| COMMUNITY BANCORP INC ITEM 1A RISK FACTORS An investment in our common stock is subject to risks inherent to our business |
| The material risks and uncertainties that management believes may affect our business are described below |
| Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this Annual Report |
| The risks and uncertainties described below are not the only ones facing our business |
| Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations |
| This Annual Report is qualified in its entirety by these risk factors |
| If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected |
| If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment |
| Risks Associated with our Business |
| We are highly dependent on real estate and a downturn in the real estate market could hurt our business |
| A significant portion of our loan portfolio is dependent on real estate |
| At December 31, 2005, real estate served as the principal source of collateral with respect to approximately 86dtta1prca of our loan portfolio |
| A decline in current economic conditions or rising interest rates could have an adverse effect on the demand for new loans, 25 ______________________________________________________________________ [52]Table of Contents the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing loans and the value of real estate owned by us, as well as our financial condition and results of operations in general and the market value of our common stock |
| Acts of nature, including earthquakes, floods and fires, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition |
| We have a concentration in commercial real estate loans |
| We have a high concentration in commercial real estate or CRE loans |
| Approximately 59dtta9prca of our lending portfolio can be classified as CRE lending |
| CRE loans generally involve a higher degree of credit risk than residential mortgage lending due, among other things, to the large amounts loaned to individual borrowers |
| Losses incurred on loans to a small number of borrowers could have a material adverse impact on our income and financial condition |
| In addition, unlike residential mortgage loans, commercial real estate loans generally depend on the cash flow from the property to service the debt |
| Cash flow may be significantly affected by general economic conditions |
| Banking regulators have recently issued proposed guidance regarding institutions that have particularly high concentrations of CRE within their lending portfolios |
| This guidance suggests that institutions that exceed certain levels of CRE lending may be required, in the future, to maintain higher capital ratios than institutions with lower concentrations in CRE lending if they do not have appropriate risk management policies and practices in place |
| We are currently above the proposed CRE concentration level |
| If and when this proposed guidance becomes final, we may be subject to enhanced regulatory scrutiny and subject to higher capital requirements |
| Our earnings are highly dependent on our continued ability to originate, sell and service SBA loans |
| Our earnings are highly dependent on our ability to generate new SBA loans |
| Increases in interest rates and other economic conditions could result in decreased SBA loan demand as well as lower gain on sale |
| Legislative and regulatory developments related to SBA lending may adversely affect our revenue |
| SBA lending is a federal government created and administered program |
| As such, legislative and regulatory developments can affect the availability and funding of the program |
| This dependence on legislative funding and regulatory restrictions from time to time causes limitations and uncertainties with regard to the continued funding of SBA loans, with a resulting potential adverse financial impact on our business |
| For example, the SBA 7a program was halted briefly in January 2004, and when the program returned to operation, the maximum loan size had been decreased from dlra1dtta3 million to dlra750cmam000 per loan |
| Furthermore, the loans can no longer be secured by a second trust deed as previously allowed under the rules |
| Currently, there are no planned or pending changes to the program known |
| In 2003 we began to concentrate on the efficient origination of our SBA 504 lending |
| In 2005, the SBA 504 product accounted for 62dtta7prca of our SBA loan production, or dlra101dtta4 million, which is a significant increase over prior years |
| We believe we can now shift a significant portion of the demand for the larger real estate secured loans from the 7a program to the SBA 504 loan product, which has been unaffected by the Government’s limitations on 7a loans |
| As a result, if we generate fewer 7a loans and have less gain on sale revenue in future periods due to governmental restrictions on 7a lending, we expect the increased income from our expanded SBA 504 portfolio will help lessen the impact of the restricted 7a program |
| Our real estate lending exposes us to the risk of environmental liabilities |
| In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties |
| We may be held liable to a governmental entity or to 26 ______________________________________________________________________ [53]Table of Contents third persons for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property |
| The costs associated with investigation or remediation activities could be substantial |
| In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property |
| If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected |
| Our business is subject to interest rate risk and changes in interest rates may adversely affect our performance and financial condition |
| Our earnings are impacted by changing interest rates |
| Changes in interest rates impact the demand for new loans, the credit profile of our borrowers, the rates received on loans and securities and rates paid on deposits and borrowings |
| The difference between the rates received on loans and securities and the rates paid on deposits and borrowings is known as interest rate spread |
| Given our current volume and mix of interest-bearing liabilities and interest-earning assets, we would expect our interest rate spread to increase if interest rates rise and, conversely, to decline if interest rates fall |
| Increasing levels of competition in the banking and financial services business may decrease our net interest margin by forcing us to offer lower lending interest rates and pay higher deposit interest rates |
| Although we believe our current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates and increasing competition may have an adverse effect on our business, financial condition and results of operations |
| A sustained decrease in market interest rates could adversely affect our earnings |
| When interest rates decline, borrowers tend to refinance higher-rate, fixed-rate loans at lower rates, prepaying their existing loans |
