**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 
| **(Mark One)**                                                                                                                                                                                       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **ý****ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**                                                                                                 |
|                                                                                                                                                                                                 |
| **For the fiscal year ended December 31, 2002**                                                                                                                                                      |
|                                                                                                                                                                                                 |
| **o****TRANSITION REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**                                                                                                  |
|                                                                                                                                                                                                 |
| **For the transition period from               to               ** |
|                                                                                                                                                                                                 |
| **Commission file number: 0-22732**                                                                                                                                                                  |
|                                                                                                                                                                                                 |
| **PACIFIC CREST CAPITAL, INC.**                                                                                                                                                                      |
| (Exact name of registrant as specified in its charter)                                                                                                                                               |

 
| **Delaware**                                                    | **95-4437818**                        |
|-----------------------------------------------------------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) | (I.R.S. Employer  Identification No.) |
|                                                            |                                  |
| **30343 Canwood Street  Agoura Hills, California**              | **91301**                             |
| (Address of principal executive offices)                        | (Zip Code)                            |

 
| Registrant’s telephone number, including area code: **(818) 865-3300** |
|-----------------------------------------------------------------------------|
|                                                                        |
| Securities registered pursuant to Section 12(b) of the Act: **None**        |
|                                                                        |
| Securities registered pursuant to Section 12(g) of the Act:                 |
|                                                                        |
| **Common Stock, $.01 par value**                                            |
| **9.375% Cumulative Trust Preferred  Securities of PCC Capital I**          |
| **Guarantee of Pacific Crest Capital, Inc.  with respect to the**           |
| **9.375% Cumulative Trust Preferred  Securities of PCC Capital I**          |
| (Title of Class)                                                            |

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 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 such filingrequirements for the past 90 days. YES  ý NO o

 

Indicate bycheck mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K. ý

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)Yes o No ý

 

The aggregatemarket value of the voting stock held by non-affiliates of the registrant onJune 28, 2002, based on the closing price of such stock on the Nasdaq NationalMarket, was $64,048,000.

 

As of March14, 2003, the number of shares outstanding of the registrant’s $ .01 par valueCommon Stock was 4,855,273.

 

**Documents Incorporated by Reference**

 

Portions ofthe Definitive Proxy Statement for the Annual Meeting of Shareholders to beheld on May 9, 2003 are incorporated by reference into Part III of this Form10-K.

 

 

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**PACIFIC CREST CAPITAL, INC.**

 

**2002 ANNUAL REPORT ON FORM 10-K**

 

**TABLE OF CONTENTS**

 
| **PART I**         |
|--------------------|
| **ITEM  1**   | **Business** |
|               | General |
|               | Loans |
|               | Asset Quality Review |
|               | Allowance for Loan Losses |
|               | Investments |
|               | Deposits |
|               | Borrowings |
|               | Employees |
|               | Asset/Liability Management |
|               | Regulation |
|               | Factors That May Affect the Company’s  Business or Stock Value |
| **ITEM  2**   | **Properties** |
| **ITEM  3**   | **Legal Proceedings** |
| **ITEM   4**  | **Submission of Matters to a Vote of  Security Holders** |
|               |   |
| **PART II**        |
|               |   |
| **ITEM   5**  | **Market for Registrant’s Common Equity and  Related Stockholder Matters** |
| **ITEM   6**  | **Selected Financial Data** |
| **ITEM   7**  | **Management’s Discussion and Analysis of  Financial Condition and Results of Operations** |
|               | General |
|               | Results of Operations |
|               | Financial Condition |
|               | Liquidity |
|               | Dividends |
|               | Capital Resources |
|               |   |
| **ITEM   7A** | **Quantitative and Qualitative Disclosures  About Market Risk** |
| **ITEM   8**  | **Financial Statements and Supplementary Data** |
| **ITEM   9**  | **Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure** |
|               |   |
| **PART III**       |
|               |   |
| **ITEM 10**        | **Directors and Executive Officers of the  Registrant** |
| **ITEM 11**        | **Executive Compensation** |
| **ITEM 12**        | **Security Ownership of Certain Beneficial  Owners and Management** |
| **ITEM 13**        | **Certain Relationships and Related  Transactions** |
| **ITEM 14.**       | **Controls and Procedures** |
|               |   |
| **PART IV**        |
|               |   |
| **ITEM  15**       | **Exhibits,  Financial Statements and Reports on Form 8-K** |

 

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**PART I**

** **

**ITEM 1.  Business**

** **

**GENERAL**

 

Pacific CrestCapital, Inc. (“Pacific Crest” or the “Parent”) is a bank holding companyprincipally engaged in income property lending and U.S. Small BusinessAdministration (“SBA”) lending through its wholly owned subsidiary, PacificCrest Bank (the “Bank”). See “Pacific Crest Bank” below.  Pacific Crest is regulated by the Board ofGovernors of the Federal Reserve System (the “Federal Reserve”).  Unless the context otherwise indicates, the“Company” refers to Pacific Crest together with its wholly owned subsidiaries,Pacific Crest Bank and PCC Capital I.

 

**Forward-LookingInformation**

 

Certainmatters discussed in this Annual Report on Form 10-K may constituteforward-looking statements under Section 27A of the Securities Act of 1933, asamended (the “Securities Act”), and Section 21E of the Securities Exchange Actof 1934, as amended (the “Exchange Act”). These statements may involve risks and uncertainties.  These forward-looking statements relate to,among other things, expectations of the business environment in which theCompany operates, projections of future performance, perceived opportunities inthe market and statements regarding the Company’s mission and vision.  Forward-looking statements include, but arenot limited to, statements preceded by, followed by or that include the word“will,” “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates”or similar expressions.  The Company’sactual results, performance or achievements may differ significantly from theresults, performance or achievements expressed or implied in such forward-lookingstatements.  For discussion of thefactors that might cause such a difference, see “Factors That May Affect theCompany’s Business or Stock Value.” Management of the Company believes that these forward-looking statementsare reasonable; however, undue reliance should not be placed on suchstatements, which are based on current expectations.

 

**PacificCrest Bank**

 

Pacific CrestBank is a California state chartered commercial bank that is supervised andregulated by the California Commissioner of Financial Institutions (the“Commissioner”), the California Department of Financial Institutions (the“Department” or “DFI”), and the Federal Deposit Insurance Corporation(“FDIC”).  The Bank’s deposits areinsured by the FDIC up to applicable limits. The Bank introduced full-service,consumer checking accounts to all of its retail customers in the fourth quarterof 2000.  During 2002, the Bankintroduced business checking accounts as well as debit cards, online banking,and online bill pay.  Additionally, duringthis same period, the Bank introduced a business lending program and a varietyof depository services for business professionals and small businesses tocomplement its SBA lending programs. Products offered under the new lending program include a business lineof credit and a business term loan.  This program is designed to build significant depository relationshipswith business customers.

 

Pacific CrestBank is a business bank that concentrates on marketing to and serving the needsof investors, entrepreneurs, and small businesses located predominantly inCalifornia.  The Bank conducts itsdeposit operations through three branch offices located in Beverly Hills,Encino, and San Diego, California. The Bank currently offers consumer andbusiness checking accounts, money market checking accounts, savings accounts,and certificates of deposit.  The Bankhas focused its lending activities primarily on income producing real estateloans and small business loans under the SBA 7(a) and 504 loan programs.  The Bank conducts its lending operations inCalifornia through its lending and marketing representatives.  To a lesser extent, and on a very selectivebasis, the Bank makes real estate loans in other western states.

 

1

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**PCCCapital I**

 

PCC Capital I(“PCC Capital”) is a Delaware statutory business trust that was created for theexclusive purpose of issuing and selling 9.375% Cumulative Trust PreferredSecurities (the “Trust Preferred Securities”). On September 22, 1997, PCCCapital completed a $17.25 million public offering of the Trust PreferredSecurities and invested the gross proceeds from the offering in juniorsubordinated debentures issued by Pacific Crest bearing interest at 9.375%.  The junior subordinated debentures wereissued concurrent with the issuance of the Trust Preferred Securities.  The interest on the junior subordinateddebentures paid by Pacific Crest to PCC Capital represents the sole revenues ofPCC Capital and the sole source of dividend distributions to the holders of theTrust Preferred Securities.  PacificCrest has fully and unconditionally guaranteed all of PCC Capital’s obligationsunder the Trust Preferred Securities.

 

Pacific Cresthas the right, assuming no default has occurred, to defer payments of intereston the junior subordinated debentures at any time for a period not to exceed 20consecutive quarters.  The TrustPreferred Securities will mature on October 1, 2027, but became callablein part or in total on October 1, 2002 by PCC Capital.

 

The TrustPreferred Securities are presented on a separate line on the ConsolidatedBalance Sheets under the caption “Trust preferred securities.”  For financial reporting purposes, theCompany records the dividend distributions on the Trust Preferred Securities as“Interest expense – trust preferred securities” on its Consolidated Statementsof Income.

 

**Issuanceof New Trust Preferred Securities**

 

On March 20,2003, the Company announced that it had issued $13,330,000 of trust preferredsecurities (the “New Trust Preferred Securities”) in a private placementoffering.  Estimated net proceeds to theCompany from the offering after expenses were $13,320,000.  There were no commissions or expensescharged by the underwriter on this transaction.  The New Trust Preferred Securities were issued by a newlyestablished subsidiary of the Company, Pacific Crest Capital Trust I.   The New Trust Preferred Securities have amaturity of 30 years, but are callable by Pacific Crest Capital, Inc. in partor in total at par after five years. The New Trust Preferred Securities have a fixed interest rate of 6.335%during the first five years, after which the interest rate will float and resetquarterly at the three-month Libor rate plus 3.25%.

 

**LOANS**

 

**LendingActivities**

 

The Bank’sprimary focus in its lending activities is the origination of income propertyloans and small business loans under the SBA 7(a) and 504 loan programs.  The Company categorizes non-residential realestate loans and multi-family residential loans as income property loans.  As of December 31, 2002, the Bank held 514income property loans with an average balance of $800,000, as well as 171 SBAloans with an average balance of $218,000. Loans generally are made for terms from three to 20 years.

 

In order to manage interestrate risk, the Company endeavors to underwrite most of its income propertyloans on either an adjustable rate basis or a short-term fixed rate basis,whereby the loan initially has a fixed rate for a period from three to fiveyears, after which the loan reprices on either a quarterly, semi-annual, orannual basis.  The  adjustable rate income property loansreprice on either a quarterly, semi-annual, or annual basis.   All of the Company’s SBA 7(a) and 504second lien loans are adjustable rate and reprice either monthly or quarterlybased upon the *Wall Street Journal* prime lending rate, while the Company’sSBA 504 first lien loans are generally fixed rate.   A number of loans have interest rate floors and ceilings thatlimit the interest rate repricing of the loans.  For more information on the Company’s loan repricing, see Item7A. “Quantitative and Qualitative Disclosures About Market Risk”.

 

2

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The followingtable presents the Bank’s loan originations for the periods indicated (inthousands):

 
|                              |   | **Years Ended December 31,** |   |
|-----------------------------------|--------|------------------------------|--------|
|                              |   | **2002**                     |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Income property loans             |   | $                            | 77,108 |   | $ | 99,613 |   | $ | 67,122 |   | $ | 127,604 |   | $ | 103,129 |   |
| Commercial business loans (1)     |   | —                       |   | 6,225 |   | — |   | — |   | — |   |
| SBA business loans:               |   |                         |   |   |   |   |   |   |   |   |   |
| 7(a) loans - guaranteed portion   |   | 14,115                       |   | 10,667 |   | 8,064 |   | 3,064 |   | 4,287 |   |
| 7(a) loans - unguaranteed portion |   | 4,487                        |   | 3,394 |   | 2,662 |   | 985 |   | 1,423 |   |
| Total 7(a) loans                  |   | 18,602                       |   | 14,061 |   | 10,726 |   | 4,049 |   | 5,710 |   |
| 504 first lien loans (2)          |   | 3,910                        |   | 4,758 |   | 1,334 |   | — |   | — |   |
| 504 second lien loans             |   | 3,056                        |   | 4,589 |   | 1,080 |   | — |   | — |   |
| Total 504 loans                   |   | 6,966                        |   | 9,347 |   | 2,414 |   | — |   | — |   |
| Total SBA business loans          |   | 25,568                       |   | 23,408 |   | 13,140 |   | 4,049 |   | 5,710 |   |
| Total loan originations           |   | 102,676                      |   | 129,246 |   | 80,262 |   | 131,653 |   | 108,839 |   |
|                                   |        |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)           Primarily representsunsecured loans to financial institutions.

(2)           Excludes $14.6million in SBA 504 first lien loans brokered during 2002, which generated$998,000 in broker fee income.

 

**IncomeProperty Lending**

 

The Bank’sincome property loans have been originated primarily through either directcontacts with borrowers by Bank marketing representatives or referrals fromcommercial loan brokers, other banks, realtors, and other third parties, forwhich the borrower generally pays a referral fee normally between 0.5% to 1% ofthe loan amount. The Bank employs commercial marketing representatives whomaintain contacts with loan referral sources, screen referred transactions, andprovide customer service.

 

The Bank’scredit approval process includes an examination of the cash flow and debtservice coverage of the property serving as loan collateral, as well as thefinancial condition and credit references of the borrower. Following analysis ofthe borrower’s credit, cash flows and collateral, loans are submitted to theBank’s Credit Committee for approval. The Bank’s senior management is activelyinvolved in its lending activities and collateral valuation and review process.The Bank obtains independent third party appraisals of all properties securingits loans. In addition, the Bank employs an individual who serves as internalproperty analyst to inspect properties and review the third party appraisalsfor the benefit of the Credit Committee.

 

The Bankcurrently offers income property loans that generally fall within a range of$250,000 to $4.0 million.  Management,in consultation with the Bank’s Board of Directors, periodically adjusts andmodifies its underwriting criteria and lending and underwriting policies inresponse to economic conditions and business opportunities.

 

As of December31, 2002, $411.2 million, or 90.2% of the Company’s loans were categorized asincome property loans.  The Company hasbeen specializing in this type of lending for over 15 years and believes thatit has developed highly effective risk diversification policies as well asexceptionally strong credit and collateral analysis skills in this area.  During each of the years ended December 31,2002, 2001, 2000, and 1998, total recoveries on income property loans exceededcharge-offs.  As of December 31, 2002,2001, and 2000, the Company had no income property loans categorized asnon-accrual.  The management of theCompany believes that its excellent history of credit losses has been due to astrong, diversified regional economy as well as the intense focus by theCompany on risk management for income property lending.  For additional information on the Company’sasset quality and allowance for loan losses activity for the last five years,see “Asset Quality Review” and “Allowance for Loan Losses”.

 

3

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The Companybelieves that it manages credit risk tightly in its income property loanportfolio and uses a variety of policy guidelines and analytical tools toachieve its asset quality objectives. Key risk control features include:

 

•                                          Geographicdiversification of real estate collateral throughout Southern California andelsewhere, avoiding large submarket concentrations (see the following table ongeographic locations of the Company’s income property loans at December 31,2002).

 

•                                          Avoidinglending in geographic areas that have rapidly escalating property rents or highlevels of new construction.

 

**•**                                          Focusing onproperty types that are less prone to the “boom and bust” building cycle.

 

•                                          Limitingloan size on any one property.  As ofDecember 31, 2002, the largest single income property loan was $3.7 million andthe average loan size of this portfolio was $800,000.

 

•                                          Analyzingthe ability of the underlying real estate to service the related borrower’sloan through various economic and interest rate cycles.

 

•                                          Requiringhigher debt service coverage ratios on new loans during times of low interestrates in order to insulate the Company as much as possible from borrowerdefaults as interest rates rise.  Thiswas particularly emphasized during 2002 due to historically low short-terminterest rates.

 

•                                          Carefulevaluation of professional property appraisals by both the Company’s CreditCommittee and the Company’s internal property valuation review analyst.

 

•                                          Deployingonly highly seasoned and skilled specialists in both business development andCredit Committee member positions. Employees in these roles at December 31, 2002 averaged over 15 years ofservice with the Company and over 25 years of lending experience.

 

The tablebelow presents the Bank’s income property loans by (1) collateral type and, (2)tenant occupied vs. owner occupied, as of December 31, 2002 (dollars in thousands):

 
|                                     |   | **Tenant  Occupied** |    | **Owner  Occupied** |   | **Total** |   | **Number  of Loans** |    | **Average  Loan Size** |   |
|------------------------------------------|--------|----------------------|---------|---------------------|--------|-----------|--------|----------------------|---------|------------------------|--------|
| ***Non-residential real estate loans:*** |   |                 |    |                |   |      |   |                 |    |                   |   |
| Neighborhood retail centers              |   | $                    | 209,671 |                | $      | 7,827     |   | $                    | 217,498 |                   | 243    |   | $ | 895 |   |
| Mixed use properties                     |   | 46,411               |    | 3,723               |   | 50,134    |   | 62                   |    | 809                    |   |
| Industrial warehouse facilities          |   | 24,810               |    | 5,681               |   | 30,491    |   | 44                   |    | 693                    |   |
| Automotive related properties            |   | 20,765               |    | 6,023               |   | 26,788    |   | 37                   |    | 724                    |   |
| Business office buildings                |   | 19,649               |    | 5,830               |   | 25,479    |   | 33                   |    | 772                    |   |
| Single purpose properties                |   | 17,233               |    | 2,635               |   | 19,868    |   | 36                   |    | 552                    |   |
| Industrial manufacturing facilities      |   | 7,680                |    | 1,880               |   | 9,560     |   | 14                   |    | 683                    |   |
| Medical care facilities                  |   | 4,545                |    | 1,353               |   | 5,898     |   | 7                    |    | 843                    |   |
| Land                                     |   | —               |    | 975                 |   | 975       |   | 2                    |    | 488                    |   |
| Total non-residential real estate loans  |   | 350,764              |    | 35,927              |   | 386,691   |   | 478                  |    | 809                    |   |
| ***Multi-family residential loans***     |   | 24,535               |    | —              |   | 24,535    |   | 36                   |    | 682                    |   |
| ***Construction loans***                 |   | —               |    | —              |   | —    |   | —               |    | —                 |   |
| Total income property loans              |   | $                    | 375,299 |                | $      | 35,927    |   | $                    | 411,226 |                   | 514    |   | $ | 800 |   |

 

4

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The tablebelow presents the Bank’s income property loans by geographic concentration atDecember 31, 2002 (dollars in thousands):

 
|                                              |   | **Percent  of Total** |   | **Amount** |    | **Number  of Loans** |   | **Average  Loan Size** |   |
|---------------------------------------------------|--------|-----------------------|--------|------------|---------|----------------------|--------|------------------------|--------|
| **Southern California Counties**                  |   |                  |   |       |    |                 |   |                   |   |
| Los Angeles County:                               |   |                  |   |       |    |                 |   |                   |   |
| Los Angeles County North                          |   | 11.1                  | %      | $          | 45,734  |                 | 71     |                   | $      | 644 |   |
| Los Angeles County South                          |   | 7.5                   | %      | 30,961     |    | 45                   |   | 688                    |   |
| Los Angeles County East                           |   | 5.1                   | %      | 21,074     |    | 27                   |   | 781                    |   |
| Los Angeles County West                           |   | 5.0                   | %      | 20,579     |    | 25                   |   | 823                    |   |
| Jefferson Park, Crenshaw, Leimert Park, Hyde Park |   | 3.0                   | %      | 12,458     |    | 15                   |   | 831                    |   |
| Hollywood, Silverlake, Glassell Park, Echo Park   |   | 2.0                   | %      | 8,223      |    | 13                   |   | 633                    |   |
| Mid-City, Koreatown, Westlake                     |   | 1.8                   | %      | 7,517      |    | 12                   |   | 626                    |   |
| South Los Angeles City, Inglewood                 |   | 1.5                   | %      | 5,968      |    | 7                    |   | 853                    |   |
| Downtown Area, Chinatown                          |   | 0.5                   | %      | 1,966      |    | 1                    |   | 1,966                  |   |
| Los Angeles County Other                          |   | 5.4                   | %      | 22,362     |    | 34                   |   | 658                    |   |
| Total Los Angeles County                          |   | 43.0                  | %      | 176,842    |    | 250                  |   | 707                    |   |
|                                              |   |                  |   |       |    |                 |   |                   |   |
| Outside of Los Angeles County:                    |   |                  |   |       |    |                 |   |                   |   |
| Orange                                            |   | 11.8                  | %      | 48,578     |    | 57                   |   | 852                    |   |
| Riverside                                         |   | 5.2                   | %      | 21,527     |    | 24                   |   | 897                    |   |
| San Bernardino                                    |   | 5.2                   | %      | 21,210     |    | 24                   |   | 884                    |   |
| San Diego                                         |   | 4.1                   | %      | 16,966     |    | 19                   |   | 893                    |   |
| Ventura                                           |   | 2.6                   | %      | 10,629     |    | 11                   |   | 966                    |   |
| All other counties (2)                            |   | 0.2                   | %      | 888        |    | 2                    |   | 444                    |   |
| Total outside of Los Angeles County               |   | 29.1                  | %      | 119,798    |    | 137                  |   | 874                    |   |
|                                              |   |                  |   |       |    |                 |   |                   |   |
| ***Total Southern California Counties***          |   | 72.1                  | %      | 296,640    |    | 387                  |   | 767                    |   |
|                                              |   |                  |   |       |    |                 |   |                   |   |
| **Northern California Counties**                  |   |                  |   |       |    |                 |   |                   |   |
| Santa Clara                                       |   | 2.5                   | %      | 10,230     |    | 11                   |   | 930                    |   |
| Sacramento                                        |   | 1.8                   | %      | 7,281      |    | 9                    |   | 809                    |   |
| Sonoma                                            |   | 0.9                   | %      | 3,788      |    | 4                    |   | 947                    |   |
| Solano                                            |   | 0.9                   | %      | 3,506      |    | 4                    |   | 877                    |   |
| Alameda                                           |   | 0.5                   | %      | 2,024      |    | 3                    |   | 675                    |   |
| San Mateo                                         |   | 0.4                   | %      | 1,674      |    | 4                    |   | 419                    |   |
| San Francisco                                     |   | 0.3                   | %      | 1,316      |    | 2                    |   | 658                    |   |
| Shasta                                            |   | 0.3                   | %      | 1,228      |    | 1                    |   | 1,228                  |   |
| All other counties (10)                           |   | 1.4                   | %      | 5,658      |    | 10                   |   | 566                    |   |
| ***Total Northern California Counties***          |   | 8.9                   | %      | 36,705     |    | 48                   |   | 765                    |   |
|                                              |   |                  |   |       |    |                 |   |                   |   |
| Total California                                  |   | 81.1                  | %      | 333,345    |    | 435                  |   | 766                    |   |
|                                              |   |                  |   |       |    |                 |   |                   |   |
| **Outside of California**                         |   |                  |   |       |    |                 |   |                   |   |
| Arizona                                           |   | 9.8                   | %      | 40,287     |    | 33                   |   | 1,221                  |   |
| Texas                                             |   | 3.0                   | %      | 12,497     |    | 9                    |   | 1,389                  |   |
| Washington                                        |   | 1.8                   | %      | 7,270      |    | 11                   |   | 661                    |   |
| Nevada                                            |   | 1.6                   | %      | 6,675      |    | 7                    |   | 954                    |   |
| Oregon                                            |   | 1.0                   | %      | 4,181      |    | 11                   |   | 380                    |   |
| All other states (7)                              |   | 1.7                   | %      | 6,971      |    | 8                    |   | 871                    |   |
| ***Total outside of California***                 |   | 18.9                  | %      | 77,881     |    | 79                   |   | 986                    |   |
|                                              |   |                  |   |       |    |                 |   |                   |   |
| Total loans                                       |   | 100.0                 | %      | $          | 411,226 |                 | 514    |                   | $      | 800 |   |

 

5

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**SBALending**

 

As of December31, 2002, the Company had achieved SBA “Preferred Lender” status in the entireSouthern California region from Santa Barbara to San Diego, in all of NorthernCalifornia, and in the entire state of Oregon. Preferred Lender status is thehighest designation awarded to lenders by the SBA, and accordingly, grants suchlenders full lending authority to approve SBA loans.

 

***SBA7(a) Loan Program***

 

Loans made bythe Company under the SBA 7(a) program generally are made to small businessesto provide working capital or to provide funding for the purchase ofbusinesses, real estate, or machinery and equipment.  These loans generally are secured by a combination of assets thatmay include equipment, receivables, inventory, business real property, andsometimes a lien on the personal residence of the borrower. SBA 7(a) loans areall adjustable rate loans based upon the *Wall Street Journal* prime lending rate.The SBA generally guarantees 75%-85% of the loan balance.  Under the SBA 7(a) program, the Company cansell in the secondary market the guaranteed portion of its SBA 7(a) loans andretain the related unguaranteed portion of these loans, as well as theservicing on such loans, for which it is paid a fee. The loan servicing spreadis generally a minimum of 1.00% on all loans. The Company generally offers SBA 7(a) loans within a range of $50,000 to$1.0 million.

 

The Companybases its SBA 7(a) loan sales on the level of its SBA 7(a) loan originations,the premiums available in the secondary market for the sale of such loans, andgeneral liquidity considerations of the Company.  During 2002, the Company originated $18.6 million in SBA 7(a)loans, of which $14.1 million represented the guaranteed portion.  During 2002, the Company elected to sell$2.9 million of the guaranteed portion of its SBA 7(a) loans, for which itrecognized a gain of $221,000.

 

***SBA504 Loan Program***

 

Loans made bythe Company under the SBA 504 program generally are made to small businesses toprovide funding for the purchase of real estate.  Under this program, the Company generally provides up to 90%financing of the total purchase cost, represented by two loans to the borrower.  The first lien loan is generally a long-term,fully amortizing, fixed rate loan and made in the amount of 50% of the totalpurchase cost.  The second lien loan isa short-term, interest only, adjustable rate loan, based upon the *Wall StreetJournal* prime lending rate, and made in the amount of 40% of thetotal purchase cost. The Company’s second lien loan serves as an interim bridgeloan to the borrower until the Certified Development Corporation (“CDC”)obtains bond funding, pays off the Company’s second lien loan, and provideslong-term, fixed rate financing directly to the borrower.  The CDC pays off the Company’s second lienloan generally within three to six months after the loan proceeds have beenfully disbursed by the Company to the borrower.  The CDC is a non-profit corporation established to contribute tothe economic development of its community by working together with the SBA andprivate sector lenders such as the Bank, to provide financing to smallbusinesses.  The Company generallyoffers SBA 504 loans within a range of $300,000 to $3.0 million.

 

The Company’sintent is to sell its SBA 504 first lien loans to other banks, and since theSBA 504 second lien loans are ultimately funded by the CDC, the SBA 504 loanprogram has been functioning as fee income vehicle for the Company, as it generallydoes not retain any portion of these loans.

 

As analternative to selling SBA 504 first lien loans that it originates, the Companyalso brokers SBA 504 first lien loans to other banks for which it is paid afee.  In such situations, the thirdparty bank originates the first lien loan, while the Company originates thesecond lien loan, which is ultimately paid off by the CDC.

 

6

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The tablebelow presents the Bank’s SBA business loans by geographic concentration atDecember 31, 2002 (dollars in thousands):

 
|                                              |   | **Percent  of Total** |   | **Amount** |   | **Number  of Loans** |   | **Average  Loan Size** |   |
|---------------------------------------------------|--------|-----------------------|--------|------------|--------|----------------------|--------|------------------------|--------|
| **Southern California Counties**                  |   |                  |   |       |   |                 |   |                   |   |
| Los Angeles County:                               |   |                  |   |       |   |                 |   |                   |   |
| Los Angeles County South                          |   | 10.5                  | %      | $          | 3,915  |                 | 11     |                   | $      | 356 |   |
| Los Angeles County North                          |   | 10.1                  | %      | 3,764      |   | 17                   |   | 221                    |   |
| Los Angeles County East                           |   | 3.3                   | %      | 1,219      |   | 7                    |   | 174                    |   |
| Los Angeles County West                           |   | 0.8                   | %      | 283        |   | 1                    |   | 283                    |   |
| Jefferson Park, Crenshaw, Leimert Park, Hyde Park |   | 2.0                   | %      | 753        |   | 3                    |   | 251                    |   |
| Mid-City, Koreatown, Westlake                     |   | 0.5                   | %      | 187        |   | 1                    |   | 187                    |   |
| South Los Angeles City, Inglewood                 |   | 0.2                   | %      | 63         |   | 1                    |   | 63                     |   |
| Los Angeles County Other                          |   | 3.3                   | %      | 1,228      |   | 8                    |   | 154                    |   |
| Total Los Angeles County                          |   | 30.6                  | %      | 11,412     |   | 49                   |   | 233                    |   |
|                                              |   |                  |   |       |   |                 |   |                   |   |
| Outside of Los Angeles County:                    |   |                  |   |       |   |                 |   |                   |   |
| San Diego                                         |   | 37.5                  | %      | 13,972     |   | 75                   |   | 186                    |   |
| Orange                                            |   | 10.1                  | %      | 3,777      |   | 13                   |   | 291                    |   |
| San Bernardino                                    |   | 2.6                   | %      | 971        |   | 4                    |   | 243                    |   |
| Ventura                                           |   | 1.3                   | %      | 496        |   | 4                    |   | 124                    |   |
| Riverside                                         |   | 0.7                   | %      | 250        |   | 3                    |   | 83                     |   |
| All other counties (2)                            |   | 0.6                   | %      | 242        |   | 2                    |   | 121                    |   |
| Total outside of Los Angeles County               |   | 52.9                  | %      | 19,708     |   | 101                  |   | 195                    |   |
|                                              |   |                  |   |       |   |                 |   |                   |   |
| ***Total Southern California Counties***          |   | 83.5                  | %      | 31,120     |   | 150                  |   | 207                    |   |
|                                              |   |                  |   |       |   |                 |   |                   |   |
| **Northern California Counties**                  |   |                  |   |       |   |                 |   |                   |   |
| San Mateo                                         |   | 3.8                   | %      | 1,399      |   | 3                    |   | 466                    |   |
| Butte                                             |   | 2.3                   | %      | 848        |   | 1                    |   | 848                    |   |
| Madera                                            |   | 1.2                   | %      | 438        |   | 1                    |   | 438                    |   |
| San Francisco                                     |   | 0.9                   | %      | 322        |   | 1                    |   | 322                    |   |
| Contra Costa                                      |   | 0.5                   | %      | 196        |   | 1                    |   | 196                    |   |
| Santa Clara                                       |   | 0.4                   | %      | 154        |   | 1                    |   | 154                    |   |
| ***Total Northern California Counties***          |   | 9.0                   | %      | 3,357      |   | 8                    |   | 420                    |   |
|                                              |   |                  |   |       |   |                 |   |                   |   |
| Total California                                  |   | 92.5                  | %      | 34,477     |   | 158                  |   | 218                    |   |
|                                              |   |                  |   |       |   |                 |   |                   |   |
| **Outside of California**                         |   |                  |   |       |   |                 |   |                   |   |
| Oregon                                            |   | 4.6                   | %      | 1,732      |   | 7                    |   | 247                    |   |
| Washington                                        |   | 2.6                   | %      | 987        |   | 5                    |   | 197                    |   |
| Arizona                                           |   | 0.2                   | %      | 86         |   | 1                    |   | 86                     |   |
| ***Total outside of California***                 |   | 7.5                   | %      | 2,805      |   | 13                   |   | 216                    |   |
|                                              |   |                  |   |       |   |                 |   |                   |   |
| Total loans                                       |   | 100.0                 | %      | $          | 37,282 |                 | 171    |                   | $      | 218 |   |

 

7

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**LoanPortfolio**

 

The followingtable presents the categories of the Bank’s loans at the dates indicated (inthousands):

 
|                              |   | **December 31,** |    |
|-----------------------------------|--------|------------------|---------|
|                              |   | **2002**         |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| ***Income property loans:***      |   |             |    |   |   |   |   |   |   |   |   |
| Non-residential real estate loans |   | $                | 386,691 |   | $ | 408,524 |   | $ | 362,868 |   | $ | 339,368 |   | $ | 277,171 |   |
| Multi-family residential loans    |   | 24,535           |    | 21,896 |   | 19,728 |   | 17,944 |   | 1,443 |   |
| Construction loans                |   | —           |    | 860 |   | — |   | 1,200 |   | 1,496 |   |
| Total income property loans       |   | 411,226          |    | 431,280 |   | 382,596 |   | 358,512 |   | 280,110 |   |
|                              |   |             |    |   |   |   |   |   |   |   |   |
| ***SBA business loans:***         |   |             |    |   |   |   |   |   |   |   |   |
| 7(a) loans - guaranteed portion   |   | 21,314           |    | 12,170 |   | 8,771 |   | 3,269 |   | 4,787 |   |
| 7(a) loans - unguaranteed portion |   | 10,969           |    | 7,860 |   | 5,949 |   | 3,690 |   | 2,667 |   |
| Total 7(a) loans                  |   | 32,283           |    | 20,030 |   | 14,720 |   | 6,959 |   | 7,454 |   |
| 504 first lien loans              |   | 3,113            |    | 1,489 |   | 1,330 |   | — |   | — |   |
| 504 second lien loans             |   | 1,886            |    | 2,647 |   | 803 |   | — |   | — |   |
| Total 504 loans                   |   | 4,999            |    | 4,136 |   | 2,133 |   | — |   | — |   |
| Total SBA business loans          |   | 37,282           |    | 24,166 |   | 16,853 |   | 6,959 |   | 7,454 |   |
|                              |   |             |    |   |   |   |   |   |   |   |   |
| ***Other loans:***                |   |             |    |   |   |   |   |   |   |   |   |
| Commercial business/other loans   |   | 7,127            |    | 6,230 |   | 246 |   | 291 |   | 310 |   |
| Single-family residential loans   |   | 295              |    | 303 |   | 568 |   | 571 |   | 1,194 |   |
| Total other loans                 |   | 7,422            |    | 6,533 |   | 814 |   | 862 |   | 1,504 |   |
|                              |   |             |    |   |   |   |   |   |   |   |   |
| Gross loans                       |   | 455,930          |    | 461,979 |   | 400,263 |   | 366,333 |   | 289,068 |   |
| Deferred loan costs (fees)        |   | 197              |    | (4 | ) | 22 |   | (381 | ) | (582 | ) |
| Allowance for loan losses         |   | (8,585           | )       | (7,946 | ) | (7,240 | ) | (6,450 | ) | (5,024 | ) |
| Net loans                         |   | $                | 447,542 |   | $ | 454,029 |   | $ | 393,045 |   | $ | 359,502 |   | $ | 283,462 |   |

 

The followingtable presents the Bank’s loans by category as a percentage of gross loans atthe dates indicated:

 
|                  |   | **December 31,** |   |
|-----------------------|--------|------------------|--------|
|                  |   | **2002**         |   | **2001** |   | **2000** |   | **1999** |   | **1998** | ** ** |
| Income property loans |   | 90.19            | %      | 93.35 | % | 95.59 | % | 97.87 | % | 96.90 | % |
| SBA business loans    |   | 8.18             | %      | 5.23 | % | 4.21 | % | 1.90 | % | 2.58 | % |
| Other loans           |   | 1.63             | %      | 1.41 | % | 0.20 | % | 0.24 | % | 0.52 | % |
| Total gross loans     |   | 100.00           | %      | 100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % |

 

The tablebelow sets forth the contractual maturities of the Bank’s gross loans atDecember 31, 2002 (in thousands):

 
|                                     |   | **Loan  Balance** |    |
|------------------------------------------|--------|-------------------|---------|
| Due in one year or less                  |   | $                 | 4,121   |   |
| Due after one year through three years   |   | 6,647             |    |
| Due after three years through five years |   | 12,246            |    |
| Due after five years through 15 years    |   | 394,454           |    |
| Due after 15 years                       |   | 38,462            |    |
| Total                                    |   | $                 | 455,930 |   |

 

8

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**ASSETQUALITY REVIEW**

 

Non-performingassets consist of non-accrual loans and other real estate owned.  The following table sets forthnon-performing assets as of the dates indicated (dollars in thousands):

 
|                                                        |   | **December 31,** |   |
|-------------------------------------------------------------|--------|------------------|--------|
|                                                        |   | **2002**         |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Non-accrual loans                                           |   | $                | — |   | $ | — |   | $ | — |   | $ | 210 |   | $ | — |   |
| Other real estate owned                                     |   | —           |   | — |   | — |   | — |   | 806 |   |
| Total non-performing assets                                 |   | $                | — |   | $ | — |   | $ | — |   | $ | 210 |   | $ | 806 |   |
| Non-accrual loans to total loans, net of deferred loan fees |   | 0.00             | %      | 0.00 | % | 0.00 | % | 0.06 | % | 0.00 | % |
| Total non-performing assets to total assets                 |   | 0.00             | %      | 0.00 | % | 0.00 | % | 0.03 | % | 0.12 | % |

 

The followingtable presents net (charge-offs) recoveries, OREO valuation adjustments, andrelated asset quality ratios as of the dates or for the periods indicated(dollars in thousands):

 
|                                                                |   | **At or For the Years Ended December 31,** |       |
|---------------------------------------------------------------------|--------|--------------------------------------------|------------|
|                                                                |   | **2002**                                   |       | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Income property loans:                                              |   |                                       | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Charge-offs                                                         |   | $                                          | (162       | ) | $ | — |   | $ | — |   | $ | (280 | ) | $ | (20 | ) |
| Recoveries                                                          |   | 314                                        |       | 42 |   | 309 |   | 36 |   | 34 |   |
| Net (charge-offs) recoveries                                        |   | $                                          | 152        |   | $ | 42 |   | $ | 309 |   | $ | (244 | ) | $ | 14 |   |
|                                                                |   |                                       |       |   |   |   |   |   |   |   |   |
| SBA business loans:                                                 |   |                                       |       |   |   |   |   |   |   |   |   |
| Charge-offs                                                         |   | $                                          | (48        | ) | $ | (111 | ) | $ | (123 | ) | $ | (7 | ) | $ | — |   |
| Recoveries                                                          |   | 64                                         |       | 115 |   | — |   | — |   | — |   |
| Net (charge-offs) recoveries                                        |   | $                                          | 16         |   | $ | 4 |   | $ | (123 | ) | $ | (7 | ) | $ | — |   |
|                                                                |   |                                       | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Total net (charge-offs) recoveries                                  |   | $                                          | 168        |   | $ | 46 |   | $ | 186 |   | $ | (251 | ) | $ | 14 |   |
| OREO valuation adjustments                                          |   | —                                     |       | — |   | — |   | (43 | ) | (50 | ) |
| Total net (charge-offs) recoveries and OREO valuation adjustments   |   | $                                          | 168        |   | $ | 46 |   | $ | 186 |   | $ | (294 | ) | $ | (36 | ) |
|                                                                |   |                                       |       |   |   |   |   |   |   |   |   |
| Net (charge-offs) recoveries to average loans                       |   | 0.04                                       | %          | 0.01 | % | 0.05 | % | (0.07 | %) | 0.01 | % |
| Allowance for loan losses to total loans, net of deferred loan fees |   | 1.88                                       | %          | 1.72 | % | 1.81 | % | 1.76 | % | 1.74 | % |
| Allowance for loan losses to non-accrual loans                      |   | —                                     |       | — |   | — |   | 3071 | % | — |   |

 

**Non-accrual Loans**

 

Non-accrualloans are loans not classified as “troubled debt restructurings” that showlittle or no current payment ability. These loans, however, are backed bycollateral or cash flow that supports the collectibility of the Company’sremaining book balance. Non-accrual loan balances are net of any priorwrite-offs, but any specifically assigned general allowance for loan losses isnot deducted from the non-accrual loan balances.

 

9

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The Company’sgeneral policy is to discontinue the accrual of interest on income propertyloans when any installment payment is 90 days or more past due, or whenmanagement otherwise determines the collectibility of principal or interest isunlikely prior to the loan becoming 90 days past due.  On the guaranteed portion of SBA 7(a) loans, interest ondelinquent loans is guaranteed by the SBA up to 120 days.  The Company’s policy is to continue accruinginterest up to 120 days, at which time the guaranteed portion of the loan wouldbe placed on non-accrual status. The unguaranteed portion of the SBA 7(a) loanwould be placed on non-accrual status when it becomes 90 days past due.

 

During thesecond quarter of 2002, the Company changed its non-accrual loan policy toplace loans on non-accrual status starting at 90 days past due, rather than at61 days past due.  However, the Companymay place a loan on non-accrual status sooner if management determines that thecollectibility of principal or interest is unlikely prior to the loan becoming90 days past due.  This change was madein order to be consistent with general banking industry practice.

 

Interestincome on non-accrual loans is subsequently recognized when the loan becomescontractually current. Accounts that are deemed uncollectible by management arecharged off for the amount that exceeds management’s estimated net realizablevalue of the underlying real estate collateral.

 

The Company’sgeneral policy is to begin initiating foreclosure proceedings when loans becomemore than 30 days past due. In some instances, loans that are more than 30 dayspast due are never actually foreclosed upon, because the borrower brings theaccount current either before a formal notice of default is filed or before theproperty goes to foreclosure sale.

 

On loans thatare more than 89 days past due, an updated third party appraisal generally isordered to ascertain the current fair market value of the collateral securingthe loan. Between the time that the appraisal is ordered and the time that itis received, (normally about a 60 day period), management evaluates thecollateral securing the loan in order to ascertain the amount of general loanloss reserves that should be allocated to the loan. Upon receipt of the thirdparty appraisal, further general loan loss reserves are allocated, ifnecessary, based on the estimated net realizable value of the collateral (whichis calculated based on the estimated sales price of the collateral less allselling costs).

 

Thecalculation of the adequacy of the allowance for loan losses is based on avariety of factors, including loan classifications and underlying loan collateralvalues, and is not tied directly to the level of non-accrual loans.  Therefore, changes in the amount ofnon-accrual loans will not necessarily result in an associated increase ordecrease in the allowance for loan losses.

 

**OtherReal Estate Owned**

 

Assetsclassified as other real estate owned (“OREO”) include foreclosed real estateowned by the Company.   The Companyrecords and carries its OREO at the lower of cost or fair value, which mayrequire the Company to make valuation adjustments to its OREO, based on currentcollateral appraisal data and other relevant information, which may effectivelyreduce the book value of such assets to their estimated fair value less sellingcost.  The fair value of the real estatetakes into account the real estate values net of expenses such as brokeragecommissions, past due property taxes, property repair expenses, and otheritems.  The estimated sale priceutilized by the Company to help determine fair value may not necessarilyreflect the appraisal value, which management believes, in some cases, to behigher than what could be realized in a sale of the OREO.

 

**TroubledDebt Restructurings**

 

A troubleddebt restructuring (“TDR”) is a loan for which the Company, for reasons relatedto the borrower’s financial difficulties, grants a permanent concession to theborrower, such as a reduction in the loan’s fully-indexed interest rate, areduction in the face amount of the debt, or an extension of the maturity dateof the loan, that the Company would not otherwise consider. TDR balances arereflected net of any prior write-offs, but any specifically assigned generalallowance for loan losses is not deducted from TDR balances.   The Company had no TDRs as of December 31,2002, 2001, 2000, 1999, and 1998.

 

10

----

 

**PotentialProblem Loans**

 

In addition toloans disclosed above as non-accrual and TDR at December 31, 2002, of which theCompany had none, the Company had four loans totaling $711,000 that have beencategorized as potential problem loans by the Company.  These loans have been so classified as aresult of known information about the possible credit problems of theborrowers, which has caused management to have doubts about the ability of suchborrowers to comply with current loan repayment terms, and which may result inthe future inclusion of these loans in either the non-accrual loan or TDRcategories.  The loss exposure on thesefour loans is mitigated in that three of these loans totaling $432,000 are SBA7(a) loans, of which $329,000 is fully secured and guaranteed by the SBA.  Further, the collateral securing the loanswould generally be liquidated in a workout situation, and would provide somerecovery in addition to the SBA guarantee. The one non-SBA 7(a) loan for $279,000 is well secured bynon-residential real estate, and any loss exposure would be mitigated by thecollateral value of the real estate securing the loan.

 

**ALLOWANCEFOR LOAN LOSSES**

 

**ClassifiedAssets**

 

In connectionwith examinations of insured institutions, the FDIC and the DFI examiners havethe authority to identify problem assets and, if necessary, require them to beclassified. There are three primary classifications for problem assets:“substandard,” “doubtful” and “loss.” “Substandard” assets are assets that arecharacterized by the distinct possibility that the institution will sustainsome loss if deficiencies are not corrected. “Doubtful” assets have all of theweaknesses inherent in “substandard” loans, but also have the characteristic that,on the basis of existing facts, conditions and values, collection orliquidation in full is highly questionable and improbable. “Loss” assets areassets that are considered uncollectible. Assets that are classified “loss”require the institution either to establish a specific reserve in the amount of100% of the portion of the asset classified “loss” or to charge-off the asset.In addition, the FDIC characterizes certain assets as “special mention.” Theseare assets that do not currently warrant classification in one of the threeprimary problem assets categories but that do possess weaknesses deservingmanagement’s close attention.

 

The Companyutilizes an internally developed loan classification and monitoring system indetermining the appropriate level of the allowance for loan losses. This systeminvolves periodic reviews of the loan portfolio and loan classifications basedon that review.

 

**Allowancefor Loan Losses**

** **

The Company’sallowance for loan losses is established through a provision for loan lossesbased on management’s evaluation of the risk inherent in the loanportfolio.  General loan loss reservestypically are established by assigning all loans to specified risk categoriesand then determining the appropriate levels of reserve for each risk category.A special management “Reserve Committee” meets monthly to review the loanportfolio, delinquency trends, collateral value trends, non-performing assetdata and other material information. The amount of the allowance is based uponmanagement’s evaluation of numerous factors, including the adequacy ofcollateral securing the loans in the Company’s portfolio, delinquency trends,historical loan loss experience, and existing economic conditions.

