UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

 

For the fiscal year ended December 31, 2006

or

 

For the transition period from             to              ..

Commission File No.: 0-22193

Pacific Premier Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

1600 Sunflower Ave. 2nd Floor, Costa Mesa, California 92626

(714) 431-4000

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $0.01 per share
(Title of class)

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

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 o 

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 the 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. x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one).

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No x

The aggregate market value of the voting stock held by non-affiliates of the registrant, i.e., persons other than directors and executive officers of the registrant, was approximately $57,356,443 and was based upon the last sales price as quoted on The NASDAQ Stock Market as of June 30, 2006, the last business day of the most recently completed 2nd fiscal quarter.

As of March 30, 2007, the Registrant had 5,213,488 shares outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2007 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

INDEX

		Page
PART I			3
ITEM 1. BUSINESS			3
ITEM 1A. RISK FACTORS			34
ITEM 1B. UNRESOLVED STAFF COMMENTS			38
ITEM 2. PROPERTIES			39
ITEM 3. LEGAL PROCEEDINGS			39
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			40
PART II			41
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES			41
ITEM 6. SELECTED FINANCIAL DATA			43
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			45
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			54
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA			57
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE			86
ITEM 9A. CONTROLS AND PROCEDURES			86
ITEM 9B. OTHER INFORMATION.			87
PART III			88
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE			88
ITEM 11. EXECUTIVE COMPENSATION			88
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS			88
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE			89
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES			89
PART IV			89
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES			89
SIGNATURES			91

 

PART I

ITEM 1. BUSINESS

Overview

All references to “we”, “us”, “our”, or the “Company” mean Pacific Premier Bancorp, Inc. and our consolidated subsidiaries, including Pacific Premier Bank, our primary operating subsidiary. All references to ‘‘Bank’’ refer to Pacific Premier Bank.

The statements contained herein that are not historical facts are forward looking statements based on management’s current expectations and beliefs concerning future developments and their potential effects on the Company. There can be no assurance that future developments affecting the Company will be the same as those anticipated by management. Actual results may differ from those projected in the forward-looking statements. These forward-looking statements involve risks and uncertainties. These include, but are not limited to, the following risks: (1) changes in the performance of the financial markets, (2) changes in the demand for and market acceptance of the Company’s products and services, (3) changes in general economic conditions including interest rates, presence of competitors with greater financial resources, and the impact of competitive projects and pricing, (4) the effect of the Company’s policies, (5) the continued availability of adequate funding sources, and (6) various legal, regulatory and litigation risks.

We are a California-based holding company for Pacific Premier Bank, a federally-chartered savings bank. As the Company continues to transition to a commercial business platform, management determined that a California commercial bank charter was better aligned with its strategic plans. Accordingly, management submitted a conversion application in June 2006 to the California Department of Financial Institutions (“DFI”) and the Federal Deposit Insurance Corporation (“FDIC”) to convert its existing federal savings bank charter to a California chartered commercial bank. In connection with the charter conversion, the Company will become a bank holding company regulated by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). We expect the charter conversion to be completed in the first quarter of 2007.

We conduct business throughout Southern California from our six locations in the counties of Los Angeles, Orange and San Bernardino. We operate five depository branches in the cities of Costa Mesa, Huntington Beach, Los Alamitos, San Bernardino and Seal Beach, a Small Business Administration (“SBA”) loan production office in Pasadena and our corporate headquarters in Costa Mesa California. In the first quarter of 2007, we opened an additional depository branch in the City of Newport Beach, California.

We provide banking services within our targeted markets in Southern California to businesses, including the owners and employees of those businesses, professionals, real estate investors and non-profit organizations, as well as, consumers in the communities we serve. Through our branches and our web site at www.PPBI.net on the Internet, we offer a broad array of deposit products and services for both commercial businesses, professionals, non-profit organizations, and consumer customers including checking, money market and savings accounts, cash management services, electronic banking, and on-line bill payment. Our employees are compensated to increase low cost deposits through relationship banking. We offer a wide array of loan products, such as commercial business loans, lines of credit, commercial real estate loans, SBA loans, residential home loans, and home equity loans. At December 31, 2006, we had consolidated total assets of $730.9 million, net loans of $605.1 million, total deposits of $339.4 million, consolidated total stockholders’ equity of $58.0 million, and the Bank was considered a “well-capitalized” financial institution for regulatory capital purposes.