| Under those circumstances, we would not be able to reinvest those prepayments in assets earning interest rates as high as the rates on the prepaid loans |
| In addition, our commercial real estate and commercial loans, which carry interest rates that, in general, adjust in accordance with changes in the prime rate, will adjust to lower rates |
| We are also significantly affected by the level of loan demand available in our market |
| The inability to make sufficient loans directly affects the interest income we earn |
| Lower loan demand will generally result in lower interest income realized as we place funds in lower yielding investments |
| Failure to successfully execute our strategy could adversely affect our performance |
| Our financial performance and profitability depends on our ability to execute our corporate growth strategy |
| Continued growth, however, may present operating and other problems that could adversely affect our business, financial condition and results of operations |
| Accordingly, there can be no assurance that we will be able to execute our growth strategy or maintain the level of profitability that we have recently experienced |
| Factors that may adversely affect our ability to attain our long-term financial performance goals include those stated elsewhere in this section, as well as: • Inability to control non-interest expense, including, but not limited to, rising employee and healthcare costs; • Inability to increase non-interest income; and • Continuing ability to expand, through de novo branching or finding acquisition targets at valuation levels we find attractive |
| Our primary market area is an increasingly competitive and overcrowded banking market |
| Our ability to achieve the growth outlined in our corporate strategic goals may be dependent in part on an ability to grow through the successful addition of new branches or the identification and acquisition of potential targets at acceptable pricing levels either inside or outside of our primary market |
| If we are unable to attract significant 27 ______________________________________________________________________ [54]Table of Contents new business through strategic branching, or acquire new business through our acquisition of other banks, our growth in loans and deposits and, therefore, our earnings, may be adversely affected |
| Incorporating banks we recently merged with into our systems and corporate culture may be difficult and more costly than we have estimated |
| In October 2004 we acquired Cuyamaca Bank, NA and in August 2005 we acquired Rancho Bernardo Community Bank |
| Details of these transactions are presented in Note 2 — Merger Related Activity in the notes to consolidated financial statements included in Item 8 Financial Statements and Supplementary Data, which is located elsewhere in this report |
| Following these mergers, we are now in operation in the additional cities of El Cajon, Encinitas, La Mesa, Rancho Bernardo and Santee |
| The mergers provide us with the opportunity to streamline our back-office operations and improve the efficiency of our risk management processes |
| We are currently in the midst of integrating these banks into our systems to create a fully-integrated institution |
| Even though we have allocated significant resources to the planning and execution of this integration, there can be no assurance that unforeseen issues will not adversely affect us |
| Failure to successfully complete this integration could result in the failure to achieve anticipated operating efficiencies and loss of customers |
| Potential acquisitions may disrupt our business and dilute stockholder value |
| We regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies |
| As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity securities may occur at any time |
| Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our stock’s tangible book value and net income per common share may occur in connection with any future transaction |
| Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our financial condition and results of operations |
| We may seek merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale or expanded services |
| We do not currently have any specific plans, arrangements or understandings regarding such expansion |
| We cannot say with any certainty that we will be able to consummate, or if consummated, successfully integrate, future acquisitions or that we will not incur disruptions or unexpected expenses in integrating such acquisitions |
| In attempting to make such acquisitions, we anticipate competing with other financial institutions, many of which have greater financial and operational resources |
| Acquiring other banks, businesses, or branches involves various risks commonly associated with acquisitions, including, among other things: • Potential exposure to unknown or contingent liabilities of the target company |
| • Exposure to potential asset quality issues of the target company |
| • Difficulty and expense of integrating the operations and personnel of the target company |
| • Potential disruption to our business |
| • Potential diversion of management’s time and attention |
| • The possible loss of key employees and customers of the target company |
| • Difficulty in estimating the value of the target company |
| • Potential changes in banking or tax laws or regulations that may affect the target company |
| 28 ______________________________________________________________________ [55]Table of Contents Economic conditions in areas San Diego and Western Riverside Counties could adversely affect our operations and/or cause us to sustain losses |
| Our retail and commercial banking operations are concentrated primarily in San Diego and western Riverside Counties |
| As a result of this geographic concentration, our results of operations depend largely upon economic conditions in this area |
| A significant source of risk arises from the possibility that losses will be sustained if a significant number of our borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans |
| This risk increases when the economy is weak |
| We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our credit portfolio |
| These policies and procedures, however, may not prevent unexpected losses that could materially adversely affect our results of operations in general and the market value of our stock |
| We face strong competition from financial service companies and other companies that offer banking services that could hurt our business |
| The financial services business in our market areas is highly competitive |
| It is becoming increasingly competitive due to changes in regulation, technological advances, and the accelerating pace of consolidation among financial services providers |
| We face competition both in attracting quality assets and deposits and in making loans |
| We compete for loans principally through the interest rates and loan fees we charge and the efficiency and quality of services we provide |