 

The full Boardof Directors reviews the adequacy of the allowance for loan losses set bymanagement on a quarterly basis. Management utilizes its best judgment inproviding for possible loan losses and establishing the allowance for loanlosses. However, the allowance is an estimate, which is inherently uncertainand depends on the outcome of future events. In addition, regulatory agencies,as an integral part of their examination process, periodically review theCompany’s allowance for loan losses. Such agencies may require the Company torecognize additions to the allowance based upon their judgment of theinformation available to them at the time of their examination.

 

Adverseeconomic conditions or a declining real estate market could adversely affectcertain borrowers’ abilities to contractually repay their loans. A decline inthe economy could result in deterioration in the quality of the loan portfolioand could result in high levels of non-performing assets and charge-offs, whichwould adversely affect the financial condition and results of operations of theCompany.

 

11

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The followingtable sets forth the allocation of the Company’s allowance for loan lossesamong the Company’s loan categories by dollar amount and as a percent of thetotal allowance as of the dates indicated (dollars in thousands):

 
|                            |   | **December 31,** |   |
|---------------------------------|--------|------------------|--------|
|                            |   | **2002**         |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Income property loans           |   | $                | 7,727  |   | $ | 7,376 |   | $ | 6,978 |   | $ | 6,291 |   | $ | 4,823 |   |
| SBA business loans              |   | 687              |   | 477 |   | 262 |   | 106 |   | 108 |   |
| Other loans                     |   | 171              |   | 93 |   | — |   | 53 |   | 93 |   |
| Total allowance for loan losses |   | $                | 8,585  |   | $ | 7,946 |   | $ | 7,240 |   | $ | 6,450 |   | $ | 5,024 |   |
|                            |   |             |   |   |   |   |   |   |   |   |   |
| Income property loans           |   | 90.00            | %      | 92.83 | % | 96.38 | % | 97.54 | % | 96.00 | % |
| SBA business loans              |   | 8.00             | %      | 6.00 | % | 3.62 | % | 1.64 | % | 2.15 | % |
| Other loans                     |   | 2.00             | %      | 1.17 | % | 0.00 | % | 0.82 | % | 1.85 | % |
| Total allowance for loan losses |   | 100.00           | %      | 100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % |

 

The followingtable sets forth activity in the Company’s allowance for loan losses for theperiods indicated (in thousands):

 
|                               |   | **Years Ended December 31,** |   |
|------------------------------------|--------|------------------------------|--------|
|                               |   | **2002**                     |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Allowance at beginning of year     |   | $                            | 7,946  |   | $ | 7,240 |   | $ | 6,450 |   | $ | 5,024 |   | $ | 4,100 |   |
| Provision for loan losses          |   | 471                          |   | 660 |   | 604 |   | 1,677 |   | 910 |   |
| Net (charge-offs) recoveries:      |   |                         |   |   |   |   |   |   |   |   |   |
| Charge-offs:                       |   |                         |   |   |   |   |   |   |   |   |   |
| Income property loans              |   | (162                         | )      | — |   | — |   | (280 | ) | (20 | ) |
| SBA business loans                 |   | (48                          | )      | (111 | ) | (123 | ) | (7 | ) | — |   |
| Total charge-offs                  |   | (210                         | )      | (111 | ) | (123 | ) | (287 | ) | (20 | ) |
| Recoveries:                        |   |                         |   |   |   |   |   |   |   |   |   |
| Income property loans              |   | 314                          |   | 42 |   | 309 |   | 36 |   | 34 |   |
| SBA business loans                 |   | 64                           |   | 115 |   | — |   | — |   | — |   |
| Total recoveries                   |   | 378                          |   | 157 |   | 309 |   | 36 |   | 34 |   |
| Total net (charge-offs) recoveries |   | 168                          |   | 46 |   | 186 |   | (251 | ) | 14 |   |
| Allowance at end of year           |   | $                            | 8,585  |   | $ | 7,946 |   | $ | 7,240 |   | $ | 6,450 |   | $ | 5,024 |   |

 

12

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**INVESTMENTS**

 

The Company’sinvestment portfolio is used for both liquidity purposes and for investmentincome. The following table sets forth certain information regarding theCompany’s investment securities available for sale, which are recorded andcarried at market value, as well as its short-term investments in repurchaseagreements, as of the dates indicated (in thousands):

 
|                                                                             |   | **December 31,** |       |
|----------------------------------------------------------------------------------|--------|------------------|------------|
|                                                                             |   | **2002**         |       | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                             |   |             |       |   |   |   |   |   |   |   |   |
| Securities purchased under resale agreements (“repurchase agreements”) |   | $                | 7,802      |   | $ | 16,174 |   | $ | 3,017 |   | $ | 3,501 |   | $ | 22,048 |   |
|                                                                             |   |             |       |   |   |   |   |   |   |   |   |
| Investment securities available for sale, at market value:                       |   |             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| U.S. government sponsored agency:                                                |   |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Callable bonds                                                                   |   | $                | —     |   | $ | — |   | $ | 227,106 |   | $ | 233,071 |   | $ | 307,919 |   |
| Mortgage-backed securities                                                       |   | 70,516           |       | 55,537 |   | 3,799 |   | 3,856 |   | 1,606 |   |
| Corporate debt securities                                                        |   | 2,902            |       | 3,415 |   | 3,543 |   | 3,833 |   | 11,736 |   |
| Total investment securities                                                      |   | $                | 73,418     |   | $ | 58,952 |   | $ | 234,448 |   | $ | 240,760 |   | $ | 321,261 |   |

 

**Securities Purchased Under Resale Agreements**

 

The Companyinvests excess cash overnight and up to three months in securities purchasedunder resale agreements (“repurchase agreements”). The Company has masterrepurchase agreements with several nationally recognized investment banks,commercial banks, and broker-dealers. The maximum investment with one brokeragefirm or bank is generally limited to $25 million. Collateral securing therepurchase agreements is limited to U.S. Treasury bonds, notes and bills, andsecurities issued by either U.S. government agencies or U.S. governmentsponsored agencies.  Collateral securingthe repurchase agreements is held for safekeeping under third-party custodialagreements and is required to be segregated from, and separately accounted foras compared to, all other securities held by the custodian for its othercustomers or for its own account.

 

**InvestmentSecurities**

 

The Company’sinvestment securities portfolio at December 31, 2002 consisted of fixed rateU.S. government sponsored agency mortgage-backed securities issued by FannieMae and Ginnie Mae, as well as adjustable rate investments in corporate debtsecurities.   The index of the corporatedebt securities is based upon the three month London Interbank Offered Rate(“LIBOR”), which reprices on a quarterly basis.

 

The followingtable sets forth the composition of the Company’s investment securitiesavailable for sale portfolio at December 31, 2002 (dollars in thousands):

 
|                                  |   | **December 31, 2002** |   |
|---------------------------------------|--------|-----------------------|--------|
|                                  |   | **Amortized  Cost**   |   | **Estimated  Fair Value** |   | **Weighted  Average  Yield** | ** ** |
| Mortgage-backed securities issued by: |   |                  |   |   |   |   |   |
| Ginnie Mae                            |   | $                     | 67,057 |   | $ | 69,027 |   | 4.29 | % |
| Fannie Mae                            |   | 1,409                 |   | 1,489 |   | 6.80 | % |
| Total mortgage-backed securities      |   | 68,466                |   | 70,516 |   | 4.34 | % |
|                                  |   |                  |   |   |   |   |   |
| Corporate debt securities             |   | 3,377                 |   | 2,902 |   | 4.07 | % |
| Total investment securities           |   | $                     | 71,843 |   | $ | 73,418 |   | 4.33 | % |

 

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**DEPOSITS**

 

The followingtable sets forth information regarding the composition of the Company’s depositsas of the dates indicated (in thousands):

 
|                          |   | **December 31,** |    |
|-------------------------------|--------|------------------|---------|
|                          |   | **2002**         |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Non-interest-bearing checking |   | $                | 2,800   |   | $ | 1,649 |   | $ | — |   | $ | — |   | $ | — |   |
| Interest-bearing checking     |   | 13,214           |    | 13,263 |   | 14,414 |   | 18,783 |   | 23,849 |   |
| Total checking accounts       |   | 16,014           |    | 14,912 |   | 14,414 |   | 18,783 |   | 23,849 |   |
| Savings accounts              |   | 128,420          |    | 136,145 |   | 148,347 |   | 196,368 |   | 276,011 |   |
| Certificates of deposit       |   | 215,062          |    | 250,466 |   | 336,076 |   | 269,233 |   | 182,979 |   |
| Total deposits                |   | $                | 359,496 |   | $ | 401,523 |   | $ | 498,837 |   | $ | 484,384 |   | $ | 482,839 |   |

 

One of theCompany’s primary sources of funds is FDIC-insured deposits collected by theBank.  The Company has deposit-gatheringbranches located in Beverly Hills, Encino and San Diego, California. TheCompany’s headquarters office in Agoura Hills is an administrative office anddoes not accept retail deposits.  TheCompany’s current deposit products include consumer and business checkingaccounts, limited draft money market checking accounts, savings accounts, andterm certificates of deposit with 30-day to five-year maturities.  Additionally, the Company offers debitcards, on-line banking, and on-line bill pay. Included among these deposit programs are individual retirement accountsand Keogh retirement accounts.  TheCompany also conducts a wholesale deposit operation through which deposits fromother financial institutions located throughout the United States aresolicited.

 

**BORROWINGS**

 

The followingtable sets forth information regarding the composition of the Company’sborrowings as of the dates indicated (in thousands):

 
|                                       |   | **December 31,** |    |
|--------------------------------------------|--------|------------------|---------|
|                                       |   | **2002**         |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Securities sold under repurchase greements |   | $                | —  |   | $ | — |   | $ | 23,500 |   | $ | 30,500 |   | $ | 30,779 |   |
| State of California borrowings             |   | —           |    | — |   | 28,000 |   | 20,000 |   | — |   |
| FHLB advances                              |   | 120,000          |    | 40,000 |   | — |   | — |   | — |   |
| Term borrowings                            |   | —           |    | 40,000 |   | 40,000 |   | 40,000 |   | 79,450 |   |
| Trust preferred securities(1)              |   | 17,250           |    | 17,250 |   | 17,250 |   | 17,250 |   | 17,250 |   |
| Total borrowings                           |   | $                | 137,250 |   | $ | 97,250 |   | $ | 108,750 |   | $ | 107,750 |   | $ | 127,479 |   |

 

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(1)           For a description of the trust preferred securities see“General - PCC Capital I”

 

**SecuritiesSold Under Repurchase Agreements**

 

A secondarysource of funds for the Company consists of short-term borrowings in the formof securities sold under repurchase agreements (“reverse repurchaseagreements”). The Company has set up short-term borrowing relationships withseveral investment banking firms.  Therepayment terms on this short-term debt generally range from one day to up tothree months. The interest rate paid can vary daily, but typically approximatesthe federal funds rate plus 25 basis points. These borrowings are secured bypledging U.S. government sponsored agency securities.  The Company utilizes these borrowings to cover short-termfinancing needs.

 

 

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**Stateof California Borrowings**

 

The Bank has afixed rate borrowing facility with the State of California Treasurer’s Officeunder which the Bank can borrow an amount not to exceed its unconsolidatedtotal shareholder’s equity.  Borrowingmaturity dates under this program cannot exceed one year.  The State of California requires collateralwith a value of at least 110% of the outstanding borrowing amount.  The Bank pledges U.S. government sponsoredagency securities to meet the collateral requirement under this borrowingfacility.  As of December 31, 2002, theBank’s unconsolidated total shareholder’s equity was $57.8 million and the Bankhad no outstanding State of California borrowings.

 

**FHLBAdvances**

 

During thesecond quarter of 2001, the Bank became a member of the FHLB, which serves as asource of both fixed rate and adjustable rate borrowings, with maturitiesranging from one day to 30 years.  Underthe FHLB’s credit facility, the Bank is able to borrow an FHLB-approvedpercentage of the Bank’s unconsolidated total assets.  All FHLB advances must be secured by eligible collateral, subjectto FHLB guidelines and limitations. Such collateral may consist of either non-residential real estate loans,multi-family residential loans, U.S. government sponsored agencymortgage-backed securities, or a combination thereof.  For pledged non-residential real estate loans, the FHLB will lendup to 55% on an individual loan basis and up to 20% of the Bank’s unconsolidatedtotal assets on an aggregate basis.  Formulti-family residential loans, the FHLB will lend up to 80% on an individualbasis. For mortgage-backed securities, the FHLB will lend up to 97% of themarket value.

 

As of December31, 2002, the Bank’s FHLB credit line totaled $193.0 million, based on anFHLB-approved borrowing limit of 35% of the Bank’s unconsolidated totalassets.  Advances are limited to theamount of eligible collateral pledged by the Bank, which totaled $129.5million, and consisted of non-residential real estate loans and multi-familyresidential loans.  As noted above, thepledged amount of non-residential real estate loans is limited to 20% ofassets.  The Bank had $120.0 million ofoutstanding advances at December 31, 2002.

 

As an FHLBmember, the Bank is required to own capital stock of the FHLB in an amountequal to the greater of 5% of its FHLB advances or 1% of its aggregateresidential real estate loans and U.S. government sponsored agencymortgage-backed securities at the beginning of the year.  As of December 31, 2002, the Bank was incompliance with this requirement and its investment in the capital stock of theFHLB totaled $6.3 million.  The Bankreceives quarterly dividends declared by the FHLB on its investment in thecapital stock of the FHLB.

 

**TermBorrowings**

 

The Companyhas borrowing relationships with several investment banking firms, whereby theCompany is able to obtain fixed rate, long-term borrowings secured by U.S.government sponsored agency securities.  As of December 31, 2002, the Company had no outstanding term borrowings.

 

**EMPLOYEES**

 

As of December31, 2002, the Company employed  85persons on a full-time basis. Management believes that its relations with its employees are good. TheCompany is not a party to any collective bargaining agreement.

 

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**ASSET/LIABILITYMANAGEMENT**

 

The Company’searnings depend primarily on its net interest income, which is the differencebetween the interest income it earns on its loans and securities (its“interest-earning assets”), and the interest expense it pays on its depositsand borrowings (its “interest-bearing liabilities”).  Net interest income is affected by (i) the difference between theinterest rate earned on its interest-earning assets and the interest rate paidon its interest-bearing liabilities, (ii) the difference between the balance,or volume, of its interest-earning assets and the balance, or volume, of itsinterest-bearing liabilities, and (iii) changes in the composition ofinterest-earning assets and interest-bearing liabilities, for example, ifhigher yielding loans were to replace lower yielding securities.

 

The Company issubject to potential net interest income contraction or expansion, particularlyin times of changing interest rates. Management has established an Asset/Liability Committee (“ALCO”),comprised of senior executive officers, to monitor interest rate risk on aregular basis.  The Company attempts tominimize the effect on net interest income of changing interest rates through avariety of asset and liability management strategies that include:

 

•              Regularreview of loan programs to target the most desirable mix of adjustable rateversus fixed rate loans.

 

•                                          Regularreview of deposit programs to attempt to achieve the proper mix of one-year orlonger term certificates of deposit versus more interest rate sensitive moneymarket checking accounts.

 

•                                          Useof long-term borrowings from the FHLB or national investment bankingfirms.

 

•                                          Utilizationof short-term borrowings available from the FHLB, State of California, ornational investment banking firms.

 

•                                          Possibleuse of interest rate hedges, such as interest rate swaps, caps or collars.

 

•                                          Determinationof the optimum size, repayment characteristics, and interest rate features ofthe Company’s investment securities portfolio.

 

See Item 7A.“Quantitative and Qualitative Disclosures About Market Risk” for additionalinformation regarding maturity and repricing characteristics of the Company’s interest-earningassets and interest-bearing liabilities.

 

**REGULATION**

 

**General**

 

Bank holdingcompanies and banks are extensively regulated under both federal and statelaw.  This regulation is intendedprimarily for the protection of depositors and the deposit insurance fund andnot for the benefit of stockholders of Pacific Crest.  Set forth below is a summary description of the material laws andregulations which relate to the operations of Pacific Crest and the Bank.  The description is qualified in its entiretyby reference to the applicable laws and regulations.

 

**PacificCrest Capital, Inc.**

 

Pacific Crest,as a registered bank holding company, is subject to regulation under the BankHolding Company Act of 1956, as amended (the “BHCA”).  Pacific Crest is required to file with the Federal Rerserveperiodic reports and such additional information as the Federal Reserve mayrequire pursuant to the BHCA.  TheFederal Reserve may conduct examinations of Pacific Crest and its subsidiaries.

 

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The FederalReserve may require that Pacific Crest terminate an activity or terminatecontrol of or liquidate or divest certain subsidiaries or affiliates when theFederal Reserve believes the activity or the control of the subsidiary oraffiliate constitutes a significant risk to the financial safety, soundness orstability of any of its banking subsidiaries. The Federal Reserve also has the authority to regulate provisions of certainbank holding company debt, including the authority to impose interest ceilingsand reserve requirements on such debt. Under certain circumstances, Pacific Crest must file written notice andobtain approval from the Federal Reserve prior to purchasing or redeeming itsequity securities.

 

Further,Pacific Crest is required by the Federal Reserve to maintain certain levels ofcapital.  See “Capital Standards.”

 

Pacific Crestis required to obtain the prior approval of the Federal Reserve for theacquisition of more than 5% of the outstanding shares of any class of votingsecurities or substantially all of the assets of any bank or bank holdingcompany.  Prior approval of the FederalReserve is also required for the merger or consolidation of Pacific Crest andanother bank holding company.

 

Pacific Crestis prohibited by the BHCA, except in certain statutorily prescribed instances,from acquiring direct or indirect ownership or control of more than 5% of theoutstanding voting shares of any company that is not a bank or bank holdingcompany and from engaging directly or indirectly in activities other than thoseof banking, managing or controlling banks, or furnishing services to itssubsidiaries.  However, Pacific Crest,subject to the prior approval of the Federal Reserve, may engage in any, or acquireshares of companies engaged in, activities that are deemed by the FederalReserve to be so closely related to banking or managing or controlling banks asto be a proper incident thereto.

 

Under FederalReserve regulations, a bank holding company is required to serve as a source offinancial and managerial strength to its subsidiary banks and may not conductits operations in an unsafe or unsound manner. In addition, it is the Federal Reserve’s policy that a bank holdingcompany should stand ready to use available resources to provide adequatecapital funds to its subsidiary banks during periods of financial stress oradversity and should maintain the financial flexibility and capital-raisingcapacity to obtain additional resources for assisting its subsidiarybanks.  A bank holding company’s failureto meet its obligations to serve as a source of strength to its subsidiarybanks generally will be considered by the Federal Reserve to be an unsafe andunsound banking practice or a violation of the Federal Reserve’s regulations orboth.

 

Pacific Crestis also a bank holding company within the meaning of Section 3700 of theCalifornia Financial Code.  As such,Pacific Crest and its subsidiaries are subject to examination by, and may berequired to file reports with, the California Department of FinancialInstitutions.

 

PacificCrest’s securities are registered with the Securities and Exchange Commissionunder the Securities Exchange Act of 1934, as amended (the “ExchangeAct”).  As such, Pacific Crest is subjectto the information, proxy solicitation, insider trading, and other requirementsand restrictions of the Exchange Act.

 

**PacificCrest Bank**

 

The Bank is aCalifornia chartered bank, subject to primary supervision, periodicexamination, and regulation by the California Commissioner of FinancialInstitutions (“Commissioner”) and the Federal Deposit Insurance Corporation(“FDIC”).  To a lesser extent, the Bankis also subject to certain regulations promulgated by the Federal Reserve.  If, as a result of an examination of theBank, the FDIC should determine that the financial condition, capitalresources, asset quality, earnings prospects, management, liquidity, or otheraspects of the Bank’s operations are unsatisfactory or that the Bank or itsmanagement is violating or has violated any law or regulation, various remediesare available to the FDIC.  Suchremedies include the power to enjoin “unsafe or unsound” practices, to requireaffirmative action to correct any conditions resulting from any violation orpractice, to issue an administrative order that can be judicially enforced, todirect an increase in capital, to restrict the growth of the Bank, to assesscivil monetary penalties, to remove officers and directors, and ultimately toterminate the Bank’s deposit insurance, which for a California chartered bankwould result in a revocation of the Bank’s charter.  The Commissioner has many of the same remedial powers.

 

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**Sarbanes-OxleyAct of 2002**

 

On July 30,2002, President Bush signed into law the Sarbanes-Oxley Act of 2002.  This new legislation addresses accountingoversight and corporate governance matters, including:

 

•                                          thecreation of a five-member oversight board appointed by the Securities & ExchangeCommission that will set standards for accountants and have investigative anddisciplinary powers;

 

•                                          theprohibition of accounting firms from providing various types of consultingservices to public clients and requiring accounting firms to rotate partnersamong public client assignments every five years;

 

•                                          increasedpenalties for financial crimes;

 

•                                          expandeddisclosure of corporate operations and internal controls and certification offinancial statements;

 

•                                          enhancedcontrols on and reporting of insider trading; and

 

•                                          statutoryseparations between investment bankers and analysts.

 

The Company iscurrently evaluating what impacts the new legislation and its implementingregulations will have upon its operations, including a likely increase in certainoutside professional costs.

 

**USA PATRIOT Act of 2001**

 

On October 26,2001, President Bush signed the USA PATRIOT Act of 2001 (the “Act”).  The Act is intended to strengthen U.S lawenforcement’s and the intelligence communities’ abilities to work cohesively tocombat terrorism on a variety of fronts. The potential impact of the Act onfinancial institutions of all kinds is significant and wide ranging. The Actcontains sweeping anti-money laundering and financial transparency laws inaddition to current requirements and requires the creation and implementationof various regulations, including:

 

•                                          duediligence requirements for financial institutions that administer, maintain, ormanage private bank accounts or correspondent accounts for non-US persons;

 

•                                          standardsfor verifying customer identification at account opening;

 

•                                          rulesto promote cooperation among financial institutions, regulators, and lawenforcement entities in identifying parties that may be involved in terrorismor money laundering;

 

•                                          reportsby nonfinancial businesses filed with the Treasury Department’s FinancialCrimes Enforcement Network for transactions exceeding $10,000; and

 

•                                          filingof suspicious activities reports by securities brokers and dealers if theybelieve a customer may be violating U.S. laws and regulations.

 

On July 23,2002, the U.S. Treasury proposed regulations requiring institutions toincorporate into their written money laundering plans a board approved customeridentification program implementing reasonable procedures for:

 

•                                          verifyingthe identity of any person seeking to open an account, to the extent reasonableand practicable;

 

•                                          maintainingrecords of the information used to verify the person’s identity; and

 

•                                          determiningwhether the person appears on a list of known or suspected terrorists orterrorist organizations.

 

Account isdefined as a formal banking or business relationship established to provideongoing services, dealings, or other financial transactions. The Company doesnot expect that the proposed regulations will have a material impact on itsoperations.

 

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**FinancialServices Modernization Legislation**

 

***General***

 

On November12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999(the “GLBA”).  The general effect of thelaw is to establish a comprehensive framework to permit affiliations amongcommercial banks, insurance companies, securities firms, and other financialservice providers by revising and expanding the BHCA framework to permit aholding company system to engage in a full range of financial activitiesthrough a new entity known as a financial holding company.

 

The law also:

 

•                                          Broadenedthe activities that may be conducted by national banks, banking subsidiaries ofbank holding companies, and their financial subsidiaries;

 

•                                          Providedan enhanced framework for protecting the privacy of consumer information;

 

•                                          Adopteda number of provisions related to the capitalization, membership, corporategovernance, and other measures designed to modernize the Federal Home Loan Banksystem;

 

•                                          Modifiedthe laws governing the implementation of the Community Reinvestment Act; and

 

•                                          Addresseda variety of other legal and regulatory issues affecting both day-to-dayoperations and long-term activities of financial institutions.

 

Pacific Crestand the Bank do not believe that the GLBA has had a significant effect onoperations, except for the beneficial effect of changes in FHLB membership andrelated loan collateral requirements.  However,to the extent that it permits banks, securities firms, and insurance companiesto affiliate, the financial services industry may experience furtherconsolidation.  The GLBA is intended togrant to community banks certain powers as a matter of right that largerinstitutions have accumulated on an ad hoc basis.  Nevertheless, this act may have the result of increasing theamount of competition that Pacific Crest and the Bank face from largerinstitutions and other types of companies offering financial products, many ofwhich have substantially more financial resources than Pacific Crest and theBank.

 

***FinancialHolding Companies***

 

Bank holdingcompanies that elect to become a financial holding company may affiliate withsecurities firms and insurance companies and engage in other activities thatare financial in nature or are incidental or complementary to activities thatare financial in nature. “Financial in nature” activities include:

 

•                                          securitiesunderwriting;

 

•                                          dealingand market making;

 

•                                          sponsoringmutual funds and investment companies;

 

•                                          insuranceunderwriting and agency;

 

•                                          merchantbanking; and

 

•                                          activitiesthat the Federal Reserve, in consultation with the Secretary of the Treasury,determines from time to time to be so closely related to banking or managing orcontrolling banks as to be a proper incident thereto.

 

Prior tofiling a declaration of its election to become a financial holding company, allof the bank holding company’s depository institution subsidiaries must be wellcapitalized, well managed, and, except in limited circumstances, in compliancewith the Community Reinvestment Act.

 

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Failure tosustain compliance with the financial holding company election requirements orcorrect any non-compliance within a fixed time period could lead to divestitureof subsidiary banks or require all activities of such company to conform tothose permissible for a bank holding company. No Federal Reserve approval is required for a financial holding companyto acquire a company (other than a bank holding company, bank or savingsassociation) engaged in those activities determined by the Federal Reserve thatare financial in nature or incidental to activities that are financial innature, including but not limited to:

 

•                                          lending,exchanging, transferring, investing for others, or safeguarding financialassets other than money or securities;

 

•                                          providingany device or other instrumentality for transferring money or other financialassets; or

 

•                                          arranging,effecting or facilitating financial transactions for the account of third parties.

 

A bank holdingcompany that is not also a financial holding company can only engage in bankingand such other activities determined by the Federal Reserve to be so closelyrelated to banking or managing or controlling banks as to be a proper incidentthereto.

 

Pacific Crestis not currently a financial holding company. Management of Pacific Crest has not determined at this time whether itwill seek an election to become a financial holding company.

 

***ExpandedBank Activities***

 

The GLBA alsopermits national banks to engage in expanded activities through the formationof financial subsidiaries.  A nationalbank may have a subsidiary engaged in any activity authorized for nationalbanks directly or any financial activity, except for insurance underwriting,insurance investments, real estate investment or development, or merchantbanking, which may only be conducted through a subsidiary of a financialholding company.  Financial activitiesinclude all activities permitted under new sections of the BHCA or permitted byregulation.

 

A nationalbank seeking to have a financial subsidiary, and each of its depositoryinstitution affiliates, must be “well-capitalized,” “well-managed” and insatisfactory compliance with the Community Reinvestment Act.  The total assets of all financialsubsidiaries may not exceed the lesser of 45% of a bank’s total assets, or $50billion.  A national bank must excludefrom its assets and equity all equity investments, including retained earnings,in a financial subsidiary.  The assetsof the subsidiary may not be consolidated with the bank’s assets.  The bank must also have policies andprocedures to assess financial subsidiary risk and protect the bank from suchrisks and potential liabilities.

 

***Privacy***

 

Under theGLBA, federal banking regulators adopted rules that limit the ability of banksand other financial institutions to disclose non-public information aboutconsumers to nonaffiliated third parties. Pursuant to these rules, effectiveJuly 1, 2001, financial institutions must provide:

 

•                                          initialnotices to customers about their privacy policies, describing the conditionsunder which they may disclose nonpublic personal information to nonaffiliatedthird parties and affiliates;

 

•                                          annualnotices of their privacy policies to current customers; and

 

•                                          areasonable method for customers to “opt out” of disclosures to nonaffiliatedthird parties.

 

These privacyprovisions affect how consumer information is transmitted through diversifiedfinancial companies and conveyed to outside vendors.  Since the GLBA’s enactment, a number of states have implementedtheir own versions of privacy laws.  TheCompany has implemented its privacy policies in accordance with the law.

 

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**Dividendsand Other Transfers of Funds**

 

Dividends fromthe Bank constitute the principal source of income to Pacific Crest.  Pacific Crest is a legal entity separate anddistinct from the Bank. The Bank is subject to various statutory and regulatoryrestrictions on its ability to pay dividends to Pacific Crest.  In addition, the California Department ofFinancial Institutions and the FDIC have the authority to prohibit the Bankfrom paying dividends, depending upon the Bank’s financial condition, if suchpayment is deemed to constitute an unsafe or unsound practice.

 

***Transactions withAffiliates***

 

The Bank issubject to certain restrictions imposed by federal law on any extensions of creditto, or the issuance of a guarantee or letter of credit on behalf of, PacificCrest or other affiliates, the purchase of, or investments in, stock or othersecurities thereof, the taking of such securities as collateral for loans, andthe purchase of assets of Pacific Crest or other affiliates. Such restrictionsprevent Pacific Crest and such other affiliates from borrowing from the Bankunless the loans are secured by marketable obligations of designated amounts.Further, such secured loans and investments by the Bank to or in Pacific Crestor to or in any other affiliate are limited, individually, to 10.0% of theBank’s capital and surplus (as defined by federal regulations), and suchsecured loans and investments are limited, in the aggregate, to 20.0% of theBank’s capital and surplus (as defined by federal regulations).  California law also imposes certainrestrictions with respect to transactions involving Pacific Crest and othercontrolling persons of the Bank. Additional restrictions on transactions withaffiliates may be imposed on the Bank under the prompt corrective actionprovisions of federal law. See “Prompt Corrective Action and Other EnforcementMechanisms.”

 

**CapitalStandards**

 

The federalbanking agencies have adopted risk-based minimum capital guidelines intended toprovide a measure of capital that reflects the degree of risk associated with abanking organization’s operations for both transactions reported on the balancesheet as assets and transactions which are recorded as off balance sheetitems.  Under these guidelines, nominaldollar amounts of assets and credit equivalent amounts of off balance sheetitems are multiplied by one of several risk adjustment percentages, which rangefrom 0% for assets with low credit risk federal banking agencies, to 100% forassets with relatively high credit risk.

 

The guidelinesrequire a minimum ratio of qualifying total capital to risk-adjusted assets of8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%.  In addition to the risk-based guidelines,federal banking regulators require banking organizations to maintain a minimumamount of Tier 1 capital to total assets, referred to as the leverageratio.  For a banking organization ratedin the highest of the five categories used by regulators to rate bankingorganizations, the minimum leverage ratio of Tier 1 capital to total assetsmust be 3%.  In addition to theseuniform risk-based capital guidelines and leverage ratios that apply across theindustry, the regulators have the discretion to set individual minimum capitalrequirements for specific institutions at rates significantly above the minimumguidelines and ratios.

 

At December31, 2002, both Pacific Crest and the Bank exceeded all minimum required capitalratios.  See Item 7. “Management’sDiscussion and Analysis of Financial Condition and Results of Operations —Capital Resources.”

 

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**Predatory Lending**

 

The term“predatory lending,” much like the terms “safety and soundness” and “unfair anddeceptive practices,” is far-reaching and covers a potentially broad range ofbehavior. As such, it does not lend itself to a concise or a comprehensivedefinition. But typically, predatory lending involves at least one, and perhapsall three, of the following elements:

 

•                                          makingunaffordable loans based on the assets of the borrower rather than on theborrower’s ability to repay an obligation (“asset-based lending”);

 

•                                          inducinga borrower to refinance a loan repeatedly in order to charge high points andfees each time the loan is refinanced (“loan flipping”); and

 

**•**                                          engagingin fraud or deception to conceal the true nature of the loan obligation from anunsuspecting or unsophisticated borrower.

 

On October 1,2002, the Federal Reserve regulations aimed at curbing such lending becameeffective.  The rule significantlywidens the pool of high-cost home-secured loans covered by the Home Ownershipand Equity Protection Act of 1994, a federal law that requires extradisclosures and consumer protections to borrowers.  The following triggers coverage under the act:

 

•                                          interestrates for first lien mortgage loans in excess of 8 percentage points abovecomparable Treasury securities;

 

•                                          subordinate-lienloans of 10 percentage points above Treasury securities; and

 

•                                          feessuch as optional insurance and similar debt protection costs paid in connectionwith the credit transaction, when combined with points and fees if deemedexcessive.

 

In addition,the regulation bars loan flipping by the same lender or loan servicer within ayear.  Lenders also will be presumed tohave violated the law — which says loans should not be made to people unable torepay them — unless they document that the borrower has the ability torepay.  Lenders that violate the rulesface cancellation of loans and penalties equal to the finance charges paid.

 

**Prompt Corrective Action and OtherEnforcement Mechanisms**

 

Federalbanking agencies possess broad powers to take corrective and other supervisoryaction to resolve the problems of insured depository institutions, includingbut not limited to those institutions that fall below one or more prescribedminimum capital ratios.  Each federalbanking agency has promulgated regulations defining the following fivecategories in which an insured depository institution will be placed, based onits capital ratios: well capitalized, adequately capitalized, undercapitalized,significantly undercapitalized, and critically undercapitalized.

 

At December31, 2002, both Pacific Crest and the Bank exceeded the required ratios forclassification as “well capitalized.” See Item 7. “Management’s Discussion and Analysis of Financial Conditionand Results of Operations – Capital Resources.”

 

An institutionthat, based upon its capital levels, is classified as well capitalized,adequately capitalized, or undercapitalized may be treated as though it were inthe next lower capital category if the appropriate federal banking agency,after notice and opportunity for hearing, determines that an unsafe or unsoundcondition or an unsafe or unsound practice warrants such treatment.  At each successive lower capital category,an insured depository institution is subject to more restrictions.  The federal banking agencies, however, maynot treat a significantly undercapitalized institution as criticallyundercapitalized unless its capital ratio actually warrants such treatment.

 

In addition tomeasures taken under the prompt corrective action provisions, commercialbanking organizations may be subject to potential enforcement actions by thefederal regulators for unsafe or unsound practices in conducting theirbusinesses or for violations of any law, rule, regulation, or any conditionimposed in writing by the agency or any written agreement with the agency.  Finally, pursuant to an interagencyagreement, the FDIC can examine any institution that has a substandardregulatory examination score or is considered undercapitalized – without theexpress permission of the institution’s primary regulator.

 

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**Safetyand Soundness Standards**

 

The federalbanking agencies have adopted guidelines designed to assist the federal bankingagencies in identifying and addressing potential safety and soundness concernsbefore capital becomes impaired. The guidelines set forth operational andmanagerial standards relating to:

 

•                                          internalcontrols, information systems and internal audit systems;

 

•                                          loandocumentation;

 

•                                          creditunderwriting;

 

•                                          assetgrowth;

 

•                                          earnings;and

 

•                                          compensation,fees and benefits.

 

In addition,the federal banking agencies have also adopted safety and soundness guidelineswith respect to asset quality and earnings standards. These guidelines providesix standards for establishing and maintaining a system to identify problemassets and prevent those assets from deteriorating. Under these standards, aninsured depository institution should:

 

•                                          conductperiodic asset quality reviews to identify problem assets;

 

•                                          estimatethe inherent losses in problem assets and establish reserves that aresufficient to absorb estimated losses;

 

•                                          compareproblem asset totals to capital;

 

•                                          takeappropriate corrective action to resolve problem assets;

 

•                                          considerthe size and potential risks of material asset concentrations; and

 

•                                          provideperiodic asset quality reports with adequate information for management and theboard of directors to assess the level of asset risk.

 

These newguidelines also set forth standards for evaluating and monitoring earnings andfor ensuring that earnings are sufficient for the maintenance of adequatecapital and reserves.

 

**Premiumsfor Deposit Insurance**

 

Through theBank Insurance Fund (“BIF”), the FDIC insures the deposits of the Bank up toprescribed limits for each depositor. The amount of FDIC assessments paid byeach BIF member institution is based on its relative risk of default asmeasured by regulatory capital ratios and other factors. Specifically, theassessment rate is based on the institution’s capitalization risk category andsupervisory subgroup category. An institution’s capitalization risk category isbased on the FDIC’s determination of whether the institution is wellcapitalized, adequately capitalized, or less than adequately capitalized. Aninstitution’s supervisory subgroup category is based on the FDIC’s assessmentof the financial condition of the institution and the probability that FDICintervention or other corrective action will be required.

 

FDIC-insureddepository institutions pay an assessment rate equal to the rate assessed ondeposits insured by the Savings Association Insurance Fund (“SAIF”).

 

The assessmentrate currently ranges from zero to 27 cents per $100 of domestic deposits. TheFDIC may increase or decrease the assessment rate schedule on a semi-annualbasis. Due to continued growth in deposits and some recent bank failures, theBIF is nearing its minimum ratio of 1.25% of insured deposits as mandated bylaw.  If the ratio drops below 1.25%, itis likely that the FDIC will be required to assess premiums on all banks forthe first time since 1996.

 

23

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The FDIC isauthorized to terminate a depository institution’s deposit insurance upon afinding by the FDIC that the institution’s financial condition is unsafe orunsound or that the institution has engaged in unsafe or unsound practices orhas violated any applicable rule, regulation, order or condition enacted orimposed by the institution’s regulatory agency. The termination of depositinsurance for the Bank would have a material adverse effect on the Company’searnings.

 

AllFDIC-insured depository institutions must pay an annual assessment to providefunds for the payment of interest on bonds issued by the Financing Corporation,a federal corporation chartered under the authority of the Federal HousingFinance Board. The bonds, commonly referred to as FICO bonds, were issued tocapitalize the Federal Savings and Loan Insurance Corporation. The FDICestablished the FICO assessment rates effective for the fourth quarter of 2002at approximately $0.017 per $100 of assessable deposits. The FICO assessmentsare adjusted quarterly to reflect changes in the assessment bases of the FDIC’sinsurance funds and do not vary depending on a depository institution’scapitalization or supervisory evaluations.

 

**Interstate Banking and Branching**

 

The BHCApermits bank holding companies from any state to acquire banks and bank holdingcompanies located in any other state, subject to certain conditions, includingcertain nationwide- and state-imposed concentration limits.  The Bank has the ability, subject to certainrestrictions, to acquire by acquisition or merger banks or branches outside itshome state.  The establishment of newinterstate branches is also possible in those states with laws that expresslypermit it.  Interstate branches aresubject to certain laws of the states in which they are located.  Competition may increase further as banksbranch across state lines and enter new markets.

 

**CommunityReinvestment Act and Fair Lending Developments**

 

The Bank issubject to certain fair lending requirements and reporting obligationsinvolving home mortgage lending operations and Community Reinvestment Act(“CRA”) activities. The CRA generally requires the federal banking agencies toevaluate the record of a financial institution in meeting the credit needs ofits local communities, including low- and moderate-income neighborhoods. A bankmay be subject to substantial penalties and corrective measures for a violationof certain fair lending laws.  Thefederal banking agencies may take compliance with such laws and CRA obligationsinto account when regulating and supervising other activities.  Furthermore, financial institutions aresubject to annual reporting and public disclosure requirements for certainwritten agreements that are entered into between insured depositoryinstitutions or their affiliates and nongovernmental entities or persons thatare made pursuant to, or in connection with, the fulfillment of the CRA.

 

A bank’scompliance with its CRA obligations is based a performance-based evaluationsystem which bases CRA ratings on an institution’s lending service andinvestment performance. When a bank holding company applies for approval toacquire a bank or other bank holding company, the Federal Reserve will reviewthe assessment of each subsidiary bank of the applicant bank holding company,and such records may be the basis for denying the application.  Based on its most recent examination, theBank received a “Satisfactory” rating.

 

**Federal Reserve System**

 

The FederalReserve requires all depository institutions to maintain non-interest bearingreserves at specified levels against their transaction accounts (primarilychecking, NOW, and Super NOW checking accounts) and non-personal timedeposits.  At December 31, 2001, theBank was in compliance with these requirements.

 

**Nonbank Subsidiaries**

 

PacificCrest’s nonbank subsidiary, PCC Capital, is also subject to regulation by theFederal Reserve and other applicable federal and state agencies.

 

24

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**FACTORS THAT MAY AFFECT THE COMPANY’SBUSINESS OR STOCK VALUE**

 

*Certain matters discussed in this AnnualReport on Form 10-K may constitute forward-looking statements underSection 27A of the Securities Act and Section 21E of the Securities ExchangeAct.  These statements may involve risksand uncertainties.  Theseforward-looking statements relate to, among other things, expectations of thebusiness environment in which the Company operates in, projections of futureperformance, perceived opportunities in the market and statements regarding theCompany’s mission and vision.  TheCompany’s actual results, performance, or achievements may differ significantlyfrom the results, performance, or achievements expressed or implied in suchforward-looking statements.  Thefollowing is a summary of some of the important factors that could affect theCompany’s future results of operations and/or stock price, and should beconsidered carefully.*

 

**Competition**

 

The bankingand financial services industry in California generally, and in Pacific Crest’smarket areas specifically, is highly competitive.  The competitive environment is a result primarily of changes inregulation, changes in technology and product delivery systems, and theaccelerating pace of consolidation among financial services providers.  The Bank competes for loans, deposits, andcustomers with other commercial banks, savings and loan associations, securitiesand brokerage companies, mortgage companies, insurance companies, financecompanies, money market funds, credit unions, and other nonbank financialservice providers.  Many of thesecompetitors are much larger in total assets and capitalization, have greateraccess to capital markets and offer a broader range of financial services thanthe Bank. See “Regulation – Financial Services Modernization Legislation.”

 

**Effectof Economic Conditions in Southern California**

 

The Company isheadquartered in and its operations are primarily concentrated in SouthernCalifornia.  As a result of thisgeographic concentration, the Company’s results depend largely upon economicand business conditions in this area. Deterioration of the economic conditions in Southern California couldhave a material adverse impact on the quality of the Company’s loan portfolioand the demand for its products and services.

 

**CreditQuality**

 

A significantsource of risk arises from the possibility that losses will be sustainedbecause borrowers, guarantors and related parties may fail to perform inaccordance with the terms of their loans. The Company has adopted underwritingand credit monitoring procedures and credit policies, including theestablishment and review of the allowance for credit losses, that itsmanagement believes are appropriate to minimize this risk by assessing thelikelihood of nonperformance, tracking loan performance and diversifying theloan portfolio geographically within Southern Califonia, but such policies andprocedures may not prevent unexpected losses that could materially adverselyaffect the Company’s results.  See“Asset Quality Review” and “Allowance for Loan Losses.”

 

**InterestRates**

 

The Company’sprofitability, like most financial institutions, primarily depends on interestrate differentials.  In general, thedifference between the interest rates paid by the Bank on interest-bearingliabilities, such as deposits and other borrowings, and the interest ratesreceived by the Bank on its interest-earning assets, such as loans extended toits clients and securities held in its investment portfolio, comprise the majorportion of the Company’s earnings. These interest rates are highly sensitive to many factors that arebeyond the control of the Company, such as inflation, recession andunemployment.

 

The Company issubject to possible interest rate spread compression, which would adverselyimpact net interest income, particularly in times of rising or volatileinterest rates.  The amount of suchinterest rate spread compression would depend upon the frequency, magnitude andduration of such interest rate increases or fluctuations.  The Company’s senior management continuallyattempts to minimize the effect of interest rate changes in net interest incomethrough a variety of asset/liability strategies that are modified from time totime based on a variety of factors.  See“Asset/Liability Management” and Item 7A. “Quantitative and QualitativeDisclosures About Market Risk”.

 

25

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**GovernmentRegulation and Legislation**

 

The Company’sbusiness also is influenced by the monetary and fiscal policies of the federalgovernment and the policies of regulatory agencies, particularly the FederalReserve. The Federal Reserve implements national monetary policies (withobjectives such as curbing inflation and combating recession) through itsopen-market operations in U.S. Government securities by adjusting the requiredlevel of reserves for depository institutions subject to its reserverequirements, and by varying the target federal funds and discount ratesapplicable to borrowings by depository institutions.  The actions of the Federal Reserve in these areas influence thegrowth of bank loans, investments, and deposits and also affect interest ratesearned on interest-earning assets and paid on interest-bearingliabilities.  The nature and impact onthe Company of any future changes in monetary and fiscal policies cannot bepredicted.

 

From time totime, legislation, as well as regulations, are enacted which have the effect ofincreasing the cost of doing business, limiting or expanding permissibleactivities, or affecting the competitive balance between banks and otherfinancial services providers.  Proposalsto change the laws and regulations governing the operations and taxation ofbanks, bank holding companies, and other financial institutions and financialservices providers are frequently made in the U.S. Congress, in the statelegislatures, and before various regulatory agencies. This legislation maychange banking statutes and the operating environment of the Company insubstantial and unpredictable ways. If enacted, such legislation could increaseor decrease the cost of doing business, limit or expand permissible activitiesor affect the competitive balance among banks, savings associations, creditunions, and other financial institutions. The Company cannot predict whether any of this potential legislationwill be enacted, and if enacted, the effect that it, or any implementingregulations, would have on its financial condition or results ofoperations.  See “Regulation – FinancialServices Modernization Legislation.”

 

**Dependenceon Key Employees**

 

If the Companywere to lose key employees temporarily or permanently, particularly if theywent to work for competitors, it could hurt the Company’s business.  The Company’s future success depends on thecontinued contributions of existing senior management personnel.

