10-Q 1 a4765756.txt TEMECULA VALLEY UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: September 30, 2004 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to ___________________ TEMECULA VALLEY BANCORP INC. (Exact name of registrant as specified in its charter) California 46-0476193 (State or other jurisdiction of (I.R.S. Employer incorporate or organization) Identification No.) 27710 Jefferson Avenue, Suite A100 Temecula, California 92590 (Address of principal executive offices) Registrant's telephone number, including area code: (951) 694-9940 Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Check whether or not the Company is an accelerated filer as defined in Exchange Act Rule 12b-2. Yes[ ] No[X] As of November 10, 2004, there were 8,708,467 shares of the Registrant's common stock outstanding. This Form 10-Q contains 25 pages. Exhibit Index: Page 21 PART I - FINANCIAL INFORMATION Item 1 - Financial Statements TEMECULA VALLEY BANCORP INC. STATEMENT OF FINANCIAL CONDITION September 30, 2004 and December 31, 2003 (UNAUDITED) 2004 2003 ----------------------------------- ASSETS Cash and Due from Banks $10,362,018 $9,348,013 Federal Funds Sold 26,900,000 21,400,000 ----------------------------------- Total Cash and Cash Equivilents 37,262,018 30,748,013 Loans Held for Sale 23,018,728 17,005,198 Loans: Commercial 28,236,554 33,008,385 Real Estate - Construction 179,394,158 113,846,726 Real Estate - Other 275,582,264 195,991,515 Consumer and Other 2,579,587 3,194,582 ----------------------------------- TOTAL LOANS 485,792,563 346,041,208 Net Deferred Loan Fees (3,442,305) (2,297,015) Allowance for Loan Losses (5,351,737) (3,607,833) ------------------------------------- NET LOANS 476,998,521 340,136,360 Federal Reserve & Home Loan Bank Stock, at Cost 2,125,500 1,145,000 Other Real Estate Owned 302,698 485,036 Premises and Equipment 3,979,370 2,185,543 Cash Surrender Value of Life Insurance 9,494,528 5,740,729 Deferred Tax Assets 2,428,615 2,393,000 SBA Servicing Assets 7,709,287 6,116,679 SBA Interest-Only Strips Receivable 23,644,223 20,495,511 Accrued Interest and Other Assets 8,282,710 4,761,049 -------------------------------------- $595,246,198 $431,212,118 ===================================== 1 TEMECULA VALLEY BANCORP INC. STATEMENT OF FINANCIAL CONDITION September 30, 2004 and December 31, 2003 (UNAUDITED) 2004 2003 ------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-Bearing Demand $138,303,661 $112,367,018 Money Market and NOW 73,760,874 61,340,428 Savings 44,766,390 35,180,027 Time Deposits Under $100,000 133,095,630 88,771,099 Time Deposits $100,000 and Over 138,764,865 85,828,794 ------------------------------------- TOTAL DEPOSITS 528,691,420 383,487,366 Junior Subordinated Debt Securities 20,620,000 12,372,000 Accrued Interest and Other Liabilities 6,144,102 5,669,687 ------------------------------------- TOTAL LIABILITIES 555,455,522 401,529,053 Shareholders' Equity: Common Stock - No Par Value Authorized 40,000,000 Shares; Issued and Outstanding 8,690,503 Shares at 09/30/2004 and 8,151,914 Shares at 12/31/2003 0 0 Surplus 16,596,751 14,082,278 Retained Earnings 23,193,925 15,600,787 ------------------------------------- TOTAL SHAREHOLDERS' EQUITY 39,790,676 29,683,065 ------------------------------------- $595,246,198 $431,212,118 ===================================== 2
TEMECULA VALLEY BANCORP INC. STATEMENT OF INCOME (UNAUDITED) Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 -------------------------------------------------------------------- INTEREST INCOME Interest and Fees on Loans $8,746,232 $6,335,067 $23,324,087 $17,335,478 Interest on HTM Securities - U.S. Treasuries 539 220 1,032 220 Interest on Federal Funds Sold 36,615 17,182 65,541 106,334 -------------------------------------------------------------------- TOTAL INTEREST INCOME 8,783,386 6,352,469 23,390,660 17,442,032 INTEREST EXPENSE Interest on Money Market and NOW 132,537 116,965 361,123 436,303 Interest on Savings Deposits 50,528 45,437 136,096 149,322 Interest on Time Deposits 1,380,918 953,189 3,328,896 2,771,682 Interest on Federal Funds Purchased 0 0 0 878 Interest on FHLB Advances 10,625 4,036 59,992 32,295 Interest on Junior Subordinated Debt Securities 176,237 99,492 482,942 288,955 -------------------------------------------------------------------- TOTAL INTEREST EXPENSE 1,750,845 1,219,119 4,369,049 3,679,435 -------------------------------------------------------------------- NET INTEREST INCOME 7,032,541 5,133,350 19,021,611 13,762,597 Provision for Loan Losses 1,635,000 150,000 2,385,000 650,000 -------------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 5,397,541 4,983,350 16,636,611 13,112,597 NON-INTEREST INCOME Service Charges and Fees 169,902 193,218 516,225 604,253 Gain on Sale of Loans/Assets 4,870,793 4,160,363 13,304,011 10,978,491 Fees, and Other Income 2,247,553 2,085,196 6,922,701 6,391,960 -------------------------------------------------------------------- TOTAL NON-INTEREST INCOME 7,288,248 6,438,777 20,742,937 17,974,704 -------------------------------------------------------------------- NON-INTEREST EXPENSE Salaries and Employee Benefits 5,457,390 5,076,043 16,555,198 15,037,254 Occupancy Expenses 502,233 312,429 1,177,661 875,932 Furniture and Equipment 292,755 220,571 808,790 636,714 Other Expenses 2,413,300 1,790,171 5,976,348 4,855,557 -------------------------------------------------------------------- TOTAL NON-INTEREST EXPENSE 8,665,678 7,399,214 24,517,997 21,405,457 -------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 4,020,111 4,022,913 12,861,551 9,681,844 Income Taxes 1,645,749 1,643,420 5,268,413 3,958,392 -------------------------------------------------------------------- NET INCOME $2,374,362 $2,379,493 $7,593,138 $5,723,452 ==================================================================== Per Share Data: Net Income - Basic $0.27 $0.30 $0.90 $0.74 ==================================================================== Net Income - Diluted $0.25 $0.27 $0.81 $0.66 ==================================================================== Average Number of Shares Outstanding 8,662,855 7,980,546 8,432,075 7,720,546 ==================================================================== Average Number of Shares and Equivilents 9,481,185 8,925,436 9,335,237 8,656,638 ====================================================================
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TEMECULA VALLEY BANCORP INC. STATEMENT OF CASH FLOWS (UNAUDITED) Nine Months Ended September 30, 2004 2003 ----------------------------------------- OPERATING ACTIVITIES Net Income $7,593,138 $5,723,452 Adjustments to Reconcile Net Income to Net Cash (used) provided by Operating Activities: Depreciation and Amortization 4,911,691 3,452,630 Provision for Loan Losses 2,385,000 650,000 Decrease (Increase) of Deferred Tax Asset (35,615) 0 Gain on Loan Sales (13,372,009) (10,974,941) Loans Originated for Sale (203,588,878) (183,487,804) Proceeds from Loan Sales 216,006,592 191,174,010 Increase in Cash Surrender Value of Life Insurance (181,800) (139,950) Net Change in Other Assets and Liabilities (12,185,462) (9,348,731) ----------------------------------------- NET CASH (USED) PROVIDED BY OPERATING ACTIVITIES 1,532,657 (2,951,334) ----------------------------------------- INVESTING ACTIVITIES Purchases of Investments (698,668) (150,000) Repayment (Purchases) of FRB/FHLB Stock (980,500) 497,850 Maturity of Investments 700,000 150,000 Net Increases in Loans (144,124,060) (83,745,314) Purchase of Life Insurance (3,572,000) (600,000) Purchases