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PFF Bank & Trust: “customers first” brand of banking.

CASE DESCRIPTION

The primary subject matter of this case concerns PFF Bank and
Trust, a fast growing regional bank located in Southern California.
Secondary issues examined include the structure of the banking industry,
competition in the banking industry and the challenges facing the
financial services sector. The case has difficulty levels of four, five
and six. The case is designed to be taught in three class hours and is
expected to require four hours of outside preparation by students.

CASE SYNOPSIS

The case presents PFF, a $4 billion full-service community bank
headquartered in Pomona, California. The case begins with a discussion
of the structure of the banking industry. It continues with a discussion
of major industry trends such as consolidation, record earnings,
declining mortgage volume, technological advances and the corporate
scandals that have rocked the financial services industry in recent
years. The case then presents PFF, beginning with its founding in Pomona
in 1892 as The Mutual Building and Loan, continuing with its explosive
growth mirroring the population expansion in the Inland Empire of
Southern California, and ending with its current challenges. The case
discusses the organizational and management structure of PFF, its
corporate culture, and key elements of its growth strategy, sprinkled
with excerpts from an interview with its CEO, Mr. Larry Rinehart. The
case then turns to the competitive landscape in PFF’s home turf,
the Inland Empire, and discusses major regional and national
competitors. The case concludes with the future challenges that PFF
faces.

The case provides many tables and figures to support its content,
especially detailed multiyear financial statements for PFF Bancorp. In
addition, it includes an appendix that provides information on how to
analyze a bank. Since accounting systems of financial institutions are
different from those of other companies, we believe this would serve
instructors and students well. The greatest strength of the case is that
it focuses on a firm that has been very successful competing in a
regional space against other regional and much larger national
competitors in an industry with which students are seldom familiar. The
challenge facing the student analyst is coming up with a defensible set
of recommended strategies for a firm that has been very successful in
doing what it does to continue to be successful in its competitive
space.

INTRODUCTION

Mr. Larry Rinehart (Rinehart, 2005), President and CEO of PFF
Bancorp, the public holding company that operated PFF Bank & Trust
(PFF), was contemplating the bank’s future. In his 13 years as
President and CEO, PFF had transitioned from a mutually owned
savings-and-loan (S&L) institution to a publicly traded full-service
bank listed on the NYSE, an accomplishment of which Larry was
particularly proud since PFF was the only local financial institution
listed on the NYSE and was one of only a handful of firms in the Inland
Empire (a geographical region east of Los Angeles comprising San
Bernardino and Riverside Counties) to have been represented on the
NYSE’s famous podium. PFF, a $4 billion full-service community bank
headquartered in Pomona, California, had achieved a 15% annual growth in
return on stockholders’ equity (ROE) since going public in 1996.
The banking industry had changed tremendously during the 27 years Larry
had spent with PFF. Deregulation created new competitors and new
regulations passed by Congress to combat the corporate malfeasance of
the past few years and address terrorism created additional challenges
for firms that operated in the industry. How should PFF weather the
shifting competitive and regulatory landscapes of the banking industry?
How should PFF continue to sustain such growth in ROE and achieve its
financial objectives of 10% annual growth in EPS?

STRUCTURE OF BANKING INSTITUTIONS

Banking institutions included commercial banks and thrifts,
distinguished primarily by their ownership and management of assets and
liabilities (Encarta, n.d.b). As of Q1 2005, the FDIC insured 7,598
commercial banks with total assets of over $8.59 trillion, total
deposits of over $5.70 trillion, and 1.8 billion employees; 1,332
thrifts with $1.69 trillion in total assets, over $1 trillion in total
deposits, $1.2 trillion in net loans and leases, and 277,920 employees
(FDIC, 2004). Commercial banks can be owned by stockholders or by
holding companies. A holding company primarily holds stock in another
company (see Table 1 for the largest US Bank Holding Companies). In
2000, 76% of banks were owned by bank holding companies, as compared
with 62% in 1984 (Encarta, n.d.b). Holding companies enabled banks to
engage in financial activities otherwise prohibited by law by allowing
them to set up subsidiaries under the holding company. These
subsidiaries engaged in activities such as financial-investment
services, underwriting securities, and other investment-banking
activities (Encarta, n.d.b).

Commercial banks derived their earnings primarily from two earning
assets: loans and securities. Loans included commercial, consumer, and
real estate loans. Commercial and residential real-estate loans were
long-term, secured by real property and generated predictable cash flow,
thus making them the least risky type of loan. Commercial and industrial
(C&I) loans, made to businesses, could be secured or unsecured and
could vary in maturity–short-, medium-, or long-term. These loans had
flexible interest rates, low processing costs, and were typically the
lowest yielding of a bank’s loans. Consumer loans included
credit-card lending and other installment loans. They tended to be
medium-length in maturity, had predictable cash flow in interest and
principal payments, but carried a higher risk of default and tended to
have higher processing costs than business loans. In addition to loans,
banks invested in securities to earn interest income. Since banks needed
to maintain liquidity to meet deposit withdrawal and sudden increases in
loan demand, they held about 95% of their portfolio in fixed-income
securities such as municipal bonds and U.S. government and Treasury
bonds. Commercial banks also invested in trading-account securities,
which were interest-bearing securities held primarily to realize capital
gains. These tended to have higher risks as they were strongly affected
by interest-rate trends (Standard & Poor’s, 2004a). As of Q1
2005, commercial banks had net loans and leases of $4.91 trillion and
trading-account assets of $488 billion (FDIC, 2004).

Thrifts’ earning assets were typically composed of
residential-mortgage loans although they could offer consumer loans (see
Table 2 for the Leading Thrift Institutions and Table 3 for a typical
Savings Association Insurance Fund (SAIF)-insured thrift’s loan
portfolio). The single-family-home mortgage was either fixed-rate, the
15- to 30-year mortgage, or adjustable rate mortgages (ARMs). ARMs had
been an essential instrument in reducing thrifts’ vulnerability to
interest rate changes. The interest rates on ARMs varied monthly,
quarterly or annually based on the movement of a cost-of-funds index or
on the one-year Treasury bill rate. When interest rates were low,
consumers preferred fixed-rate mortgages so they could lock in a low
rate. The low fixed-mortgage rates of 2001 through 2003 created record
refinancing activities and made fixed-rate mortgages the choice of new
homebuyers. Rising mortgage rates and predictions of higher rates in
2005 and 2006 have created a resurgence in ARM lending. In Q2 2004, 50%
of the industry’s originations were ARMs, up from the high teens
between July 2000 and July 2003. Many thrifts also offered hybrid ARMs,
with initial fixed term of three to ten years. As with commercial banks,
the primary liabilities of thrifts included time and demand deposits
(Standard & Poor’s, 2004b).

Deposits, debt, and shareholders’ equity were the principal
liabilities of commercial banks and thrifts. There were many types of
deposits: consumer-demand and time deposits, corporate-demand and time
deposits, foreign deposits and borrowings, and negotiable certificates
of deposit or jumbo CDs. Demand deposits could be withdrawn by the
depositor at any time and in any amount. Examples included checking
accounts, money orders, travelers’ checks, etc. Checking accounts
were also transaction accounts because they could be used to make
payments to a third party.