 

**OtherRisks**

 

From time totime, the Company details other risks with respect to its businesses and/or itsfinancial results in its filings with the Securities and Exchange Commission(the “SEC”), the FDIC and the DFI, respectively.

 

 

26

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**ITEM 2.  Properties**

 

The Company’sprincipal executive offices are located at 30343 Canwood Street, Agoura Hills,California 91301. The Bank conducts its deposit and lending operations throughthree branch offices located in Beverly Hills, Encino and San Diego,California.   Additionally, the Companyhas a separate SBA administrative office located in San Diego.  The Company leases all of its offices.

 

Informationwith respect to the Company’s principal executive, branch, and SBAadministrative offices is as follows:

 
| **Location**                                      |   | **Square  Footage** |   | **Annual  Rent** |    | **Lease  Expiration  Date** | ** ** |
|---------------------------------------------------|--------|---------------------|--------|------------------|---------|-----------------------------|------------|
| Corporate Headquarters - Agoura Hills, California |   | 18,121              |   | $                | 344,042 |                        | 2006       |   |
| Branch Office - Beverly Hills, California         |   | 3,102               |   | 136,541          |    | 2004                        |       |
| Branch Office - Encino, California                |   | 3,310               |   | 73,345           |    | 2007                        |       |
| Branch Office - San Diego, California             |   | 4,505               |   | 131,748          |    | 2010                        |       |
| SBA Administrative Office - San Diego, California |   | 4,107               |   | 90,453           |    | 2003                        |       |
|                                                   |        |                     |        |                  |         |                             |            |  |

 

**ITEM 3.  LegalProceedings**

 

There arecurrently no legal claims pending against the Company .

 

**ITEM4.  Submission of Matters to a Vote ofSecurity Holders**

 

Notapplicable.

 

27

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**PARTII**

 

**ITEM5.  Market for Registrant’s Common Equityand Related Stockholder Matters**

 

As of March14, 2003, there were approximately 1,700 beneficial owners of the Company’s$0.01 par value common stock  (the“Common Stock”).  The Common Stock istraded on the Nasdaq National Market under the Nasdaq symbol “PCCI.”

 

The followingtables present the high, low, and closing Common Stock prices as well as thecash dividends declared and paid per common share during each quarter for thelast two years.  All amounts have beenadjusted to reflect the 2-for-1 stock split distributed November 12, 2002.

 
|                |   | **Year Ended December 31, 2002** |       |
|---------------------|--------|----------------------------------|------------|
| **Quarter  Ended:** |   | **High**                         |       | **Low** |   | **Closing** |   | **Dividends** |   |
| December 31         |   | $                                | 16.950     |   | $ | 14.615 |   | $ | 15.800 |   | $ | 0.05 |   |
| September 30        |   | 16.680                           |       | 13.425 |   | 15.375 |   | 0.05 |   |
| June 30             |   | 14.421                           |       | 11.950 |   | 14.250 |   | 0.04 |   |
| March 31            |   | 12.200                           |       | 10.350 |   | 12.200 |   | 0.04 |   |
|                |   |                             |       |   |   |   |   |   |   |
|                |   | **Year Ended December 31, 2001** | ** ** |
| **Quarter Ended:**  |   | **High**                         |       | **Low** |   | **Closing** |   | **Dividends** | ** ** |
| December 31         |   | $                                | 10.600     |   | $ | 9.100 |   | $ | 10.525 |   | $ | 0.04 |   |
| September 30        |   | 10.375                           |       | 9.203 |   | 9.350 |   | 0.04 |   |
| June 30             |   | 9.925                            |       | 8.450 |   | 9.900 |   | 0.04 |   |
| March 31            |   | 9.688                            |       | 7.250 |   | 8.875 |   | 0.04 |   |

 

The Company’sability to pay dividends is subject to restrictions set forth in the DelawareGeneral Corporation Law.  The DelawareGeneral Corporation Law provides that a Delaware corporation may pay dividendseither (i) out of the corporation’s surplus (as defined by Delaware law), or(ii) if there is no surplus, out of the corporation’s net profits for thefiscal year in which the dividend is declared and/or the preceding fiscal year.The Company’s ability to pay cash dividends to its shareholders in the futurewill depend in large part on the Bank’s ability to pay dividends on its capitalstock to the Parent.  The Bank’s abilityto pay dividends to the Parent is subject to restrictions set forth in theCalifornia Financial Code. See Item 1. “Business – Regulation – Dividends andOther Transfers of Funds.”

 

**ITEM6.  Selected Financial Data**

 

The followingselected consolidated financial data should be read in conjunction with theCompany’s audited Consolidated Financial Satements and related notes, which areincluded in this Annual Report on Form 10-K.

 

28

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**FIVE-YEAR BALANCE SHEETS**

 
|                                                   |   | **December 31,** |    |
|--------------------------------------------------------|--------|------------------|---------|
| **(in  thousands)**                                    |   | **2002**         |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Cash                                                   |   | $                | 3,199   |   | $ | 2,508 |   | $ | 2,319 |   | $ | 1,282 |   | $ | 3,592 |   |
| Securities purchased under resale agreements           |   | 7,802            |    | 16,174 |   | 3,017 |   | 3,501 |   | 22,048 |   |
| Cash and cash equivalents                              |   | 11,001           |    | 18,682 |   | 5,336 |   | 4,783 |   | 25,640 |   |
|                                                   |   |             |    |   |   |   |   |   |   |   |   |
| ***Investment securities available for  sale:***       |   |             |    |   |   |   |   |   |   |   |   |
| U.S. agency callable bonds                             |   | —           |    | — |   | 227,106 |   | 233,071 |   | 307,919 |   |
| U.S. agency mortgage-backed securities                 |   | 70,516           |    | 55,537 |   | 3,799 |   | 3,856 |   | 1,606 |   |
| Corporate debt securities                              |   | 2,902            |    | 3,415 |   | 3,543 |   | 3,833 |   | 11,736 |   |
| Total investment securities, at market                 |   | 73,418           |    | 58,952 |   | 234,448 |   | 240,760 |   | 321,261 |   |
|                                                   |   |             |    |   |   |   |   |   |   |   |   |
| ***Loans:***                                           |   |             |    |   |   |   |   |   |   |   |   |
| Income property loans                                  |   | 411,226          |    | 431,280 |   | 382,596 |   | 358,512 |   | 280,110 |   |
| SBA business loans                                     |   | 37,282           |    | 24,166 |   | 16,853 |   | 6,959 |   | 7,454 |   |
| Other loans                                            |   | 7,422            |    | 6,533 |   | 814 |   | 862 |   | 1,504 |   |
| Gross loans                                            |   | 455,930          |    | 461,979 |   | 400,263 |   | 366,333 |   | 289,068 |   |
| Deferred loan costs (fees)                             |   | 197              |    | (4 | ) | 22 |   | (381 | ) | (582 | ) |
| Allowance for loan losses                              |   | (8,585           | )       | (7,946 | ) | (7,240 | ) | (6,450 | ) | (5,024 | ) |
| Net loans                                              |   | 447,542          |    | 454,029 |   | 393,045 |   | 359,502 |   | 283,462 |   |
|                                                   |   |             |    |   |   |   |   |   |   |   |   |
| Unsettled mortgage-backed securities trades, at market |   | 56,672           |    | — |   | — |   | — |   | — |   |
| Accrued interest receivable and other assets           |   | 15,111           |    | 13,095 |   | 15,831 |   | 18,215 |   | 14,135 |   |
| Other real estate owned (OREO)                         |   | —           |    | — |   | — |   | — |   | 806 |   |
| Total assets                                           |   | $                | 603,744 |   | $ | 544,758 |   | $ | 648,660 |   | $ | 623,260 |   | $ | 645,304 |   |
|                                                   |   |             |    |   |   |   |   |   |   |   |   |
| ***Deposits:***                                        |   |             |    |   |   |   |   |   |   |   |   |
| Checking accounts                                      |   | $                | 16,014  |   | $ | 14,912 |   | $ | 14,414 |   | $ | 18,783 |   | $ | 23,849 |   |
| Savings accounts                                       |   | 128,420          |    | 136,145 |   | 148,347 |   | 196,368 |   | 276,011 |   |
| Certificates of deposit                                |   | 215,062          |    | 250,466 |   | 336,076 |   | 269,233 |   | 182,979 |   |
| Total deposits                                         |   | 359,496          |    | 401,523 |   | 498,837 |   | 484,384 |   | 482,839 |   |
|                                                   |   |             |    |   |   |   |   |   |   |   |   |
| ***Borrowings:***                                      |   |             |    |   |   |   |   |   |   |   |   |
| Securities sold under repurchase agreements            |   | —           |    | — |   | 23,500 |   | 30,500 |   | 30,779 |   |
| State of California borrowings                         |   | —           |    | — |   | 28,000 |   | 20,000 |   | — |   |
| FHLB advances                                          |   | 120,000          |    | 40,000 |   | — |   | — |   | — |   |
| Term borrowings                                        |   | —           |    | 40,000 |   | 40,000 |   | 40,000 |   | 79,450 |   |
| Trust preferred securities                             |   | 17,250           |    | 17,250 |   | 17,250 |   | 17,250 |   | 17,250 |   |
| Total borrowings                                       |   | 137,250          |    | 97,250 |   | 108,750 |   | 107,750 |   | 127,479 |   |
|                                                   |   |             |    |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities                     |   | 496,746          |    | 498,773 |   | 607,587 |   | 592,134 |   | 610,318 |   |
| Accounts payable for unsettled securities trades       |   | 56,012           |    | — |   | — |   | — |   | — |   |
| Accrued interest payable and other liabilities         |   | 5,807            |    | 8,010 |   | 7,143 |   | 5,577 |   | 4,846 |   |
| Total liabilities                                      |   | 558,565          |    | 506,783 |   | 614,730 |   | 597,711 |   | 615,164 |   |
|                                                   |   |             |    |   |   |   |   |   |   |   |   |
| ***Shareholders’ equity:***                       |   |             |    |   |   |   |   |   |   |   |   |
| Common stock, at par (1)                               |   | 60               |    | 60 |   | 60 |   | 60 |   | 60 |   |
| Additional paid-in capital (1)                         |   | 27,471           |    | 27,750 |   | 27,760 |   | 27,855 |   | 28,027 |   |
| Retained earnings                                      |   | 25,628           |    | 19,140 |   | 14,542 |   | 9,978 |   | 5,559 |   |
| Accumulated other comprehensive income (loss)          |   | 1,296            |    | (198 | ) | (1,532 | ) | (6,355 | ) | 1,199 |   |
| Common stock in treasury, at cost                      |   | (9,276           | )       | (8,777 | ) | (6,900 | ) | (5,989 | ) | (4,705 | ) |
| Total shareholders’ equity                        |   | 45,179           |    | 37,975 |   | 33,930 |   | 25,549 |   | 30,140 |   |
| Total liabilities and shareholders’ equity        |   | $                | 603,744 |   | $ | 544,758 |   | $ | 648,660 |   | $ | 623,260 |   | $ | 645,304 |   |

 

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(1)  All years adjusted to reflect the 2-for-1 stock split distributedNovember 12, 2002.

 

29

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**FIVE-YEAR INCOME STATEMENTS**

** **
|                                                |   | **Years Ended December 31,** |   |
|-----------------------------------------------------|--------|------------------------------|--------|
| **(in  thousands*)***                               |   | **2002**                     |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| ***Interest income:***                              |   |                         |   |   |   |   |   |   |   |   |   |
| Loans                                               |   | $                            | 37,405 |   | $ | 38,091 |   | $ | 37,182 |   | $ | 32,857 |   | $ | 25,653 |   |
| Investment securities available for sale            |   | 3,766                        |   | 8,106 |   | 16,405 |   | 16,091 |   | 19,366 |   |
| Securities purchased under resale agreements        |   | 171                          |   | 456 |   | 132 |   | 413 |   | 221 |   |
| Total interest income                               |   | 41,342                       |   | 46,653 |   | 53,719 |   | 49,361 |   | 45,240 |   |
|                                                |   |                         |   |   |   |   |   |   |   |   |   |
| ***Interest expense:***                             |   |                         |   |   |   |   |   |   |   |   |   |
| Deposits:                                           |   |                         |   |   |   |   |   |   |   |   |   |
| Checking accounts                                   |   | 234                          |   | 403 |   | 658 |   | 967 |   | 949 |   |
| Savings accounts                                    |   | 2,577                        |   | 4,853 |   | 8,355 |   | 11,519 |   | 11,226 |   |
| Certificates of deposit                             |   | 9,603                        |   | 16,994 |   | 19,284 |   | 11,613 |   | 9,241 |   |
| Total interest on deposits                          |   | 12,414                       |   | 22,250 |   | 28,297 |   | 24,099 |   | 21,416 |   |
| Borrowings:                                         |   |                         |   |   |   |   |   |   |   |   |   |
| Securities sold under repurchase agreements         |   | —                       |   | 216 |   | 2,022 |   | 871 |   | 1,418 |   |
| State of California borrowings                      |   | —                       |   | 609 |   | 1,805 |   | 148 |   | — |   |
| FHLB advances                                       |   | 2,192                        |   | 166 |   | — |   | — |   | — |   |
| Term borrowings                                     |   | 1,672                        |   | 2,686 |   | 1,999 |   | 3,455 |   | 4,087 |   |
| Trust preferred securities                          |   | 1,617                        |   | 1,617 |   | 1,617 |   | 1,617 |   | 1,617 |   |
| Total interest on borrowings                        |   | 5,481                        |   | 5,294 |   | 7,443 |   | 6,091 |   | 7,122 |   |
| Total interest expense                              |   | 17,895                       |   | 27,544 |   | 35,740 |   | 30,190 |   | 28,538 |   |
|                                                |   |                         |   |   |   |   |   |   |   |   |   |
| ***Net interest income***                           |   | 23,447                       |   | 19,109 |   | 17,979 |   | 19,171 |   | 16,702 |   |
| ***Provision for loan losses***                     |   | 471                          |   | 660 |   | 604 |   | 1,677 |   | 910 |   |
| Net interest income after provision for loan losses |   | 22,976                       |   | 18,449 |   | 17,375 |   | 17,494 |   | 15,792 |   |
|                                                |   |                         |   |   |   |   |   |   |   |   |   |
| ***Non-interest income:***                          |   |                         |   |   |   |   |   |   |   |   |   |
| Loan prepayment and late fee income                 |   | 822                          |   | 345 |   | 346 |   | 662 |   | 788 |   |
| Gain on sale of SBA 7(a) loans                      |   | 221                          |   | 395 |   | 112 |   | 250 |   | 254 |   |
| Gain on sale of SBA 504 loans and broker fee income |   | 1,201                        |   | 503 |   | — |   | — |   | — |   |
| Gain (loss) on sale of investment securities        |   | (763                         | )      | 95 |   | (2 | ) | 661 |   | 252 |   |
| Gain on sale of income property loans               |   | —                       |   | — |   | 561 |   | — |   | 467 |   |
| Gain on sale of other real estate owned (OREO)      |   | —                       |   | — |   | 115 |   | 25 |   | 120 |   |
| Other income                                        |   | 1,007                        |   | 1,193 |   | 581 |   | 861 |   | 597 |   |
| Total non-interest income                           |   | 2,488                        |   | 2,531 |   | 1,713 |   | 2,459 |   | 2,478 |   |
|                                                |   |                         |   |   |   |   |   |   |   |   |   |
| ***Non-interest expense:***                         |   |                         |   |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                      |   | 8,787                        |   | 7,152 |   | 6,407 |   | 6,652 |   | 5,822 |   |
| Net occupancy expenses                              |   | 1,796                        |   | 1,665 |   | 1,422 |   | 1,687 |   | 1,616 |   |
| Communication and data processing                   |   | 1,020                        |   | 1,057 |   | 880 |   | 933 |   | 778 |   |
| Legal, audit, and other professional fees           |   | 525                          |   | 986 |   | 563 |   | 526 |   | 356 |   |
| Travel and entertainment                            |   | 491                          |   | 457 |   | 352 |   | 452 |   | 361 |   |
| Other expenses                                      |   | 594                          |   | 544 |   | 566 |   | 1,119 |   | 958 |   |
| Total operating expenses                            |   | 13,213                       |   | 11,861 |   | 10,190 |   | 11,369 |   | 9,891 |   |
| Credit and collection expenses                      |   | 26                           |   | — |   | (134 | ) | 43 |   | 127 |   |
| OREO expenses                                       |   | —                       |   | — |   | (10 | ) | 28 |   | 211 |   |
| OREO valuation adjustments                          |   | —                       |   | — |   | — |   | 43 |   | 50 |   |
| Total non-interest expense                          |   | 13,239                       |   | 11,861 |   | 10,046 |   | 11,483 |   | 10,279 |   |
|                                                |   |                         |   |   |   |   |   |   |   |   |   |
| ***Income before income taxes***                    |   | 12,225                       |   | 9,119 |   | 9,042 |   | 8,470 |   | 7,991 |   |
| Income tax expense                                  |   | 4,863                        |   | 3,734 |   | 3,772 |   | 3,415 |   | 3,144 |   |
| ***Net income***                                    |   | $                            | 7,362  |   | $ | 5,385 |   | $ | 5,270 |   | $ | 5,055 |   | $ | 4,847 |   |

 

30

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**FIVE-YEAR SELECTED RATIOS AND FINANCIAL DATA**

 
|                                                            |   | **At or For the Years Ended December 31,** |   |
|-----------------------------------------------------------------|--------|--------------------------------------------|--------|
| **(dollars in  thousands)**                                     |   | **2002**                                   |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| **Performance Ratios:**                                         |   |                                       |   |   |   |   |   |   |   |   |   |
| Return on average shareholders’ equity (1)                 |   | 18.18                                      | %      | 14.75 | % | 15.98 | % | 16.65 | % | 17.02 | % |
| Return on average total assets                                  |   | 1.32                                       | %      | 0.95 | % | 0.82 | % | 0.83 | % | 0.90 | % |
| Net interest rate spread (2)                                    |   | 4.03                                       | %      | 3.06 | % | 2.48 | % | 2.94 | % | 2.93 | % |
| Net interest margin (3)                                         |   | 4.30                                       | %      | 3.43 | % | 2.80 | % | 3.19 | % | 3.17 | % |
| Operating expenses to average total assets                      |   | 2.37                                       | %      | 2.10 | % | 1.59 | % | 1.87 | % | 1.84 | % |
| Efficiency ratio (4)                                            |   | 49.49                                      | %      | 55.05 | % | 53.58 | % | 54.28 | % | 53.93 | % |
| Dividend payout ratio (5)                                       |   | 13.14                                      | %      | 15.69 | % | 14.00 | % | 13.19 | % | 3.66 | % |
| Average shareholders’ equity to average total  assets |   | 7.32                                       | %      | 6.43 | % | 4.25 | % | 4.62 | % | 5.64 | % |
|                                                            |   |                                       |   |   |   |   |   |   |   |   |   |
| **Asset Quality Data:**                                         |   |                                       |   |   |   |   |   |   |   |   |   |
| Non-accrual loans                                               |   | $                                          | — |   | $ | — |   | $ | — |   | $ | 210 |   | $ | — |   |
| Non-performing assets (6)                                       |   | —                                     |   | — |   | — |   | 210 |   | 806 |   |
| Net (charge-offs) recoveries                                    |   | 168                                        |   | 46 |   | 186 |   | (251 | ) | 14 |   |
| Non-accrual loans to total loans                                |   | 0.00                                       | %      | 0.00 | % | 0.00 | % | 0.06 | % | 0.00 | % |
| Non-performing assets to total assets (6)                       |   | 0.00                                       | %      | 0.00 | % | 0.00 | % | 0.03 | % | 0.12 | % |
| Allowance for loan losses to total loans                        |   | 1.88                                       | %      | 1.72 | % | 1.81 | % | 1.76 | % | 1.74 | % |
| Allowance for loan losses to non-accrual loans                  |   | NM                                         |   | NM |   | NM |   | 3071.43 | % | NM |   |
| Net (charge-offs) recoveries to average total loans             |   | 0.04                                       | %      | 0.01 | % | 0.05 | % | (0.07% | ) | 0.01 | % |
|                                                            |   |                                       |   |   |   |   |   |   |   |   |   |
| **Capital Ratios - Pacific Crest Capital,  Inc. (7):**     |   |                                       |   |   |   |   |   |   |   |   |   |
| Leverage ratio                                                  |   | 10.33                                      | %      | 9.49 | % | 7.16 | % | 6.89 | % | — |   |
| Tier 1 risk-based capital ratio                                 |   | 13.31                                      | %      | 11.11 | % | 10.63 | % | 10.18 | % | — |   |
| Total risk-based capital ratio                                  |   | 15.17                                      | %      | 13.36 | % | 13.11 | % | 13.02 | % | — |   |
|                                                            |   |                                       |   |   |   |   |   |   |   |   |   |
| **Per Share Data (8):**                                         |   |                                       |   |   |   |   |   |   |   |   |   |
| Cash dividends per common share                                 |   | $                                          | 0.18   |   | $ | 0.16 |   | $ | 0.14 |   | $ | 0.12 |   | $ | 0.03 |   |
| Diluted earnings per common share                               |   | 1.37                                       |   | 1.02 |   | 1.00 |   | 0.91 |   | 0.82 |   |
| Basic earnings per common share                                 |   | 1.52                                       |   | 1.09 |   | 1.04 |   | 0.95 |   | 0.86 |   |
| Tangible book value per common share                            |   | 9.31                                       |   | 7.85 |   | 6.74 |   | 4.91 |   | 5.60 |   |
|                                                            |   |                                       |   |   |   |   |   |   |   |   |   |
| **Share Information (in thousands) (8):**                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Weighted average basic common shares outstanding                |   | 4,855                                      |   | 4,940 |   | 5,051 |   | 5,324 |   | 5,634 |   |
| Weighted average diluted common shares outstanding              |   | 5,359                                      |   | 5,301 |   | 5,245 |   | 5,556 |   | 5,942 |   |
| Common shares outstanding at year-end, net of treasury          |   | 4,854                                      |   | 4,840 |   | 5,031 |   | 5,203 |   | 5,382 |   |
|                                                            |   |                                       |   |   |   |   |   |   |   |   |   |
| **Average Balances:**                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Average shareholders’ equity                               |   | $                                          | 40,752 |   | $ | 36,247 |   | $ | 27,291 |   | $ | 28,010 |   | $ | 30,401 |   |
| Average realized shareholders’ equity (1)                  |   | 40,494                                     |   | 36,508 |   | 32,979 |   | 30,359 |   | 28,396 |   |
| Average total assets                                            |   | 556,723                                    |   | 564,088 |   | 642,382 |   | 606,396 |   | 538,783 |   |
| Average total loans                                             |   | 462,060                                    |   | 413,986 |   | 387,794 |   | 346,698 |   | 238,950 |   |

 

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(1)           Calculation excludesaccumulated other comprehensive income (loss) from shareholders’ equity.

(2)           Yield earned onaverage total interest-earning assets less the rate paid on average totalinterest-bearing liabilities.

(3)           Net interest incomedivided by average total interest-earning assets.

(4)           Operating expensedivided by sum of net interest income, loan prepayment and late fee income,gain on sale of SBA 7(a) loans, gain on sale of SBA 504 loans and broker feeincome, and other income.

(5)           Cash dividends percommon share divided by diluted earnings per common share.  The Company first declared and paid cashdividends in the fourth quarter of 1998.

(6)           Non-performingassets consist of non-accrual loans and other real estate owned (“OREO”).

(7)           There were noregulatory capital ratios for Pacific Crest Capital, Inc. prior to itsconversion to a bank holding company in December 1999.   The minimum required regulatory capitalratios for a well capitalized institution are 5% leverage, 6% Tier 1 risk-basedcapital, and 10% total risk-based capital.

(8)           All years adjustedto reflect the 2-for-1 stock split distributed November 12, 2002.

 

31

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**ITEM7.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**GEN****ERAL**

 

Pacific CrestCapital, Inc. (“Pacific Crest or the “Parent”), a Delaware corporation, is abank holding company and owns 100% of the stock of Pacific Crest Bank (the“Bank”), and 100% of the common stock of PCC Capital I (“PCC Capital”).  The consolidated financial statements andfinancial data included herein include the accounts of Pacific Crest and itswholly owned subsidiaries and are referred to as the consolidated financialstatements of the “Company.”

 

The followingdiscussion should be read in conjunction with the information under Item 6.“Selected Financial Data” and the Company’s consolidated financial statementsand related notes contained elsewhere herein. Certain statements under this Item 7 constitute “forward-lookingstatements” under Section 27A of the Securities Act and Section 21E of theExchange Act, which involve risks and uncertainties.  The Company’s actual results may differ significantly from theresults discussed in these forward-looking statements.  Factors that might cause such a difference,include but are not limited to, credit quality, economic conditions,competition in the geographic and business areas in which the Company conductsits operations, fluctuations in interest rates and government regulation.  For additional information concerning thesefactors, see Item 1. “Business —Factors That May Affect the Company’s Businessor Stock Value.”

 

**Issuanceof New Trust Preferred Securities**

 

On March 20,2003, the Company announced that it had issued $13,330,000 of trust preferredsecurities (the “New Trust Preferred Securities”) in a private placementoffering.  Estimated net proceeds to theCompany from the offering after expenses were $13,320,000.  There were no commissions or expensescharged by the underwriter on this transaction.  The New Trust Preferred Securities were issued by a newlyestablished subsidiary of the Company, Pacific Crest Capital Trust I.   The New Trust Preferred Securities have amaturity of 30 years, but are redeemable (callable) by Pacific Crest Capital,Inc. in part or in total at par after five years.  The New Trust Preferred Securities have a fixed interest rate of6.335% during the first five years, after which the interest rate will floatand reset quarterly at the three-month Libor rate plus 3.25%.

 

**UnsettledSecurities Trades**

 

In December of2002, the Company executed trades to purchase $56 million of fixed rate, GNMAmortgage-backed securities with an estimated interest rate yield of 5%.  The $56 million in GNMA securities tradesdid not fund until late January of 2003, and are reflected on the ConsolidatedBalance Sheets as “Unsettled mortgage-backed securities trades,” with therelated liability reported as “Accounts payable for unsettled securitiestrades.”  The securities did not earninterest for the Company until the trades were funded in late January of 2003.

 

**Two-For-OneStock Split**

 

On October 17,2002, the Company announced that its Board of Directors had approved a 2-for-1stock split, to be effected in the form of a 100 percent stock dividend.  Shareholders received one additional shareof common stock for each share that they held on the record date of October 30,2002.  The additional shares weredistributed on November 12, 2002.

 

The stocksplit resulted in the issuance of 2,986,530 shares of common stock.  Par value of the stock remained unchanged at$0.01 per share.  Accordingly, theCompany recorded the transaction on November 12, 2002 and increased “Commonstock” by $29,865, with an offsetting reduction to “Additional paid-in capital”in the same amount.

 

The effect ofthe stock split has been recognized retroactively in “Common stock” and“Additional paid-in capital,” as well as in all share and per share amounts, inthe financial tables and text of this Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.

 

32

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**Capital**

 

As of December31, 2002, Pacific Crest’s leverage ratio, Tier 1 risk-based capital ratio andtotal risk-based ratio were 10.33%, 13.31%, and 15.17%, respectively.  The Bank’s leverage ratio, Tier 1 risk-basedcapital ratio and total risk-based capital ratio were 10.05%, 12.91%, and14.17%, respectively. These ratios placed Pacific Crest and the Bank in the“well-capitalized” category as defined by federal regulations, which requirecorresponding capital ratios of 5%, 6% and 10%, respectively, to qualify forthat designation.

 

**Dividends**

 

On January 23,2003, the Company announced that the Board of Directors had declared a cashdividend of $0.05 per common share on a post-split basis for the first quarterof 2003.  The dividend was paid on March14, 2003 to shareholders of record at the close of business on February 28, 2003.  During the year ended December 31, 2002, theCompany declared and paid cash dividends in the aggregate of $0.18 per commonshare on a post-split basis for a total of $874,000.  During the year ended December 31, 2001, the Company declared andpaid cash dividends in the aggregate of $0.16 per common share on a post-splitbasis for a total of $787,000.

 

**StockRepurchase Plan**

 

During theyear ended December 31, 2002, pursuant to its common stock repurchase program,the Company repurchased 98,800 shares of its common stock at an average costper share of $14.05 on a post-split basis. The total amount paid for these shares was approximately $1.4million.  During the same period, theCompany utilized repurchased shares for all of its common stock issuances underthe Company’s employee stock purchase plan, non-employee directors stockpurchase plan, and employee stock option plan, which totaled 112,144 shares ona post-split basis.  As of December 31,2002, the Company had 70,200 shares remaining authorized for repurchase underits common stock repurchase program on a post-split basis.

 

**Saleof Interest Rate Cap Agreement**

 

On February 8,2000, the Company sold its interest rate cap agreement for $2.5 million andrecognized a deferred gain of $1.8 million, which was reported in theConsolidated Balance Sheets under the caption “Accrued interest payable andother liabilities”.  The interest ratecap agreement had originally been purchased on June 8, 1998, at a price of $925,000.  The deferred gain is being amortized as acredit to “Interest expense –deposits” over the remaining life of the originalinterest rate cap agreement, which had a maturity date of June 8, 2003.  During the years ended December 31, 2002,2001, and 2000, the amount of deferred gain amortization totaled $554,000,$554,000, and $495,000, respectively, which resulted in a reduction in interestexpense on deposits.  As of December 31,2002, the remaining unamortized balance of the deferred gain resulting from thesale of the interest rate cap totaled $240,000 and will be amortized during thefirst six months of 2003.

 

**CorporateGovernance**

 

The followingare some of the key corporate governance practices at the Company, which areoriented to ensure that there are no conflicts of interest and that the Companyis operated in the best interest of shareholders:

 

•                                          Fourof the Company’s five directors are independent outside directors.

 

•                                          Noneof the Company’s officers and directors has loans from the Company.

 

•                                          Thereare no loans by the Company to outside companies controlled by or affiliatedwith officers or directors.

 

•                                          Outsidedirectors do not receive compensation from the Company other than directorfees.  In recent years, outsidedirectors have elected to receive 50% of their director fees in shares ofCompany common stock.

 

•                                          TheCompany’s Board of Directors has nominating and governance, audit, andcompensation committees comprised solely of independent outside directors.

 

Additionally,one of the Company’s directors, Rudolph I. Estrada, is a member of the NationalAssociation of Corporate Directors and Chairman of the Company’s Nominating andGovernance Committee.

 

33

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**SBA Preferred Lender Status**

 

During 2002,the Company was awarded “Preferred Lender” status in the Sacramento and SanFrancisco SBA districts by the U.S. Small Business Administration (“SBA”), andthus became an SBA Preferred Lender in all of Northern California.  The Company was previously awarded“Preferred Lender” status in the SBA districts comprising the entire SouthernCalifornia region from Santa Barbara to San Diego, as well as the entire stateof Oregon.  “Preferred Lender” status isthe highest designation granted lenders by the SBA.

 

**Declining Interest Rate Environment**

 

During 2002,the Federal Reserve reduced the federal funds target rate by 50 basis points to1.25%,  and during 2001, the FederalReserve lowered the federal funds target rate by a total of 475 basis points,to 1.75%.  The impact of this cumulativereduction led to a lower interest rate environment in 2001, which continuedinto 2002, and resulted in (i) issuer calls of $219.2 million and Company salesof $10.0 million of the Company’s fixed rate, U.S. government sponsored agencycallable bonds (the “callable bonds”) during the first nine months of 2001,(ii) downward repricing of the Company’s adjustable rate loans, and (iii) theCompany’s lowering of interest rates on all of its deposit products.  Additionally, the interest rates declined onthe Company’s adjustable rate investments and borrowings.

 

**FHLB Credit Line Expansion**

 

In July of 2002, the FHLB approved an increase in Pacific Crest Bank’savailable credit line from 20% of total assets to 35% of total assets.  As a result, the Bank’s credit line increasedby $81.5 million, to $190.2 million, based on total assets at that time.  All FHLB advances must be secured byeligible loans and/or eligible securities. The FHLB credit facility serves as an excellent source of low costfunding and is an important component of the Company’s strategy to reducefunding costs.  The Company is focusingon using the FHLB credit facility primarily for fixed rate advances with 12-36month terms as part of its hedging strategy to insulate the Company frompotentially higher interest rates in 2003, 2004, and 2005.  During 2002, the Company obtained $80.0million in long-term, fixed rate FHLB advances, with a weighted averageinterest rate of 2.81% and maturities ranging from 1.5 years to 3.0 years.

 

**FederalIncome Tax Refund**

 

In April of2002, the Company received a payment from the Internal Revenue Service (“IRS”)in connection with a refund claim filed by the Company for a prior year’sincome taxes.  The total amount of thepayment was $1,218,000, which was comprised of $804,000 for income taxes and$414,000 for interest.  The $804,000 wasapplied as a reduction of “Deferred income taxes, net” on the ConsolidatedBalance Sheets, while the $414,000 was applied to a receivable included in“Prepaid expenses and other assets”. The Company had accrued as “Other income”$300,000 of the interest during the fourth quarter of 2001 and accrued theremaining $114,000 during the first quarter of 2002.

 

**SBA Loan Sales**

 

The following table presents the Company’sSBA loan sales for the periods indicated (in thousands):

 
|                                |   | **Years Ended December 31,** |   |
|-------------------------------------|--------|------------------------------|--------|
|                                |   | **2002**                     |   | **2001** |   | **2000** |   |
| SBA 7(a) loans - guaranteed portion |   | $                            | 2,929  |   | $ | 7,299 |   | $ | 2,601 |   |
| SBA 504 first lien loans            |   | 3,427                        |   | 4,592 |   | — |   |
| Total SBA loan sales                |   | $                            | 6,356  |   | $ | 11,891 |   | $ | 2,601 |   |

 

34

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**Non-RecurringItems**

 

During 2002,the Company recorded the following items which it considered non-recurring:

 

•      The Company wrote down to marketvalue one of its corporate debt securities in order to reflect an other thantemporary decline in the market value of that security.  The write-down was based on a variety offactors, including a rating agency downgrade of the security’s debt rating.  This write-down totaled $763,000 and isincluded in “Gain (loss) on sale of investment securities” in the ConsolidatedStatements of Income.  In January of2003, the Company sold this corporate debt security for a gain of $20,000.

 

•      The Company recorded a one-timereduction of $220,000 in the “Income tax provision” on the ConsolidatedStatements of Income, which was related to the following change in theCalifornia state tax law.  In Septemberof 2002, the state of California passed a law that impacted the Company’sallowable tax deduction for loan loss reserves.  Under this recently enacted law, the state of California hasconformed to the federal income tax law and the Company is not allowed to usethe reserve method to determine its California tax bad debt deduction fortaxable years beginning on or after January 1, 2002.  This recently enacted law also allows for permanent forgivenessof 50% of the California tax that was related to loan loss reserves thatexisted as of January 1, 2002.  Thepermanent impact of this change in the tax law was recognized in the third quarterof 2002 and resulted in the one-time $220,000 income tax reduction.

 

**RESULTSOF OPERATIONS**

 

#### **Thefollowing table presents condensed statements of income and related performancedata for the periods indicated and the dollar and percentage changes betweenthe periods (in thousands):**

 
|                                            |   |                         |   |              |   |              |   | **Increase  (Decrease)** |   | **Increase  (Decrease)** |   |
|-------------------------------------------------|--------|------------------------------|--------|-------------------|--------|-------------------|--------|--------------------------|--------|--------------------------|--------|
|                                            |   | **Years Ended December 31,** |   | **2002 vs. 2001** |   | **2001 vs. 2000** |   |
|                                            |   | **2002**                     |   | **2001**          |   | **2000**          |   | **$**                    |   | **%**                    |   | **$** |   | **%** | ** ** |
| Net interest income                             |   | $                            | 23,447 |              | $      | 19,109            |   | $                        | 17,979 |                     | $      | 4,338 |   | 22.7 | % | $ | 1,130 |   | 6.3 | % |
| Provision for loan losses                       |   | 471                          |   | 660               |   | 604               |   | (189                     | )      | (28.6                    | %)     | 56 |   | 9.3 | % |
| Non-interest income                             |   | 2,488                        |   | 2,531             |   | 1,713             |   | (43                      | )      | (1.7                     | %)     | 818 |   | 47.8 | % |
| Non-interest expense                            |   | 13,239                       |   | 11,861            |   | 10,046            |   | 1,378                    |   | 11.6                     | %      | 1,815 |   | 18.1 | % |
| Income before income taxes                      |   | 12,225                       |   | 9,119             |   | 9,042             |   | 3,106                    |   | 34.1                     | %      | 77 |   | 0.9 | % |
| Income tax provision                            |   | 4,863                        |   | 3,734             |   | 3,772             |   | 1,129                    |   | 30.2                     | %      | (38 | ) | (1.0 | %) |
| Net income                                      |   | $                            | 7,362  |              | $      | 5,385             |   | $                        | 5,270  |                     | $      | 1,977 |   | 36.7 | % | 115 |   | 2.2 | % |
|                                            |   |                         |   |              |   |              |   |                     |   |                     |   |   |   |   |   |
| Diluted earnings per share (1)                  |   | $                            | 1.37   |              | $      | 1.02              |   | $                        | 1.00   |                     |   |   |   |   |   |   |   |   |
| Cash dividends per share (1)                    |   | $                            | 0.18   |              | $      | 0.16              |   | $                        | 0.14   |                     |   |   |   |   |   |   |   |   |
| Tangible book value per share (1)               |   | $                            | 9.31   |              | $      | 7.85              |   | $                        | 6.74   |                     |   |   |   |   |   |   |   |   |
| Return on average shareholders’ equity (2) |   | 18.18                        | %      | 14.75             | %      | 15.98             | %      |                     |   |                     |   |   |   |   |   |
| Return on average total assets                  |   | 1.32                         | %      | 0.95              | %      | 0.82              | %      |                     |   |                     |   |   |   |   |   |
|                                                 |        |                              |        |                   |        |                   |        |                          |        |                          |        |  |  |  |  |  |  |  |  |  |

#### ** **

----

#### **(1)  All years adjusted to reflect the 2-for-1stock split distributed November 12, 2002.**

(2)  Based on average realizedshareholders’ equity, which excludes average accumulated other comprehensiveincome (loss) from average shareholders’ equity.  Average realized shareholders’ equity was $40,494, $36,508, and$32,979 for 2002, 2001, and 2000, respectively.

 

35

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*2002 COMPARED WITH 2001*

 

#### **EarningsPerformance Summary**

Net income was$7.4 million (or $1.37 per common share on a post-split diluted basis) for theyear ended December 31, 2002, compared to $5.4 million (or $1.02 per commonshare on a post-split diluted basis) for 2001. Pre-tax income was $12.2 million for the year ended December 31, 2002and $9.1 million for 2001.  Thefollowing describes the changes in the major components of pre-tax income forthe year ended December 31, 2002 compared to 2001:

 

•    Net interest income grew by $4.3million, to $23.4 million, primarily due to a $9.6 million decline in interestexpense, which was principally attributable to the Company’s lowering ofinterest rates on its deposits and related deposit run-off.  The decreases in interest rates on theCompany’s deposits resulted from a lower interest rate environment due to thecumulative reduction of 525 basis points, to 1.25%, in the federal funds targetrate by the Federal Reserve during 2002 and 2001.   Partially offsetting the decline in interest expense was a $5.3million drop in interest income, which was primarily due to the calls and salesof the Company’s callable bonds in 2001 and the impact of declining interestrates on the Company’s adjustable rate loans and investments.

 

•    Provision for loan losses decreasedby $189,000, to $471,000, reflecting management’s evaluation of the allowancefor loan losses and the risk inherent in the Company’s loan portfolio.  During the year ended December 31, 2002, theallowance for loan losses increased by $639,000, to $8.6 million, whichreflected the $471,000 provision and net recoveries of $168,000.  During the year ended December 31, 2001, theallowance for loan losses increased by $706,000, to $7.9 million, whichreflected a $660,000 provision and net recoveries of $46,000.  The allowance for loan losses as apercentage of total loans was 1.88% and 1.72% at December 31, 2002 and 2001,respectively.

 

•    Non-interest income decreased by$43,000, to $2.5 million, primarily due to a $858,000 reduction in gain on saleof investment securities, which was attributable to a $763,000 write-down tomarket value on one of the Company’s corporate debt securities.  This was partially offset by an increase of$739,000 in broker fee income, which was attributable to the growth in brokeredSBA 504 loans.

 

•      Non-interest expense grew by $1.4 million,to $13.2 million, primarily due to an increase of $1.7 million in salaries andemployee benefits.  The growth insalaries and employee benefits was principally due to (i) an increase inmarketing commissions attributable to the growth in brokered SBA 504 loans, and(ii) an increase in personnel bonuses, which are partially tied to theCompany’s return on equity performance, attributable to the higher level ofreturn on equity in 2002 compared to 2001.

 

36

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***Average Balances,Interest Income and Expense, Yields and Rates***

 

The following table presents the Company’sconsolidated average balance sheets, together with the total dollar amounts ofinterest income and interest expense and the weighted average interestyields/rates for the periods indicated. All average balances are daily average balances (dollars in thousands):

 
|                                                                |   | **Years Ended December 31,** |       |
|---------------------------------------------------------------------|--------|------------------------------|------------|
|                                                                |   | **2002**                     |       | **2001** |   | **2000** |   |
|                                                                |   |                         |       | **Interest  Income/  Expense** |   | **Average  Yield/  Rate** | ** ** |   |   | **Interest  Income/  Expense** |   | **Average  Yield/  Rate** | ** ** |   |   | **Interest  Income/  Expense** | ** ** | **Average  Yield/  Rate** | ** ** |
|                                                                |   | **Average  Balance**         | ** ** | **Average  Balance** | ** ** | ** ** | **Average  Balance** | ** ** |
|                                                                |   | ** **                   | ** ** |
| **Interest-Earning Assets:**                                        |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1)                                                           |   | $                            | 462,060    |   | $ | 37,405 |   | 8.10 | % | $ |  413,986 |   | $ | 38,091 |   | 9.20 | % | $ | 387,794 |   | $ | 37,182 |   | 9.59 | % |
| Securities purchased under resale agreements                        |   | 10,688                       |       | 171 |   | 1.60 | % | 13,525 |   | 456 |   | 3.37 | % | 2,058 |   | 132 |   | 6.41 | % |
| Investment securities (2):                                          |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. agency securities:                                             |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Callable bonds                                                      |   | —                       |       | — |   | — |   | 74,356 |   | 4,853 |   | 6.53 | % | 243,199 |   | 15,768 |   | 6.48 | % |
| Mortgage-backed securities                                          |   | 68,661                       |       | 3,613 |   | 5.26 | % | 51,187 |   | 2,988 |   | 5.84 | % | 3,898 |   | 274 |   | 7.03 | % |
| Corporate debt securities                                           |   | 3,959                        |       | 153 |   | 3.86 | % | 4,117 |   | 265 |   | 6.44 | % | 4,102 |   | 363 |   | 8.85 | % |
| Total investment securities                                         |   | 72,620                       |       | 3,766 |   | 5.19 | % | 129,660 |   | 8,106 |   | 6.25 | % | 251,199 |   | 16,405 |   | 6.53 | % |
| Total interest-earning assets                                       |   | 545,368                      |       | 41,342 |   | 7.58 | % | 557,171 |   | 46,653 |   | 8.37 | % | 641,051 |   | 53,719 |   | 8.38 | % |
| Investment in FHLB stock                                            |   | 3,990                        |       |   |   |   |   | 584 |   |   |   |   |   | — |   |   |   |   |   |
| Unrealized gain (loss) on investment securities                     |   | 437                          |       |   |   |   |   | (404 | ) |   |   |   |   | (9,692 | ) |   |   |   |   |
| Non-interest-earning assets                                         |   | 15,405                       |       |   |   |   |   | 14,216 |   |   |   |   |   | 17,983 |   |   |   |   |   |
| Allowance for loan losses                                           |   | (8,477                       | )          |   |   |   |   | (7,479 | ) |   |   |   |   | (6,960 | ) |   |   |   |   |
| Total assets                                                        |   | $                            | 556,723    |   |   |   |   |   | $ | 564,088 |   |   |   |   |   | $ | 642,382 |   |   |   |   |   |
|                                                                |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-Bearing Liabilities:**                                   |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Checking accounts                                                   |   | $                            | 15,719     |   | 234 |   | 1.49 | % | $ | 14,816 |   | 403 |   | 2.72 | % | $ | 15,503 |   | 658 |   | 4.24 | % |
| Savings accounts                                                    |   | 132,533                      |       | 2,577 |   | 1.94 | % | 141,436 |   | 4,853 |   | 3.43 | % | 165,778 |   | 8,355 |   | 5.04 | % |
| Certificates of deposit                                             |   | 236,742                      |       | 9,603 |   | 4.06 | % | 283,447 |   | 16,994 |   | 6.00 | % | 313,825 |   | 19,284 |   | 6.14 | % |
| Total deposits                                                      |   | 384,994                      |       | 12,414 |   | 3.22 | % | 439,699 |   | 22,250 |   | 5.06 | % | 495,106 |   | 28,297 |   | 5.72 | % |
| Securities sold under repurchase agreements                         |   | —                       |       | — |   | — |   | 4,015 |   | 216 |   | 5.38 | % | 31,153 |   | 2,022 |   | 6.49 | % |
| State of California borrowings                                      |   | —                       |       | — |   | — |   | 12,688 |   | 609 |   | 4.80 | % | 30,170 |   | 1,805 |   | 5.98 | % |
| FHLB advances                                                       |   | 76,942                       |       | 2,192 |   | 2.85 | % | 5,260 |   | 166 |   | 3.16 | % | — |   | — |   | — |   |
| Term borrowings (3)                                                 |   | 24,904                       |       | 1,672 |   | 6.71 | % | 40,000 |   | 2,686 |   | 6.72 | % | 32,404 |   | 1,999 |   | 6.17 | % |
| Trust preferred securities                                          |   | 17,250                       |       | 1,617 |   | 9.37 | % | 17,250 |   | 1,617 |   | 9.37 | % | 17,250 |   | 1,617 |   | 9.37 | % |
| Total borrowings                                                    |   | 119,096                      |       | 5,481 |   | 4.60 | % | 79,213 |   | 5,294 |   | 6.68 | % | 110,977 |   | 7,443 |   | 6.71 | % |
| Total interest-bearing liabilities                                  |   | 504,090                      |       | 17,895 |   | 3.55 | % | 518,912 |   | 27,544 |   | 5.31 | % | 606,083 |   | 35,740 |   | 5.90 | % |
| Non-interest-bearing liabilities                                    |   | 11,881                       |       |   |   |   |   | 8,929 |   |   |   |   |   | 9,008 |   |   |   |   |   |
| Shareholders’ equity                                           |   | 40,752                       |       |   |   |   |   | 36,247 |   |   |   |   |   | 27,291 |   |   |   |   |   |
| Total liabilities and shareholders’equity                      |   | $                            | 556,723    |   |   |   |   |   | $ | 564,088 |   |   |   |   |   | $ | 642,382 |   |   |   |   |   |
|                                                                |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Excess of interest-earning assets over interest-bearing liabilities |   | $                            | 41,278     |   |   |   |   |   | $ | 38,259 |   |   |   |   |   | $ | 34,968 |   |   |   |   |   |
| Net interest income                                                 |   |                         |       | $ | 23,447 |   |   |   |   |   | $ | 19,109 |   |   |   |   |   | $ | 17,979 |   |   |   |
| Net interest rate spread (4)                                        |   |                         |       |   |   | 4.03 | % |   |   |   |   | 3.06 | % |   |   |   |   | 2.48 | % |
| Net interest margin (5)                                             |   |                         |       |   |   | 4.30 | % |   |   |   |   | 3.43 | % |   |   |   |   | 2.80 | % |

 

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(1)                                  Averagebalances of loans are calculated net of deferred loan fees, but includenon-accrual loans, which have a zero yield.