of Premises and Equipment (2,358,951) (258,633) Proceeds from Sale of Premises and Equipment 49,000 16,450 ----------------------------------------- NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (150,985,179) (84,089,647) ----------------------------------------- FINANCING ACTIVITIES Net Increases in Demand, NOW,Money Market and Savings Accounts 47,943,452 25,597,215 Net Increases in Time Deposits 97,260,602 70,389,260 Net Increases/(Decreases) in Borrowings 8,248,000 (5,000,000) Proceeds from the Exercise of Stock Warrants 0 811,495 Proceeds from the Exercise of Stock Options 2,514,473 1,075,553 ----------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 155,966,527 92,873,523 ----------------------------------------- NET INCREASE IN CASH AND CASH EQUIVILENTS 6,514,005 5,832,542 Cash and Cash Equivilents at Beginning of Period 30,748,013 12,180,415 ----------------------------------------- CASH AND CASH EQUIVILENTS AT END OF PERIOD $37,262,018 $18,012,957 ========================================= Supplemental Disclosures of Cash Flow Information: Interest Paid $ 4,316,437 $ 3,650,927 Income Taxes Paid $ 5,869,371 $ 4,982,328 Loans Transferred to Other Real Estate Owned $ 1,410,000 $ 1,336,036 Loans Transferred out of Other Real Estate Owned $ 1,592,338 $ -
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TEMECULA VALLEY BANCORP INC. STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY For the Period beginning December 31, 2002 and ending September 30, 2004 (UNAUDITED) Common Retained Shares Stock Surplus Earnings Total Balance at December 31, 2002 3,723,323 $3,723 $11,866,032 $7,746,448 $19,616,203 Exercise of Options 58,536 59 426,615 426,674 Including the Realization of Tax Benefits of $101,721 Exercise of Warrants 19,252 19 96,241 96,260 Net Income 1,495,279 1,495,279 ------------------------------------------------------------- Balance at March 31, 2003 3,801,111 3,801 12,388,888 9,241,727 21,634,416 Exercise of Options 19,157 19 93,282 93,301 Exercise of Warrants 143,047 143 715,092 715,235 Net Income 1,848,680 1,848,680 ------------------------------------------------------------- Balance at June 30, 2003 3,963,315 3,963 13,197,262 11,090,407 24,291,632 Exercise of Options 80,492 81 555,497 555,578 Including the Realization of Tax Benefits of $173,871 Net Income 2,379,493 2,379,493 ------------------------------------------------------------- Balance at September 30, 2003 4,043,807 4,044 13,752,759 13,469,900 27,226,703 Exercise of Options 32,150 34 325,441 325,475 Including the Realization of Tax Benefits of $149,318 Adjustment for Reorganization (4,078) 4,078 0 2 for 1 Stock Split 4,075,957 Net Income 2,130,887 2,130,887 ------------------------------------------------------------- Balance at December 31, 2003 8,151,914 0 14,082,278 15,600,787 29,683,065 Exercise of Options 156,982 0 930,408 930,408 Including the Realization of Tax Benefits of $588,840 Net Income 2,572,150 2,572,150 ------------------------------------------------------------- Balance at March 31, 2004 8,308,896 0 15,012,686 18,172,937 33,185,623 Exercise of Options 299,642 0 1,078,144 1,078,144 Including the Realization of Tax Benefits of $221,141 Net Income 2,646,626 2,646,626 ------------------------------------------------------------- Balance at June 30, 2004 8,608,538 0 16,090,830 20,819,563 36,910,393 Exercise of Options 81,965 0 505,921 505,921 Including the Realization of Tax Benefits of $208,871 Net Income 2,374,362 2,374,362 ------------------------------------------------------------- Balance at September 30, 2004 8,690,503 $0 $16,596,751 $23,193,925 $39,790,676 =============================================================
5 TEMECULA VALLEY BANCORP INC. NOTES TO FINANCIAL STATEMENTS September 30, 2004 1) Basis of Presentation: Temecula Valley Bancorp Inc. (the "Company") is the parent company of Temecula Valley Bank, N.A. (the "Bank"). The term "Company" includes the Bank throughout this Report, unless the context otherwise requires. The Company prepares its consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying financial statements are unaudited except the balance sheet at December 31, 2003, which was derived from the audited consolidated financial statements as of that date. The unaudited information furnished herein reflects all adjustments (consisting only of normal, recurring accruals), which are, in the opinion of management, necessary to fairly present the financial position of the Company with respect to the interim financial statements and the results of operations for the interim period ended September 30, 2004. The interim financial statements include the accounts of Temecula Valley Bancorp Inc. and the Bank. These financial statements do not include all disclosures associated with the Company's annual financial statements and, accordingly, should be read in conjunction with such statements. We also have three unconsolidated subsidiaries, Temecula Valley Statutory Trust I, Temecula Valley Statutory Trust II, and Temecula Valley Statutory Trust III. The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities as of the end of the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the valuation of loan servicing rights, interest only strips and the allowance for estimated loan losses. The results of operations for the nine-month period ending September 30, 2004 are not necessarily indicative of the results to be expected for the full year. 2) Accounting Policies: There were no significant accounting policy changes since the last report. 3) Stock Based Compensation Plans: At September 30, 2004, the Company has three stock based compensation plans. Two of these plans are described in Note J in the Company's 2003 Annual Report on Form 10-K. A new plan entitled the Temecula Valley Bancorp Inc. 2004 Incentive Compensation Plan was approved by the Company's shareholders at the annual meeting on May 25, 2004. That plan, as amended, is an exhibit to the second quarter 2004 10-Q. The Company continues to account for grants under its stock option plans using the intrinsic value method prescribed in Accounting Principals Board Opinion 25. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of grant over the amount an individual must pay to acquire the stock. 4) Other Matters: Temecula Valley Bancorp Inc., a one bank holding company for Temecula Valley Bank, N.A., was formed on June 3, 2002. The stock symbol for the common shares changed from TMUL.OB to TMCV.OB and the par value changed from $1.25 to $.001. The stock exchange was one share for one share. In December 2003, the Bancorp reincorporated from Delaware to California and the par value changed from $.001 to zero. All financial statements were adjusted to reflect the par value change. Stock Split: On October 24, 2003, Temecula Valley Bancorp Inc. announced a two for one stock split which was voted and approved by shareholders at a special shareholders' meeting held December 18, 2003 in Temecula, California. The split was effective December 19, 2003 and payable December 24, 2003. All share and per share data have been adjusted to reflect the common stock two for one split. 