| Increasing levels of competition in the banking and financial services business may reduce our market share, decrease loan demand, cause the prices we charge for our services to fall, or decrease our net interest margin by forcing us to offer lower lending interest rates and pay higher deposit interest rates |
| Therefore, our results may differ in future periods depending upon the nature or level of competition |
| Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods |
| For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds |
| Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks |
| The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits |
| The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations |
| Our success depends, in large part, on our ability to attract and retain key people |
| Competition for the best people in most of our activities can be intense and we may not be able to hire people or to retain them |
| The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel |
| Our internal operations are subject to a number of risks |
| We are subject to certain operations risks, including, but not limited to, data processing system failures and errors, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters |
| We maintain a system of internal controls to mitigate against such occurrences and maintain insurance coverage for such risks that are insurable, but should such an event occur that is not prevented or detected by our internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on our business, financial condition or results of operations |
| We rely heavily on communications and information systems to conduct our business |
| Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems |
| While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed |
| The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations |
| Technological Advances |
| The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services |
| The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs |
| Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations |
| Many of our competitors have substantially greater resources to invest in technological improvements |
| We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers |
| Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations |
| Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business |
| Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses |
| For example, Southern California is subject to earthquakes and fires |
| Operations in our market could be disrupted by both the evacuation of large portions of the population as well as damage and or lack of access to our banking and operation facilities |
| While we have not experienced such an occurrence to date, other severe weather or natural disasters, acts of war or terrorism or other adverse external events may occur in the future |
| Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations |
| We depend on cash dividends from our subsidiary bank to meet our cash obligations |
| As a holding company, dividends from our subsidiary bank provide a substantial portion of our cash flow used to service the interest payments on our trust preferred securities and our other obligations, including cash dividends |
| ” Various statutory provisions restrict the amount of dividends our subsidiary bank can pay to us without regulatory approval |
| Risks Associated with our Industry |
| We are subject to government regulation that could limit or restrict our activities, which in turn could adversely impact our operations |
| The financial services industry is regulated extensively |
| Federal and State regulation is designed primarily to protect the deposit insurance funds and consumers, and not to benefit our shareholders |
| These regulations can sometimes impose significant limitations on our operations |
| New laws and regulations or changes in existing laws and regulations or repeal of existing laws and regulations may adversely impact our business |
| For example, operating expenses were impacted by the dlra319cmam000 cost of compliance with the Sarbanes-Oxley Section 404 provisions in the year ended December 31, 2005 |
| 30 ______________________________________________________________________ [57]Table of Contents Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects economic conditions for us |
| New legislative and regulatory proposals may affect our operations and growth |
| Proposals to change the laws and regulations governing the operations and taxation of, and federal insurance premiums paid by, banks and other financial institutions and companies that control such institutions are frequently raised in the US Congress, state legislatures and before bank regulatory authorities |
| The likelihood of any major changes in the future and the impact such changes might have on us or our subsidiaries are impossible to determine |
| Similarly, proposals to change the accounting treatment applicable to banks and other depository institutions are frequently raised by the SEC, the federal banking agencies, the IRS and other appropriate authorities |
| The likelihood and impact of any additional future changes in law or regulation and the impact such changes might have on us or our subsidiaries are impossible to determine at this time |
| Risks Associated with our Stock |
| Our Stock Trades Less Frequently Than Others |
| Although our common stock is listed for trading on the Nasdaq National Market, the trading volume in our common stock is less than that of other larger financial services companies |
| A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time |
| This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control |
| Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall |
| Our Stock Price Is Affected by a Variety of Factors |
| Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive |
| Our stock price can fluctuate significantly in response to a variety of factors discussed in this section, including, among other things: • Actual or anticipated variations in quarterly results of operations |
| • Recommendations by securities analysts |
| • Operating and stock price performance of other companies that investors deem comparable to our company |
| • News reports relating to trends, concerns and other issues in the financial services industry |
| • Perceptions in the marketplace regarding our company and/or its competitors |
| Our Common Stock Is Not An Insured Deposit |
| Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity |
| Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company |
| As a result, if you acquire our common stock, you may lose some or all of your investment |
| Provisions of our certificates of incorporation, bylaws and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be 31 ______________________________________________________________________ [58]Table of Contents perceived to be beneficial to our shareholders |
| The combination of these provisions may hinder a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock |