**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K**

 

**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 
| **For the fiscal year ended:  December 31, 2002** |   | **Commission File:  0-23131** |
|---------------------------------------------------|--------|-------------------------------|

 

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**People’s Preferred Capital Corporation**

(Exact name of registrantas specified in its Charter)

 

| **Maryland**                                                     |   | **95-4642529**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **221 S. Figueroa Street, Los  Angeles, California, 90012**      |
| (Address of principal  executive offices, including zip code)    |
|                                                             |   |                                  |
| **(213) 443-1400**                                               |
| (Registrant’s telephone  number, including area code)       |
|                                                             |   |                                  |
| Securities registered pursuant to Section 12(g) of the Act:      |
| **9.75% Noncumulative Exchangeable  Preferred Stock, Series A**  |

 

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Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to filing requirementsfor the past 90 days.  Yes ý  No o.

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form10-K.  ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).  Yes o  No ý

 

All 10,000 shares ofCommon Stock were held by California National Bank at December 31, 2002;therefore, no Common Stock is held by non-affiliates.

 

| **Documents incorporated by reference   in this Form 10-K** |   | **Part of Form 10-K****which incorporated** |
|-------------------------------------------------------------|--------|---------------------------------------------|
|                                                        |   | —                                      |

 

Refer to ExhibitsIndex on page 44

 

 

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| **PART I**   | **Page**                                                                                    |
|--------------|---------------------------------------------------------------------------------------------|
| Item 1       | Business                                                                                    | 3 |
|         | •                                                                                      | General | 5 |
|         | •                                                                                      | General  Description of Mortgage Assets and Other Authorized Investments; Investment  Policy | 7 |
|         | •                                                                                      | Management Policies | 11 |
|         | •                                                                                      | Servicing | 15 |
|         | •                                                                                      | Federal Income Tax  Considerations | 15 |
|         | •                                                                                      | Taxation of the Company | 15 |
|         | •                                                                                      | Taxation of  United States Stockholders | 16 |
|         | •                                                                                      | Taxation of Foreign  Stockholders | 17 |
|         | •                                                                                      | Information  Reporting Requirements and Backup Withholding Tax | 18 |
|         | •                                                                                      | Other Tax Consequences | 18 |
| Item 2       | Properties                                                                                  | 18 |
| Item 3       | Legal Proceedings                                                                           | 18 |
| Item  4      | Submission  of Matters to a Vote of Security Holders                                        | 18 |
|         |
| **PART II**  |                                                                                        |
| Item  5      | Market  for Registrant’s Common Equity and Related Stockholder Matters                 | 19 |
| Item 6       | Selected Financial Data                                                                     | 20 |
| Item  7      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 21 |
|         | •                                                                                      | Description of Portfolio | 21 |
|         | •                                                                                      | Financial Condition | 25 |
|         | •                                                                                      | Results of Operations | 25 |
|         | •                                                                                      | Allowance for Loan Losses | 26 |
|         | •                                                                                      | Liquidity and Capital  Resources | 26 |
|         | •                                                                                      | Interest Rate Risk | 26 |
| Item  7A     | Quantitative  and Qualitative Disclosures About Market Risk                                 | 27 |
| Item  8      | Financial  Statements and Supplementary Data                                                | 28 |
| Item  9      | Changes  in/Disagreements with Accountants on Accounting and Financial Disclosure           | 39 |
|         |                                                                                        |
| **PART III** |                                                                                        |
| Item  10     | Directors  and Executive Officers of the Corporation                                        | 40 |
| Item 11      | Executive Compensation                                                                      | 41 |
| Item  12     | Security  Ownership of Certain Beneficial Owners and Management                             | 42 |
| Item  13     | Certain  Relationships and Related Transactions                                             | 42 |
| Item 14      | Controls and Procedures                                                                     | 43 |
|         |
| **PART IV**  |                                                                                        |
| Item 15      | Exhibits, Financial Statement  Schedules and Reports on Form 8-K                            | 44 |

 

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**PEOPLE’SPREFERRED CAPITAL CORPORATION**

 

**PART I**

 

**ITEM 1:           BUSINESS**

 

**General**

 

*General*. People’s Preferred CapitalCorporation (the “Company”) was originally a real estate investment trust(“REIT”) formed in June 1997 to acquire, hold and manage mortgage assets andother authorized investments.  TheCompany is a wholly owned subsidiary of California National Bank (the “Bank”).  To date, all the Company’s mortgage assetshave been acquired from the Bank, and we expect that any new mortgage assetswill be acquired from the Bank.

 

On April 30, 2001, PBOC Holdings, Inc. (“PBOC”), thesole stockholder and holding company of People’s Bank of California, wasacquired by FBOP Corporation (“FBOP”), a closely held bank and savingsinstitution holding company that owns banks in California, Illinois, Texas andArizona.  FBOP merged People’s Bank ofCalifornia into its wholly-owned subsidiary, California National Bank, onNovember 13, 2001 and the subsidiaries of People’s Bank of California,including the Company, became subsidiaries of California National Bank.

 

*Failureto Continue to Qualify as a REIT*.  By virtue of the acquistion of PBOC by FBOP, we have failed toqualify for taxation as a REIT, retroactive to the beginning of 2001.  Because FBOP is a privately-ownedcorporation, we no longer satisfy the “five or fewer” test which requires thatno more than 50% in value of our outstanding stock be owned, directly orindirectly, by five or fewer individuals at any time during the last half ofeach taxable year.  Prior to theconsummation of the acquistion, we were able to attribute ownership indirectlyto PBOC’s public stockholders.

 

By failing to qualify for taxation as a REIT, we aresubject to tax (including any applicable alternative minimum tax) on ourtaxable income at regular corporate rates, which reduces income that wouldotherwise be available to our stockholders. The provision for income taxes was $2,442,000 for the year endedDecember 31, 2002. Unless entitled to relief under specific statute, we aredisqualified from taxation as a REIT for the four taxable years following theyear during which qualification was lost and we are not permitted to requalifyunless we distribute any earnings and profits attributable to the period duringwhich we failed to qualify.

 

Distributions to stockholders are not required to bemade nor are they deductible by the Company. If made, all distributions to stockholders, to the extent of current andaccumulated earnings and profits, are taxable as ordinary income but, subjectto certain limitations of the Internal Revenue Code of 1986 as amended (the“Code”), corporate distributees may be eligible for the dividends receiveddeduction. Distributions to stockholders in excess of the Company’s current andaccumulated earnings and profits would represent a return of capital andgenerally would not be taxable.  For thefiscal years ended December 31, 2002 and December 31, 2001, the Company made distributionsin excess of current and accumulated earnings and profits such that thedistributions to stockholders for the year included a return of capitalcomponent.

 

*CompanyCould Redeem the Series A Preferred Shares*. On or afterOctober 15, 2002, the Series A Preferred Shares may be redeemed at any time, inwhole or in part, at a redemption price of per share equal to (i) $25.00 and(ii) an amount equal to all authorized, declared and unpaid dividends, if any,to the redemption date, without interest, and without duplication, anadditional amount equal to the amount of dividends that would be payable on theSeries A Preferred Shares from the first day of the dividend 

 

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period in which the redemption date occurs to the redemption date(assuming such dividends are authorized and declared).  The Company is evaluating the possibility ofredeeming the Series A Preferred Shares.

 

The Company commenced its operations in October 1997upon consummation of a public offering of 1,426,000 shares of its 9.75%Noncumulative Exchangeable Preferred Stock, Series A (the “Series APreferred Shares”), at an offering price of $25.00 per share. The Series APreferred Shares are traded on the NASDAQ National Market under the symbol“PPCCP.” All shares of common stock are owned by the Bank.  Subsequently, our Board of Directors,including a majority of the independent directors, authorized the filing of aRegistration Statement with the Securities and Exchange Commission (“SEC”) forthe issuance of Series B Preferred Shares, which to the extent issued, will beparity stock with respect to the Series A shares.  The Registration Statement was filed on August 9, 1999.  To date, the Company has not issued anySeries B Preferred Shares and, due to market conditions, the Company has noimmediate plans with respect to the issuance of such securities.

 

*Descriptionof the Business*.  TheCompany’s principal business objective is to acquire, hold and manage MortgageAssets and Other Authorized Investments (as defined herein) that will generatenet earnings for distribution to stockholders. At December 31, 2002, we had total assets of $75.6 million, totalliabilities of $3.8 million and stockholders’ equity of $71.8 million.  As of that date, $63.0 million of ourassets, or 83.4%, were comprised of mortgage loans, net of the allowance forloan losses.  The loan portfoliocontained 1 residential mortgage loan, representing approximately 1% of theunpaid principal balance of our total portfolio, and 67 commercial mortgageloans, representing 99% of the unpaid principal balance of our total portfolio.

 

The Company’s Mortgage Assets may be acquired from theBank or purchased from unaffiliated third parties as whole loans secured byfirst mortgages or deeds of trust (“Mortgage Loans”) on single-family(1-4 unit) residential real estate properties (“Residential Mortgage Loans”) orby multifamily residential and commercial nonresidential properties(collectively, “Commercial Mortgage Loans”). Although the Company has the authority to acquire an unlimited number ofResidential Mortgage Loans and Commercial Mortgage Loans from unaffiliatedthird parties such as other financial institutions and mortgage banks, all ofthe Company’s Mortgage Assets as of December 31, 2002 were acquired from theBank. The Company has no present plans or expectations with respect topurchases from unaffiliated third parties. During 2002, the Company acquired additional multifamily mortgage loansoriginated by the Bank with an aggregate principal balance of $21.9million.  In 2001, the Company acquiredmortgage loans with an aggregate principal balance of $69.6 million from theBank.

 

*DividendPolicy*. Dividends are authorized and declared at thediscretion of the Board of Directors after considering the Company’s fundsavailable for distribution, financial requirements, tax considerations andother factors. The Company currently expects that its cash available fordistribution will be approximately equal to the amount needed to pay dividendson the Series A Preferred Shares. Accordingly, the Company does not expect topay dividends to the holder of its Common Stock unless and until net income isin excess of the amount needed to pay dividends on the Series A PreferredShares.

 

The Company did not declare any dividends on theCommon Stock in 2002, compared to $700,000 declared and paid in 2001.  When the Company declares a Common Stockdividend, there are limitations on the Company’s ability to pay suchdividends.  First, no cash dividends orother distributions may be paid on the Common Stock unless and until (i) theCompany has paid full dividends on the Series A Preferred Shares for the fourmost recent Dividend Periods and has declared a cash dividend on the Series APreferred Shares at the annual dividend rate for the current Dividend Period,and (ii) the terms of all other Company stock ranking senior to the CommonStock have been complied with.  Second,the Maryland General Corporation law (“MGCL”) provides that dividends and otherdistributions may not be paid by a corporation if, after giving effect to thedistribution (i) the corporation would not be able to pay its

 

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indebtedness as it becomes due in the usual course of business or (ii)the corporation’s total assets would be less than the sum of the corporation’stotal liabilities plus the amount needed to satisfy the preferential rights ondissolution, if the corporation were to be dissolved at the time ofdistribution, of stockholders whose preferential rights on dissolution aresuperior to those receiving the distribution, unless the articles ofincorporation of the corporation permit otherwise.  The Articles of Incorporation of the Company do not permitotherwise.  The Company has compliedwith the above requirements.

 

The Office of the Comptroller of the Currency (“OCC”)is the primary regulator of the Bank. Under the prompt corrective actionregulations no financial institution may make a capital distribution unless itis at least “adequately capitalized” and the capital distribution would notcause it to be less than “adequately capitalized”.  Currently, an institution is considered “adequately capitalized”if it has a total risk-based capital ratio of at least 8.0%, a Tier 1risk-based capital ratio of at least 4.0% and a leverage (or core capital)ratio of at least 4.0%.  At December 31,2002, the Bank’s total risk-based capital ratio was 11.74%, the Tier 1risk-based capital ratio was 10.70% and core capital (or leverage) ratio was8.97%.  The Bank intends to maintain itscapital ratios in excess of the “well-capitalized” levels under the promptcorrective action regulations.  However,there can be no assurance that the Bank will be able to maintain such capitallevels.

 

If the Bank should (i) become “undercapitalized” underthe prompt corrective action regulations established pursuant to the FederalDeposit Insurance Corporation Improvement Act of 1991, as amended (“FDICIA”),(ii) be placed into conservatorship or receivership or (iii) the appropriatefederal regulatory agency, in its sole discretion, anticipates the Bankbecoming “undercapitalized” in the near term (an “Exchange Event”), theappropriate federal regulatory agency will direct in writing that each Series APreferred Share be exchanged automatically (the “Automatic Exchange”) for onenewly issued Series A preferred share of the Bank (“Bank PreferredShares”).  In the event of the AutomaticExchange, the Bank Preferred Shares would constitute a new series of preferredshares of the Bank that would have the same dividend rights, liquidationpreference, redemption options and other attributes as the Series A PreferredShares, except that (i) the Bank Preferred Shares would not be redeemable uponthe occurrence of a Tax Event and (ii) the Bank Preferred Shares would not belisted on a national stock exchange or national quotation system, and wouldrank on an equal basis in terms of cash dividend payments and liquidationpreference with any other shares of preferred stock of the Bank outstanding atthe time of the Automatic Exchange.

 

If an Automatic Exchange were to occur, then the Bankwould likely be prohibited from paying dividends on the Preferred Shares.  In all circumstances following an AutomaticExchange, the Bank’s ability to pay dividends would be subject to variousrestrictions under OCC regulations. Under certain circumstances, including a determination that the Bank’srelationship to the Company results in an unsafe and unsound banking practice,the OCC has the authority to issue an order that restricts the ability of theCompany to make dividend payments to its stockholders.  In addition, in the event of a liquidationof the Bank, the claims of the Bank’s depositors and creditors would beentitled to priority of payment over the dividend and other claims of holdersof equity interests, such as the Bank Preferred Shares, issued pursuant to anAutomatic Exchange.

 

**General Description of MortgageAssets and Other Authorized Investments; Investment Policy**

 

*ResidentialMortgage Loans*.  TheCompany may from time to time acquire both conforming and nonconformingResidential Mortgage Loans.  ConformingResidential Mortgage Loans comply with the requirements for inclusion in a loanguarantee program sponsored by either the Federal Home Loan MortgageCorporation (“FHLMC”) or Federal National Mortgage Association (“FNMA”). Undercurrent regulations, the maximum principal balance allowed on conformingResidential Mortgage Loans ranges from $322,700 for one-unit residential loansto $620,550 for four-unit residential loans. Nonconforming Residential MortgageLoans are Residential Mortgage Loans that do not qualify in one or morerespects for

 

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purchase by FNMA or FHLMC under their standard programs.  The nonconforming Residential Mortgage Loansacquired by the Company to date are nonconforming because they have originalprincipal balances which exceed the requirements for FHLMC or FNMA programs orbecause they vary in certain other respects from the requirements of suchprograms other than the requirements relating to the creditworthiness of themortgagors.  The Company’s nonconformingResidential Mortgage Loans are expected to meet the requirements for sale tonational private mortgage conduit programs or other investors in the secondarymortgage market.

 

Each Residential Mortgage Loan is evidenced by apromissory note secured by a mortgage or deed of trust or other similarsecurity instrument creating a first lien on single-family (1-4 unit)residential properties.  Residentialreal estate properties underlying Residential Mortgage Loans consist ofindividual dwelling units, individual condominium units, two-to-four familydwelling units, townhouses and planned unit developments.  All of the Residential Mortgage Loansacquired to date by the Company have been fixed rate Mortgage Loans.  However, the Company may from time to timeacquire adjustable rate Residential Mortgage Loans.

 

*CommercialMortgage Loans*.  TheCompany may from time to time acquire Commercial Mortgage Loans secured bymultifamily properties of five units or more, industrial, warehouse andself-storage properties, office buildings, office and industrial condominiums,retail space and strip shopping centers, mixed use commercial properties,mobile home parks, nursing homes, hotels and motels (“CommercialProperties”).  All of the CommercialMortgage Loans in the Company’s portfolio are secured by real estate located inCalifornia.

 

  UnlikeResidential Mortgage Loans, Commercial Mortgage Loans generally lackstandardized terms. Commercial Mortgage Loans also may not be fully amortizing,meaning that they may have a significant principal balance or “balloon” paymentdue on maturity. Moreover, commercial properties, particularly industrial andwarehouse properties, generally are subject to relatively greater environmentalrisks than non-commercial properties, giving rise to increased costs ofcompliance with environmental laws and regulations.  There is no requirement regarding the percentage of anycommercial real estate property that must be leased at the time the Companyacquires a Commercial Mortgage Loan secured by such commercial real estateproperty nor are Commercial Mortgage Loans required to have third partyguarantees.

