| CENTER FINANCIAL CORP ITEM 1A RISK FACTORS You should carefully consider the following risk factors and all other information contained in this Annual Report before making investment decisions concerning the Company’s common stock |
| The risks and uncertainties described below are not the only ones the Company faces |
| Additional risks and uncertainties not presently known to the Bank or that the Bank currently believes are immaterial but may also impair the Bank’s business |
| If any of the events described in the following risk factors occur, the Bank’s business, results of operations and financial condition could be materially adversely affected |
| In addition, the trading price of the Company’s common stock could decline due to any of the events described in these risks |
| Poor economic conditions in California may cause us to suffer higher default rates on our loans |
| A substantial majority of the Bank’s loans are generated in the greater Los Angeles area in Southern California |
| As a result, any poor economic conditions in the Los Angeles area could cause us to incur losses associated with higher default rates and decreased collateral values in our loan portfolio |
| The Los Angeles area has, at times, experienced stagnant economic activity in line with slowdowns California |
| Concentrations of real estate loans could subject us to increased risks in the event of a real estate recession or natural disaster |
| Approximately dlra776dtta7 million or 63prca of the Bank’s loan portfolio as of December 31, 2005, and dlra607dtta3 million or 59prca of the Bank’s loan portfolio as of December 31, 2004, were concentrated in commercial real estate loans |
| Of this amount, dlra226dtta3 million represented loans secured by industrial buildings, and dlra127dtta1 million represented loans secured by retail shopping centers as of December 31, 2005 |
| Although commercial loans generally provide for higher interest rates and shorter terms than single-family residential loans, such loans generally involve a higher degree of risk, as the ability of borrowers to repay these loans is often dependent upon the profitability of the borrowers’ businesses |
| An increase in the percentage of Nonperforming assets in commercial real estate, commercial and industrial loan portfolios may have a material impact on the Bank’s financial condition and results of operations, by reducing the Bank’s income, increasing the Bank’s expenses, and leaving less cash available for lending and other activities |
| As the primary collateral for many of the Bank’s loans rests on commercial real estate properties, a downturn in real estate values in the greater Southern California region could negatively impact us by providing us with decreased collateral values in the Bank’s loan portfolio |
| In the early 1990s, the entire state of California experienced an economic recession, particularly impacting real estate values that resulted in increases in the level of delinquencies and losses for many of the state’s financial institutions |
| If any similar real estate recession affecting the Bank’s market areas should occur in the future, the security for many of the Bank’s loans could be reduced and the ability of many of the Bank’s borrowers to pay could decline |
| Similarly, the occurrence of a natural disaster like those California has experienced in the past, including earthquakes, brush fires, and flooding, could impair the value of the collateral the Bank holds for real estate secured loans and negatively impact the Bank’s results of operations |
| There is some concern California’s real estate market’s rapid appreciation rates may slow down in the future |
| The Southern California residential real estate market ended 2005 with new price peaks and a strong, but not record-breaking sales pace |
| If real estate sales and appreciation weakens, the Bank might experience an increase in the percentage of Nonperforming assets in its commercial real estate and commercial and industrial loan portfolios |
| Such an increase may have a material impact on the Bank’s financial condition and results of operations, by reducing the Bank’s income, increasing the Bank’s expenses, and leaving less cash available for lending and other activities |
| The Bank has not experienced any deterioration in the commercial real estate loan portfolio during the 2005 |
| However, there was an increase in charge-offs among construction loans, due to one large participated construction loan in the amount of dlra2dtta3 million in 2004 |
| The construction associated with this loan has been completed and the hotel is operational |
| The borrower filed a bankruptcy petition to the court followed by a Chapter 11 Plan in July 2004 |
| On November 3, 2004, the Court approved the Chapter 11 Plan |
| According to the 15 ______________________________________________________________________ [40]Table of Contents Plan, the participating group, of which the Company is a member, will be paid in 6 years |
| (See “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition —Nonperforming Assets”) |
| The Bank maintains an allowance for loan losses at a level we believe is adequate to absorb any inherent losses in the loan portfolio |
| However, changes in economic, operating and other conditions, including changes in interest rates that are beyond the Bank’s control may cause its actual loan losses to exceed current allowance estimates |
| If the actual loan losses exceed the allowance for loan losses, it will hurt the Bank’s business |
| In addition, the FDIC and the California Department of Financial Institutions, as part of their supervisory functions, periodically review the Bank’s allowance for loan losses |
| Such agencies may require the Bank to increase its provision for loan losses or to recognize further loan losses, based on their judgments, which may be different from those of the Bank’s management |
| Any increase in the allowance required by the FDIC or the Department of Financial Institutions could also hurt the Bank’s business |
| The Bank tries to limit the risk that borrowers will fail to repay loans by carefully underwriting the loans |
| Losses nevertheless occur |
| The Bank establishes a loan loss allowance for probable losses inherent in the loan portfolio as of the statements of financial condition date |
| The Bank bases allowance on estimates of the following: • industry standards; • historical loss experience; • evaluation of current economic conditions; • assessment of risk factors for loans with exposure to the economies of South Korea and other Pacific Rim countries; • regular reviews of the quality mix and size of the overall loan portfolio; • regular reviews of delinquencies; and • the quality of the collateral underlying the Bank’s loans |
| The Bank may have difficulty managing its growth |
| The Bank’s total assets have increased to dlra1dtta7 billion as of December 31, 2005, from dlra1dtta3 billion and dlra1dtta0 billion as of December 31, 2004 and 2003, respectively |
| The Bank opened on average, two new branch offices from 2002 through 2005 |
| The Bank intends to investigate other opportunities to open additional branches that would complement the Bank’s existing business as such opportunities may arise; however, the Bank can provide no assurance that it will be able to identify additional locations or open additional branches |
| The Bank’s ability to manage its growth will depend primarily on its ability to: • monitor operations; • control costs; • maintain positive customer relations; and • attract, assimilate and retain qualified personnel |
| If the Bank fails to achieve those objectives in an efficient and timely manner, the Bank may experience interruptions and dislocations in its business, which could substantially increase the expenses and negatively impact the ability to retain the Bank’s customers |
| In addition, such concerns may cause federal and state banking regulators to require us to delay or forgo any proposed growth until such problems have been addressed to the satisfaction of those regulators |
| 16 ______________________________________________________________________ [41]Table of Contents The Bank has found that growth by de novo branch banking in 2005 and prior years has temporarily increased the Bank’s overhead expenses as a percentage of its total assets |
| If the Bank continues to open additional branches, it expects to face similar increased costs |
| The Bank’s earnings are subject to interest rate risk, especially if rates fall |
| Banking companies’ earnings depend largely on the relationship between the cost of funds, primarily deposits and borrowings, and the yield on earning assets, such as loans and investment securities |
| This relationship, known as the interest rate spread, is subject to fluctuation and is affected by the monetary policies of the Federal Reserve Board, the international interest rate environment, as well as by economic, regulatory and competitive factors which influence interest rates, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of Nonperforming assets |
| Many of these factors are beyond the Bank’s control |
| Fluctuations in interest rates affect the demand of customers for products and services |
| The Bank is subject to interest rate risk to the degree that interest-bearing liabilities reprice or mature more slowly or more rapidly or on a different basis than interest-earning assets |
| Given current volume and mix of interest-bearing liabilities and interest-earning assets, interest rate spread could be expected to increase during times of rising interest rates and, conversely, to decline during times of falling interest rates |
| Therefore, significant fluctuations in interest rates may have an adverse or a positive effect on results of operations |
| See “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Risk |
| ” All of the Bank’s lending involves underwriting risks, especially in a competitive lending market |
| At December 31, 2005, commercial real estate loans represented 63prca of the Bank’s total loan portfolio; commercial lines and term loans to businesses represented 20prca of the bank’s total loan portfolio; and SBA loans represented 4prca of the bank’s total loan portfolio |
| Real estate lending involves risks associated with the potential decline in the value of underlying real estate collateral and the cash flow from income producing properties |
| Declines in real estate values and cash flows can be caused by a number of factors, including adversity in general economic conditions, rising interest rates, changes in tax and other governmental and other policies affecting real estate holdings, environmental conditions, governmental and other use restrictions, development of competitive properties, and increasing vacancy rates |
| The Bank’s dependence increases the risk of loss both in the Bank’s loan portfolio and with respect to any other real estate owned when real estate values decline |
| The Bank seeks to reduce risk of loss through underwriting and monitoring procedures |
| Commercial lending, even when secured by the assets of a business, involves considerable risk of loss in the event of failure of the business |
| To reduce such risk, the Bank typically takes additional security interests in other collateral, such as real property, certificates of deposit or life insurance, and/or obtains personal guarantees |
| Specific risks associated with SBA lending are discussed in a separate risk factor below |
| The Bank operates in a highly competitive market, and some of its competitors offer a broader range of services than the Bank provides, and have lower cost structures |
| The banking business in the Bank’s current and intended future market areas is highly competitive with respect to virtually all products and services |
| While the banking market in our primary market area is generally dominated by a relatively small number of major banks with many offices operating over a wide geographic area, the main competitors include several locally owned and operated Korean-American banks and subsidiaries of one Korean bank |
| These other banks have branches located in many of the same neighborhoods as the Bank, provide similar types of products and services and use the same Korean language publications and media for their marketing purposes |
| There is a high level of competition within this specific market |
| While major banks have not historically focused their marketing efforts on the Korean-American customer base in Southern California, their 17 ______________________________________________________________________ [42]Table of Contents competitive influence could increase in the future |
| Such banks have substantially greater lending limits than the Bank, offer certain services the Bank cannot, and often operate with “economies of scale” that result in lower operating costs than the bank can on a per loan or per asset basis |
| In addition to competitive factors impacting the bank’s specific market niche, the Bank is affected by more general competitive trends in the banking industry, including intra-state and interstate consolidation, competition from non-bank sources and technological innovations |
| Many of the Bank’s competitors have advantages conducting certain businesses and providing certain services, and there can be no assurance that the Bank will be able to compete successfully |
| The Bank also competes with other financial institutions such as savings and loan associations, credit unions, thrift and loan companies, mortgage companies, securities brokerage companies and insurance companies located within and without the Bank’s service area and with quasi-financial institutions such as money market funds for deposits and loans |
| Financial services are increasingly offered over the Internet on a national and international basis, and the Bank competes with the providers of these services as well |
| Ultimately, competition can drive down the Bank’s interest margins and reduce profitability |
| It also can make it more difficult for us to continue to increase the size of the loan portfolio and deposit base |
| ” The Company might not be able to continue to pay cash dividends in the future |
| As a banking holding company, which currently has no significant assets other than the Company’s equity interest in Center Bank, the Company’s ability to pay dividends primarily depends upon the dividends the Company receives from Center Bank |
| The dividend practice of Center Bank, like the Company’s dividend practice, will depend upon its earnings, financial position, current and anticipated cash requirements and other factors deemed relevant by Center Bank’s board of directors at that time |
| In addition, during any period in which Center Financial has deferred payment of interest otherwise due and payable on its subordinated debt securities, the Company may not make any dividends or distributions with respect to our capital stock |
| ” The Company paid quarterly cash dividends of 4 cents per share in 2005 and 2004 and currently plans to continue to pay cash dividends on a quarterly basis |
| However, the amount of any such dividend will be determined each quarter by our Board of Directors in its discretion, based on the factors described in the previous paragraph |
| No assurance can be given that future performance will justify the payment of dividends in any particular quarter |
| The Company is a legal entity separate and distinct from its subsidiaries |
| Substantially all of our revenue and cash flow, including funds available for the payment of dividends and other operating expenses, is dependent upon the payment of dividends to the Company by the Company’s subsidiaries |
| Dividends payable to the Company by Center Bank are restricted under California and federal laws and regulation |
| ” The Bank has specific risks associated with Small Business Administration loans |
| The Bank realized dlra2dtta5 million, dlra4dtta2 million, and dlra2dtta7 million, respectively, in 2005 and in 2004 and 2003, in gains recognized on secondary market sales of the Bank’s SBA loans |
| The Bank has regularly sold the guaranteed portions of these loans in the secondary market in previous years |
| However, the Company initiated the sale of the unguaranteed portion of SBA loans during the third quarter of 2004 |
| The Bank can provide no assurance that it will be able to continue originating these loans, or that a secondary market will exist for, or that it will continue to realize premiums upon the sale of the SBA loans |
| The federal government presently guarantees 75prca to 80prca of the principal amount of each qualifying SBA loan |
| The Bank can provide no assurance that the federal government will maintain the SBA program, or if it does, that such guaranteed portion will remain at its current funding level |
| Furthermore, the Bank can provide no assurance that it will retain the preferred lender status, which, subject to certain limitations, allows us to approve and fund SBA loans without the necessity of having the loan approved in advance by the SBA, or that if it does, the federal government will not reduce the amount of such loans |
| The Bank believes that the SBA loan portfolio does not involve more than a normal risk of collectibility |
| However, since the Bank has sold some of the guaranteed portions of the SBA loan portfolio, the 18 ______________________________________________________________________ [43]Table of Contents Bank incurs a pro rata credit risk on the non-guaranteed portion of the SBA loans since the Bank shares pro rata with the SBA in any recoveries |