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History

The Bank was founded in 1983 as a state chartered savings and loan and converted to a federally chartered stock savings bank in 1991. From 1983 to 1994, the Bank engaged in traditional community banking activities, consisting primarily of deposit taking and originating one-to-four family home loans. In 1994, the Bank shifted its operating strategy and implemented a nationwide sub-prime focused mortgage banking platform. The Bank expanded its operations to originate and to sell sub-prime residential home loans through asset securitizations and whole loan sales.  Lending activities were funded primarily through non-core deposits, such as wholesale and brokered certificates of deposit (“CDs”), as well as, high rate consumer CDs. In 1998, the Company and Bank began to experience losses. By the third quarter of 2000, the Bank was deemed under-capitalized, was operating under regulatory enforcement agreements and incurring losses primarily due to loan defaults.

The current management team was retained and implemented a new business plan in the fourth quarter of 2000 in order to primarily refocus the Company’s business model toward a community bank. We implemented a three phase strategic plan which involved (1) lowering the risk profile of the Bank and re-capitalizing the Company, (2) growing the balance sheet at an accelerated rate through the origination of adjustable rate multi-family loans, thus, returning the Company to profitability, and (3) transforming the institution to a commercial banking business model. The first two phases of our plan were completed in 2002 and 2004, respectively. Phase three of our plan involves the transition to a commercial banking platform and, thus, we are focusing on changing the deposit base to a higher percentage of low cost core deposits and a diversification of the Bank’s loan portfolio. We began implementing this phase of our strategic plan in late 2004 through a shift in our corporate focus towards relationship banking.

When we implemented the second phase of our plan in 2002, our lending was focused on multi-family or apartment loans. We began originating these loans in the second quarter of 2002 with a focus on small to medium-sized loans, in the $200,000 to $2.0 million range, as we believe this market was underserved, especially in Southern California. During 2005, we began shifting our focus towards commercial real estate loans, both owner occupied and investor owned, and commercial and industrial (“C&I”) business loans as part of our strategic transition towards a commercial banking platform. In 2006, we added SBA loans as part of our commercial banking platform. We will continue to originate multi-family loans that satisfy our loan criteria and compliment our business plan.

Operating Strategy

Our goal is to develop the Bank into one of Southern California’s top performing commercial banks as an alternative to the large regional and national banks for small businesses, professionals and real estate entrepreneurs for the long term benefit of our shareholders, customers and employees. The following are our operating strategies to achieve our goals:

·       Recruitment of Commercial Bankers. We began our transition to a commercial banking platform in 2005 by recruiting experienced commercial bankers who possess an established following of customer relationships. These relationships typically include businesses that have both deposit and loan needs, as well as, the personal depository needs of the business owners themselves. Our incentive plans compensate our commercial bankers for the generation and retention of customer relationships as measured by the level of low cost deposits maintained at the Bank. We will continue to recruit experienced bankers to staff our branches and serve our targeted markets.

·       Relationship Banking. We recognize that customer relationships are built through a series of consistently executed experiences in both routine transactions and higher value interactions. Our commercial bankers are focused on developing long term relationships with business owners, professionals, real estate investors, and non-profit organizations through consistent and frequent contact. Our bankers work closely with our real estate originators to cross-sell clients to ensure we

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are capturing the entire banking relationship of each customer with which we do business. Our bankers are actively involved in community organizations and events, thus building and capitalizing on the Bank’s reputation within our local communities.