 

The credit quality of a Commercial Mortgage Loan maydepend on, among other factors, the existence and structure of underlyingleases, the physical condition of the property (including whether anymaintenance has been deferred), the creditworthiness of tenants, the historicaland anticipated level of vacancies and rents on the property and on othercomparable properties located in the same region, potential or existingenvironmental risks, the availability of credit to refinance the CommercialMortgage Loan at or prior to maturity and the local and regional economicclimate in general. Foreclosures of defaulted Commercial Mortgage Loansgenerally are subject to a number of complicating factors, includingenvironmental considerations, which are not generally present in foreclosuresof Residential Mortgage Loans.

 

*Mortgage-BackedSecurities*.  TheCompany may from time to time acquire Mortgage-Backed Securities representinginterests in or obligations backed by pools of Mortgage Loans (“Mortgage-BackedSecurities”).  The Company intends toacquire only investment-grade Mortgage-Backed Securities or those issued orguaranteed by agencies of the federal government or government-sponsoredagencies.  The Mortgage Loans underlyingthe Mortgage-Backed Securities would be secured by single-family residential,multi-family or commercial real estate properties located throughout the UnitedStates.  The Company does not intend toacquire any interest-only, principal-only or high-risk Mortgage-Backed Securities.The Company is not precluded from investing in Mortgage-Backed Securities inwhich the Bank is the sponsor

 

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or issuer.  At December 31,2002, the Company did not hold any investments in Mortgage-Backed Securities.

 

*OtherAssets*.  The Companymay invest up to 20% of the total value of its assets in investments other thanResidential Mortgage Loans, Commercial Mortgage Loans and Mortgage-BackedSecurities, cash and cash equivalents, including receivables, and governmentsecurities. At December 31, 2002, the Company did not hold any suchinvestments.

 

**ManagementPolicies**

 

*General*.  In administering the Company’s MortgageAssets and Other Authorized Investments, the Advisor (defined below) has a highdegree of autonomy. The Board of Directors, however, has adopted certainpolicies to guide administration of the Company and the Advisor with respect tothe acquisition and disposition of assets, use of capital and leverage, creditrisk management and certain other activities. These policies, which arediscussed below, may be amended or revised from time to time at the discretionof the Board of Directors (in certain circumstances subject to the approval ofa majority of the Independent Directors) without a vote of the Company’sstockholders, including holders of the Series A Preferred Shares.

 

*UnderwritingStandards*.  The Bankhas represented to the Company that all of the Residential Mortgage Loans andCommercial Mortgage Loans acquired by the Company (including those that wereoriginated by unaffiliated third parties) were originated in accordance withthe underwriting policy customarily employed by the Bank during the periods inwhich the Residential Mortgage Loans and Commercial Mortgage Loans acquired bythe Company were originated.

 

The underwriting standards applied at origination ofthe Residential Mortgage Loans included in the Company’s portfolio wereintended to evaluate the borrower’s credit standing and repayment ability, andthe value and adequacy of the underlying mortgaged property as collateral.  Generally, each prospective borrower wasrequired to provide a loan application and other supporting documentsdescribing assets and liabilities, the borrower’s income and expenses, as wellas, to the extent required by applicable state law, an authorization to applyfor a credit report which summarized the borrower’s credit history withmerchants and lenders and any record of bankruptcy.

 

For any prospective borrower, an employmentverification was obtained from the borrower’s employer which included thelength of employment with the employer, the employee’s current salary, andwhether it was expected that the borrower would continue such employment in thefuture or the borrower submitted such other evidence of employment (such as paystubs) satisfactory to the Bank. For a self-employed prospective borrower, theborrower generally was required to submit copies of personal and businessfederal income tax returns for the previous two years. For certain prospectiveborrowers, the borrower authorized verification of all deposits at financialinstitutions at which the borrower had demand or savings accounts.  The underwriting officer considering theloan application then reviewed the credit report and employment and depositverifications and made a determination as to whether the prospective borrowerhad sufficient monthly income available to meet (i) the borrower’s monthlyobligations on the proposed Residential Mortgage Loan (determined on the basisof the monthly payments due in the year of origination) and other relatedexpenses and (ii) other financial obligations and monthly living expenses.

 

In determining the adequacy of the property ascollateral, an appraisal was made of each property considered for financing.  Each appraiser was selected in accordancewith predetermined guidelines established for appraisers. The appraiser wasrequired to inspect the property and verify that it was in good condition andthat construction, if new, had been completed. The appraisal was based on theappraiser’s judgment of value giving appropriate weight to both the marketvalue of comparable properties and the cost of replacing the property and otherfactors as appropriate. If the appraiser reported any exceptions to the

 

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verification, the Bank or its agent determined that the property hadbeen substantially completed or other exception remedied to its satisfaction.The Bank’s underwriting standards also required a search of the public recordsrelating to a mortgaged property for liens and judgments against such mortgagedproperty, as well as customary title insurance.

 

The loan underwriting procedures and guidelinesutilized by the Bank in originating Commercial Mortgage Loans acquired by theCompany were intended to assess the value of the related mortgaged property,the ability of such mortgaged property to be used by the borrower or its agentsand the financial condition of the borrower, including its ability to service theCommercial Mortgage Loan.  Theunderwriting guidelines took into account such factors as suitability of themortgaged property for its proposed use, the availability, rental rates andrelative value of comparable properties in the relevant market area, theanticipated growth or decline in both the immediate and broader geographicareas in which the mortgaged property is located, the current or projectedoccupancy or leasing ratios, if relevant, the condition and age of themortgaged property; the management ability of the borrower, including businessexperience and financial soundness and such other economic, demographic andother factors as, in the Bank’s judgment, might affect the value of themortgaged property and the ability of the borrower to service the CommercialMortgage Loan. Each proposal for a Commercial Mortgage Loan was presented tothe appropriate lending personnel of the Bank, which analyzed the proposedtransaction focusing on economic assumptions and the feasibility of the loan,identified and evaluated potential risks and made a recommendation to approveor disapprove the loan.

 

The proposed transaction was then presented to thecredit committee of the Bank for approval. After a loan proposal was approved, a loan commitment was issued by theBank to the proposed borrower, subject to, among other things, an appraisalreport and, if required or deemed appropriate, environmental engineeringreports.  The Bank contracted withapproved firms to prepare certain required reports.

 

*AssetAcquisition and Disposition Policies*.  The Company anticipates that from time totime it will purchase additional Mortgage Loans from the Bank on a basisconsistent with secondary market standards, pursuant to its Mortgage PurchaseAgreements with the Bank, from the proceeds received in connection with therepayment or disposition of Mortgage Loans or the issuance of additional sharesof Preferred Stock.  The Companyanticipates that additional Mortgage Loans purchased from the Bank will bepurchased on terms that are substantially identical to those that could beobtained by the Company if such loans were purchased from third partiesunaffiliated with the Company. The Company has no present plans or intentionsto purchase Mortgage Loans from unaffiliated third parties. The Companycurrently anticipates that additional Mortgage Loans acquired by the Companywill be of the types described in “Item 7. Management’s Discussion and Analysisof Financial Condition and Results of Operations – Description of Portfolio,”although the Company may purchase additional types of Mortgage Loans and is notlimited as to the amount that may be purchased.

 

In addition, the Company from time to time may acquireMortgage-Backed Securities representing interests in or obligations backed bypools of Mortgage Loans secured by single-family residential, multi-family orcommercial real estate properties located throughout the United States, as wellas a limited amount of Other Authorized Investments. The Company currentlyanticipates that it will not acquire the right to service any Mortgage Loan itacquires in the future and that the Bank will act as servicer of any suchResidential Mortgage Loans and Commercial Mortgage Loans.  The Company anticipates that any servicingarrangement that it enters into in the future with the Bank will contain feesand other terms that would be substantially equivalent to those that would becontained in servicing arrangements entered into with third partiesunaffiliated with the Company.  See“Servicing.”

 

The Company’s current policy is not to acquire anysingle Commercial Mortgage Loan that constitutes more than 15.0% of the totalbook value of the Mortgage Assets of the Company at the time of itsacquisition.  In addition, the Company’scurrent policy prohibits the acquisition of any Mortgage Loan or

 

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any interest in a Mortgage Loan (other than an interest resulting fromthe acquisition of Mortgage-Backed Securities), which (i) is delinquent in thepayment of principal or interest at the time of proposed acquisition; (ii) isor was at any time during the preceding 12 months either classified, onnonaccrual status or renegotiated due to the financial deterioration of theborrower; or (iii) has been, more than once during the preceding 12 months,more than 30 days past due in the payment of principal or interest.  Mortgage Loans that are in “nonaccrualstatus” are generally loans that are past due 90 days or more in principal orinterest, and “classified” Mortgage Loans are generally troubled loans that aredeemed substandard, doubtful or loss with respect to collectibility.  See “Servicing” for a discussion of thetreatment of Mortgage Loans which become nonperforming or real estate owned(“REO”).

 

*Capitaland Leverage Policies*. To the extent the Board of Directors determines that additional fundingis required, the Company may raise funds through additional equity offerings,debt financing or retention of cash flow, taking into account taxes that wouldbe imposed on undistributed taxable income, or a combination of these methods.

 

The Company had no debt outstanding at December 31,2002, and the Company does not currently intend to incur any indebtedness.However, the organizational documents of the Company do not contain anylimitation on the amount or percentage of debt, funded or otherwise, theCompany might incur, except that the debt for borrowed money the Company incursin excess of 20% of the Company’s total stockholders’ equity will require theapproval of a majority of the independent directors.  Any such debt incurred may include intercompany advances made bythe Bank to the Company.

 

The Company also may issue additional series ofPreferred Stock.  However, the Companymay not issue additional shares of Preferred Stock senior to the Series APreferred Shares without first obtaining the consent of holders of at leasttwo-thirds of the outstanding shares of Series A Preferred Shares, and theCompany may not issue additional shares of Preferred Stock on a parity with theSeries A Preferred Shares without first obtaining the approval of a majority ofthe Company’s independent directors. The Company does not currently intend toissue any additional series of Preferred Stock unless it simultaneouslyreceives additional capital contributions from the Bank equal to the aggregateoffering price of such additional Preferred Stock plus the Company’s expenses(including underwriting commissions or placement fees) in connection with theissuance of such additional shares of Preferred Stock.  Prior to the issuance of additional sharesof Preferred Stock, the Company will take into consideration, among otherthings, the Bank’s regulatory capital requirements and an assessment of otheravailable options for raising any necessary capital.

 

*CreditRisk Management Policies*. The Company expects that each Mortgage Loan acquired in the future willrepresent a first lien position and will be originated by the Bank or anunaffiliated third party in the ordinary course of its real estate lendingactivities based on the underwriting standards applied by the Bank or thirdparty for its own account, at the time of origination.  See “Underwriting Standards.”  The Company also expects that all MortgageLoans held by the Company will be serviced pursuant to the Servicing Agreementsdescribed below, which require servicing in conformity with FNMA and FHLMCguidelines and procedures, in the case of Residential Mortgage Loans, and withany servicing guidelines promulgated by the Company with respect to CommercialMortgage Loans.

 

*Conflictof Interest Policies*. Because of the nature of the Company’s relationship with the Bank, it islikely that conflicts of interest will arise with respect to certaintransactions, including, without limitation, the Company’s acquisition ofMortgage Loans from the Bank, disposition of Mortgage Loans to the Bank,foreclosure on defaulted Commercial Mortgage Loans and the modification of theAdvisory Agreement or the Servicing Agreements. It is the Company’s policy thatthe terms of any financial dealings with the Bank will be consistent with thoseavailable from third parties in the mortgage lending industry. In addition,neither the Advisory Agreement nor the Servicing Agreements may be modified orterminated without the approval of a majority of the independent directors.

 

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Conflicts of interest between the Company and the Bankmay also arise in connection with making decisions regarding the creditarrangements that the Bank may have with a mortgagor under a Mortgage Loan.Conflicts also could arise in connection with actions taken by the Bank as acontrolling person in the Company.  Itis the intention of the Company and the Bank that any agreements andtransactions between the Company and the Bank, including without limitation theMortgage Purchase Agreements and Servicing Agreements, be fair to all partiesand consistent with market terms for such transactions.  The requirement in the Articles ofIncorporation that certain actions of the Company be approved by a majority ofthe independent directors also is intended to ensure fair dealings between theCompany and the Bank.  There can be noassurance, however, that any such agreement or transaction will be on terms asfavorable to the Company as could have been obtained from unaffiliated thirdparties.

 

There are no provisions in the Company’s Articles ofIncorporation limiting any officer, director, security holder or affiliate ofthe Company from having any direct or indirect pecuniary interest in anyMortgage Asset to be acquired or disposed of by the Company or in anytransaction in which the Company has an interest or from engaging in acquiring,holding and managing Mortgage Assets. As described herein, the Bank has directinterests in transactions with the Company (including without limitation thesale of Mortgage Assets to the Company); however, no officers or directors ofthe Company have or will have any interests in such Mortgage Assets.

 

*OtherPolicies*.  The Companyintends to operate in a manner that will not subject it to regulation under theInvestment Company Act.  The Companydoes not intend to (i) invest in the securities of other issuers for thepurpose of exercising control over such issuers, (ii) underwrite securities ofother issuers, (iii) actively trade in loans or other investments, (iv) offersecurities in exchange for property or (v) make loans to third parties,including, without limitation, officers, directors or other affiliates of theCompany. The Company may, under certain circumstances, purchase the Series APreferred Shares and other shares of its capital stock in the open market orotherwise.  The Company has no presentintention to repurchase any shares of its capital stock, and any such actionwould be taken only in conformity with applicable federal and state laws andregulations.

 

The Company conducts its operations so as not tobecome regulated as an investment company under the Investment CompanyAct.  The Investment Company Act exemptsentities that, directly or through majority-owned subsidiaries, are “primarilyengaged in the business of purchasing or otherwise acquiring mortgages andother liens on and interests in real estate” (“Qualifying Interests”).  Under current interpretations by the staffof the Securities and Exchange Commission (“SEC”), in order to qualify for thisexemption, the Company, among other things, must maintain at least 55% of itsassets in Qualifying Interests and also may be required to maintain an additional25% in Qualifying Interests or other real estate-related assets.  Therefore, the assets that the Company mayacquire may be limited by the provisions of the Investment Company Act.  The Company has established a policy oflimiting Other Authorized Investments to no more than 20% of the value of theCompany’s total assets.

 

The Articles of Incorporation provide that the Companyshall maintain its status as a reporting company under the Securities andExchange Act of 1934, as amended (“Exchange Act”) for so long as any of theSeries A Preferred Shares are outstanding.

 

*AdvisoryAgreement*.  TheCompany entered into an advisory agreement with the Bank (the “AdvisoryAgreement”) pursuant to which the Bank administers the day-to-day operations ofthe Company. In its role as advisor under the terms of the Advisory Agreement,the Bank is hereinafter referred to as the “Advisor.” The Advisor isresponsible for, among other things: (i) monitoring the credit quality of Mortgage Assets and OtherAuthorized Investments held by the Company; (ii) advising the Company withrespect to the acquisition, management, financing and disposition of theCompany’s Mortgage Assets and Other Authorized Investments; and (iii)representing the Company in its day-to-day dealings with persons

 

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with whom the Company interacts. The Advisor may subcontract all or a portion of its duties to one ormore of its affiliates.  The Advisormay, with the approval of a majority of the Board of Directors, including amajority of the independent directors, subcontract all or a portion of itsobligations under the Advisory Agreement to unrelated third parties. Inconnection with the subcontracting of any of its obligations under the AdvisoryAgreement, the Advisor will not be discharged or relieved in any respect fromits obligations under the Advisory Agreement. The Advisor and its personnelhave substantial experience in mortgage finance and in the administration ofMortgage Loans and Other Authorized Investments.

 

The Advisory Agreement had an initial term of fiveyears, and is renewed automatically for additional five-year periods unlessnotice of nonrenewal is delivered to the Advisor by the Company. The Companymay terminate the Advisory Agreement at any time with 90 days notice. As longas any Series A Preferred Shares remain outstanding, any decision by theCompany either not to renew the Advisory Agreement or to terminate the AdvisoryAgreement must be approved by a majority of the Board of Directors, as well asby a majority of the independent directors. Prior to September 2002, theAdvisor was entitled to receive an annual advisory fee of $200,000.  However, the Advisor waived its advisoryfees from June 30, 2001 to June 30, 2002 and agreed that it would not attemptat any later date to go back and recover any of the foregone fees.  As of September 2002, the annual advisoryfee is $40,000, paid in quarterly installments.

