance with SFAS No. 142, such amount will be recognized in our consolidated statement of income as the cumulative effect of a change in accounting principle on January 1, 2002.
SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets, replaces SFAS No. 121. SFAS No. 144 requires that long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. It also expands the reporting of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. The adoption of this statement is not expected to have a material impact on our financial position, results of operations or cash flows.
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Item 2. PROPERTIES
Our principal executive offices are located at 3701 Wilshire Blvd., Los Angeles, California 90010. We conduct our operations through fourteen branch offices and four loan production offices located throughout California, in the greater New York City metropolitan area and in Chicago, Seattle, New Jersey, and Atlanta. We lease all of our offices. The leases expire under various dates, including options to renew, through January 31, 2041. We believe our present facilities are adequate for our present needs, We also believe that, if necessary, we could secure suitable alternative facilities or similar terms, without adversely impacting operations.
Item 3. LEGAL PROCEEDINGS
We are a party to routine litigation incidental to our business, none of which is considered likely to have a material adverse effect on us.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of our security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended December 31, 2001.
Item 4(a). EXECUTIVE OFFICERS OF THE REGISTRANT
The following individuals are executive officers of Nara Bancorp. Pertinent information relating to these individuals is set forth below. There are no family relationships between any of the officers.
Benjamin B. Hong- Chief Executive Officer and President — Age 69
Mr. Hong has served as President and Chief Executive Officer of Nara Bank since 1994 and as President and Chief Executive Officer of Nara Bancorp since February 2001. Mr. Hong previously served as President and Chief Executive Officer of Hanmi Bank from 1988 to 1994.
Bon T. Goo- Executive Vice President and Chief Financial Officer — Age 52
Mr. Goo has served as Executive Vice President and Chief Financial Officer of Nara Bank since 1990 and as Executive Vice President and Chief Financial Officer of Nara Bancorp since February 2001. Mr. Goo previously served as Vice President and Manager of the Accounting, Investment and Control Division of Hanmi Bank from 1988 to 1990.
Min Jung Kim- Executive Vice President and Chief Credit Officer — Age 42
Ms. Kim has served as Executive Vice President and Chief Credit Officer of Nara Bank since 1995 and as Executive Vice President and Chief Credit Officer of Nara Bancorp since February 2001. Ms. Kim served as Vice President and Manager of the Western Branch of Hanmi Bank from 1992 to 1995.
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Part II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock, par value $0.001 per share, began trading on the Nasdaq National Market on February 5, 2001 under the symbol “NARA.” The common stock of Nara Bank, par value $3.00 per share, also was traded on the Nasdaq National Market under the symbol “NARA” through February 2, 2001, which was Nara Bank’s last trading day.
There were 3,145,484 shares of common stock held by approximately 1,126 beneficial owners as of March 22, 2002. The following table sets forth, for the calendar quarters indicated, the range of high and low sales prices for the common stock of Nara Bancorp and Nara Bank, as applicable, for each quarter within the last two fiscal years. Sales prices represent actual sales of which our management has knowledge.
On March 21, 2001, we declared a $0.15 per share cash dividend payable on May 1, 2001 to shareholders of record at the close of business on April 24, 2001. Future dividends are subject to the discretion of our Board of Directors and will depend upon a number of factors, including future earnings, financial condition, cash needs and general business conditions. Any dividend must comply with applicable bank regulations.
Our ability to pay dividends is subject to restrictions set forth in the Delaware General Corporation Law. The Delaware General Corporation Law provides that a Delaware corporation may pay dividends either (i) out of the corporation’s surplus (as defined by Delaware law), or (ii) if there is no surplus, out of the corporation’s net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Under California law, a corporation is prohibited from paying dividends unless (i) the retained earnings of the corporation immediately prior to the distribution exceed the amount of the distribution, (ii) the assets of the corporation exceed 1-1/4 times its liabilities, or (iii) the current assets of the corporation exceed its current liabilities, but if the average pre-tax net earnings of the corporation before interest expense for the two years preceding the distribution was less than the average interest expense of the corporation for those years, the current assets of the corporation must exceed 1-1/4 times its current liabilities.
Our ability to pay cash dividends in the future will depend in large part on the ability of Nara Bank to pay dividends on its capital stock to us. The ability of Nara Bank to pay dividends to us is subject to restrictions set
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forth in the National Bank Act and the rules of the Office of Comptroller of the Currency. Pursuant to such regulations, among other restrictions, Nara Bank cannot pay dividends out of its capital; all dividends must be paid out of net profits then on hand, after deducting for expenses such as losses and bad debts. In addition, the payment of dividends out of net profits of a national bank is further limited by a statute which prohibits a bank from declaring a dividend on its shares of common stock until the surplus fund equals the amount of capital stock, or if the surplus fund does not equal the amount of capital stock, until not less than one-tenth of its net profits for the preceding half-year (in the case of quarterly dividends) or at least one-tenth of its net profits for the preceding year (in case of annual dividends) are transferred to the surplus fund.
On March 28, 2001, we completed a private placement offering of $10 million trust preferred securities, issued as part of a pooled offering with several other financial institutions. Sandler O’Neill & Partners, L.P. and Barclay’s Capital acted as underwriters for the offering and the trust preferred securities were sold by the underwriters to MMCapS Funding I, Ltd., a Cayman Islands limited liability company established to acquire the trust preferred securities issued by us and by 25 other trust subsidiaries of bank holding companies.
Our trust preferred securities bear a 10.18% fixed rate of interest, payable semi-annually. The trust preferred securities were issued by our subsidiary, Nara Bancorp Capital Trust I, a Delaware statutory business trust. Nara Bancorp Capital Trust I used the proceeds from the sale of the trust preferred securities to purchase junior subordinated deferrable interest debentures issued by us.
The sale of the trust preferred securities was considered to be exempt from registration under the Securities Act of 1933, as amended, in reliance on Section 4(2) of such Act. The sale was made to one institutional, accredited investor and therefor would not be a transaction involving a public offering of our securities.
Holders of the Capital Securities are entitled to receive cumulative cash distributions, accumulating from March 28, 2001, the date of original issuance, and payable semi-annually in arrears on June 8 and December 8 of each year, commencing June 8, 2001, at an annual rate of 10.18% of the liquidation amount of $1,000 per Trust Security. We have the right under certain circumstances to defer payments of interest on the Junior Subordinated Debentures at any time and from time to time for a period not exceeding 10 consecutive semi-annual periods with respect to each deferral period, provided that no deferral period may end on a day other than an interest payment date or extend beyond the stated maturity date of the Junior Subordinated Debentures. If and for so long as interest payments on the Junior Subordinated Debentures are so deferred, cash distributions on the Trust Securities will also be deferred and we will not be permitted, subject to certain exceptions, to declare or pay any cash distributions with respect to our capital stock (which includes common and preferred stock) or to make any payment with respect to our debt securities that rank equal with or junior to the Junior Subordinated Debentures.
Upon the repayment on June 8, 2031, the stated maturity date, or prepayment prior to this date of the Junior Subordinated Debentures, the proceeds from such repayment or prepayment shall be applied to redeem the Trust Securities upon not less than 30 nor more than 60 days notice of a date of redemption at the applicable redemption price. At maturity, the redemption price shall equal the principal of and accrued and unpaid interest on the Junior Subordinated Debentures. The Junior Subordinated Debentures will be prepayable prior to the maturity date either through special event or at the option. Special event, as defined in the indenture, redemption price is 106.09% of the principal payable in whole. Optional prepayment on or after June 8, 2011, in whole or in part, price is equal to 105.09% of the principal amount thereof on the prepayment date, declining ratably on each June 8 thereafter to 100% on or after June 8, 2021, plus accrued and unpaid interest thereon to the date of prepayment.