·       Growing Core Deposits/Reducing our Wholesale Funding. The second phase of our strategic plan relied on wholesale borrowings, such as advances from Federal Home Loan Bank (“FHLB”) System and brokered deposits to fund a large portion of our accelerated growth during that phase. As we transition towards a commercial banking platform, we intend to reduce our reliance on these funding sources over time. We will manage our growth and our concentration in commercial real estate, in part, by selling excess loan production, generally multi-family loans. We also expect to increase the growth of low cost core deposit accounts via the expansion of our branch network, in order to better serve our market area and to attract additional small business customers. We opened two new branches in the cities of Los Alamitos and Costa Mesa in 2006. Additionally, we relocated our Huntington Beach branch to a new facility which will enable us to better serve our existing business clients and to attract additional business in the surrounding area. In the first quarter of 2007, we will open our sixth full service branch in Newport Beach to serve the business owners, professionals, real estate entrepreneurs, non-profit organizations, and consumers of Newport Beach and the surrounding communities.

·       Expansion through de novo branches, organic growth and acquisitions. We believe that the consolidation in the banking industry has created an opportunity at the community banking level in the areas that we serve. Many bank customers feel displaced by large out-of-market acquirers and are attracted to local institutions that have local decision making capability, more responsive customer service, and more familiarity with the needs in their markets. We intend to continue expanding our franchise in the high growth areas of Orange and Los Angeles Counties, including the previously mentioned branches. Furthermore, as opportunities arise, we will consider expansion into markets contiguous to our own through potential acquisitions and/or de novo branching.

·       Diversifying our Loan Portfolio. We believe it is important to diversify our loan portfolio and to increase the amount of commercial real estate, C&I loans and SBA loans within our portfolio. As a result, we believe it is essential to be able to offer our customers a wide array of products and services. We provide flexible and structured loan products to meet our customer’s needs, which, in turn, provide us the opportunity to become their full service banker. We continually reassess our various product and service offerings to ensure they allow us to achieve our objectives.

·       Change in our Banking Charter. As we increase the amount of the commercial real estate and C&I loans in our portfolio we will begin to approach the maximum amount of non-residential real estate loans allowed under our current charter (i.e., four times our regulatory capital). Additionally, our charter limits the amount of C&I loans we may invest in up to 20% of our assets, provided that the amounts in excess of 10% of total assets are used for small business loans. Consequently, the Bank and Company have filed applications to change its charter from a federally-chartered savings association whose primary regulator is the Office of Thrift Supervision (“OTS”) to a California chartered commercial bank whose primary regulator is the DFI. In connection with such a charter change, the Federal Reserve Board would become the primary regulator of the Company. We expect the change in the charter to be completed sometime in the first quarter of 2007.

·       Maintain Excellent Asset Quality. Our credit and risk management culture has resulted in low levels of nonperforming loans and an overall high credit quality within our loan portfolio. We monitor existing economic trends and conditions that could positively or negatively impact our business. We will continue to adjust our risk management practices to changes in the conditions that impact our business.

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·       Premier Customer Service Provider. We believe it is imperative that the Bank provide a consistent level of quality service which generates customer retention and referrals. All of our employees, through training, understand that each interaction with our customers is an opportunity to exceed their expectations. Our employees’ incentive compensation is, in part, predicated on achieving a consistently high level of customer satisfaction.

Our executive offices are located at 1600 Sunflower Avenue, 2nd Floor, Costa Mesa, California  92626 and our telephone number is (714) 431-4000. Our internet website address is www.ppbi.net. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and all amendments thereto, from 1998 to present, are available free of charge on our internet website. Also on our website are our Code of Ethics, Insider Trading and Beneficial Ownership forms, and Corporate Governance Guidelines. The information contained in our website, or in any websites linked by our website, is not a part of this Annual Report on Form 10-K.

Lending Activities

General.   In 2006, we continued our efforts to diversify our lending activities as the Bank transitioned toward a commercial banking platform. We focused on increasing C&I, SBA and commercial real estate lending activities in addition to continuing our strong multi-family lending programs. Loans were made primarily to borrowers within our market area and secured by real property and business assets located principally in Southern California. We emphasized relationship lending, and focused on generating retail production by dealing directly with customers. We have and will continue to offer loans up to our legal lending limit, which was $9.7 million as of December 31, 2006. These efforts assisted us in establishing depository relationships with new and existing customers consistent with the Bank’s strategic direction. During 2006, we originated $182.4 million in multi-family, $90.8 million in commercial real estate and land loans, and $72.1 million of business loans consisting of $28.4 million of commercial real estate owner-occupied loans, $34.5 million of C&I loans, and $9.2 million of SBA loans and $1.5 million in other loans. At December 31, 2006, we had $607.6 million in total gross loans outstanding.