6 Item 2- Management's Discussion and Analyses of Financial Condition and Results of Operations Statements made in this Report that state the intentions, beliefs, expectations or predictions by Temecula Valley Bancorp Inc. (the "Company") or its management of the future are forward-looking statements. The Company's actual results could differ materially from those projected in such forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the Company's Form 10K and other filings made by the Company with the SEC. Copies of such filings may be obtained by contacting the Company or accessing the Company's filings at www.sec.gov. OVERVIEW This Management discussion is intended to provide additional information regarding the significant changes and trends in the Company's Financial Condition, Statement of Operations, Funds Management and Capital Planning. Commencement of operations of Temecula Valley Bank, N.A. ("Bank") was December 16, 1996. The Company, which became a one-bank holding company for the Bank, was formed on March 4, 2002, and the share exchange was on June 3, 2002. On that date one share of common stock of the Bank (Par value $1.25) was exchanged for one common share of the Company (par value $.001). In December 2003, the Company reincorporated from Delaware to California and the par value of the stock changed from $.001 to zero. On June 26, 2002, the Company participated in a Trust Preferred Securities pool in the amount of $7,000,000. The borrowing net proceeds in the amount of $6,789,000 were transferred to the Bank as capital. On September 17, 2003, the Company participated in a Trust Preferred Securities pool in the amount of $5,000,000. The borrowing proceeds in the amount of $5,000,000 were transferred to the Bank as capital. On September 20, 2004 the Company participated in a Trust Preferred Securities pool in the amount of $8,000,000. The borrowing net proceeds of $8,000,000 were transferred to the Bank as capital. Since the Bank opened, it has consistently, from year to year, had substantial growth. All per share data has been adjusted for a two for one common stock split effective December 23, 2003. Since the date of opening, the Bank, and now collectively with the Company, has grown to 247 employees (244 full time equivalent), of which 234 are full time. One third of the employees are directly involved in the origination, underwriting and processing of SBA loans. Additional support staff is required to service the SBA loans after they are funded. All employees are employed at the Bank. It is anticipated that growth will remain strong for 2004 with the opening of the full service branch in June 2004 in Rancho Bernardo (San Diego County) and the opening of the Corona branch (Riverside County) in August 2004. The full service office in Murrieta was opened on January 11, 2001 and the loan production office in El Cajon converted to a full service branch on June 18, 2001. The SBA department has expanded considerably since 2001, with loan production offices now located in Chico, CA; Fresno, CA; Sherman Oaks, CA; Anaheim Hills, CA; Irvine, CA; Sacramento, CA; St. Petersburg, FL; Coral Springs, FL; Jacksonville, FL; Atlanta, GA; Westlake, OH; Gurnee, IL; Ocean City, NJ and Bellevue, WA. In the third quarter of 2002, a real estate department that concentrates on single family residence tract lending began operating. The department is located in Corona, California. At the end of 2003, a loan production office was opened in Encinitas, California. In late 1998, staffing increased due to the addition of a full service office in Fallbrook, California, and in the third quarter of 1999 staffing increased due to the addition of a full service office in Escondido, California. In 2000, staffing increased due to the addition of the Mortgage department in Temecula and anticipatory staffing of the Murrieta office. The Mortgage department originates FHA, VA, and conventional mortgages and sells them in the secondary market. The Bank was formed as a locally owned and managed financial institution that assumes an active community role. The Bank focuses primarily upon local banking services and community needs, as well as nationwide SBA loan origination. The Bank's marketing strategy stresses its local ownership and commitment to serve the banking needs of the people and businesses in Temecula Valley, the Interstate 15 corridor and surrounding areas, as well as originating loans through the SBA network nationwide. The Bank will continue to take advantage of new full service and/or loan production office locations if they make good business sense and are located within the Bank's geographic service area. 7 FINANCIAL CONDITION Assets Total assets increased from $411,201,196 at September 30, 2003 to $431,212,118 at December 31, 2003 and to $595,246,198 at September 30, 2004. Most of the increase in the first nine months of 2004 was in loans outstanding and Federal Funds Sold. Total loans, excluding loans held for sale, increased from $346,041,208 at year-end 2003 to $485,792,563 at September 30, 2004, a $139,751,355 or 40.4% increase due to increased SBA, construction, and tract lending. The loan portfolio composition is primarily construction, commercial and real estate secured loans. The rate of loan growth should continue to be strong for 2004, due to the SBA loan production offices that have not yet reached their expected production levels, the addition of the real estate tract-lending department, the addition of the loan production office in Encinitas, California and the opening of the loan production office in San Rafael, California in July 2004. Investments Investments, which is comprised only of Federal Funds Sold, increased from $21,400,000 at December 31, 2003 to $26,900,000 at September 30, 2004. The timing of loan sales during the month, as well as deposit generation and loan growth, are the factors that most effect the Federal Funds Sold balance. Allowance for Loan Losses The allowance for loan losses increased from $3,607,833 at December 31, 2003 to $5,351,737 at September 30, 2004. This allowance does not include the $400,000 reserve for undisbursed loans, which is carried in other liabilities. The allowance was, as a percentage of loans outstanding, 1.00% at December 31, 2003 and 1.06% at September 30, 2004. The large increase in the provision in 2004 was due to the increase in SBA lending, increase in tract and other construction, and the general overall growth of the loan portfolio. The provision was $2,385,000 in the first nine months of 2004, with net chargeoffs of $641,096. The provision was $1,635,000 in the third quarter of 2004, which increased the allowance from 0.90% of total loans at June 30, 2004 to 1.06% at September 30, 2004. Management considers, through quarterly analysis, the allowance to be adequate and expects it will continue to add to this reserve for the remainder of the year as the loan portfolio balance increases. The analysis considers general factors such as changes in lending policies and procedures, economic trends, loan volume trends, changes in lending management and staff, trends in delinquencies, nonaccruals and charge-offs, changes in loan review and Board oversight, the effects of competition, legal and regulatory requirements and factors inherent to each loan pool. Summary of Allowance for Loan Loss 9 Months 2002 2003 2004 ---- ---- ---- Beginning Balance $1,239,308 $3,017,395 $3,607,833 Chargeoffs 707,455 505,586 649,737 Recoveries 25,542 74,024 8,641 Provision 2,460,000 1,022,000 2,385,000 --------- --------- --------- Ending Balance $3,017,395 $3,607,833 $5,351,737 ========= ========= ========= 8 At September 30, 2003, there was $4,951,758 of non-accrual loans, of which $4,157,030 was guaranteed by the SBA. The Bank had $9,868,931 of non-accrual loans as of September 30, 2004, of which $7,327,611 was guaranteed by the SBA. The Bank also had other real estate owned (REO) at September 30, 2004 of $302,698, consisting of one parcel of land.
NON-CURRENT LOANS & OTHER REAL ESTATE OWNED Government Guaranteed --------------------- September 30, 2003 Gross Balance Net Balance ------------------ ------------- ----------- 30 - 89 Days Past Due $ 1,195,112 ($ 946,172) $ 248,940 90+ Days Past Due & Accruing 0 (0) 0 Non-Accrual 4,951,758 (4,157,030) 794,728 --------- --------- ------- Subtotal 6,146,870 (5,103,202) 1,043,668 Other Real Estate Owned (REO) 1,336,036 (638,250) 697,786 --------- ------- ------- Total $7,482,906 ($5,741,452) $ 1,741,454 ========= ========= ========= December 31, 2003 ----------------- 30 - 89 Days Past Due $3,243,706 ($ 582,205) $ ,661,501 90+ Days Past Due & Accruing 0 (0) 0 Non-Accrual 6,764,713 (5,269,317) 1,495,396 --------- --------- --------- Subtotal 10,008,419 (5,851,522) 4,156,897 Other Real Estate Owned (REO) 485,036 (0) 485,036 --------- --------- --------- Total $10,493,455 ($5,851,522) $4,641,933 ========== ========= ========= September 30, 2004 ------------------ 30 - 89 Days Past Due $862,778 $ 3,177) $ 199,601 90+ Days Past Due & Accruing 0 (0) 0 Non-Accrual 9,868,931 (7,327,611) 2,541,320 --------- --------- --------- Subtotal 10,731,709 (7,990,788) 2,740,921 Other Real Estate Owned (REO) 302,698 (227,023) 75,675 --------- --------- --------- Total $11,034,407 ($ 8,217,811) $ 2,816,596 ========== ========= =========
Other Assets The ratio of interest earning assets to total assets was 86.86% for the first nine months of 2003 compared to 85.79% for the first nine months of 2004. The target is to keep this ratio above 90%, but has remained below that level due SBA sales that increased the SBA servicing asset, the related SBA interest only strip receivable, and the cash surrender value of life insurance. The SBA servicing asset was $5,571,993, the SBA I/O strip receivable was $18,883,704 and the cash surrender value of life insurance was $4,723,133 at September 30, 2003. At September 30, 2004, the SBA servicing asset was $7,709,287 the SBA I/O strip receivable was $23,644,233 and the cash surrender value of life insurance was $9,494,528. At December 31, 2003, the SBA servicing asset was $6,116,679, the SBA I/O strip receivable was $20,495,511 and the cash surrender value of life insurance was $5,740,729. Even though these assets are not considered interest bearing for net interest margin purposes, they do produce, or are related to, income that is part of non-interest income. 9 Liabilities Deposits increased from $383,487,366 at December 31, 2003 to $528,691,420 at September 30, 2004. Money market and NOW accounts increased $12,420,446, savings increased $9,586,363, demand deposits increased $25,936,643, and certificate of deposits (CD's) increased $97,260,602. Demand deposits comprised 26% of deposits at September 30, 2004, compared to 29% at December 31, 2003 and 30% at September 30, 2003. The increase in the ratio of certificates of deposits to total deposits is due to CD promotions in 2003 and 2004 to help fund the rapid loan growth. At September 30, 2004, more than 57% of deposits have balances of $100,000 or more. No one customer has balances that exceed 10% of the deposits of the Bank. The Bank depends on core deposits as a source of funds for the loan portfolio. Consequently, the Bank tries to attract solid core accounts yet maintain a reasonable funding cost. The core deposit base was helped by the addition of the Murrieta and El Cajon branches in 2001, the continued deposit increases at all five branches, and will be helped in the second half of 2004 by the opening of the full service branches in Rancho Bernardo in June, and Corona in August. The Bank will continue to solicit core deposits to diminish reliance on volatile funds. At December 31, 2003 and September 30, 2004 there were no short-term advances from the Federal Home Loan Bank. The borrowing capacity at the Federal Home Loan Bank as of December 31, 2003 was $25,553,805 and is $39,332,609 at September 2004. On June 26, 2002, the Company issued $7,217,000 of junior subordinated debt securities to Temecula Valley Statutory Trust I, a statutory trust created under the laws of the State of Connecticut. These debt securities are subordinated to effectively all borrowings of the Company and are due and payable on June 26, 2032. Interest is payable quarterly on these debt securities at 3-Month LIBOR plus 3.45% for an effective rate of 5.40% as of September 30, 2004. The debt securities can be redeemed for 107.5% of the principal balance through June 26, 2007 and at par thereafter. The debt securities can also be redeemed at par if certain events occur that impact the tax treatment or the capital treatment of the issuance. On September 17, 2003, the Company issued $5,155,000 of junior subordinated debt securities to Temecula Valley Statutory Trust II, a statutory trust created under the laws of the State of Delaware. These debt securities are subordinated to effectively all borrowings of the Company and are due and payable on September 17, 2033. Interest is payable quarterly on these debt securities at 3-Month LIBOR plus 2.95% for an effective rate of 4.84% as of September 30, 2004. The debt securities can be redeemed for 107.5% of the principal balance through September 17, 2008 and at par thereafter. The debt securities can also be redeemed at par if certain events occur that impact the tax treatment or the capital treatment of the issuance. On September 20, 2004 the Company issued $8,248,000 of junior subordinated debt securities to Temecula Valley Statutory Trust III, a statutory trust created under the laws of the State of Delaware. These debt securities are subordinated to effectively all borrowings of the Company and are due and payable on September 20, 2034. Interest is payable quarterly on these debt securities at 3-Month LIBOR plus 2.20% for an effective rate of 4.07% as of September 30, 2004. The debt securities can be redeemed for 107.5% of the principal balance through September 17, 2009 and at par thereafter. The debt securities can also be redeemed at par if certain events occur that impact the tax treatment or the capital treatment of the issuance. The Company also purchased a 3% minority interest in Temecula Valley Statutory Trusts I, II and III. The balance of the equity of Temecula Valley Statutory Trusts I, II and III is comprised of mandatory redeemable preferred securities. Under FASB Interpretation (FIN) No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51," the Company is not allowed to consolidate Temecula Valley Statutory Trusts I, II and III into the Company financial statements. Prior to the issuance of FIN No. 46, Bank Holding companies typically consolidated these entities. The Federal Reserve Board had ruled that certain mandatory redeemable preferred securities of a consolidated entity qualified as Tier 1 and Tier 2 Capital. At the Company, up to 25% of the Tier 1 Capital can be these debt securities with the remainder of the debt securities qualifying as Tier 2 Capital. The Company has included the net junior subordinated debt securities in its Tier 1 and Tier 2 Capital for regulatory capital purposes. 