Time deposits were those in which a depositor kept his or her money
in the bank until a specified date, or incurred penalties. Certificates
of Deposit (CDs), money-market, and negotiable-order-of-withdrawal (NOW)
accounts were examples of time deposits. They typically required a
minimum deposit amount and often paid higher interest rates than regular
savings accounts. The traditional savings account was also a
time-deposit account which paid interest to the depositor but had no
specific maturity date (Standard & Poor’s, 2004a). Thanks to
consumers who sought investments with higher rates of return, such as
mutual funds, the very low deposit growth of the late 1990s was being
reversed. The stock market crash of 2000 and 2001 produced a
“flight to safety,” with more investment dollars flowing into
banks. The FDIC’s Q1 2005 report showed deposit growth of 9.5% for
all institutions insured by the FDIC (FDIC, 2005a). Debt for banks
included federal funds, other short-term borrowings like commercial
paper, and long-term debt (FDIC, 2004). The Gramm-Leach Bliley Act of
1999 deregulated the financial services industry and blurred the lines
between banks and other financial services providers such as insurance
and investment companies. Many thrifts pursued a
commercial/consumer-banking model in response to competition in their
core business. Many in the thrift industry believed that thrifts should
be folded into the banking industry. Many thrifts experienced a decline
in their deposits-to-loans ratio and ongoing pressure on margins from
Fannie Mae (Federal National Mortgage Association or FNMA) and Freddie
Mac (Federal Home Loan Mortgage Corporation or FHLMC). Fannie Mae and
Freddie Mac were government-sponsored enterprises (GSEs) that engaged in
purchasing, guaranteeing, and securitizing mortgages for sale to
investors or for holding in their portfolios. The GSEs had access to
less expensive financing (due to investors’ perception of implicit
government backing in the event of an insolvency) and lower operating
costs, which gave them a competitive advantage over thrifts and enabled
them to gain a larger share of mortgage-debt holdings. However, the
growth of GSEs has had a beneficial effect on thrifts by allowing them
to function as mortgage bankers, that is, sell their fixed-rate-mortgage
production to the secondary markets (Standard & Poor’s, 2004b).

INDUSTRY TRENDS

Commercial banks and thrifts enjoyed record earnings due to
expanding economic conditions. Real GDP growth over the period 2001-04
was 2.8%. Real GDP growth in Q1 2005 was 3.8% over Q1 2004 (Bureau of
Economic Analysis, n.d.). The consensus was for continued economic
improvement. According to the FDIC, over 62% (nearly two in three) of
commercial banks reported earnings in 2004 higher than a year earlier,
and 47% of savings institutions had higher 2004 earnings than a year
earlier. Both commercial banks and savings institutions insured by the
FDIC reported record earnings in Q1 2005. Net income was $34.3 billion,
a 7.7% increase over the record of $32.4 billion set in 2004. The FDIC
attributed this primarily to lower expenses for bad loans and the
absence of significant merger-related costs. The industry experienced a
decline in net operating revenues (the sum of net interest income and
total non-interest income) primarily due to rising short-term interest
rates. A flattening yield curve means declining NIM (net interest
margin, which is net interest income divided by average earning assets)
and lower net interest income. NIM dropped to a 15-year low of 3.54%
from 3.63% in Q4 2004. Net interest income of $435 million declined 0.3%
from Q4 2004 (FDIC, 2004).

Although the industry continued to enjoy strong mortgage demand,
mortgage volume slipped from its recent record levels. Mortgage
originations were expected to decline 36% in 2004 and 28% in 2005. The
greatest drop was expected in the refinancing area, where total
originations were expected to drop 43% in 2004 and 24% in 2005. Deposit
growth outstripped loan growth for the second quarter in a row. Total
deposits increased by $124.5 billion in Q1 2005, a 38% decline from the
$200.5 billion increase in the previous quarter. Loans increased by
$81.8 billion in Q1 2005, 40.5% lower than the $137.7 billion increase
in the previous quarter. According to FDIC Chairman Powell, “The
growth in deposits is an especially good sign for the banking industry.
It shows that Americans appreciate the safety, the simplicity, and the
convenience of FDIC-insured deposits, because there are many other
options available to them” (FDIC, 2004).

The competitive drive to expand market share, increase the number
of products and services offered, enhance geographic coverage, and
improve efficiency led to significant consolidations in the industry
over the past 20 years. The peak of consolidation activities in the
mid-1990s saw 600 banks absorbed by mergers and acquisitions annually.
The pace of merger activities declined from 2000 to 2002 due to
declining stock prices. The number of bank mergers had reduced to fewer
than 300 by 2003. However, S&P foresaw greater merger activity with
small to mid-size regional banks (assets of less than $20 billion),
especially those located in high-growth areas like the Southeast, Texas,
and parts of the West Coast, as likely targets of larger domestic or
foreign banks. The need to compete more efficiently in a deregulated
environment will continue to drive consolidation over the long term,
which has increased concentration in certain segments of the industry.
For example, 60% of the credit-card market was controlled by the five
largest providers, 60% of the corporate-lending segment was controlled
by the five largest banks, and 40% of the mortgage market was controlled
by the largest ten firms in that segment. Consolidation also allowed
banks to gain economies of scale and to earn healthy shareholder returns
from larger portfolios. Consumers as well as the banks themselves
benefited from these scale advantages (Standard & Poor’s,
2004a).

The financial-services sector was battered by multiple scandals. In
2003, Freddie Mac came under investigation by the Securities and
Exchange Commission (SEC) and the Justice Department on accounting
irregularities. In 2004, Fannie Mae was cited with violating generally
accepted accounting principles (GAAP) by the Office of Federal Housing
Enterprise Oversight (OFHEO) and also came under investigation by the
SEC and the Justice Department. Congress passed the Federal Enterprise
Regulatory Reform Act in 2004 to transfer overseership from OFHEO to an
independent regulator, the Office of Federal Enterprise Supervision in
the Treasury Department, with additional powers to regulate the
government-sponsored enterprises (GSEs) Freddie Mac and Fannie Mae. In
2003, Eliot Spitzer, New York State’s attorney general, announced
that certain mutual funds had engaged in improper trading
practices–“market timing” and “late trading.”
Several financial institutions, including banks, were named in the
mutual-fund scandal. This poses a potential risk for the industry in the
form of financial penalties and damage to their reputation (Standard
& Poor’s, 2004a). Already highly regulated, these scandals
posed the threat of additional regulations. Newer regulations, such as
the Bankruptcy Abuse Prevention and Consumer Protection Act passed by
Congress in March 2005, were favorable to the industry; however, others,
such as Sarbanes-Oxley Act of 2002 (SOX) and the USA Patriot Act of
2001, have created additional costs for financial institutions.