 

**Servicing**

 

*ResidentialMortgage Loan Servicing*. All Residential Mortgage Loans owned by the Company are serviced by theBank under the terms of a Residential Mortgage Loan Servicing Agreement.  The Residential Servicing Agreement providesthat the Servicing Agent will receive an annual servicing fee with respect toeach Residential Mortgage Loan serviced for the Company that shall be equal tothe outstanding principal balance of such Residential Mortgage Loans multipliedby a fee of 0.25% (in the case of fixed rate Residential Mortgage Loans) and0.375% (in the case of adjustable rate Residential Mortgage Loans).

 

The Residential Servicing Agreement requires theServicing Agent to service the Company’s Residential Mortgage Loans in a mannergenerally consistent with servicing guidelines promulgated by the Bank and withFNMA and FHLMC guidelines and procedures and as otherwise set forth in theResidential Servicing Agreement. The Servicing Agent will collect and remitprincipal and interest payments, administer mortgage, custodial and escrowaccounts, submit and pursue insurance claims and initiate and superviseforeclosure proceedings on the Residential Mortgage Loans it services. TheServicing Agent also will provide accounting and reporting services to theCompany for such Residential Mortgage Loans. Additionally the Servicing Agent will assume responsibility for paymentof ground rents, taxes, assessments, mortgage insurance premiums, and othercharges that are or may become liens upon the mortgaged property. The ServicingAgent is responsible for any late charges or tax penalties incurred due to itsfailure to pay such bills.  TheResidential Servicing Agreement requires the Servicing Agent to followcollection procedures that are consistent with the Servicing Agent’s proceduresfor servicing mortgage loans comparable to the Residential Mortgage Loans andto exercise the degree of care required by FNMA and FHLMC.

 

The Servicing Agent may waive, modify or vary any termof any Residential Mortgage Loan or consent to the postponement of compliancewith any such term or in any manner grant indulgence to any borrower if in theServicing Agent’s reasonable and prudent determination such waiver,modification, postponement or indulgence is not materially adverse to theCompany, except that the Servicing Agent shall not permit any modification withrespect to any Residential Mortgage Loan that would decrease the mortgageinterest rate (other than by adjustments required by the terms of the mortgagenote), defer or forgive the payment of any principal or interest payments,reduce the outstanding principal amount (except for actual payments ofprincipal), make future advances or extend the final maturity date on

 

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any Residential Mortgage Loan without the Company’s prior writtenconsent.  However, the Servicing Agentmay permit forbearance or allow for suspension of monthly payments if theborrower is in default or the Servicing Agent determines in its reasonablediscretion that default is imminent and that granting such forbearance orsuspension is in the best interest of the Company. The Servicing Agent will useits best efforts, consistent with the procedures the Servicing Agent would usein servicing loans for its own account, to foreclose upon or otherwise convertthe ownership of properties securing any Residential Mortgage Loans that comeinto and continue in default for which no satisfactory agreements can be madefor the collection of delinquent payments.

 

The Residential Servicing Agreement requires theServicing Agent to pay all customary reasonable and necessary expenses relatedto the performance of its duties under such agreements, including, but notlimited to, costs associated with the preservation, restoration and protectionof mortgaged property and enforcement of any required judicialproceedings.  For advances ofreimbursable out-of-pocket costs and expenses, the Servicing Agent generallywill be reimbursed out of proceeds related to such Residential Mortgage Loan.

 

In connection with any foreclosure proceedings thatthe Servicing Agent may institute, the Servicing Agent may exercise any powerof sale contained in any mortgage or deed of trust, obtain a deed in lieu offoreclosure or otherwise acquire title to a mortgaged property underlying aResidential Mortgage Loan by operation of law or otherwise in accordance withthe terms of the Residential Servicing Agreement.  In the event that title to the property securing a ResidentialMortgage Loan is acquired in foreclosure or by deed in lieu of foreclosure, thedeed or certificate of sale shall be taken in the name of the Company.  The Bank will service such REO on behalf ofthe Company.

 

The Company may terminate the Residential ServicingAgreement upon the occurrence of one or more events specified in theAgreement.  Such events generally relateto either (i) the Servicer’s proper and timely performance of its duties andobligations under the Residential Servicing Agreement or (ii) the appointmentof a conservator, receiver or liquidator in any insolvency, bankruptcy orsimilar proceeding.  In addition, theCompany may terminate the Residential Servicing Agreement with the Bank withoutcause upon payment of a termination fee equal to 1.5% of the aggregateoutstanding principal balance of the loans then serviced under theAgreement.  As long as any Series APreferred Shares remain outstanding, the Company may not terminate, or electnot to renew, the Residential Servicing Agreement without first obtaining theapproval of a majority of the independent directors.

 

As is customary in the mortgage loan servicingindustry, the Servicing Agent will be entitled to retain any late paymentcharges, penalties and assumption fees collected in connection with theResidential Mortgage Loans it services. In addition, the Servicing Agent will receive any benefit derived frominterest earned on collected principal and interest payments between the dateof collection and the date of remittance to the Company and from interestearned on tax and insurance impound funds with respect to Residential MortgageLoans it services.  The ResidentialServicing Agreement requires the Servicing Agent to remit to the Company nolater than the 18th day of each month (or the next business day ifthe 18th day is not a business day) all principal and interestcollected from borrowers of Residential Mortgage Loans it services during theimmediately preceding month.

 

When any mortgaged property underlying a Mortgage Loanis conveyed by a mortgagor, the Servicing Agent generally will enforce any“due-on-sale” clause contained in the Residential Mortgage Loan, to the extentpermitted under applicable law and governmental regulations and subject to theCompany’s prior approval.  The terms ofa particular Residential Mortgage Loan or applicable law, however, may providethat the exercise of the “due-on-sale” clause is prohibited under certaincircumstances.  Under suchcircumstances, the Servicing Agent will negotiate an assumption agreement withthe person to whom the mortgaged property has been conveyed or is proposed tobe conveyed, in which such person becomes liable under the mortgage note.  When an assumption is allowed, the Servicing

 

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Agent will be authorized to negotiate a substitution of liabilityagreement with the person to whom the mortgage property has been conveyed or isproposed to be conveyed in which the original mortgagor is released fromliability and such person is substituted as mortgagor and becomes liable underthe applicable mortgage note. Upon any assumption of a Residential MortgageLoan by a transferee, a fee equal to a specified percentage of the outstandingprincipal balance of the Residential Mortgage Loan is typically required. TheServicing Agent will be authorized to collect and retain such assumption feesas are permitted by the terms of the mortgage loan documents and applicable lawas additional servicing compensation.

 

*CommercialMortgage Loan Servicing*. The Bank services the Commercial Mortgage Loans pursuant to the terms ofa Commercial Servicing Agreement.  TheBank receives an annual servicing fee with respect to each Commercial MortgageLoan serviced for the Company equal to the outstanding principal balance ofsuch Commercial Mortgage Loans multiplied by a fee of 0.25% to 0.375%.

 

The Bank may, from time to time, subject to approvalof a majority of the independent directors, subcontract all or a portion of itsobligations under the Commercial Servicing Agreement.  To the extent it subcontracts any of its obligations under theCommercial Servicing Agreement, the Bank will not be discharged or relieved inany way from its obligations to the Company to perform thereunder.

 

The Commercial Servicing Agreement requires the Bankto service the Company’s Commercial Mortgage Loans in a manner generallyconsistent with procedures and practices customarily employed and exercised bythe Bank and with any servicing guidelines promulgated by the Company.  The Bank collects and remits principal andinterest payments, administers custodial and escrow accounts, submits andpursues insurance claims and initiates and supervises foreclosure proceedingson the Commercial Mortgage Loans it services. The Bank also provides accounting and reporting services required by theCompany for such Commercial Mortgage Loans.  Additionally, for all Commercial Mortgage Loans, the Bank assumesresponsibility for payment of taxes and other charges that are or may become alien upon the mortgaged property.  TheBank also is responsible for any late charges or tax penalties incurred due toits failure to pay such bills.  TheCommercial Servicing Agreement requires the Bank to follow collectionprocedures that are consistent with the Bank’s procedures for the CommercialMortgage Loans held for its own account, including contacting delinquentborrowers and supervising foreclosures and property dispositions in the eventof unremedied defaults.  The Bank may,in its discretion, arrange with a defaulting borrower a schedule for theliquidation of delinquencies.  The Bankwill use its best efforts, consistent with the procedures that the Bank woulduse in servicing loans for its own account, to foreclose upon or otherwisecomparably convert the ownership of properties securing the Commercial MortgageLoans that come into and continue in default for which no satisfactoryagreements can be made for collection of delinquent payments.

 

The Commercial Servicing Agreement requires the Bankto pay all customary, reasonable and necessary expenses related to theperformance of its duties under the Commercial Servicing Agreement, including,but not limited to, costs associated with the preservation of mortgagedproperty and enforcement of any required judicial proceedings.  The Bank generally will be reimbursed priorto the Company out of proceeds related to such Commercial Mortgage Loans.  The Bank also will be entitled toreimbursement by the Company for expenses incurred by it in connection with theliquidation of defaulted Commercial Mortgage Loans serviced by it and inconnection with the restoration of mortgaged property.

 

If claims are not made orpaid under applicable insurance policies or if coverage thereunder has ceased,the Company will suffer a loss to the extent that the proceeds from liquidationof the mortgaged property, after reimbursement of the Bank’s selling expenses,are less than the outstanding principal balance of the related CommercialMortgage Loan.  The Bank is responsibleto the Company for any loss suffered as a result of its failure to make andpursue timely claims or as a result of actions taken or omissions made by itwhich cause the policies to be canceled by the insurer.

 

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In connection with anyforeclosure proceedings that the Bank may institute, the Bank may exercise anypower of sale contained in any mortgage or deed of trust, obtain a deed in lieuof foreclosure or otherwise acquire title to a mortgaged property underlying aCommercial Mortgage Loan by operation of law or other means in accordance withthe terms of the Commercial Servicing Agreement.  The Bank is not permitted under the terms of the CommercialServicing Agreement to acquire title to any commercial real estate propertyunderlying a Commercial Mortgage Loan or take any action that would cause theCompany to be an “owner” or an “operator” within the meaning of certain federalenvironmental laws, unless it has also previously determined, based on a reportprepared by an independent person who regularly conducts environmentalassessments, that (i) the mortgaged property is in compliance with applicableenvironmental laws or that it would be in the best interests of the Company totake such actions as are necessary to cause the mortgaged property to complytherewith and (ii) there are no circumstances or conditions present at themortgaged property relating to the use, management or disposal of any hazardoussubstances, hazardous materials, hazardous wastes or petroleum-based materialsfor which investigation, testing, monitoring, containment, clean-up or remediationcould be required under any federal, state or local law or regulation, or, ifany such materials are present for which such action could be required, that itwould be in the best interest of the Company to take such actions with respectto the mortgaged property.

 

The Company may terminate the Commercial Servicing Agreement upon theoccurrence of one or more events specified in the Agreement.  Such events relate generally to (i) theBank’s proper and timely performance of its duties and obligations under theCommercial Servicing Agreement or (ii) the appointment of a conservator,receiver or liquidator in any insolvency, bankruptcy or similarproceeding.  In addition, the Companymay also terminate the Commercial Servicing Agreement without cause but will berequired to pay a termination fee, competitive with those generally payable inthe industry, equal to 1.5% of the aggregate outstanding principal amount ofthe loans then serviced under the Commercial Servicing Agreement.  As long as any Series A Preferred Sharesremain outstanding, the Company may not terminate or elect not to renew theCommercial Servicing Agreement without the approval of a majority of theindependent directors.

 

The Bank will be entitledto retain any late payment charges, prepayment fees, penalties and assumptionfees collected in connection with the Commercial Mortgage Loans itservices.  In addition, the Bank willreceive any benefit derived from interest earned on collected principal andinterest payments between the date of collection and the date of remittance tothe Company and from interest earned on tax and insurance impound funds withrespect to Commercial Mortgage Loans it services.  The Commercial Servicing Agreement requires the Bank to remit tothe Company no later than the 18th day of each month (or the nextbusiness day if such 18th day is not a business day) all principaland interest collected from borrowers of Commercial Mortgage Loans serviced byit during the immediately preceding month.

 

When any mortgage propertyunderlying a Commercial Mortgage Loan is conveyed by a mortgagor, the Bankgenerally will enforce any “due-on-sale” clause contained in the CommercialMortgage Loan note, including collection of any mortgage prepayment penalties,to the extent permitted under applicable law, governmental regulations and theloan documents.

 

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**FederalIncome Tax Considerations**

 

The following summary of material federal income taxconsiderations regarding the Company is based upon current law, is for generalinformation only and is not tax advice. The discussion below is based onexisting federal income tax law, which is subject to change, with possibleretroactive effect. The discussion below does not address all aspects oftaxation that may be relevant in the particular circumstances of eachstockholder or to certain types of stockholders (including insurance companies,tax-exempt entities, financial institutions or broker-dealers, foreigncorporations and persons who are not citizens or residents of the UnitedStates, except to the extent discussed) subject to special treatment under thefederal income tax laws.

 

**Taxationof the Company**

 

*General. *A REIT generally is notsubject to federal corporate income taxes on that portion of its ordinaryincome or capital gain that is currently distributed to stockholders. Suchtreatment substantially eliminates the federal “double taxation” of earnings(at the corporate and the stockholder levels) that generally results frominvestment in a corporation.  Asmentioned above, by virtue of the acquisition of PBOC by FBOP, we have failedto qualify for taxation as a REIT, retroactive to the beginning of 2001.  Because FBOP is a privately-ownedcorporation, we no longer satisfy the “five or fewer” test which requires thatno more than 50% in value of our outstanding stock be owned, directly orindirectly, by five or fewer individuals at any time during the last half ofeach taxable year.

 

By failing to qualify for taxation as a REIT, we aresubject to tax (including any applicable alternative minimum tax) on ourtaxable income at regular corporate rates, which reduces income that wouldotherwise be available to our stockholders. The provision for income taxes was $2,442,000 for the year endedDecember 31, 2002.  Distributions tostockholders are not required nor are they deductible by us.  If made, distributions to stockholders to the extent of current andaccumulated earnings and profits are taxable as ordinary income but, subject tocertain limitations of the Internal Revenue Code of 1986 as amended (the“Code”), corporate distributees may be eligible for the dividends receiveddeduction.  Unless entitled to reliefunder specific statutory provision, we are disqualified from taxation as a REITfor the four taxable years following the year during which qualification waslost and we are not permitted to requalify unless we distribute any earningsand profits attributable to the period during which we failed to qualify.

 

**Taxation of United StatesStockholders**

 

*Distributions*.  For periods in which the Company qualifies as a REIT,distributions to a United States Stockholder up to the amount of the Company’scurrent or accumulated earnings and profits (and not designated as capital gainsdividends) will be taken into account as ordinary income and will not beeligible for the dividends-received deduction for corporations. Distributionsthat are designated by the Company as capital gain dividends will be treated aslong-term capital gains for the taxable year (to the extent they do not exceedthe Company’s actual net capital gain) without regard to the period for whichthe stockholder has held its stock. However, corporate stockholders may berequired to treat up to 20% of certain capital gains dividends as ordinaryincome, pursuant to Section 291(d) of the Code. A distribution in excess ofcurrent or accumulated earnings and profits first would be treated as atax-free return of capital, reducing the tax basis in the United StatesStockholder’s Series A Preferred Shares, and a distribution in excess of theUnited States Stockholder’s tax basis in its Series A Preferred Shares will bea taxable gain realized from the sale of such shares.

 

The tax implications ofthe Company’s failure to qualify as a REIT retroactive to January 1, 2001 arediscussed above under “Taxation of the Company—General”.  Dividends declared by the Company inOctober, November or December of any year payable to a stockholder of record ona specified date in any such month shall be treated as both paid by the Companyand received by the stockholder on December 31

 

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of such year, provided that the dividend actually is paid by theCompany during January of the following calendar year. Stockholders may notclaim the benefit of any tax losses of the Company on their own income taxreturns.

 

Losses incurred on thesale or exchange of Series A Preferred Shares held for less than six monthswill be deemed a long-term capital loss to the extent of any capital gaindividends received by the selling stockholder with respect to the shares.

 

*Tax Treatment of Automatic Exchange.*  Upon the occurrence of an “Exchange Event”(as described in “Item 1. Business-General-Dividend Policy”) the outstandingSeries A Preferred Shares automatically will be exchanged on a one-for-onebasis for Bank Preferred Shares.  TheAutomatic Exchange will be taxable and each holder of the Series A PreferredShares will have a gain or loss measured by the difference between the basis ofsuch holder in the Series A Preferred Shares and the fair market value of theBank Preferred Shares received in the Automatic Exchange.  Provided that such holder’s Series APreferred Shares were held as capital assets for more than 12 months prior tothe Automatic Exchange, any gain or loss will be a long-term capital gain orloss.  Long-term capital losses aredeductible, subject to certain limitations. The holder’s basis in the Bank Preferred Shares will be the shares’ fairmarket value at the time of the Automatic Exchange.