10 Capital Total capital was $39,790,676 at September 30, 2004, $29,683,065 at December 31, 2003, and $27,226,703 at September 30, 2003. For the first nine months of 2003, the $7,610,500 increase consisted of $5,723,452 of net income, $1,075,553 on the exercise of stock options and $811,495 on the exercise of warrants. For the first nine months of 2004, the $10,107,611 increase was due to $7,593,138 in net income and $2,514,473 on the exercise of stock options. Total risk based capital was 11.70%, the tier one risk based ratio was 9.47%, and the tier one leverage ratio was 9.32% at September 30, 2004, compared to a total risk based capital of 11.29%, tier one risk based capital of 9.55%, and tier one leverage ratio of 8.86% at September 30, 2003. At September 30, 2003, December 31, 2003, and September 30, 2004 the Bank and the Company were in the regulatory "well capitalized" category. RESULTS OF OPERATIONS Net Income For the third quarter of 2003, the Company earned $2,379,493 compared to $2,374,362 in 2004. Net income per basic share for the third quarter was $.30 in 2003 compared to $.27 in 2004. 2.35.69% for the third quarter of 2003, compared to 2.35% for the third quarter of 2004. The return on average assets was 2.35% for the third quarter of 2003, compared to 1.69% for the third quarter of 2004. The return on average equity was 36.77% for the third quarter of 2003, compared to 24.61% for the third quarter of 2004. For the first nine months of 2003, the Company earned $5,723,452, compared to $7,593,138 in 2004. Net income per basic share for the first nine months was $.74 in 2003 compared to $.90 in 2004. Net income per diluted share was $.66 per share in the first nine months of 2003 compared to $.81 in 2004. The return on average assets was 2.06% for the first nine months of 2003, compared to 2.03% for the first nine months of 2004. The return on average equity was 32.88% for the first nine months of 2003, compared to 29.21% for the first nine months of 2004. The 2003 and 2004 earnings were significantly affected by the sale of loans in the secondary market, most of which are SBA and mortgage loans. The sales of the SBA loans are expected to continue at this level or higher for the remainder of the year. Mortgage loans sales have slowed down from the 2003 pace. The net interest margin has stabilized after the 4.75% Federal Reserve Bank rate reductions in 2001, the .50% reduction in November 2002 and the .25% reduction in June 2003. The expected gradual increases in rates in the second half of 2004 which started with the .25% increase in July and the .25% increase in August should have a small positive effect on the net interest margin. Net income in the first nine months of 2003 and 2004 was increased by the sale of the unguaranteed portion of SBA loans. These sales increased net income before taxes by $1,965,150 in the first nine months of 2003 compared to $4,055,353 in the first nine months of 2004. These sales are expected to continue for the remainder of the year. The opening of the full service offices in Rancho Bernardo in June 2004 and the Corona full service office in August 2004 had a negative effect on earnings in the third quarter and will continue to have a negative effect in the fourth quarter of 2004. Stock-Based Compensation SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options will be measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, the Company's net income and earnings per share for the half would have been reduced the pro forma amounts indicated on the following schedule. 11
Nine Months Ending September 30 2004 2003 ---- ---- Net Income as reported $7,593,138 $ 5,723,452 Stock based compensation using the Intrinsic Value Method 20,139 8,007 Stock based compensation that would have been reported (126,090) (379,093) ------- ------- Pro Forma Net Income $7,487,187 $ 5,352,366 ========= ========= Basic per share as reported $ .90 69 Basic per share pro forma $ .81 $ .663 Diluted per share as reported 89 $ .39 Diluted per share pro forma $ .80 $ .62
Three Months Ending September 30 2004 2003 ---- ---- Net Income as reported $2,374,362 $ 2,379,493 Stock based compensation using the Intrinsic Value Method 6,951 2,669 Stock based compensation that would have been reported (42,030) (126,364) ------ ------- Pro Forma Net Income $2,339,283 $ 2,255,798 ========= ========= Basic per share as reported $ .27 $ .30 Basic per share pro forma $ .25 $ .27 Diluted per share as reported $ .27 $ .28 Diluted per share pro forma $ .25 $ .25
Net Interest Earnings Net interest income was $ 5,133,350 in the third quarter of 2003, compared to $7,032,541 in 2004. For the third quarter of 2003 the net interest margin was 5.91%, compared to 5.77% in 2004. The net interest margin decreased from 2001 to 2004 due to the Federal Reserve Bank rate reductions of 4.75% in 2001, 0.50% in late 2002 and .25% in late June 2003. The .25% Federal Reserve rate increase in July 2004 and the .25% increase in August 2004 will increase the net interest margin. The loan to deposit ratio decreased from 97.68% at September 30, 2003 to 95.59% at September 30, 2004. The net interest margin was also helped by a healthy average of 28.34% DDA to total deposits ratio for the first nine months of 2003 and 28.13% for the first nine months of 2004. The yield on loans decreased from 7.46% for the third quarter of 2003 to 7.21% for the third quarter of 2004. Rate floors on nearly $265 million of variable rate loans at September 30, 2004 helped to mitigate the effects of Federal Reserve rate reductions. The yield on investments, which are all in federal funds sold and US Treasuries, for the third quarter of 2003 was 1.56%, compared to 1.45% in 2004. The cost of interest bearing deposits was 1.73% in the third quarter of 2003 and 1.69% in the third quarter of 2004. The decrease in 2004 is due to higher CD balances offset by a lower rate environment. The cost of other borrowings, which consisted of Federal Funds purchased, Federal Home Loan Bank advances and junior subordinated debt securities borrowing was 4.52% for the third quarter of 2003 and 4.84% in 2004. The increase in the cost of other borrowings in 2004 is due to a higher percentage of the borrowings in 2004 attributable to junior Subordinated Debt Securities. 