Sourcing of our Loans.   We primarily obtain new multi-family and commercial real estate loans, from established relationships with mortgage brokers operating throughout Southern California. Our commercial bankers work out of our corporate office and are responsible for building and maintaining these relationships. In 2006, we maintained relationships with over 50 brokerage companies of which five could be termed significant. In 2006, the top five brokerage companies accounted for 62.0% of the multi-family and commercial real estate loans originated by the Bank. Within these five brokerage companies, we funded loans with a total of 26 different agents. Our commercial bankers have relationships with these individuals and seek to maintain the relationship regardless of where these agents are employed. Additionally, our bankers seek to establish relationships with other agents within these brokerage companies that have not done business with us in the past.

Direct loan originations in 2006 accounted for 25.9% of our loans, which represented an increase of 134.9% over 2005. These loans were sourced through referrals from our depository branches and by soliciting these loans directly. Our bankers will continue to focus on developing and maintaining relationships with individual investors, accountants, consultants, commercial real estate investment sales and leasing agents, and other banks to further increase the percentage of direct referrals in future periods.

Commercial business loans are sourced by our Business Development Officers and Branch Managers. These bankers call on business owners, accountants, attorneys, consultants, non-profit organizations, and various other referral sources to generate new business banking relationships. Upon securing the business banking relationships, they work with the business owner to offer personal banking products and services to the business owner, their families, and the businesses’ employees as well. Additionally, our Branch

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Managers work closely with our commercial bankers to capture the full banking needs of our multi-family and commercial real estate loan customers.

SBA loans are sourced by our SBA lending office in Pasadena, CA, our web site, brokers, and through direct contact by our Business Development Officers and Branch Managers. As with other business loans, our bankers work to establish full banking relationships with our SBA loan customers.

Interest Rates on Our Loans.   We employ a risk-based pricing strategy on all loans we fund. The interest rates we charge on our loans generally vary based on a number of factors, including the degree of credit risk, size, maturity of the loan, borrower/property management/business expertise, and prevailing market rates for similar types of loans. Depending on market conditions at the time the loan is originated, certain loan agreements will include prepayment penalties. All of the multi-family and commercial real estate loans originated in 2006, except for two loans, had a prepayment penalty provision. Most of our loans are adjustable-rate, and 3, 5, 7, or 10 year fixed rate hybrid adjustable-rate loans and are based on one of several interest rate indices. Mostly all of the loans originated by the Bank in 2006 were fixed rate hybrid adjustable-rate loans and had minimum interest rates (“floor rates”) at which the rate charged may not be reduced further regardless of further reductions in the underlying interest rate index.

Lending Risks on our Loans.   The majority of our loans involve larger extensions of credit to a single borrower that are generally viewed as exposing us to a greater risk than one-to-four family residential lending. The liquidation values of the properties securing our multi-family and commercial real estate loans may be adversely affected by risks generally incidental to interests in real property, such as:

·       Changes or continued weakness in general or local economic conditions;

·       Changes or continued weakness in specific industry segments;

·       Declines in real estate values;

·       Declines in rental rates;

·       Declines in occupancy rates;

·       Increases in other operating expenses (including energy costs);

·       The availability of refinancing at lower interest rates or better loan terms;

·       Changes in governmental rules, regulations and fiscal policies, including rent control ordinances, environmental legislation and taxation;

·       Increases in interest rates, real estate and personal property tax rates; and

·       Other factors beyond the control of the borrower or the lender.

We attempt to mitigate these risks through sound and prudent underwriting practices, as well as a proactive loan review process and our risk management practices. See “Lending Activities - Underwriting and Approval Authority for Our Loans.”

We will not extend credit to any one borrower that is in excess of regulatory limits. Pursuant to OTS regulations, loans-to-one borrower cannot exceed 15% of the Bank’s unimpaired capital and surplus. At December 31, 2006, the Bank’s loans-to-one borrower limit was $9.7 million. See “Regulation—Federal Savings Institution Regulation—Loans-to-One Borrower.”