Advances in technology enabled the industry to increase efficiency
through lowering operating costs. Technology improvement enabled the
replacement of labor-intensive functions and a reduction in
labor-related expenses (Standard & Poor’s, 2004a). The Internet
enabled banks to provide several of their traditional services online,
such as mortgage-lending and deposit-gathering. Online mortgage
originations comprised 45% of total originations in 2003 and 43% in
2002. Online banking was fast becoming the industry norm. Many banks
invested substantial resources to provide the convenience of online
banking. The Internet also created new competitors such as E*Trade Bank,
Ditech, and ING Bank, which operated primarily online. Despite the
growth in online banking, banks continued to make investments in their
brick-and-mortar infrastructure as a way to reach consumers (Standard
& Poor’s, 2004a). One of the downsides of technology has been
the loss of customer information to computer hackers and identity theft.
Several banks have had sensitive customer information stolen by computer
hackers. As a result, banks have had to devote substantial resources to
security infrastructure.

Globalization was another important industry trend. With a maturing
and saturated US market in most product/service segments, many banks
pursued globalization to increase revenue growth and market power. Banks
had many reasons to go global, a key one being to service the banking
needs of their domestic clients. Many banks “followed the
customer” to foreign countries where they operated. Not only were
U.S. banks growing their international operations, foreign banks were
also expanding their presence in the U.S. (see Figure 1). As of 2004,
U.S. banks had $945 billion in foreign assets, an increase of 136% from
the 1984 figure, and foreign banks had $1.15 trillion in U.S. assets, an
increase of 324% over the 1984 figure. U.S. banks focused their
activities in Asia and Europe, with Asian banks having a 23% share of
U.S. banks’ foreign assets as of December 31, 2004, and European
banks having 54% (see Table 4). While commercial and industrial lending
dominated the overseas operations of both U.S. and foreign banks,
non-banking subsidiaries were the fastest source of foreign assets for
U.S. bank-holding companies (FDIC, 2005c).

[FIGURE 1 OMITTED]

Many globalization activities involved the very large banks with
very large corporate customers. However, small firms accounted for a
third of U.S. exports in 2001 and continually faced challenges to
finance their international operations. California had the largest
number of small-manufacturing-enterprise (SME) exporters at 55,000
firms, followed by Florida, New York, Texas, and Illinois. SMEs
typically needed financing to produce the goods they exported, e.g.,
working-capital loans, or to finance the sale of exports, e.g., letters
of credit. Only about two percent of banks engaged in any significant
amount of trade financing in 1988, and the FDIC believed that the
numbers have not changed much since then. Growth in worldwide trade may
provide smaller banks an opportunity to garner additional loan business
and increased fee income by servicing the needs of SMEs (FDIC, 2005b).

HISTORY OF PFF

PFF was founded on Christmas Eve of 1892 by a group of community
leaders in Pomona as The Mutual Building and Loan. The company opened
its first branch in Pomona, California, a city located in the Inland
Empire about 30 miles east of downtown Los Angeles. The bank’s
corporate office was located in Pomona. The Mutual Building and Loan
Company focused on making loans to local individuals, two of whom were
Walter and Cordella Knott, who founded the now famous Knott’s Berry
Farm theme park in Southern California. During the difficult times the
nation faced in the Great Depression of the 1930s, the Federal Home Loan
Bank Board was created to establish a federal system of bank charters.
In 1938, The Mutual Building and Loan became known as Pomona First
Federal (PFF) (PFF Bank & Trust, 2005a).

PFF, still focused on home loans, grew apace with the housing
demand in Southern California. In response to housing needs created by
returning WWII veterans and new families moving into the Pomona Valley,
PFF developed a construction-loan program. Pomona Valley continued to
grow in the mid-50s. PFF expanded by opening new branches in Upland,
Chino, and San Dimas, all neighboring communities. Eleven additional
branches were opened in the seventies and eighties. By 2005, PFF had
grown to 30 full-service-banking branch offices in eastern Los Angeles
County, northern Orange County, and Riverside and San Bernardino
Counties (see Figure 2). It planed to add two new branches in fiscal
2006, one in the city of Riverside and the other in Mira Loma, with
additional branch openings planned in the future (PFF Bank & Trust,
2005b).

[FIGURE 2 OMITTED]

During the 1990s, PFF consolidated all lending functions into its
Loan Center in Rancho Cucamonga and initiated the
laptop-loan-origination system in order to shorten the loan-approval
process. The laptop initiative enabled customers to apply for loans in
their homes with a loan counselor who accepted and transmitted the
application to the Loan Center for faster processing. More recently, the
firm established a TeleBanking Center where customers can obtain
personalized service in both English and Spanish 24/7. The firm also had
a “24/7 Internet Banking” and online banking for business,
iLink, and a Spanish-language website in addition to its
English-language website. The company’s goal was to “raise the
bar” on service and convenience by making banking easier than ever.
PFF also offered the FastTrack Loan, a business line of credit aimed as
allowing small business owners the ability to meet operating expenses,
take advantage of trade discounts or finance new inventory. The
streamlined loan process allowed applicants to receive a decision in 48
hours and to activate the account by simply writing a check against
their PFF business account.

PFF went public in 1996, adopted the name PFF Bank & Trust, and
created the parent company PFF Bancorp, Inc. PFF Bancorp was a unitary
savings-and-loan holding company and federally chartered, thus making it
a federal savings bank, subject to regulation by the Office of Thrift
Supervision (the “OTS”) and the Federal Deposit Insurance
Corporation (the “FDIC”).

Since the initial IPO, PFF’s stock price went from $10 to $28
after two different stock splits. Excluding the stock splits, Larry
estimated the stock’s value in the high $60 range. The bank
realized compounded annual earnings growth in the vicinity of 15% for
the last ten years. Larry believed that PFF was slated to maintain the
15% compounded annual growth in 2005 (Rinehart, 2005).

PFF MANAGEMENT AND ORGANIZATIONAL STRUCTURE

PFF’s seven-person executive committee was responsible for
formulating policies and procedures for the firm and for developing and
monitoring the strategic plan (see Figure 3 for the current
organizational chart). This structure allowed the bank to be
entrepreneurial by permitting quicker decision-making. The development
of Diversified Builder Services and Glencrest Investment Advisors are
examples of the PFF management team’s ability to recognize
opportunity and to move quickly to execute them.

At $4 billion in assets and 30 branches, PFF was very small
relative to its larger competitors. This enabled it to be agile and to
very quickly recognize and take advantage of opportunities in its
environment. According to Larry, “we are able to make decisions
very quickly, whereas they [larger competitors such as WAMU and Wells
Fargo] typically cannot. If one of my team finds a plot of land and
says: ‘Larry, this would be great to build a branch on. I’ve
done the demographics, the homework and it is not just a fly by night
recommendation, we really need to get this thing now.’ We’ll
do it; we’ll turn that decision the same day. I think they’re
incapable of moving quite that quickly. Our agility gives us the ability
to act upon these things quickly, to recognize these opportunities and
act on them.”

Larry had what he described as a “hands on, but not hands
in” leadership approach. “That means I want to know everything
of significance and importance in the different departments of the bank,
but I don’t interfere unless it’s absolutely essential and I
don’t get involved in the details and inner workings. I’ve got
competent people working for me. I cannot do a better job than them.
Just tell me what is going on so I’m always informed. This helps me
plan my next move better.”