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Item 6. SELECTED FINANCIAL DATA
The following table presents selected financial and other data of Nara Bancorp and prior to the February 2001 reorganization, financial and other data of Nara Bank, for each of the years in the five-year period ended December 31, 2001. The information below should be read in conjunction with, and is qualified in its entirety by, the more detailed information included elsewhere herein including our Audited Consolidated Financial Statements and Notes thereto.
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Accounting for the allowance for loan losses involves significant judgments and assumptions by management which have a material impact on the carrying value of net loans. Management considers this accounting policy to be a critical accounting policy. The judgments and assumptions used by management are based on historical data and management’s view of the current economic environment as described in “Allowance for Loan and Lease Losses and Methodology”.
We generally cease to accrue interest on any loan with respect to which the loan’s contractual payments are more than 90 days delinquent, as well as loans classified substandard for which interest payment reserves were established from loan funds rather than borrower funds. In addition, interest is not recognized on any loan for which management has determined that collection of our investment in the loan is not reasonably assured. A nonaccrual loan may be restored to accrual status when delinquent principal and interest payments are brought current, the loan is paying in accordance with its payment terms for a period, minimum six month, and future monthly principal and interest payments are expected to be allocated.
Properties acquired through foreclosure, or deed in lieu of foreclosure, are transferred to the other real estate owned portfolio and carried at the lower of cost or estimated fair value less the estimated costs to sell the property. The fair value of the property is based upon a current appraisal. The difference between the fair value of the real estate collateral and the loan balance at the time of transfer is recorded as a loan charge-off if fair value is lower. Subsequent to foreclosure, management periodically performs valuations and the property is carried at the lower of carrying value or fair value, less costs to sell. The determination of a property’s estimated fair value includes revenues projected to be realized from disposal of the property, construction and renovation costs.
Certain Small Business Administration (“SBA”) loans that we have the intent to sell prior to maturity are designated as held for sale at origination and are recorded at the lower of cost or market value, on an aggregate basis. A valuation allowance is established if the market value of such loans is lower than their cost, and operations are charged or credited for valuation adjustments. A portion of the gains on sale of SBA loans is recognized as other operating income at the time of the sale. The remaining portion of the gain is deferred and amortized over the remaining life of the loan as an adjustment to yield. Upon sales of such loans, a fee is received for servicing the loans. The servicing asset is recorded based on the present value of the contractually specified servicing fee, net of servicing costs over the estimated life of the loan, currently discounted at the rate of the related note plus 1 percent. The servicing asset is amortized in proportion to and over the period of estimated servicing income. Management periodically evaluates the servicing asset for impairment, which is the carrying amount of the servicing asset in excess of the related fair value. Impairment, if it occurs, is recognized in a valuation allowance in the period of impairment.
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Results of Operations
Our most significant source of income is net interest income, which is the difference between our interest income and our interest expense. Generally, interest income is generated from our loans and investments and interest expense is generated from interest-bearing deposits and other borrowings that we may have, such as Federal Home Loan Bank borrowings, our debt securities, and trust preferred securities. Our ability to generate profitable levels of net interest income is largely dependent on our ability to maintain sound asset quality and appropriate levels of capital and liquidity. Interest income and interest expense can fluctuate widely based on changes in the level of interest rates in the economy.
We attempt to minimize the effect of interest rate fluctuations on net interest margin by matching a portion of our interest-sensitive assets against our interest-sensitive liabilities. Net interest income also can be affected by a change in the composition of assets and liabilities, for example, if higher yielding loans were to replace a like amount of lower yielding investment securities. Changes in volume and changes in rates also affect net interest income. Volume changes are caused by differences in the level of interest-earning assets and interest-bearing liabilities. Rate changes result from differences in yields earned on assets and rates paid on liabilities.
We also have other operating income from sources other than interest income. Those sources include service charges and fees on deposit accounts, fees from trade finance activities and the issuance of letters of credit, and net gains on sale of loans and investment securities available for sale. In addition to interest expense, our income is impacted by other operating expenses, such as salaries and benefits, occupancy, furniture and equipment expenses, and provision for loan losses.
Net Income
We reported net income of $10.8 million in 2001, or $1.85 per diluted share, compared with $10.5 million, or $1.98 per diluted share, in 2000, and $4.0 million, or $0.80 per diluted share, in 1999. The annualized return on average assets was 1.70% for 2001 as compared to 2.18% for 2000, and 1.27% for 1999. The annualized return on average equity was 21.38% for 2001 as compared to 30.31% for 2000 and 15.92% for 1999.
During 2001, the increase in net income is largely attributable to continued growth in the loan portfolio despite a decline in net interest margin from series of rate cuts by the Federal Reserve, and an increase in other operating income offset by higher other operating expenses. The increase in net income in 2000 as compared to 1999 was mainly the result of an increase in net interest income from $17.3 million to $27.5 million as discussed below in net interest income section.
The following table summarizes increases and decreases, as applicable, in income and expense for the years indicated.
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Operations Summary
Net Interest Income
We reported net interest income of $30.9 million in 2001, which was an increase of $3.4 million, or 12.4% compared to net interest income of $27.5 million in 2000. Although the average interest-earning assets increased $155.4 million or 37.3% to $572.2 million for 2001 from $416.8 million for 2000, the net interest income only increased 12.5% due to a decrease in interest margin. Net interest margin decreased 120-basis points or 18.2% to 5.4% for 2001 from 6.6% for 2000. This was due to a 475 basis point drop market interest rates during the year 2001.
Interest and fees on loans increased $6.3 million or 18.4% to $40.5 million for 2001, from $34.2 million for 2000. This increase is derived primarily from 45.5% growth in average net loan portfolio. Approximately $10.6 million is attributable to growth in loan volume, and negative $4.4 million is attributable to rate decrease. The average yield earned on net loans decreased to 9.0% in 2001, from 11.1% in 2000. The decrease is primarily due to series of rate cuts made by the Federal Reserve during the year. Interest income on securities and other investments increased $1.3 million or 36.1% to $4.9 million in 2001 from $3.6 million in 2000, mainly due to increase in investment portfolio. Nara Bank’s average yield earned on investment securities slightly decreased to 6.9% in 2001 from 7.0% in 2000. Overall, our yield on average interest-earning assets decreased to 8.4% in 2001 from 10.0% in 2000 primarily due to decrease in interest rates.
Interest paid on deposits increased $1.8 million or 13.1% to $15.5 million in 2001 from $13.7 million in 2000. Of this increase, approximately $3.2 million is attributed to the increase in average interest-bearing deposits of $98.1 million or 36.1% and a negative $1.4 million is attributed to the decrease in interest rates. Our overall cost on average interest-bearing liabilities decreased to 4.4% in 2001 from 5.1% in 2000. This decrease was primarily due to the decrease in rates paid on all interest-bearing deposits, predominantly on time deposits.
We reported net interest income of $27.5 million in 2000 which was an increase of $10.2 million, or 59.0% compared to net interest income of $17.3 million in 1999 Our volume growth in interest-earning assets, especially with the acquisition of KFBNY, was the cause of a 64.4% increase in total interest income to $41.6 million for 2000 from $25.3 million for 1999. Net interest margin improved to 6.6% for 2000 from 6.4% for 1999.
Interest and fees on loans increased $12.9 million or 60.6 % to $34.2 million for 2000, from $21.3 million for 1999. Of this increase, approximately $11.2 million was attributable to volume growth, and $1.7 million was attributable to rate increase. Our average yield earned on net loans slightly increased to 11.1% in 2000, from 10.4% in 1999, due to increases in prime rates that are tied directly to our loan interest rates. Interest income on securities and other investments increased $2.0 million or 125.0% to $3.6 million in 2000, from $1.6 million in 1999, due to an increase in our investment portfolio. Our average yield earned on investment securities remained almost the same
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at 7.0% in 2000, from 7.1% in 1999. Overall, our yield on average interest-earning assets has increased to 10.0% in 2000, from 9.3% in 1999.
Interest paid on deposits increased $5.9 million or 75.6% to $13.7 million in 2000, from $7.8 million in 1999. Of this increase, approximately $4.7 million is attributable to 244.7% average volume increase in interest-bearing deposits and an approximately $1.2 million is attributable to increase in interest rates. Our overall cost on average interest-bearing liabilities increased to 5.1% in 2000, compared to 4.4% in 1999.
Net Yield and Interest Rate Spread
We analyze our earnings performance using, among other measures, the interest rate spread and net yield on interest-earning assets. The interest rate spread represents the difference between the interest yield received on interest-earning assets and the interest rate paid on interest-bearing liabilities. Net interest income, when expressed as a percentage of average total interest-earning assets, is referred to as the net yield on interest-earning assets or net interest margin. Our net yield on interest-earning assets is affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes.
Interest rates charged on the loans are affected principally by the demand for such loans, the supply of money available for lending purposes, and other competitive factors. These factors are in turn affected by general economic conditions and other factors beyond our control, such as federal economic policies, the general supply of money in the economy, legislative tax policies, governmental budgetary matters, and the action of the Federal Reserve Board. The table below presents the average yield on each category of interest-earning asset, average rate paid on each category of interest-bearing liability, and the resulting interest rate spread and net yield on interest-earning assets for each year in the three-year period ended December 31, 2001.
Average Balance Sheet and Analysis of Net Interest Income
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The following table shows changes in interest income (including loan fees) and interest expense and the amount attributable to variations in interest rates and volumes for the period indicated. The variances attributable to simultaneous volume and rate changes have been allocated to the change due to volume and the change due to rate categories in proportion to the relationship of the absolute dollars amounts attributable solely to the change in volume and to the change in rate.
Provision for loan losses
The provision for loan losses represents the current period credit cost associated with maintaining an appropriate allowance for loan losses. The loan loss provision for each period is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of the quality for the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in our market area. Periodic fluctuations in the provision for loan losses result from management’s assessment of the adequacy of the allowance for loan losses; however, actual loan losses may vary from current estimates.
Refer to the section “Financial Condition-Allowance for Loan Losses” for a description of our systematic methodology employed in determining an adequate allowance for loan losses.
For the year ended December 31, 2001, the provision for loan losses was $750,000, an increase of $1.85 million or 168.2%, from the net recapture of loan losses of $1.1 million in 2000. The increase in provision for loan
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losses for 2001 is primarily due to the significant growth experienced in the loan portfolio of $146.6 million or 40.4%. The provision for loan losses decreased $4.5 million or 132.4% to negative $1.1 million in 2000 from $3.4 million in 1999. Provision for (recapture of) loan losses is charged (added back) to income to bring the allowance for loan losses to a level deemed appropriate by management based on the factors discussed under the “Allowance for Loan Losses” section of this report.
In 2000, there was a total recapture of loan loss provision of $1.5 million. As the result of our acquisition of KFBNY in February 2000, we had evaluated and brought forward an additional loan loss reserve of $7.9 million relating to the KFBNY loan portfolio, which was determined to be at higher risk of default based on weak underwriting standards and lower loan quality in comparison to our own loan portfolio. Additionally, we recorded a provision for loan losses of $400,000 during the third quarter of 2000, because of an identified loan with high-risk exposure, which was deteriorating rapidly. During the year 2000, we charged off approximately $6.6 million of loans and had recoveries of $4.0 million. Approximately $3.5 million or 53.0% of total charged off loans were those from KFBNY, which were charged off after the closing of the acquisition. However, approximately $3.6 million in KFBNY loans were eventually recovered during the year 2000, some of which were not anticipated. The high level of recoveries during the latter half of year 2000 led to the recapture of $1.5 million of loan loss provisions.
We use systematic methodology to calculate the allowance for loan losses. Through applying this methodology, which takes into account our loan portfolio mix, credit quality, loan growth, the amount and trends relating to our delinquent and non-performing loans, regulatory policies, general economic conditions and other factors relating to the collectibility of loans in our portfolio, we determine the appropriateness of our allowance for loan losses, which is further adjusted by quarterly provisions charged against earnings.
Other Operating Income
Our other operating income increased $1.8 million or 13.3% to $15.3 million in 2001, compared to $13.5 million in 2000. The increase was primarily due to increased SBA loans sales and also due to sale of securities. The gain on sale of SBA loans increased approximately $900,000 or 131.8% to $1.6 million in 2001, compared to $683,000 in 2000. We sold a total of $30.8 million in SBA loans in 2001, which was an increase of $16.6 million or 116.9% from $14.9 million in 2000. The earnings on cash surrender value increased $197,000 or 73.8% to $464,000 in 2001, compared to $267,000 in 2000. This increase was due to additional purchase of Bank- Owned Life Insurance of $1.8 million for Benjamin Hong and $3.2 million for the group of key employees during 2001. During 2001, we also recognized $917,000 of gains from the sale of investment securities, which totaled $16.5 million in book value.
Our other operating income increased $5.5 million or 68.8%, to $13.5 million in 2000, compared to $8.0 million in 1999. Service charges on deposit accounts, particularly non-sufficient fund fees and account analysis fees, increased $2.3 million or 70.0% to $5.6 million in 2000, from $3.3 million in 1999. These increases were mainly due to increases in deposit accounts, especially the three New York branches acquired from KFBNY in February of 2000.
The fee income generated from our international letter of credit transactions increased $827,000 or 45.9% to $2.7 million in 2000 from $1.8 million in 1999. Increase in trade finance activities from three locations (Los Angeles, Silicon Valley, and New York) contributed to this increase. Other operating income increased due to transaction increases in operating activities from newly acquired branches as well as the existing branches.
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The breakdown of other operating income by category is reflected below:
Other Operating Expenses
Our other operating expenses increased $3.6 million or 14.5% to $28.4 million in 2001, compared to $24.8 million in 2000. Salaries and benefits increased $2.4 million or 17.6% to $16.0 million in 2001, compared to $13.6 million in 2000. This increase was primarily due increased bonus reserves to compensate employees and the additional staffing for the newly opened branches during 2001. Occupancy expenses increased approximately $471,000 or 14.3% to $3.8 million in 2001, compared to $3.3 million in 2000. Furniture and equipment expenses also increased $237,000 or 21.5% to $1.3 million in 2001, compared to $1.1 million in 2000. These increases also were primarily due to the additional branches opened during 2001 and partly due to leasehold improvements made in our New York branches.
Our regulatory fees increased $87,000 or 21.5% to $491,000 in 2001, compared to $404,000 in 2000. The increase primarily came as the result of an increase in the OCC’s assessment fees, which are calculated based on our asset size. Communication expenses also increased $154,000 or 32.2% to $632,000 in 2001, compared to $478,000 in 2000. This increase was mainly due to upgrading and installing data lines to accommodate faster network services. Directors’ fees increased $73,000 or 24.2% to $375,000 in 2001, compared to $302,000 in 2000, as of result of the hiring of new Directors for Nara Bancorp, commencing in early 2001. Other income decreased by 48.0%, mainly due to a discontinuation of lease income received from the Manhattan building, which was sold at the end of year 2000. The lease income totaled approximately $439,000 in year 2000.
During 2000, other operating expenses increased $8.5 million or 52.1% to $24.8 million from $16.3 million in 1999. Salaries and benefits, which accounted for over 50% of other operating expenses, increased $5.4 million or 65.9% to $13.6 million in 2000, compared to $8.2 million in 1999, mainly because of an increased number of employees resulting from the KFBNY acquisition and the opening of new branches. Occupancy expenses increased $1.4 million or 73.7% to $3.3 million in 2000, compared to $1.9 million in 1999. This was primarily due to an increase in the depreciation of buildings acquired in the KFBNY transaction. All other operating expenses increased as well, largely due to the acquisition of KFBNY although some portion of the increase was related to other expansions and projects that we accomplished.
Other operating expenses generally reflect the direct expenses and related administrative expenses associated with staffing, maintaining, promoting and operating branch facilities. Consequently, other operating expenses have increased as our asset size increased and the number of branch offices and other offices increased.
A breakdown of other operating expenses by category is reflected below:
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Provision for Income Taxes
During 2001, we recorded a $6.3 million provision for income taxes, which resulted in an effective tax rate of 37%, compared with $6.8 million or effective tax rate of 39%, and $1.7 million, or effective tax rate of 29%, for the years ended December 31, 2000 and 1999, respectively. This decrease in 2001 compared to 2000 was primarily due to the state income tax benefits related to the acquisition of KFBNY. At December 31, 2001, we had federal and California net operating loss carryforwards relating to Nara Bank’s ownership change that occurred on July 15, 1994 of approximately $664,000 and $622,000, respectively, which will expire through 2009. Also at December 31, 2001, we had federal and New York net operating loss carryforwards relating to the purchase of KFBNY that occurred on February 25, 2000, both approximating $7,185,000, which will expire through 2019. Due to the ownership change in 1994 and restructuring in 2000, the annual limitation that can be utilized to offset future taxable income approximates $83,000 and $497,000, respectively.
Financial Condition
Our total assets increased $76.8 million or 12.7% to $679.4 million at December 31, 2001, compared to $602.6 million at December 31, 2000. This increase was primarily due to growth in our loan portfolio. Net loans, including loans held for sale, increased $146.4 million or 41.2% to $502.1 million at December 31, 2001, compared to $355.7 million at December 31, 2000. The increase in loans was primarily funded by deposits. Total deposits increased $62.1 million or 11.8% to $589.8 million at December 31, 2001, compared to $527.7 million at December 31, 2000. The details are discussed below.
At December 31, 2000, our total assets increased $243.5 million or $67.8% to $602.6 million from $359.1 million at December 31, 1999. Net loans increased $120.2 million or 51.0% to $355.7 million at 2000 year-end from $235.5 million at the previous year-end. This accounted for 49.4% of the total increase in assets. Total deposits at December 31, 2000 also increased $207.8 million or 65.0% to $527.7 million from $319.9 million at December 31, 1999. This resulted from the acquisition of KFBNY and the growth of existing branches during the year.
Investment Security Portfolio
The main objectives of our investment strategy are to support a sufficient level of liquidity while providing a means to manage our interest rate risk, and to generate an adequate level of interest income without taking undue risks. Our investment policy permits investment in various types of securities, certificates of deposits and federal funds sold in compliance with various restrictions in the policy. Securities are classified as held-to-maturity or available-for-sale. The securities that we have the ability and intent to hold to maturity are classified as held-to-maturity securities. All other securities are classified as available-for-sale. There were no trading securities at December 31, 2001 or 2000. As of December 31, 2001, held-to-maturity securities totaled $4.3 million, compared to $15.7 million at December 31, 2000, and available-for-sale securities totaled $65.1 million at December 31, 2001, compared to $54.9 million at December 31, 2000. The decrease in held-to-maturity securities is primarily due to called agency bonds during 2001 as a result of decreases in interest rates. During 2001, a total of $36.7 million in agency securities were called and a total of $51.8 million in securities available for sale were purchased. From the investment portfolio, securities with amortized cost of approximately $2.5 million and $4.2 million were pledged to Federal Reserve Board as required or permitted by law at December 31, 2001 and 2000, respectively. The investment portfolio consists of government sponsored agency bonds, mortgage backed securities, bank qualified California municipals, and corporate bonds. This investment portfolio composition reflects our investment strategy.
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Loan Portfolio
Our net loans increased $146.4 million or 41.2% to $502.1 million at December 31, 2001, compared to $355.7 million at December 31, 2000. Net loans accounted for 81.6% of our total interest-earning assets at year-end 2001, compared to 66.7% at year-end 2000. The average net loans for 2001 increased $139.8 million or 45.5% from the previous year. From the total increase of $146.4 million in net loans, approximately 42.8% was contributed by the branches in the New York regions. The net loans in the New York region increased $62.7 or 80.1% to $141.0 million at December 31, 2001, compared to $78.3 million at December 31, 2000.
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As a result of continued focus on commercial lending activities, loan growth remained concentrated in the commercial loans. Our commercial loans increased $71.7 million or 51.4% to $211.2 million at December 31, 2001, compared to $139.5 million at December 31, 2000. Real estate loans, mostly consisting of commercial real estate loans, also increased $73.9 million or 41.6% to $251.7 million at December 31, 2001, compared to $177.8 million at December 31, 2000.
Our net loans increased by $120.2 million or 51.0% to $355.7 million at December 31, 2000, compared to $235.5 million at December 31, 1999. Net loans accounted for 66.7% of our total interest-earning assets at year-end 2000, compared to 74.7% at year-end 1999. While total net loans outstanding increased 51.0% as of December 31, 2000, average net loans for the year increased 49.2% from the previous year. The increase was due to the acquisition of KFBNY and growth in our existing branches, including the newly acquired New York branches. Approximately $30.8 million or 25.6% of the total increase in net loans was attributable to the acquisition of KFBNY. Net loans from the three branches in New York, including the $30.8 million acquired in the KFBNY transaction, increased $23.1 million or 41.4% to $78.9 million at year-end 2000, from $55.8 million at year-end 1999.
We carry all loans at face amount, less payments collected, net of deferred loan origination fees and the allowance for loan losses. Interest on all loans is accrued daily on a simple interest basis. Once a loan is placed on non-accrual status, accrual of interest is discontinued and previously accrued interest is reversed. Loans are placed on a non-accrual basis when principal and interest on a loan is past due 90 days or more, unless a loan is both well-secured and in process of collection.
The rates of interest charged on variable rate loans are set at specified increments in relation to our prime lending rate and accordingly vary as our prime lending rate varies. Approximately 81.0% of our net loans were variable-rate loans at December 31, 2001.
With certain exceptions, we are permitted, under applicable law, to make unsecured loans to individual borrowers in aggregate amounts of up to 15% of the sum of our total capital and the allowance for loan losses (as defined for regulatory purposes). As of December 31, 2001, our lending limit was approximately $9.6 million for unsecured loans. For the purpose of lending limits, a secured loan is defined as a loan secured by readily marketable collateral having a current market value of at least 100% of the amount of the loan or extension of credit at all times. In addition to unsecured loans, we are permitted to make collateral-secured loans in an additional amount up to 10% of our total capital and the allowance for loan losses.
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Commercial Loans and Real Estate Loans
Commercial loans are made for the purposes of providing working capital, financing the purchase of inventory, especially for importers and exporters, or equipment and for other business purposes. Short term business loans (within one year) are generally used to finance current transactions and typically provide for periodic interest payments, with principal being payable at maturity. Term loans (5 to 7 years) normally provide for monthly payments of both principal and interest. The credit-worthiness of the borrower is reviewed on a periodic basis, and most loans are collateralized by inventory, equipment and/or real estate. Our real estate loans consist primarily of loans secured by deeds of trust on commercial property and are normally written for a short duration. It is our policy to restrict real estate loans to 70% of the appraised value of the property. We offer both fixed and floating rate loans. The maturities on such loans are generally restricted to seven years (on an amortization up to 25 years with a balloon payment due at maturity).
SBA Loans
Our SBA loans typically are made for the purpose of providing working capital, financing the purchase of equipment or inventory, financing the purchase of a business, debt refinancing, or financing the purchase or construction of owner occupied commercial property. SBA Commercial loans typically are term loans with maturities ranging from 7 to 25 years. These loans normally provide for floating interest rates, with monthly payments of both principal and interest. At December 31, 2001, total SBA commercial loans were $10.5 million. SBA real estate loans generally are 25 year term loans with full amortization. At December 31, 2001, total SBA real estate loans were $63.6 million. Our SBA lending represents an important portion of its loan portfolio because of our ability to sell the guaranteed portion in the secondary market at a premium, while earning servicing fees on the sold portion over the remaining life of the loan. Thus, in addition to the yield earned on the portion of the SBA loans retained by us, we recognize income from the gains on the sales from the loan servicing on the loans sold into the secondary market.
Most of our consumer loan portfolio consists of automobile loans and savings-secured loans. Nara Bank began originating automobile loans in early 1995. Referrals from automobile dealers comprise the majority of originations of such loans. We also offer fixed-rate loans to buyers of new and previously owned automobiles who are not qualified for automobile dealers’ most preferential loan rates. These loans are reviewed on an annual basis.
We extend lines of credit to business customers usually on an annual review basis. We do not normally make loan commitments in material amounts for periods in excess of one year. Our undisbursed commercial loan commitments at December 31, 2001, 2000 and 1999 were $146.2 million, $87.9 million, and $56.3 million, respectively.
The following table shows our loan commitments and letters of credit outstanding at the dates indicated:
Interest income on all loans is recognized under the accrual method of accounting. Accrual accounting takes the daily interest earned on the daily outstanding loan balance and records it as interest revenue regardless of the individual loan payment dates. The calculation is based on the simple interest method where the unpaid loan
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balance is multiplied by the number of outstanding days and then multiplied by the applicable interest rate per day. We generally do not record as revenue the potential interest on loans that are classified as probable losses.
Non-performing Loans and Other Real Estate Owned(“OREO”)
Loans are placed on nonaccrual status when they become 90 days past due, unless the loan is both well- secured and in the process of collection. Loans may be placed on nonaccrual status earlier if, in management’s opinion, the full and timely collection of principal or interest becomes uncertain. When a loan is placed on nonaccrual status, unpaid accrued interest is charged against interest income. Loans are charged off when our management determines that collection has become unlikely. OREO consists of real estate acquired by us through foreclosure.
Non-performing loans decreased $282,000 or 13.8% to $1.8 million at December 31, 2001, compared to $2.0 million at December 31, 2000. Non-performing loans increased $515,000 or 33.8% to $2.0 million at December 31, 2000, compared to $1.5 million at December 31, 1999. The primary reason for this increase was because of a $1.2 million loan that was subsequently charged off in February of 2001.
We did not own any other real estate at December 31, 2001. There was no expense incurred through OREO transactions in 2001. We owned other real estate, taken through foreclosure, in aggregate amounts of approximately $263,000 and $44,000 at December 31, 2000 and 1999, respectively. We reserved $37,000 and $13,000 at December 31, 2000 and 1999, respectively, as a valuation allowance. We incurred expenses of $90,748 and $16,629 in 2000 and 1999, respectively. We earned income of $2,893 and $906 from the properties in 2001 and 1999, respectively. The following table summarizes our OREO at the dates indicated:
Maturity of Loans and Sensitivity of Loans to Changes in Interest Rates
The following table sets forth by category of loan (including fixed and variable rate loans) the amounts of loans outstanding as of December 31, 2001, which are based on remaining scheduled repayment of principal, due in less than one year, due in one to five years, or due in more than five years. Loan maturities are based on contractual maturities.
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Loan concentrations are considered to exist when there are significant amounts of loans to a multiple number of borrowers engaged in similar activities, which would cause them to be similarly impacted by economic or other conditions. The following table describes the industry concentrations in our loan portfolio, which exceeded 10% of our total loans as of the dates indicated:
Summary of Loan Loss Experience
The risk of nonpayment on loans is inherent in all commercial banking operations. We employ a concept of total quality loan management in order to minimize our credit risk. For new loans, we thoroughly analyze each loan application and a majority of those loans is approved by the Management Loan Committee, which is comprised of six officers including the Chief Executive Officer, Chief Credit Officer and Chief Financial Officer. For existing loans, we maintain a systematic loan review program, which includes a quarterly loan review by the internal loan review officer and a semi-annual loan review by external loan consultants. Based on the reviews, loans are graded for their overall quality, which is measured based on the type of the loan being made, the credit-worthiness or history of the borrower over the term of the loan, security for the loan and cash flow of the borrower. We closely monitor loans that management has determined require further supervision because of the loan size, loan structure, and/or complexity of the borrower. These loans are periodically reviewed by the Management Loan Committee.
When principal or interest on a loan is past due 90 days or more, a loan is normally placed on non-accrual status unless it is considered to be both well-secured and in the process of collection. Further, a loan is considered to be a loss in whole or in part when (1) its loss exposure beyond any collateral value is apparent, (2) servicing of the unsecured portion has been discontinued or (3) collection is not anticipated due to the borrower’s financial condition and general economic conditions in the borrower’s industry. Any loan, or portion of a loan, judged by management to be uncollectible is charged against the allowance for loan losses, while any recoveries are credited to such allowance.
Our allowance for loan losses is established to provide for loan losses, which can be reasonably anticipated. The allowance for loan losses is established through charges to operating expenses in the form of provisions for loan
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losses. Actual loan losses or recoveries are charged or credited, respectively, directly to the allowance for loan losses. The amount of the allowance is determined by management and reported to the Board quarterly. The results of both internal and external loan reviews are used to determine the loan loss reserve. Our current loan review system takes into consideration such factors as the current financial condition of the borrower, the value of security, future economic conditions and their impacts on various industries. Our own historical loan loss experience is factored into a detailed loss migration analysis method, which determines loss factors to be used in calculating the allowance for loan losses.
At December 31, 2001, the allowance for loans losses was $6.7 million, which was an decrease of $300,000 or 4.3% from $7.0 million at December 31, 2000. During the year 2001, we charged off approximately $3.8 million and recovered $2.3 million of which $2.0 million was the recoveries from KFBNY loans either before or after the acquisition. The allowance for loan losses increased $3.5 million or 100.0% to $7.0 million at year ended 2000, from $3.5 million at year ended 1999. Approximately $7.9 million of loan loss reserve in 2000 were transferred from the KFBNY acquisition. During the year 2000, we charged off approximately $6.6 million and recovered $4.0 million in loans.
Specific reserves for impaired loans in accordance with SFAS No. 114, were $1.4 million at year-end 2001, compared to $1.9 million at year-end 2000 and $1.0 million at year-end 1999. Our management and Board of Directors review the adequacy of the allowance for loan losses at least quarterly. Based upon these evaluations and internal and external reviews of the overall quality of our loan portfolio, management and the Board of Directors believe that the allowance for loan losses was adequate as of December 31, 2001, to absorb estimated losses associated with the loan portfolio. However, no assurances can be given as to whether we will experience further losses in excess of the allowance, which may require additional provisions for loan loss reserves. If there are further losses, they may have a negative impact on our earnings.
The allowances as a percentage of loans outstanding at December 31, 2001, 2000 and 1999 were 1.48%, 2.21%, and 1.65%, respectively. Management believes that the allowance for loan losses is adequate to cover all reasonably anticipated losses in the loan portfolio. However, no assurance can be given that future economic conditions will not adversely affect our service areas or that other circumstances, including circumstances beyond our control, will not result in increased losses in our loan portfolio, which could possibly exceed the total allowance for loan losses.
The following table shows the provision made for loan losses, the amount of loans charged off, the recoveries on loans previously charged off together with the balance in the allowance for possible loan losses at the beginning and end of each period, the amount of average and total loans outstanding, and other pertinent ratios as of the dates and for the periods indicated:
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The reserve for losses on commitments to extend credit and letters of credit is primarily related to undisbursed funds on lines of credit. We evaluate credit risk associated with the loan portfolio at the same time we evaluate credit risk associated with the commitments to extend credit and letters of credits. However, the allowances necessary for the commitments is reported separately in other liabilities in the accompanying consolidated statements of financial conditions, and not as part of the allowance for loan losses, as presented above. The reserve for losses on commitments to extend credit and letters of credit was $437,000 and $901,000 at December 31, 2001 and 2000, respectively.
Allowance For Loan and Lease Losses and Methodology
We maintain an allowance for loan and lease losses (“Allowance”) in an amount believed to be adequate to absorb the estimated known and inherent losses identified in the loan portfolio for the next twelve months. Our methodology for determining the adequacy of the Allowance is based on a consistent and comprehensive analysis that is performed quarterly by management. By assessing the probable estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon the most recent information that has become available.
We use three different methodologies to determine the adequacy of the Allowance: (1) the Migration Analysis; (2) the Reasonableness Test; and (3) the Specific Allocation method.
The Migration Analysis is a formula method based on our actual historical net charge-off experience for each loan type pools and undisbursed commitments graded Pass (less cash secured loans), Special Mention, Substandard, and Doubtful.
We use an eight-quarter rolling average of historical losses detailing charge-offs, recoveries, and loan type pool balances to determine the estimated credit losses for non-classified and classified loans. Also, in order to reflect the impact of recent events, the eight-quarter rolling average has been weighted. The most recent four quarters have been assigned a 60% weighted average and the older four quarters have been assigned a 40% weighted average.
The resultant migration risk factors, or our established minimum risk factor for loan type pools that have no historical loss, whichever is greater, for each loan type pool is used to calculate our General Reserve. For loan type pools that have no historical loss, we have established a minimum risk factor for each loan grade Pass (0.40% — 1.0%), Special Mention (3.0% — 5.0%), Substandard (7.0% — 15.0%), Doubtful (50.0%), and Loss (100.0%).
For unfunded/undisbursed commitments and contingent liabilities, we use 50.0% of the migration/minimum risk factor for loans graded Pass, due to the fact that in many cases the Bank has the option of freezing or withholding unfunded loan proceeds if the Bank becomes aware of a problem or potential problem with the borrower. For graded loans (Special Mention, Substandard, Doubtful, and Loss), 100% of the migration/minimum risk factor is assigned to the unfunded/undisbursed commitments and contingent liabilities.
For identified impaired loans, if the calculated impairment is less than the migration risk factor, the migration risk factor is used. If the calculated impairment is greater than the migration risk factor, the General Reserve is increased by the amount of the difference.
Additionally, in order to systematically quantify the credit risk impact of trends and changes within the loan portfolio, we subjectively, within established parameters, make adjustments to the Migration Analysis for:
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Our parameters for making adjustments are established under a Credit Risk Matrix that provides seven possible scenarios for each of the above factors. The matrix allows for three positive/decrease (Major, Moderate, and Minor), three negative/increase (Major, Moderate, and Minor), and one neutral credit risk scenarios within each factor for each loan type pool. Generally, the factors are considered to have no impact (neutral) to our migration ratios. However, if information exits to warrant adjustment to the Migration Analysis, we make the changes in accordance with the established parameters supported by narrative and/or statistical analysis. Our Credit Risk Matrix and the seven possible scenarios enable us to adjust the Migration Analysis as much as 50 basis points in either direction (positive or negative) for each loan type pool.
The Reasonableness Test is based on a national historical loss experience for each loan graded Special Mention, Substandard, Doubtful, and Loss; and an established minimum for loans graded Pass. The reserve factors applied under this method are: 1.0% for loans graded Pass; 5.0% for loans graded Special Mention; 15.0% for loans graded Substandard; 50.0% for loans graded Doubtful; and 100.0% for loans graded Loss. This method in not intended to substitute or override the Bank’s other methodologies, but rather is used for comparative purposes.
Under the Specific Allocation method, management establishes specific allowances for loans where management has identified significant conditions or circumstances related to a credit that are believed to indicate the probability that a loss may be incurred. The specific allowance amount is determined by a method prescribed by the Statement of Financial Accounting Standards (SFAS) No. 114, “Accounting by Creditors for Impairment of a Loan.” Our actual historical repayment experience and the borrower’s cash flow, together with an individual analysis of the collateral held on a loan, is taken into account in determining the allocated portion of the required Allowance under this method. As estimations and assumptions change, based on the most recent information available for a credit, the amount of the required specific allowance for a credit will increase or decrease. The Migration Analysis risk factor is used to determine the unallocated portion of the required Allowance under this method. By analyzing the identified credits on a quarterly basis, we are able to adjust a specific allowance based upon the most recent information that has become available.
Deposits
Deposits are our primary source of funds to use in lending and investment activities. Our deposits consist of demand deposits, savings deposits, money market, super-NOW, and time deposits with various maturities. At December 31, 2001, we had $199.1 million in non-interest bearing demand deposits; $84.1 million in interest-bearing demand deposits; $78.9 million in savings; and $227.7 million in time deposits.
Total deposits increased $62.1 million or 11.8% to $589.8 million at December 31, 2001, compared to $527.7 million at December 31, 2000. Average deposits increased $121.4 million or 28.3% to $550.3 million at
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December 31, 2001, compared to $428.9 million at December 31, 2000. From the total increase of $62.1 million, approximately $21.2 million or 34.1% was attributable to the branches in the New York region Total deposits in the New York region increased $21.2 million or 14.7% to $165.6 million at December 31, 2001, compared to $144.4 million at December 31, 2000. Total deposits in Northern California increased $9.3 million or 16.6% to $65.4 million at December 31, 2001, compared to $56.1 million at December 31, 2000. This increase was attributable to the Oakland branch, which opened during 2000. During the year 2001, our total non-interest bearing deposit increased $6.2 million or 3.2%, time deposits increased $24.7 million or 12.2%, savings increased $29.1 million or 58.4%, and money market and other accounts increased $2.1 million or 2.5%. All of these increases were primarily due to new deposits accounts and changes in balances of existing accounts.
Included in the time deposits are $5.0 million brokered deposits; $2.0 million with five year maturity at 5.65%; $2.0 million with two year maturity at 5.30% and $0.9 million with one year maturity at 5.15%. Included also are $10.0 million of time deposit from the State; two $5.0 million with one and a half year maturity at 1.83% and 2.19%, respectively.
At December 31, 2000, we had $192.8 million in non-interest bearing demand deposits; $82.0 million in interest bearing demand deposits; $49.8 million in savings; and $203.0 million in time deposits. A total of $125.7 million of the deposits in 2000 was in the form of certificates of deposit in denominations of $100,000 or more as of December 31, 2000. Of our total deposits in 2000, 61.9% were time and savings deposits (including money market deposit accounts) and 38.1% were demand deposits and other transaction accounts (including NOW accounts).
Total deposits increased $207.8 million, or 65.0% to $527.7 million at December 31, 2000, from $319.9 million at December 31, 1999. The average deposits increased $148.6 million or 53.0% to $428.9 million at December 31, 2000 from $280.3 million at December 31, 1999. Non-interest bearing deposits increased $77.2 million or 66.8% to $192.8 million at December 31, 2000 from $115.6 million at December 31, 1999. Approximately $30.7 million or 39.8% of the total increase in non-interest bearing deposits was attributable to the three branches acquired in the KFBNY transaction. Interest-bearing deposits increased $130.7 million or 64.0% to $334.9 million at December 31, 2000, from $204.2 million at December 31, 1999. The increase in deposits partly resulted from the acquisition of the three branches of KFBNY, and partly from growth in those branches as well as in our other existing branches. Approximately $67.2 million or 32.3% of total increase was contributed by three newly acquired branches. Deposits in the New York region increased over 37.7% in 2000, and accounted for 27.4% of our total deposits. Noninterest-bearing deposits accounted for 36.5% of total deposits at 2000 year-end, which was slightly higher than in 1999. Time deposits accounted for 38.5% of total deposits. Time deposits of $100,000 or more increased 64.1% and other time deposits increased 49.2% in 2000. Savings deposits and other interest-bearing demand deposits increased 29.3% and 120.0% in 2000, respectively
Although our deposits vary with local and national economic conditions, management does not believe that our deposits are seasonal in nature. The following table sets forth information for the periods indicated regarding the balances of our deposits by category.
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The following table shows the maturity schedules of our certificates of deposit for $100,000 or more, for the years indicated (dollars in thousands).
Other Borrowings
On September 31, 1999, we issued five-year subordinated capital notes in the aggregate amount of $4.3 million with a stated interest rate of 9.0%, maturing on September 30, 2004. Interest on the notes is payable quarterly and no scheduled payments of principal are due prior to maturity. We may redeem the notes prior to their maturity as of or after September 30, 2002. The notes qualify as Tier 2 risk-based capital under Comptroller of the Currency guidelines for assessing regulatory capital. For the total risk-based capital ratio, the amount of notes that qualify as capital is reduced as those notes approach maturity. At December 31, 2001, $1.7 million, which represented 40% of the total outstanding amount of the notes, qualified as risk-based capital.
During 2000, we established a borrowing line with the FHLB of San Francisco. Advances may be obtained from the FHLB of San Francisco to supplement our supply of lendable funds, Advances from the FHLB of San Francisco typically are secured by a pledge of mortgage loans and/or securities, with a market value at least equal to outstanding advances. At December 31, 2001, we had $5.0 million of advance outstanding, all collaterized with securities pledged by Nara Bank, with an amortized cost of $6.1 million. The borrowing has a seven-year, fixed rate term.
On March 28, 2001, our subsidiary, Nara Capital Trust I, completed a private placement of $10 million of trust preferred securities, as part of a pooled offering with several other financial institutions. The trust preferred securities bear a 10.18% fixed rate of interest payable semi-annually. Nara Capital used the proceeds from the sale of the trust preferred securities to purchase junior subordinated deferrable interest debentures of Nara Bancorp. The net proceeds from the trust preferred securities will be used to accommodate stock repurchase program. Pending deployment of the funds for the repurchase program, we have invested the proceeds in federal fund overnight accounts. Under applicable regulatory guidelines, the trust preferred securities qualify as Tier I Capital.
Capital Resources
Historically, our primary source of capital has been the retention of operating earnings. In order to ensure adequate levels of capital, we conduct ongoing assessments of projected sources and uses of capital in conjunction with projected increases in assets and level of risk. We have considered, and we will consider, additional sources of capital as the need may arise, whether through the issuance of additional securities, debt or otherwise.
As mentioned above, On March 28, 2001, our subsidiary, Nara Capital, completed an offering of $10 million in trust preferred securities through its wholly owned subsidiary, Nara Capital. At December 31, 2001, total shareholders’ equity was $55.4 million, which represents $10.9 million or 24.5% increase from $44.5 million at December 31, 2000. For 2000, total shareholders’ equity also increased $17.8 million or 66.7% to $44.5 million from $26.7 million at December 31, 1999.
During August of 2000, we raised additional capital of $6.9 million through the issuance of 175,000 units, with each unit consisting of four shares of common stock plus a fully vested, immediately exercisable warrant to purchase an additional share of common stock. The warrant is a three year warrant to purchase a share of common stock at a price of $11, if exercised within one year, $12 if exercised after one and within two years, and $13 if exercised after two and within three years, from the date of grant.
At December 31, 2001, Tier 1 Capital, shareholders’ equity less intangible assets, plus proceeds from the trust preferred securities, was $63.4 million. This represents an increase of $20.7 million or 48.5% over Tier 1 Capital of $42.7 million at December 31, 2000. At December 31, 2001, Nara Bancorp had a ratio of total capital to total risk-weighted assets of 12.4% and a ratio of Tier 1 Capital to total risk weighted assets of 11.0%. The Tier 1 leverage ratio was 9.7% at December 31, 2001. Nara Bank had a ratio of total risk-weighted assets of 10.9%, a ratio of Tier 1 Capital to total risk-weighted assets at 9.5%, and Tier 1 leverage ratio was 8.8% at December 31, 2001.
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At December 31, 2000, Tier 1 Capital, shareholders’ equity less intangible assets, plus proceeds from the trust preferred securities, was $42.7 million . This represents an increase of $17.6 million or 70.1% over Tier 1 Capital of $25.1 million at December 31, 1999. At December 31, 2000, we had a ratio of total capital to total risk-weighted assets of 11.9% and a ratio of Tier 1 Capital to total risk weighted assets of 10.0%. The Tier 1 leverage ratio was 7.7% at December 31, 2000
The following table presents the amounts of regulatory capital and the capital ratios for Nara Bancorp and Nara Bank , compared to their minimum regulatory capital requirements as of December 31, 2001.
Liquidity Management
Liquidity risk is the risk to earnings or capital resulting from our inability to meet our obligations when they come due without incurring unacceptable losses. Liquidity risk includes the ability to manage unplanned decreases or changes in funding sources and to recognize or address changes in market conditions that affect our ability to liquidate assets quickly and with minimum loss of value. Factors considered in liquidity risk management are stability of the deposit base; marketability, maturity, and pledging of investments; and the demand for credit.
The objective of our liquidity management is to have funds available to pay anticipated deposit withdrawals and any other maturing financial obligations promptly and fully in accordance with their terms. Liquidity management involves our ability to convert assets into cash or cash equivalents without incurring significant loss, and to raise cash or maintain funds without incurring excessive additional cost.
In general, liquidity risk is managed daily by controlling the level of federal funds and the use of funds provided by the cash flow from the investment portfolio. To meet unexpected demands, lines of credit are maintained with correspondent banks, the Federal Home Loan Bank and the Federal Reserve Bank. The sale of bonds maturing in the near future can also serve as a contingent source of funds. Increases in deposit rates are considered a last resort as a means of raising funds to increase liquidity.
For deposits, our primary source of funds, we maintain a deposit policy under which we endeavor to match our interest-bearing liabilities to fund interest-earning assets as closely as possible. We also endeavor to cover all volatile funds with liquid assets, as a method to ensure adequate liquidity. Thus, we analyzes our deposits’ maturity and interest rates in order to monitor and control the cost of funds and review the stability of our supply of funds.
At times when we have more funds than the amount we need for our reserve requirements or short-term liquidity needs, we sell federal funds to other financial institutions. We derived $3.3 million in income from sales of
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Federal Funds during the year ended December 31, 2001, and $3.5 million and $2.1 million in income from such sales during the year ended December 31, 2000 and 1999, respectively.