 

*Treatment of Tax-Exempt Stockholders*.  Distributions from the Company to atax-exempt employee pension trust or other domestic tax-exempt stockholdergenerally will not constitute “unrelated business taxable income” (“UBTI”)unless the stockholder has borrowed to acquire or carry its Series A PreferredShares.

 

**Taxation of Foreign Stockholders**

 

The following is a discussion of certain anticipatedU.S. federal income tax consequences of the ownership and disposition of theCompany’s stock applicable to Non-U.S. Holders of such stock.  The discussion is based on current law andis for general information only.  Thediscussion addresses only certain and not all aspects of U.S. federal incometaxation.

 

*Ordinary Dividends.*  The portion of dividends received byNon-United States Holders payable out of the Company’s earnings and profits(which are not attributable to capital gains of the Company and which are noteffectively connected with a U.S. trade or business of the Non-United StatesHolder) will be subject to U.S. withholding tax at the rate of 30%, unlessreduced by treaty. In general, Non-United States Holders will not be consideredengaged in a U.S. trade or business solely as a result of their ownership ofstock of the Company.  In cases wherethe dividend income from a Non-United States Holder’s investment in stock ofthe Company is (or is treated as) effectively connected with the Non-UnitedStates Holder’s conduct of a U.S. trade or business, the Non-United StatesHolder generally will be subject to U.S. tax at graduated rates, in the samemanner as a United States Stockholder with respect to such dividends.  In addition, if the Non-United States Holderis a foreign corporation, it may also be subject to the 30% branch profits tax.

 

*Non-Dividend Distributions.*  Distributions by the Company that are notdividends out of the accumulated earnings and profits of the Company will notbe subject to U.S. income or withholding tax. The Company can estimate whether a dividend is paid out of earnings andprofits and is not required to withhold on dividends in excess of earnings andprofits.

 

*Capital Gain Dividends*.  Under the Foreign Investment in RealProperty Tax Act of 1980 (“FIRPTA”), a distribution made by the Company to aNon-United States Holder, to the extent attributable to gains from dispositionsof United States Real Property Interests (“USRPIs”) will be consideredeffectively connected with a U.S. trade or business of the Non-United StatesHolder and subject to U.S.

 

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income tax at the rate applicable to U.S. individuals or corporations,without regard to whether such distribution is designated as a capital gaindividend.  Shares of a corporation aretreated as USRPIs only if the fair market value of the USRPIs owned by thecorporation equals or exceeds 50% of the fair market value of its totalassets.  If at no time during the fiveyears preceding the sale or exchange of shares in the Company, the Series APreferred Shares constituted a USRPI, gain or loss on the sale or exchange willnot be treated as effectively connected with a U.S. trade or business by reasonof FIRPTA.  Although ownership of realproperty in the U.S. is always a USRPI, a loan secured by a mortgage on U.S.real property does not constitute a USRPI unless the amounts payable by theborrower are contingent on the income or receipts of the borrower or theproperty or otherwise based on the property. The Company believes that it is unlikely that its shares will be USRPIsor that it will derive significant gain from USRPIs, although the finaldetermination will depend on the facts as they ultimately develop.  If the shares do constitute USRPIs, theCompany will be required to withhold tax equal to 30% of the amount ofdividends to the extent such dividends constitute USRPI capital gains.Distributions subject to FIRPTA may also be subject to a 30% branch profits taxin the hands of a foreign corporate stockholder that is not entitled to atreaty exemption.

 

*Disposition of Stock of the Company. *The Company does notqualify for taxation as a REIT retroactive to January 1, 2001.  Although the Company does not constitute adomestically controlled REIT, a Non-United States Holder’s sale of stockgenerally will still not be subject to tax under FIRPTA as a sale of a USRPIprovided that (i) the stock is “regularly traded” (as defined by applicableTreasury regulations) on an established securities market (e.g., the Series APreferred Stock is traded on the NASDAQ exchange) and (ii) the sellingNon-United States Holder held 5% or less of the Company’s outstanding stock atall times during the specified testing period.

 

If gain on the sale ofstock of the Company were subject to taxation under FIRPTA, the Non-UnitedStates Holder would be subject to the same treatment as a United StatesStockholder with respect to such gain (subject to applicable alternativeminimum tax and a special alternative minimum tax in the case of nonresidentalien individuals) and the purchaser of the stock could be required to withhold10% of the purchase price and remit such amount to the IRS.

 

Capital gains not subjectto FIRPTA will nonetheless be taxable in the United States to a Non-UnitedStates Holder in two cases:  (i) if theNon-United States Holder’s investment in the stock of the Company iseffectively connected with a U.S. trade or business conducted by suchNon-United States Holder, the Non-United States Holder will be subject to thesame treatment as a United States Stockholder with respect to such gain, or(ii) if the Non-United States Holder is a nonresident alien individual who waspresent in the United States for 183 days or more during the taxable year andcertain other conditions apply, the nonresident alien individual will besubject to tax on the capital gain.

 

**InformationReporting Requirements and Backup Withholding Tax**

 

The Company will report to its stockholders and theIRS the amount of dividends paid or deemed paid during each calendar year, andthe amount of tax withheld, if any.

 

*United States Stockholders*.  Under certain circumstances, a United StatesStockholder of Series A Preferred Shares may be subject to backup withholdingat a rate of 30% on payments made with respect to, or cash proceeds of a saleor exchange of, Series A Preferred Shares. Backup withholding will apply only if the holder (i) fails to furnishthe person required to withhold with its Taxpayer Identification Number (“TIN”)which, for an individual, is his or her Social Security Number, (ii) furnishesan incorrect TIN, (iii) is notified by the IRS that it has failed to properlyreport payments of interest and dividends, or (iv) under certain circumstances,fails to certify under penalty of perjury, that it has furnished a correct TINand has not been notified by the IRS that it is subject to backup withholdingfor failure to report interest and dividend payments. Backup withholding willnot apply to payments made to certain exempt recipients, such

 

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as corporations and tax-exempt organizations.  A United States Stockholder should consult with a tax advisorregarding qualification for exemption from backup withholding and the procedurefor obtaining such an exemption. Backup withholding is not an additional tax.Rather, the amount of any backup withholding with respect to a payment to aUnited States Stockholder will be allowed as a credit against such UnitedStates Stockholder’s United States federal income tax liability and may entitlesuch United States Stockholder to a refund, provided that the requiredinformation is furnished to the IRS.

 

*Foreign Stockholders*.  Additional issues may arise pertaining toinformation reporting and back up withholding requirements.  Backup withholding for a Non-United StatesHolder is not an additional tax.  Ratherthe amount of any backup withholding with respect to a payment to a Non-UnitedStates Holder will be allowed as a credit against any United States federalincome tax liability of such Non-United States Holder.  If withholding results in an overpayment oftaxes, a refund may be obtained provided that the required information isfurnished to the IRS.

 

**OtherTax Consequences**

 

The Company and its stockholders may be subject tostate or local taxation in various state or local jurisdictions, includingthose in which it or they transact business or reside. The state and local taxtreatment of the Company and its stockholders may not conform to the federalincome tax consequences discussed above. Prospective stockholders should consult their own tax advisors regardingthe effect of state and local tax laws on an investment in the Company.

 

**ITEM 2:           PROPERTIES**

 

The Company utilizes office space and conference roomfacilities located in Los Angeles at 221 S. Figueroa Street, Los Angeles,California 90012, the building in which the Bank’s principal executive officesare located. The cost related to this office space is included in the fees paidto the Bank under the terms of the Advisory Agreement.

 

**ITEM 3:           LEGAL PROCEEDINGS**

 

The Company is not involved in any litigation atDecember 31, 2002.  From time to time,the Company may be involved in routine litigation arising in the ordinarycourse of business.

 

**ITEM 4:           SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

None.

 

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**PART II**

 

**ITEM 5:****           MARKET FOR REGISTRANT’SCOMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

The Company is authorizedto issue up to 4,000,000 shares of common stock, $0.01 par value per share(“Common Stock”), and 4,000,000 shares of Preferred Stock, $0.01 par value pershare (“Preferred Stock”).  As ofDecember 31, 2002 there were 10,000 shares of Common Stock outstanding, all ofwhich are owned by the Bank. Accordingly, there is no trading market for the Company’s CommonStock.  At December 31, 2002, there were1,426,000 shares of Preferred Stock issued and outstanding known as theSeries A Preferred Shares.  The Bankintends that, as long as any Series A Preferred Shares are outstanding, itwill maintain direct or indirect ownership of at least a majority of theoutstanding Common Stock of the Company.

 

*Dividends*.  The holder(s) of Common Stock are entitled to receive dividendswhen, as and if authorized and declared by the Board of Directors out of assetslegally available for this purpose, provided that if any shares of PreferredStock are outstanding, no dividends or other distributions (includingredemptions and purchases) may be made with respect to the Common Stock unlessfull dividends on the shares of all series of Preferred Stock, have been paidand any other conditions established under the terms of such series ofPreferred Stock have been satisfied. Several limitations exist which may restrict the Company’s ability topay dividends on the Common Stock.  See“Item 1. Business-General-Dividend Policy.”

 

*Voting Rights*.  Subject to the rights, if any, of the holders of any class orseries of Preferred Stock, including the Series A Preferred Shares, all votingrights are vested in the Common Stock. The holders of Common Stock are entitledto one vote per share. All of the issued and outstanding shares of Common Stockare held by the Bank.

 

As the holder of all ofthe outstanding shares of Common Stock of the Company, the Bank will be able,subject to the terms of the Series A Preferred Shares and of any other class orseries of stock subsequently issued by the Company, to elect and removedirectors, amend the Articles of Incorporation and approve other actionsrequiring stockholder approval under the MGCL or otherwise.

 

*Rights Upon Liquidation*.  In the event of the liquidation, dissolutionor winding up of the Company, whether voluntary or involuntary, after the fullpreferential amounts to which the holders of all series of Preferred Stock areentitled have been paid or set aside, the holder(s) of Common Stock will beentitled to share equally and ratably in any assets remaining after the paymentof all debts and liabilities.

 

19

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**ITEM 6:           SELECTED FINANCIAL DATA**

 

**Financial Data**

As of December 31, 2002,2001, 2000,1999 and 1998

For the Years EndedDecember 31, 2002, 2001, 2000,1999 and 1998

(Dollars in thousands)

 
|                                         |   | **At or for the  Year-ended  12/31/02** |   | **At or for the  Year ended  12/31/01** |   | **At or for the  Year ended  12/31/00** |   | **At or for the  Year ended  12/31/99** |   | **At or for the  Year ended  12/31/98** |   |
|-----------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------|--------|
| **STATEMENT OF EARNINGS:**              |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Interest income                         |   | $                                       | 6,038  |                                    | $      | 5,724                                   |   | $                                       | 5,694  |                                    | $      | 5,621 |   | $ | 5,780 |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Other income                            |   | —                                  |   | 457                                     |   | —                                  |   | —                                  |   | —                                  |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Operating  expenses                     |   | 293                                     |   | 411                                     |   | 504                                     |   | 483                                     |   | 530                                     |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Income tax  expense                     |   | 2,442                                   |   | 2,431                                   |   | —                                  |   | —                                  |   | —                                  |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Net earnings                            |   | 3,303                                   |   | 3,339                                   |   | 5,190                                   |   | 5,138                                   |   | 5,250                                   |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| **BALANCE SHEET:**                      |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Mortgage loans, net                     |   | $                                       | 63,031 |                                    | $      | 71,245                                  |   | $                                       | 71,571 |                                    | $      | 70,446 |   | $ | 69,457 |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Total assets                            |   | 75,585                                  |   | 75,332                                  |   | 72,847                                  |   | 72,393                                  |   | 72,405                                  |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Total liabilities                       |   | 3,792                                   |   | 3,366                                   |   | 44                                      |   | 42                                      |   | 42                                      |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Total stockholders’ equity         |   | 71,793                                  |   | 71,966                                  |   | 72,803                                  |   | 72,351                                  |   | 72,363                                  |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| **OTHER DATA:**                         |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Dividends on preferred stock            |   | 3,476                                   |   | 3,476                                   |   | 3,476                                   |   | 3,476                                   |   | 3,476                                   |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Dividends on common stock               |   | —                                  |   | 700                                     |   | 1,262                                   |   | 1,674                                   |   | 1,548                                   |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Number of preferred shares  outstanding |   | 1,426,000                               |   | 1,426,000                               |   | 1,426,000                               |   | 1,426,000                               |   | 1,426,000                               |   |
|                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |                                    |   |
| Number of common shares  outstanding(1) |   | 10,000                                  |   | 10,000                                  |   | 10,000                                  |   | 10,000                                  |   | 10,000                                  |   |

 

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(1)               Because theCompany’s Common Stock is wholly owned by the Bank, earnings per share data isnot presented.

 

20

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| **ITEM  7:** |   | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|--------------|--------|-------------------------------------------------------------------------------------------------|

 

**Descriptionof Portfolio**

 

Information with respect to the Residential andCommercial Mortgage Loans acquired by the Company since the commencement of itsoperations is presented as of December 31, 2002.  References to percentages of Mortgage Loans acquired by theCompany refer to the percentage of the aggregate outstanding principal balanceof the Mortgage Loans as of December 31, 2002 after giving effect to scheduledmonthly payments received and applied on or before such date.

 

*General*. As of December 31, 2002, the Company owned one Residential MortgageLoan, representing approximately 1% of the unpaid principal balance of theMortgage Loans in the Company’s portfolio, and 67 Commercial Mortgage Loans,representing approximately 99% of the unpaid principal balance of the MortgageLoans in the Company’s portfolio.  OnDecember 31, 2002, the Mortgage Loans included in the Company’s portfolio hadan aggregate outstanding principal balance of $63.3 million.

 

The one ResidentialMortgage Loan included in the Company’s portfolio was originated by the Bank inthe ordinary course of its real estate lending activities in 1998 with anoriginal term to maturity of 15 years. Management believes that this Residential Mortgage Loan was originatedin a manner consistent with the underwriting policies of the Bank at the timeat which the loan was originated.

 

As of December 31, 2002,the actual and average outstanding principal balance of Residential MortgageLoans was $636,526.  The weightedaverage number of months since origination for Residential Mortgage Loans(calculated as of December 31, 2002) was 50 months and the weighted averageremaining maturity was 130 months.  Theweighted average Loan-to-Value Ratio (defined below) of the Company’sResidential Mortgage Loans was 73.3%. “Loan-to-Value Ratio” means the ratio ofthe original principal amount of such Mortgage Loan to the lesser of (i) theappraised value of the underlying mortgaged property at origination or (ii) thepurchase price of the mortgaged property, if the Mortgage Loan was made tofinance the acquisition of property, expressed as a percentage.

 

Each Commercial Mortgage Loan included in the Company’s portfolio wasoriginated or purchased by the Bank in the ordinary course of its commercialreal estate lending activities.  All ofthe Commercial Mortgage Loans in the Company’s portfolio were originated orpurchased between March 1974 and December 2000, and had original terms tostated maturity of 5 to 30 years.  As ofDecember 31, 2002, the average outstanding principal balance of CommercialMortgage Loans was $937,878.  Theweighted average number of months since origination of the Company’s CommercialMortgage Loans (calculated as of December 31, 2002) was approximately 74 monthsand the weighted average expected maturity was 115 months.  As of December 31, 2002, the currentweighted average Loan-to-Value Ratio of the Company’s Commercial Mortgage Loanswas 55.6%.  As of December 31, 2002, noCommercial Mortgage Loan held by the Company had a Loan-to-Value Ratio greaterthan 81.1%**.**

 

*ResidentialMortgage Loans*.  Thefollowing table sets forth as of December 31, 2002 certain information with respectto the Residential Mortgage Loan included in the Company’s portfolio:

 

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**Type of Residential Mortgage Loans**

 
| **Type**        |   | **Aggregate  Principal Balance  (In Thousands)** |   | **Percentage  of  Residential  Mortgage Loans by  Aggregate  Principal Balance** |   | **Weighted  Average  Initial Loan to  Value (LTV)** |   | **Weighted  Average Expected  Remaining Maturity  (in mo.)** |   |
|-----------------|--------|--------------------------------------------------|--------|----------------------------------------------------------------------------------|--------|-----------------------------------------------------|--------|--------------------------------------------------------------|--------|
|            |   |                                             |   |                                                                             |   |                                                |   |                                                         |   |
| Fixed Bi-weekly |   | 637                                              |   | 100.0                                                                            |   | 73.3                                                | %      | 130                                                          |   |
| Total           |   | $                                                | 637    |                                                                             | 100.0  | %                                                   |   |                                                         |   |   |
|                 |        |                                                  |        |                                                                                  |        |                                                     |        |                                                              |        |  |

 

The following table contains certain additional dataabout the interest rate (fixed) of the Residential Mortgage Loan included inthe Company’s portfolio:

 

**InterestRates of Residential Mortgage Loans**

 
| **Current Interest Rate** |   | **Number of  Mortgage  Loans** |   | **Aggregate  Principal Balance  (In Thousands)** |   | **Percentage of the  Company’s  Portfolio by  Aggregate Principal  Balance** |   |
|---------------------------|--------|--------------------------------|--------|--------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|
|                      |   |                           |   |                                             |   |                                                                              |   |
| 6.000 - 6.999%            |   | 1                              |   | $                                                | 637    |                                                                              | 100.0  |   |
| Total                     |   | 1                              |   | $                                                | 637    |                                                                              | 100.0  | % |

 

*Commercial Mortgage Loans*.  The Commercial Mortgage Loans included inthe Company’s portfolio consist of loans secured by nonresidential commercialor multi-family properties located in California.  The borrowers of the Commercial Mortgage Loans in the Company’sportfolio are primarily customers of the Bank to which the Bank has extendedsuch Commercial Mortgage Loans in the ordinary course of its commercial realestate lending activities.  Theoutstanding principal balances of the Commercial Mortgage Loans included in theCompany’s portfolio ranged from $4,432 to $3.2 million as of December 31, 2002.