[FIGURE 3 OMITTED]

PFF CULTURE

PFF’s culture focused on customer service. The company had
established multiple award programs aimed at maintaining and sustaining
its service culture. The Quest for Excellence Employee Program rewarded
employees for ideas that resulted in improved customer service and
reduced costs. Employees were given the Service Champion Award, the
highest service honor an employee could receive, for going beyond the
call of duty in satisfying customer needs. PFF also gave a Got Service
Award, where employees recommended colleagues who had gone beyond the
call of duty to provide them assistance in resolving a customer problem.
The recommendation went to a committee which conferred the award and
also to the supervisor and colleagues of the recommended employee. PFF
communicated awards for excellent service via its newsletter, which also
contained letters of commendation from customers to employees. The firm
strongly believed that for employees to participate to their maximum
effectiveness, they had to be owners of the bank. PFF management
established an Employee Stock Ownership Program (ESOP) when the bank
went public. The ESOP had added substantially to several employees’
incomes due to the appreciation of the stock value and had enabled the
bank to retain high-quality employees. PFF was a hometown bank and many
executives were known personally to the employees and participated in
company events. Management’s open-door policy was communicated
personally to all employees during new-hire orientations by Larry who
gave employees his direct extension. Managers were encouraged to talk
and listen to employees, and employees were encouraged to take any issue
to any level of management.

PFF built its brand on customer service and invested significant
resources on training employees for superior customer service. The logo
of the company was “customers first.” Employees were
encouraged to greet customers by name. The bank estimated that about 50%
of new customers came from existing-customer referrals and believed this
showed that the “customers first” pledge was working.
According to Larry:

   You have to have that customer-first attitude, because if you
   don't, there is no reason for that customer not to walk across the
   street to Bank of America or Washington Mutual. They have more
   branches, more ATMs, and also some longer lines and some things
   that go along with it, but why wouldn't they? So you better put
   that customer first no matter how bad of a day you're having. I
   want you to have that smile on your face when you greet that
   customer-it's critical to our success. You as the frontline teller,
   or the frontline new-accounts person, are PFF to those people. It's
   not Larry Rinehart or our board of directors. They know Jane or
   John Doe on that teller line as PFF and whatever they take back
   from their experience with you is going to go back to their
   friends, their relatives ... And if Jane or John was rude to that
   customer today, they're going to go back to their friends and say
   what a bunch of SoBs at PFF. But if Jane or John is smiling, even
   when they're having a real tough day and they're saying, 'Glad to
   have your business, Mr. Smith, is there anything else I can help
   you with?' they're going to take that back too, and that's the way
   PFF has to survive against the large banks.

The company had contracted with an independent firm since 1998 to
conduct branding-advocacy studies aimed at attracting new customers and
retaining current customers. The study measured five variables: trust
(confidence that the bank can handle a full spectrum of services),
esteem, satisfaction (do customers like the bank), loyalty (will
customers stay with the bank), and advocacy (will customers recommend
the bank to friends, relatives, co-workers, etc.). The latest
“brand advocacy” score placed PFF in the top spot in both
business- and customer-banking segments relative to its competitors (see
Table 5 for the customer-banking results). PFF’s “customers
first” brand placed the company second in aggregate total deposits
for the communities in which it operated. The bank had a 14.3% aggregate
share in its served market.

PFF’S GROWTH STRATEGY

PFF had pursued a strategy of organic expansion or “de
novo” branching, that is, it expanded branch operations by building
branches from scratch. The company bucked the trend of expansion via
acquisition in the banking industry. With the exception of a small
acquisition to enter the Sacramento market, it expanded primarily
through de novo branching. This strategy enabled the company to build
new branches in places where people were moving to, not places where
people are moving from (Rinehart, 2005). The Southern California region
had experienced a 12.81% population growth rate since the 1990 census.
The Inland Empire experienced the highest growth rate both in Southern
California and statewide (Southern California Association of
Governments, n.d.). In 2004, the area accounted for more than 35% of the
new jobs in Southern California, 48% of all housing starts, and 75% of
new industrial construction in the state of California (PFF Bank &
Trust, 2005b). The four-county area where PFF located branches
experienced an average population growth rate of 20% between 1990 and
2000, with Riverside County experiencing the highest rate at 32%, San
Bernardino 20%, Orange County 18.1%, and Los Angeles 7.4% (Southern
California Association of Governments, n.d.). With homes getting more
expensive in Orange and Los Angeles counties, more and more people were
moving into San Bernardino and Riverside counties, areas where PFF had
concentrated its branch-expansion activities.

To transition from an S&L to a full-service community bank, PFF
had to deal with the challenge of developing new products and services.
Similar to its “de novo” branching strategy, the firm
developed new products and services internally to further meet the
changing needs of its customers. Glencrest Investments Advisors, Inc.
was a registered investment advisor. Glencrest provided
wealth-management and–advisory services to high-net-worth individuals
and businesses through its three California offices located in
Claremont, Irvine, and Palm Desert. The subsidiary was developed
internally, as Larry explained:

   What we did was find a wonderful individual, Tom Stefancie, who had
   a tremendous track record as far as trading fixed-income securities
   and equities with a very large firm back east. He was going into
   semi retirement. We were so impressed with Tom that we talked him
   into coming to work for us full time. Really, the business is built
   around the individual.... So, I'm very proud of the formation of
   Glencrest, and it is growing very rapidly. It has about $350M in
   assets under management right now.

Diversified Builders Services, Inc. (DBS) was created to meet the
needs of developers in PFF’s market. It provided financing and
consulting services to homebuilders and land developers. It operated out
of one office in Claremont, California. In true entrepreneurial fashion,
DBS grew out of one individual with a great idea. Again, as Larry
explained:

   The manager of our major loan department, Kevin Brooks, did all the
   tract-construction lending and all the very large loans for the
   bank. After about 15 years, he burned out. He took a break, and
   came back with a great idea. He had many connections with the
   builders, and wanted to get involved in specialty areas of
   financing for them, for example, if they needed a bridge loan to
   acquire a piece of property very quickly, or to have entitlements
   processed for a tract map, or assistance in appraising different
   properties. All these myriad opportunities we had with the builders
   resulted in the formation of DBS. We told Kevin to run with it,
   gave him a great salary, a great incentive program, and bonus
   potential. The company is now two years old. The first year, it
   produced $2M in after-tax income to the bank, and this year it has
   produced in the vicinity of $3M after tax for the bank. I think
   that the real significance, what really astounds you when you hear
   those numbers, is that it's a three-person operation. Kevin Brooks,
   an assistant, and an administrative assistant. It's
   entrepreneurial, but it's something that we just said, 'This guy
   can do it, he's been here 15 years, so let's see what happens.'

PFF had targeted the “Generation Y” market with on-line
banking, no-hassle account opening and faster transaction services.
Sixty million individuals born between 1979 and 1994 made up this
market. One in four lived in a single-parent household, three in four
had working mothers and they started tapping away at computers in
nursery school (Neuborne & Kerwin, 1999). They spent most of their
time on-line, they responded to ads differently, and preferred to
encounter ads in different places. PFF specifically targeted this group
with a new advertising campaign that had a less serious business tone
and more comical ads than was typical in the banking industry.

PFF also targeted Hispanics, who represented the largest ethnic
group in Southern California at 40.6% (Southern California Association
of Governments, n.d.). Approximately 35-45% of the Inland Empire’s
population was Hispanic. This was a $2M to $2.5M emerging market
(Rinehart, 2005). PFF allowed undocumented aliens to use the matricula
consular cards (an official Mexican-government document that contains
the name, date, place of birth, current photograph, the holder’s
signature, a U.S. address, and a current address) to open accounts and
cash checks. The U.S. Treasury Department gave explicit approval to U.S.
banking institutions to accept the matricula consular card for
identifying and verifying the identity of customers seeking to open
financial accounts (Treasury Department, 2002). According to Larry:

   When Ron Gutierrez, our emerging-market director, came to me and
   said that most Hispanic people did not have checking accounts and
   were utilizing these paycheck stores, paying up to 20% just to cash
   their check. Then to add to that misery, they were walking around
   with all this cash in their pockets. We decided to honor the card,
   regardless of political feelings ... It's interesting that that
   comes back to enhancing the bank's shareholder value. We're doing
   something that is the correct and right thing to do socially. As a
   consequence, we get new Hispanic business, which enhances
   shareholder value through increasing stock price and having more
   customers.

A core element of PFF’s strategy in this emerging market was
to gain the trust of this target market. Another core element of the
strategy was to educate. Employees of the firm volunteered in
Pomona’s K-12 schools because of its high concentration of
minorities. They educated the children regarding banking and sound
personal-finance practices including how to balance a checkbook, how to
save, and how to apply for a loan. To better compete for this segment,
PFF developed a Spanish-language website, and marketed through
Spanish-language publications and radio stations.

PFF focused on what the company called the Four Cs: commercial
loans and leases, construction and land, commercial real estate, and
consumer loans.

   The four Cs are what we emphasize in our lending program because
   they have higher yields. It's just that simple. Construction loans
   generate an awful lot more as far as return goes than a
   single-family home loan. They're riskier loans so you have to allow
   for bigger general valuation allowances, but they pay out much
   quicker. You deal with people that you know, you respect, you
   trust. We base our loans primarily on the projects rather than the
   individuals' financial condition. These are customers that we've
   known for 10 or 15 years and they've weathered all the storms in
   homebuilding. The rising interest rates, I don't like to see. But
   the impact on the bank, it's minimized. Our net interest margin
   continues to expand even with rising interest rates, albeit very
   slowly. That's something very rare for a bank in the United States.
   As far as the residential loans we have, virtually all of those
   loans are adjustable-type mortgages. The fixed rates are sold off
   to Fannie Mae. We don't want the fixed-rate exposure. We retain the
   servicing too, so we never lose that customer relationship.

The company derived the preponderance of its revenues from interest
on loans and leases, and additional revenues from fee income and
interest and dividends on securities. Its primary sources of funds
included deposits, principal and interest payments on loans, leases and
securities, and Federal Home Loan Bank (FHLB) advances and other
borrowings. PFF concentrated its deposit-gathering activities in the
communities where its branches were located. PFF originated loans on a
wholesale basis throughout Southern California, and it had expanded its
lending activities to markets outside Southern California on a limited
basis. The bank focused primarily on local promotional activities,
extended hours on weekdays, Saturday banking, Internet banking, and its
website (located at www.pffbank.com) (PFF Bancorp, Inc., 2005).

PFF’s goal was steady growth. The firm did not intend to
succumb to the “merger mania” currently gripping the banking
industry. PFF focused on the following key financial objectives in order
of importance:

   A minimum threshold of 10% increase in EPS over the prior year's
      earnings
   A minimum threshold of 15% annual ROE
   Below 50% efficiency ratio (how much it costs to generate a
      dollar) was considered good in the industry; PFF was at 48%.

PFF’s strategy appeared to be working (see Exhibits 1 and 2
for financial statements). In the fiscal year that ended March 31, 2005,
net income after taxes was $45.8 million, an 11.98% growth rate over
2004; total assets were $3.9 billion, a 5.4% growth rate over 2004;
total loans were $3.4 billion; and total deposits were $2.7 billion (PFF
Bancorp, Inc., 2005).

I COMPETITION IN THE BANKING INDUSTRY

   When asked to identify the competition, Larry Rinehart had the
   following to say:

   "Most certainly the regional banks. In addition, probably to an
   equal extent, it's the locally based community banks-Foothill
   Independent, Vineyard Bank ... there's a plethora of these little
   community banks out there. Foothill and Citizens Business Bank come
   to the forefront. I would say the top five are Bank of America,
   Washington Mutual, Citizens Business Bank, Foothill Independent,
   and Vineyard. I'll tell you a concern that I've got. Take Bank of
   America, right across the street. It used to delight me somewhat to
   walk into their lobby and see that it was jam packed with people;
   it would take you sometimes 30 minutes to get through that line.
   The interior was unkempt; they didn't seem to take any pride in
   their work ("they" being the tellers and new accounts people). It
   delighted me because I knew you weren't going to get any of this at
   PFF. You're not going to get long lines, and you're going to get
   nice buildings and nice interiors. Within the last year, I've
   noticed major changes; they've got that personal greeter out there
   now. The lines are more expeditious, the interior is better. You
   can see that Bank of America is recognizing this as a shortcoming.
   They won't be able to sustain that. It's not the attitude and
   culture of the bank. They are recognizing it and it's intriguing
   me."

Regional Competitors

Foothill Independent Bank

Foothill Independent Bank was owned by Foothill Independent
Bancorp, a publicly owned one-bank holding company listed on NASDAQ. The
bank was headquartered in Glendora, California and, as of December 31,
2004 had total assets of $787 million and 163 full-time and 86 part-time
employees (Foothill Independent Bancorp, 2005a). Foothill was founded in
1973 and in 1982 became the sole subsidiary of the newly formed Foothill
Independent Bancorp (Foothill Independent Bancorp, n.d.). It offered a
full range of commercial banking services and operated 12 banking
offices located in Los Angeles, San Bernardino, and Riverside counties.
Foothill offered drive-up and walk-up facilities, 24-hour ATMs at its
banking offices, online banking, and a computerized telephone service
(Foothill Independent Bancorp, 2005a).

Foothill reported record profits in the first half of 2005, aided
by a growing loan portfolio and substantial improvement in its net
interest margin. For the first six months of 2005, net income grew 22%
to $5.38 million compared to $4.41 million in the first half of last
year. According to George Langley, President and CEO of Foothill,
“Our balance-sheet management has contributed to three consecutive
quarters of net-interest-margin expansion. We have continued to build
our low-cost deposit base, keeping our cost of funds relatively stable.
However, as interest rates have increased, so have the yields on the
adjustable rate loans in our portfolio. We may see further margin
expansion as long as interest rates continue to rise at a reasonable
pace” (Foothill Independent Bancorp, 2005b).

Citizens Business Bank

Citizens Business Bank, headquartered in Ontario, California, was a
wholly-owned subsidiary of CVB Financial Corporation. CVB was
incorporated in 1981 and D. Linn Wiley has served as President and CEO
since October 1991 (Citizens Business Bank, n.d.). As of December 31,
2004, CVB had $4.51 billion in total consolidated assets, $2.12 billion
in net loans, and $2.88 billion in deposits (Citizens Business Bank,
2005a). Citizens was chartered as a state bank on August 9, 1974 as
Chino Valley Bank and, on March 29, 1996, became Citizens Business Bank.
In early 2005, Citizens obtained two additional business-financial
centers through its acquisition of Granite State Bank of Monrovia,
California. Citizens was not a member of the Federal Reserve System
(Citizens Business Bank, 2005a). Citizens reported net income of $17.7
million in Q1 2005, a growth of 75.7% compared with the same period in
2004. Assets grew at over 20%, deposits at 11.8%, and gross loans and
leases at over 20% for Q1 2005 as compared with Q1 2004 (Citizens
Business Bank, 2005b).