On the other hand, when we have less funds than we need, we are allowed to borrow funds from both its correspondent banks and from the Federal Reserve Bank (FRB). The maximum borrowing amount from our correspondent banks is $13 million on an overnight basis. The maximum borrowing amount from the FRB discount window is 97% of the market value of the pledged security with the FRB, which was $1.0 million at December 31, 2001. We also have an available borrowing line with Federal Home Loan Bank of San Francisco of up to 25% of our total assets. At December 31, 2001 and 2000, we had $5.0 million of advances outstanding from Federal Home Loan Bank.
We maintain a portion of our funds in interest-bearing cash deposits in other banks, funds loaned to other banks overnight (federal funds sold), and investment securities available-for-sale. At December 31, 2001, our liquidity level was 18.3% totaling $124.1 million, reflecting a $63.3 million decrease compared to a liquidity level of $187.4 million at 2000 year-end. The decrease was mainly due to $57.5 million decrease in federal funds sold from $99.7 million at 2000 year-end to $42.2 million at 2001 year-end. At December 31, 2001, our liquid assets included cash and cash equivalents, federal funds sold, interest-bearing deposits in other banks with maturities of one year or less, and available-for-sale investment securities not pledged. At December 31, 2001, cash and cash equivalents totaled $72.6 million. This represented a decrease of $60.1 million or 45.3%, from a total of $132.7 million at December 31, 2000.
Because our primary sources and uses of funds are loans and deposits, the relationship between gross loans and total deposits provides a useful measure of our liquidity. Typically, the closer the ratio of loans to deposits is to 100%, the more we rely on its loan portfolio to provide for short-term liquidity needs. Because repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan to deposit ratio, the less liquid are our assets. For 2001, our loan to deposit ratio averaged 82.6%, compared to an average ratio of 73.6% for 2000, and a ratio of 74.5% for 1999.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISKS
Market risk is the risk of loss to future earnings, to fair values, or to future cash flow that may result from changes in the price of a financial instrument. Our primary market risk is interest rate risk. Our success is largely dependent upon our ability to manage interest rate risk, which is the impact of adverse fluctuations in interest rates on our net interest income and net portfolio value. The objective is to measure the effect on net interest income and to manage the assets and liabilities to minimize the interest rate risk while at the same time maximizing income. The management of interest risk is governed by policies reviewed and approved annually by the Board of Directors (“Board”). Our Board of Directors delegates responsibility for interest risk management to the Asset and Liability Management Committee (“ALCO”), which is composed of Nara Bank’s senior executives and other designated officers.
The fundamental objective of the ALCO is to manage our exposure to interest rate fluctuations while maintaining adequate levels of liquidity and capital. The ALCO meets regularly to monitor the interest rate risk, the sensitivity of our assets and liabilities to interest rate changes, the book and market values of assets and liabilities, investment activities and directs changes in the composition of the balance sheet. Our balance sheet is assets sensitive, which means that assets generally reprice more often than liabilities. Because an asset-sensitive balance sheet tends to reduce net interest income when interest rates decline and to increase net interest income when interest rate rise, careful forecasts of interest rates and changes to the security portfolio are used to manage the interest rate risk.
We monitor the interest rate “sensitivity” risk to earnings from potential changes in interest rates using various methods, including a maturity/repricing gap analysis. This analysis measures, at specific time intervals, the
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differences between interest-earning assets and interest-bearing liabilities for which repricing opportunities will occur. A positive difference, or gap, indicates that earning assets will reprice faster than interest-bearing liabilities. This will generally produce a greater net interest margin during periods of rising interest rates, and a lower net interest margin during periods of declining interest rates. Conversely, a negative gap will generally produce a lower net interest margin during periods of rising interest rates and a greater net interest margin during periods of decreasing interest rates.
Table below provides our maturity/repricing gap analysis at December 31, 2001. We had a positive cumulative 180 day gap of $118,436 million at December 31, 2001. In theory, this would indicate that at December 31, 2001, $118,4336 million more in assets than liabilities would re-price if there were to be a change in interest rates over the next 180 days. If interest rates increase, the positive gap would tend to result in a higher net interest margin. If interest rates decrease, the positive gap would tend to result in a decrease in net interest margin.
Asset and Liability Maturity/Repricing Gap
The interest rates paid on deposit accounts do not always move in unison with the rates charged on loans. In addition, the magnitude of changes in the rates charged on loans is not always proportionate to the magnitude of changes in the rate paid for deposits. Consequently, changes in interest rates do not necessarily result in an increase or decrease in the net interest margin solely as a result of the differences between repricing opportunities of earning assets or interest-bearing liabilities. The fact that we reported a positive gap at December 31, 2001 does not necessarily indicate that, if interest rates increase, net interest income would increase, or if interest rates decrease, net interest income would decrease.
We also utilize the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The sensitivity of our net interest income is measured over a one year period. The simulation model estimates the impact of changing interest rates on the interest income from all interest earning assets and the interest expense paid on all interest bearing liabilities reflected on our balance sheet. The following reflects our net interest income sensitivity analysis as of December 31, 2001:
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The estimated sensitivity does not necessarily represent our forecast and the results may not be indicative of actual changes to Nara Bank’s net interest income. These estimates are based upon a number of assumptions including; the nature and timing of interest rate levels including yield curve shape, prepayment on loans and securities, pricing strategies on loans and deposits, and replacement of asset and liability cashflow. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, together with the report thereon of Deloitte & Touche LLP dated March 26, 2002, begin at page F-1 of this Report and contain the following:
See “Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K” below for financial statements filed as a part of this Report.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
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PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference is the information from the section entitled “Election of Directors” from Nara Bancorp’s definitive Proxy Statement, to be filed with the SEC within 120 days after December 31, 2001. Reference is also made in connection with the list of Executive Officers, which is provided under Item 4(a), “Executive Officers of the Registrant.”
Item 11. EXECUTIVE COMPENSATION
Incorporated herein by reference is the information from the sections entitled “Election of Directors — Compensation of Board of Directors,” “Executive Compensation” and “Compensation Committee Interlocks and Insider Participation” from Nara Bancorp’s definitive Proxy Statement, to be filed with the SEC within 120 days after December 31, 2001.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference is the information from the section entitled “Beneficial Ownership of Principal Stockholders and Management” from Nara Bancorp’s definitive Proxy Statement, to be filed with the SEC within 120 days after December 31, 2001.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference is the information from the section entitled “Certain Transactions” from Nara Bancorp’s definitive Proxy Statement, to be filed with the SEC within 120 days after December 31, 2001.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1 and 2. Financial Statements
(b) Reports on Form 8-K
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SIGNATURES
In accordance with Section 13 or 15 (d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 29, 2002.
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities on the dates indicated.
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Nara Bancorp, Inc.and Subsidiaries
Consolidated Financial Statements as ofDecember 31, 2001 and 2000 and forEach of the Three Years in the PeriodEnded December 31, 2001 andIndependent Auditors’ Report
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INDEPENDENT AUDITORS’ REPORT
To the Board of Directors and StockholdersNara Bancorp, Inc.Los Angeles, California:
We have audited the accompanying consolidated statements of financial condition of Nara Bancorp, Inc. and subsidiaries (the “Company”) as of December 31, 2001 and 2000 and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Nara Bancorp, Inc. and subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for the each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America.
March 26, 2002
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NARA BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITIONDECEMBER 31, 2001 AND 2000
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See accompanying notes to consolidated financial statements.
(Concluded)
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CONSOLIDATED STATEMENTS OF INCOMETHREE-YEAR PERIOD ENDED DECEMBER 31, 2001
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYTHREE-YEAR PERIOD ENDED DECEMBER 31, 2001
(Continued)
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CONSOLIDATED STATEMENTS OF CASH FLOWSTHREE-YEAR PERIOD ENDED DECEMBER 31, 2001
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTSTHREE-YEAR PERIOD ENDED DECEMBER 31, 2001
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