(2)                                  Averagebalances of investment securities are presented on a historical amortized costbasis.

(3)                                  Interestexpense is calculated based on the applicable interest rate multiplied by theratio of actual days in period to 360 days.

(4)                                  Netinterest rate spread represents the yield earned on average totalinterest-earning assets less the rate paid on average total interest-bearingliabilities.

(5)                                  Netinterest margin is computed by dividing net interest income by average totalinterest-earning assets.

 

37

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***NetChanges in Average Balances, Composition, Yields and Rates***

 

The following table sets forth the composition of averageinterest-earning assets and average interest-bearing liabilities by categoryand by the percentage of each category to the total for the periods indicated,including the change in average balance, composition, and yield/rate betweenthese respective periods (dollars in thousands):

 
|                                                                |   | **Years Ended December 31,** |    |
|---------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                |   | **2002**                     |    | **2001** |   | **Increase (Decrease)** |   |
|                                                                |   |                         |    | **%** |   | **Average** |   |   |   | **%** |   | **Average** |   |   |   | **%** |   | **Average** |   |
|                                                                |   | **Average**                  |    | **of** |   | **Yield/** |   | **Average** |   | **of** |   | **Yield/** |   | **Average** |   | **of** |   | **Yield/** | ** ** |
|                                                                |   | **Balance**                  |    | **Total** |   | **Rate** |   | **Balance** |   | **Total** |   | **Rate** |   | **Balance** |   | **Total** |   | **Rate** | ** ** |
| **Interest-Earning Assets:**                                        |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                                               |   | $                            | 462,060 |   | 84.7 | % | 8.10 | % | $ | 413,986 |   | 74.3 | % | 9.20 | % | $ | 48,074 |   | 10.4 | % | (1.10 | )% |
| Securities purchased under                                          |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| resale agreements                                                   |   | 10,688                       |    | 2.0 | % | 1.60 | % | 13,525 |   | 2.4 | % | 3.37 | % | (2,837 | ) | (0.4 | )% | (1.77 | )% |
| Investment securities:                                              |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. agency securities:                                             |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Callable bonds                                                      |   | —                       |    | — |   | — |   | 74,356 |   | 13.4 | % | 6.53 | % | (74,356 | ) | (13.4 | )% | (6.53 | )% |
| Mortgage-backed securities                                          |   | 68,661                       |    | 12.6 | % | 5.26 | % | 51,187 |   | 9.2 | % | 5.84 | % | 17,474 |   | 3.4 | % | (0.58 | )% |
| Corporate debt securities                                           |   | 3,959                        |    | 0.7 | % | 3.86 | % | 4,117 |   | 0.7 | % | 6.44 | % | (158 | ) | 0.0 | % | (2.58 | )% |
| Total investment securities                                         |   | 72,620                       |    | 13.3 | % | 5.19 | % | 129,660 |   | 23.3 | % | 6.25 | % | (57,040 | ) | (10.0 | )% | (1.06 | )% |
| Total interest-earning assets                                       |   | $                            | 545,368 |   | 100.0 | % | 7.58 | % | $ | 557,171 |   | 100.0 | % | 8.37 | % | $ | (11,803 | ) |   |   | (0.79 | )% |
|                                                                |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-Bearing Liabilities:**                                   |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Checking accounts                                                   |   | $                            | 15,719  |   | 3.1 | % | 1.49 | % | $ | 14,816 |   | 2.8 | % | 2.72 | % | $ | 903 |   | 0.3 | % | (1.23 | )% |
| Savings accounts                                                    |   | 132,533                      |    | 26.3 | % | 1.94 | % | 141,436 |   | 27.3 | % | 3.43 | % | (8,903 | ) | (1.0 | )% | (1.49 | )% |
| Certificates of deposit                                             |   | 236,742                      |    | 47.0 | % | 4.06 | % | 283,447 |   | 54.6 | % | 6.00 | % | (46,705 | ) | (7.6 | )% | (1.94 | )% |
| Total deposits                                                      |   | 384,994                      |    | 76.4 | % | 3.22 | % | 439,699 |   | 84.7 | % | 5.72 | % | (54,705 | ) | (8.3 | )% | (2.50 | )% |
| Securities sold under repurchase agreements                         |   | —                       |    | — |   | — |   | 4,015 |   | 0.8 | % | 5.38 | % | (4,015 | ) | (0.8 | )% | (5.38 | )% |
| State of California borrowings                                      |   | —                       |    | — |   | — |   | 12,688 |   | 2.5 | % | 4.80 | % | (12,688 | ) | (2.5 | )% | (4.80 | )% |
| FHLB advances                                                       |   | 76,942                       |    | 15.3 | % | 2.85 | % | 5,260 |   | 1.0 | % | 3.16 | % | 71,682 |   | 14.3 | % | (0.31 | )% |
| Term borrowings                                                     |   | 24,904                       |    | 4.9 | % | 6.71 | % | 40,000 |   | 7.7 | % | 6.72 | % | (15,096 | ) | (2.8 | )% | (0.01 | )% |
| Trust preferred securities                                          |   | 17,250                       |    | 3.4 | % | 9.37 | % | 17,250 |   | 3.3 | % | 9.37 | % | — |   | 0.1 | % | 0.00 | % |
| Total borrowings                                                    |   | 119,096                      |    | 23.6 | % | 4.60 | % | 79,213 |   | 15.3 | % | 6.68 | % | 39,883 |   | 8.3 | % | (2.08 | )% |
| Total interest-bearing liabilities                                  |   | $                            | 504,090 |   | 100.0 | % | 3.55 | % | $ | 518,912 |   | 100.0 | % | 5.31 | % | $ | (14,822 | ) |   |   | (1.76% | ) |
|                                                                |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Excess of interest-earning assets over interest-bearing liabilities |   | $                            | 41,278  |   |   |   |   |   | $ | 38,259 |   |   |   |   |   | $ | 3,019 |   |   |   |   |   |
| Net interest income                                                 |   |                         |    | $ | 23,447 |   |   |   |   |   | $ | 19,109 |   |   |   |   |   | $ | 17,979 |   |   |   |
| Net interest rate spread                                            |   |                         |    |   |   | 4.03 | % |   |   |   |   | 3.06 | % |   |   |   |   | 0.97 | % |
| Net interest margin                                                 |   |                         |    |   |   | 4.30 | % |   |   |   |   | 3.43 | % |   |   |   |   | 0.87 | % |
|                                                                     |        |                              |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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***Volume and RateVariance Analysis of Net Interest Income***

 

The following table presents the dollaramount of changes in interest income and interest expense due to (i) changes inaverage balances of interest-earning assets and interest-bearing liabilities,as well as (ii) changes in interest rates, for the periods indicated. For eachcategory of interest-earning assets and interest-bearing liabilities,information is provided on changes attributable to:  (i) changes in volume (i.e. changes in average balance multipliedby prior period rate) and (ii) changes in rate (i.e. changes in rate multipliedby prior period average balance). For purposes of this table, changesattributable to both rate and volume which cannot be segregated, have beenallocated proportionately based on the absolute dollar amounts of the changesdue to volume and rate (in thousands):

 
|                              |   | **Years Ended December 31,**                  |   |
|-----------------------------------|--------|-----------------------------------------------|--------|
|                              |   | **2002 vs. 2001  Increase (Decrease) Due To** |   | **2001 vs. 2000  Increase (Decrease) Due To** |   |
|                              |   | **Volume**                                    |   | **Rate** |   | **Total** |   | **Volume** |   | **Rate** |   | **Total** |   |
| **Interest Income:**              |   |                                          |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1)                         |   | $                                             | 4,149  |   | $ | (4,835 | ) | $ | (686 | ) | $ | 2,455 |   | $ | (1,546 | ) | $ | 909 |   |
| Securities purchased under resale |   |                                          |   |   |   |   |   |   |   |   |   |   |   |
| agreements                        |   | (81                                           | )      | (204 | ) | (285 | ) | 414 |   | (90 | ) | 324 |   |
| Investment securities:            |   |                                          |   |   |   |   |   |   |   |   |   |   |   |
| U.S. agency securities:           |   |                                          |   |   |   |   |   |   |   |   |   |   |   |
| Callable bonds                    |   | (4,853                                        | )      | — |   | (4,853 | ) | (11,036 | ) | 121 |   | (10,915 | ) |
| Mortgage-backed securities        |   | 944                                           |   | (319 | ) | 625 |   | 2,768 |   | (54 | ) | 2,714 |   |
| Corporate debt securities         |   | (10                                           | )      | (102 | ) | (112 | ) | 1 |   | (99 | ) | (98 | ) |
| Total investment securities       |   | (3,919                                        | )      | (421 | ) | (4,340 | ) | (8,267 | ) | (32 | ) | (8,299 | ) |
| Total interest income             |   | 149                                           |   | (5,460 | ) | (5,311 | ) | (5,398 | ) | (1,668 | ) | (7,066 | ) |
|                              |   |                                          |   |   |   |   |   |   |   |   |   |   |   |
| **Interest Expense:**             |   |                                          |   |   |   |   |   |   |   |   |   |   |   |
| Checking accounts                 |   | 24                                            |   | (193 | ) | (169 | ) | (28 | ) | (227 | ) | (255 | ) |
| Savings accounts                  |   | (288                                          | )      | (1,988 | ) | (2,276 | ) | (1,103 | ) | (2,399 | ) | (3,502 | ) |
| Certificates of deposit           |   | (2,495                                        | )      | (4,896 | ) | (7,391 | ) | (1,853 | ) | (437 | ) | (2,290 | ) |
| Total deposits                    |   | (2,759                                        | )      | (7,077 | ) | (9,836 | ) | (2,984 | ) | (3,063 | ) | (6,047 | ) |
| Securities sold under repurchase  |   |                                          |   |   |   |   |   |   |   |   |   |   |   |
| agreements                        |   | (216                                          | )      | — |   | (216 | ) | (1,510 | ) | (296 | ) | (1,806 | ) |
| State of California borrowings    |   | (609                                          | )      | — |   | (609 | ) | (892 | ) | (304 | ) | (1,196 | ) |
| FHLB advances                     |   | 2,044                                         |   | (18 | ) | 2,026 |   | 166 |   | — |   | 166 |   |
| Term borrowings                   |   | (1,014                                        | )      | — |   | (1,014 | ) | 499 |   | 188 |   | 687 |   |
| Trust preferred securities        |   | —                                        |   | — |   | — |   | — |   | — |   | — |   |
| Total borrowings                  |   | 205                                           |   | (18 | ) | 187 |   | (1,737 | ) | (412 | ) | (2,149 | ) |
| Total interest expense            |   | (2,554                                        | )      | (7,095 | ) | (9,649 | ) | (4,721 | ) | (3,475 | ) | (8,196 | ) |
| Net interest income               |   | $                                             | 2,703  |   | $ | 1,635 |   | $ | 4,338 |   | $ | (677 | ) | $ | 1,807 |   | $ | 1,130 |   |

 

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(1) Does not include interest income that would have been earned onnon-accrual loans.

 

### ***NetInterest Income***

The Company’s earnings depend primarily onits net interest income, which is the difference between the interest income itearns on its loans and securities (its “interest-earning assets”), and theinterest expense it pays on its deposits and borrowings (its “interest-bearingliabilities”).  Net interest income isaffected by (i) the difference between the interest rate earned on itsinterest-earning assets and the interest rate paid on its interest-bearingliabilities, (ii) the difference between the balance, or volume, of itsinterest-earning assets and the balance, or volume, of its interest-bearingliabilities, and (iii) changes in the composition of interest-earning assetsand interest-bearing liabilities, for example, if higher yielding loans were toreplace lower yielding securities.

 

39

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On an overallbasis, net interest income grew by $4.3 million, to $23.4 million, during theyear ended December 31, 2002 compared to 2001, primarily due to a $9.6 milliondecline in interest expense, which was principally attributable to theCompany’s lowering of interest rates on its deposits and related depositrun-off.  The decreases in interestrates on the Company’s deposits resulted from a lower interest rate environmentdue to the reduction of 475 basis points, to 1.75%, in the federal funds targetrate by the Federal Reserve in 2001, as well as the reduction of 50 basispoints, to 1.25%, in 2002.  Partiallyoffsetting the decline in interest expense was a $5.3 million drop in interestincome, which was primarily due to the calls and sales of the Company’scallable bonds in 2001 and the impact of declining interest rates on theCompany’s loans and investments.

 

On a volumeand rate analysis basis, the $4.3 million growth in net interest income was dueto increases of $2.7 million and $1.6 million attributable to changes in volumeand interest rates, respectively.  The$2.7 million increase attributable to changes in volume was principally due toincreases in interest income of $4.1 million and $0.9 million attributable togrowth in loans and mortgage-backed securities, respectively, and decreases ininterest expense of $2.8 million and $1.8 million resulting from depositrun-off and pay-offs of non-FHLB borrowings, respectively. Partially offsettingthese factors was a $4.9 million reduction in interest income attributable tothe calls and sales of the Company’s callable bonds, as well as a $2.0 millionincrease in interest expense resulting from the growth in FHLB advances.

 

During 2002,the Company used lower rate FHLB advances, both short-term and long-term,primarily to fund the run-off of higher rate certificates of deposit, thematurities of higher rate term borrowings, and the purchases of higher ratemortgage-backed securities.  This helpedto lower the Company’s cost of funds and increase its net interest income.

 

The $1.6million increase in net interest income attributable to changes in interestrates was primarily attributable to a $7.1 million decrease in interest expenseresulting from the Company’s lowering of the interest rates on its deposits.  This factor was partially offset by a $4.8million decrease in interest income on loans, which resulted from the downwardrepricing of the Company’s adjustable rate loans and the weighted averageinterest rate on loan payoffs exceeding the weighted average interest rate onloan originations.  All of these factorsresulted from a lower interest rate environment attributable to the cumulative525 basis point reduction, to 1.25%, in the federal funds target rate by theFederal Reserve during 2002 and 2001.

 

The impact ofthe federal funds rate decreases in 2002 and 2001 caused downward repricing onthe Company’s adjustable rate loans. The federal funds rate is the rate at which banks lend to each other inthe overnight market.  Reductions in thefederal funds target rate generally result in reductions of the prime ratesoffered by major banks, including Bank of America.  The Company’s prime rate loans are priced at a margin aboveeither Bank of America’s prime lending rate or the published *Wall StreetJournal* prime lending rate. As of December 31, 2002 and 2001, 85.4% and 84.2% of the Company’s loanportfolio consisted of adjustable rate loans, respectively.  See Item 7A. “Quantitative and QualitativeDisclosures About Market Risk” for information regarding the breakdown of theCompany’s loan portfolio by index as of December 31, 2002 and 2001.

 

The downwardrepricing of the Company’s adjustable rate loans was partially offset by theimpact of the interest rate floors that exist on most of the Company’s adjustablerate loans.  Interest rate floorsprotect the Company in a declining interest rate environment, as affected loansdo not reprice downward to their fully indexed rate when interest rates fall.  Another offsetting factor was that theCompany’s adjustable rate loans generally can reprice only up to a maximum of200 basis points in a year.

 

The netinterest rate spread grew by 97 basis points, to 4.03%, during the year endedDecember 31, 2002, compared to 2001. This was primarily due to a decrease of 176 basis points, to 3.55%, inthe rate paid on average total interest-bearing liabilities, partially offsetby a decrease of 79 basis points, to 7.58%, in the yield earned on averagetotal interest-earning assets.  Thedecrease in the rate paid on average total interest-bearing liabilities wasprincipally attributable to the previously mentioned lowering by the Company ofthe interest rates on its deposits, partially offset by a change in thecomposition of average total interest-bearing liabilities to higher rateborrowings from lower rate deposits. The decrease in the yield earned on average total interest-earningassets was primarily due to a decline in the yield on loans, partially offsetby a change in the composition of average total interest-earning assets tohigher yield loans from lower yield investment securities, which resultedprincipally from the calls and sales of the callable bonds.

 

40

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***Total**Interest Income***

 

On an overallbasis, total interest income decreased by $5.3 million, to $41.3 million,during the year ended December 31, 2002 compared to 2001, primarily due to thecalls and sales of the Company’s callable bonds.  On a volume and rate analysis basis, the decrease in interestincome was primarily due to a decline in the yield earned on average totalinterest-earning assets, which decreased interest income by $5.4 million.

 

Average totalinterest-earning assets declined by $11.8 million, to $545.4 million, during2002 compared to 2001, and was principally due to a reduction in averagecallable bonds of $74.4 million, partially offset by increases of $48.1 millionand $17.5 million in average loans and average mortgage-backed securities,respectively.  The changes in averageinvestment securities and average loans resulted in a shift in the mix ofaverage total interest-earning assets to higher yield loans from lower yieldinvestment securities.  The percentageof average loans to average total interest-earning assets increased to 84.7%during the year ended December 31, 2002 from 74.3% during 2001.

 

The reductionin average callable bonds of $74.4 million, to zero, was due to the liquidationof the Company’s fixed rate callable bond portfolio during the first ninemonths of 2001.  The liquidationoccurred primarily through issuer calls of $219.2 million, as well as Companysales of $10.0 million.  The issuercalls were attributable to the declining interest rate environment caused bythe Federal Reserve’s 350 basis point lowering of the federal funds target rateduring the first nine months of 2001.

 

The increasein average mortgage-backed securities of $17.5 million, to $68.7 million, wasprimarily due to fixed rate purchases of $25.5 million, in March of 2002, aswell as $22.2 million in late July and August of 2002, partially offset byprincipal payments received on these securities.

 

The yieldearned on average total interest-earning assets decreased by 79 basis points,to 7.58%, during the year ended December 31, 2002 compared to  2001, primarily due to the followingdecreases in yields attributable to the declining interest rate environmentduring 2002 and 2001:

 

•      The yield on average loans declined by 110basis points, to 8.10%, primarily due to the downward repricing of theCompany’s adjustable rate loans and the weighted average interest rate on loanpayoffs exceeding the weighted average interest rate on loan originations.

 

•      The yield on average short-term securitiespurchased under resale agreements decreased by 177 basis points, to 1.60%.

 

•      The yield on average fixed ratemortgage-backed securities dropped by 58 basis points, to 5.26%, primarily dueto a slightly faster acceleration in the amortization of the premiums paid onthe mortgage-backed securities, which was attributable to an increase in thepayoffs of the underlying mortgage loans.

 

•      The yield on average adjustable ratecorporate debt securities declined by 258 basis points, to 3.86%, reflectingthe downward repricing of these adjustable rate instruments.

 

Partiallyoffsetting the decline in the yield earned on average total interest-earningassets was the change in the composition of average total interest-earningassets to higher yield loans from lower yield investment securities.

 

 

***Total InterestExpense***

 

On an overallbasis, total interest expense decreased by $9.6 million, to $17.9 million,during the year ended December 31, 2002 compared to 2001, primarily due to theCompany’s lowering of interest rates on its deposits and the related depositrun-off.  On a volume and rate analysisbasis, the decrease in interest expense was due to a decline in the rate paidon average interest-bearing liabilities, which decreased interest expense by$7.1 million, as well as to a reduction in the balance of these liabilities,which reduced interest expense by $2.5 million.

 

41

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Average totalinterest-bearing liabilities declined by $14.8 million, to $504.1 million,during 2002 compared to 2001, and was primarily due to a decrease of $54.7 millionin average deposits, partially offset by an increase of $39.9 million inaverage borrowings.   The changes inaverage deposits and average borrowings resulted in a change in the compositionof average total interest-bearing liabilities to higher rate borrowings fromlower rate deposits.  The percentage ofaverage borrowings to average total interest-bearing liabilities increased to23.6% during the year ended December 31, 2002 from 15.3% during 2001.

 

The decline inaverage deposits of $54.7 million, to $385.2 million, during the year endedDecember 31, 2002 compared to 2001, was principally due to reductions of $46.7million and $8.9 million in average certificates of deposit and average savingsaccounts, respectively.  These decreaseswere primarily attributable to the Company’s lowering of interest rates on allof its deposit products in response to the lower interest rate environmentresulting from the cumulative 525 basis point reduction in the federal fundstarget rate by the Federal Reserve during 2002 and 2001.

 

The changes inthe average balances of the Company’s deposit products resulted in a shift inthe composition of average deposits to lower rate checking and savings accountsfrom higher rate certificates of deposit. This reflected the Company’s currentstrategy and efforts to help reduce the overall cost of its deposits. Thepercentage of average checking and savings accounts to average deposits rose to38.5% during the year ended December 31, 2002, from 35.5% during 2001.

 

The growth inaverage borrowings of $39.9 million, to $119.1 million, during 2002 compared to2001, was principally due to an increase of $71.7 million in average FHLBadvances.  This was comprised of $62.4million of average long-term advances and $9.3 million of average short-termadvances.  The Company started usinglong-term, fixed rate FHLB advances in November of 2001 and started usingshort-term, variable rate advances in April of 2002.  The increase in FHLB advances was partially offset by decreasesof $12.7 million and $4.0 million in short-term average State of Californiaborrowings and average securities sold under repurchase agreements,respectively, as well as a decrease of $15.1 million in average termborrowings.  The short-term borrowingsmatured at various times during 2001 and were paid off by the Company primarilyusing the proceeds from the calls and sales of the callable bonds.  The average term borrowings declined due tomaturities of $10.0 million, $20.0 million, and $10.0 million in April,September, and October of 2002.

 

The changes inthe average balances of the Company’s borrowing facilities resulted in a shiftin the composition of average borrowings to lower rate FHLB advances fromhigher rate non-FHLB borrowings.  Thisreflected the Company’s strategy in using the FHLB’s low cost credit facilityprimarily for fixed rate advances with 12-36 month terms to insulate theCompany from potentially higher interest rates in 2003, 2004, and 2005.  The percentage of average FHLB advances toaverage borrowings rose to 64.6% during 2002 from 6.64% in 2001.

 

The rate onaverage total interest-bearing liabilities decreased by 176 basis points, to3.55%, during the year ended December 31, 2002 compared to 2001, and wasprincipally due to the reduction of 250 basis points, to 3.22%, in the rate onaverage deposits, as well as the reduction of 208 basis points, to 4.60%, inthe rate on average borrowings. Partially offsetting these factors was the change in the composition ofaverage total interest-bearing liabilities to higher rate borrowings, with aweighted average rate of 4.60%, from lower rate deposits, with a weightedaverage rate of 3.22%.

 

The 250 basis point decline in the rate on average deposits reflectedthe Company’s lowering of interest rates on its deposit products, whichresulted in reductions of 123 basis points, 149 basis points, and 194 basispoints in the rates on average checking accounts, average savings accounts, andaverage certificates of deposit, respectively. Contributing to the decrease in the rate on average deposits was thepreviously mentioned change in the composition of average deposits to lowerrate checking and savings accounts from higher rate certificates of deposit.

 

The 208 basispoint decrease in the rate on average borrowings was primarily due to thepreviously mentioned change in the composition of average borrowings resultingfrom (i) the payoffs and maturities during 2001 of short-term securities soldunder repurchase agreements and State of California borrowings, bearing higheraverage rates of 5.38% and 4.80%, respectively, for the year ended December 31,2001, and (ii) the addition of FHLB advances, bearing a lower weighted averagerate of 2.85%, for the year ended December 31, 2002.  The 2.85% was comprised of 2.99% for long-term FHLB advances and1.85% for short-term FHLB advances.

 

42

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**Provision for Loan Losses**

 

During 2002, the Company decreased itsprovision for loan losses by $189,000, to $471,000, compared to 2001.  The Company uses the provision for loanlosses to establish the allowance for loan losses based on management’sevaluation of the risk inherent in the loan portfolio.  See “Financial Condition - Allowance forLoan Losses” and Item 1. “Business - Allowance for Loan Losses.”

 

Although the Company maintains its allowancefor loan losses at a level which it considers to be adequate to provide forpotential losses, there can be no assurance that any actual losses will notexceed the estimated amounts, thereby adversely affecting future results ofoperations. The calculation of the adequacy of the allowance for loan losses isbased on a variety of factors, including adequacy of collateral, which includesan evaluation of loan balance to collateral value, loan debt service coverageratio and secondary collateral, if applicable. In addition, management evaluates the following factors: currentdelinquency trends, historical Company loan loss experience, regional realestate economic conditions and overall economic trends impacting the Company’sreal estate lending portfolio.

 

#### **Non-interestIncome**

 

The following table reflects the majorcomponents of non-interest income for the periods indicated and the dollar andpercentage changes between the periods (dollars in thousands):

 
|                                                 |   |                         |   |              |   |              |   | **Increase (Decrease)** |   |
|------------------------------------------------------|--------|------------------------------|--------|-------------------|--------|-------------------|--------|-------------------------|--------|
|                                                 |   | **Years Ended December 31,** |   | **2002 vs. 2001** |   | **2001 vs. 2000** |   |
|                                                 |   | **2002**                     |   | **2001**          |   | **2000**          |   | **$**                   |   | **%** |   | **$** |   | **%** | ** ** |
| Loan prepayment and late fee income                  |   | $                            | 822    |              | $      | 345               |   | $                       | 346    |   | $ | 477 |   | 138.3 | % | $ | (1 | ) | (0.3 | )% |
| Gain on sale of SBA 7(a) loans                       |   | 221                          |   | 395               |   | 112               |   | (174                    | )      |  44.1 | )% | 283 |   | 252.7 | % |
| Gain on sale of SBA 504 loans and broker fee income: |   |                         |   |              |   |              |   |                    |   |   |   |   |   |   |   |
| Gain on sale of SBA 504 loans                        |   | 203                          |   | 244               |   | —            |   | (41                     | )      | (16.8 | )% | 244 |   | 100.0 | % |
| Broker fee income                                    |   | 998                          |   | 259               |   | —            |   | 739                     |   | 285.3 | % | 259 |   | 100.0 | % |
| Total                                                |   | 1,201                        |   | 503               |   | —            |   | 698                     |   | 138.8 | % | 503 |   | 100.0 | % |
| Gain (loss) on sale of investment securities         |   | (763                         | )      | 95                |   | (2                | )      | (858                    | )      | (903.2 | )% | 97 |   | (4850.0% | ) |
| Gain on sale of income property loans                |   | —                       |   | —            |   | 561               |   | —                  |   | — |   | (561 | ) | (100.0% | ) |
| Gain on sale of other real estate owned              |   | —                       |   | —            |   | 115               |   | —                  |   | — |   | (115 | ) | (100.0% | ) |
| Other income                                         |   | 1,007                        |   | 1,193             |   | 581               |   | (186                    | )      | (15.6 | )% | 612 |   | 105.3 | % |
| Total non-interest income                            |   | $                            | 2,488  |              | $      | 2,531             |   | $                       | 1,713  |   | $ | (43 | ) | (1.7 | )% | $ | 818 |   | 47.8 | % |

 

Non-interestincome for the year ended December 31, 2002 declined by $43,000, to $2.5million, compared to 2001.  This wasprimarily due to an $858,000 reduction in gain on sale of investmentsecurities, as well as decreases of $186,000 and $174,000 in other income andgain on sale of SBA 7(a) loans, respectively.  These factors were partially offset by increases of $739,000 and$477,000 in broker fee income and loan prepayment and late fee income,respectively.

 

The $858,000reduction in gain on sale of investment securities was due to a $763,000write-down to market value on one of the Company’s corporate debt securities inorder to reflect an other than temporary decline in the market value of thatsecurity.  The write-down was based on avariety of factors, including a rating agency downgrade of the security’s debtrating.  In January of 2003, the Companysold this corporate debt security for a gain of $20,000.

 

The $186,000decrease in other income was primarily due a reduction of $186,000 in interestincome that the Company recorded in connection with a favorable IRS ruling thatthe Company received on an income tax refund claim.   The Company accrued $300,000 of such interest during the fourthquarter of 2001 and recorded $114,000 during the first quarter of 2002.   Contributing to the reduction in otherincome was a decline in loan origination fees attributable to the 21% drop inloan originations from $129.2 million in 2001 to $102.3 million in 2002.   Partially offsetting these factors was$153,000 of dividend income that the Company recorded on its investment in FHLBstock during 2002.

 

43

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The $174,000decrease in gain on sale of SBA 7(a) loans was due to reduced loan sales by theCompany in 2002.  The Company bases itsSBA 7(a) loan sales on the level of SBA 7(a) loan originations, the premiumsavailable in the secondary market for the sale of such loans, and generalliquidity considerations of the Company.

 

The $739,000increase in broker fee income was attributable to the growth in brokered SBA504 loans.

 

The $477,000rise in loan prepayment and late fee income reflected higher prepayment feesattributable to a lower interest rate environment and a resulting greateramount of loan payoffs.   Such payoffsgrew by 83.7%, to $107.2 million during 2002 compared to 2001.

 

#### **Non-interestExpense**

 

The following table reflects the majorcomponents of non-interest expense for the periods indicated and the dollar andpercentage changes between the periods (dollars in thousands):

 
|                                      |   |                         |   |              |   |              |   | **Increase (Decrease)** |   |
|-------------------------------------------|--------|------------------------------|--------|-------------------|--------|-------------------|--------|-------------------------|--------|
|                                      |   | **Years Ended December 31,** |   | **2002 vs. 2001** |   | **2001 vs. 2000** |   |
|                                      |   | **2002**                     |   | **2001**          |   | **2000**          |   | **$**                   |   | **%** |   | **$** |   | **%** |   |
| Salaries and employee benefits            |   | $                            | 8,787  |              | $      | 7,152             |   | $                       | 6,407  |   | $ | 1,635 |   | 22.9 | % | $ | 745 |   | 11.6 | % |
| Net occupancy expense                     |   | 1,796                        |   | 1,665             |   | 1,422             |   | 131                     |   |   | % | 243 |   | 17.1 | % |
| Communication and data processing         |   | 1,020                        |   | 1,057             |   | 880               |   | (37                     | )      | (3.5 | )% | 177 |   | 20.1 | % |
| Legal, audit, and other professional fees |   | 525                          |   | 986               |   | 563               |   | (461                    | )      | (46.8 | )% | 423 |   | 75.1 | % |
| Travel and entertainment                  |   | 491                          |   | 457               |   | 352               |   | 34                      |   | 7.4 | % | 105 |   | 29.8 | % |
| Credit and collection expenses            |   | 26                           |   | —            |   | (134              | )      | 26                      |   | 100.0 | % | 134 |   | 100.0 | % |
| OREO expense                              |   | —                       |   | —            |   | (10               | )      | —                  |   | — |   | 10 |   | 100.0 | % |
| Other expenses                            |   | 594                          |   | 544               |   | 566               |   | 50                      |   | 9.2 | % | (22 | ) | (3.9 | )% |
| Total non-interest expense                |   | $                            | 13,239 |              | $      | 11,861            |   | $                       | 10,046 |   | $ | 1,378 |   | 11.6 | % | $ | 1,815 |   | 18.1 | % |

 

Non-interest expense for the year ended December 31, 2002 grew by $1.4million, to $13.2 million, compared to 2001. This was primarily due to increases of $1.7 million and $131,000 insalaries and employee benefits and net occupancy expenses, respectively,partially offset by a reduction of $461,000 in legal, audit, and otherprofessional fees.

 

The $1.7 million increase in salaries and employee benefits wasprimarily due to the following factors:

 

•      Marketingcommissions increased due to the growth in brokered SBA 504 loans.

•      Personnelbonuses, which are partially tied to the Company’s return on equityperformance, increased due to the higher level of return on equity achievedduring 2002 compared to 2001.

•      InJanuary of 2002, employee base salaries increased by approximately 4%.

•      The Company expanded the staffing level ofits SBA lending program.  The averagenumber of full-time employees increased by three for  2002 compared to 2001.

 

The $131,000 increase in net occupancy expenses was primarily due to acost of approximately $110,000 related to a defalcation at one of the Company’sbranches.

 

The $461,000 reduction in legal, audit, and other professional fees wasprimarily due to (i) a $350,000 accrual taken during the fourth quarter of 2001for estimated expenses relating to obtaining a favorable ruling on an IRSincome tax refund claim, and settling a legal claim brought against the Bank,and (ii) the $175,000 reversal in the first quarter of 2002 of a portion ofsuch expenses.

#### ** **

44

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*2001 COMPARED WITH 2000*

 

#### **EarningsPerformance Summary**

Net income was $5.4 million (or $2.03 per common share on a dilutedbasis) for the year ended December 31, 2001, compared to $5.3 million (or $2.01per common share on a diluted basis) for the year ended December 31, 2000.  Pre-tax income was $9.1 million compared to$9.0 million for the years ended December 31, 2001 and 2000, respectively.  The following describes the changes in themajor components of pre-tax income:

 

•      Net interest income increased by $1.1million, to $19.1 million, primarily due to a decrease in interest expense,which was attributable to the Company’s lowering of interest rates on itsdeposits, related deposit run-off, the reduction of interest rates on theCompany’s borrowing facilities, and the pay-down of short-term borrowings.  Partially offsetting the decrease ininterest expense was a decline in interest income, which was primarily due tothe $229.2 million liquidation of the entire portfolio of the Company’s fixedrate U.S. government sponsored agency callable bonds (the “callablebonds”).  The liquidation occurredprincipally through issuer calls of $219.2 million, as well as Company sales of$10.0 million.  The decrease in interestrates on the Company’s deposits and borrowings and the calls of the Company’sfixed rate callable bonds, resulted from a lower interest rate environment dueto the Federal Reserve’s 475 basis point reduction in the federal funds targetrate during 2001.

 

•      Provision for loan losses increased by$56,000, to $660,00, reflecting management’s evaluation of the allowance forloan losses and the risk inherent in the Company’s loan portfolio.  During 2001, the allowance for loan lossesincreased by $706,000, to $7.9 million, which reflected the $660,000 provisionand net recoveries of $46,000.  During2000, the allowance for loan losses increased by $790,000, to $7.2 million,which reflected a $604,000 provision and net recoveries of $186,000.

 

•      Non-interest income increased by $818,000,to $2.5 million, primarily due to $503,000 in gain on sale of SBA 504 loans andbroker fee income, which were new programs for the Company in 2001, and a$283,000 increase in the gain on sale of SBA 7(a) loans.  Also contributing to the increase innon-interest income was $300,000 of interest income that the Company recordedin connection with a favorable IRS ruling received during the fourth quarter of2001 on its income tax refund claim of approximately $800,000.  Partially offsetting these factors weregains in 2000 of $561,000 and $115,000 on the sale of an income property loanand an OREO, respectively, which were not repeated in 2001.

 

•      Non-interest expense increased by $1.8million, to $11.9 million, primarily due to increases of $745,000, $423,000,and $243,000 in salaries and employee benefits; legal, audit, and otherprofessional fees; and net occupancy expenses, respectively.  The increase in salaries and employee benefitswas primarily attributable to (i) the impact of a full year of expenses fornine full-time employees hired during the last seven months of 2000 in order toestablish and expand the Company’s SBA lending program in San Diego, and (ii)the hiring of eight full-time employees during 2001 in order to further expandthe Company’s SBA lending program.  Theincrease in legal, audit, and other professional fees was primarily due to$350,000 of expenses recorded in connection with obtaining the above mentionedfavorable ruling on the Company’s IRS income tax refund claim and settling aclaim brought against the Bank in which the plaintiff alleged that he deposited$50,000 with the Bank in 1984 and that the principal and accrued interest werenever returned.  Also contributing tothe increase in legal, audit, and other professional fees was the outsourcingof the Company’s internal audit function, which replaced the Company’s in-houseinternal audit department.

 

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***Net Changes in Average Balances, Composition,Yields and Rates***

 

The following table sets forth the composition of averageinterest-earning assets and average interest-bearing liabilities by categoryand by the percentage of each category to the total for the periods indicated,including the change in average balance, composition, and yield/rate betweenthese respective periods (dollars in thousands):

 
|                                                                |   | **Years Ended December 31,** |       |
|---------------------------------------------------------------------|--------|------------------------------|------------|
|                                                                |   | **2001**                     |       | **2000** |   | **Increase (Decrease)** |   |
|                                                                |   |                         |       | **%****of  Total** |   | **Average  Yield/  Rate** |   | **Average  Balance** |   | **%****of  Total** |   | **Average  Yield/  Rate** |   | **Average  Balance** |   | **%****of  Total** |   | **Average  Yield/  Rate** |   |
|                                                                |   | **Average  Balance**         |       |   |   |   |   |   |   |   |   |
|                                                                |   | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest-Earning Assets:**                                        |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                                               |   | $                            | 413,986    |   | 74.3 | % | 9.20 | % | $ | 387,794 |   | 60.5 | % | 9.59 | % | $ | 26,192 |   | 13.8 | % | (0.39 | )% |
| Securities purchased under resale agreements                        |   | 13,525                       |       | 2.4 | % | 3.37 | % | 2,058 |   | 0.3 | % | 6.41 | % | 11,467 |   | 2.1 | % | (3.04 | )% |
| Investment securities:                                              |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. agency securities:                                             |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Callable bonds                                                      |   | 74,356                       |       | 13.4 | % | 6.53 | % | 243,199 |   | 37.9 | % | 6.48 | % | (168,843 | ) | (24.5% | ) | 0.05 | % |
| Mortgage-backed securities                                          |   | 51,187                       |       | 9.2 | % | 5.84 | % | 3,898 |   | 0.6 | % | 7.03 | % | 47,289 |   | 8.6 | % | (1.19 | )% |
| Corporate debt securities                                           |   | 4,117                        |       | 0.7 | % | 6.44 | % | 4,102 |   | 0.7 | % | 8.85 | % | 15 |   | 0.0 | % | (2.41 | )% |
| Total investment securities                                         |   | 129,660                      |       | 23.3 | % | 6.25 | % | 251,199 |   | 39.2 | % | 6.53 | % | (121,539 | ) | (15.9 | )% | (0.28 | )% |
| Total interest-earning assets                                       |   | $                            | 557,171    |   | 100.0 | % | 8.37 | % | $ | 641,051 |   | 100.0 | % | 8.38 | % | $ | (83,880 | ) |   |   | (0.01 | )% |
|                                                                |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-Bearing Liabilities:**                                   |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Checking accounts                                                   |   | $                            | 14,816     |   | 2.8 | % | 2.72 | % | $ | 15,503 |   | 2.6 | % | 4.24 | % | $ | (687 | ) | 0.2 | % | (1.52 | )% |
| Savings accounts                                                    |   | 141,436                      |       | 27.3 | % | 3.43 | % | 165,778 |   | 27.3 | % | 5.04 | % | (24,342 | ) | 0.0 | % | (1.61 | )% |
| Certificates of deposit                                             |   | 283,447                      |       | 54.6 | % | 6.00 | % | 313,825 |   | 51.8 | % | 6.14 | % | (30,378 | ) | 2.8 | % | (0.14 | )% |
| Total deposits                                                      |   | 439,699                      |       | 84.7 | % | 5.06 | % | 495,106 |   | 81.7 | % | 5.72 | % | (55,407 | ) | 3.0 | % | (0.66 | )% |
| Securities sold under repurchase agreements                         |   | 4,015                        |       | 0.8 | % | 5.38 | % | 31,153 |   | 5.1 | % | 6.49 | % | (27,138 | ) | (4.3% | ) | (1.11 | )% |
| State of California borrowings                                      |   | 12,688                       |       | 2.5 | % | 4.80 | % | 30,170 |   | 5.0 | % | 5.98 | % | (17,482 | ) | (2.5% | ) | (1.18 | )% |
| FHLB advances                                                       |   | 5,260                        |       | 1.0 | % | 3.16 | % | — |   | — |   | — |   | 5,260 |   | 1.0 | % | 3.16 | % |
| Term borrowings                                                     |   | 40,000                       |       | 7.7 | % | 6.72 | % | 32,404 |   | 5.4 | % | 6.17 | % | 7,596 |   | 2.3 | % | 0.55 | % |
| Trust preferred securities                                          |   | 17,250                       |       | 3.3 | % | 9.37 | % | 17,250 |   | 2.8 | % | 9.37 | % | — |   | 0.5 | % | 0.00 | % |
| Total borrowings                                                    |   | 79,213                       |       | 15.3 | % | 6.68 | % | 110,977 |   | 18.3 | % | 6.71 | % | (31,764 | ) | (3.0% | ) | (0.03 | )% |
| Total interest-bearing liabilities                                  |   | $                            | 518,912    |   | 100.0 | % | 5.31 | % | $ | 606,083 |   | 100.0 | % | 5.90 | % | $ | (87,171 | ) |   |   | (0.59 | )% |
|                                                                |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Excess of interest-earning assets over interest-bearing liabilities |   | $                            | 38,259     |   |   |   |   |   | $ | 34,968 |   |   |   |   |   | $ | 3,291 |   |   |   |   |   |
| Net interest rate spread                                            |   |                         |       |   |   | 3.06 | % |   |   |   |   | 2.48 | % |   |   |   |   | 0.58 | % |
| Net interest margin                                                 |   |                         |       |   |   | 3.43 | % |   |   |   |   | 2.80 | % |   |   |   |   | 0.63 | % |

 

46

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**Net Interest Income**

 

Net interest income grew by $1.1 million to$19.1 million, during the year ended December 31, 2001 compared to the sameperiod in 2000, primarily due to a $1.8 million increase attributable tochanges in interest rates. This was principally due to a decrease in interestexpense resulting from the Company’s lowering of the interest rates on itsdeposits, as well as the reduction of interest rates on its borrowingfacilities.  These factors werepartially offset by a decrease in interest income on loans resulting from thedownward repricing of the Company’s adjustable rate loans and the weightedaverage interest rate on loan payoffs exceeding the weighted average interestrate on loan originations.  All of thesefactors resulted from a lower interest rate environment attributable to theFederal Reserve’s 475 basis point reduction in the federal funds target rate, to1.75%, during 2001.

 

Partiallyoffsetting the above $1.8 million growth in net interest income attributable tochanges in interest rates, was a $677,000 decrease attributable to changes involume.  This was primarily due to areduction in interest income resulting from the calls and sales of theCompany’s callable bonds. Partially offsetting this factor was (i) an increasein interest income due to loan growth and the purchases of U.S. governmentsponsored agency mortgage-backed securities (the “mortgage-backed securities”),and (ii) a reduction of interest expense resulting from deposit run-off and thepay-down of short-term borrowings. The funding for the loan growth,mortgage-backed securities purchases, deposits outflows, and borrowingspay-downs was obtained principally from the proceeds of the calls and sales ofcallable bonds.

 

The netinterest rate spread grew by 58 basis points, to 3.06%, during the year endedDecember 31, 2001, compared to the same period in 2000.  This was primarily due to a decrease of 59basis points, to 5.31%, in the rate paid on average total interest-bearingliabilities, partially offset by a decrease of one basis point, to 8.37%, inthe yield earned on average total interest-earning assets.  The decrease in the rate paid on averagetotal interest-bearing liabilities was principally attributable to the abovementioned lowering by the Company of the interest rates on its deposits and thereduction in rates on the Company’s short-term borrowing facilities.  The decrease in the yield earned on averagetotal interest-earning assets was primarily due to a decline in the yield onloans, partially offset by a change in the composition of average totalinterest-earning assets to higher yield loans from lower yield investmentsecurities, which resulted primarily from the calls and sales of callablebonds.

 

# ***TotalInterest Income***

 

Total interestincome decreased by $7.1 million, to $46.7 million, during the year endedDecember 31, 2001 compared to the same period in 2000.  This was primarily due to a reduction inaverage total interest-earning assets, which decreased interest income by $5.4million, as well as to a decline in yield earned on these assets, whichdecreased interest income by $1.7 million.