Vineyard Bank

Vineyard National Bank was founded in 1981 and changed its name to
Vineyard Bank in August 2001. It prided itself on being one of
California’s strongest community banks. As of December 31, 2004,
the bank had total consolidated assets of $1.3 billion, total
consolidated net loans of $1.0 billion, total consolidated deposits of
$965.5 million, and total consolidated stockholders’ equity of
$85.2 million (Vineyard Bank, 2005). Vineyard operated nine full-service
banking centers in Los Angeles, Riverside, and San Bernardino counties,
two SBA loan-production offices in San Diego and Anaheim, California and
an income-property loan-production office in Irvine, California. Norman
Morales had been the company’s president and CEO since October
2000. For the six months ended June 30, 2005, Vineyard reported record
net earnings of $9.2 million, a 47% increase over the comparable period
in 2004 (Vineyard Bank, 2005).

National Competitors

Bank of America

Bank of America Corporation, the holding company for Bank of
America (BofA), was formed from NationsBank’s acquisition of
BankAmerica Corporation in 1998 (Encarta, n.d.a). Bank of America
introduced a credit card known as the BankAmericard, which was later
renamed Visa when it sold its bank-card system in 1970. BofA saw
tremendous expansion in the 1990s by opening bank branches in
supermarkets and providing Internet banking. In addition to developing
new products and services, the company continued to expand through
mergers and acquisitions. In 1992, it merged with California’s
Security Pacific Corporation, in 1994 it acquired Continental Bank
Corporation of Chicago, and in 1997 it purchased the San Francisco
investment-banking group Robertson Stephens. NationsBank acquired
BofA’s parent company, BankAmerica Corporation, for about $60
billion in 1998 (Encarta, n.d.a). BofA acquired FleetBoston Financial
Corporation in 2003 and MBNA Corporation, a leading issuer of credit
cards, in 2005. During Q2 2005, BofA announced it would pay $3 billion
to buy 9% of the stock of China Construction Bank, with options for
increasing its stake in the future (Bank of America, 2005).

Bank of America, headquartered in Charlotte, North Carolina, was
the second largest bank in the United States with 2004 assets in excess
of $1 trillion and revenues of over $48 billion (see Table 1) (Standard
& Poor’s, 2004a). Net income totaled $14.1 billion in 2004, a
31% increase over 2003. BofA had 5,889 banking centers in 29 states and
the District of Columbia, operated 16,798 ATMs, and had international
offices in 35 countries supporting clients in 150 countries (Bank of
America, n.d.).

Washington Mutual

Washington Mutual, Inc., headquartered in Seattle, Washington, was
the holding company for Washington Mutual (WaMu). Washington Mutual
began in Seattle in 1889 as the Washington National Building Loan and
Investment Association. It went public in 1983 and also acquired Murphey
Favre, Inc., a full-service securities-brokerage firm. Kerry K.
Killinger, executive vice president at Murphey Favre when it was
acquired, became the CEO in April 1990 and was elected Chairman of the
Board of Directors in January 1991 (Washington Mutual, Inc., n.d.).

Washington Mutual was the largest thrift holding company in the
United States with total assets in 2004 of $307 billion, net income of
$2.9 billion, and market capitalization of over $21 billion (see Table
2) (Washington Mutual, Inc., 2005). It had over 50,000 employees and
served over 11.7 million households. It operated 1,939 retail-banking
stores, 478 lending stores and centers, 3,350 ATMs and telephone-call
centers, and enabled online banking. WaMu became truly bicoastal after
its acquisitions of Bank United Corp. of Houston in 2001 and New
York-based Dime Bancorp in 2002 (Standard & Poor’s, 2004b).

PFF’S FUTURE CHALLENGES

Mr. Larry Rinehart retired from being President of PFF in the fall
of 2005. He retains the position of CEO and Mr. Kevin McCarthy was made
President in addition to his position of COO. Larry, Kevin and their
team of executives were mulling over what to do next. Was the industry
changing in ways that would make growth more difficult? Was the
competition getting too intense? What key strategic issues did the bank
face? In order to meet the firm’s primary financial objective of
10% increase in EPS year over year, they would need to find new
opportunities and avenues of growth. They needed to decide whether PFF
should grow only in the Inland Empire in line with its current strategy
or expand to other parts of California. The bank could replicate the
success it has had in Southern California in Northern California. The
Sacramento area in Northern California was experiencing similar growth
patterns as in the south. Its population grew by 17.5% between the 1990
and 2000 Census (Southern California Association of Governments, n.d.).
It is the third hottest building area in the U.S. PFF could expand its
branch system in Northern California by closely sticking to the strategy
that had worked so well for it in Southern California. They need to
decide whether or not PFF should diverge from its de novo growth
strategy and follow a different growth model by pursuing mergers and
acquisitions. The bank could acquire small local banks as part of an
expansion strategy or to reach particular target customers; or it could
seek to be an acquisition target to the “right” national or
international bank. PFF’s location in one of the few population
growth areas in the nation provided it attractive acquisition targets as
well as made it an attractive acquisition target for large national and
foreign banks seeking to expand their reach. Which of these (or other)
options make the best sense for PFF over the next three years?

Mr. McCarthy was preparing to address the board and, besides
reviewing PFF’s current situation and strategy, was going to
outline PFF’s major strategic alternatives and recommend which one
PFF should pursue. How would you help him?

APPENDIX A

ANALYZING A BANK

Accounting systems of financial institutions differ from those of
other companies. While some measures of financial condition are
calculated in a similar manner as those of other corporations, such as
ROA and ROE, there are measures that are unique to financial
institutions. Such measures are most useful when trends are examined and
when comparisons are made with similar financial institutions. Table A1
displays key measures of a bank’s profitability.

Table A1: Measures of a Bank's Profitability

Measure                         what iT shows

Yield on earning assets (YEA)   The quality of a bank's interest
                                earning assets such as loans, short-
                                term investments, lease financings,
                                and taxable and nontaxable
                                investment securities
Cost of funding assets (COF)    How much a bank pays to obtain
                                earning assets such as deposits and
                                other borrowed funds used to
                                generate income
Net interest margin (NIM)       How successful a bank has been in
                                managing its assets and liabilities
Provision for loan losses       The provision's size as a
                                percentage of total loans reflects
                                the risk inherent in a bank's loan
                                portfolio
Noninterest income              Income from noninterest sources
                                such as charges on deposit
                                accounts, insurance commissions,
                                charges for trust services, and other
                                fees.
Efficiency ratio                The costs associated with
                                maintaining operations, including
                                personnel, occupancy, retail
                                branches, etc.

Measure                         how to calculate

Yield on earning assets (YEA)   Interest income on earning assets
                                divided by average value of these
                                assets
Cost of funding assets (COF)    Total interest expense on the funds a
                                bank uses to support earning assets
                                divided by total average level of
                                funds employed
Net interest margin (NIM)       Yield on earning assets minus the cost
                                of funding earning assets
Provision for loan losses       Income statement item
Noninterest income              Income statement item
Efficiency ratio                Noninterest expenses divided by net
                                operating revenues

Source: Adapted from Standard & Poor's (2005, July 7). Standard &
Poor's Industry Surveys: Banking, Vol 173, No. 27, Section 2. New
York: McGraw-Hill Companies.

In addition to profitability measures, other measures of a
bank’s financial condition are shown in Table A2.

Table A2: Measures of a Bank's Financial Condition

Measure                   what iT shows

Reserve for loan losses   An amount put aside by a bank to
                          protect itself from possible defaults.
                          It reflects the quality of the loan
                          portfolio
Nonperforming loans       Loans that no longer produce
                          interest income and for which
                          repayment has been scheduled. The
                          level of nonperforming loans
                          indicates the quality of a bank's
                          loan portfolio.
Net charge-offs           Uncollectible loans and leases less
                          collections from previously charge-
                          off loans and leases
Debt leverage             Indicates the extent of a bank's
                          financial leverage and relative risk
                          profile
Liquidity                 A bank's ability to raise funds for
                          lending and other purposes

Measure                   how to calculate

Reserve for loan losses   Balance sheet item
Nonperforming loans       The ratio of nonperforming loans to total
                          loans
Net charge-offs           Calculated as a percentage of loans
                          outstanding during a particular period
Debt leverage             Long-term debt divided by the sum of total
                          equity and total debt
Liquidity                 The proportion of loans outstanding to total
                          assets

Source: Adapted from Standard & Poor's (2005, July 7). Standard &
Poor's Industry Surveys: Banking, Vol 173, No. 27, Section 2.
New York: McGraw-Hill Companies.

REFERENCES

Bank of America. (July 18, 2005). Form 8-K Bank of America.
Retrieved July 25, 2005, from
www.sec.gov/Archives/edgar/data/70858/000119312505143377/dex991.htm

Bank of America. (n.d.). Facts about the Corporation. Retrieved
July 25, 2005, from http://www.bankofamerica.com/facts/index.cfm?Menu_Sel=mktleader

Bureau of Economic Analysis. (n.d.). New release: Gross Domestic
Product. Retrieved on August 12, 2005, from
http://www.bea.gov/bea/newsrel/gdpnewsrelease.htm

Citizens Business Bank. (2005a). Form 10-K Fiscal Year Ended
December 31, 2004. Retrieved August 1, 2005, from
http://www.sec.gov/Archives/edgar/
data/354647/000095012905002388/a06626e10vk.htm

Citizens Business Bank. (2005b, April 20). Financial Highlights.
Retrieved August 1, 2005, from
http://www.cbbank.com/about_us/financial_highlights.asp?
Directory=AboutUs&Topic=Financial_Highlights

Citizens Business Bank. (n.d.). About Us. Retrieved August 1, 2005,
from http://www.snl.com/Interactive/IR/bio.asp?IID=100224&PID=30951&AIP=27195

Encarta Encyclopedia Online. (n.d.a) Bank of America Corporation.
MSN. Retrieved July 25, 2005, from
http://Encarta.msn.com/encyclopedia_761588057/
Bank_of_America_Corporation.html

Encarta Encyclopedia Online. (n.d.b). Banking. Retrieved on July
26, 2005, from http://encarta.msn.com/encyclopedia_761575515/Banking.html

Federal Deposit Insurance Corporation. (2004, June 30). Statistics
on depository institutions. Retrieved August 8, 2005, from
http://www2.fdic.gov/SDI/rpt_Financial..asp

Federal Deposit Insurance Corporation. (2005a, May 26). Banks and
thrifts report record earnings in first quarter 2005. Retrieved on
August 8, 2005, from http://www.fdic.gov/new/news/press/2005/pr4705.html

Federal Deposit Insurance Corporation. (2005b, summer). FDIC
Outlook: Opportunities and Risks Facing Community Lenders that Support
International Trade. Retrieved August 16, 2005, from
http://www.fdic.gov/analytical/regional/ro20052q/na/2005summer_04.html

Federal Deposit Insurance Corporation. (2005c, summer). FDIC
Outlook: The globalization of the U.S. banking industry. Retrieved
August 16, 2005, from
http://www.fdic.gov/analytical/regional/ro20052q/na/2005summer_03.html

Foothill Independent Bancorp. (2005a). Form 10-K Fiscal Year Ended
December 31, 2004. Retrieved July 27, 2005, from
http://www.sec.gov/Archives/edgar/data/718903/000119312505050867/d10k.htm

Foothill Independent Bancorp. (2005b, July 19). Press Release.
Retrieved July 29, 2005, from
http://www.snl.com/Interactive/IR/file.asp?IID=100278&FID=1866957&OSID=9

Foothill Independent Bancorp. (n.d.). Corporate Profile. Retrieved
July 29, 2005, from http://www.snl.com/Interactive/IR/corp.asp?IID=100278

Neuborne, E. & Kerwin, K. (1999). Generation Y: Today’s
teens-the biggest bulge since the boomers-may force marketers to toss
their old tricks. BusinessWeekOnline. Retrieved September 26, 2005, from
http://www.busienssweek.com/1999/99_07/b3616001.htm?scriptFramed

PFF Bancorp, Inc. (2005). Form 10-K Fiscal Year Ended March 31,
2005. Retrieved July 27, 2005, from
http://www.sec.gov/Archives/edgar/data/
1004969/000119312505125196/d10k.htm

PFF Bank & Trust. (n.d.a). A history more than a century old.
Retrieved July 18, 2005, from http://www.pffbank.com/contact/history.htm

PFF Bank & Trust (n.d.b). Building momentum: Summary annual
report 2005. Retrieved August 22, 2005, from
http://www.pffbank.com/ir/2005_pff_bancorp_annual_report.pdf

Rinehart, L. (2005, May 12). Personal Interview.

Southern California Association of Governments. (n.d.). Annual
report. Retrieved July 29, 2005, from http://www.scag.ca.gov/census

Standard & Poor’s (2004a, August 19). Standard &
Poor’s Industry Surveys: Banking, Vol 172, No. 34, Section 1. New
York: McGraw-Hill Companies.

Standard & Poor’s (2004b, December 2). Standard &
Poor’s Industry Surveys: Savings and Loans, Vol 172, No. 49,
Section 2. New York: McGraw-Hill Companies.

Treasury Department. (2002, July 16). Section 326 summary.
Retrieved August 19, 2005, from
http://search.treas.gov/search?q=cache:Oxaw80B08EJ:
www.treas.gov/press/releases/doc.