Underwriting and Approval Authority for Our Loans.   Our board of directors establishes our lending policies. Each loan must meet minimum underwriting criteria established in our lending policies and must fit within our overall strategies for yield, interest rate risk, and portfolio concentrations. The underwriting and quality control functions are managed through our corporate office. Each loan application is evaluated

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from a number of underwriting perspectives. For real estate secured loans, these underwriting considerations include property appraised value, loan-to-value, level of debt service coverage utilizing both the actual net operating income and forecasted net operating income, use and condition of the property, as well as, the borrower’s liquidity, income, credit history, net worth, and operating experience. For business and SBA loans, underwriting considerations include historic business cash flows, debt service coverage, loan-to-value ratios of underlying collateral, if any, debt to equity ratios, credit history, business experience, history of business, forecasts of operations, business viability, net worth, and liquidity.

Loans secured by real estate are originated on both a non-recourse and full recourse basis. Business loans are generally originated as recourse or with full guarantees from key borrowers or borrower principals. On loans made to entities, such as partnerships, limited liability companies, corporations or trusts, we typically obtain personal guarantees from the appropriate managing members, major shareholders, trustees or other appropriate principals. In 2006, 99% of our income property loans to entities were originated with full recourse and/or personal guarantees from principals of the borrowers.

Upon receipt of a completed loan application from a prospective borrower, a credit report and other required reports are ordered and, if necessary, additional information is requested. Prior to processing and underwriting any loan, we issue a letter of interest based on a preliminary analysis by our bankers, which letter details the terms and conditions on which we will consider the loan request. Upon receipt of the signed letter of interest and a deposit fee, we process and underwrite each loan application and prepare all loan documentation wherein the loan has been approved.

Our credit memorandum, which are prepared by our underwriters, include a description of the transaction and prospective borrower and guarantors, the collateral securing the loan, if any, the proposed uses of loan proceeds and source(s) of repayment, as well as an analysis of the borrower’s business and personal financial statements and creditworthiness. The financial statements and creditworthiness of any guarantors are also analyzed. For loans secured by real property, the credit memorandum will include an analysis of the historic operating income of the property. Loans secured by real estate require an independent appraisal conducted by a licensed appraiser. All appraisal reports are appropriately reviewed by our appraisal department. Our board of directors reviews and approves annually the independent list of acceptable appraisers. When appropriate, environmental reports are obtained and reviewed as well.

Following loan approval and prior to funding, our underwriting and processing departments assure that all loan approval terms have been satisfied, that they conform with lending policies (or are properly documented as exceptions with required approvals), and that all required documentation is present and in proper form.

Commercial business loans are subject to Bank guidelines regarding appropriate covenants and periodic monitoring requirements which include but are not limited to:

·       Capital and lease expenditures;

·       Capital levels;

·       Salaries and other withdrawals;

·       Working capital levels;

·       Debt to net worth ratios;

·       Sale of assets;

·       Change of management;

·       Change of ownership;

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·       Cash flow requirements;

·       Profitability requirements;

·       Debt service ratio;

·       Collateral coverage ratio;

·       Current and quick ratios.

Subject to the above standards, our board of directors delegates authority and responsibility for loan approvals to management up to $1.5 million for all loans secured by real estate and up to $250,000 for loans not secured by real estate. Loan approvals at the management level require the approval of at least two members of our Management Loan Committee, consisting of our President and Chief Executive Officer, Chief Credit Officer, and Chief Banking Officer. All loans in excess of $1.5 million, including total aggregate borrowings in excess of $1.5 million, and any loan in excess of $250,000 not secured by real estate require a majority approval of our board’s Credit Committee, which is comprised of three directors, including our President and Chief Executive Officer.