| In the event of default on an SBA loan, pursuit of remedies against a borrower would be subject to SBA approval, and where the SBA establishes that its loss is attributable to deficiencies in the manner in which the loan application has been prepared and submitted, the SBA may decline to honor its guarantee with respect to the SBA loans or it may seek the recovery of damages from us |
| The SBA has never declined to honor its guarantees with respect to its SBA loans, although no assurance can be given that the SBA would not attempt to do so in the future |
| (See “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Loan Portfolio—Small Business Administration (SBA) Loans |
| ”) Another economic downturn in South Korea could cause us to incur losses with respect to certain of loans and credit transactions, exposed to the Korean Economy |
| Because a significant portion of the Bank’s customer base is Korean-American, the Bank has historically had exposure to the Korean economy with respect to certain of the loans and credit transactions |
| The Bank has historically made four types of credit extensions involving direct exposure to the South Korean economy: (i) commercial loans to US affiliates, subsidiaries, or branches of companies located in South Korea (“ Korean Affiliate Loans”), (ii) unused commitments for loans to affiliates of Korean companies, (iii) acceptances by South Korean banks, and (iv) loans against standby letters of credit issued by South Korean banks |
| The Bank also has indirect exposure to the economies of various Pacific Rim countries because the Bank provides short term trade financing to local import and/or export businesses in connection with issuing letters of credit to overseas suppliers/sellers, as well as making working capital and other business loans to such businesses, some of which could be hurt by a downturn in the economies of such countries |
| The Korean economy and its capital markets suffered significant downturns in late 1997 and early 1998, and the Bank had one Korean Affiliate Loan for dlra2 million that had to be charged off in 1997 because such customer was directly impacted by the problems in South Korea |
| Since that time the Bank fully recovered all dlra2dtta0 million |
| This one charge-off in 1997 represented in excess of 42dtta7prca of the Bank’s total charge-offs in 1997 |
| See “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Nonperforming Assets, Allowance for Loan Losses and Market Risk/Interest Rate Risk Management |
| ” Since that time, the Bank has been closely monitoring the exposure to the Korean economy and those of other Pacific Rim countries and has taken steps to reduce the exposure and to make sure that the allowance for loan losses is adequate to absorb any losses that might occur if problems were to arise again in South Korea or those other countries |
| However, another severe downturn in the Korean economy or in the economies of other Pacific Rim countries could cause the Bank to incur significant credit losses |
| The Company and Bank’s directors and executive officers control a large amount of the Company’s stock, and shareholder’s interests may not always be the same as those of the board and management |
| As of December 31, 2005, the Company’s directors and executive officers together with their affiliates, beneficially owned approximately 26dtta83prca of Company’s outstanding voting stock (not including vested option shares) |
| As a result, if all of these shareholders were to take a common position, they would be able to significantly affect the election of directors as well as the outcome of most corporate actions requiring shareholder approval, such as the approval of mergers or other business combinations |
| Such concentration may also have the effect of delaying or preventing a change in control of Center Financial |
| In some situations, the interests of the Company’s directors and executive officers may be different from the shareholders |
| However, the Company’s Board of Directors and executive officers have a fiduciary duty to act in the best interests of the shareholders, rather than in their own best interests, when considering a proposed business combination or any of these types of matters |
| Provisions in the Company’s Articles of Incorporation will delay or prevent changes in control of the Company or the Company’s management include: • staggered terms of office for members of the board of directors; 19 ______________________________________________________________________ [44]Table of Contents • the elimination of cumulative voting in the election of directors; and • a requirement that the Company’s Board of Directors consider the potential social and economic effects on the Bank’s employees, depositors, customers and the communities served as well as certain other factors, when evaluating a possible tender offer, merger or other acquisition of Center Financial |
| These provisions make it more difficult for another company to acquire the Company, which could reduce the market price of the company’s common stock and the price that the shareholder may ultimately receive when their stock is sold |
| The Company is involved in litigation |
| From time to time, the Company is involved in litigation |
| If litigation arises against us, the Company will vigorously enforce and defend its rights |
| Litigation may result in significant expense to us and divert the efforts of the Company’s management personnel from their day-to-day responsibilities |
| In addition, in the event of an adverse result in litigation, the Company could also be required to pay substantial damages |
| The Company is currently a party to a lawsuit entitled Korea Export Insurance Corporation v |
| Korea Data Systems (USA), Inc, et al |
| As a result, the Company’s defense of this lawsuit, regardless of its eventual outcome, will likely be costly and time consuming |