 

Average totalinterest-earning assets declined by $83.9 million, to $557.2 million, during2001 compared to 2000, principally due to a reduction in average callable bondsof $168.8 million, partially offset by increases of $47.3 million, $26.2million, and $11.5 million in average mortgage-backed securities, averageloans, and average securities purchased under resale agreements,respectively.  The changes in averageinvestment securities and average loans resulted in a shift in the mix ofaverage total interest-earning assets to higher yield loans from lower yieldinvestment securities.  The percentageof average loans to average total interest-earning assets increased to 74.3%during the year ended December 31, 2001 from 60.5% during the same period in2000.

 

The reductionin average callable bonds of $168.8 million, to $74.4 million, was due to callsand sales of $229.2 million with a weighted average yield of 6.42%, whichoccurred during the first nine months of 2001. This was comprised of issuer calls of $219.2 million, with a weighted averageyield of 6.46%, and sales in January of 2001 of $10.0 million, with a weightedaverage yield of 5.63%.  The issuercalls of these fixed rate securities were attributable to the declininginterest rate environment caused by the Federal Reserve’s lowering of thefederal funds target rate during 2001.

 

47

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The increasein average mortgage-backed securities of $47.3 million, to $51.2 million, wasprimarily due to fixed rate purchases of $108.0 million, which occurred duringthe seven-month period from February to August of 2001, partially offset bysales in May and August of 2001 totaling $42.4 million.  The purchases made in the first quarter of2001 were funded primarily with the proceeds from the calls and sale of thecallable bonds and enabled the Bank to meet the FHLB membership test forhousing-related assets in its successful application for membership in theFHLB.

 

The increasein average securities purchased under resale agreements of $11.5 million, to$13.5 million, was primarily due to the investment of the proceeds from (1) thecalls and sales of callable bonds during the first nine months of 2001, and (2)the $40.0 million long-term FHLB advances during the fourth quarter of 2001.

 

The yieldearned on average total interest-earning assets decreased by one basis point,to 8.37%, during the year ended December 31, 2001 compared to the same periodin 2000, primarily due to the following decreases in yields attributable to thedeclining interest rate environment during 2001:

 

•      The yield on average loans declined by 39basis points, to 9.20%, primarily due to the downward repricing of theCompany’s adjustable rate loans and the weighted average interest rate on loanpayoffs exceeding the weighted average interest rate on loan originations.  Partially offsetting the decline in theyield on average loans was the impact of interest rate floors that exist onmost of the Company’s adjustable rate loans. Interest rate floors protect the Company in a declining interest rateenvironment, as affected loans do not reprice downward to their fully indexedrate when interest rates fall.  Anothercontributing factor was that even though the federal funds target rate dropped475 basis points during 2001, the Company’s adjustable rate loans generally canreprice only up to a maximum of 200 basis points in a year.

 

•      The yield on average short-term securitiespurchased under resale agreements decreased by 304 basis points, to 3.37%.

 

•      The yield on average fixed rate mortgage-backedsecurities dropped by 119 basis points, to 5.84%, primarily due to the loweryield purchases made during the lower interest rate environment of 2001 withthe proceeds from the calls and sales of callable bonds.

 

•      The yield on average adjustable ratecorporate debt securities declined by 241 basis points, to 6.44%, reflectingthe downward repricing of these variable rate instruments.

 

Partiallyoffsetting the decline in the yield earned on average total interest-earningassets was the change in the composition of average total interest-earningassets to higher yield loans from lower yield investment securities, whichresulted primarily from the calls and sales of callable bonds.

 

***Total InterestExpense***

 

Total interestexpense decreased by $8.2 million, to $27.5 million, during the year endedDecember 31, 2001 compared to the same period in 2000.  This was due to a reduction in averageinterest-bearing liabilities, which decreased interest expense by $4.7 million,as well as to a decline in the interest rate paid on these liabilities, whichreduced interest expense by $3.5 million.

 

Average totalinterest-bearing liabilities declined by $87.2 million, to $518.9 million,during 2001 compared to 2000, due to decreases of $55.4 million and $31.8million in average deposits and average borrowings, respectively.  The changes in average deposits and averageborrowings resulted in a shift in the mix of average total interest-bearingliabilities to lower rate deposits from higher rate borrowings.  The percentage of average deposits toaverage total interest-bearing liabilities increased to 84.7% during 2001 from81.7% during 2000.

 

48

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The decline inaverage deposits of $55.4 million, to $439.7 million, during 2001 compared to2000, was principally due to reductions of $30.4 million and $24.3 million inaverage certificates of deposit and average savings accounts,respectively.  These decreases wereprimarily attributable to the Company’s lowering of interest rates on all ofits deposit products in anticipation of and in response to the 475 basis pointreduction in the federal funds target rate by the Federal Reserve during2001.  The Company funded the depositrun-off primarily with the proceeds from the calls and sales of the callablebonds.

 

The decline inaverage borrowings of $31.8 million, to $79.2 million, during 2001 compared2000, was principally due to decreases of $27.1 million and $17.5 million inshort-term average securities sold under repurchase agreements and averageState of California borrowings, respectively, partially offset by increases of$7.6 million and $5.2 million in average term borrowings and average FHLBadvances, respectively.  The Companyused the proceeds from the calls and sales of the callable bonds in order tofund the reductions in the short-term borrowings, which resulted in a shift inthe composition of average borrowings to the long-term, higher rate trustpreferred securities.  The percentage ofaverage trust preferred securities to average borrowings rose to 21.8% during2001, from 15.5% during 2000.

 

The rate onaverage total interest-bearing liabilities decreased by 59 basis points, to5.31%, during the year ended December 31, 2001 compared to the same period in2000, and was principally due to the reduction of 66 basis points, to 5.06%, inthe rate on average deposits, as well as the reduction of three basis points,to 6.68%, in the rate on average borrowings, and a shift in the mix of averagetotal interest-bearing liabilities to lower rate deposits from higher rateborrowings.

 

The 66 basis point decline in the rate on average deposits reflectedthe Company’s lowering of interest rates on its deposit products, whichresulted in reductions of 152 basis points, 161 basis points, and 14 basispoints in the rates on average checking accounts, average savings accounts, andaverage certificates of deposit, respectively.

 

The threebasis point decrease in the rate on average borrowings was primarily due to thereductions in the rates on the Company’s short-term borrowing facilities, whichwere attributable to the declining interest rate environment during 2001.  Contributing to the decrease in the rate onaverage borrowings was the addition during the fourth quarter of 2001 of $40.0million long-term FHLB advances with a low weighted average rate of 3.16%.  The interest rates on average securitiessold under repurchase agreements and average State of California borrowingsdeclined by 111 basis points and 118 basis points, respectively, and werereflected in the following events:

 

•      During the first quarter of 2001, theCompany paid off the $23.5 million balance at December 31, 2000 of securitiessold under repurchase agreements.  Theseborrowings had a weighted average rate of 6.61% at December 31, 2000.

 

•      During the first quarter of 2001, $15.0million in State of California borrowings matured, bearing interest at a higherweighted average rate of 6.31%, and were paid off by the Company.

 

•      During the second quarter of 2001, an $8.0million State of California borrowing matured, bearing interest at a higherrate of 6.33%, and was paid off by the Company.

 

•      During the second quarter of 2001, a $5.0million State of California borrowing matured, bearing interest at a higherrate of 6.24%, and was replaced by the Company with a State of Californiaborrowing maturing in August of 2001 and bearing interest at a lower rate of3.69%.

 

•      During the second quarter of 2001, theCompany borrowed $25.0 million from the State of California, bearing interestat a lower weighted average rate of 3.61%, and maturing in the third quarter of2001.

 

•      During the third quarter of 2001, theentire $30.0 million outstanding balance of State of California borrowingsmatured, bearing interest at a weighted average rate of 3.62%, and was paid offby the Company with the proceeds from the calls of the callable bonds.

 

Partiallyoffsetting the decline in the rate on average borrowings was the abovementioned shift in the composition of average borrowings to higher rate trustpreferred securities, as well as the increase of 55 basis points, to 6.72%, inthe rate on average term borrowings. The $40.0 million of term borrowings were obtained during the risinginterest rate environment of 2000 and matured in 2002.

 

49

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**Provision for Loan Losses**

 

During 2001, the Company increased itsprovision for loan losses by $56,000, to $660,000, compared to 2000.  The Company uses the provision for loanlosses to establish the allowance for loan losses based on management’sevaluation of the risk inherent in the loan portfolio.  See “Financial Condition - Allowance forLoan Losses” and Item 1. “Business - Allowance for Loan Losses.”

 

#### **Non-interestIncome**

 

Non-interest income for the year endedDecember 31, 2001 increased by $818,000, to $2.5 million, compared to the sameperiod in 2000.  This was primarily dueto $503,000 in gain on sale of SBA 504 loans and broker fee income, which werenew programs for the Company in 2001, and a $283,000 increase in the gain onsale of SBA 7(a) loans.  Alsocontributing to the increase in non-interest income was $300,000 of interestincome that the Company recorded in “Other Income” in connection with the previouslymentioned favorable IRS ruling received on the Company’s income tax refundclaim.  Partially offsetting thesefactors were gains in 2000 of $561,000 and $115,000 on the sale of an incomeproperty loan and an OREO, respectively, which were not repeated in 2001.

#### ** **

#### **Non-interestExpense**

 

Non-interest expense for the year ended December 31, 2001 increased by$1.8 million, to $11.9 million, compared to the same period in 2000.  This was primarily due to decreases of$745,000, $423,000, $243,000 in salaries and employee benefits; legal, audit,and other professional fees; and net occupancy expense, respectively.

 

Salaries and employee benefits for the year ended December 31, 2001increased by $745,000, to $7.2 million, compared to the same period in 2000,and was primarily due to the following:

 

•      In January of 2001, employee base salariesincreased by approximately 4%.

 

•      Salaries and employee benefits for 2001reflected a full year of expenses for an income property marketingrepresentative in Laguna Hills, California, hired in June of 2000 to handlelending in Orange County and the Inland Empire.

 

•      Salaries and employee benefits for 2001reflected a full year of expenses for nine full-time employees hired during thelast seven months of 2000 to establish and expand the Company’s SBA lendingprogram in San Diego.  These employeesconsisted of one Senior Vice President, four Vice Presidents, and four otherpersonnel.

 

•      During 2001, the Company hired eightfull-time employees to further expand the Company’s SBA lending program, andthey consisted of four Vice Presidents and four other personnel.

 

Legal, audit, and other professional fees for the year ended December31, 2001 increased by $423,000, to $986,000, compared to the same period in2000, primarily due to $350,000 of expenses recorded in connection withobtaining the previously mentioned favorable ruling on the Company’s IRS incometax refund claim and settling a claim brought against the Bank in which theplaintiff alleged that he deposited $50,000 with the Bank in 1984 and that theprincipal and accrued interest were never returned.  Also contributing to the increase in legal, audit, and otherprofessional fees was the outsourcing of the Company’s internal audit function,which replaced the Company’s in-house internal audit department.

 

Net occupancy expense for the year ended December 31, 2001 increased by$243,000, to $1.7 million, compared to the same period in 2000.  This was primarily due to the inclusion in2001 of a full year of rent and related expenses for an office opened in LagunaHills during June of 2000 for the above mentioned income property marketingrepresentative, as well as an office opened in San Diego during November of2000 for the above mentioned SBA lending personnel.

 

Communications and data processing for the year ended December 31, 2001increased by $177,000, to $1.1 million, compared to the same period in 2000,primarily due to expenses incurred in connection with the above mentionedincreases in personnel and office facilities.

 

50

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**FINANCIAL CONDITION**

 

**BalanceSheet Analysis**

 

The followingtable presents condensed balance sheets as of the dates indicated and thedollar and percentage changes between the periods (dollars in thousands):

 
|                                                   |   |             |    |              |   |              |   | **Increase (Decrease)** |    |
|--------------------------------------------------------|--------|------------------|---------|-------------------|--------|-------------------|--------|-------------------------|---------|
|                                                   |   | **December 31,** |    | **2002 vs. 2001** |   | **2001 vs. 2000** |   |
|                                                   |   | **2002**         |    | **2001**          |   | **2000**          |   | **$**                   |    | **%** |   | **$** |   | **%** |   |
| **Assets**                                             |   |             |    |              |   |              |   |                    |    |   |   |   |   |   |   |
| Cash and cash equivalents                              |   | $                | 11,001  |              | $      | 18,682            |   | $                       | 5,336   |   | $ | (7,681 | ) | (41.1 | )% | $ | 13,346 |   | 250.1 | % |
| Investment securities, at market:                      |   |             |    |              |   |              |   |                    |    |   |   |   |   |   |   |
| U.S. agency callable bonds                             |   | —           |    | —            |   | 227,106           |   | —                  |    | — |   | (227,106 | ) | (100.0 | )% |
| U.S. agency MBS                                        |   | 70,516           |    | 55,537            |   | 3,799             |   | 14,979                  |    | 27.0 | % | 51,738 |   | 1361.9 | % |
| Corporate debt securities                              |   | 2,902            |    | 3,415             |   | 3,543             |   | (513                    | )       | (15.0 | )% | (128 | ) | (3.6 | )% |
| Total investment securities                            |   | 73,418           |    | 58,952            |   | 234,448           |   | 14,466                  |    | 24.5 | % | (175,496 | ) | (74.9 | )% |
| Loans:                                                 |   |             |    |              |   |              |   |                    |    |   |   |   |   |   |   |
| Total loans, net of deferred fees                      |   | 456,127          |    | 461,975           |   | 400,285           |   | (5,848                  | )       | (1.3 | )% | 61,690 |   | 15.4 | % |
| Allowance for loan losses                              |   | (8,585           | )       | (7,946            | )      | (7,240            | )      | (639                    | )       | (8.0 | )% | (706 | ) | (9.8 | )% |
| Net loans                                              |   | 447,542          |    | 454,029           |   | 393,045           |   | (6,487                  | )       | (1.4 | )% | 60,984 |   | 15.5 | % |
| Unsettled mortgage-backed securities trades, at market |   | 56,672           |    | —            |   | —            |   | 56,672                  |    | 100.0 | % | — |   | — |   |
| Other assets                                           |   | 15,111           |    | 13,095            |   | 15,831            |   | 2,016                   |    | 15.4 | % | (2,736 | ) | (17.3 | )% |
| Total assets                                           |   | $                | 603,744 |              | $      | 544,758           |   | $                       | 648,660 |   | $ | 58,986 |   | 10.8 | % | $ | (103,902 | ) | (16.0% | ) |
|                                                   |   |             |    |              |   |              |   |                    |    |   |   |   |   |   |   |
| **Liabilities**                                        |   |             |    |              |   |              |   |                    |    |   |   |   |   |   |   |
| Checking accounts                                      |   | $                | 16,014  |              | $      | 14,912            |   | $                       | 14,414  |   | $ | 1,102 |   | 7.4 | % | $ | 498 |   | 3.5 | % |
| Savings accounts                                       |   | 128,420          |    | 136,145           |   | 148,347           |   | (7,725                  | )       | (5.7 | )% | (12,202 | ) | (8.2 | )% |
| Certificates of deposit                                |   | 215,062          |    | 250,466           |   | 336,076           |   | (35,404                 | )       | (14.1 | )% | (85,610 | ) | (25.5 | )% |
| Total deposits                                         |   | 359,496          |    | 401,523           |   | 498,837           |   | (42,027                 | )       | (10.5 | )% | (97,314 | ) | (19.5 | )% |
| Securities sold under repurchase agreements            |   | —           |    | —            |   | 23,500            |   | —                  |    | — |   | (23,500 | ) | (100.0 | )% |
| State of California borrowings                         |   | —           |    | —            |   | 28,000            |   | —                  |    | — |   | (28,000 | ) | (100.0 | )% |
| FHLB advances                                          |   | 120,000          |    | 40,000            |   | —            |   | 80,000                  |    | 200.0 | % | 40,000 |   | 100.0 | % |
| Term borrowings                                        |   | —           |    | 40,000            |   | 40,000            |   | (40,000                 | )       | (100.0 | )% | — |   | — |   |
| Trust preferred securities                             |   | 17,250           |    | 17,250            |   | 17,250            |   | —                  |    | — |   | — |   | — |   |
| Total borrowings                                       |   | 137,250          |    | 97,250            |   | 108,750           |   | 40,000                  |    | 41.1 | % | (11,500 | ) | (10.6% | ) |
| Accounts payable for unsettled securities trades       |   | 56,012           |    | —            |   | —            |   | 56,012                  |    | 100.0 | % | — |   | — |   |
| Other liabilities                                      |   | 5,807            |    | 8,010             |   | 7,143             |   | (2,203                  | )       | (27.5 | )% | 867 |   | 12.1 | % |
| Total liabilities                                      |   | 558,565          |    | 506,783           |   | 614,730           |   | 51,782                  |    | 10.2 | % | (107,947 | ) | (17.6 | )% |
|                                                   |   |             |    |              |   |              |   |                    |    |   |   |   |   |   |   |
| **Shareholders’ Equity**                          |   |             |    |              |   |              |   |                    |    |   |   |   |   |   |   |
| Common stock, at par(1)                                |   | 60               |    | 60                |   | 60                |   | —                  |    | — |   | — |   | — |   |
| Additional paid-in capital(1)                          |   | 27,471           |    | 27,750            |   | 27,760            |   | (279                    | )       | (1.0 | )% | (10 | ) | — |   |
| Retained earnings                                      |   | 25,628           |    | 19,140            |   | 14,542            |   | 6,488                   |    | 33.9 | % | 4,598 |   | 31.6 | % |
| Accumulated other comprehensive income (loss)          |   | 1,296            |    | (198              | )      | (1,532            | )      | 1,494                   |    | 754.5 | % | 1,334 |   | 87.1 | % |
| Common stock in treasury, at cost                      |   | (9,276           | )       | (8,777            | )      | (6,900            | )      | (499                    | )       | (5.7 | )% | (1,877 | ) | (27.2 | )% |
| Total shareholders’ equity                        |   | 45,179           |    | 37,975            |   | 33,930            |   | 7,204                   |    | 19.0 | % | 4,045 |   | 11.9 | % |
| Total liabilities and shareholders’ equity        |   | $                | 603,744 |              | $      | 544,758           |   | $                       | 648,660 |   | $ | 58,986 |   | 10.8 | % | $ | (103,902 | ) | (16.0 | )% |

 

----

(1) All years adjusted to reflect the 2-for-1 stock split distributedNovember 12, 2002.

 

51

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***December 31, 2002 vs. December 31, 2001***

 

Total assets grew by $59.0 million, to $603.7 million, during the yearended December 31, 2002, primarily due to increases of $56.7 million and $14.5million in unsettled mortgage-backed securities trades and investmentsecurities,  respectively, partiallyoffset by decreases of $7.7 million and $6.5 million in cash and cashequivalents and net loans, respectively. See “Liquidity” for discussion of the $7.7 million decrease in cash andcash equivalents.

 

The $56.7 million increase in unsettled mortgage-backed securitiestrades reflected executed trades in December of 2002 to purchase $56 million offixed rate, GNMA mortgage-backed securities with an estimated interest rateyield of 5%.  The trades were not fundedby the Company until late January of 2003. The securities did not earn interest for the Company until the tradeswere funded.

 

The $14.5 million increase in investment securities, to $73.4 million,was principally due to mortgage-backed securities purchases of $25.5 million inMarch of 2002 and $22.2 million in late July and August of 2002. Partiallyoffsetting this increase were principal payments on mortgage-backed securitiestotaling $33.4 million.

 

The $6.5 decline in net loans, to $447.5 million, was primarily due to$107.2 million of loan payoffs and principal payments as well as $6.4 millionof SBA loan sales, partially offset by $102.3 million of loan originations and$4.9 million of loan purchases.  Thesignificant amount of loan payoffs was due to a high level of refinanceactivity attributable to a lower interest rate environment.

 

Total liabilities grew by $51.8 million, to $558.6 million, during theyear ended December 31, 2002, primarily due to increases of $56.0 million and$40.0 million in accounts payable for unsettled securities trades andborrowings, respectively, partially offset by a reduction of $42.0 million indeposits.  The accounts payable forunsettled securities trades represented the liability for the unsettledmortgage-backed securities trades discussed above.

 

The $42.0 million decrease in deposits, to $359.5 million, wasprimarily due to reductions of $35.4 million and $7.7 million in certificatesof deposit and savings accounts, respectively. The overall decline in deposits was principally attributable to theCompany’s lowering of deposits in response to the low interest rate environmentand the 50 basis point reduction in the federal funds target rate by theFederal Reserve during 2002.  Thechanges in the balances of the Company’s deposit products resulted in a shiftin the composition of deposits to lower rate checking and savings accounts fromhigher rate certificates of deposit. This reflected the Company’s strategy and efforts to help reduce theoverall cost of its deposits.  Thepercentage of checking and savings accounts to total deposits increased to40.2% at December 31, 2002 from 37.6% at December 31, 2001.

 

The $40.0 million growth in borrowings was primarily due to an increaseof $80.0 million in FHLB advances, partially offset by a $40.0 millionreduction in term borrowings. During 2002, the Company used lower rate FHLBadvances, both short-term and long-term, principally to (i) replace maturing,higher rate certificates of deposit, (ii) payoff $40.0 million in maturing,higher rate, 6.63% term borrowings, and (iii) purchase higher ratemortgage-backed securities.  In order totake advantage of the low interest rate environment and insulate the Companyfrom potentially higher interest rates in 2003, 2004, and 2005, the Companyconverted all of its short-term FHLB advances to long-term FHLB advances during2002, ultimately adding $80.0 million with a weighted average interest rate of2.81% and maturities ranging from 1.5 years to 3.0 years.

 

The changes inthe balances of the Company’s borrowing facilities resulted in a change in thecomposition of borrowings to lower rate FHLB advances from higher rate termborrowings and trust preferred securities, as well as a reduction in the Company’soverall cost of borrowings. The percentage of FHLB advances to total borrowingsincreased to 87.4% at December 31, 2002 from 41.1% at December 31, 2001.

 

52

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Shareholders’equity increased by $7.2 million, to $45.2 million, during the year endedDecember 31, 2002.  Changes inshareholders’ equity were due to the following factors:

 
| • |   | The Company  recorded $7.4 million of net income during 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | The Company  declared and paid cash dividends of $874,000 during 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | The $198,000  accumulated other comprehensive loss at December 31, 2001, decreased by $1.5  million, to a $1.3 million accumulated other comprehensive income position at  December 31, 2002, primarily due to (i) unrealized gains on the Company’s  investment securities portfolio, (ii) a $763,000 write-down to market value  on one of the Company’s corporate debt securities available for sale, and  (iii) unrealized gains on the Company’s unsettled mortgage-backed securities  trades.                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | Common stock  in treasury increased by $499,000, to $9.3 million, during 2002, principally  due to the $1.4 million purchase of 98,800 shares of the Company’s common  stock on a post-split basis under its stock repurchase plan.  This increase in treasury stock was  partially offset by the issuance of 112,144 shares of common stock in  treasury on a post-split basis, at an aggregate cost of $888,000, under the  Company’s employee stock purchase plan, non-employee directors stock purchase  plan, and employee stock option plan. |

 

***December 31, 2001vs. December 31, 2000***

 

Total assetsdeclined by $103.9 million, to $544.8 million, during the year ended December31, 2001, primarily due to a $175.5 million decrease in investment securities,partially offset by increases of $61.0 million and $13.3 million in net loansand cash and cash equivalents, respectively. See “Liquidity” for discussion of the $13.3 million increase in cash andcash equivalents.

 

The $175.5million decrease in investment securities, to $59.0 million, was principallydue to the $229.2 million liquidation of the Company’s callable bonds, whichconsisted of issuer calls of $219.2 million and Company sales of $10.0million.  Partially offsetting thereduction in callable bonds was an increase of $51.4 million in mortgage-backedsecurities, to $55.2 million, which was primarily due to $108.0 million ofpurchases, partially offset by sales of $42.3 million.

 

The $61.0million increase in net loans, to $454.0 million, was principally due to $129.2million of originations, partially offset by $58.4 million of principalpayments and $11.9 million in sales of SBA loans.

 

Totalliabilities declined by $107.9 million, to $506.8 million, during the yearended December 31, 2001, principally due to reductions of $97.3 million and$11.5 million in deposits and borrowings, respectively.

 

The $97.3million decrease in deposits, to $401.5 million, was primarily due toreductions of $85.6 million and $12.2 million in certificates of deposit andsavings accounts, respectively.  Theoverall decline in deposits was principally attributable to the Company’slowering of its deposits rates in anticipation of and in response to the 475basis point reduction in the federal funds target rate by the Federal Reserveduring 2001.  The reduction in depositswas funded primarily with the proceeds from the calls and sales of callablebonds.

 

The changes inthe balances of the Company’s deposit products resulted in a shift in thecomposition of deposits to lower rate checking and savings accounts from higherrate certificates of deposit.  Thisreflected the Company’s strategy and efforts to help reduce the overall cost ofits deposits.  The percentage ofchecking and savings accounts to total deposits increased to 37.6% at December31, 2001 from 32.6% at December 31, 2000.

 

The $11.5million decline in borrowings, to $97.3 million, was principally due todecreases of $23.5 million and $28.0 million in short-term securities soldunder repurchase agreements and State of California borrowings, respectively.  The reduction in these short-termborrowings, which took place during the first nine months of 2001, was fundedprimarily with the proceeds from the calls and sales of the callable bonds.  Partially offsetting the decline inborrowings was an increase of $40.0 million in long-term FHLB advances,obtained during the fourth quarter of 2001.

 

53

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Shareholders’equity increased by $4.0 million, to $38.0 million, during the year endedDecember 31, 2001.  Changes inshareholders’ equity were due to the following:

 
| • |   | The Company  recorded $5.4 million of net income during 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • |   | The Company  declared and paid quarterly cash dividends of $787,000 during 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| • |   | The $1.5  million accumulated other comprehensive loss at December 31, 2000, decreased  by $1.3 million, to $198,000 at December 31, 2001, primarily due to the calls  and sales of callable bonds available for sale, as well as to an increase in  market value of the Company’s investment securities available for sale.                                                                                                                                                                                                                                     |
| • |   | Common stock  in treasury increased by $1.9 million, to $8.8 million, during 2001,  principally due to the $2.0 million purchase of 209,000 shares of the  Company’s common stock on a post-split basis under its stock repurchase plan.  This increase in treasury stock was  partially offset by the issuance of 18,458 shares of common stock in treasury  on a post-split basis, at an aggregate cost of $136,000, under the Company’s  employee stock purchase plan, non-employee directors stock purchase plan, and  employee stock option plan. |

 

**Allowance for Loan Losses**

 

The allowancefor loan losses increased by $639,000, to $8.6 million, during the year endedDecember 31, 2002, due to $471,000 recorded in provision for loan losses andnet recoveries of $168,000.  Theallowance for loan losses as a percentage of loans was 1.88% at December 31,2002, as compared to 1.72% at December 31, 2001.

 

The Company’smanagement considered the following recent loan loss and credit experience inevaluating the allowance for loan losses at December 31, 2002:

 
| • |   | During the  years ended December 31, 2002, 2001, and 2000, recoveries exceeded  charge-offs by $168,000, $46,000, and $186,000, respectively, for a total of  $400,000.  See Item 1.  “Business-Allowance for Loan Losses” for a table presenting yearly activity  in the allowance for loan losses for the five-year period ended December 31,  2002.                                                                                                                                                                                                                                                                                                             |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | There were  no non-accrual loans and other real estate owned at December 31, 2002, and at  nine of the last twelve quarter-end periods as of December 31, 2002.  See Item 1. “Business-Asset Quality  Review” for a table presenting non-accrual loans and other real estate owned  as of year-end for the five-year period ended December 31, 2002.                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | Most of the  Company’s adjustable rate borrowers experienced some decline in the interest  payments on their loans due to the cumulative 525 basis point reduction in  the federal funds target rate during 2002 and 2001, which strengthened their  debt service capabilities.  However,  many of these borrowers did not realize the full impact of the interest rate  reduction on their loan payments due to interest rate floors that exist on a  significant number of the Company’s adjustable rate loans.  As of December 31, 2002 and 2001, 85.4%  and 84.2% of the Company’s loan portfolio consisted of adjustable rate loans,  respectively. |

 

In addition torecent loan loss and credit experience, management considers historical loanloss experience as well as changes within the loan portfolio in evaluating theadequacy of the allowance for loan losses.  Changes in the loan portfolio include (i) the growth in SBA lending,(ii) changes in geographic concentration, (iii) changes in the collateral mixof the loan portfolio, and (iv) the debt service ability of borrowers.  In addition, management attempts to factor inthe changes that relate to the economy in specific cities or locations. Most ofthese factors (geographic concentration, collateral concentration, debt servicecoverage of borrowers, and current vacancy rates) are favorable to theCompany’s current loan portfolio compared to the loan portfolio during prioreconomic periods.  Management believesthat the ability to predict the direction of the current U.S. economy is difficultgiven the continued risk of possible terrorism, the continued negative impactof declines in corporate earnings and the stock market and the loss of consumerconfidence.  Management feels that theeconomy may only experience slow to modest growth during 2003.  In considering all of the above factors,management believes that the allowance for loan losses as of December 31, 2002is adequate.

 

54

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Although the Company maintains its allowance for loan losses at a levelwhich it considers to be adequate to provide for potential losses, there can beno assurance that such losses will not exceed the estimated amounts, therebyadversely affecting future results of operations.

 

## **LIQUIDITY**

 

The Company’s primary sources of funds aredeposits, borrowings, and payments of principal and interest on loans andinvestment securities. While maturities and scheduled principal amortization onloans are a reasonably predictable source of funds, deposit flows and mortgageloan prepayments are greatly influenced by the level of interest rates,economic conditions, and competition.  As a measure of protection against these uncertainties, the Companymaintains borrowing relationships with several investment banking firms, wherebythe Company is able to borrow funds that are secured by pledging U.S.government sponsored agency securities. The Company is generally able to borrow up to 98% of the market value ofthese securities.  As of December 31,2002, the market values of U.S. government sponsored agency securities thatwere available for collateral purposes totaled $70.5 million.

 

The Bank also has a fixed rate borrowingfacility with the State of California Treasurer’s Office under which the Bankcan borrow an amount not to exceed its unconsolidated total shareholder’sequity.  Borrowing maturity dates underthis program cannot exceed one year. The State of California requires collateral with a value of at least110% of the outstanding borrowing amount. The Bank pledges U.S. government sponsored agency securities to meet thecollateral requirement under this borrowing facility.  As of December 31, 2002, the Bank’s unconsolidated totalshareholder’s equity was $57.8 million and the Bank had no outstanding State ofCalifornia borrowings.

 

During the second quarter of 2001, the Bank became a member of theFHLB, which serves as a source of both fixed rate and adjustable rateborrowings, with maturities ranging from one day to 30 years.  Under the FHLB’s credit facility, the Bankis able to borrow an FHLB-approved percentage of the Bank’s unconsolidatedtotal assets.  All FHLB advances must besecured by eligible collateral, subject to FHLB guidelines andlimitations.  Such collateral may consistof either non-residential real estate loans, multi-family residential loans, U.S.government sponsored agency mortgage-backed securities, or a combinationthereof.  For pledged non-residentialreal estate loans, the FHLB will lend up to 55% on an individual loan basis andup to 20% of the Bank’s unconsolidated total assets on an aggregate basis.  For multi-family residential loans, the FHLBwill lend up to 80% on an individual basis. For mortgage-backed securities, theFHLB will lend up to 97% of the market value.

 

As of December 31, 2002, the Bank’s FHLBcredit line totaled $193.0 million, based on an FHLB-approved borrowing limitof 35% of the Bank’s unconsolidated total assets.  Advances are limited to the amount of eligible collateral pledgedby the Bank, which totaled $129.5 million, and consisted of non-residentialreal estate loans and multi-family residential loans.  As noted above, the pledged amount of non-residential real estateloans is limited to 20% of assets. However, as mentioned previously, the Bank had $70.5 million ofmortgage-backed securities available for collateral purposes. The Bank had$120.0 million of outstanding advances at December 31, 2002.

 

The Company’s primary lending and investmentactivities have generally been the origination of income property and SBAbusiness loans, the purchase of investment securities, and, to a lesser extent,the purchase of short-term securities purchased under resale agreements. Thepurchases of investment securities and short-term securities purchased underresale agreements provide a source of long and short-term liquidity.

 

The Company’s most liquid assets are cash andsecurities purchased under resale agreements. The levels of these assets dependon the Company’s operating, investing, and financing activities during anygiven period.  Liquidity for the Companyis monitored daily and evaluated monthly. Excess funds are invested inshort-term securities purchased under resale agreements.

 

55

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During theyear ended December 31, 2002, the Company’s cash and cash equivalents decreasedby $7.7 million to $11.0 million.   Thisdecrease was the result of the uses of cash in financing, operating, andinvesting activities in the amounts of $3.7 million, $3.0 million, and $1.0million, respectively.  The $3.7 millionuse of cash in financing activities was primarily for the funding of $42.0million in deposit run-off and payment of $40.0 million in maturing termborrowings.  This financing activity waspartially offset by the proceeds of $80.0 million from long-term FHLBadvances.  The $1.0 million use of cashin investing activities was principally for the funding of $84.7 million inoriginations of loans held for investment, as well as $47.7 million, $4.9million, and $4.2 million in purchases of mortgage-backed securities, loansheld for investment, and FHLB stock, respectively.  This investing activity was partially offset by $107.2 millionand $33.4 million in principal payments received on loans and mortgage-backedsecurities, respectively.

 

During the year ended December 31, 2001, the Company’scash and cash equivalents increased by $13.3 million to $18.7 million.  This increase was the result of the additionof $116.7 million and $8.1 million in cash from investing and operatingactivities, respectively, partially offset by the use of $111.5 million in cashfor financing activities. The $116.7 million source of cash from investingactivities was principally due to $271.6 million in proceeds from the calls andsales of callable bonds and mortgage-backed securities, as well as $58.4 millionfrom principal payments received on loans. This investing activity was partially offset by uses of cash for $113.8million in originations of loans held for investment and $108.0 million inmortgage-backed securities purchases. The $111.5 million use of cash in financing activities was primarily forthe funding of deposit run-off of $97.3 million, as well as the payment of$23.5 million and $28.0 million in short-term securities sold under repurchaseagreements and State of California borrowings, respectively.  This financing activity was partially offsetby proceeds from the $40.0 million of long-term FHLB advances obtained duringthe fourth quarter of 2001.

 

**DIVIDENDS**

 

As a Delaware corporation, Pacific Crest maypay common dividends out of surplus or, if there is no surplus, from netprofits for the current and preceding fiscal year. Pacific Crest, on anunconsolidated basis, had approximately $3.6 million in cash and investmentsless current liabilities and short-term debt at December 31, 2002. However,these funds are necessary to pay future operating expenses of Pacific Crest,service all outstanding debt, including the $17.25 million junior subordinateddebentures payable to PCC Capital, and fund possible future capital infusionsinto the Bank. Without dividends from the Bank, Pacific Crest must rely solelyon existing cash, investments and the ability to secure borrowings.

 

The Bank’s ability to pay dividends toPacific Crest is restricted by California State law, which requires thatsufficient retained earnings be available to pay the dividend. At December 31,2002, the Bank had retained earnings of $26.7 million available for futuredividend payments.

 

On March 14, 2003, the Bank paid a cashdividend of $800,000 to Pacific Crest for the first quarter of 2003. During2002, the Bank declared and paid aggregate cash dividends of $3.2 million toPacific Crest.  During 2001, the Bankdeclared and paid aggregate cash dividends of $3.0 million to Pacific Crest.

 

On January 28, 2003, the Company announced thatthe Board of Directors had declared a cash dividend of $0.05 per common shareon a post-split basis for the first quarter of 2003.  The dividend was paid on March 14, 2003, to shareholders ofrecord at the close of business on February 28, 2003.   During 2002, the Company declared and paid aggregate cashdividends of $0.18 per common share on a post-split basis for a total of$874,000.   During 2001, the Companydeclared and paid aggregate cash dividends of $0.16 per common share on apost-split basis for a total of $787,000.

 

56

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**CAPITALRESOURCES**

 

The Company’s objective is to maintain alevel of capital that will support sustained asset growth, provide foranticipated credit risks, and ensure that regulatory guidelines and industrystandards are met.

 

Pacific Crest and the Bank are subject tocertain leverage and risk-based capital guidelines adopted by the FederalReserve and the FDIC. Risk-based capital consists of a core capital component(Tier 1), essentially total shareholders’ equity excluding accumulated othercomprehensive income (loss), and a supplemental component (Tier 2), whichincludes the allowance for loan losses up to 1.25% of risk-weighted assets, anda system for assigning assets and off-balance sheet items to one of fourrisk-weighted categories. These capital standards require a minimum Tier 1risk-based capital ratio of 4.00% and total risk-based capital ratio (Tier 1plus Tier 2) of 8.00%.

 

In addition to the risked-based guidelines,federal banking agencies require banking organizations to maintain a minimumamount of Tier 1 capital to average total assets, referred to as the leverageratio. For a banking organization rated in the highest of the five categoriesused by regulators to rate banking organizations, the minimum leverage ratio ofTier 1 capital to average total assets must be 3.00%. For all bankingorganizations not rated in the highest category, the minimum leverage ratiomust be at least 100 to 200 basis points above the 3.00% minimum, or 4.00% to5.00%.

 

Under the prompt corrective action provisions, an insured depositoryinstitution is placed in one of five categories based on its capital ratios,the highest category being well capitalized. The minimum required ratios for this well capitalized category are 5.00%leverage, 6.00% Tier 1 risk-based capital and 10.00% total risk-based capital.

 

At December 31, 2002 and 2001, Pacific Crest and the Bank wereclassified as “well capitalized” and were in compliance with all such requirements.The following tables sets forth the regulatory capital ratios for Pacific Crestand the Bank as of the dates indicated:

 
|             |                        | **Leverage  Ratio** |   | **Tier 1  Risk-Based  Capital  Ratio** |       | **Total  Risk-Based  Capital  Ratio** |   |
|------------------|-----------------------------|---------------------|--------|----------------------------------------|------------|---------------------------------------|--------|
|             |                        |                |   | ** **                             |
|             |                        |                |   | ** **                             |
|             |                        |                |   |                                   | ** ** |
| **Actual**       |                        |                |   |                                   |       |                                  |   |   |
|             | December 31, 2002           |                |   |                                   |       |                                  |   |   |
|             | Pacific Crest Capital, Inc. |                | 10.33  | %                                      | 13.31      | %                                     | 15.17  | % |
|             | Pacific Crest Bank          |                | 10.05  | %                                      | 12.91      | %                                     | 14.17  | % |
|             |                        |                |   |                                   |       |                                  |   |
|             | December 31, 2001           |                |   |                                   |       |                                  |   |   |
|             | Pacific Crest Capital, Inc. |                | 9.49   | %                                      | 11.11      | %                                     | 13.36  | % |
|             | Pacific Crest Bank          |                | 9.61   | %                                      | 11.22      | %                                     | 12.47  | % |
|             |                        |                |   |                                   |       |                                  |   |
| **Requirements** |                        |                |   |                                   |       |                                  |   |   |
|             | Minimum Well Capitalized    |                | 5.00   | %                                      | 6.00       | %                                     | 10.00  | % |
|             | Minimum Capital Adequacy    |                | 4.00   | %                                      | 4.00       | %                                     | 8.00   | % |
|                  |                             |                     |        |                                        |            |                                       |        |  |  |  |

 

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**ITEM 7A.       Quantitativeand Qualitative Disclosures About Market Risk**

 

The Company’s primary market risk is interest rate risk. Interest raterisk is the potential of economic losses due to future interest rate changes.These economic losses can be reflected as a loss of future net interest incomeand/or a loss of current fair market values. The objective is to measure theeffect on net interest income and to adjust the balance sheet to minimize theinherent risk while at the same time to maximize income. Management realizescertain risks are inherent and that the goal is to identify and minimize therisks.  The Company’s exposure to marketrisk is reviewed on a regular basis by the Asset/Liability Committee. Toolsused by management include an interest rate shock analysis and to a lesserextent, the standard GAP report, which measures the estimated differencebetween the amount of interest-sensitive assets and interest-sensitiveliabilities anticipated to mature or reprice during future periods, based oncertain assumptions.  The Company has nomarket risk sensitive instruments held for trading purposes and is notcurrently engaged in transactions involving derivative financialinstruments.  Management believes thatthe Company’s market risk is reasonable at this time.

 

The purpose of asset/liability management is to minimize the risk ofloss resulting from changes in interest rates. To the extent consistent withits interest rate spread objectives, the Company attempts to manage itsinterest rate risk and has taken actions to minimize the potential negativeimpact of changing interest rates. In addition to focusing on making commercialreal estate loans which generally provide for quarterly repricing, the Companyhas written a significant amount of its loans with interest rate floors.Interest rate floors protect the Company in a declining interest rateenvironment as affected loans do not reprice downward to their fully indexedrate when interest rates fall.

 

The Company primarily uses an interest rateshock analysis to evaluate and manage interest rate risk and measure the impactof fluctuations in interest rates on the Company’s net interest income.  This analysis is generated from anasset/liability system that reprices loans and deposits utilizing hypotheticalmarket interest rates on the date of repricing.

 

Another method of assessing the potentialrisk associated with changes in interest rates used to a lesser extent by theCompany is to examine the extent to which assets and liabilities are “interestrate sensitive” by monitoring the institution’s interest rate sensitivity“GAP.” An asset or liability is said to be interest rate sensitive within aspecific time period if it will mature or reprice within that time period. Theinterest rate sensitivity GAP is defined as the difference between the amountof interest-earning assets anticipated to mature or reprice within a specifictime period and the amount of interest-bearing liabilities anticipated tomature or reprice within that same time period, based upon certain assumptions.  A GAP is considered positive when the amountof interest rate sensitive assets exceeds the amount of interest rate sensitiveliabilities. A GAP is considered negative when the amount of interest ratesensitive liabilities exceeds the amount of interest rate sensitive assets.During a period of rising interest rates, a negative GAP would generally tendto adversely affect net interest income, while a positive GAP would generallytend to result in an increase in net interest income. During a period ofdeclining interest rates, a negative GAP would generally tend to result inincreased net interest income, while a positive GAP would generally tend toadversely affect net interest income.

 

The GAP analysis tables presented below werebased on certain assumptions. Except as stated below, the amount of assets andliabilities shown which reprice or mature during a particular period weredetermined in accordance with the earlier of the repricing timing or maturitydate of the asset or liability. The Company hasassumed, for purposes of these  GAPanalysis tables, that its checking accounts and savings accounts repriceimmediately.

 

Certain shortcomings are inherent in themethod of using GAP analysis to evaluate interest rate risk as presented in thefollowing tables. For example, GAP analysis assumes that when interest rateschange, all rates change by the same amount and at the same time. Althoughcertain assets and liabilities may be available for repricing at the same time,assets and liabilities often react independently to market interest ratechanges, resulting in variable degrees of change dependent on the type of assetor liability. Also, the interest rates on certain types of assets andliabilities may fluctuate in advance of changes in market interest rates, whileinterest rates on other types may lag behind changes in market rates.Additionally, some adjustable rate loans have features, which restrict changesin interest rates on a short-term basis and over the life of the asset. Loanprepayments and early withdrawal of certificates of deposit could also causethe interest sensitivities to vary from those reflected in the table. Due tothese factors, the GAP analysis may not provide a complete or accurateassessment of the Company’s exposure to changes in interest rates.

 

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In order tomanage interest rate risk, the Company endeavors to underwrite most of itsloans on an adjustable rate or short-term fixed rate basis.  The Company’s adjustable rate loans repriceon either a quarterly, semi-annual or annual basis.  A portion of these adjustable rate loans were initially fixedrate for a period of one to five years, but thereafter will reprice on either aquarterly, semi-annual, or annual basis. The table below presents the Company’sadjustable rate loans by index as well as fixed rate loans as of the datesindicated (dollars in thousands):

 
|                                        |   | **December 31, 2002** |       | **December 31, 2001** |       |
|---------------------------------------------|--------|-----------------------|------------|-----------------------|------------|
|                                        |   | **Amount**            |       | **Percent  of Total** |       | **Amount** |   | **Percent  of Total** |   |
|                                        |   | ** **            | ** ** | ** **            | ** ** |
| **Adjustable Rate:**                        |   |                  |       |                  |       |   |   |   |   |
| 6-month LIBOR                               |   | $                     | 202,179    |                  | 44.34      | % | $ | 161,996 |   | 35.07 | % |
| Prime rate                                  |   | 178,176               |       | 39.08                 | %          | 209,998 |   | 45.46 | % |
| 1-year and 10-year U.S. Treasury Bill rates |   | 6,316                 |       | 1.39                  | %          | 9,869 |   | 2.14 | % |
| 11th District Cost of Funds index           |   | 2,632                 |       | 0.58                  | %          | 7,238 |   | 1.57 | % |
| Total adjustable rate                       |   | 389,303               |       | 85.39                 | %          | 389,101 |   | 84.22 | % |
|                                        |   |                  |       |                  |       |   |   |   |   |
| **Fixed Rate**                              |   | 66,627                |       | 14.61                 | %          | 72,878 |   | 15.78 | % |
|                                        |   |                  |       |                  |       |   |   |   |   |
| Total gross loans                           |   | $                     | 455,930    |                  | 100.00     | % | $ | 461,979 |   | 100.00 | % |

 

The following table is a summary of the Company’s one-year GAP as ofthe dates indicated (in thousands):

 
|                                                                                                           |   | **December 31,  2002** |    | **December 31,  2001** |   | **Increase  (Decrease)** |   |
|----------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|------------------------|--------|--------------------------|--------|
|                                                                                                           |   |                   |    |                   |
| Total interest-sensitive assets maturing or repricing within one year  (“one-year assets”)           |   | $                      | 344,438 |                   | $      | 329,491                  |   | $ | 14,947 |   |
|                                                                                                           |   |                   |    |                   |   |                     |   |
| Total interest-sensitive liabilities maturing or repricing within one  year (“one-year liaiblities”) |   | 312,995                |    | 408,971                |   | (95,976                  | )      |
|                                                                                                           |   |                   |    |                   |   |                     |   |
| One-year GAP                                                                                                   |   | $                      | 31,443  |                   | $      | (79,480                  | )      | $ | 110,923 |   |

 

The one-year GAP increased by $110.9 million during the year ended December31, 2002, due to an increase in one-year assets of $14.9 million and a decreasein one-year liabilities of $96.0 million.

 

The growth in one-year assets was primarily due to a $23.8 millionincrease in the one-year loan category, partially offset by a $8.4 milliondecline in securities purchased under resale agreements.  The increase in one-year loans wasprincipally due to loans that moved into the one-year category from longer termcategories because they were initially fixed rate for a period of one to fiveyears and have now converted to the adjustable rate period of their terms.   Additionally, the Company’s loanoriginations during the year ended December 31, 2002 primarily consisted ofadjustable rate loans.  The $8.4 milliondecline in short-term securities purchased under resale agreements, a cashequivalent, is discussed under “Liquidity” as part of the decrease in cash andcash equivalents for 2002.

 

The reduction in one-year liabilities was primarily due to decreases of$69.4 million, $40.0 million, and $7.7 million in one-year certificates ofdeposit, term borrowings, and savings accounts, respectively, partially offsetby an increase of $20.0 million in long-term, fixed rate FHLB advances thatmoved into the one-year category.

 

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The Companyhas assumed, for purposes of the GAP table below, that its checking and savingsaccounts reprice immediately.

 

While the Company’s one-year GAP at December 31, 2002 indicates thatinterest-sensitive assets exceed interest-sensitive liabilities, GAP analysisis an imprecise measure of the impact of rising or falling interest ratesbecause variable rate assets and liabilities are tied to different interestrate indices and/or are affected by different market forces.  Additionally, the Company has certainvariable rate loans included in the under one-year asset categories which areat their contractual interest rate floors, and therefore will not immediatelyadjust after an interest rate increase. The Company is attempting to mitigate the effect on net interest incomeof this loan floor issue by extending the maturities of its interest-sensitiveliabilities beyond one year wherever practical.  Such efforts primarily involve the replacement of maturing certificatesof deposit and term borrowings with fixed rate FHLB advances and certificatesof deposit, which generally have terms of 12 to 36 months.

 

For information on the estimated fair valuesof the Company’s interest-sensitive assets and liabilities as of December 31,2002 and 2001, see Note 24, “Estimated Fair Value of Financial Instruments”.

 

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The GAP tablesbelow provide information about the Company’s balance sheet non-derivativefinancial instruments at December 31, 2002 and 2001 that are sensitive tochanges in interest rates. For all outstanding financial instruments, thetables presents the outstanding principal balance and the weighted averageinterest yield/rate of the instruments by either the date the instrument can berepriced for variable rate financial instruments, or the maturity date, forfixed rate financial instruments (dollars in thousands):

 

 
|                                                        |       | **Maturity or Repricing Date** |          |                      |   |
|-------------------------------------------------------------|------------|--------------------------------|---------------|---------------------------|--------|
|                                                        |       | **Within  6  Months**          |          | **Over  6 to 12  Months** |   | **Over  12 to 18  Months** |   | **Over  18 to 24  Months** |   | **Over  24  Months** |   | **Total** |   |
|                                                        |       |                           |          |                      |   |   |   |
| **December 31, 2002**                                       | ** ** |                           |          |                      |   |   |   |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| **Interest-Sensitive Assets:**                              |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| Securities purchased under resale agreements                |       | $                              | 7,802         |                      | $      | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 7,802 |   |
| average yield (variable rate)                               |       | 1.10                           | %             | —                    |   | — |   | — |   | — |   | 1.10% |   |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| U.S. government sponsored agency mortgage-backed securities |       | —                         |          | —                    |   | — |   | — |   | 70,516 |   | 70,516 |   |
| average yield (fixed rate)                                  |       | —                         |          | —                    |   | — |   | — |   | 4.34 | % | 4.34 | % |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| Corporate debt securities                                   |       | 2,902                          |          | —                    |   | — |   | — |   |   |   | 2,902 |   |
| average yield (variable rate)                               |       | 4.07                           | %             | —                    |   | — |   | — |   | — |   | 4.07% |   |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| Loans, gross(1)                                             |       | 286,475                        |          | 47,259                    |   | 31,077 |   | 22,671 |   | 68,448 |   | 455,930 |   |
| average yield                                               |       | 7.37                           | %             | 7.73                      | %      | 8.24 | % | 8.24 | % | 8.26 | % | 7.64 | % |
| Total interest-sensitive assets                             |       | $                              |  297,179 |                      | $      |  47,259 |   | $ |  31,077 |   | $ |  22,671 |   | $ | 138,964 |   | $ | 537,150 |   |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| **Interest-Sensitive Liabilities:**                         |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| Checking accounts                                           |       | $                              | 16,014        |                      | $      | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 16,014 |   |
| average rates (variable rate)                               |       | 1.22                           | %             | —                    |   | — |   | — |   | — |   | 1.22 | % |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| Savings accounts                                            |       | 128,420                        |          | —                    |   | — |   | — |   | — |   | 128,420 |   |
| average rates (variable rate)                               |       | 2.04                           | %             | —                    |   | — |   | — |   | — |   | 2.04 | % |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| Certificates of deposit                                     |       | 77,700                         |          | 70,861                    |   | 32,142 |   | 27,395 |   | 6,964 |   | 215,062 |   |
| average rates (fixed rate)                                  |       | 2.72                           | %             | 2.81                      | %      | 3.82 | % | 4.75 | % | 4.76 | % | 3.24 | % |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| FHLB advances                                               |       | —                         |          | 20,000                    |   | 40,000 |   | 10,000 |   | 50,000 |   | 120,000 |   |
| average rates (fixed rate)                                  |       | —                         |          | 3.01                      | %      | 2.80 | % | 2.68 | % | 3.05 | % | 2.93 | % |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| Trust preferred securities                                  |       | —                         |          | —                    |   | — |   | — |   | 17,250 |   | 17,250 |   |
| average rates (fixed rate)                                  |       | —                         |          | —                    |   | — |   | — |   | 9.38 | % | 9.38 | % |
| Total interest-sensitive liabilities                        |       | $                              | 222,134       |                      | $      | 90,861 |   | $ | 72,142 |   | $ | 37,395 |   | $ | 74,214 |   | $ | 496,746 |   |
|                                                        |       |                           |          |                      |   |   |   |   |   |   |   |   |   |
| **GAP**                                                     |       | $                              | 75,045        |                      | $      | (43,602 | ) | $ | (41,065 | ) | $ | (14,724 | ) | $ | 64,750 |   | $ | 40,404 |   |
| **Cumulative GAP**                                          |       | 75,045                         |          | 31,443                    |   | (9,622 | ) | (24,346 | ) | 40,404 |   |   |   |

 

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(1)   Themajority of the adjustable rate loans included in the “Within 6 Months” and“Over 6 to 12 Months” categories were at their contractual interest rate floorsat December 31, 2002 and thus would not reprice downward.  The adjustable rate loans at contractualinterest rate floors that are above the fully indexed loan interest rate willnot reprice upward until the fully indexed interest rate exceeds thecontractual interest rate floor.  TheCompany is endeavoring to minimize this “lag effect” in loan repricing byborrowing at fixed interest rates for terms of 12 to 36 months wherever practical.

 

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|                                                        |   | **Maturity or Repricing Date** |       |                      |
|-------------------------------------------------------------|--------|--------------------------------|------------|---------------------------|
| **December 31, 2001**                                       |   | **Within  6  Months**          |       | **Over  6 to 12  Months** |   | **Over  12 to 18  Months** |   | **Over  18 to 24  Months** |   | **Over  24  Months** |   | **Total** |   |
|                                                        |   |                           | ** ** |                      | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Interest-Sensitive Assets:**                              |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| Securities purchased under resale agreements                |   | $                              | 16,174     |                      | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 16,174 |   |
| average yield (variable rate)                               |   | 1.65                           | %          | —                    |   | — |   | — |   | — |   | 1.65 | % |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| U.S. government sponsored agency mortgage-backed securities |   | —                         |       | —                    |   | — |   | — |   | 55,537 |   | 55,537 |   |
| average yield (fixed rate)                                  |   | —                         |       | —                    |   | — |   | — |   | 5.31 | % | 5.31 | % |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| Corporate debt securities                                   |   | 3,415                          |       | —                    |   | — |   | — |   |   |   | 3,415 |   |
| average yield (variable rate)                               |   | 4.21                           | %          | —                    |   | — |   | — |   | — |   | 4.21 | % |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| Loans, gross (1)                                            |   | 214,114                        |       | 95,788                    |   | 21,717 |   | 15,195 |   | 115,165 |   | 461,979 |   |
| average yield                                               |   | 8.62                           | %          | 8.25                      | % | 8.97 | % | 8.80 | % | 8.36 | % | 8.50 | % |
| Total interest-sensitive assets                             |   | $                              | 233,703    |                      | $ | 95,788 |   | $ | 21,717 |   | $ | 15,195 |   | $ | 170,702 |   | $ | 537,105 |   |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| **Interest-Sensitive Liabilities:**                         |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| Checking accounts                                           |   | $                              | 14,912     |                      | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 14,912 |   |
| average rates (variable rate)                               |   | 2.69                           | %          | —                    |   | — |   | — |   | — |   | 2.69 | % |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| Savings accounts                                            |   | 136,145                        |       | —                    |   | — |   | — |   | — |   | 136,145 |   |
| average rates (variable rate)                               |   | 2.65                           | %          | —                    |   | — |   | — |   | — |   | 2.65 | % |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| Certificates of deposit                                     |   | 124,109                        |       | 93,805                    |   | 5,550 |   | 7,585 |   | 19,417 |   | 250,466 |   |
| average rates (fixed rate)                                  |   | 5.12                           | %          | 4.39                      | % | 5.34 | % | 4.54 | % | 6.12 | % | 4.91 | % |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| FHLB advances                                               |   | —                         |       | —                    |   | — |   | 20,000 |   | 20,000 |   | 40,000 |   |
| average rates (fixed rate)                                  |   | —                         |       | —                    |   | — |   | 3.01 | % | 3.30 | % | 3.16 | % |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| Term borrowings                                             |   | 10,000                         |       | 30,000                    |   | — |   | — |   | — |   | 40,000 |   |
| average rates (fixed rate)                                  |   | 6.65                           | %          | 6.62                      | % | — |   | — |   | — |   | 6.63 | % |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| Trust preferred securities                                  |   | —                         |       | —                    |   | — |   | — |   | 17,250 |   | 17,250 |   |
| average rates (fixed rate)                                  |   | —                         |       | —                    |   | — |   | — |   | 9.38 | % | 9.38 | % |
| Total interest-sensitive liabilities                        |   | $                              | 285,166    |                      | $ | 123,805 |   | $ | 5,550 |   | $ | 27,585 |   | $ | 56,667 |   | $ | 498,773 |   |
|                                                        |   |                           |       |                      |   |   |   |   |   |   |   |   |   |
| **GAP**                                                     |   | $                              | (51,463    | )                         | $ | (28,017 | ) | $ | 16,167 |   | $ | (12,390 | ) | $ | 114,035 |   | $ | 38,332 |   |
| **Cumulative GAP**                                          |   | (51,463                        | )          | (79,480                   | ) | (63,313 | ) | (75,703 | ) | 38,332 |   |   |   |
|                                                             |        |                                |            |                           |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

| (1) | The majority  of the adjustable rate loans included in the “Within 6 Months” and “Over 6 to  12 Months” categories were at their contractual interest rate floors as of  December 31, 2001 and thus would not reprice downward. |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

 

62

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##### **ITEM 8.          FinancialStatements and Supplementary Data**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

 
|   | Report of Deloitte & Touche LLP, Independent Auditors                                                               |
|--------|-------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                    |
|   | Consolidated Balance Sheets at December 31, 2002 and 2001                                                               |
|   |                                                                                                                    |
|   | Consolidated Statements of Income for the  years ended  December 31, 2002, 2001, and 2000                               |
|   |                                                                                                                    |
|   | Consolidated Statements of Changes in  Shareholders’ Equity for the years ended  December 31, 2002, 2001, and 2000 |
|   |                                                                                                                    |
|   | Consolidated Statements of Cash Flows for  the years ended  December 31, 2002, 2001, and 2000                           |
|   |                                                                                                                    |
|   | Notes to Consolidated Financial Statements                                                                              |

 

63

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**INDEPENDENTAUDITORS’ REPORT**

 

**To the Board of Directors and Shareholders**

**Pacific Crest Capital, Inc.**

 

We have audited theaccompanying consolidated balance sheets of Pacific Crest Capital, Inc. (the“Company”) as of December 31, 2002 and 2001, and the related consolidatedstatements of income, changes in shareholders’ equity, and cash flows for eachof the three years in the period ended December 31, 2002. These consolidatedfinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audits.

 

We conducted our audits inaccordance with auditing standards generally accepted in the United States ofAmerica.  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether theconsolidated financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Pacific Crest Capital, Inc. at December 31, 2002 and2001, and the results of its operations and its cash flows for each of thethree years in the period ended December 31, 2002, in conformity withaccounting principles generally accepted in the United States of America.

 

 

DELOITTE & TOUCHE LLP

 

 

Los Angeles, California

January 30, 2003

(March 20, 2003 as to Note 27)

 

64

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**PACIFIC CREST CAPITAL, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(dollars in thousands, except per share data)**

 
|                                                                                                                |   | **December 31,** |    |
|---------------------------------------------------------------------------------------------------------------------|--------|------------------|---------|
|                                                                                                                |   | **2002**         |    | **2001** |   |
| **Assets**                                                                                                          |   |             |    |   |   |
| Cash                                                                                                                |   | $                | 3,199   |   | $ | 2,508 |   |
| Securities purchased under resale agreements                                                                        |   | 7,802            |    | 16,174 |   |
| Cash and cash equivalents                                                                                           |   | 11,001           |    | 18,682 |   |
| Investment securities available for sale, at market                                                                 |   | 73,418           |    | 58,952 |   |
| Unsettled mortgage-backed securities trades                                                                         |   | 56,672           |    | — |   |
| Loans:                                                                                                              |   |             |    |   |   |
| Loans held for investment                                                                                           |   | 432,196          |    | 449,182 |   |
| Loans held for sale                                                                                                 |   | 23,734           |    | 12,797 |   |
| Gross loans                                                                                                         |   | 455,930          |    | 461,979 |   |
| Deferred loan (fees) costs                                                                                          |   | 197              |    | (4) |   |
| Allowance for loan losses                                                                                           |   | (8,585)          |    | (7,946) |   |
| Net loans                                                                                                           |   | 447,542          |    | 454,029 |   |
| Other assets:                                                                                                       |   |             |    |   |   |
| Investment in FHLB stock                                                                                            |   | 6,306            |    | 2,000 |   |
| Deferred income taxes, net                                                                                          |   | 3,596            |    | 5,203 |   |
| Accrued interest receivable                                                                                         |   | 2,353            |    | 2,532 |   |
| Prepaid expenses and other assets                                                                                   |   | 1,749            |    | 2,087 |   |
| Premises and equipment                                                                                              |   | 1,107            |    | 1,273 |   |
| Total other assets                                                                                                  |   | 15,111           |    | 13,095 |   |
| Total assets                                                                                                        |   | $                | 603,744 |   | $ | 544,758 |   |
|                                                                                                                |   |             |    |   |   |
| **Liabilities**                                                                                                     |   |             |    |   |   |
| Deposits:                                                                                                           |   |             |    |   |   |
| Non-interest-hearing checking                                                                                       |   | $                | 2,800   |   | $ | 1,649 |   |
| Interest-bearing checking                                                                                           |   | 13,214           |    | 13,263 |   |
| Total checking accounts                                                                                             |   | $                | 16,014  |   | $ | 14,912 |   |
| Savings accounts                                                                                                    |   | 128,420          |    | 136,145 |   |
| Certificates of deposit                                                                                             |   | 215,062          |    | 250,466 |   |
| Total deposits                                                                                                      |   | 359,496          |    | 401,523 |   |
| Borrowings:                                                                                                         |   |             |    |   |   |
| FHLB advances                                                                                                       |   | 120,000          |    | 40,000 |   |
| Term borrowings                                                                                                     |   | —           |    | 40,000 |   |
| Trust preferred securities                                                                                          |   | 17,250           |    | 17,250 |   |
| Total borrowings                                                                                                    |   | 137,250          |    | 97,250 |   |
| Accounts payable for unsettled securities trades                                                                    |   | 56,012           |    | — |   |
| Accrued interest payable and other liabilities                                                                      |   | 5,807            |    | 8,010 |   |
| Total liabilities                                                                                                   |   | 558,565          |    | 506,783 |   |
|                                                                                                                |   |             |    |   |   |
| **Shareholders’ Equity**                                                                                       |   |             |    |   |   |
|                                                                                                                |   |             |    |   |   |
| Common stock, $.01 par value (10,000,000 shares authorized, 5,973,060  shares issued at December 31, 2002 and 2001) |   | 60               |    | 60 |   |
| Additional paid-in capital                                                                                          |   | 27,471           |    | 27,750 |   |
| Retained earnings                                                                                                   |   | 25,628           |    | 19,140 |   |
| Accumulated other comprehensive income (loss)                                                                       |   | 1,296            |    | (198 | ) |
| Common stock in treasury, at cost (1,119,418 shares at                                                              |   |             |    |   |   |
| December 31, 2002 and 1,132,762 shares at December 31, 2001)                                                        |   | (9,276           | )       | (8,777 | ) |
| Total shareholders’ equity                                                                                     |   | 45,179           |    | 37,975 |   |
| Total liabilities and shareholders’ equity                                                                     |   | $                | 603,744 |   | $ | 544,758 |   |
| Tangible book value per common share                                                                                |   | $                | 9.31    |   | $ | 7.85 |   |

* *

*See accompanying Notes to Consolidated Financial Statements.*

65

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**PACIFIC CREST CAPITAL, INC.**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**(dollars in thousands, except per share data)**

 
|                                                |   | **Years Ended December 31,** |   |
|-----------------------------------------------------|--------|------------------------------|--------|
|                                                |   | **2002**                     |   | **2001** |   | **2000** |   |
| **Interest income:**                                |   |                         |   |   |   |   |   |
| Loans                                               |   | $                            | 37,405 |   | $ | 38,091 |   | $ | 37,182 |   |
| Investment securities available for sale            |   | 3,766                        |   | 8,106 |   | 16,405 |   |
| Securities purchased under resale agreements        |   | 171                          |   | 456 |   | 132 |   |
| Total interest income                               |   | 41,342                       |   | 46,653 |   | 53,719 |   |
| **Interest expense:**                               |   |                         |   |   |   |   |   |
| Deposits:                                           |   |                         |   |   |   |   |   |
| Checking accounts                                   |   | 234                          |   | 403 |   | 658 |   |
| Savings accounts                                    |   | 2,577                        |   | 4,853 |   | 8,355 |   |
| Certificates of deposit                             |   | 9,603                        |   | 16,994 |   | 19,284 |   |
| Total interest on deposits                          |   | 12,414                       |   | 22,250 |   | 28,297 |   |
| Borrowings:                                         |   |                         |   |   |   |   |   |
| Securities sold under repurchase agreements         |   | —                       |   | 216 |   | 2,022 |   |
| State of California borrowings                      |   | —                       |   | 609 |   | 1,805 |   |
| FHLB advances                                       |   | 2,192                        |   | 166 |   | — |   |
| Term borrowings                                     |   | 1,672                        |   | 2,686 |   | 1,999 |   |
| Trust preferred securities                          |   | 1,617                        |   | 1,617 |   | 1,617 |   |
| Total interest on borrowings                        |   | 5,481                        |   | 5,294 |   | 7,443 |   |
| Total interest expense                              |   | 17,895                       |   | 27,544 |   | 35,740 |   |
| **Net interest income**                             |   | 23,447                       |   | 19,109 |   | 17,979 |   |
| **Provision for loan losses**                       |   | 471                          |   | 660 |   | 604 |   |
| Net interest income after provision for loan losses |   | 22,976                       |   | 18,449 |   | 17,375 |   |
| **Non-interest income:**                            |   |                         |   |   |   |   |   |
| Loan prepayment and late fee income                 |   | 822                          |   | 345 |   | 346 |   |
| Gain on sale of SBA 7(a) loans                      |   | 221                          |   | 395 |   | 112 |   |
| Gain on sale of SBA 504 loans and broker fee income |   | 1,201                        |   | 503 |   | — |   |
| Gain (loss) on sale of investment securities        |   | (763                         | )      | 95 |   | (2 | ) |
| Gain on sale of income property loans               |   | —                       |   | — |   | 561 |   |
| Gain on sale of other real estate owned             |   | —                       |   | — |   | 115 |   |
| Other income                                        |   | 1,007                        |   | 1,193 |   | 581 |   |
| Total non-interest income                           |   | 2,488                        |   | 2,531 |   | 1,713 |   |
| **Non-interest expense:**                           |   |                         |   |   |   |   |   |
| Salaries and employee benefits                      |   | 8,787                        |   | 7,152 |   | 6,407 |   |
| Net occupancy expenses                              |   | 1,796                        |   | 1,665 |   | 1,422 |   |
| Communication and data processing                   |   | 1,020                        |   | 1,057 |   | 880 |   |
| Legal, audit, and other professional fees           |   | 525                          |   | 986 |   | 563 |   |
| Travel and entertainment                            |   | 491                          |   | 457 |   | 352 |   |
| Credit and collection expenses                      |   | 26                           |   | — |   | (134 | ) |
| Other real estate owned expenses                    |   | —                       |   | — |   | (10 | ) |
| Other expenses                                      |   | 594                          |   | 544 |   | 566 |   |
| Total non-interest expense                          |   | 13,239                       |   | 11,861 |   | 10,046 |   |
| **Income before income taxes**                      |   | 12,225                       |   | 9,119 |   | 9,042 |   |
| Income tax provision                                |   | 4,863                        |   | 3,734 |   | 3,772 |   |
| **Net income**                                      |   | $                            | 7,362  |   | $ | 5,385 |   | $ | 5,270 |   |
|                                                |   |                         |   |   |   |   |   |
| Earnings per common share:                          |   |                         |   |   |   |   |   |
| Basic                                               |   | $                            | 1.52   |   | $ | 1.09 |   | $ | 1.04 |   |
| Diluted                                             |   | $                            | 1.37   |   | $ | 1.02 |   | $ | 1.00 |   |

 

*Seeaccompanying Notes to Consolidated Financial Statements.*

 

66

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**PACIFIC CREST CAPITAL, INC.**

**CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**

**(dollars in thousands, except per share data)**

 
|                                                          |   |              |   | **Common  Stock in  Treasury** |   | **Additional  Paid-in  Capital** |   | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Total  Shareholders’  Equity** |   |
|---------------------------------------------------------------|--------|-------------------|--------|--------------------------------|--------|----------------------------------|--------|------------------------|--------|------------------------------------------------------|--------|---------------------------------------|--------|
|                                                          |   | **Common  Stock** |   |                           |   |                             |   |                   |
|                                                          |   |              |   |                           |   |                             |   |
|                                                          |   |              |   |                           |   |                             |   |
| Balance at December 31, 1999                                  |   | $                 | 60     |                           | $      | (5,989                           | )      | $                      | 27,855 |                                                 | $      | 9,978                                 |   | $ | (6,355 | ) | $ | 25,549 |   |
| Comprehensive income (loss):                                  |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Net income                                                    |   | —            |   | —                         |   | —                           |   | 5,270                  |   | —                                               |   | 5,270                                 |   |
| Other comprehensive income:                                   |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Unrealized gain on investment securities, net of income taxes |   | —            |   | —                         |   | —                           |   | —                 |   | 4,823                                                |   | 4,823                                 |   |
| Total comprehensive income                                    |   |              |   |                           |   |                             |   |                   |   |                                                 |   | 10,093                                |   |
| Issuances of common stock in treasury:                        |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Employee stock purchase plan                                  |   | —            |   | 55                             |   | (14                              | )      | —                 |   | —                                               |   | 41                                    |   |
| Non-employee directors’ stock                            |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| purchase plan                                                 |   | —            |   | 61                             |   | (11                              | )      | —                 |   | —                                               |   | 50                                    |   |
| Employee stock option plan                                    |   | —            |   | 122                            |   | (70                              | )      | —                 |   | —                                               |   | 52                                    |   |
| Purchases of common stock in treasury                         |   | —            |   | (1,149                         | )      | —                           |   | —                 |   | —                                               |   | (1,149                                | )      |
| Cash dividends paid ($0.14 per share)                         |   | —            |   | —                         |   | —                           |   | (706                   | )      | —                                               |   | (706                                  | )      |
| Balance at December 31, 2000                                  |   | $                 | 60     |                           | $      | (6,900                           | )      | $                      | 27,760 |                                                 | $      | 14,542                                |   | $ | (1,532 | ) | $ | 33,930 |   |
| Comprehensive income:                                         |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Net income                                                    |   | —            |   | —                         |   | —                           |   | 5,385                  |   | —                                               |   | 5,385                                 |   |
| Other comprehensive income:                                   |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Unrealized gain on investment securities, net of income taxes |   | —            |   | —                         |   | —                           |   | —                 |   | 1,334                                                |   | 1,334                                 |   |
| Total comprehensive income                                    |   |              |   |                           |   |                             |   |                   |   |                                                 |   | 6,719                                 |   |
| Issuances of common stock in treasury:                        |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Employee stock purchase plan                                  |   | —            |   | 62                             |   | (7                               | )      | —                 |   | —                                               |   | 55                                    |   |
| Non-employee directors’ stock purchase plan              |   | —            |   | 42                             |   | 7                                |   | —                 |   | —                                               |   | 49                                    |   |
| Employee stock option plan                                    |   | —            |   | 32                             |   | (10                              | )      | —                 |   | —                                               |   | 22                                    |   |
| Purchases of common stock in treasury                         |   | —            |   | (2,013                         | )      | —                           |   | —                 |   | —                                               |   | (2,013                                | )      |
| Cash dividends paid ($0.16 per share)                         |   | —            |   | —                         |   | —                           |   | (787                   | )      | —                                               |   | (787                                  | )      |
| Balance at December 31, 2001                                  |   | $                 | 60     |                           | $      | (8,777                           | )      | $                      | 27,750 |                                                 | $      | 19,140                                |   | $ | (198 | ) | $ | 37,975 |   |
| Comprehensive income:                                         |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Net income                                                    |   | —            |   | —                         |   | —                           |   | 7,362                  |   | —                                               |   | 7,362                                 |   |
| Other comprehensive income:                                   |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
|                                                          |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Unrealized gains on the following, net of income taxes:       |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Investment securities                                         |   | —            |   | —                         |   | —                           |   | —                 |   | 1,111                                                |   | 1,111                                 |   |
| Unsettled mortgage-backed securities trades                   |   | —            |   | —                         |   | —                           |   | —                 |   | 383                                                  |   | 383                                   |   |
| Total comprehensive income                                    |   |              |   |                           |   |                             |   |                   |   |                                                 |   | 8,856                                 |   |
| Issuances of common stock in treasury:                        |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| Employee stock purchase plan                                  |   | —            |   | 55                             |   | (4                               | )      | —                 |   | —                                               |   | 51                                    |   |
| Non-employee directors’ stock                            |   |              |   |                           |   |                             |   |                   |   |                                                 |   |                                  |   |
| purchase plan                                                 |   | —            |   | 31                             |   | 21                               |   | —                 |   | —                                               |   | 52                                    |   |
| Employee stock option plan                                    |   | —            |   | 803                            |   | (296                             | )      | —                 |   | —                                               |   | 507                                   |   |
| Purchases of common stock in treasury                         |   | —            |   | (1,388                         | )      | —                           |   | —                 |   | —                                               |   | (1,388                                | )      |
| Cash dividends paid ($0.18 per share)                         |   | —            |   | —                         |   | —                           |   | (874                   | )      | —                                               |   | (874                                  | )      |
| Balance at December 31, 2002                                  |   | $                 | 60     |                           | $      | (9,276                           | )      | $                      | 27,471 |                                                 | $      | 25,628                                |   | $ | 1,296 |   | $ | 45,179 |   |

 

*See accompanying Notes to Consolidated Financial Statements.*

67

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**PACIFIC CREST CAPITAL, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(dollars in thousands)**

 
|                                                                               |   | **Years Ended December 31,** |   |
|------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                               |   | **2002**                     |   | **2001** |   | **2000** |   |
| **Operating activities:**                                                          |   |                         |   |   |   |   |   |
| Net income                                                                         |   | $                            | 7,362  |   | $ | 5,385 |   | $ | 5,270 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |                         |   |   |   |   |   |
| Provision for loan losses                                                          |   | 471                          |   | 660 |   | 604 |   |
| Gain on sale of SBA 7(a) and 504 loans held  for sale                              |   | (424                         | )      | (639 | ) | (112 | ) |
| Loss (gain) on sale of investment  securities                                      |   | 763                          |   | (95 | ) | 2 |   |
| Gain on sale of income property loans                                              |   | —                       |   | — |   | (561 | ) |
| Gain on sale of other real estate owned                                            |   | —                       |   | — |   | (115 | ) |
| Depreciation and amortization of premises  and equipment                           |   | 406                          |   | 386 |   | 326 |   |
| Accretion of deferred loan fees                                                    |   | (86                          | )      | (98 | ) | (209 | ) |
| Amortization of premium (discount) on  investment securities                       |   | 980                          |   | 491 |   | (22 | ) |
| Dividends on FHLB stock                                                            |   | (153                         | )      | (12 | ) | — |   |
| Deferred income tax expense (benefit)                                              |   | (79                          | )      | 66 |   | (1,127 | ) |
| Proceeds from sales of SBA 7(a) and 504  loans held for sale                       |   | 6,821                        |   | 12,707 |   | 2,764 |   |
| Originations of SBA 7(a) and 504 loans held  for sale                              |   | (18,025                      | )      | (15,425 | ) | (9,398 | ) |
| Federal income tax refund                                                          |   | 804                          |   | — |   | — |   |
| Decrease in accrued interest receivable                                            |   | 179                          |   | 4,050 |   | 22 |   |
| Decrease (increase) in prepaid expenses and  other assets                          |   | 405                          |   | (251 | ) | 452 |   |
| (Decrease) increase in accrued interest  payable and other liabilities             |   | (2,403                       | )      | 867 |   | 1,566 |   |
| Net cash (used in) provided by operating  activities                               |   | (2,979                       | )      | 8,092 |   | (538 | ) |
|                                                                               |   |                         |   |   |   |   |   |
| **Investing activities:**                                                          |   |                         |   |   |   |   |   |
| Proceeds from sales and calls of investment  securities available for sale         |   | —                       |   | 271,610 |   | 14,453 |   |
| Purchases of investment securities  available for sale                             |   | (47,694                      | )      | (107,955 | ) | — |   |
| Principal payments on investment securities  available for sale                    |   | 33,401                       |   | 13,745 |   | 193 |   |
| Originations of loans held for investment                                          |   | (84,651                      | )      | (113,821 | ) | (70,864 | ) |
| Purchases of loans held for investment                                             |   | (4,915                       | )      | (2,879 | ) | — |   |
| Proceeds from sales of commercial real  estate loans                               |   | —                       |   | — |   | 1,428 |   |
| Principal payments on loans                                                        |   | 107,229                      |   | 58,377 |   | 42,846 |   |
| Purchases of FHLB stock                                                            |   | (4,153                       | )      | (1,988 | ) | — |   |
| Proceeds from sales of other real estate  owned                                    |   | —                       |   | — |   | 75 |   |
| Purchases of premises and equipment, net                                           |   | (240                         | )      | (347 | ) | (781 | ) |
| Net cash (used in) provided by investing  activities                               |   | (1,023                       | )      | 116,742 |   | (12,650 | ) |
|                                                                               |   |                         |   |   |   |   |   |
| **Financing activities:**                                                          |   |                         |   |   |   |   |   |
| Net increase (decrease) in checking  accounts                                      |   | 1,102                        |   | 498 |   | (4,369 | ) |
| Net decrease in savings accounts                                                   |   | (7,725                       | )      | (12,202 | ) | (48,021 | ) |
| Net (decrease) increase in certificates of  deposit                                |   | (35,404                      | )      | (85,610 | ) | 66,843 |   |
| Net decrease in securities sold under  repurchase agreements                       |   | —                       |   | (23,500 | ) | (7,000 | ) |
| Net (decrease) increase in State of  California borrowings                         |   | —                       |   | (28,000 | ) | 8,000 |   |
| Net increase in FHLB advances                                                      |   | 80,000                       |   | 40,000 |   | — |   |
| Net decrease in term borrowings                                                    |   | (40,000                      | )      | — |   | — |   |
| Proceeds from issuances of common stock in  treasury                               |   | 610                          |   | 126 |   | 143 |   |
| Purchases of common stock in treasury, at  cost                                    |   | (1,388                       | )      | (2,013 | ) | (1,149 | ) |
| Cash dividends paid                                                                |   | (874                         | )      | (787 | ) | (706 | ) |
| Net cash (used in) provided by financing  activities                               |   | (3,679                       | )      | (111,488 | ) | 13,741 |   |
|                                                                               |   |                         |   |   |   |   |   |
| Net (decrease) increase  in cash and cash equivalents                         |   | (7,681                       | )      | 13,346 |   | 553 |   |
| Cash and cash equivalents at beginning of  year                                    |   | 18,682                       |   | 5,336 |   | 4,783 |   |
| Cash and cash equivalents at end of year                                           |   | $                            | 11,001 |   | $ | 18,682 |   | $ | 5,336 |   |

* *

*See accompanying Notes to Consolidated Financial Statements*

 

68

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**PACIFIC CREST CAPITAL.INC**.

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**December 31,2002**

 

**Note 1. Organization**

 

Pacific CrestCapital, Inc. (“Pacific Crest” or the “Parent”) is a bank holding companyprincipally engaged in income property lending and U.S. Small BusinessAdministration (“SBA”) lending through its wholly owned subsidiary, PacificCrest Bank (the “Bank”).  Pacific Crestis regulated by the Board of Governors of the Federal Reserve System (the“Federal Reserve”).  Unless the contextotherwise indicates, the “Company” refers to Pacific Crest together with itswholly owned subsidiaries, Pacific Crest Bank and PCC Capital I.

 

Pacific CrestBank is a California state chartered commercial bank that is supervised andregulated by the California Commissioner of Financial Institutions (the“Commissioner”), the California Department of Financial Institutions (the“Department” or “DFI”), and the Federal Deposit Insurance Corporation(“FDIC”).  The Bank’s deposits areinsured by the FDIC up to applicable limits. The Bank introduced full-service,consumer checking accounts to all of its retail customers in the fourth quarterof 2000.  During 2002, the Bankintroduced business checking accounts as well as debit cards, online banking,and online bill pay.  Additionally,during this same period, the Bank introduced a business lending program and avariety of depository services for business professionals and small businessesto complement its SBA lending programs.

 

Pacific CrestBank is a business bank that concentrates on marketing to and serving the needsof investors, entrepreneurs, and small businesses located predominantly inCalifornia.  The Bank conducts itsdeposit operations through three branch offices located in Beverly Hills,Encino, and San Diego, California. The Bank currently offers consumer andbusiness checking accounts, money market checking accounts, savings accounts,and certificates of deposit.  The Bankhas focused its lending activities primarily on income producing real estateloans and small business loans under the SBA 7(a) and 504 loan programs.  The Bank conducts its lending operations inCalifornia through its lending and marketing representatives.  To a lesser extent, and on a very selectivebasis, the Bank makes real estate loans in other western states.

 

PCC Capital I(“PCC Capital”) is a Delaware statutory business trust that was created for theexclusive purpose of issuing and selling $17.25 million of 9.375% CumulativeTrust Preferred Securities (the “Trust Preferred Securities”).  The Trust Preferred Securities are presentedon a separate line on the Consolidated Balance Sheets under the caption “Trustpreferred securities.” For financial reporting purposes, the Company recordsthe dividend distributions on the Trust Preferred Securities as “Interestexpense – trust preferred securities” on its Consolidated Statements of Income.

 

**Note2. Summary of Significant Accounting Policies**

### *** ***

### ***Principles ofConsolidation***

 

The Consolidated Financial Statements include the accounts of PacificCrest and its wholly owned subsidiaries, the Bank and PCC Capital.  All significant intercompany transactionsand balances have been eliminated. Certain reclassifications have been made to the prior years’Consolidated Financial Statements in order to conform to the current yearpresentation.

 

TheConsolidated Financial Statements have been prepared in accordance withaccounting principles generally accepted in the United States of America. Inpreparing the Consolidated Financial Statements, management is required to makeestimates and assumptions that affect the reported amounts of assets andliabilities as of the date of the balance sheets and revenues and expenses forthe year. Actual results in future years could differ from those estimates bymanagement in the current year. Material estimates that are particularlysusceptible to significant change relate to the determination of the allowance forloan losses.

 

69

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***Business Segments***

 

The Company is organized and operated as asingle reporting segment principally engaged in income property lending and SBAlending.  The Company’s lendingactivities concentrate on marketing to and serving the needs of investors,entrepreneurs, and small businesses located predominantly in California.  The Company conducts its deposit operationsthrough three branch offices, located in Southern California.  The Consolidated Financial Statements, asthey appear in this document, represent the grouping of revenue and expenseitems as they are presented to executive management of the Company, for use instrategically directing the operations of the Company.

### *** ***

### ***Cash and Cash Equivalents***

 

For purposes of the Consolidated BalanceSheets and Consolidated Statements of Cash Flows, “Cash and cash equivalents”include cash and securities purchased under resale agreements, which haveoriginal maturities of three months or less and are carried at cost.

 

### ***Securities Purchased Under Resale Agreements***

 

The Company invests excess cash overnight andup to three months in securities purchased under resale agreements (“repurchaseagreements”).   Collateral securing therepurchase agreements is limited to U.S. Treasury bonds, notes and bills, andsecurities issued by either U.S. government agencies or U.S. governmentsponsored agencies.  Collateral securingthe repurchase agreements is held for safekeeping under third-party custodialagreements and is required to be segregated from, and separately accounted foras compared to, all other securities held by the custodian for its othercustomers or for its own account.

 

### ***Investment Securities***

 

The Company invests in U.S. governmentsponsored agency securities, and to a lesser extent, investment grade corporatedebt securities.  At the date ofpurchase, the Company elects to segregate the security into either the held tomaturity portfolio or the available for sale portfolio, depending uponmanagement’s ability and intent to hold such securities to maturity.  Debt securities classified as held tomaturity are recorded at amortized cost while securities classified asavailable for sale are recorded at market. Unrealized gains or losses on securities available for sale are excludedfrom earnings and reported in “Accumulated other comprehensive income (loss)”as a separate component of Shareholders’ Equity, net of tax effect.  Realized gains or losses are recorded usingthe specific identification method.  Purchase premiums and discounts are recognized in interest incomeusing the level yield method.

 

### ***Loans***

 

Loans that management has the intent andability to hold for the foreseeable future or until maturity are reported attheir outstanding unpaid specific principal balances adjusted for specificcharge-offs, and any remaining unamortized deferred loan fees or costs.  Interest income is accrued on the unpaidspecific principal balance.  Loanorigination fees, net of certain estimated indirect origination costs, aredeferred and recognized as an adjustment of the related loan yield using theinterest method over the term of the loan.

 

### ***SBA Loans Held For Sale***

 

SBA loans originated and intended for sale inthe secondary market are carried at the lower of cost or estimated market valuein the aggregate.  Net unrealizedlosses, if any, are recognized through a valuation allowance by charges toincome.

 

70

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### ***Allowance for Loan Losses***

** **

The Company charges current income in amounts necessary to maintain ageneral allowance for loan losses deemed adequate to cover potential losses onloans. The amount of the allowance is based on management’s evaluation ofnumerous factors including adequacy of collateral, which includes loan balanceto collateral value, loan debt service coverage ratio and secondary collateral,if applicable.  Other factors include anevaluation of the strengths and weaknesses of the borrower’s financial position,and strengths and weaknesses of the tenants in the properties.  In addition, management evaluates currentdelinquency trends, historical Company loan loss experience, regional realestate economic conditions and overall economic trends impacting the Company’sreal estate lending portfolio.  Thecombination of these factors are utilized in establishing the allowance forloan losses.

 

### ***OtherReal Estate Owned***

 

Assets classified as other real estate owned (“OREO”) includeforeclosed real estate owned by the Company. The Company records and carries its OREO at the lower of cost or fairvalue, which may require the Company to make valuation adjustments to itsOREO,  based on current collateralappraisal data and other relevant information, which may effectively reduce thebook value of such assets to their estimated fair value less selling cost.  The fair value of the real estate takes intoaccount the real estate values net of expenses such as brokerage commissions,past due property taxes, property repair expenses, and other items.  The estimated sale price utilized by theCompany to help determine fair value may not necessarily reflect the appraisalvalue, which management believes, in some cases, to be higher than what couldbe realized in a sale of the OREO.

 

***Deferred IncomeTaxes***

 

Deferred income tax assets and liabilities are determined using theliability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determinedbased on the tax effects of the temporary differences between the financialstatement amounts of assets and liabilities and their respective tax bases.Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years when those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date.

 

***Premises andEquipment***

 

Office furniture, fixtures, equipment, andleasehold improvements are carried at cost, less accumulated depreciation.Depreciation and amortization are provided principally on the straight-linemethod over the estimated useful lives of the property. Office furniture,fixtures and equipment are generally estimated to have useful lives of betweenthree and eight years. Leasehold improvements are amortized over either theuseful life or the life of the lease, whichever is shorter.

 

71

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***Stock Options***

 

The Company applies Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issuedto**Employees*(“APB 25”*)*, in accounting for its stock options,whereby compensation cost is measured as the excess, if any, of the quotedmarket price of the stock at the grant date over the amount an employee mustpay to acquire the stock.  Stock optionsissued under the Company’s stock option plans have no intrinsic value at thegrant date, and accordingly, under APB 25, no compensation cost is recognizedfor them.  Had compensation cost beendetermined based on the fair value at the grant dates, consistent with themethod prescribed by SFAS No. 123, *Accountingfor Stock-based Compensation*, the Company’s net income and earningsper share would have been reduced to the pro forma amounts indicated in thefollowing table for the periods presented (dollars and shares in thousands,except per share data):

 
|                                        |   | **Years Ended December 31,** |   |
|---------------------------------------------|--------|------------------------------|--------|
|                                        |   | **2002**                     |   | **2001** |   | **2000** |   |
| Net income:                                 |   |                         |   |   |   |   |   |
| As reported                                 |   | $                            | 7,362  |   | $ | 5,385 |   | $ | 5,270 |   |
| Pro forma                                   |   | 7,190                        |   | 5,218 |   | 5,101 |   |
| Basic earnings per common share:            |   |                         |   |   |   |   |   |
| As reported                                 |   | $                            | 1.52   |   | $ | 1.09 |   | $ | 1.04 |   |
| Pro forma                                   |   | 1.48                         |   | 1.06 |   | 1.01 |   |
| Diluted earnings per common share:          |   |                         |   |   |   |   |   |
| As reported                                 |   | $                            | 1.37   |   | $ | 1.02 |   | $ | 1.00 |   |
| Pro forma                                   |   | 1.34                         |   | 0.98 |   | 0.97 |   |
| Weighted average common shares outstanding: |   |                         |   |   |   |   |   |
| Basic                                       |   | 4,855                        |   | 4,940 |   | 5,051 |   |
| Diluted                                     |   | 5,359                        |   | 5,301 |   | 5,245 |   |
| **Assumptions:**                            |   |                         |   |   |   |   |   |
| Dividend yield                              |   | 1.30                         | %      | 1.71 | % | 2.27 | % |
| Expected volatility                         |   | 25                           | %      | 25 | % | 30 | % |
| Risk free interest rate                     |   | 3.50                         | %      | 5.00 | % | 6.00 | % |
| Expected life                               |   | 7.0 years                    |   | 7.5 years |   | 7.5 years |   |

 

***Recent AccountingPronouncements***

 

In June of 2001, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets* (“SFAS 144”).  SFAS 144 supersedes SFAS No. 121, *Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of,* and the accounting andreporting provisions of Accounting Principles Board Opinion No. 30, * Reporting theResults of Operations – Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions*("APB 30"), and addresses financialaccounting and reporting for the impairment or disposal of long-livedassets.  SFAS 144 was effective January1, 2002.  The adoption of SFAS 144 didnot have a material impact on the Company’s consolidated financial position orresults of operations.

 

In April of 2002, the FASB issued SFAS No.145, *Rescission of FASB Statements No. 4,44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections*(“SFAS145”).  SFAS 145 eliminates theautomatic classification of gain or loss on extinguishment of debt as anextraordinary item, and requires that such gain or loss be evaluated forextraordinary classification under the criteria of APB 30.  SFAS 145 requires sale-leaseback accountingfor certain lease modifications that have economic effects that are similar tosale-leaseback transactions, and makes various other technical corrections toexisting pronouncements.  SFAS 145 iseffective for the Company for the year ended December 31, 2003.  The adoption of SFAS 145 is not expected tohave a material impact on the Company’s consolidated financial position orresults of operations.

 

72

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In July of 2002, the FASB issued SFAS No.146, *Accounting for Costs Associated withExit or Disposal Activities*(“SFAS 146”).  SFAS 146 requires costs associated with exit or disposalactivities to be recognized when they are incurred, and applies prospectivelyto such activities that are initiated after December 31, 2002.  The adoption of SFAS 146 is not expected tohave a material impact on the Company’s consolidated financial position orresults of operations.

 

In October of 2002, the FASB issued SFAS No.147, *Acquisitions of Certain FinancialInstitutions* (“SFAS 147”), which provides guidance on the accountingfor the acquisitions of a financial institution.  SFAS 147 requires that the excess of the fair value ofliabilities assumed over the fair value of tangible and identifiable intangibleassets acquired in a business combination represents goodwill that should beaccounted for under SFAS No. 142, *Goodwilland other Intangible Assets*. Thus, the specialized accounting guidance in paragraph 5 of SFAS No. 72,*Accounting for Certain Acquisitions ofBanking or Thrift Institutions*, will not apply after September 30,2002.  If certain criteria in SFAS 147are met, the amount of the unidentifiable intangible asset will be reclassifiedto goodwill upon adoption of the statement. Financial institutions meeting conditions outlined in SFAS 147 will berequired to restate previously issued financial statements.  Additionally, the scope of SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*, is amended to include long-termcustomer-relationship intangible assets such as depositor- andborrower-relationship intangible assets and credit cardholder intangible assets.  SFAS 147 is effective beginning October 1,2002.  The adoption of SFAS 147 did nothave and is not expected to have a material impact on the Company’sconsolidated financial position or results of operations.

 

In December of 2002, the FASB issued SFAS No. 148, *Accounting for Stock-Based Compensation —Transitionand Disclosure, an amendment of FASB Statement No. 123*(“SFAS 148”).SFAS 148 amends SFAS No. 123, *Accounting forStock-Based Compensation* (“SFAS 123”), to provide alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation.  In addition, SFAS 148amends the disclosure requirements of SFAS 123 to require prominent disclosuresin both annual and interim financial statements about the method of accountingfor stock-based employee compensation and the effect of the method used onreported results. SFAS 148 shall be effective for financial statements forfiscal years ending after December 15, 2002 and is not expected to have amaterial impact on the Company’s consolidated financial position or results ofoperations.

 

In November of 2002, the FASB issued FASB Interpretation No. 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of the Indebtedness of Others*(“FIN 45”), which clarifies the requirements of SFAS No. 5, *Accounting for Contingencies*, relating toa guarantor’s accounting for and disclosures of certain guarantees issued.FIN 45 requires enhanced disclosures for certain guarantees. FIN 45also requires certain guarantees that are issued or modified afterDecember 31, 2002, to be initially recorded on the balance sheet at fairvalue. For guarantees issued on or before December 31, 2002, liabilities arerecorded when and if payments become probable and estimable. The adoption ofFIN 45 is not expected to have a material impact on the Company’s consolidatedfinancial position or results of operations.

##### ** **

##### **In January of 2003, the FASB issued FASBInterpretation No. 46*, Consolidation ofVariable Interest Entities* (“FIN 46”), which clarifies theapplication of Accounting Research Bulletin No. 51, *Consolidated Financial Statements*,relating to consolidation of certain entities. FIN 46 applies in the firstfiscal year or interim period beginning after June 15, 2003, to variableinterest entities in which the enterprise holds a variable interest it acquiredbefore February 1, 2003, and is not expected to have a material impact on theCompany’s consolidated financial position or results of operations.**

 

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##### **Note 2. Two-For-One Stock Split**

 

On October 17, 2002, the Company announced that its Board of Directorshad approved a 2-for-1 stock split to be effected in the form of a 100 percentstock dividend.  Shareholders receivedone additional share of common stock for each share that they held on therecord date of October 30, 2002.  Theadditional shares were distributed on November 12, 2002.

 

The stock split resulted in the issuance of 2,986,530 shares of commonstock.  Par value of the stock remainedunchanged at $0.01 per share. Accordingly, the Company recorded the transaction on November 12, 2002and increased "Common stock" by $29,865, with an offsetting reductionto "Additional paid-in capital" in the same amount.  The effect of the stock split has beenrecognized retroactively in “Common stock” and “Additional paid-in capital” onthe Consolidated Balance Sheets, as well as in all share and per share amountsin the Consolidated Financial Statements.

 

##### **Note 3.Computation of Earnings per Common Share**

 

Basic and diluted earnings per common share were determined by dividingnet income by the applicable basic and diluted weighted average common sharesoutstanding. For the diluted earnings per share computation, the basic weightedaverage common shares outstanding were increased to include additional commonshares that would have been outstanding if dilutive stock options had beenexercised.  The dilutive effect of stockoptions was calculated using the treasury stock method.

 

The table below presents the basic anddiluted earnings per share computations for the periods indicated (inthousands, except per share data):

 
|                                               |   | **Years Ended December 31,** |   |
|----------------------------------------------------|--------|------------------------------|--------|
|                                               |   | **2002**                     |   | **2001** |   | **2000** |   |
| Net income                                         |   | $                            | 7,362  |   | $ | 5,385 |   | $ | 5,270 |   |
|                                               |   |                         |   |   |   |   |   |
| Basic weighted average common shares outstanding   |   | 4,855                        |   | 4,940 |   | 5,051 |   |
| Dilutive effect of stock options                   |   | 504                          |   | 361 |   | 194 |   |
| Diluted weighted average common shares outstanding |   | 5,359                        |   | 5,301 |   | 5,245 |   |
|                                               |   |                         |   |   |   |   |   |
| Earnings per common share:                         |   |                         |   |   |   |   |   |
| Basic                                              |   | $                            | 1.52   |   | $ | 1.09 |   | $ | 1.04 |   |
| Diluted                                            |   | $                            | 1.37   |   | $ | 1.02 |   | $ | 1.00 |   |

 

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##### **Note 4.Computation of Tangible Book Value per Common Share**

 

Tangible book value per common share was calculated by dividing totalshareholders’ equity by the number of common shares issued less common sharesheld in treasury.  The table belowpresents the computation of tangible book value per common share as of thedates indicated (in thousands, except per share data):

##### ** **

|                                        |   | **December 31,** |   |
|---------------------------------------------|--------|------------------|--------|
|                                        |   | **2002**         |   | **2001** |   |
| Total shareholders’ equity             |   | $                | 45,179 |   | $ | 37,975 |   |
|                                        |   |             |   |   |   |
| Common shares issued                        |   | 5,973,060        |   | 5,973,060 |   |
| Less:   common shares held in treasury |   | (1,119,418       | )      | (1,132,762 | ) |
| Common shares outstanding                   |   | 4,853,642        |   | 4,840,298 |   |
|                                        |   |             |   |   |   |
| Tangible book value per common share        |   | $                | 9.31   |   | $ | 7.85 |   |

 

**Note 5. Supplemental Disclosure of Cash FlowInformation**

 

Supplemental disclosure of cash flow information is as follows for theperiods indicated (in thousands):

 
|                                            |   | **Years Ended December 31,** |   |
|-------------------------------------------------|--------|------------------------------|--------|
|                                            |   | **2002**                     |   | **2001** |   | **2000** |   |
| Cash paid during the year for:                  |   |                         |   |   |   |   |   |
| Interest                                        |   | $                            | 18,475 |   | $ | 28,162 |   | $ | 35,390 |   |
| Income taxes                                    |   | 5,950                        |   | 2,935 |   | 5,400 |   |
|                                            |   |                         |   |   |   |   |   |
| Non-cash investing and financing activities:    |   |                         |   |   |   |   |   |
| Unsettled mortgage-backed securities trades     |   | $                            | 56,012 |   | $ | — |   | $ | — |   |
| Transfers from loans to other real estate owned |   | —                       |   | — |   | 210 |   |
| Loans made to facilitate the sale of OREO       |   | —                       |   | — |   | 250 |   |

 

**Note 6. Securities Purchased Under Resale Agreements**

 

The table below presents securities purchased under resale agreementsas of the dates or for the periods indicated (dollars in thousands):

 
|                                           |   | **At or For the Years Ended December 31,** |   |
|------------------------------------------------|--------|--------------------------------------------|--------|
|                                           |   | **2002**                                   |   | **2001** |   | **2000** |   |
| Balance at year-end                            |   | $                                          | 7,802  |   | $ | 16,174 |   | $ | 3,017 |   |
| Average balance during the year                |   | 10,688                                     |   | 13,525 |   | 2,058 |   |
| Maximum month-end balance during the year      |   | 35,637                                     |   | 33,706 |   | 4,025 |   |
| Weighted average interest rate during the year |   | 1.60                                       | %      | 3.37 | % | 6.41 | % |
| Weighted average interest rate at end of year  |   | 1.10                                       | %      | 1.65 | % | 6.10 | % |
|                                                |        |                                            |        |  |  |  |  |  |  |  |

 

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**Note 7. Investment Securities Available forSale**

** **

The Company’s investment securities portfolio at December 31, 2002consisted of fixed rate U.S. government sponsored agency mortgage-backedsecurities issued by Fannie Mae and Ginnie Mae, as well as adjustable rateinvestments in corporate debt securities. The index of the corporate debt securities is based upon the three monthLondon Interbank Offered Rate (“LIBOR”), which reprices on a quarterly basis.As of December 31, 2002, the Company’s entire investment securities portfoliowas scheduled to mature after ten years. However, the average life of the Company's mortgage-backed securitiesportfolio may be shorter due to principal prepayments.

 

No securities were pledged to secure borrowings at December 31,2002.  Mortgage-backed securities withmarket values totaling $47.3 million were pledged to secure borrowings totaling$40.0 million at December 31, 2001.

 

During 2002, the Company wrote down to market value one of itscorporate debt securities in order to reflect an other than temporary declinein the market value of that security. The write-down was based on a variety of factors, including a recentrating agency downgrade of the security’s debt rating.  This write-down totaled $763,000 and isincluded in “Gain (loss) on sale of investment securities” in the ConsolidatedStatements of Income.  In January of2003, the Company sold this corporate debt security for a gain of $20,000.

 

In December of 2002, the Company executed trades to purchase $56million of fixed rate, GNMA mortgage pass-through securities with an estimatedinterest rate yield of 5%.  The $56million in GNMA securities trades did not fund until late January of 2003, andare reflected on the Consolidated Balance Sheets as “Unsettled mortgage-backedsecurities trades,” with the related liability reported as “Accounts payablefor unsettled securities trades.”  Thesecurities did not earn interest for the Company until the trades were fundedin late January of 2003.

 

The following tables present the amortizedcost and estimated fair values of the Company’s investment securities availablefor sale and unsettled mortgage-backed securities trades as of the datesindicated (dollars in thousands):

 
|                                                         |   | **December 31, 2002** |   |
|--------------------------------------------------------------|--------|-----------------------|--------|
|                                                         |   |                  |   |   |   |   |   |   |   | **Weighted** |   |
|                                                         |   | **Amortized**         |   | **Gross Unrealized** |   | **Estimated** |   | **Average** |   |
|                                                         |   | **Cost**              |   | **Gains** |   | **Losses** |   | **Fair Value** |   | **Yield** |   |
| Investment securities available for sale:                    |   |                  |   |   |   |   |   |   |   |   |   |
| U.S. government sponsored agency mortgage-backed  securities |   | $                     | 68,466 |   | $ | 2,050 |   | $ | — |   | $ | 70,516 |   | 4.34 | % |
| Corporate debt securities                                    |   | 3,377                 |   | — |   | (475 | ) | 2,902 |   | 4.07 | % |
| Total investment securities                                  |   | $                     | 71,843 |   | $ | 2,050 |   | $ | (475 | ) | $ | 73,418 |   | 4.33 | % |
|                                                         |   |                  |   |   |   |   |   |   |   |   |   |
| Unsettled mortgage-backed securities trades                  |   | $                     | 56,012 |   | $ | 660 |   | $ | — |   | $ | 56,672 |   | N/A |   |

 
|                                                         |   | **December 31, 2001** |   |
|--------------------------------------------------------------|--------|-----------------------|--------|
|                                                         |   |                  |   |   |   |   |   |   |   | **Weighted** |   |
|                                                         |   | **Amortized**         |   | **Gross Unrealized** |   | **Estimated** |   | **Average** |   |
|                                                         |   | **Cost**              |   | **Gains** |   | **Losses** |   | **Fair Value** |   | **Yield** |   |
| Investment securities available for sale:                    |   |                  |   |   |   |   |   |   |   |   |   |
| U.S. government sponsored agency mortgage-backed  securities |   | $                     | 55,169 |   | $ | 368 |   | $ | — |   | $ | 55,537 |   | 5.31 | % |
| Corporate debt securities                                    |   | 4,124                 |   | — |   | (709 | ) | 3,415 |   | 4.21 | % |
| Total investment securities                                  |   | $                     | 59,293 |   | $ | 368 |   | $ | (709 | ) | $ | 58,952 |   | 5.24 | % |

 

76

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The following table presents gross realized gains and losses on salesof investment securities and proceeds from sales and calls of investmentsecurities for the periods indicated (in thousands):

##### ** **

|                                      |   | **Years Ended December 31,** |   |
|-------------------------------------------|--------|------------------------------|--------|
|                                      |   | **2002**                     |   | **2001** |   | **2000** |   |
| Gross realized gains                      |   | $                            | — |   | $ | 108 |   | $ | — |   |
| Gross realized losses                     |   | (763                         | )      | (13 | ) | (2 | ) |
| Net gain (loss)                           |   | $                            | (763   | ) | $ | 95 |   | $ | (2 | ) |
|                                      |   |                         |   |   |   |   |   |
| Applicable income tax benefit (provision) |   | $                            | 320    |   | $ | (39 | ) | $ | 1 |   |
|                                      |   |                         |   |   |   |   |   |
| Proceeds from sales and calls             |   | $                            | — |   | $ | 271,610 |   | $ | 14,453 |   |

 

##### **Note 8. Loans**

 

***Loan Composition***

 

The following table presents the composition of the Company’s loanportfolio as of the dates indicated (in thousands):

 
|                              |   | **December 31,** |    |
|-----------------------------------|--------|------------------|---------|
|                              |   | **2002**         |    | **2001** |   |
| Income property loans:            |   |             |    |   |   |
| Non-residential real estate loans |   | $                | 386,691 |   | $ | 408,524 |   |
| Multi-family residential loans    |   | 24,535           |    | 21,896 |   |
| Construction loans                |   | —           |    | 860 |   |
| Total income property loans       |   | 411,226          |    | 431,280 |   |
|                              |   |             |    |   |   |
| SBA business loans:               |   |             |    |   |   |
| 7(a) loans - guaranteed portion   |   | 21,314           |    | 12,170 |   |
| 7(a) loans - unguaranteed portion |   | 10,969           |    | 7,860 |   |
| Total 7(a) loans                  |   | 32,283           |    | 20,030 |   |
| 504 first lien loans              |   | 3,113            |    | 1,489 |   |
| 504 second lien loans             |   | 1,886            |    | 2,647 |   |
| Total 504 loans                   |   | 4,999            |    | 4,136 |   |
| Total SBA business loans          |   | 37,282           |    | 24,166 |   |
|                              |   |             |    |   |   |
| Other loans:                      |   |             |    |   |   |
| Commercial business/other loans   |   | 7,127            |    | 6,230 |   |
| Single-family residential loans   |   | 295              |    | 303 |   |
| Total other loans                 |   | 7,422            |    | 6,533 |   |
|                              |   |             |    |   |   |
| Gross loans                       |   | 455,930          |    | 461,979 |   |
| Deferred loan costs (fees)        |   | 197              |    | (4 | ) |
| Allowance for loan losses         |   | (8,585           | )       | (7,946 | ) |
| Net loans                         |   | $                | 447,542 |   | $ | 454,029 |   |

 

As of December 31, 2002 and 2001, the Bank had pledged non-residentialreal estate loans and multi-family residential loans totaling $327.7 millionand $312.4 million, respectively, to secure its credit facility with the FHLB.

 

77

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The following table presents SBA loans held for sale as of the datesindicated (in thousands):

 
|                          |   | **December 31,** |   |
|-------------------------------|--------|------------------|--------|
|                          |   | **2002**         |   | **2001** |   |
| SBA guaranteed 7(a) loans     |   | $                | 20,621 |   | $ | 11,308 |   |
| SBA 504 first lien loans      |   | 3,113            |   | 1,489 |   |
| Total SBA loans held for sale |   | $                | 23,734 |   | $ | 12,797 |   |

 

***Allowance for LoanLosses***

 

The table below presents activity in theallowance for loan losses for the periods indicated (in thousands):

 
|                                           |   | **Years Ended December 31,** |   |
|------------------------------------------------|--------|------------------------------|--------|
|                                           |   | **2002**                     |   | **2001** |   | **2000** |   |
| Allowance for loan losses at beginning of year |   | $                            | 7,946  |   | $ | 7,240 |   | $ | 6,450 |   |
| Provision for loan losses                      |   | 471                          |   | 660 |   | 604 |   |
| Net (charge-offs) recoveries:                  |   |                         |   |   |   |   |   |
| Charge-offs                                    |   | (210                         | )      | (111 | ) | (123 | ) |
| Recoveries                                     |   | 378                          |   | 157 |   | 309 |   |
| Net (charge-offs) recoveries                   |   | 168                          |   | 46 |   | 186 |   |
| Allowance for loan losses at end of year       |   | $                            | 8,585  |   | $ | 7,946 |   | $ | 7,240 |   |

 

Accounts which are deemed uncollectible bymanagement or for which no payment has been received for five consecutivemonths are charged-off for the amount that is not collateralized by theestimated fair value less selling costs of the underlying real estatecollateral.

** **

***Non-Accrual Loans***

 

It is the Company’s policy to suspend the recognition of income on anyloan when any installment payment is 90 days or more contractually delinquentor when management otherwise determines that collectibility of principal orinterest is unlikely prior to the loan becoming 90 days past due. Recognitionof income generally is resumed, and suspended income is recognized, when theloan becomes contractually current.

 

There were no non-accrual loans at December31, 2002, 2001, and 2000.

 

***Impaired Loans***

 

The Company classifies certain loans as impaired. A loan is consideredimpaired when, based on current information and events, it is probable that theCompany will be unable to collect the scheduled payments of principal orinterest when due according to the contractual terms of the loanagreement.  Factors considered bymanagement in determining impairment include payment status, collateral value,and the probability of collecting scheduled principal and interest paymentswhen due.  Loans that experienceinsignificant payment delays and payment shortfalls generally are notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record, and the amount ofthe shortfall in relation to the principal and interest owed.  Impaired loans are generally measured by theCompany based on the present value of expected future cash flows discounted at theloan’s effective rate unless the loan is fully collateralized.

 

78

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The Company had noinvestment in impaired loans nor a valuation reserve in impaired loans as ofDecember 31, 2002, 2001, and 2000.  TheCompany had no average recorded investment in impaired loans for the yearsended December 31, 2002 and 2001, but did have a $279,000 balance for the yearended December 31, 2000.

 

### ***SBA Loan Programs***

 

During 1997, the Company initiated an SBA7(a) loan program.  Loans made underthis program generally are made to small businesses to provide working capitalor to provide funding for the purchase of businesses, real estate, or machineryand equipment.  SBA 7(a) loans are alladjustable rate based upon the *Wall StreetJournal* prime lending rate. The SBA generally guarantees 75% - 85%of the loan balance.  Under the SBA 7(a)program, the Company can sell in the secondary market the guaranteed portion ofselected SBA loans that it originates and can retain the unguaranteed portionof the loans, as well as the servicing on the loans, for which it is paid afee. The loan servicing spread is generally a minimum of 1.00% on all loans.

 

During the fourth quarter of 2000, theCompany initiated an SBA 504 loan program. Loans made by the Company under this program generally are made to smallbusinesses to provide funding for the purchase of real estate.  Under this program, the Company generallyprovides up to 90% financing of the total purchase cost, represented by two loansto the borrower. The first lien loan is generally a long-term, fixed rate loanand made in the amount of 50% of the total purchase cost. The Company’s intentis to sell the first lien loans to other banks.  The second lien loan is a short-term, adjustable rate loan, basedupon the *Wall Street Journal*prime lending rate, and made in the amount of 40% of the total purchasecost.  The Company’s second lien loanserves as an interim bridge loan to the borrower until the CertifiedDevelopment Corporation (“CDC”) obtains bond funding, pays off the Company’ssecond lien loan, and provides long-term, fixed rate financing directly to theborrower. The CDC pays off the Company’s second lien loan generally withinthree months after the loan proceeds have been fully disbursed by the Companyto the borrower.  The CDC is anon-profit corporation established to contribute to the economic development ofits community by working together with the SBA and private sector lenders suchas the Bank, to provide financing to small businesses.

 

The table below presents information related to SBA loan sales for theperiods indicated (in thousands):

 
|                                 |   | **Years Ended December 31,** |   |
|--------------------------------------|--------|------------------------------|--------|
|                                 |   | **2002**                     |   | **2001** |   | **2000** |   |
| Gains on SBA loan sales:             |   |                         |   |   |   |   |   |
| SBA guaranteed 7(a) loans            |   | $                            | 221    |   | $ | 395 |   | $ | 112 |   |
| SBA 504 first lien loans             |   | 203                          |   | 244 |   | — |   |
| Total gains on SBA loan sales        |   | $                            | 424    |   | $ | 639 |   | $ | 112 |   |
|                                 |   |                         |   |   |   |   |   |
| SBA loan sales (principal balances): |   |                         |   |   |   |   |   |
| SBA guaranteed 7(a) loans            |   | $                            | 2,929  |   | $ | 7,299 |   | $ | 2,601 |   |
| SBA 504 first lien loans             |   | 3,427                        |   | 4,592 |   | — |   |
| Total SBA loan sales                 |   | $                            | 6,356  |   | $ | 11,891 |   | $ | 2,601 |   |

 

The following table presents SBA loansserviced for others as of the dates indicated (in thousands):

 
|                                                                                                  |   | **December 31,** |   |
|-------------------------------------------------------------------------------------------------------|--------|------------------|--------|
|                                                                                                  |   | **2002**         |   | **2001** |   |
| SBA guaranteed 7(a) loans sold and serviced for  others (not included in Consolidated Balance Sheets) |   | $                | 13,784 |   | $ | 13,162 |   |
|                                                                                                       |        |                  |        |  |  |  |  |

 

79

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**Note 9. Premises and Equipment**

 

Premises and equipment of the Company is presented in the table belowas of the dates indicated (in thousands):

 
|                                            |   | **December 31,** |   |
|-------------------------------------------------|--------|------------------|--------|
|                                            |   | **2002**         |   | **2001** |   |
| Furniture, fixtures and equipment               |   | $                | 2,910  |   | $ | 2,706 |   |
| Leasehold improvements                          |   | 948              |   | 912 |   |
| Premises and equipment, gross                   |   | 3,858            |   | 3,618 |   |
| Less: accumulated depreciation and amortization |   | (2,751           | )      | (2,345 | ) |
| Premises and equipment, net                     |   | $                | 1,107  |   | $ | 1,273 |   |

 

Depreciation expense for the years endedDecember 31, 2002, 2001, and 2000 amounted to $406,000, $386,000, and $326,000,respectively.

 

##### **Note 10. Deposits**

 

Checking accounts and savings accounts have no contractualmaturity.  Certificates of deposit havematurities ranging from 30 days to five years. The approximate remaining maturities of certificates of deposit inamounts less than $100,000 and $100,000 or more as of December 31, 2002 were asfollows (in thousands):

 
|                                    |   | **Certificates of Deposit** |       |
|-----------------------------------------|--------|-----------------------------|------------|
|                                    |   | **Less Than  $100,000**     |       |   | **$ 100,000  Or More** |   |   |   |
|                                    |   | ** **                  | ** ** | **Total** | ** ** |
| Three months or less                    |   | $                           | 34,527     |   | $ | 12,899 |   | $ | 47,426 |   |
| Over three months through twelve months |   | 73,088                      |       | 28,047 |   | 101,135 |   |
| Over one year through three years       |   | 44,544                      |       | 19,249 |   | 63,793 |   |
| Over three years                        |   | 1,457                       |       | 1,251 |   | 2,708 |   |
| Total                                   |   | $                           | 153,616    |   | $ | 61,446 |   | $ | 215,062 |   |

 

**Note 11. Securities Sold Under RepurchaseAgreements**

 

Securities sold under repurchase agreements are summarized as followsas of the dates or for the periods indicated (dollars in thousands):

 
|                                           |   | **At or For the Years Ended December 31,** |   |
|------------------------------------------------|--------|--------------------------------------------|--------|
|                                           |   | **2002**                                   |   | **2001** |   | **2000** |   |
| Balance at year-end                            |   | $                                          | — |   | $ | — |   | $ | 23,500 |   |
| Average balance during the year                |   | —                                     |   | 4,015 |   | 31,153 |   |
| Maximum month-end balance during the year      |   | —                                     |   | 10,000 |   | 51,100 |   |
| Weighted average interest rate during the year |   | —                                     |   | 5.38 | % | 6.49 | % |
| Weighted average interest rate at end of year  |   | —                                     |   | — |   | 6.61 | % |
|                                                |        |                                            |        |  |  |  |  |  |  |  |

 

The Company has short-term borrowing relationships with severalinvestment banking firms.  The repaymentterms on this short-term debt range from one day to three months. The interestrate paid can vary daily, but typically approximates the federal funds rateplus 25 basis points. These borrowings are secured by pledging U.S. governmentsponsored agency securities.  TheCompany utilizes these borrowings to cover short-term financing needs.

 

80

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## **Note 12. FHLB Advances**

 

As of December 31, 2002 and 2001, the Bank had long-term, fixed rateFederal Home Loan Bank (“FHLB”) advances secured by non-residential real estateloans and multi-family residential loans, and a required investment in FHLBstock of $6.3 million and $2.0 million, respectively.  The tables below describe the attributes of these FHLB advancesas of the dates indicated (dollars in thousands):

 
|                |   | **December 31, 2002** |    |
|---------------------|--------|-----------------------|---------|
| **Borrowing Date**  |   | **Amount**            |    | **Rate** |   | **Term** |   | **Maturity Date** |   |
| November 2001       |   | $                     | 20,000  |   | 3.01 | % | 24 months |   | November 2003 |   |
| July 2002           |   | 20,000                |    | 2.29 | % | 18 months |   | January 2004 |   |
| November 2001       |   | 20,000                |    | 3.30 | % | 30 months |   | May 2004 |   |
| July 2002           |   | 10,000                |    | 2.68 | % | 24 months |   | July 2004 |   |
| August 2002         |   | 20,000                |    | 3.03 | % | 36 months |   | August 2005 |   |
| October 2002        |   | 30,000                |    | 3.06 | % | 36 months |   | October 2005 |   |
| Total FHLB advances |   | $                     | 120,000 |   | 2.93 | % |   |   |   |   |

 
|                |   | **December 31, 2001** | ** ** |
|---------------------|--------|-----------------------|------------|
| **Borrowing Date**  |   | **Amount**            | ** ** | **Rate** | ** ** | **Term** | ** ** | **Maturity Date** | ** ** |
| November 2001       |   | $                     | 20,000     |   | 3.01 | % | 24 months |   | November 2003 |   |
| November 2001       |   | 20,000                |       | 3.30 | % | 30 months |   | May 2004 |   |
| Total FHLB advances |   | $                     | 40,000     |   | 3.16 | % |   |   |   |   |

 

The Bank started using long-term, fixed rate FHLB advances in Novemberof 2001, and started using short-term, variable rate FHLB advances in April of2002.  Although there were nooutstanding short-term FHLB advances at December 31, 2002, the related averagebalance during 2002 was $9,298,000, the maximum month-end balance during 2002was $42,500,000, and the weighted average interest rate during 2002 was 1.85%.

##### ** **

##### **As of December 31, 2002, the Bank’scredit line with the FHLB totaled $193.0 million, based on an FHLB-approvedborrowing limit of 35% of the Bank’s unconsolidated total assets.**

##### ** **

##### **Note 13. TermBorrowings**

 

The Company has borrowing relationships withseveral investment banking firms, whereby the Company is able to obtainlong-term, fixed rate term borrowings secured by U.S. government sponsoredagency securities.  As of December 31,2002, the Company had no outstanding term borrowings.  The table below describes the attributes of the Company’s termborrowings as of the date indicated (dollars in thousands):

 
|                  |   | **December 31, 2001** |   |
|-----------------------|--------|-----------------------|--------|
| **Borrowing Date**    |   | **Amount**            |   | **Rate** |   | **Term** |   | **Maturity Date** |   |
| October 2000          |   | $                     | 10,000 |   | 6.65 | % | 18 months |   | April 2002 |   |
| September 2000        |   | 20,000                |   | 6.62 | % | 24 months |   | September 2002 |   |
| October 2000          |   | 10,000                |   | 6.61 | % | 24 months |   | October 2002 |   |
| Total term borrowings |   | $                     | 40,000 |   | 6.63 | % |   |   |   |   |

 

81

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##### **Note 14. Trust Preferred Securities**

 

On September 22, 1997, PCC Capital completed a $ 17.25 million publicoffering of the Trust Preferred Securities and invested the gross proceeds fromthe offering in junior subordinated debentures issued by Pacific Crest bearinginterest at 9.375%.  The juniorsubordinated debentures were issued concurrent with the issuance of the TrustPreferred Securities.  The interest onthe junior subordinated debentures paid by Pacific Crest to PCC Capitalrepresents the sole revenues of PCC Capital and the sole source of dividenddistributions to the holders of the Trust Preferred Securities. Pacific Cresthas fully and unconditionally guaranteed all of PCC Capital’s obligations underthe Trust Preferred Securities. Pacific Crest has the right, assuming nodefault has occurred, to defer payments of interest on the junior subordinateddebentures at any time for a period not to exceed 20 consecutive quarters. TheTrust Preferred  Securities will matureon October 1, 2027, but can be called in part or in total anytime after October1, 2002 by PCC Capital.

 

**Note 15. Income Taxes**

 

The income tax provision for the periods indicated is presented in thetable below (in thousands):

 
|                                  |   | **Years Ended December 31,** |   |
|---------------------------------------|--------|------------------------------|--------|
|                                  |   | **2002**                     |   | **2001** |   | **2000** |   |
| Current:                              |   |                         |   |   |   |   |   |
| Federal                               |   | $                            | 3,125  |   | $ | 2,588 |   | $ | 3,679 |   |
| State                                 |   | 1,213                        |   | 1,080 |   | 1,220 |   |
| Current income tax expense            |   | 4,338                        |   | 3,668 |   | 4,899 |   |
| Deferred:                             |   |                         |   |   |   |   |   |
| Federal                               |   | 763                          |   | 128 |   | (890 | ) |
| State                                 |   | (238                         | )      | (62 | ) | (237 | ) |
| Deferred income tax expense (benefit) |   | 525                          |   | 66 |   | (1,127 | ) |
| Total:                                |   |                         |   |   |   |   |   |
| Federal                               |   | 3,888                        |   | 2,716 |   | 2,789 |   |
| State                                 |   | 975                          |   | 1,018 |   | 983 |   |
| Income tax provision                  |   | $                            | 4,863  |   | $ | 3,734 |   | $ | 3,772 |   |

 

The tax effects of temporary differences that give rise to significantportions of the deferred tax assets as of the dates indicated are presented inthe table below (in thousands):
|                                            |   | **December 31,** |   |
|-------------------------------------------------|--------|------------------|--------|
|                                            |   | **2002**         |   | **2001** |   |
| Deferred tax assets:                            |   |             |   |   |   |
| Allowance for loan losses                       |   | $                | 3,675  |   | $ | 2,956 |   |
| Unrealized (gain) loss on investment securities |   | (939             | )      | 143 |   |
| Reserves and accruals                           |   | 355              |   | 758 |   |
| Write-down on corporate debt security           |   | 320              |   | — |   |
| State income taxes                              |   | 145              |   | 186 |   |
| Deferred gain on interest rate cap sale         |   | 110              |   | 356 |   |
| FHLB stock dividends                            |   | (70              | )      | — |   |
| Federal net loss carryback                      |   | —           |   | 804 |   |
| Total deferred tax assets                       |   | 3,596            |   | 5,203 |   |
|                                                 |        |                  |        |  |  |  |  |

 

82

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The table below presents a reconciliation between the federal statutoryincome tax rate and the effective income tax rate implicit in the ConsolidatedStatements of Income for the periods indicated:

 
|                                                |   | **Years Ended December 31,** |   |
|-----------------------------------------------------|--------|------------------------------|--------|
|                                                |   | **2002**                     |   | **2001** |   | **2000** |   |
| Federal statutory income tax rate                   |   | 35.00                        | %      | 35.00 | % | 35.00 | % |
| State franchise tax rate, net of federal tax effect |   | 5.18                         | %      | 7.26 | % | 7.07 | % |
| Other, net                                          |   | (0.40                        | )%     | (1.31 | )% | (0.35 | )% |
| Effective income tax rate                           |   | 39.78                        | %      | 40.95 | % | 41.72 | % |

 

**Note 16. Common Stock**

*** ***

The following table presents the activity in the number of shares ofcommon stock and common stock in treasury for the periods indicated: 

 
|                                             |   |              |   | **Common  Stock in  Treasury** |   | **Total (1)** |   |
|--------------------------------------------------|--------|-------------------|--------|--------------------------------|--------|---------------|--------|
|                                             |   | **Common  Stock** |   |                           |   |
|                                             |   |              |   |                           |
| Number of shares at December 31, 1999            |   | 5,973,060         |   | (769,612                       | )      | 5,203,448     |   |
| Issuances of common stock in treasury:           |   |              |   |                           |   |          |   |
| Employee stock purchase plan                     |   | —            |   | 7,040                          |   | 7,040         |   |
| Non-employee directors’ stock purchase plan |   | —            |   | 8,192                          |   | 8,192         |   |
| Employe stock option plan                        |   | —            |   | 16,160                         |   | 16,160        |   |
| Purchases of common stock in treasury            |   | —            |   | (204,000                       | )      | (204,000      | )      |
| Number of shares at December 31, 2000            |   | 5,973,060         |   | (942,220                       | )      | 5,030,840     |   |
| Issuances of common stock in treasury:           |   |              |   |                           |   |          |   |
| Employee stock purchase plan                     |   | —            |   | 8,474                          |   | 8,474         |   |
| Non-employee directors’ stock purchase plan |   | —            |   | 5,648                          |   | 5,648         |   |
| Employe stock option plan                        |   | —            |   | 4,336                          |   | 4,336         |   |
| Purchases of common stock in treasury            |   | —            |   | (209,000                       | )      | (209,000      | )      |
| Number of shares at December 31, 2001            |   | 5,973,060         |   | (1,132,762                     | )      | 4,840,298     |   |
| Issuances of common stock in treasury:           |   |              |   |                           |   |          |   |
| Employee stock purchase plan                     |   | —            |   | 7,076                          |   | 7,076         |   |
| Non-employee directors’ stock purchase plan |   | —            |   | 3,936                          |   | 3,936         |   |
| Employe stock option plan                        |   | —            |   | 101,132                        |   | 101,132       |   |
| Purchases of common stock in treasury            |   | —            |   | (98,800                        | )      | (98,800       | )      |
| Number of shares at December 31, 2002            |   | 5,973,060         |   | (1,119,418                     | )      | 4,853,642     |   |

 

----

(1)Represents total common shares issued and outstanding

 

**Note 17. Stock Purchase Plans and Stock Option Plans**

 

***Non-EmployeeDirectors’ Stock Purchase Plan***

 

The Company maintains a Non-Employee Directors’ Stock Purchase Plan(the “Directors’ Plan”).  The Directors’Plan allows the directors to purchase the stock of the Company from proceeds oftheir directors’ fees. During 2002, 2001, and 2000, the Company issued 3,936,5,648, and 8,192 treasury shares, respectively, under the Directors’ Plan.

 

83

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***Employee StockPurchase Plan***

 

The Company maintains an Employee Stock Purchase Plan (“ESPP”) whichallows employees to purchase shares of the Company’s common stock at the lowerof fair value at the beginning of the plan year, or 90% of fair value at theend of the plan year. Employees’ purchases may not exceed the lesser of $25,000or 15% of their annual base compensation. Shares of common stock purchasedunder the ESPP are not issuable until the end of the year. The maximum numberof shares of common stock that may be issued under the ESPP is 150,000shares.  During 2002, 2001, and 2000,the Company issued 7,076, 8,474, and 7,040 treasury shares, respectively, underthe ESPP.  There were 76,272 sharesavailable for issuance under the ESPP as of December 31, 2002.

 

***Employee StockOption Plan***

 

Both the 2002 EquityIncentive Plan (the “2002 Plan”) and the 1993 Equity Incentive Plan (the “1993Plan”) are designed to promote and advance the interests of the Company and itsshareholders by enabling the Company to attract, retain, and reward keyemployees. The plans offer stock and cash incentive awards, as well as stockoptions. 

 

Under the 1993 Plan, themaximum number of shares of common stock with respect to which awards may begranted was initially 300,000 shares as of December 1993, with annual increasesof two percent (2%) of the total issued and outstanding shares of the Company’scommon stock as of the first day of each year, beginning on January 1, 1995.This annual 2% increase continued through the term of the 1993 Plan, whichexpired on December 31, 2002. The maximum number of shares of common stock withrespect to which awards could be granted under the 1993 Plan at December 31,2002 was 1,105,247, of which 1,062,498 had been granted, and the remaining42,749 stock option grants had expired. Of the 1,062,498 stock options that hadbeen granted through December 31, 2002, 172,944 had been exercised, leaving889,554 stock options outstanding.

 

                The 2002 Planwas approved by the Company’s shareholders at the May 10, 2002 Annual Meetingof Shareholders.  Under the 2002 Plan,the maximum number of shares of common stock with respect to which awards maybe granted is 1,000,000 shares.  At December31, 2002, the Company had no stock option grants issued under the 2002 Plan.

 

The tablebelow summarizes stock option activity for the periods indicated and has beenadjusted for the 2-for-stock split distributed November 12, 2002:

 
|                             |   | **Number of  Option  Shares** |       | **Range of  Exercise  Prices** |   | **Weighted  Average  Exercise  Price** |   |
|----------------------------------|--------|-------------------------------|------------|--------------------------------|--------|----------------------------------------|--------|
|                             |   | ** **                    | ** ** | ** **                     |
|                             |   | ** **                    | ** ** | ** **                     |
|                             |   | ** **                    | ** ** | ** **                     |
| Outstanding at December 31, 1999 |   | 708,386                       |       | $1.75  - $10.13                |   | $                                      | 5.10   |   |
| Options granted                  |   | 146,300                       |       | 5.20-6.38                      |   | 5.69                                   |   |
| Options cancelled                |   | (26,372                       | )          | 3.78-9.00                      |   | 6.97                                   |   |
| Options exercised                |   | (16,160                       | )          | 1.75-6.00                      |   | 3.26                                   |   |
| Outstanding at December 31, 2000 |   | 812,154                       |       | $1.75-$10.13                   |   | $                                      | 5.19   |   |
| Options granted                  |   | 111,600                       |       | 7.28-9.93                      |   | 8.50                                   |   |
| Options cancelled                |   | (5,368                        | )          | 5.69-9.00                      |   | 7.56                                   |   |
| Options exercised                |   | (4,336                        | )          | 3.78-6.00                      |   | 5.15                                   |   |
| Outstanding at December 31, 2001 |   | 914,050                       |       | $1.75-$10.13                   |   | $                                      | 5.58   |   |
| Options granted                  |   | 105,600                       |       | 10.98-15.50                    |   | 11.36                                  |   |
| Options cancelled                |   | (28,964                       | )          | 5.69-10.98                     |   | 8.52                                   |   |
| Options exercised                |   | (101,132                      | )          | 1.75-9.00                      |   | 5.01                                   |   |
| Outstanding at December 31, 2002 |   | 889,554                       |       | $1.75-$15.50                   |   | $                                      | 6.23   |   |

 

The estimated weighted average fair value ofstock options granted during 2002, 2001, and 2000, was $3.30, $5.44, and $4.00,respectively.

 

84

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The following table presents information onoutstanding and exercisable stock options at December 31, 2002,  and has been adjusted for the 2-for-1 stocksplit distributed November 12, 2002:

 
| **Range of  Exercise  Prices** |                                   |       |                    | **Stock Options Outstanding** |                                   | **Stock Options Exercisable** |                    |
|--------------------------------|----------------------------------------|------------|-------------------------|-------------------------------|----------------------------------------|-------------------------------|-------------------------|
|                           | **Weighted  Average  Remaining  Life** |       | **Number  Outstanding** |                          | **Weighted  Average  Exercise  Price** |                          | **Number  Exercisable** |   | **Weighted  Average  Exercise  Price** |   |
|                           | ** **                             | ** ** | ** **              | ** **                    | ** **                             |
|                           | ** **                             | ** ** | ** **              | ** **                    | ** **                             |
|                           | ** **                             | ** ** | ** **              | ** **                    | ** **                             |
| $1.75-$2.00                    |                                   | 2.1 years  |                    | 10,000                        |                                   | $                             | 1.75                    |   | 10,000 |   | $ | 1.75 |   |
| 2.01-3.00                      |                                   | 1.4 years  |                    | 167,422                       |                                   | 2.93                          |                    | 167,422 |   | 2.93 |   |
| 3.01-4.00                      |                                   | 2.6 years  |                    | 139,870                       |                                   | 3.67                          |                    | 139,870 |   | 3.67 |   |
| 5.01-6.00                      |                                   | 5.6 years  |                    | 206,607                       |                                   | 5.79                          |                    | 128,681 |   | 5.91 |   |
| 6.01-7.00                      |                                   | 7.1 years  |                    | 16,000                        |                                   | 6.30                          |                    | 7,748 |   | 6.34 |   |
| 7.01-8.00                      |                                   | 6.3 years  |                    | 76,955                        |                                   | 7.48                          |                    | 45,648 |   | 7.48 |   |
| 8.01-9.00                      |                                   | 6.7 years  |                    | 166,700                       |                                   | 8.73                          |                    | 78,200 |   | 9.00 |   |
| 9.01-10.00                     |                                   | 7.5 years  |                    | 9,000                         |                                   | 9.54                          |                    | 3,500 |   | 9.16 |   |
| 10.01-12.00                    |                                   | 9.0 years  |                    | 85,000                        |                                   | 10.97                         |                    | 1,000 |   | 10.13 |   |
| 12.01-15.50                    |                                   | 9.5 years  |                    | 12,000                        |                                   | 14.36                         |                    | — |   | — |   |
|                           |                                   | 5.0 years  |                    | 889,554                       |                                   | $                             | 6.23                    |   | 582,069 |   | $ | 5.02 |   |

 

**Note 18. Dividends**

 

As a Delawarecorporation, Pacific Crest may pay common dividends out of surplus or, if thereis no surplus, from net profits for the current and preceding fiscal year.Pacific Crest, on an unconsolidated basis, had approximately $3.6 million incash and investments less current liabilities and short-term debt at December31, 2002. However, these funds are necessary to pay future operating expensesof Pacific Crest, service all outstanding debt, including the $17.25 millionjunior subordinated debentures payable to PCC Capital, and fund possible futurecapital infusions into the Bank. Without dividends from the Bank, Pacific Crestmust rely solely on existing cash, investments and the ability to secure borrowings.  On January 28, 2003, the Company announcedthat the Board of Directors had declared a cash dividend of $0.05 per commonshare on a post-split basis for the first quarter of 2003.  The dividend was paid on March 14, 2003, toshareholders of record at the close of business on February 28, 2003.  During 2002, the Company declared and paidaggregate cash dividends of $0.18 per common share on a post-split basis for atotal of $874,000.   During 2001, theCompany declared and paid aggregate cash dividends of $0.16 per common share ona post-split basis for a total of $787,000.

 

The Bank’s ability to pay dividends toPacific Crest is restricted by California State law, which requires thatsufficient retained earnings are available to pay the dividend. At December 31,2002, the Bank had retained earnings of $26.7 million available for futuredividend payments.  During 2002, theBank declared and paid aggregate cash dividends of $3.2 million to PacificCrest.   During 2001, the Bank declaredand paid aggregate cash dividends of $3.0 million to Pacific Crest. 

 

85

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**Note 19. Accumulated Other ComprehensiveIncome (Loss)**

 

The following table presents activity inaccumulated other comprehensive income (loss) and the components of othercomprehensive income (loss) for the periods indicated (in thousands):

 
|                                                                                |   | **Years Ended December 31,** |   |
|-------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                |   | **2002**                     |   | **2001** |   | **2000** |   |
| Accumulated other comprehensive income (loss) at  beginning of year                 |   | $                            | (198   | ) | $ | (1,532 | ) | $ | (6,355 | ) |
| Other comprehensive income, net of income taxes:                                    |   |                         |   |   |   |   |   |
| ***Unrealized gains  on investment securities available for sale:***                |   |                         |   |   |   |   |   |
| Unrealized gains arising during the period                                          |   | 1,153                        |   | 2,306 |   | 8,313 |   |
| Reclassification of realized net (gains) losses  included in net income             |   | 763                          |   | (6 | ) | 2 |   |
| Net unrealized gains on investment securities,  pre-tax                             |   | 1,916                        |   | 2,300 |   | 8,315 |   |
| Income tax expense on unrealized gains                                              |   | (485                         | )      | (968 | ) | (3,491 | ) |
| Income tax expense (benefit) on realized net  (gains) losses included in net income |   | (320                         | )      | 2 |   | (1 | ) |
| *Net change in unrealized gains on  investment securities available for sale*       |   | 1,111                        |   | 1,334 |   | 4,823 |   |
| ***Unrealized gains  on unsettled mortgage-backed securities trades:***             |   |                         |   |   |   |   |   |
| Unrealized gains arising during the period                                          |   | 660                          |   | — |   | — |   |
| Income tax expense on unrealized gains                                              |   | (277                         | )      | — |   | — |   |
| *Net change in unrealized gains on  unsettled mortgage-backed securities trades*    |   | 383                          |   | — |   | — |   |
| Total other comprehensive income, net of income  taxes                              |   | 1,494                        |   | 1,334 |   | 4,823 |   |
|                                                                                |   |                         |   |   |   |   |   |
| Accumulated other comprehensive income (loss) at  end of year                       |   | $                            | 1,296  |   | $ | (198 | ) | $ | (1,532 | ) |

 

##### **Note 20.Regulatory Capital Requirements**

 

Pacific Crest is subject to legal andregulatory requirements of the Federal Reserve, while the Bank is subject tolegal and regulatory requirements of the California Financial Code, CaliforniaGeneral Corporation Law and the FDIC. These legal and regulatory requirementsspecify certain minimum capital ratios and place limits on the size and type ofloans that may be made.

 

The Bank may establish and maintain capital,surplus and undivided profits accounts and may from time to time allocate itsshareholder’s equity among such accounts so long as no part of its contributedcapital is allocated to the undivided profits account and the undivided profitsaccount never exceeds the Bank’s retained earnings.

 

Both Pacific Crest and the Bank are subjectto various regulatory capital requirements administered by the Federal Reserveand the FDIC. Failure to meet minimum capital requirements can initiate certainmandatory and possibly additional discretionary actions by the regulators that,if undertaken, could have a direct material effect on Pacific Crest’s and theBank’s financial statements. Under capital adequacy guidelines and theregulatory framework for prompt corrective action, both Pacific Crest and theBank must meet specific capital guidelines that involve quantitative measuresof assets, liabilities and certain off-balance sheet items as calculated underregulatory accounting practices. Capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk weightings and otherfactors.

 

86

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Quantitative measures established byregulation to ensure capital adequacy require both Pacific Crest and the Bankto maintain minimum amounts and ratios as set forth in the table below of totaland Tier 1 capital to risk-weighted assets and Tier 1 capital to averagequarterly assets.  Management believesthat both Pacific Crest and the Bank met all capital adequacy requirements towhich they were subject as of December 31, 2002 and 2001.

 

As of December 31, 2002 and 2001, bothPacific Crest and the Bank maintained capital ratios that categorized them as“well capitalized” under the regulatory framework for prompt corrective action.To be categorized as well capitalized, a company must maintain minimum totalrisk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in thetable below. There are no conditions known to management that would havechanged either institution’s category.

 

The followingtables present the amounts of regulatory capital and capital ratios for PacificCrest and the Bank compared to their minimum well capitalized and capitaladequacy requirements as of the dates indicated (dollars in thousands): 

 
|                                     |   | **Actual** |       | **Minimum  Well Capitalized  Requirements** |       | **Minimum  Capital Adequacy  Requirements** |       |
|------------------------------------------|--------|------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
|                                     |   |       |       |                                        |
|                                     |   | ** ** | ** ** | ** **                                  |
|                                     |   | **Amount** | ** ** | **Ratio**                                   | ** ** | **Amount**                                  | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **December 31, 2002**                    |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
|                                     |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| ***Leverage ratio -***                   |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| (Tier 1 capital to average total assets) |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 58,511     |                                        | 10.33      | %                                           | $          | 28,323 |   | 5.00 | % | $ | 22,658 |   | 4.00 | % |
| Pacific Crest Bank                       |   | 56,517     |       | 10.05                                       | %          | 28,131                                      |       | 5.00 | % | 22,505 |   | 4.00 | % |
|                                     |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| ***Tier 1  risk-based capital ratio -*** |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| (Tier 1 capital to risk-weighted assets) |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 58,511     |                                        | 13.31      | %                                           | $          | 26,374 |   | 6.00 | % | $ | 17,583 |   | 4.00 | % |
| Pacific Crest Bank                       |   | 56,517     |       | 12.91                                       | %          | 26,267                                      |       | 6.00 | % | 17,511 |   | 4.00 | % |
|                                     |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| ***Total risk-based  capital ratio -***  |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| (Total capital to risk-weighted assets)  |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 66,666     |                                        | 15.17      | %                                           | $          | 43,957 |   | 10.00 | % | $ | 35,166 |   | 8.00 | % |
| Pacific Crest Bank                       |   | 62,028     |       | 14.17                                       | %          | 43,779                                      |       | 10.00 | % | 35,023 |   | 8.00 | % |
|                                     |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| Average total assets -                   |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 566,454    |                                        |       |                                        |       |   |   |   |   |   |   |   |
| Pacific Crest Bank                       |   | 562,627    |       |                                        |       |                                        |       |   |   |   |   |   |   |
|                                     |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| Risk-weighted assets -                   |   |       |       |                                        |       |                                        |       |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 439,570    |                                        |       |                                        |       |   |   |   |   |   |   |   |
| Pacific Crest Bank                       |   | 437,787    |       |                                        |       |                                        |       |   |   |   |   |   |   |

 

87

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|                                     |   | **Actual** |       | **Minimum  Well Capitalized  Requirements** |       | **Minimum  Capital Adequacy  Requirements** |
|------------------------------------------|--------|------------|------------|---------------------------------------------|------------|---------------------------------------------|
|                                     |   |       |       |
|                                     |   | ** ** | ** ** |
|                                     |   | **Amount** | ** ** | **Ratio**                                   | ** ** | **Amount**                                  | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **December 31, 2001**                    |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
|                                     |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| ***Leverage ratio -***                   |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| (Tier 1 capital to average total assets) |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 50,887     |                                        | 9.49       | %                                           | $ | 26,808 |   | 5.00 | % | $ | 21,446 |   | 4.00 | % |
| Pacific Crest Bank                       |   | 51,165     |       | 9.61                                        | %          | 26,618                                      |   | 5.00 | % | 21,295 |   | 4.00 | % |
|                                     |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| ***Tier 1  risk-based capital ratio -*** |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| (Tier 1 capital to risk-weighted assets) |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 50,887     |                                        | 11.11      | %                                           | $ | 27,477 |   | 6.00 | % | $ | 18,318 |   | 4.00 | % |
| Pacific Crest Bank                       |   | 51,165     |       | 11.22                                       | %          | 27,370                                      |   | 6.00 | % | 18,247 |   | 4.00 | % |
|                                     |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| ***Total risk-based  capital ratio -***  |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| (Total capital to risk-weighted assets)  |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 61,165     |                                        | 13.36      | %                                           | $ | 45,796 |   | 10.00 | % | $ | 36,637 |   | 8.00 | % |
| Pacific Crest Bank                       |   | 56,895     |       | 12.47                                       | %          | 45,617                                      |   | 10.00 | % | 36,494 |   | 8.00 | % |
|                                     |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| Average total assets -                   |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 536,150    |                                        |       |                                        |   |   |   |   |   |   |   |   |
| Pacific Crest Bank                       |   | 532,367    |       |                                        |       |                                        |   |   |   |   |   |   |   |
|                                     |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| Risk-weighted assets -                   |   |       |       |                                        |       |                                        |   |   |   |   |   |   |   |
| Pacific Crest Capital, Inc.              |   | $          | 457,958    |                                        |       |                                        |   |   |   |   |   |   |   |   |
| Pacific Crest Bank                       |   | 456,171    |       |                                        |       |                                        |   |   |   |   |   |   |   |

 

**Note 21. Retirement Savings and SupplementalExecutive Retirement Plans**

 

Company employees participate in theCompany’s 401(k) Plan (the “Retirement Plan”). The Retirement Plan coverssubstantially all employees.  During2002, employees were able to contribute up to 20% of their salary up to amaximum of $11,000.  The Company matchesemployee contribution amounts equal to 100% of the first 6% of compensationcontributed by each participant. Amounts charged to expense under theRetirement Plan for these matching contributions were $298,000, $255,000, and$233,000, for the years ended December 31, 2002, 2001, and 2000, respectively.

 

At December 31, 2002, four executive officersof the Company participated in the Company’s Supplemental Executive RetirementPlan (the “Executive Retirement Plan”). The Executive Retirement Plan providesfor annual retirement benefits that would be payable to the executives on theirnormal retirement date. The Executive Retirement Plan provides for the offsetfor social security benefits and matching 401(k) contributions made under theRetirement Plan. Offsets for social security and 401(k) matching contributionsmay be substantial.

 

88

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The following table presents activity in theExecutive Retirement Plan for the periods indicated (in thousands):

 
|                                                    |   | **Years Ended December 31,** |   |
|---------------------------------------------------------|--------|------------------------------|--------|
|                                                    |   | **2002**                     |   | **2001** |   | **2000** |   |
| **Change in Benefit Obligation**                        |   |                         |   |   |   |   |   |
| Benefit obligation at beginning of the year             |   | $                            | 1,123  |   | $ | 1,071 |   | $ | 949 |   |
| Service cost                                            |   | 48                           |   | 55 |   | 50 |   |
| Interest cost                                           |   | 88                           |   | 87 |   | 78 |   |
| Actuarial (gain) loss                                   |   | 38                           |   | (90 | ) | (6 | ) |
| Benefit obligation at end of the year                   |   | 1,297                        |   | 1,123 |   | 1,071 |   |
|                                                    |   |                         |   |   |   |   |   |
| **Change in Plan Assets**                               |   |                         |   |   |   |   |   |
| Fair value of plan assets at beginning and end of  year |   | —                       |   | — |   | — |   |
|                                                    |   |                         |   |   |   |   |   |
| **Funded Status**                                       |   | (1,297                       | )      | (1,123 | ) | (1,071 | ) |
| Unrecognized prior service cost                         |   | 143                          |   | 159 |   | 175 |   |
| Unrecognized net actuarial (gain) loss                  |   | (78                          | )      | (116 | ) | (26 | ) |
| Accrued pension cost                                    |   | $                            | (1,232 | ) | $ | (1,080 | ) | $ | (922 | ) |

 

The following table presents the components of net periodic pensioncost for the periods indicated (in thousands):

 
|                               |   | **Years Ended December 31,** |   |
|------------------------------------|--------|------------------------------|--------|
|                               |   | **2002**                     |   | **2001** |   | **2000** |   |
| Service cost                       |   | $                            | 48     |   | $ | 55 |   | $ | 50 |   |
| Interest cost                      |   | 88                           |   | 87 |   | 78 |   |
| Amortization of prior service cost |   | 16                           |   | 16 |   | 16 |   |
| Net periodic pension cost          |   | $                            | 152    |   | $ | 158 |   | $ | 144 |   |

 

Accrued pension cost was reported in the Consolidated Balance Sheetsunder the caption “Accrued interest payable and other liabilities”.   Net periodic pension cost was reported inthe Consolidated Statements of Income under the caption “Salaries and employeebenefits”.

 

##### **Note 22. Interest Rate Cap**

 

On February 8, 2000, the Company sold itsinterest rate cap agreement for $2.5 million and recognized a deferred gain of$1.8 million, which is reported in the Consolidated Balance Sheets under thecaption, “Accrued interest payable and other liabilities”.  The interest rate cap agreement had originallybeen purchased on June 8, 1998, at a price of $925,000.  The deferred gainis being amortized as a credit to “Interest expense – deposits” over theremaining life of the original interest rate cap agreement, which had amaturity date of June 8, 2003.  Duringthe years ended December 31, 2002, 2001, and 2000, the amount of deferred gainamortization totaled $554,000, $554,000, and $495,000, respectively, whichresulted in a reduction in interest expense on deposits.  As of December 31, 2002, the remainingunamortized balance of the deferred gain resulting from the sale of theinterest rate cap totaled $240,000.

 

89

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**Note 23. Commitments and Contingencies**

 

***Lease Commitments***

 

The Companyleases its office facilities. Future minimum rental payments required underoperating leases that have initial and remaining non-cancelable terms in excessof one year are approximately as indicated in the table below as of December31, 2002 (in thousands):

 
| **Years ended December 31,** |
|------------------------------|
| 2003                         |   | $ | 776 |   |
| 2004                         |   | 629 |   |
| 2005                         |   | 595 |   |
| 2006                         |   | 415 |   |
| 2007                         |   | 240 |   |
| Thereafter                   |   | 500 |   |
| Total                        |   | $ | 3,155 |   |

 

Certain leasescontain rental escalation clauses based on increases in the Consumer PriceIndex and renewal options, which may be exercised by the Company.  Rent expense for the years ended December31, 2002, 2001, and 2000 totaled $836,000, $836,000, and $743,000,respectively.

 

### ***UnfundedCommitments***

 

The Bank makes unfunded commitments with itsincome property lending activities for building improvements to property.  At December 31, 2002 and 2001, the Bank hadunfunded commitments to fund income property loans secured by real estate of $0.5 million and $1.7 million, respectively. The Bank’s unfunded income property loan commitments may involve tovarying degrees, elements of credit and interest rate risk that are notrecognized in the Consolidated Balance Sheets. The Company’s exposure to credit loss is represented by the contractualamount of these commitments.  Theserisks are generally mitigated by the real estate collateral securing the incomeproperty loan commitments and the SBA guarantee on SBA 7(a) loan commitments.

 

***Litigation***

 

There arecurrently no legal claims pending against the Company.

##### ** **

##### **Note 24. EstimatedFair Value of Financial Instruments**

 

The fair valueof a financial instrument is the current amount that would be exchanged betweenwilling parties, other than in a forced liquidation.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are noquoted market prices for the Company’s various financial instruments.  In cases where quoted market prices are notavailable, fair values are based on estimates using present value or othervaluation techniques.  Those techniquesare significantly affected by the assumptions used, including the discount rateand estimates of future cash flows. Accordingly, the fair value estimates may not be realized in animmediate settlement of the instrument. SFAS No. 107, *Disclosures About FairValue of Financial Instruments*, excludes certain financialinstruments and all non-financial instruments from its disclosure requirements.Accordingly, the aggregate fair value amounts presented may not necessarilyrepresent the underlying fair value of the Company.

 

Because noconventional market exists for a significant portion of the Company’s financialinstruments, and because of the inherent imprecision of estimating fair valuesfor financial instruments for which no conventional trading market exists,management believes that the fair market value estimates should be viewed asonly approximate values that the Company would receive if the Company’s assetsand liabilities were sold.

 

90

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The carryingamounts and estimated fair values for certain of the Company’s financialinstruments as of the dates indicated are summarized in the following table (inthousands):

 
|                                         |   | **December 31, 2002** |       | **December 31, 2001**     |       |
|----------------------------------------------|--------|-----------------------|------------|---------------------------|------------|
|                                         |   | **Carrying  Amount**  |       | **Estimated  Fair Value** |       | **Carrying  Amount** |   | **Estimated  Fair Value** |   |
|                                         |   | ** **            | ** ** | ** **                | ** ** |
| **Assets**                                   |   |                  |       |                      |       |   |   |   |   |
| Cash                                         |   | $                     | 3,199      |                      | $          | 3,199 |   | $ | 2,508 |   | $ | 2,508 |   |
| Securities purchased under resale agreements |   | 7,802                 |       | 7,802                     |       | 16,174 |   | 16,174 |   |
|                                         |   |                  |       |                      |       |   |   |   |   |
| Investment securities available for sale:    |   |                  |       |                      |       |   |   |   |   |
| U.S. agency mortgage-backed securities       |   | 70,516                |       | 70,516                    |       | 55,537 |   | 55,537 |   |
| Corporate debt securities                    |   | 2,902                 |       | 2,902                     |       | 3,415 |   | 3,415 |   |
| Total investment securities                  |   | 73,418                |       | 73,418                    |       | 58,952 |   | 58,952 |   |
|                                         |   |                  |       |                      |       |   |   |   |   |
| Unsettled mortgage-backed securities trades  |   | 56,672                |       | 56,672                    |       | — |   | — |   |
| Loans, net                                   |   | 447,542               |       | 465,024                   |       | 454,029 |   | 471,181 |   |
| Accrued interest receivable                  |   | 2,353                 |       | 2,353                     |       | 2,532 |   | 2,532 |   |
|                                         |   |                  |       |                      |       |   |   |   |   |
| **Liabilities**                              |   |                  |       |                      |       |   |   |   |   |
| Deposits:                                    |   |                  |       |                      |       |   |   |   |   |
| Checking accounts                            |   | 16,014                |       | 16,014                    |       | 14,912 |   | 14,912 |   |
| Savings accounts                             |   | 128,420               |       | 128,420                   |       | 136,145 |   | 136,145 |   |
| Certificates of deposit                      |   | 215,062               |       | 217,213                   |       | 250,466 |   | 252,971 |   |
| Total deposits                               |   | 359,496               |       | 361,647                   |       | 401,523 |   | 404,028 |   |
|                                         |   |                  |       |                      |       |   |   |   |   |
| Borrowings:                                  |   |                  |       |                      |       |   |   |   |   |
| FHLB advances                                |   | 120,000               |       | 121,873                   |       | 40,000 |   | 39,515 |   |
| Term borrowings                              |   | —                |       | —                    |       | 40,000 |   | 41,096 |   |
| Trust preferred securities                   |   | 17,250                |       | 17,267                    |       | 17,250 |   | 17,250 |   |
| Total borrowings                             |   | 137,250               |       | 139,140                   |       | 97,250 |   | 97,861 |   |
|                                         |   |                  |       |                      |       |   |   |   |   |
| Accrued interest payable                     |   | 416                   |       | 416                       |       | 995 |   | 995 |   |
|                                              |        |                       |            |                           |            |  |  |  |  |  |  |  |  |

 

The followingmethods and assumptions were used by the Company in estimating fair valuedisclosures for financial instruments:

 

***Cash*-**The carrying amounts reported in the balance sheet for cash approximatefair value.

 

***Securities purchasedunder resale agreements******-***The carryingamounts of securities purchased under resale agreements approximate their fairvalues due to the short maturity of these investments.

 

### ***Investmentsecurities available for sale***- Fair value isbased on the quoted market price of these securities by broker dealers making amarket for these securities on a national exchange.

 

***Unsettledmortgage-backed securities trades -*****Fair value is based on the quoted marketprice of these securities by broker dealers making a market for thesesecurities on a national exchange.

 

91

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### ***Loans***- TheCompany established the fair market value of the loan portfolio by segregatingthe loan portfolio into categories by utilizing selected factors (i.e., paymenthistory, collateral values, risk classification, cash flows) and thenforecasting an estimated fair market value sale price for each of theestablished loan categories. The estimated market value of the loan portfolioincludes categories of loans the Company believes would sell at a premiumbetween 0% and 3.0%, and categories of loans that would sell at a discountbetween 0% and 25%. A significant number of the Company’s variable rate loanscontain “floors” or minimum interest rates. The Company’s variable rate loansgenerally reprice on a quarterly basis. Many of these same loans also containcovenants requiring penalties for early repayment. The Company believes thatloans with these characteristics, as well as being well collateralized, with no```history of delinquencies, would sell at a premium. On the other hand, loanson a non-accrual basis, or loans that have been classified due to an identifiedweakness, even though fully secured, could normally only be sold for a discountdepending on the anticipated level of ultimate recovery upon liquidation of thecollateral. Fair value then, is based upon the estimated sales prices less costof sales of these loans.

 

***Deposits***- Fair value of the Company’s fixed maturity deposits are estimated using ratescurrently offered for deposits of similar remaining maturities.  The fair value of deposits with no statedmaturity such as checking accounts and savings accounts are disclosed as theamount payable on demand.

 

***FHLB advances***– The carrying amounts of short-term FHLB advances approximate their fairvalues due to the short maturity of these borrowings.  The fair values of long-term FHLB advances are estimated usingdiscounted cash flow analysis based on the Company’s current incrementalborrowing rates for similar types of borrowing arrangements.

 

***Term borrowings***- The fair values of the Company’s term borrowings are estimated usingdiscounted cash flow analysis based on the Company’s current incrementalborrowing rates for similar types of borrowing arrangements.

 

***Trust preferredsecurities******-***Fair value is based on the quoted marketprice of these securities by broker dealers making a market for thesesecurities on a national exchange.

### *** ***

***Accrued interestreceivable and payable*-** The carrying amounts ofaccrued interest receivable and payable approximate their fair value.

##### ** **

92

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##### **Note 25.  Parent Company Financial Information**

 

The following tables present the financialstatements of Pacific Crest Capital, Inc. (Parent company only) as of the datesor for the periods indicated (in thousands):

 

*** ***

 
|                                            |   | **December 31,** |       |
|-------------------------------------------------|--------|------------------|------------|
| **Parent Company Only - Balance Sheets**        |   | **2002**         |       | **2001** |   |
| **Assets**                                      |   |             | ** ** |   | ** ** |
| Cash                                            |   | $                | 141        |   | $ | 96 |   |
| Securities purchased under resale agreements    |   | 3,445            |       | 3,130 |   |
| Cash and cash equivalents                       |   | 3,586            |       | 3,226 |   |
|                                            |   |             |       |   |   |
| Investment in Pacific Crest Bank                |   | 57,813           |       | 50,977 |   |
| Investment in PCC Capital I                     |   | 534              |       | 534 |   |
| Other assets                                    |   | 1,213            |       | 1,122 |   |
| Total assets                                    |   | $                | 63,146     |   | $ | 55,859 |   |
|                                            |   |             |       |   |   |
| **Liabilities**                                 |   |             | ** ** |   | ** ** |
| Subordinated debentures due to PCC Capital I    |   | $                | 17,784     |   | $ | 17,784 |   |
| Other liabilities                               |   | 183              |       | 100 |   |
| Total liabilities                               |   | 17,967           |       | 17,884 |   |
|                                            |   |             |       |   |   |
| **Shareholders’ Equity**                   |   |             |       |   |   |
| Common stock, at par                            |   | 60               |       | 60 |   |
| Additional paid-in capital                      |   | 27,471           |       | 27,750 |   |
| Retained earnings                               |   | 25,628           |       | 19,140 |   |
| Accumulated other comprehensive income (loss)   |   | 1,296            |       | (198 | ) |
| Common stock in treasury, at cost               |   | (9,276           | )          | (8,777 | ) |
| Total shareholders’ equity                 |   | 45,179           |       | 37,975 |   |
| Total liabilities and shareholders’ equity |   | $                | 63,146     |   | $ | 55,859 |   |

 
|                                            |   | **Years Ended December 31,** |   |
|-------------------------------------------------|--------|------------------------------|--------|
| **Parent  Company Only - Statements of Income** |   | **2002**                     |   | **2001** |   | **2000** |   |
| Interest income:                                |   |                         |   |   |   |   |   |
| Investment securities available for sale        |   | $                            | — |   | $ | 106 |   | $ | 569 |   |
| Securities purchased under resale agreements    |   | 50                           |   | 80 |   | — |   |
| Total interest income                           |   | 50                           |   | 186 |   | 569 |   |
| Interest expense:                               |   |                         |   |   |   |   |   |
| Securities sold under repurchase agreements     |   | —                       |   | 73 |   | 442 |   |
| Subordinated debentures due to PCC Capital I    |   | 1,667                        |   | 1,667 |   | 1,667 |   |
| Total intest expense                            |   | 1,667                        |   | 1,740 |   | 2,109 |   |
| Net interest expense                            |   | (1,617                       | )      | (1,554 | ) | (1,540 | ) |
| Equity income - Pacific Crest Bank              |   | 8,542                        |   | 6,451 |   | 6,338 |   |
| Dividend income - PCC Capital I                 |   | 50                           |   | 50 |   | 50 |   |
| Other income                                    |   | 1                            |   | 2 |   | 2 |   |
| Non-interest expense                            |   | (467                         | )      | (409 | ) | (340 | ) |
| Income before income taxes                      |   | 6,509                        |   | 4,540 |   | 4,510 |   |
| Income tax benefit                              |   | 853                          |   | 845 |   | 760 |   |
| Net income                                      |   | $                            | 7,362  |   | $ | 5,385 |   | $ | 5,270 |   |

 

 

93

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|                                                                           |   | **Years Ended December 31,** |       |
|--------------------------------------------------------------------------------|--------|------------------------------|------------|
| **Parent  Company Only - Statements of Cash Flows**                            |   | **2002**                     |       | **2001** |   | **2000** |   |
| **Operating activities:**                                                      |   |                         | ** ** |   | ** ** |   | ** ** |
| Net income                                                                     |   | $                            | 7,362      |   | $ | 5,385 |   | $ | 5,270 |   |
| Adjustments to reconcile net income to net cash  used in operating activities: |   |                         |       |   |   |   |   |
| Equity income - Pacific Crest Bank                                             |   | (8,542                       | )          | (6,451 | ) | (6,338 | ) |
| Net change to other assets and other liabilities                               |   | (8                           | )          | 239 |   | (377 | ) |
| Net cash used in operating activities                                          |   | (1,188                       | )          | (827 | ) | (1,445 | ) |
|                                                                           |   |                         |       |   |   |   |   |
| **Investing activities:**                                                      |   |                         | ** ** |   | ** ** |   | ** ** |
| Proceeds from sales of investment securities                                   |   | —                       |       | 10,000 |   | — |   |
| Dividends received from Pacific Crest Bank                                     |   | 3,200                        |       | 3,000 |   | 2,200 |   |
| Net cash provided by investing activities                                      |   | 3,200                        |       | 13,000 |   | 2,200 |   |
|                                                                           |   |                         |       |   |   |   |   |
| **Financing activities:**                                                      |   |                         | ** ** |   | ** ** |   | ** ** |
| (Decrease) increase in securities sold under  repurchase agreements            |   | —                       |       | (6,500 | ) | 1,000 |   |
| Proceeds from issuances of common stock in treasury                            |   | 610                          |       | 126 |   | 143 |   |
| Purchases of common stock in treasury, at cost                                 |   | (1,388                       | )          | (2,013 | ) | (1,149 | ) |
| Cash dividends paid                                                            |   | (874                         | )          | (787 | ) | (706 | ) |
| Net cash used in financing activities                                          |   | (1,652                       | )          | (9,174 | ) | (712 | ) |
|                                                                           |   |                         |       |   |   |   |   |
| Net increase in cash and cash equivalents                                      |   | 360                          |       | 2,999 |   | 43 |   |
| Cash and cash equivalents at beginning of year                                 |   | 3,226                        |       | 227 |   | 184 |   |
| Cash and cash equivalents at end of year                                       |   | $                            | 3,586      |   | $ | 3,226 |   | $ | 227 |   |

 

94

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**Note 26. Selected Quarterly Financial Data (Unaudited)**

 

The following table presents selectedquarterly financial data for the periods indicated (in thousands, except pershare data):

 
|                              |   | **Year Ended December 31, 2002** |   |
|-----------------------------------|--------|----------------------------------|--------|
|                              |   | **Fourth********Quarter**        |   | **Third  Quarter** |   | **Second  Quarter** |   | **First  Quarter** |   |
|                              |   |                             |   |   | ** ** |
| Interest income                   |   | $                                | 10,064 |   | $ | 10,484 |   | $ | 10,430 |   | $ | 10,364 |   |
| Interest expense                  |   | 3,745                            |   | 4,280 |   | 4,738 |   | 5,132 |   |
| Net interest income               |   | 6,319                            |   | 6,204 |   | 5,692 |   | 5,232 |   |
| Provision for loan losses         |   | 46                               |   | 175 |   | 150 |   | 100 |   |
| Non-interest income               |   | 453                              |   | 544 |   | 867 |   | 624 |   |
| Non-interest expense              |   | 3,194                            |   | 3,622 |   | 3,347 |   | 3,076 |   |
| Income   before income taxes |   | 3,532                            |   | 2,951 |   | 3,062 |   | 2,680 |   |
| Income tax provision              |   | 1,387                            |   | 1,000 |   | 1,319 |   | 1,157 |   |
| Net income                        |   | $                                | 2,145  |   | $ | 1,951 |   | $ | 1,743 |   | $ | 1,523 |   |
|                              |   |                             |   |   |   |   |   |   |   |
| Earnings per common share:        |   |                             |   |   |   |   |   |   |   |
| Basic                             |   | $                                | 0.44   |   | $ | 0.40 |   | $ | 0.36 |   | $ | 0.31 |   |
| Diluted                           |   | $                                | 0.40   |   | $ | 0.36 |   | $ | 0.33 |   | $ | 0.29 |   |

 
|                              |   | **Year Ended December 31, 2001** | ** ** |
|-----------------------------------|--------|----------------------------------|------------|
|                              |   | **Fourth********Quarter**        |       | **Third  Quarter** |   | **Second  Quarter** |   | **First  Quarter** | ** ** |
|                              |   |                             |       |   | ** ** |
| Interest income                   |   | $                                | 10,856     |   | $ | 11,323 |   | $ | 11,746 |   | $ | 12,728 |   |
| Interest expense                  |   | 5,444                            |       | 6,552 |   | 7,225 |   | 8,323 |   |
| Net interest income               |   | 5,412                            |       | 4,771 |   | 4,521 |   | 4,405 |   |
| Provision for loan losses         |   | 430                              |       | 150 |   | 40 |   | 40 |   |
| Non-interest income               |   | 897                              |       | 536 |   | 559 |   | 539 |   |
| Non-interest expense              |   | 3,703                            |       | 2,848 |   | 2,716 |   | 2,594 |   |
| Income   before income taxes |   | 2,176                            |       | 2,309 |   | 2,324 |   | 2,310 |   |
| Income tax provision              |   | 810                              |       | 989 |   | 971 |   | 964 |   |
| Net income                        |   | $                                | 1,366      |   | $ | 1,320 |   | $ | 1,353 |   | $ | 1,346 |   |
|                              |   |                             |       |   |   |   |   |   |   |
| Earnings per common share:        |   |                             |       |   |   |   |   |   |   |
| Basic                             |   | $                                | 0.28       |   | $ | 0.27 |   | $ | 0.27 |   | $ | 0.27 |   |
| Diluted                           |   | $                                | 0.26       |   | $ | 0.25 |   | $ | 0.25 |   | $ | 0.25 |   |

 

**Note 27. Subsequent Event**

 

On March 20, 2003, the Company announced that it had issued $13,330,000of trust preferred securities (the “New Trust Preferred Securities”) in aprivate placement offering.  Estimatednet proceeds to the Company from the offering after expenses were$13,320,000.  There were no commissionsor expenses charged by the underwriter on this transaction.  The New Trust Preferred Securities wereissued by a newly established subsidiary of the Company, Pacific Crest CapitalTrust I.   The New Trust PreferredSecurities have a maturity of 30 years, but are redeemable (callable) byPacific Crest Capital, Inc. in part or in total at par after five years.  The New Trust Preferred Securities have afixed interest rate of 6.335% during the first five years, after which theinterest rate will float and reset quarterly at the three-month Libor rate plus3.25%.

 

95

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**ITEM 9.          Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

 

None.

 

**PARTIII**

 

**ITEM10.       Directors and Executive Officersof the Registrant**

 

The Company’sDefinitive Proxy Statement for the Annual Meeting of Shareholders to be held onMay 9, 2003 (the “Proxy Statement”), is to be filed with the SEC within 120days after December 31, 2002.  Theinformation required by Item 10 will appear in the Proxy Statement under thecaptions “Election of Director” and “Executive Officers” and is incorporated hereinby reference..

 

**ITEM 11.       Executive Compensation**

 

Theinformation required by Item 11 will appear in the Proxy Statement under thecaptions “Director Compensation,” “Executive Compensation,” and  “Certain Relationships and RelatedTransactions - Compensation Committee Interlocks and Insider Participation” andis incorporated herein by reference.

 

**ITEM12.       Security Ownership of CertainBeneficial Owners and Management**

 

Theinformation required by Item 12 will appear in the Proxy Statement under thecaptions “Beneficial Ownership of Principal Shareholders and Management” and“Equity Compensation Plan Information” and is incorporated herein by reference.

 

**ITEM13.       Certain Relationships andRelated Transactions**

 

Theinformation required by Item 13 will appear in the Proxy Statement under thecaption “Certain Relationships and Related Transactions” and is incorporatedherein by reference.

 

**ITEM 14.       Controlsand Procedures**

 

(a)           Basedon their evaluation of the Company’s disclosure controls and procedures conductedwithin 90 days of the date of filing this report on Form 10-K, the Company’sChief Executive Officer and Chief Financial Officer have concluded that theCompany’s disclosure controls and procedures (as defined in Rules 13a-14(c) and15d-14(c) promulgated under the Securities Exchange Act of 1934, as amended)are effective.

 

(b)           Therehave been no significant changes in the Company’s internal controls or in otherfactors that could significantly affect these controls subsequent to the dateof their evaluation.

 

**PARTIV**

** **

**ITEM15.****       Exhibits, Financial Statements,Schedules, and Reports on Form 8-K**

** **

**(a)           1 and 2. Financial Statements**

 

The listing of financial statements requiredby this item is set forth on the Index to Consolidated Financial Statementsincluded under Item 8. “Financial Statements and Supplementary Data” as part ofthis report. All schedules have been omitted because the required informationis not applicable or has been included in the Consolidated Financial Statementsand related notes.

 

96

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**(b)           Reportson Form 8-K**

 

On October 25, 2002, the Company filed a Form8-K with the Securities and Exchange Commission dated October 17, 2002,announcing that the Company’s Board of Directors had approved a 2-for-1 stocksplit, to be effected in the form of a 100% stock dividend.  The additional shares would be distributedon November 12, 2002 to shareholders of record at the close of business onOctober 30, 2002.

 

**(c)           Listof Exhibits**

 

 
| **Number** |   | **Description**                                                                                                                                              |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                         |
| 3(i).1     |   | Amended and restated Certificate of Incorporation (1)                                                                                                        |
| 3(ii).1    |   | Amended and restated Bylaws of Pacific Crest Capital, Inc. (1)                                                                                               |
| 4.1        |   | Subordinated Indenture dated as of September 22, 1997, by and  between Pacific Crest Capital and  Wilmington Trust   Company, as indenture trustee (10) |
| 4.2        |   | Officers’ Certificate and Company Order dated September 22, 1997 (10)                                                                                   |
| 4.3        |   | Certificate of Trust of PCC Trust I dated August 18, 1997 (10)                                                                                               |
| 4.4        |   | Trust Agreement of PCC Trust I dated as of August 18, 1997 (10)                                                                                              |
| 4.5        |   | Certificate of Amendment to Certificate of Trust of PCC Trust I dated  August 20, 1997 (10)                                                                  |
| 4.6        |   | Amended and Restated Trust Agreement of PCC Capital I, dated as of  September 22, 1997 (10)                                                                  |
| 4.7        |   | Form of Trust Preferred Certificate of PCC Capital I (included as an  exhibit to exhibit 4.6) (10)                                                           |
| 4.8        |   | Form of Common Securities Certificate of PCC Capital I  (included as an exhibit to exhibit 4.6)  (10)                                                   |
| 4.9        |   | Guarantee Agreement dated as of September 22, 1997 (10)                                                                                                      |
| 4.10       |   | Agreement as to Expenses and Liabilities (10)                                                                                                                |
| 10.1       |   | Form of Indemnification Agreement (3) *                                                                                                                      |
| 10.2       |   | Pacific Crest Capital, Inc. 1993 Equity Incentive Plan, as amended  (5) *                                                                                    |
| 10.3       |   | Pacific Crest Capital, Inc. Retirement Plan and Trust (3) *                                                                                                  |
| 10.4       |   | 1994 Employee Stock Purchase Plan , as amended (6) *                                                                                                         |
| 10.5       |   | Form of Split Dollar Agreement (3) *                                                                                                                         |
| 10.6       |   | Pacific Crest Capital, Inc. Supplemental Executive Retirement Plan  (3) *                                                                                    |
| 10.7       |   | Form of Distribution Agreement (1)                                                                                                                           |
| 10.8       |   | Form of Tax Sharing Agreement between Pacific Crest Capital, Inc. and  The Foothill Group, Inc. (3)                                                          |
| 10.9       |   | Office lease between 9320 Wilshire Associates and Pacific Crest Bank,  dated May 16, 2001 (Beverly Hills Branch) (12)                                        |
| 10.10      |   | Office lease between Gulf Construction Company and Pacific Crest  Bank, dated December 4, 1998 (San Diego Branch) (12)                                       |
| 10.11      |   | Office lease between Robert Sarno, Trustee and Frances Sarno, Trustee  and Pacific Crest Bank, dated December 31,   1997 (Encino Branch) (12)           |
| 10.12      |   | Office lease between The Klussman Family Trust and Pacific Crest  Bank, dated December 16, 1998 (Agoura Hills   Corporate Office) (12)                  |
| 10.13      |   | Office lease between American Brewing Company, Ltd. and Pacific Crest  Bank, dated October 17, 2000 (San Diego   SBA Loan Production Office) (12)       |
| 10.14.1    |   | Employment Agreement between the Company and Gary Wehrle (12) *                                                                                              |
| 10.14.2    |   | Employment Agreement between the Company and Barry Otelsberg (4) *                                                                                           |
| 10.14.3    |   | Employment Agreement between the Company and Lyle Lodwick (4) *                                                                                              |
| 10.14.4    |   | Employment Agreement between the Company and Robert J. Dennen (4) *                                                                                          |
| 10.14.5    |   | Employment Agreement between the Company and Gonzalo Fernandez  (7) *                                                                                   |
| 10.14.6    |   | Employment Agreement between the Company and M. Carolyn Reinhart (11)  *                                                                                     |
| 10.14.7    |   | Employment Agreement between the Company and Kimberlee von Disterlo  (13)*                                                                                   |
| 10.15      |   | 1996 Non-Employee Directors’ Stock Plan (8)*                                                                                                            |
| 21.1       |   | Subsidiaries of the Registrant (2)                                                                                                                           |
| 23.1       |   | Consent of Independent Auditors (2)                                                                                                                          |
| 25.1       |   | Form T-1 Statement of Eligibility of Wilmington Trust Company to act  as Trustee under the Subordinated Indenture (9)                                        |
| 25.2       |   | Form T-1 Statement of Eligibility of Wilmington Trust Company to act  as Trustee under the Amended and Restated Trust Agreement (9)                          |
| 25.3       |   | Form T-1 Statement of Eligibility of Wilmington Trust Company to act  as Trustee under the Trust Preferred Securities Guarantee Agreements (9)               |

 

97

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----

* Management contracts and compensatory planor arrangements.

 
| **Notes** |   |                                                                                                                                              |
|-----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|
|      |   |                                                                                                                                              |
| (1)       |   | Incorporated herein by reference from Registrant’s Amendment No. 2 to  Form S-1 Registration Statement No. 33-68718, filed December 3, 1993. |
| (2)       |   | Filed herewith.                                                                                                                                   |
| (3)       |   | Incorporated herein by reference from Registrant’s Amendment No. 1 to  Form S-1 Registration Statement No. 33-68718, filed October 28, 1993. |
| (4)       |   | Incorporated herein by reference from Registrant’s Annual Report on  Form 10-K dated December 31, 1993, filed March 31, 1994.                |
| (5)       |   | Incorporated herein by reference from Registrant’s Proxy Statement,  filed April 14, 1999.                                                   |
| (6)       |   | Incorporated herein by reference from Registrant’s Form S-8 Registration  Statement No. 333-74736 filed December 7, 2001.                    |
| (7)       |   | Incorporated herein by reference from Registrant’s Annual Report on  Form 10-K dated December 31, 1994 filed March 30, 1995                  |
| (8)       |   | Incorporated herein by reference from Registrant’s Form S-8 Registration  Statement No. 333-23849, filed March 23, 1997.                     |
| (9)       |   | Incorporated herein by reference from Registrant’s Form S-2  Registration Statement No. 333-34257, filed August 22, 1997.                    |
| (10)      |   | Incorporated herein by reference from Registrant’s Annual Report on  Form 10-K dated December 31, 1997, filed March 27, 1998.                |
| (11)      |   | Incorporated herein by reference from Registrant’s Annual Report on  Form 10-K dated December 31, 1998, filed March 23, 1999.                |
| (12)      |   | Incorporated herein by reference from Registrant’s Quarterly Report  on Form 10-Q dated June 30, 2001, filed August 14, 2001.                |
| (13)      |   | Incorporated herein by reference from Registrant’s Quarterly Report  on Form 10-Q dated March 31, 2002, filed May 14, 2002.                  |

 

98

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the Registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                     |   |   |   |   |   |   |   |                                                                           |            |
|--------------------------|--------|--------|--------|--------|--------|--------|--------|--------------------------------------------------------------------------------|-----------------|
|                     |   |   |   |   |   |   |   | **PACIFIC CREST CAPITAL, INC.**                                                |
|                     |   |   |   |   |   |   |   |                                                                           |            |
|                     |   |   |   |   |   |   |   | **By:**                                                                        | **GARY WEHRLE** |
|                     |   |   |   |   |   |   |   | **Gary Wehrle  Chairman of the Board, President  and Chief Executive Officer** |
|                     |   |   |   |   |   |   |   |
|                     |   |   |   |   |   |   |   |
|                     |   |   |   |   |   |   |   |                                                                           |            |
| **Date: March 26, 2003** |   |   |   |   |   |   |   |
|                     |   |   |   |   |   |   |   |                                                                           |            |
|                          |        |        |        |        |        |        |        |                                                                                |                 |  |

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the Registrant and in the capacities and on thedates indicated:

 
| **Signature**          |   | **Title**                                                     |   | **Date**       |
|------------------------|--------|---------------------------------------------------------------|--------|----------------|
|                   |   |                                                          |   |           |
| /s/ GARY WEHRLE        |   | Chairman of the Board, President

and Chief Executive Officer |   | March 26, 2003 |
| Gary Wehrle            |   |                                                          |   |
|                   |   | (Principal Executive Officer)                                 |   |           |
|                   |   |                                                          |   |           |
| /s/ ROBERT J. DENNEN   |   | Senior Vice President, Chief Financial

Officer and Secretary |   | March 26, 2003 |
| Robert J. Dennen       |   |                                                          |   |
|                   |   | (Principal Financial and Accounting Officer)                  |   |           |
|                   |   |                                                          |   |           |
| /s/ RUDOLPH I. ESTRADA |   | Director                                                      |   | March 21, 2003 |
| Rudolph I. Estrada     |   |                                                          |   |           |
|                   |   |                                                          |   |           |
|                   |   |                                                          |   |           |
| /s/ MARTIN J. FRANK    |   | Director                                                      |   | March 22, 2003 |
| Martin J. Frank        |   |                                                          |   |           |
|                   |   |                                                          |   |           |
|                   |   |                                                          |   |           |
| /s/ RICHARD S. ORFALEA |   | Director                                                      |   | March 25, 2003 |
| Richard S. Orfalea     |   |                                                          |   |           |
|                   |   |                                                          |   |           |
|                   |   |                                                          |   |           |
| /s/ STEVEN J. ORLANDO  |   | Director                                                      |   | March 24, 2003 |
| Steven J. Orlando      |   |                                                          |   |           |

 

99

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**CERTIFICATION PURSUANT TO SECTION 302**

**OF THE SARBANES-OXLEY ACT OF 2002**

 

I, Gary Wehrle, certify that:

 

1.               I have reviewedthis annual report on Form 10-K of Pacific Crest Capital, Inc.;

 

2.               Based on myknowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this annual report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this annual report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisannual report (the “Evaluation Date”); and

 

c) presented in this annual report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

6.               The registrant’sother certifying officers and I have indicated in this annual report whether ornot there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  | March 26, 2003          |   | /s/ GARY WEHRLE |
|--------|-------------------------|--------|-----------------|
|   | Gary Wehrle             |
|   | Chief Executive Officer |

 

100

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**CERTIFICATION PURSUANT TO SECTION 302**

**OF THE SARBANES-OXLEY ACT OF 2002**

 

I, Robert J. Dennen, certify that:

 

1.               I have reviewedthis annual report on Form 10-K of Pacific Crest Capital, Inc.;

 

2.               Based on myknowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this annual report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this annual report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure that materialinformation relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisannual report (the “Evaluation Date”); and

 

c) presented in this annual report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

6.               The registrant’sother certifying officers and I have indicated in this annual report whether ornot there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date:  | March 26, 2003          |   | /s/ROBERT J. DENNEN |
|--------|-------------------------|--------|---------------------|
|   | Robert J. Dennen        |
|   | Chief Financial Officer |

 

101

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**CERTIFICATION PURSUANT TO**

**18 U.S.C. SECTION 1350,**

**AS ADOPTED PURSUANT TO**

**SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002**

 

 

In connection with the Annual Report on Form 10-K of Pacific CrestCapital, Inc. (the “Company”) for the year ended December 31, 2002, as filedwith the Securities and Exchange Commission (the “Report”), we, Gary Wehrle,Chief Executive Officer, and Robert J. Dennen, Chief Financial Officer,certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002, that:

 

(1)                The Report fullycomplies with the requirements of section 13(a) or 15(d) of the SecuritiesExchange Act of 1934; and

 

(2)                The informationcontained in the Report fairly presents, in all material respects, thefinancial condition and results of operations of the Company.

 

 
| Date:  | March 26, 2003          |   | /s/GARY WEHRLE      |
|--------|-------------------------|--------|---------------------|
|   | Gary Wehrle             |
|   | Chief Executive Officer |
|   |                    |
|   |                    |
|   |                    |
| Date:  | March 26, 2003          |   | /s/ROBERT J. DENNEN |
|   | Robert J. Dennen        |
|   | Chief Financial Officer |

 

102

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