Multi-family Real Estate Lending.   We originate and purchase loans secured by multi-family residential properties (five units and greater) located predominantly in Southern California. The majority of loans we fund on multi-family properties are sold in the secondary market. Pursuant to our underwriting policies, multi-family residential loans may be made in an amount up to 75% of the lesser of the appraised value or the purchase price of the collateral property. In addition, we generally require a stabilized minimum debt service coverage ratio of 1.15:1, based on the qualifying loan interest rate. Loans are made for terms up to 30 years with amortization periods up to 30 years. As of December 31, 2006, we had $357.3 million of multi-family real estate secured loans, constituting 58.8% of our loan portfolio. Multi-family loans originated in 2006 had an average outstanding balance of $1,208,000, loan-to-value of 64.3%, and debt coverage ratio of 1.15:1 at origination.

Commercial Real Estate Lending.   We originate and purchase loans secured by commercial real estate, such as retail centers, small office and light industrial buildings, and mixed-use commercial properties located predominantly in Southern California. We will also, from time to time, make a loan secured by a special purpose property, such as a gas station or motel. Pursuant to our underwriting policies, commercial real estate loans may be made in amounts up to 75% of the lesser of the appraised value or the purchase price of the collateral property. We consider the net operating income of the property and typically require a stabilized debt service coverage ratio of at least 1.20:1, based on the qualifying interest rate. Loans are generally made for terms up to fifteen years with amortization periods up to 30 years. As of December 31, 2006, we had $173.5 million of commercial real estate secured loans, constituting 28.6% of our loan portfolio. Commercial real estate loans originated in 2006 had an average balance of $1,138,000, loan-to-value of 64.84% and debt coverage ratio of 1.24:1 at origination.

Commercial Business (C&I) Lending.   We originate loans secured by business assets including inventory, receivables, machinery and equipment to businesses located predominantly in our primary market area. In many instances, real estate holdings of the borrower, its principals or loan guarantors are also taken as loan collateral. Loan types include revolving lines of credit, term loans, seasonal loans and loans secured by liquid collateral such as cash deposits or marketable securities. We also issue letters of credit on behalf of our customers, backed by loans or deposits with the Bank. In addition to lending against business assets, our business loan programs include loans for owner-occupied commercial real estate such as retail, office and industrial properties. Owner-occupied real estate is underwritten based on the value of the building and the cash flow of the occupying business. As of December 31, 2006, we had total commitments of $48.1 million in commercial business lines of credit, of which, $30.4 million was disbursed.

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Small Business (SBA) Lending.   Our SBA Division, which started in the fourth quarter of 2005, was approved to originate loans under the SBA’s Preferred Lenders Program (“PLP”) within its first year of operation when the Bank was named a PLP lender in the third quarter of 2006. The PLP lending status affords the Bank a higher level of delegated credit autonomy, translating to a significantly shorter turnaround time from application to funding, which is critical to our marketing efforts. We originate loans under the SBA’s 7(a), 504 and Express loan programs, in conformance with SBA underwriting and documentation standards. The guaranteed portion of the 7(a) loans is typically sold on the secondary market. As of December 31, 2006, we had $5.3 million of SBA loans.

One-to-Four Family Loans.   The Bank’s portfolio of one-to-four family home loans at December 31, 2006 totaled $12.8 million, of which $10.0 million consists of loans secured by first liens on real estate and $2.8 million consists of loans secured by second or junior liens on real estate. In 2006, the Bank originated two new single family loans for $1.5 million.

Loan Servicing.   Loan servicing is centralized at our corporate headquarters. Our loan servicing operations are intended to provide prompt customer service and accurate and timely information for account follow-up, financial reporting and loss mitigation. Following the funding of an approved loan, the data is entered into our data processing system, which provides monthly billing statements, tracks payment performance, and effects agreed upon interest rate adjustments. The loan servicing activities include (i) the collection and remittance of mortgage loan payments, (ii) accounting for principal and interest and other collections and expenses, (iii) holding and disbursing escrow or impounding funds for real estate taxes and insurance premiums, (iv) inspecting properties when appropriate, (v) contacting delinquent borrowers, and (vi) acting as fiduciary in foreclosing and disposing of collateral properties.