12 The Bank tries to maximize the percentage of assets it maintains as interest earning assets, with the goal of maintaining at least 90% in that category. Effectively, all of the increase in non-interest earning assets in 2003 and 2004 was in the cash surrender value of life insurance (BOLI), the SBA servicing and SBA I/O strip receivable assets. The servicing assets are tested for impairment by computing the net present value of the amount of servicing income over the expected average life of the loan. Normal servicing (adequate compensation), in accordance with industry standards, is 40 basis points of the principal balance sold. The expected life assumes either 25 or 30 percent of the note life, depending on the term of the note. The Company's average life of loans sold has been higher than the 25% or 30% assumption, giving the calculation a conservative bias. For the first nine months of 2004, $6,333,651 was collected for servicing, the asset amortization was $4,350,038 and the SBA related servicing assets increased $4,741,320. The increase in the SBA loan servicing assets was due to the sale of $132,541,887 in 7A loans during 2004. For the same period in 2003, $4,222,760 was collected for servicing, the asset amortization was $2,953,995 and the SBA related servicing assets increased $7,571,825. There was $97,124,858 in 7A loan sales during the first nine months of 2003. The servicing assets increased less in the first nine months in 2004 than 2003 due to more loans sold with a premium bid than with a par bid. The servicing calculations contain certain assumptions such as the expected life of the loan and the discount rate used to compute the present value of future cash flows. The exposure of the loan life assumption is if loans prepay faster than expected. The exposure to the discount rate assumption is if prime rate adjusts severely and permanently. Such exposure can cause adjustments to the income statement. The Bank, on a quarterly basis, has outside analysis of the servicing assets and I/O strip receivable performed to insure the fair value approximates the book value. Asset quality is a continual primary focus of the Bank, and even though risk is an integral part of the banking industry, it is the policy of the Bank's management to actively manage the risk, without sacrificing long-term stability with short-term profits. The table below summarizes the repayment rates for national SBA pools based on their maturities: SBA Pools - Constant Prepayment Rates Variable Rate Pools Greater Less Than Than 8 Yr 8 - 11 Yr 11 - 16 16 - 21 Yr 21 Yr Issue Date Life CPR Life CPR Yr Life CPR Life CPR Life CPR ---------- -------- -------- ----------- -------- -------- 2001 15.6 13.2 11.1 11.1 11.5 2000 16.3 13.7 14.0 15.9 14.4 1999 16.4 14.7 14.3 13.9 15.4 1998 14.4 15.1 16.9 14.2 16.4 1997 13.9 14.1 15.4 16.8 17.7 The following schedule displays the WAL for each SBA pool after applying the CPRs identified above: Original Maturity WAL (Yrs.) < 8 Years 1.7 8 - 11 Years 2.3 11 - 16 Years 3.5 26 - 21 Years 4.5 > 21 Years 5.3 Based on assessing each component, our estimated discount rates for each Bank SBA pool is as follows: Original Maturity Discount Rate < 8 Years 9.50% 8 - 11 Years 9.71% 11 - 16 Years 10.02% 26 - 21 Years 10.26% > 21 Years 10.45% 13 Provision for Loan Loss As discussed under "Allowance for Loan Losses", the allowance for loan losses represents management's best estimate of losses inherent in the existing loan portfolio. The Bank has established a monitoring system for loans to identify impaired loans and potential problem loans and to permit periodic evaluation of impairment and adequacy of the allowance for loan losses in a timely manner. The monitoring system and allowance for loan losses methodology has evolved over a period of years, and loan classifications have been incorporated into the determination of the allowance for loan losses. This monitoring system and allowance methodology includes a loan-by-loan analysis for all classified loans as well as loss factors for the balance of the unclassified portfolio. Classified loans are reviewed individually to estimate the amount of probable loan losses that needs to be included in the allowance. These reviews include analysis of financial information as well as evaluation of collateral securing the credit. Loss factors on the unclassified portion of the portfolio are based on such factors as historical loss experience, current portfolio delinquency and trends, and other inherent risk factors such as economic conditions, concentrations in the portfolio, risk levels of particular loan categories, internal loan review and management oversight. The provision was $2,460,000 in 2002, $1,022,000 in 2003, and $2,385,000 for the nine months of 2004. The large increase in the provision in 2002 was due to the large increase in loans outstanding as well as the substantial increase in SBA loans. For 2003, the provisions were due to loan growth. For 2004, the provisions were due to significant loan growth as well as additional provisions for our new construction loan products. The Bank plans to continue to sell the unguaranteed portion of SBA 7A loans to mitigate the risk associated with SBA 7A loans. Non-Interest Income Non-interest income contributed significantly to the earnings of the Bank in the third quarter of 2004, as it did in 2003 and 2002. Service charges decreased from $193,218 in the third quarter of 2003 to $169,902 in 2004 due to an increased number of accounts offset by a decrease in non-sufficient funds service charges. Other income increased from $2,085,196 for the third quarter of 2003 to $2,247,553 in 2004, due mainly to higher SBA loan servicing income offset by lower SBA broker income. SBA net loan servicing income increased from $407,258 in the third quarter of 2003 to $641,743 in 2004 due to the increase in the servicing portfolio. The gain on sale of loans was $4,870,793 in the third quarter of 2004 compared to $4,160,363 in the third quarter of 2003. The 2004 increase was due to higher SBA guaranteed, unguaranteed loan sales, and SBA 504 sales offset by lower mortgage loan sales. The SBA loan sales are expected to continue at this pace or higher for the remainder of the year and the mortgage loan sales will be likelylower than last year's volume due to the increase in mortgage rates.
Gain on Sale of Loans/Assets Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ----------------------------------------------------------------------------- SBA 7A Unguaranteed Sales $ 889,974 $ 857,137 $4,055,353 $ 1,965,150 SBA 7A Guaranteed Sales 2,691,096 2,367,971 6,460,308 6,181,041 SBA 504 Sales 422,957 0 732,421 0 Mortgage Sales 379,699 712,010 1,202,266 2,404,284 Other Loan Related 483,067 223,245 921,661 424,466 REO Gain (Loss) 0 0 (72,998) 0 Fixed Assets 4,000 0 5,000 3,550 ----------------------------------------------------------------------------- Total $4,870,793 $4,160,363 $13,304,011 $10,978,491 =============================================================================
14
Other Income Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 -------------------------------------------------------------------------------- Customer Fees $ 57,901 $ 57,846 $ 172,914 $ 147,883 Loan Funding 573,623 597,507 1,800,347 1,625,692 SBA Broker Income 568,175 623,045 1,872,167 2,294,506 Mortgage Broker Income 222,690 277,976 724,768 774,424 Loan Late Charges 45,272 46,874 133,723 127,226 Other Loan Charges 1,200 3,339 4,609 7,239 SBA Servicing, Net 641,743 407,258 1,895,993 1,195,869 CSV Life Insurance 109,219 56,550 256,219 169,650 FRB/FHLB Dividend 27,214 14,645 61,347 49,100 Other 516 156 614 371 -------------------------------------------------------------------------------- Total $2,247,553 $2,085,196 $6,922,701 $ 6,391,960 ================================================================================
Non-Interest Expense Non-interest expense was $8,665,678 in the third quarter of 2004 compared to $7,399,214 in the same quarter of 2003. Salaries and benefits increased from $5,076,043 in the third quarter of 2003 to $5,457,390 for the same period in 2004 due to the increase in employees from the continued expansion of the SBA department, hiring for the Corona and Rancho Bernardo office, and to support the general growth of the Company. Other expenses rose from $1,790,171 in the third quarter of 2003 to $2,413,300 in the third quarter 2004 due to higher loan volume, processing expense, the opening of loan production offices, and the start up costs for the Rancho Bernardo and Corona offices, offset by operating efficiencies.
Other Expenses Three Months Ended Six Months Ended September 30, September 30, 2004 2003 2004 2003 --------------------------------------------------------------------------------- Processing $ 249,091 $ 256,828 $ 758,077 $ 736,140 Professional 145,644 74,976 457,750 265,010 Travel & Entertainment 139,952 125,755 448,209 385,881 Director Related 47,563 29,048 102,512 126,097 Shareholder 11,150 13,931 87,391 65,396 Loan Funding 395,714 501,448 1,017,771 1,294,895 Office Related 619,392 427,708 1,650,599 1,170,487 Marketing 299,128 215,475 726,138 512,318 OCC/FDIC Assessments 46,422 37,369 128,355 99,861 Other 459,244 107,633 599,546 199,472 --------------------------------------------------------------------------------- Total $ 2,413,300 $ 1,790,171 $ 5,976,348 $ 4,855,557 =================================================================================
15 Income Taxes Income tax expense totaled $1,643,420 for the third quarter of 2003 and $1,645,749 for the third quarter of 2004. For the full year of 2002 the effective rate was 40.7%, for the full year of 2003 the effective rate was 40.9% and for the first nine months of 2004 it was 40.9%. Deferred tax assets totaled $1,728,000 at September 30, 2003, $2,393,000 at December 31, 2003 and $2,428,615 at September 30, 2004. Over half of the deferred tax asset is due to the tax deductibility-timing differences of the provision for loan loss. LIQUIDITY Funds management is essential to the ongoing profitability of a bank. A bank must attract funds at a reasonable rate and deploy the funds at an appropriate rate of return, while taking into account risk factors, interest rates, short and long term liquidity positions and profitability needs. The Bank's cash position is determined on a daily basis and on a monthly basis liquidity analysis and asset/liability management analysis are performed. The Bank maintains Federal Funds lines of credit of $18,000,000 at correspondent banks for short-term liquidity. In addition, the Bank was approved on July 31, 2001 for membership to the Federal Home Loan Bank (FHLB). The Bank has borrowing capacity at the FHLB that will fluctuate with the loan balances that are pledged as collateral. At December 31, 2003, the borrowing capacity was $25,553,805 and $39,332,609 at September 30, 2004. Throughout 2003 and 2004, a positive liquidity position was maintained, but not at a level where profits would have been diminished. The Bank presents to the Board of Directors monthly a liquidity analysis. The analysis measures the liquidity gap on a monthly basis and should always be in at least a 2% positive liquidity gap position. Since the Bank opened, the Bank has not gone into a negative liquidity gap position, even with the strong loan growth the Bank has experienced. CAPITAL PLANNING It is the goal of the Company and the Bank to always be in the regulatory "well capitalized" category. The Company updates its multiple-year capital plan annually in conjunction with the preparation of the annual budget. Capital levels are always a primary concern of the federal regulatory authorities, and the Bank submits capital plans to them when requested. It is the Company's strategy always to have an adequate level of capital, which by definition includes not having excessive or inadequate capital. 16 CRITICAL ACCOUNTING POLICIES Our accounting policies are integral to understanding the results reported. In preparing its consolidated financial statements, the Company is required to make judgments and estimates that may have a significant impact upon its financial results. Certain accounting policies require the Company to make significant estimates and assumptions, which have a material impact on the carrying value of certain assets and liabilities, and are considered critical accounting policies. The estimates and assumptions used are based on the historical experiences and other factors, which are believed to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and results of operations for the reporting periods. The Company has identified two critical accounting policies. They concern the allowance for loan loss and the SBA servicing assets. They are considered critical due to the assumptions that are contained in their calculation, as well as external factors that can affect their value. Through quarterly review and analysis, valuations and calculations are tested for reasonableness. OFF BALANCE SHEET COMMITMENTS In the normal course of business, the Bank enters into financial commitments to meet the financing needs of its customers. These financial commitments include commitments to extend credit and standby letters of credit. Those instruments involve to varying degrees, elements of credit and interest rate risk note recognized in the statement of financial position. The Company's exposure to loan loss in the event of nonperformance on commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for loans reflected in the financial statements. As of September 30, 2004 and December 31, 2003, the Company had the following outstanding financial commitments whose contractual amount represents credit risk: 2004 2003 ---- ---- Commitments to Extend Credit $211,569,000 $171,159,000 Letters of Credit 1,683,000 1,440,000 ----------- ----------- $213,252,000 $172,599,000 =========== =========== Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments to guarantee the performance of a Company customer to a third party. Since many of the commitments and standby letters of credit are expected to expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company is based on management's credit evaluation of the customer. Item 3 - Quantitative and Qualitative Disclosures About Market Risk Market risk is the possible chance of loss from unfavorable changes in market prices and rates. These changes may result in a reduction of current and future period net interest income, which is the favorable spread earned from the excess of interest income on interest-earning assets over interest expense on interest-bearing liabilities. The Company considers interest rate risk to be one of its most significant market risks, which could potentially have a significant impact on operating earnings. The structure of the Company's loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. The ongoing monitoring and management of both interest rate risk and liquidity, in the short and long term time horizons, is an important component of the Company's asset/liability management process, which is governed by limits established in the policies reviewed and approved annually by the Board of Directors. 