 

The following table setsforth as of December 31, 2002 certain information about the types ofmulti-family and nonresidential commercial mortgage loans included in theCompany’s portfolio:

 

22

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**Type of Commercial Mortgage Loans**

 
| **Type**                         |   | **Aggregate  Principal  Balance  (In Thousands)** |   | **Percentage  of  Commercial  Mortgage Loans  by Aggregate  Principal Balance** |   | **Weighted   Average  Initial  LTV(1)** |   | **Weighted  Average  Current  LTV(2)** |   | **Weighted  Average  Months  Remaining to  Maturity** |   |
|----------------------------------|--------|---------------------------------------------------|--------|---------------------------------------------------------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|-------------------------------------------------------|--------|
|                             |   |                                              |   |                                                                            |   |                                    |   |                                   |   |                                                  |   |
| Nonresidential-fixed  rate       |   | $                                                 | 133    |                                                                            | 0.2    | %                                       | 75.0   | %                                      | 44.3   | %                                                     | 66     |   |
| Nonresidential-fixed  balloon    |   | 41,384                                            |   | 65.9                                                                            |   | 59.2                                    |   | 55.9                                   |   | 74                                                    |   |
| Nonresidential-variable  balloon |   | 942                                               |   | 1.5                                                                             |   | 75.0                                    |   | 66.3                                   |   | 61                                                    |   |
| Multi-family-fixed  rate         |   | 914                                               |   | 1.5                                                                             |   | 72.8                                    |   | 27.1                                   |   | 57                                                    |   |
| Multi-family-fixed  balloon      |   | 473                                               |   | 0.7                                                                             |   | 25.6                                    |   | 24.2                                   |   | 49                                                    |   |
| Multi-family-variable            |   | 14,746                                            |   | 23.5                                                                            |   | 68.5                                    |   | 58.6                                   |   | 240                                                   |   |
| Multi-family-variable  balloon   |   | 4,246                                             |   | 6.7                                                                             |   | 58.9                                    |   | 50.1                                   |   | 120                                                   |   |
| Total                            |   | $                                                 | 62,838 |                                                                            | 100.0  | %                                       | 61.6   |                                   | 55.6   |                                                  | 115    |   |

 

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(1)                                Representsthe ratio of the outstanding principal amount of the Commercial Mortgage Loanat the time of loan origination or modification, if applicable, to the value ofthe property securing such Commercial Mortgage Loan at the time of loanorigination or modification.

 

(2)                                Representsthe ratio of the outstanding principal amount of the Commercial Mortgage Loanat December 31, 2002 to the value of the property securing such CommercialMortgage Loan at the time of loan origination or modification, if applicable.

 

Of the CommercialMortgage Loans included in the Company’s portfolio, 37 or 55.2% are not fullyamortizing and will have significant principal balances or “balloon” paymentsdue upon maturity.  The majority of theCompany’s Commercial Mortgage Loans bear interest at fixed rates.  The interest rates of the fixed rateCommercial Mortgage Loans included in the Company’s portfolio range from 8.00%per annum to 10.75% per annum. The weighted average interest rate of theseloans is approximately 8.49% per annum. The interest rates on the variable rate loans vary from 5.75% to8.25%.  The weighted average interestrate of these loans is approximately 6.64% per annum.

 

The following tablecontains certain additional data as of December 31, 2002 with respect to theinterest rates of the Commercial Mortgage Loans included in the Company’sportfolio:

 

23

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**Interest Rates of Commercial Mortgage Loans**

 
| **Interest Rate**     |   | **Number of  Mortgage  Loans** |   | **Aggregate  Principal  Balance  (In Thous.)** |   | **Aggregate  Principal Balance  % of Portfolio** |   |
|-----------------------|--------|--------------------------------|--------|------------------------------------------------|--------|--------------------------------------------------|--------|
|                  |   |                           |   |                                           |   |                                             |   |
| 5.750 -   6.749% |   | 5                              |   | $                                              | 10,516 |                                             | 16.7   | % |
| 6.750 -   7.749  |   | 4                              |   | 8,477                                          |   | 13.5                                             |   |
| 7.750 -   8.749  |   | 29                             |   | 38,366                                         |   | 61.0                                             |   |
| 8.750 -   9.749  |   | 24                             |   | 5,126                                          |   | 8.2                                              |   |
| 9.750 - 10.449        |   | 3                              |   | 240                                            |   | 0.4                                              |   |
| 10.500 - 10.999       |   | 2                              |   | 113                                            |   | 0.2                                              |   |
| Total                 |   | 67                             |   | $                                              | 62,838 |                                             | 100.0  | % |

 

*AssetQuality. *There wereno residential or commercial mortgage loans with past due principal andinterest payments at December 31, 2002 or December 31, 2001.  Delinquencies in prior years wereimmaterial.

 

*Geographic Distribution*.  As of December 31, 2002, the residentialreal estate property underlying the Company’s one Residential Mortgage Loan islocated in California. Consequently, this Residential Mortgage Loan may besubject to a greater risk of default than other comparable Residential MortgageLoans in the event of adverse economic, political or business developments andnatural hazards in California (for example, earthquakes, wild fires and mudslides) that may affect the ability of residential property owners inCalifornia to make payments of principal and interest on the underlyingmortgages. Standard hazard insurance that borrowers are required to maintainwith respect to the Residential Mortgage Loans held by the Company may not protectthe Company against losses occurring from earthquakes and other naturaldisasters.

 

As of December 31, 2002,all of the nonresidential and multi-family properties underlying the Company’sCommercial Mortgage Loans are located in California.  Of these Commercial Mortgage Loans, approximately 1.2% is securedby real estate located in Northern California and 98.8% is secured by realestate located in Southern California. As a result, these Commercial Mortgage Loans may be subject to a greaterrisk of default than other comparable Commercial Mortgage Loans in the event ofadverse economic, political or business developments in California that mayaffect the ability of businesses in these areas to make payments of principaland interest on the underlying mortgages. In the event of a natural disaster, the Company’s ability to paydividends on the Series A Preferred Shares could be adversely affected as it isthe Company’s current intention to not maintain special hazard insurance toprotect against such losses.

 

*Loan-to-Value Ratios; Insurance*.  The Residential Mortgage Loan in theCompany’s portfolio as of December 31, 2002 had a Loan-to-Value Ratio of 73.3%at the time of origination.  Themortgagor of each Residential Mortgage Loan is required to maintain a standardhazard insurance policy in an amount equal to the maximum insurable value ofthe improvements securing the Residential Mortgage Loan or the principalbalance of such Residential Mortgage Loan, whichever is less.  If the residential real estate propertyunderlying a Residential Mortgage Loan is located in a flood zone, theResidential Mortgage Loan also may be covered by a flood insurance policy asrequired by law.  No mortgagorbankruptcy insurance will be maintained by the Company with respect toResidential Mortgage Loans, nor will any Residential Mortgage

 

24

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Loan be insured by the Federal Housing Administration or guaranteed bythe Veterans Administration.  TheCompany will not maintain any special hazard insurance policy with respect toany Residential Mortgage Loan that could mitigate damages caused by any naturaldisaster.

 

The mortgagor of each of the Commercial Mortgage Loansincluded in the Company’s portfolio is required to maintain a standard hazardinsurance policy.  If the commercialreal estate property securing a Commercial Mortgage Loan is located in a floodzone, the Commercial Mortgage Loan may be covered by a flood insurance policyas required by law.  However, as withthe Residential Mortgage Loans in the Company’s portfolio, no special hazardinsurance or mortgagor bankruptcy insurance will be maintained by the Companywith respect to the Commercial Mortgage Loans in the Company’s portfolio.

 

**FinancialCondition**

 

At December 31, 2002 and 2001, the Company had totalassets of $75.6 million and $75.3 million, respectively.  As of such dates, $63.0 million or 83.4% and$71.2 million or 94.6% of the Company’s assets was comprised of its loan portfolio,net of discounts on loans and the allowance for loan losses.  The majority of the Company’s loans wereacquired from the Bank in 2001 and 2002. During the years 2002 and 2001, the Company purchased mortgage loanswith an aggregate principal balance of $21.9 million and $69.6 million, respectively,from the Bank.  The weighted averageinterest rate of the total portfolio at December 31, 2002 and 2001 was 7.88%and 8.76%.  At December 31, 2002 and2001, respectively, due from affiliates aggregated $0 and $741,000, accruedinterest receivable amounted to $385,000 and $400,000 and the Companymaintained a general valuation allowance of $253,000.  For more information, see Note 3 of the Notes to FinancialStatements included in Item 8 below.

 

At December 31, 2002 and2001, the Company’s total liabilities amounted to $3.8 million and $3.4million, respectively. Total liabilities is comprised of $2.9 million and $2.4million, respectively, of accrued federal and state taxes payable, and $0.9million and $1.0 million, respectively, of accrued dividends and otherliabilities.  Stockholders’ equityamounted to $71.8 million and $72.0 million, after taking into considerationearnings of $3.3 million in each year and aggregate dividend payments on thecommon stock and preferred stock of $3.5 million and $4.2 million during theyears 2002 and 2001, respectively.

 

**Results of Operations**

 

The Company reported netearnings of $3.3 million for the year ended December 31, 2002 as compared to$3.3 million and $5.2 million for the years ended December 31, 2001 and 2000,respectively.  The Company declared $3.5million in dividends on the Company’s preferred stock in each of the years2002, 2001 and 2000. The Company also declared $0, $0.7 million and $1.3million in dividends on the Company’s common stock in 2002, 2001 and 2000,respectively.

 

Total revenues for theyear ended December 31, 2002 were $6.0 million as compared to $6.2 million and$5.7 million for the periods ended December 31, 2001 and 2000, respectively,primarily attributable to interest earned on the Company’s portfolio ofmortgage loans.  The Company earned$113,000, $275,000 and $99,000 of interest on deposit accounts in 2002, 2001and 2000, respectively.   A gain on thesale of mortgage loans of $457,000 was recorded in 2001.

 

Total expenses for theyears ended December 31, 2002, 2001 and 2000 amounted to $293,000, $411,000 and$504,000, respectively.  Of this amount,$20,000, $100,000 and $200,000 was paid to the Bank in 2002, 2001, and 2000 asa management fee in accordance with the terms of the Advisory Agreement.  The Bank received $174,000, $134,000 and$123,000 in 2002, 2001 and 2000, respectively, for servicing the Company’smortgage loans.  Temple Inland MortgageCo., which serviced a portion of the

 

25

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Company’s residential mortgage loans until June 2001, received $25,000and $54,000 in 2001 and 2000, respectively.

 

**Allowance for Loan Losses**

 

The Company maintains an allowance for loan losses toabsorb potential loan losses from the entire loan portfolio. Managementbelieves that the allowance for loan losses as of December 31, 2002, issufficient to absorb any losses that currently exist in the portfolio.Management will continue to review the loan portfolio to determine the extentto which any changes in loss experience may require additional provisions inthe future.

 

**Liquidity and Capital Resources**

 

The objective of liquidity management is to ensure theavailability of sufficient cash flows to meet all of the Company’s financialcommitments and to capitalize on opportunities for the Company’s businessexpansion.  The Company’s principalliquidity needs are to maintain its current portfolio size through theacquisition of additional Mortgage Loans as Mortgage Loans currently in theportfolio mature or prepay and to pay dividends on the Series A PreferredShares.  The acquisition of additionalMortgage Loans is intended to be funded with the proceeds obtained fromrepayment of principal balances by mortgagees. The Company does not have and does not anticipate having any materialcapital expenditures.

 

To the extent that theBoard of Directors determines that additional funding is required, the Companymay raise such funds through additional equity offerings, debt financing orretention of cash flow or a combination of these methods.  The organizational documents of the Companydo not contain any limitation on the amount or percentage of debt, funded orotherwise, that the Company might incur. Notwithstanding the foregoing, the Company may not, without the approvalof a majority of the independent directors, incur debt for borrowed money inexcess of 20% of the Company’s total stockholders’ equity.  Any such debt incurred may includeintercompany advances made by the Bank to the Company.

 

The Company also may issue additional series ofPreferred Stock.  However, the Companymay not issue additional shares of Preferred Stock that is or will be senior tothe Series A Preferred Shares without obtaining the prior consent ofholders of at least 66 2/3% of the shares of Preferred Stock outstanding atthat time, including the Series A Preferred Shares, and the Company maynot issue additional shares of Preferred Stock on a parity with theSeries A Preferred Shares without the prior approval of a majority of theCompany’s independent directors.

 

**InterestRate Risk**

 

The Company’s interest rate risk is primarily relatedto loan prepayments and payoffs. The average maturity of loans is substantiallyless than their average contractual terms because of prepayments and, in thecase of conventional mortgage loans, due-on-sale clauses, which generally givethe Bank the right to declare a loan immediately due and payable in the eventthat the borrower sells the real property subject to the mortgage and the loanis not repaid, among other things.  Theaverage life of mortgage loans tends to increase when the current mortgage loanrates are substantially higher than rates on existing mortgage loans and,conversely, decrease when rates on existing mortgages are substantially lowerthan current mortgage loan rates (due to refinancings of adjustable rate andfixed rate loans at lower rates). The following table summarizes theanticipated maturities or repricing of the Company’s interest-earning assets asof December 31, 2002, based on the information and assumptions set forthin the notes following.

 

26

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|                                 |   | **Within  Three  Months** |   | **Three to  Twelve  Months** |   | **One Year  To   Three Years** |   | **Three  Years  To  Five Years** |   | **Over  Five  Years** |   | **Total** |   | **Net Fair  Value** |   |
|--------------------------------------|--------|---------------------------|--------|------------------------------|--------|--------------------------------|--------|----------------------------------|--------|-----------------------|--------|-----------|--------|---------------------|--------|
| Interest-earning  assets(1) and (2): |   |                      |   |                         |   |                           |   |                             |   |                  |   |      |   |                |   |
| Single-family  loans:                |   |                      |   |                         |   |                           |   |                             |   |                  |   |      |   |                |   |
| Fixed                                |   | $                         | 42     |                         | $      | 178                            |   | $                                | 273    |                  | $      | 144       |   | $                   | — |   | $ | 637 |   | $ | 652 |   |
| Multi-family:                        |   |                      |   |                         |   |                           |   |                             |   |                  |   |      |   |                |   |
| Fixed rate                           |   | 79                        |   | 338                          |   | 497                            |   | —                           |   | —                |   | 914       |   | 952                 |   |
| Fixed rate  balloon                  |   | 30                        |   | 125                          |   | 183                            |   | 135                              |   | —                |   | 473       |   | 492                 |   |
| Variable rate                        |   | 14,746                    |   | —                       |   | —                         |   | —                           |   | —                |   | 14,746    |   | 15,284              |   |
| Variable rate  balloon               |   | 4,246                     |   | —                       |   | —                         |   | —                           |   | —                |   | 4,246     |   | 4,355               |   |
| Nonresidential  R.E.:                |   |                      |   |                         |   |                           |   |                             |   |                  |   |      |   |                |   |
| Fixed rate                           |   | 7                         |   | 34                           |   | 67                             |   | 24                               |   | 1                     |   | 133       |   | 140                 |   |
| Fixed rate  balloon                  |   | 1,423                     |   | 6,464                        |   | 11,885                         |   | 8,163                            |   | 13,259                |   | 41,194    |   | 43,393              |   |
| Variable rate  balloon               |   | 32                        |   | 909                          |   | —                         |   | —                           |   | —                |   | 941       |   | 990                 |   |
| GVA                                  |   | —                    |   | —                       |   | —                         |   | —                           |   | (253                  | )      | (253      | )      | (253                | )      |
|                                 |   | $                         | 20,605 |                         | $      | 8,048                          |   | $                                | 12,905 |                  | $      | 8,466     |   | $                   | 13,007 |   | $ | 63,031 |   | $ | 66,005 |   |

 

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(1)           Fixed-rate loans are included inperiods in which they are scheduled to be repaid, based on scheduledamortization.

(2)           Amounts disclosedrepresent outstanding principal balances as of December 31, 2002.

 

**ITEM 7A:        QUANTATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

See “Item 7: Management’s Discussion and Analysis of Financial Condition and Resultsof Operations—Interest Rate Risk.”

 

27

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**ITEM 8:           FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

**PEOPLE’SPREFERRED CAPITAL CORPORATION**

**INDEX TOFINANCIAL STATEMENTS**

 

**December31, 2002, 2001 and 2000**

 
| Statements of  Financial Condition—December 31, 2002 and 2001                                     | 31 |
|--------------------------------------------------------------------------------------------------------|----|
|                                                                                                   |
| Statements of Earnings—Years  ended December 31, 2002, 2001 and 2000                              | 32 |
|                                                                                                   |
| Statements  of Changes in Stockholders’ Equity—Years ended December 31, 2002, 2001 and  2000 | 33 |
|                                                                                                   |
| Statements of Cash Flows—Years  ended December 31, 2002, 2001, and 2000                           | 34 |
|                                                                                                   |
| Notes to Financial  Statements                                                                         | 35 |

 

28

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**IndependentAuditors’ Report**

 

The Board of Directors

People’s Preferred Capital Corporation:

 

We have audited the accompanying statements offinancial condition of People’s Preferred Capital Corporation as of December31, 2002 and 2001, and the related statements of earnings, changes instockholders’ equity and cash flows for each of the years in the three-yearperiod ended December 31, 2002.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits in accordance with auditingstandards generally accepted in the United States of America.  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles usedand significant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position ofPeople’s Preferred Capital Corporation as of December 31, 2002 and 2001, andthe results of its operations and its cash flows for each of the years in the three-yearperiod ended December 31, 2002 in conformity with accounting principlesgenerally accepted in the United States of America.

 

 
|   | KPMG LLP |
|--------|----------|

 

 

February 28, 2003

Los Angeles, California

 

29

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**PEOPLE’SPREFERRED CAPITAL CORPORATION**

**STATEMENTS OF FINANCIAL CONDITION**

**December31, 2002 and 2001**

**(Dollarsin thousands, except per share amounts)**

 
|                                                                                                                                                                          |   | **December  31, 2002** |       | **December  31, 2001** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|------------|------------------------|------------|
|                                                                                                                                                                          |   |                   |       |                   |       |
| ASSETS:                                                                                                                                                                       |   |                   |       |                   |       |
| Cash and cash  equivalents                                                                                                                                                    |   | $                      | 12,167     |                   | $          | 2,946 |   |
| Mortgage loans,  net (Note 3)                                                                                                                                                 |   | 63,031                 |       | 71,245                 |       |
| Due from  affiliate (Note 6)                                                                                                                                                  |   | —                 |       | 741                    |       |
| Accrued interest  receivable                                                                                                                                                  |   | 385                    |       | 400                    |       |
| Other assets                                                                                                                                                                  |   | 2                      |       | —                 |       |
| Total assets                                                                                                                                                                  |   | $                      | 75,585     |                   | $          | 75,332 |   |
|                                                                                                                                                                          |   |                   |       |                   |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY:                                                                                                                                   |   |                   |       |                   |       |
|                                                                                                                                                                          |   |                   |       |                   |       |
| Accounts payable  and accrued liabilities                                                                                                                                     |   | $                      | 917        |                   | $          | 935 |   |
| Accrued taxes  payable                                                                                                                                                        |   | 2,875                  |       | 2,431                  |       |
| Total  liabilities                                                                                                                                                            |   | 3,792                  |       | 3,366                  |       |
|                                                                                                                                                                          |   |                   |       |                   |       |
| Commitments and  contingencies                                                                                                                                                |   | —                 |       | —                 |       |
|                                                                                                                                                                          |   |                   |       |                   |       |
| Stockholders’  equity:                                                                                                                                                   |   |                   | ** ** |                   | ** ** |
| Preferred stock,  par  value $.01 per share, 4,000,000  shares authorized: Preferred stock series A, issued and outstanding 1,426,000  shares, liquidation value $35,650 |   | 14                     |       | 14                     |       |
| Common stock,  par value $.01 per share, 4,000,000 shares authorized: 10,000 shares issued  and outstanding                                                                   |   | —                 |       | —                 |       |
| Additional  paid-in capital                                                                                                                                                   |   | 72,075                 |       | 72,075                 |       |
| Accumulated  deficit                                                                                                                                                          |   | (296                   | )          | (123                   | )          |
| Total  stockholders’ equity                                                                                                                                              |   | 71,793                 |       | 71,966                 |       |
| **Total liabilities and stockholders’ equity**                                                                                                                           |   | **$**                  | **75,585** | ** **             | **$**      | **75,332** | ** ** |

 

See accompanying notes to financial statements.

 

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**PEOPLE’SPREFERRED CAPITAL CORPORATION**

**STATEMENTS OF EARNINGS**

**For theYears Ended December 31, 2002, 2001 and 2000**

**(Dollarsin thousands)**

 
|                          |   | **2002** |   | **2001** |   | **2000** |   |
|-------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Revenues:                     |   |     |   |     |   |     |   |
| Interest on  mortgage loans   |   | $        | 5,925  |     | $      | 5,449    |   | $ | 5,595 |   |
| Interest on  deposits         |   | 113      |   | 275      |   | 99       |   |
| Gain on sale of  loans        |   | —   |   | 457      |   | —   |   |
| Total revenues                |   | 6,038    |   | 6,181    |   | 5,694    |   |
|                          |   |     |   |     |   |     |   |
| Expenses:                     |   |     |   |     |   |     |   |
| Loan servicing  fees (Note 6) |   | 174      |   | 159      |   | 177      |   |
| Advisory fees  (Note 7)       |   | 20       |   | 100      |   | 200      |   |
| Professional  fees            |   | 59       |   | 112      |   | 88       |   |
| Other                         |   | 40       |   | 40       |   | 39       |   |
| Total expenses                |   | 293      |   | 411      |   | 504      |   |
|                          |   |     |   |     |   |     |   |
| Earnings before  income taxes |   | 5,745    |   | 5,770    |   | 5,190    |   |
| Income taxes  (Note 5)        |   | 2,442    |   | 2,431    |   | —   |   |
| Net earnings                  |   | $        | 3,303  |     | $      | 3,339    |   | $ | 5,190 |   |

 

See accompanying notes to financial statements.

 

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**PEOPLE’SPREFERRED CAPITAL CORPORATION**

**STATEMENTSOF CHANGES IN STOCKHOLDERS’ EQUITY**

**For theYears Ended December 31, 2002, 2001 and 2000**

**(Dollarsin thousands)**

 
|                          |   | **No. of  Preferred  Shares,  Par value .01  per share** |   | **Series A  Preferred  Stock** |   | **No. of  Common  Shares, par  value .01 per  share** |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Retained  Earnings  (Accum.  Deficit)** |   | **Total  Stockholder’s  Equity** |   |
|-------------------------------|--------|----------------------------------------------------------|--------|--------------------------------|--------|-------------------------------------------------------|--------|-------------------|--------|----------------------------------|--------|-------------------------------------------|--------|---------------------------------------|--------|
|                          |   |                                                     |   |                           |   |                                                  |   |              |   |                             |   |                                      |   |                                  |   |
| Balance at  December 31, 1999 |   | 1,426,000                                                |   | $                              | 14     |                                                  | 10,000 |              | $      | —                           |   | $                                         | 72,075 |                                  | $      | 262 |   | $ | 72,351 |   |
|                          |   |                                                     |   |                           |   |                                                  |   |              |   |                             |   |                                      |   |                                  |   |
| Net earnings                  |   | —                                                   |   | —                         |   | —                                                |   | —            |   | —                           |   | 5,190                                     |   | 5,190                                 |   |
| Preferred  dividends          |   | —                                                   |   | —                         |   | —                                                |   | —            |   | —                           |   | (3,476                                    | )      | (3,476                                | )      |
| Common dividends              |   | —                                                   |   | —                         |   | —                                                |   | —            |   | —                           |   | (1,262                                    | )      | (1,262                                | )      |
|                          |   |                                                     |   |                           |   |                                                  |   |              |   |                             |   |                                      |   |                                  |   |
| Balance at  December 31, 2000 |   | 1,426,000                                                |   | 14                             |   | 10,000                                                |   | —            |   | 72,075                           |   | 714                                       |   | 72,803                                |   |
|                          |   |                                                     |   |                           |   |                                                  |   |              |   |                             |   |                                      |   |                                  |   |
| Net earnings                  |   | —                                                   |   | —                         |   | —                                                |   | —            |   | —                           |   | 3,339                                     |   | 3,339                                 |   |
| Preferred  dividends          |   | —                                                   |   | —                         |   | —                                                |   | —            |   | —                           |   | (3,476                                    | )      | (3,476                                | )      |
| Common dividends              |   | —                                                   |   | —                         |   | —                                                |   | —            |   | —                           |   | (700                                      | )      | (700                                  | )      |
|                          |   |                                                     |   |                           |   |                                                  |   |              |   |                             |   |                                      |   |                                  |   |
| Balance at  December 31, 2001 |   | 1,426,000                                                |   | 14                             |   | 10,000                                                |   | —            |   | 72,075                           |   | (123                                      | )      | 71,966                                |   |
|                          |   |                                                     |   |                           |   |                                                  |   |              |   |                             |   |                                      |   |                                  |   |
| Net earnings                  |   | —                                                   |   | —                         |   | —                                                |   | —            |   | —                           |   | 3,303                                     |   | 3,303                                 |   |
| Preferred  dividends          |   | —                                                   |   | —                         |   | —                                                |   | —            |   | —                           |   | (3,476                                    | )      | (3,476                                | )      |
|                          |   |                                                     |   |                           |   |                                                  |   |              |   |                             |   |                                      |   |                                  |   |
| Balance at  December 31, 2002 |   | 1,426,000                                                |   | $                              | 14     |                                                  | 10,000 |              | $      | —                           |   | $                                         | 72,075 |                                  | $      | (296 | ) | $ | 71,793 |   |

 

See accompanying notes to financial statements.

 

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**PEOPLE’S PREFERRED CAPITALCORPORATION**

**STATEMENTS OF CASH FLOWS**

**For the Years Ended December 31,2002, 2001 and 2000**

**(Dollars in thousands)**

 
|                                                  |   | **2002** |   | **2001** |   | **2000**  |   |
|-------------------------------------------------------|--------|----------|--------|----------|--------|-----------|--------|
|                                                  |   |     |   |     |   |      |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                |   |     |   |     |   |      |   |
| Net Earnings                                          |   | $        | 3,303  |     | $      | 3,339     |   | $ | 5,190 |   |
| Decrease/(increase)  in accrued interest receivable   |   | 72       |   | (38      | )      | 9         |   |
| Decrease/(increase)in  other assets                   |   | 739      |   | (131     | )      | 47        |   |
| Increase in  accounts payable and accrued liabilities |   | 426      |   | 2,453    |   | 2         |   |
| Net cash provided  by operating activities            |   | 4,540    |   | 5,623    |   | 5,248     |   |
|                                                  |   |     |   |     |   |      |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                |   |     |   |     |   |      |   |
| Purchase of  mortgage loans, net of discount/premium  |   | (21,949  | )      | (69,559  | )      | (9,691    | )      |
| Purchase of  accrued interest receivable              |   | (57      | )      | (270     | )      | (40  | )      |
| Mortgage loan  principal repayments                   |   | 30,163   |   | 10,608   |   | 8,566     |   |
| Sale of mortgage  loans, net of discount              |   | —   |   | 60,004   |   | —    |   |
| Gain on sale of  mortgage loans                       |   | —   |   | (457     | )      | —    |   |
| Net cash  provided by (used in) investing activities  |   | 8,157    |   | 326      |   | (1,165    | )      |
|                                                  |   |     |   |     |   |      |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                |   |     |   |     |   |      |   |
| Preferred stock  dividends paid                       |   | (3,476   | )      | (2,607   | )      | (3,476    | )      |
| Common stock  dividends paid                          |   | —   |   | (700     | )      | (1,262    | )      |
| Net cash used in  financing activities                |   | (3,476   | )      | (3,307   | )      | (4,738    | )      |
|                                                  |   |     |   |     |   |      |   |
| Net increase (decrease)  in cash and cash equivalents |   | 9,221    |   | 2,642    |   | (655      | )      |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF YEAR       |   | 2,946    |   | 304      |   | 959       |   |
|                                                  |   |     |   |     |   |      |   |
| CASH AND CASH  EQUIVALENTS AT END OF YEAR             |   | $        | 12,167 |     | $      | 2,946     |   | $ | 304 |   |
|                                                  |   |     |   |     |   |      |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:    |   |     |   |     |   |      |   |
| Cash paid during  the year for income taxes           |   | $        | 2,000  |     | $      | 0         |   | $ | 0 |   |
|                                                  |   |     |   |     |   |      |   |
| OTHER NON-CASH  FINANCING ACTIVITIES                  |   |     |   |     |   |      |   |
| Dividends  declared not paid                          |   | $        | 869    |     | $      | 869       |   | $ | 0 |   |

 

See accompanying notes to financial statements.

 

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**PEOPLE’S PREFERRED CAPITAL CORPORATION**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Note 1-Organization and Basis of Presentation**

 

People’s PreferredCapital Corporation (the “Company”) is a Maryland corporation incorporated onJune 19, 1997 which was created for the purpose of acquiring, holding andmanaging mortgage loans secured by real estate assets. The Company’soutstanding common stock is wholly owned by California National Bank (the“Bank”), a national banking association.

 

The Company commenced itsoperations on October 3, 1997 with the consummation of an initial publicoffering of 1,426,000 shares of Series A Preferred Shares, $0.01 par value,which raised $33.3 million, net of underwriting and offering expenses of $2.4million. The Series A Preferred Shares are traded on the NASDAQ NationalMarket. Additional expenses incurred relative to the offering and the formationof the Company were borne by People’s Bank of California. Concurrent with theissuance of the Series A Preferred Shares, People’s Bank of Californiacontributed additional capital to the Company of $38.8 million afterreimbursement for offering expenses of $426,000.

 

On April 30, 2001, PBOCHoldings, Inc. (“PBOC”), the sole stockholder and holding company of People’sBank of California, was acquired by FBOP Corporation (“FBOP”), a closely heldbank and savings institution holding company that owns banks in California,Illinois, Texas and Arizona.  FBOPsubsequently merged People’s Bank of California into its wholly ownedsubsidiary, California National Bank, as of November 13, 2001, and thesubsidiaries of People’s Bank of California, including the Company, becamesubsidiaries of California National Bank.

 

If the appropriatefederal regulatory agency so directs, each Series A Preferred Share will beexchanged automatically (the “Automatic Exchange”) for one newly issuedpreferred share of the Bank. The circumstances under which this might occurare: (i) the Bank becomes undercapitalized under the prompt corrective actionregulations under the Federal Deposit Insurance Corporation Improvement Act of1991, (ii) the Bank is placed into conservatorship or receivership, or (iii)the appropriate federal agency anticipates the bank becoming undercapitalizedin the near future. In the event of the Automatic Exchange, the Bank preferredshares would constitute a new series of preferred shares of the Bank, and wouldhave the same dividend rights, liquidation preference, redemption options andother attributes as the Series A Preferred Shares, except that the Bankpreferred shares would not be listed on a national stock exchange or nationalquotation system, and would rank equally in terms of cash dividend payments andliquidation preference with any other shares of preferred stock of the Bankoutstanding at the time of the Automatic Exchange.

 

The Series A PreferredShares are redeemable on or after October 15, 2002 as discussed above. At anytime at the option of the Company, the Series A Preferred Shares may beredeemed for cash, in whole, at the redemption price of  (i) $25.00, plus (ii) an amount equal to anyauthorized, declared and unpaid dividends, to the date fixed for redemption,without interest, and the additional dividends that would be payable for theperiod from the first day of the dividend period in which the date fixed forredemption occurs to the date fixed for redemption.  Any redemption of Series A Preferred Shares is subject tocompliance with applicable regulatory and other restrictions.

 

Distributions tostockholders in excess of the Company’s current and accumulated earnings andprofits would represent a return of capital and generally would not betaxable.  For the fiscal years endingDecember 31, 2002 and 2001, the Company made distributions in excess of currentand accumulated earnings and profits such that the distributions tostockholders for these years include a return of capital component.

 

34

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As the Company’s common stock is wholly owned by theBank, earnings per share data is not presented.

 

**Note 2-Summary of SignificantAccounting Policies**

 

(a)          Residential andCommercial Mortgage Loans:

 

Residential and commercial mortgage loans are carriedat the principal amount outstanding, net of unamortized deferred loan fees anddirect origination costs and purchase discounts and premiums. Deferred loanfees and direct origination costs and discounts or premiums on one-to-four-familyresidential mortgage loans are accreted or amortized to income using theinterest method over the contractual term of the loans. Unaccreted orunamortized discounts or premiums on loans sold or paid in full are recognizedin income at the time of sale or payoff. The Company purchases single-familyresidential loans from the Bank. It is the Company’s policy to place a loan onnon-accrual status in the event that a borrower is 90 days or more delinquent.When a loan is placed on non-accrual status, the accrued and unpaid interestreceivable is reversed. Amortization of premiums, discounts, and deferred fees,net of deferred direct origination costs, associated with loans that are on non-accrualstatus are discontinued. Income is subsequently recognized only to the extentthat cash payments are received. When, in management’s judgment, the borrower’sability to make periodic interest and principal payments resumes, the loan isreturned to accrual status.

 

A loan is impaired when it is “probable” that acreditor will be unable to collect all principal and interest amounts dueaccording to the contractual terms of the loan agreement. The measurement ofimpairment may be based on (i) the present value of the expected future cashflows of the impaired loan discounted at the loan’s original effective interestrate, (ii) the observable market price of the impaired loan, or (iii) the fairvalue of the collateral of a collateral-dependent loan. Interest income onimpaired loans is recognized on a cash basis if it is determined thatcollection of principal is probable. The Company collectively reviews itsportfolio of residential mortgage loans for impairment. The Company reviews itscommercial loans individually for impairment.

 

Residential and commercial mortgages consist of fixedrate and adjustable rate mortgages. The Company’s commercial loan portfolioincludes fixed rate mortgages which do not fully amortize and have a balloonpayment due.

 

(b)         Allowance for LoanLosses:

 

The allowance for loan losses is a general allowancewhich is increased by charges to income and decreased by charge-offs (netof recoveries). Management’s periodic evaluation of the adequacy of theallowance is based on such factors as the Bank’s and the Company’s past loanloss experience, delinquency trends, known and inherent risks in the portfolio,potential adverse situations that may affect the borrower’s ability to repay,the estimated value of underlying collateral and current economicconditions.  Although managementbelieves its present allowance for loan losses is adequate, it will continue toreview its loan portfolio to determine the extent to which any changes in lossexperience may require additional provisions in the future.

 

35

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(c)          Cash and CashEquivalents:

 

For the purposes of the statement of cash flows, cashand cash equivalents include cash and amounts due from banks, and all otherhighly liquid debt investments.

 

(d)         Income Taxes:

 

By virtue of PBOC’s merger with FBOP, we no longerqualify for taxation as a REIT retroactive to the beginning of 2001.  Because FBOP is a privately-ownedcorporation, we no longer satisfy the “five or fewer” test which requires thatno more than 50% in value of our outstanding stock be directly or indirectlyowned by five or fewer individuals at any time during the last half of eachtaxable year.  Prior to the consummationof the merger, we were able to attribute ownership indirectly to the Company’spublic stockholders.

 

By failing to qualify for taxation as a REIT, we aresubject to tax (including any applicable alternative minimum tax) on ourtaxable income at regular corporate rates, which reduces income that wouldotherwise be available to our stockholders. The provision for income taxes was $2,442,000 and $2,431,000,respectively, for the years ended December 31, 2002 and 2001.  Unless entitled to relief under specificstatute, we are disqualified from taxation as a REIT for the four taxable yearsfollowing the year during which qualification was lost and we are not permittedto requalify unless we distribute any earnings and profit attributable to theperiod during which we failed to qualify. Distributions to stockholders are not deductible by us nor are werequired to make them.  If distributionsto stockholders are made, all distributions up to the total of current andaccumulated earnings and profits are taxable as ordinary income but, subject tocertain limitations of the Internal Revenue Code of 1986 as amended (the“Code”), corporate distributees may be eligible for the dividends receiveddeduction.

 

(e)          Use of Estimates:

 

Management of the Company has made certain estimatesand assumptions relating to the reporting of assets and liabilities andreported amounts of revenues and expenses and the disclosure of contingentassets and liabilities to prepare these financial statements in conformity withaccounting principles generally accepted in the United States of America.Actual results could differ from those estimates.

 

**Note 3-Mortgage Loans and Allowancefor Loan Losses**

 

At December 31, 2002 and 2001, net mortgage loans consisted of thefollowing (dollars in thousands):

 
|                                   |   | **December  31, 2002** |   | **December  31, 2001** |   |
|----------------------------------------|--------|------------------------|--------|------------------------|--------|
|                                   |   |                   |   |                   |   |
| 1-4 family  residential mortgage loans |   | $                      | 637    |                   | $      | 735 |   |
| Multi-family  loans                    |   | 20,380                 |   | 4,153                  |   |
| Nonresidential  loans                  |   | 42,458                 |   | 66,549                 |   |
| Total loans,  gross                    |   | 63,475                 |   | 71,437                 |   |
| (Discount)/premium  on loans           |   | (189                   | )      | 61                     |   |
| Allowance for  loan losses             |   | (253                   | )      | (253                   | )      |
| Total loans, net                       |   | $                      | 63,031 |                   | $      | 71,245 |   |

 

36

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There was no activity inthe allowance for loan losses which had a balance of $253,000 at the beginningand end of each year.

 

There were no loans onnon-accrual status at either December 31, 2002 or 2001.  The Company’s gross impaired loans were $0,$0 and $52,000 as of December 31, 2002, 2001 and 2000, respectively. Theaverage impaired loans for the years then ended were $0, $0, and $13,000.  Interest income of $0, $0 and $2,000 relatedto these loans was recognized in 2002, 2001 and 2000, respectively.

 

As of December 31, 2002,all of the real estate properties underlying the mortgage loans included in theCompany’s portfolio were located in California. The one residential mortgageloan in the Company’s portfolio as of December 31, 2002 was secured by realestate located in southern California. Of the multi-family and nonresidentialloans included in the Company’s portfolio, approximately 1.2% were secured byreal estate located in northern California and 98.8% were secured by realestate located in southern California.

 

Consequently, thesemortgage loans may be subject to a greater risk of default than othercomparable mortgage loans in the event of adverse economic, political orbusiness developments and natural hazards (earthquakes, wild fires and mudslides, for example) in California that may affect the ability of propertyowners in California to make payments of principal and interest on theunderlying mortgages. Standard hazard insurance required to be maintained withrespect to mortgage loans held by the Company may not protect the Companyagainst losses occurring from earthquakes and other natural disasters.

 

**Note 4-Dividends**

 

Holders of Series APreferred Shares are entitled to receive non-cumulative dividends, if, when andas authorized and declared by the Board of Directors of the Company out offunds legally available, at a rate of 9.75% per annum of the initialliquidation preference ($25.00 per share). Dividends on the Series A PreferredShares, if authorized and declared, are payable quarterly in arrears on thelast day of March, June, September and December.  Dividends for each of the years ended December 31, 2002, 2001 and2000 to holders of the Series A Preferred Shares totaled approximately $3.5million per year, or $2.44 per share.

 

No cash dividends orother distributions may be paid on common stock unless (i) the Company has paidfull dividends on the Series A Preferred Shares for the four most recentdividend periods (or such lesser number of dividend periods during which theSeries A Preferred Shares have been outstanding) and has declared a cashdividend on the Series A Preferred Shares at the annual dividend rate for thecurrent dividend period, and (ii) the Company is in compliance with the termsof all stock ranking senior to the common stock.

 

Dividends on common stockare paid if and when authorized and declared by the Board of Directors out offunds legally available after all preferred dividends have been paid. Therewere $0, $0.7 million and $1.3 million in common dividends paid for the yearsended December 31, 2002, 2001 and 2000, respectively.

 

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**Note 5-Income Taxes**

 

Income taxes for theyears ended December 31, 2002 and 2001 were as follows (dollars in thousands):

 
|          |   | **2002** |   | **2001** |   |
|---------------|--------|----------|--------|----------|--------|
| Current:      |   |     |   |     |   |
| Federal       |   | $        | 1,810  |     | $      | 1,804 |   |
| State         |   | 632      |   | 627      |   |
| Total Current |   | $        | 2,442  |     | $      | 2,431 |   |

 

The differences betweenthe effective tax rate and the statutory Federal income tax rate of 35% aresummarized below.

 
| Federal income  taxes at statutory rate |   | $      | 2,011  |   | $      | 2,019 |   |
|-----------------------------------------|--------|--------|--------|--------|--------|-------|--------|
| Items affecting  income tax:            |   |   |   |   |   |
| State income  taxes                     |   | 411    |   | 408    |   |
| Other items, net                        |   | 20     |   | 4      |   |
| Actual income  taxes                    |   | $      | 2,442  |   | $      | 2,431 |   |

 

**Note 6-Related Party Transactions**

 

The Company entered into servicing agreements with theBank pursuant to which the Bank performs the servicing of the commercial andsingle-family residential mortgage loans held by the Company in accordance withnormal industry practice. The servicing fee the Bank charges is 0.25% to 0.375%per year of the outstanding principal balances of the commercial andsingle-family residential mortgages.

 

Servicing fee expense paid to the Bank totaled$174,000 for the year ended December 31, 2002 compared to $134,000 and $123,000for the periods ended December 31, 2001 and 2000, respectively. Until June2001, a portion of the Company’s residential mortgage loans was serviced byTemple Inland Mortgage Corporation through a sub-servicing arrangement at theBank. The servicing fee was 0.25% per year of the outstanding principalbalances. Servicing fee expense paid to Temple Inland Mortgage Corporation forthe year ended December 31, 2001 was $25,000 compared to $54,000 for the periodended December 31, 2000.

 

In its capacity asservicer, the Bank holds mortgage loan payments received on behalf of the Companyin custodial accounts.  The balance ofsuch accounts totaled $0, $741,000 and $610,000 at December 31, 2002, 2001 and2000, respectively, and was recorded as Due From Affiliate. Such payments werepassed through to the Company the following January as provided in theservicing agreement.

 

As the owner of 100% ofthe outstanding common stock of the Company, the Bank is the sole shareholderentitled to receive common dividends. There were no common dividends paid during the year ended December 31,2002.

 

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**Note7-Management/Advisory Fees**

 

The Company has anadvisory contract with the Bank.  Theinitial term was five years after which it is automatically renewed foradditional five-year periods unless notice of nonrenewal is delivered to theBank by the Company.  The advisory feewas waived by the Bank from June 2001 to June 2002.  In September 2002, the advisory fee was reinstated at the reducedamount of $40,000 per year, paid in quarterly installments. Total advisory feesof $20,000, $100,000 and $200,000 were paid to the Bank for the three yearsended December 31, 2002, 2001 and 2000. As long as any Series A PreferredShares remain outstanding, a decision by the Company to terminate the advisorycontract must be approved by a majority of the Board of Directors, as well asby a majority of the Independent Directors.

 

**Note8-Fair Value of Financial Instruments**

 

The carrying amounts andfair value of the Company’s financial instruments consisted of the following atDecember 31, 2002 and 2001 (dollars in thousands):

 
|                       |   | **2002**            |   | **2001**        |   |
|----------------------------|--------|---------------------|--------|-----------------|--------|
|                       |   | **Carrying  Value** |   | **Fair  Value** |   | **Carrying  Value** |   | **Fair  Value** |   |
| Financial  Assets:         |   |                |   |            |   |   |   |   |   |
| Cash and cash  equivalents |   | $                   | 12,167 |            | $      | 12,167 |   | $ | 2,946 |   | $ | 2,946 |   |
| Mortgage loans,  net       |   | 63,031              |   | 66,005          |   | 71,245 |   | 73,544 |   |
|                       |   |                |   |            |   |   |   |   |   |
| Due from  affiliate        |   | —              |   | —          |   | 741 |   | 741 |   |
|                            |        |                     |        |                 |        |  |  |  |  |  |  |  |  |

 

The following methods andassumptions were used to estimate the fair value of the each type of financialinstrument:

 

Cash and cashequivalents-The carrying value approximates the fair value for cash andshort-term investments.

 

Mortgage loans-Forresidential and commercial real estate loans, fair value is estimated bydiscounting projected future cash flows using the current interest rates atwhich mortgage loans with similar terms would be made to borrowers with similarcredit and other characteristics and with similar remaining terms to maturity.

 

Due from affiliate-Thecarrying value approximates the fair value for due from affiliate.

 

**ITEM 9:****       CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

39

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**PARTIII**

 

**ITEM 10:         DIRECTORSAND EXECUTIVE OFFICERS OF THE CORPORATION**

 

*Directors and Executive Officers.*TheCompany’s Board of Directors is composed of eight members, three of whom areIndependent Directors. The Company’s Articles of Incorporation require that aslong as any shares of the Series A Preferred Stock are outstanding, the Companymust have at least two “Independent Directors”.  An “Independent Director” is a director who is either (i) not acurrent officer or employee of the Company or (ii) not a current director,officer or employee of the Bank or any affiliate of the Bank. Each of thedirectors will serve until their successors are duly elected andqualified.  There is no currentintention to alter the number of directors comprising the Board of Directors.Certain actions by the Company require the prior approval of a majority of IndependentDirectors. Pursuant to the Articles of Incorporation, the Independent Directorsare required to consider the interests of the holders of both the Common Stockand the Preferred Stock, including the Series A Preferred Shares, indetermining whether any proposed action requiring their approval is in the bestinterests of the Company. The Company currently has four officers, all of whomare Bank officers. The Company has no other employees and does not anticipatethat it will require additional employees.

 

The persons who were directors and executive officers of the Company asof December 31, 2002 are as follows:

 
| **Name**         |   | **Age(1)** |   | **Position  and Offices Held**       |
|------------------|--------|------------|--------|--------------------------------------|
|             |   |       |   |                                 |
| Michael Kelly    |   | 57         |   | Chairman and Director                |
| Robert Heskett   |   | 55         |   | Director                             |
| Gregory Mitchell |   | 45         |   | Chief Executive Officer and Director |
| Michael Dunning  |   | 50         |   | Director                             |
| Leona Gleason    |   | 53         |   | Director                             |
| Gerald Rogers    |   | 70         |   | Director                             |
| Joel Bernick     |   | 64         |   | Director                             |
| John Case        |   | 72         |   | Director                             |

 

----

(1) As of December 31, 2002.

 

Set forth below isinformation with respect to the principal occupations during the last fiveyears of the Company’s directors and officers.

 

*Michael Kelly. *Mr. Kelly is FBOPCorporation’s Chairman of the Board and Chief Executive Officer.  Mr. Kelly joined FBOP Corporation in 1981.Prior to joining FBOP Corporation, Mr. Kelly was the Division head ofCommercial Lending at Norwest Bank, Minneapolis.

 

*Robert Heskett. *Mr. Heskett is FBOPCorporation’s President and is a Director of the Corporation.  Mr. Heskett joined the FBOP Corporation in1994. Prior  to joining FBOPCorporation, Mr. Heskett was an Executive Vice President of River ForestBancorp (now Corus Bancorporation) where he worked for eighteen years.

 

*Gregory Mitchell. *Mr. Mitchell joinedCalifornia National Bank and People’s Preferred Capital Corporation on June 15,2001 as its President.  Prior to joiningCalifornia National Bank, Mr. Mitchell was a Principal with Hovde Financialwhere he was responsible for the formation and management of its West Coastinvestment banking, financial advisory, and fund management practice.  Mr. Mitchell also has a significantregulatory background acquired through ten years of service with the FederalHome Loan Bank of San Francisco and the Office of Thrift Supervision, where Mr.Mitchell was an Accredited Thrift Regulator.

 

40

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*Michael Dunning. *Mr. Dunning is a SeniorVice President and the Chief Financial Officer of FBOP Corporation.  Mr. Dunning joined FBOP Corporation in1988.  Prior to the joining theCorporation, Mr. Dunning was a Senior Vice President for First of America,Kalamazoo, Michigan where he worked for five years.

 

*Leona Gleason. *Ms. Gleason is Senior VicePresident – Retail Banking for FBOP Corporation.  Ms. Gleason joined the Corporation in 1996.  Prior to joining FBOP Corporation, Ms.Gleason was the Senior Vice President of River Forest Bancorp (now CorusBancorporation) where she worked for nineteen years.

 

*Gerald K. Rogers.*  Mr. Rogers is a director of the Companysince 2001 and a member of the Audit Committee.  Mr. Rogers also serves on the Board of Directors of RegencySavings Bank, a subsidiary of FBOP Corporation and is a member of the FBOPCorporation Audit Committee.  Prior tohis retirement in 1991, Mr. Rogers was Chief Executive Officer of RegencySavings Bank for 21 years.

 

*Joel S. Bernick. *Mr. Bernick has been adirector of the Company since 2001 and is the Chairman of the AuditCommittee.  Mr. Bernick also serves onthe Board of Directors of First Bank of Oak Park, a subsidiary of FBOPCorporation and is the Chairman of the FBOP Corporation Audit Committee.  Prior to his retirement in 1999, Mr. Bernickwas the president of CC Shops, Inc. a 28 store franchisee operation of “TheBarbers,” Hairstyling for Men and Women, Inc. Mr. Bernick sold CC Shops, Inc. in 1999 to Regis Corporation.  Mr. Bernick is also a Certified PublicAccountant.

 

*John J. Case. *Mr. Case, a director ofthe Company since 2001, is a member of the Audit Committee.  Mr. Case also serves on the Board ofDirectors of Regency Savings Bank, a subsidiary of FBOP Corporation.  Mr. Case is the President of Arginetics,Inc. and has served in that capacity since 1972.  Mr. Case has been the Chairman of PACE Suburban Bus Board ofDirectors since 1999.  Mr. Case has alsoserved in various other capacities, including Chairman of the Dupage CountyBoard of Directors.

 

**AuditCommittee**

 

The Company hasestablished an audit committee which will review the engagement andindependence of the Company’s auditors. The audit committee will also reviewthe adequacy of the Company’s internal accounting controls. The audit committeecurrently consists of Messrs. Rogers, Bernick and Case.

 

**ITEM11:         EXECUTIVE COMPENSATION**

 

**Compensation of Directors andOfficers**

 

The Company pays itsIndependent Directors fees for their services as directors. The IndependentDirectors receive a fee of $1,000 for attendance (in person or by telephone) ateach meeting of the Board of Directors or Committee of the Board. However,multiple fees shall not be paid for two or more meetings attended on the sameday. The Company does not pay any compensation to its officers or employees orto directors who are not Independent Directors.

 

41

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**Limitations on Liability of Directorsand Officers**

 

TheCompany’s Articles of Incorporation eliminate, to the fullest extent permittedby the Maryland General Corporation Law (“MGCL”), the personal liability of adirector to the Company or its stockholders for monetary damages for breach ofthe director’s fiduciary duty. The Articles of Incorporation empower theCompany to indemnify, to the fullest extent permitted by the MGCL, any of theCompany’s directors or officers. The Articles of Incorporation also allow theCompany to purchase and maintain insurance to protect any director or officeragainst any liability asserted against him or her or incurred by him or her,arising out of his or her status as such.

 

The Company’s bylaws (the“Bylaws”) require indemnification of its directors and officers and specifythat the right to indemnification is a contract right, setting forth certainprocedural and evidentiary standards applicable to the enforcement of a claimunder the Bylaws. The Bylaws also entitle any director or officer to bereimbursed for the expenses of defending any claim against him or her arisingout of his or status as such. The Bylaws also provide that the Company mayenter into contracts with any director or officer to further theindemnification provisions contained in the Bylaws and allow the Company to createa trust fund to ensure payment of amounts indemnified.

 

**ITEM 12:****     SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

As of December 31, 2002,there were 10,000 shares of Common Stock of the Company issued and outstanding,all of which were owned by the Bank. The following table set forth certaininformation concerning the ownership of the Company’s outstanding Common Stockas of that date.

 
| **Title of Class** |   | **Name and  Address  of Beneficial Owner**                                         |   | **Amount and  Nature of  Beneficial Ownership** |   | **Percent  of Class** |   |
|--------------------|--------|------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|-----------------------|--------|
|               |   |                                                                               |   |                                            |   |                  |   |
| Common Stock       |   | California National Bank  221 South Figueroa Street  Los Angeles, California 90012 |   | 10,000                                          |   | 100                   | %      |

 

**ITEM 13:         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

The Company entered intoa servicing agreement with the Bank pursuant to which the Bank performs theactual servicing of the commercial and single-family residential mortgage loansheld by the Company in accordance with normal industry practice. The servicingfee ranges from 0.25% to 0.375% per year of the outstanding principal balances.Servicing fee expense paid to the Bank totaled $174,000 for 2002, $134,000 for2001 and $123,000 for 2000. See Part 1, Item I - “Servicing.”

 

In its capacity asservicer, the Bank holds mortgage loan payments received on behalf of theCompany in custodial accounts at the Bank. The balance of such accounts totaled$0, $741,000 and $610,000 at December 31, 2002, 2001 and 2000, respectively,and was included in Due from Affiliate. Such payments were passed through tothe Company the following January as provided in the servicing agreement.  As the owner of 100% of the outstandingcommon stock of the Company, the Bank is the sole shareholder entitled toreceive common dividends. There were no common dividends paid during the yearended December 31, 2002.

 

The Company has anadvisory contract with the Bank.  Theinitial term was five years after which it is automatically renewed foradditional five-year periods unless notice of nonrenewal is delivered to the

 

42

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Bank by the Company.  Theadvisory fee was waived by the Bank from June 2001 through June 2002.  In September 2002, the advisory fee wasreinstated in the reduced amount of $40,000 per year, paid in quarterlyinstallments. Total advisory fees of $20,000 were paid to the Bank for 2002compared to $100,000 in 2001.  See Part1, Item I -“Management Policies-Advisory Agreement.”

 

**ITEM 14:        ****CONTROLS ANDPROCEDURES**

 

*Evaluationof Disclosure Controls and Procedures.*  Our Chief Executive Officer and ChiefFinancial Officer have evaluated the effectiveness of our disclosure controlsand procedures (as such terms are defined in Rules 13a-14(c) and 15d-14(c)under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) asof a date within 90 days prior to the filing date of this report (the“Evaluation Date”).  Based on suchevaluation, these officers have concluded that, as of the Evaluation Date, ourdisclosure controls and procedures are effective in alerting them on a timelybasis to material information relating to our company (including anyconsolidated subsidiaries) required to be included in our reports filed orsubmitted under the Exchange Act.

 

C*hanges in Internal Controls.*  Since the Evaluation Date, there have notbeen any significant changes in our internal controls or in other factors thatcould significantly affect such controls.

 

43

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**PARTIV**

 

**ITEM 15:         EXHIBITS****, FINANCIALSTATEMENT SCHEDULES, REPORTS ON FORM 8- K**

 

No Current Reports on Form 8-K were filed duringthe year of 2002.

 

**ExhibitIndex**

 
| **Exhibit** |   | **Description**                                                                                                           |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                      |
| 3(a)(i)     |   | Articles of Incorporation of the Company.*                                                                                |
|        |   |                                                                                                                      |
| 3(a)(ii)    |   | Amended and Restated Articles of Incorporation of  the Company.**                                                         |
|        |   |                                                                                                                      |
| 3(b)        |   | By-laws of the Company.*                                                                                                  |
|        |   |                                                                                                                      |
| 4           |   | Specimen of certificate representing Series A  Preferred Shares.*                                                         |
|        |   |                                                                                                                      |
| 10(a)       |   | Residential Mortgage Loan Purchase and Warranties  Agreement between the Company and the Bank.**                          |
|        |   |                                                                                                                      |
| 10(a)(1)    |   | Amendment to Residential Mortgage Loan Purchase and  Warranties Agreement between the Company and the Bank.**             |
|        |   |                                                                                                                      |
| 10(b)       |   | Commercial Mortgage Loan Purchase and Warranties  Agreement between the Company and the Bank.**                           |
|        |   |                                                                                                                      |
| 10(c)       |   | Residential Mortgage Loan Servicing Agreement  between the Company and the Bank.**                                        |
|        |   |                                                                                                                      |
| 10(d)       |   | Commercial Mortgage Loan Servicing Agreement between  the Company and the Bank.**                                         |
|        |   |                                                                                                                      |
| 10(e)       |   | Advisory Agreement between the Company and the  Bank.**                                                                   |
|        |   |                                                                                                                      |
| 99          |   | Certifications pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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*                                        Incorporatedby reference from the Registration Statement on Form S-11 (File No. 333-31501)of People’s Preferred Capital Corporation, as filed with the Securities andExchange Commission on July 10, 1997.

 

**                                 Incorporatedby reference from the Annual Report on Form 10-K of People’s Preferred CapitalCorporation, as filed with the Securities and Exchange Commission on March 30,1998.

 

44

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**SIGNATURES**

 

Pursuant to therequirements of the section of 13 and 15 (d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|                 |   |   | **PEOPLE’S  PREFERRED  CAPITAL CORPORATION** |
|----------------------|--------|--------|---------------------------------------------------|
|                 |   |   |                                              |
| Date: March 21, 2003 |   |   | By:/s/Gregory Mitchell                            |
|                 |   |   | Gregory Mitchell                                  |
|                 |   |   | *Chief Executive Officer*                         |

 

Pursuant to therequirements of the Securities Act, this report has been signed below by thefollowing persons on behalf of the Registrant and in the capacities and on thedates indicated.

 
| **Name**             |   | **Title** |                                 | **Date** |
|----------------------|--------|-----------|--------------------------------------|----------|
|                 |   |      |                                 |     |
| /s/ MICHAEL KELLY    |   |      | Chairman and Director                |     | March 21, 2003 |
|                 |   |      |                                 |     |
| Michael Kelly        |   |      |                                 |     |
|                 |   |      |                                 |     |
| /s/ ROBERT HESKETT   |   |      | Director                             |     | March 21, 2003 |
|                 |   |      |                                 |     |
| Robert Heskett       |   |      |                                 |     |
|                 |   |      |                                 |     |
| /s/ GREGORY MITCHELL |   |      | Chief Executive Officer and Director |     | March 21, 2003 |
|                 |   |      |                                 |     |
| Gregory Mitchell     |   |      |                                 |     |
|                 |   |      |                                 |     |
| /s/ MICHAEL DUNNING  |   |      | Director                             |     | March 21, 2003 |
|                 |   |      |                                 |     |
| Michael Dunning      |   |      |                                 |     |
|                 |   |      |                                 |     |
| /s/ LEONA GLEASON    |   |      | Director                             |     | March 21, 2003 |
|                 |   |      |                                 |     |
| Leona Gleason        |   |      |                                 |     |
|                 |   |      |                                 |     |
| /s/ GERALD ROGERS    |   |      | Director                             |     | March 21, 2003 |
|                 |   |      |                                 |     |
| Gerald Rogers        |   |      |                                 |     |
|                 |   |      |                                 |     |
| /s/ JOEL BERNICK     |   |      | Director                             |     | March 21, 2003 |
|                 |   |      |                                 |     |
| Joel Bernick         |   |      |                                 |     |
|                 |   |      |                                 |     |
| /s/ JOHN CASE        |   |      | Director                             |     | March 21, 2003 |
|                 |   |      |                                 |     |
| John Case            |   |      |                                 |     |
|                      |        |           |                                      |          |  |  |  |  |  |  |

 

45

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**CERTIFICATIONS**

 

I, Gregory Mitchell, President and Chief ExecutiveOfficer of People’s Preferred Capital Corporation (the “Company”), certifythat:

 
| (1)    | I have reviewed this report on form 10-K of People’s  Preferred Capital Corporation;                                                                                                                                                                                                                                                                                                 |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    | Based on my knowledge, this annual report does not  contain any untrue statement of a material fact or omit to state a material  fact necessary to make the statements made, in light of the circumstances  under which such statements were made, not misleading with respect to the period  covered by this annual report;                                                              |
| (3)    | Based on my knowledge, the financial statements, and  other financial information included in this report, fairly present in all  material aspects the financial condition, results of operations and cash  flows of the registrant as of and for the periods presented in this annual  report;                                                                                           |
| (4)    | The registrant’s other certifying officers and I are  responsible for establishing and maintaining disclosure controls and  procedures (as defined in Exchange Act rules 13a-14 and 15d-14) for the  registrant and have:                                                                                                                                                            |
|   | (a)                                                                                                                                                                                                                                                                                                                                                                                       | designed such disclosure controls and procedures to  ensure that material information relating to the registrant, including its  consolidated subsidiaries, is made known to us by others within those  entities, particularly during the period in which this annual report is being  prepared; |
|   | (b)                                                                                                                                                                                                                                                                                                                                                                                       | evaluated the effectiveness of the registrant’s  disclosure controls and procedures as of a date within 90 days prior to the  filing of this annual report (the “Evaluation Date”); and, |
|   | (c)                                                                                                                                                                                                                                                                                                                                                                                       | presented in this report our conclusions about the  effectiveness of the disclosure controls and procedures based on our  evaluation as of the Evaluation Date. |
| (5)    | The registrant’s other  certifying officers and I have disclosed, based on our most recent  evaluation, to the registrant’s auditors and the audit committee of the  registrant’s board of directors:                                                                                                                                                                      |
|   | (a)                                                                                                                                                                                                                                                                                                                                                                                       | all significant deficiencies in the design or  operation of internal controls which could adversely affect the registrant’s  ability to record, process, summarize and report financial data and have  identified for the registrant’s auditors any material weaknesses in internal  controls; and, |
|   | (b)                                                                                                                                                                                                                                                                                                                                                                                       | any fraud, whether or not material, that involves  management or other employees who have a significant role in the registrant’s  internal controls; and, |
| (6)    | The registrant’s other  certifying officers and I have indicated in this annual report whether there  were significant changes in internal controls or in other factors that could  significantly affect internal controls subsequent to the date of our most  recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |

 

 
| Dated:  March 21, 2003 |   |                 |
|----------------------------------|--------|----------------------|
|                             |   | Gregory A. Mitchell  |
|                             |   | President and C.E.O. |

 

46

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**CERTIFICATIONS**

 

I, Karen Schoenbaum, Chief Financial Officer ofPeople’s Preferred Capital Corporation (the “Company”), certify that:

 
| (1)    | I have reviewed this report on form 10-K of People’s  Preferred Capital Corporation;                                                                                                                                                                                                                                                                                                 |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    | Based on my knowledge, this annual report does not  contain any untrue statement of a material fact or omit to state a material  fact necessary to make the statements made, in light of the circumstances  under which such statements were made, not misleading with respect to the  period covered by this annual report;                                                              |
| (3)    | Based on my knowledge, the financial statements, and  other financial information included in this annual report, fairly present in  all material aspects the financial condition, results of operations and cash  flows of the registrant as of and for the periods presented in this annual  report;                                                                                    |
| (4)    | The registrant’s other certifying officers and I are  responsible for establishing and maintaining disclosure controls and  procedures (as defined in Exchange Act rules 13a-14 and 15d-14) for the  registrant and have:                                                                                                                                                            |
|   | (a)                                                                                                                                                                                                                                                                                                                                                                                       | designed such disclosure controls and procedures to  ensure that material information relating to the registrant, including its  consolidated subsidiaries, is made known to us by others within those  entities, particularly during the period in which this annual report is being  prepared; |
|   | (b)                                                                                                                                                                                                                                                                                                                                                                                       | evaluated the effectiveness of the registrant’s  disclosure controls and procedures as of a date within 90 days prior to the  filing of this annual report (the “Evaluation Date”); and, |
|   | (c)                                                                                                                                                                                                                                                                                                                                                                                       | presented in this report our conclusions about the  effectiveness of the disclosure controls and procedures based on our  evaluation as of the Evaluation Date. |
| (5)    | The registrant’s other  certifying officers and I have disclosed, based on our most recent  evaluation, to the registrant’s auditors and the audit committee of the  registrant’s board of directors:                                                                                                                                                                      |
|   | (a)                                                                                                                                                                                                                                                                                                                                                                                       | all significant deficiencies in the design or  operation of internal controls which could adversely affect the registrant’s  ability to record, process, summarize and report financial data and have  identified for the registrant’s auditors any material weaknesses in internal  controls; and, |
|   | (b)                                                                                                                                                                                                                                                                                                                                                                                       | any fraud, whether or not material, that involves  management or other employees who have a significant role in the registrant’s  internal controls; and, |
| (6)    | The registrant’s other  certifying officers and I have indicated in this annual report whether there  were significant changes in internal controls or in other factors that could  significantly affect internal controls subsequent to the date of our most  recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |

 

 
| Dated:  March 21, 2003 |   |                    |
|----------------------------------|--------|-------------------------|
|                             |   | Karen Schoenbaum        |
|                             |   | Chief Financial Officer |

 

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