When payments are not received by their contractual due date, collection efforts are initiated by our loss mitigation personnel. Accounts delinquent more than 15 days are reviewed by our loss mitigation manager and are assigned to our collector to begin the process of collections. Our collector begins by contacting the borrower telephonically and progresses to sending a notice of intention to foreclose within 30 days of delinquency, and we will initiate foreclosure on one-to-four family loans 30 days thereafter and on multi-family and commercial real estate 10 days thereafter if the delinquent payments are not received in full. Our loss mitigation manager conducts an evaluation of all loans 90 days or more past due by obtaining an estimate of value on the underlying collateral. The evaluation may result in our establishing a specific allowance for that loan or charging off the entire loan, but still continuing with collection efforts.

Loan Portfolio Composition.   At December 31, 2006, our net loans receivable held for investment totaled $604.3 million and net loans receivable held for sale totaled $795,000. The types of loans that the Bank may originate are subject to federal law, state law, and regulations.

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The following table sets forth the composition of our loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated:

(1)             Includes second trust deeds.

(2)             Secured by real estate

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Loan Maturity.   The following table shows the contractual maturity of the Bank’s gross loans for the period indicated. The table does not reflect prepayment assumptions.

 

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The following table sets forth at December 31, 2006, the dollar amount of gross loans receivable contractually due after December 31, 2007, and whether such loans have fixed interest rates or adjustable interest rates.

 

The following table sets forth the Bank’s loan originations, purchases, sales, and principal repayments for the periods indicated:

 

Delinquencies and Classified Assets.   Federal regulations require that the Bank utilize an internal asset classification system to identify and report problem and potential problem assets.  The Bank’s Internal Asset Review (“IAR”) Manager has responsibility for identifying and reporting problem assets to the Bank’s Internal Asset Review Committee (“IARC”), which operates pursuant to the board-approved IAR policy. The policy incorporates the regulatory requirements of monitoring and classifying all assets of the Bank. The Bank currently designates or classifies problem and potential problem assets as “Special

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Mention”, “Substandard” or “Loss” assets. An asset is considered “Substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the Bank will sustain “some loss” if the deficiencies are not corrected. All real estate owned (“REO”) acquired from foreclosure is classified as “Substandard”. Assets classified as “Loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss allowance is not warranted. Assets which do not currently expose the Bank to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated “Special Mention.”

When the Bank classifies an asset, or portions thereof, as Substandard under current OTS policy, the Bank is required to consider establishing a general valuation allowance in an amount deemed prudent by management. The general valuation allowance, which is a regulatory term, represents a loss allowance which has been established to recognize the inherent credit risk associated with lending and investing activities, but which, unlike specific allowances, has not been allocated to particular problem assets. When the Bank classifies one or more assets, or portions thereof, as “Loss,” it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.

The Bank’s determination as to the classification of its assets and the amount of its valuation allowances are subject to review by the OTS, which can order the establishment of additional general or specific loss allowances or a change in a classification. The OTS, in conjunction with the other federal banking agencies, adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation allowances. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management has analyzed all significant factors that affect the collectability of the portfolio in a reasonable manner; and that management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. While the Bank believes that it has established an adequate allowance for estimated loan losses, there can be no assurance that its regulators, in reviewing the Bank’s loan portfolio, will not request the Bank to materially increase its allowance for estimated loan losses, thereby negatively affecting the Bank’s financial condition and earnings at that time. Although management believes that an adequate allowance for estimated loan losses has been established, actual losses are dependent upon future events and, as such, further additions to the level of allowances for estimated loan losses may become necessary.

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The Bank’s IARC reviews the IAR Manager’s recommendations for classifying the Bank’s assets quarterly and reports the results of its review to the board of directors. The Bank classifies assets and establishes both a general allowance and specific allowance in accordance with the board-approved Allowance for Loan Losses policy. The following table sets forth information concerning substandard assets, REO and total classified assets at December 31, 2006 for the Company:

 

At December 31, 2006, the Company had $1.0 million of Special Mention assets, $781,000 of Substandard assets, and $166,000 assets classified as Loss that are offset by a specific allowance of the same amount. The difference between the specific allowance in the above table and the total specific allowance is the specific allowance on accounts that were Substandard at one time and are currently classified either as Special Mention or as Pass.

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The following table sets forth delinquencies in the Company’s loan portfolio as of the dates indicated:

 

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