17 As the Company does not believe it is possible to reliably predict future interest rate movements, it has maintained an appropriate process and set of measurement tools which enable it to identify and quantify sources of interest rate risk in varying rate environments. The primary tool used by the Company in managing interest rate risk is the effect of interest rate shocks on net interest income. The following reflects the Company's one-year net interest income sensitivity based on: o Asset and liability levels using September 30, 2004 as a starting point. o There are assumed to be conservative levels of balance sheet growth - low to mid single-digit growth in loans, investments and deposits, augmented by necessary changes in borrowings and retained earnings, with no growth in other major components of the balance sheet. o The prime rate and federal funds rates are assumed to move up 200 basis points and down 100 basis points over a 12-month period. o Cash flows are based on contractual maturity. Net Interest Income Sensitivity Calculated annualized Increase (decrease) in Change in projected net interest Interest Rates income at September 30, 2004 -------------- ---------------------------- + 200 basis points 15.56% - 100 basis points 2.36% In the model, both the rising and falling rate environments reflect an increase in net interest income (NII) from a flat rate environment. The analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon various assumptions. While the assumptions are developed based upon current economic and market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions. Furthermore, the sensitivity analysis does not reflect actions the Board might take in responding to or anticipating changes in interest rates. Item 4 - Controls and Procedures As of the end of the period covered by this Report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures with respect to the information generated for use in this Report. The evaluation was based in part upon reports provided by a number of executives. Based on this evaluation, as of the date of such evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective to provide reasonable assurances that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. It should be noted that the design of the Company's disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company's Chief Executive and Financial Officers have concluded that the Company's disclosure controls and procedures are, in fact, effective at a reasonable assurance level. In addition, there have been no changes in the Company's internal control over financial reporting identified in connection with the evaluation described in the above paragraph that occurred during the Company's last fiscal quarter, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 18 PART II - OTHER INFORMATION Item 1. Legal Proceedings As of September 30, 2004 the Company is not party to any litigation that is considered likely to have a material adverse effect on the Company. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to Securities Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit No. Description of Exhibit 10.13 Amended and Restated Salary Continuation Agreement between Temecula Valley Bank and Stephen H. Wacknitz dated September 30, 2004. 10.14 Amended and Restated Salary Continuation Agreement between Temecula Valley Bank and Luther J. Mohr dated January 28, 2004. 10.17 Executive Deferred Compensation Agreement between Temecula Valley Bank and Thomas P. Ivory dated April 1, 2001. 10.18 Executive Deferred Compensation Agreement between Temecula Valley Bank and Stephen H. Wacknitz dated September 30, 2004. 10.19 Salary Continuation Agreement between Temecula Valley Bank and Stephen H. Wacknitz dated January 28, 2004. 10.20 Amended and Restated Salary Continuation Agreement between Temecula Valley Bank and Scott J. Word dated September 30, 2004. 10.21 Split Dollar Agreement between Temecula Valley Bank and Thomas P. Ivory dated September 30, 2004. 10.22 Split Dollar Agreement between Temecula Valley Bank and Luther J. Mohr dated September 30, 2004. 19 10.23 Split Dollar Agreement between Temecula Valley Bank and Stephen H. Wacknitz dated September 30, 2004. 10.24 Split Dollar Agreement between Temecula Valley Bank and Scott J. Word dated September 30, 2004. 31.1 Rule 13a-14(a) Certification 31.2 Rule 13a-14(a) Certification 32.1 Section 1350 Certifications 32.2 Section 1350 Certification (b) Reports on Form 8-K The following reports on Form 8-K were filed with the Securities and Exchange Commission by the Company during the last quarter of the period covered by this Report: (1) A current report on Form 8-K dated July 7, 2004 reported a press release announcing the addition of George Cossolias to the Board of Directors of the Bank. (2) A current report on Form 8-K dated July 16, 2004 reported a press release concerning second quarter 2004 earnings. (3) A current report on Form 8-K dated July 25, 2004 that reported a press release concerning the fact that the Company was named most profitable in the United States. (4) A current report on Form 8-K dated September 30, 2004 that reported a press release and the resignation of the Banks Executive Vice President, SBA Department. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TEMECULA VALLEY BANCORP INC. DATE: November 10, 2004 BY: /s/ Stephen H. Wacknitz ---------------------------------------- Stephen H. Wacknitz, President/CEO, Chairman of the Board DATE: November 10, 2004 BY: /s/ Donald A. Pitcher ---------------------------------------- Donald A. Pitcher, Executive Vice President Chief Financial Officer 20 EXHIBIT INDEX 10.13 Amended and Restated Salary Continuation Agreement between Temecula Valley Bank and Stephen H. Wacknitz dated September 30, 2004. 10.14 Amended and Restated Salary Continuation Agreement between Temecula Valley Bank and Luther J. Mohr dated January 28, 2004. 10.17 Executive Deferred Compensation Agreement between Temecula Valley Bank and Thomas P. Ivory dated April 1, 2001. 10.18 Executive Deferred Compensation Agreement between Temecula Valley Bank and Stephen H. Wacknitz dated September 30, 2004. 10.19 Salary Continuation Agreement between Temecula Valley Bank and Stephen H. Wacknitz dated January 28, 2004. 10.20 Amended and Restated Salary Continuation Agreement between Temecula Valley Bank and Scott J. Word dated September 30, 2004. 10.21 Split Dollar Agreement between Temecula Valley Bank and Thomas P. Ivory dated September 30, 2004. 10.22 Split Dollar Agreement between Temecula Valley Bank and Luther J. Mohr dated September 30, 2004. 10.23 Split Dollar Agreement between Temecula Valley Bank and Stephen H. Wacknitz dated September 30, 2004. 10.24 Split Dollar Agreement between Temecula Valley Bank and Scott J. Word dated September 30, 2004. 31.1 Rule 13a-14(a) Certification 31.2 Rule 13a-14(a) Certification 32.1 Section 1350 Certification 32.2 Section 1350 Certification 21