Vineyard National Bancorp. (2005). Form 10-K Fiscal Year Ended
December 31, 2004. Retrieved July 29, 2005, from
http://www.sec.gov/Archives/edgar/
data/840256/000084025605000010/dec31200410k.htm

Washington Mutual, Inc. (n.d.). History. Retrieved July 26, 2005,
from http://www.wamu.com/about/corporateprofile/history/defaul.asp

Washington Mutual, Inc. (2005). Form 10-K Fiscal Year Ended
December 31, 2004. Retrieved July 26, 2005, from
http://www.sec.gov/Archives/edgar/
data/933136/000104746905006351/a2153144z10-k.htm

Olukemi O. Sawyerr, California State Polytechnic University, Pomona

Stanley C. Abraham, California State Polytechnic University, Pomona

Table 1: Largest US Bank Holding Companies Ranked by Total Assets

Rank   Company                                Total Assets ($M)

                                            3/31/2003   3/31/2004

 1     Citigroup, Inc.                      1,137,373   1,317,591
 2     Bank of America Corp                  680,197     816,012
 3     J.P. Morgan Chase & Co                755,156     801,078
 4     Wachovia Corp.                        348,064     410,991
 5     Wells Fargo & Co.                     369,607     397,354
 6     U.S. Bancorp                          182,231     192,093
 7     SunTrust Banks, Inc.                  120,062     125,245
 8     National City Corp.                   117,494     111,355
 9     BB&T Corp.                            79,648      94,282
 10    Fifth Third Bancorp                   84,325      93,732
 11    State Street Corp.                    79,109      92,896
 12    Bank of New York Co. Inc              79,548      92,652
 13    KeyCorp                               86,490      84,448
 14    PNC Financial Services Group Inc.     68,619      74,115
 15    Comerca Inc.                          55,805      54,468
 16    SouthTrust Corp.                      51,349      52,673
 17    Regions Financial Corp.               48,465      48,777
 18    AmSouth Bancorporation                42,099      47,415
 19    UnionBanCal Corp.                     40,387      46,102
 20    Charter One Financial Inc.            43,249      41,279

Rank
       % Change

 1       15.8
 2        20
 3       6.1
 4       18.1
 5       7.5
 6       5.4
 7       4.3
 8       -5.2
 9       18.4
 10      11.2
 11      17.4
 12      16.5
 13      -2.4
 14       8
 15      -2.4
 16      2.6
 17      0.6
 18      12.6
 19      14.2
 20      -4.6

Source: Standard & Poor's (2004, August 19). Standard & Poor's
Industry Surveys: Banking, Vol 172, No. 34, Section 1. New York:
McGraw-Hill Companies.


Table 2: Leading Thrift Institutions Ranked by Total Assets

Rank    Company                       Assets ($M)
                                      12/31/2002     12/31/2003

 1      Washington Mutual               268,298       275,178
 2      Golden West Financial           68,406         82,550
 3      Sovereign Bancorp               39,524         43,505
 4      New York Community Bancorp      11,313         23,441
 5      GreenPoint Financial            21,814         22,985
 6      Astoria Financial               21,698         22,458
 7      IndyMac Bancorp                  9,574         13,240
 8      Commercial Federal              13,081         12,189
 9      Downey Financial                11,978         11,646
 10     Flagstar Bancorp                 8,204         10,570

Source: Standard & Poor's (2004, December 2). Standard & Poor's
Industry Surveys: Savings and Loans, Vol 172, Number 49, Section 2.
New York: McGraw-Hill Companies.

Table 3: Typical SAIF-Insured Thrift's Loan Portfolio

         Category            % Loans (as of 12/31/2003)

1-4 family mortgages                   61.9
Mortgage-backed securities             10.5
Construction                            8.1
Apartment                               6.2
Consumer                                5.4
Commercial                              4.5
Commercial real estate                  2.5
Land                                    0.9
Total                                   100

Source: Standard & Poor's (2004, December 2). Standard & Poor's
Industry Surveys: Savings and Loans, Vol 172, Number 49, Section 2.
New York: McGraw-Hill Companies.

Table 4: Location of Foreign Branches of U.S. Banks
(dollars in billions)

                31-Dec-94                 31-Dec-04
  Location       Assets     Asset Share    Assets     Asset Share

Asia               $76          23%         $104          23%
Canada              0           0%           11           2%
Europe             161          48%          245          54%
Latin America      13           4%           13           3%
Caribbean          63           19%          41           9%
Other              21           6%           41           9%
Total             $333         100%         $456         100%

Source: Federal Deposit Insurance Corporation. (Summer 2005). FDI
Outlook: The globalization of the U.S.
banking industry. Retrieved on August 16, 2005, from
http://www.fdic.gov/analytical/regional/ro20052q/na/2005summer_03

Table 5: Brand-Awareness Tracking in Customer-Banking

Trust          Top Spot among regional banks in Inland Empire
Esteem         Top Spot among regional banks in Inland Empire
Satisfaction   Top Spot among all banks in Enland Empire
Loyalty        Top Spot among all banks in Inland Empire
Advocacy       top Spot among all banks in Inland Empire

Sourse: PFF Bancorp, 2005

Exhibit 1: PFF Bancorp, Inc. and Subsidiaries Consolidated Balance
Sheets

                                               As of March 31,

                                        2005       2004        2003

                                           (Dollars in thousands,
                                           except per share data)

Assets

Cash and equivalents                   $44,844    60,151      50,323
Investment securities                   6,736      5,742       5,753
held-to-maturity (estimated fair
value of $6,647 and $5,979 at March
31, 2005 and 2004)
Investment securities                  61,938     62,957      94,094
available-for-sale, at fair
Mortgage-backed securities             250,954    292,888     215,266
available-for-sale, at fair value
Collateralized mortgage obligations      --         --        15,200
available-for-sale, at fair value
Trading securities, at fair value        --         --          --
Loans held-for-sale value               1,466      2,119       3,327
Loans and leases receivable, net       #######   3,149,318   2,688,950
Federal Home Loan Bank (FHLB)          41,839     42,500      26,610
Accrued interest receivable stock,     16,413     14,752      14,162
at cost
Assets acquired through                  --         683         75
foreclosure, net
Property and equipment, net            30,385     27,430      23,325
Prepaid expenses and other assets      24,942     19,154      16,939

Total assets                           #######   3,677,694   3,154,024
Liabilities and Stockholders' Equity
Liabilities:
Deposits                               #######   2,455,046   2,326,108
FHLB advances and other borrowings     769,423    851,600     485,385
Junior subordinated debentures         30,928       --          --
Deferred income tax liability           3,534     14,068       7,521
Accrued expenses and other             34,313     40,609      61,878
liabilities

Total liabilities                      #######   3,361,323   2,880,892

Commitments and contingencies            --         --          --
       Stockholders' equity:
Common stock, $.01 par value.            248        168         208
Additional paid-in capital             164,536    144,585     131,770
Retained earnings, substantially       178,288    173,188     150,282
restricted
Unearned stock-based compensation       -352      -2,121      -3,996
Treasury stock (126,200 and 419,550      -1         -3          -92
shares at March 31, 2005 and 2004,
respectively)
Accumulated other comprehensive        -5,793       554       -5,040
income (losses)

Total stockholders' equity             336,926    316,371     273,132

Total liabilities and stockholders'    #######   3,677,694   3,154,024
equity

                                          As of March 31,

                                         2002        2001

                                       (Dollars in thousands,
                                       except per share data)

Assets

Cash and equivalents                    105,965     51,526
Investment securities                     703         702
held-to-maturity (estimated fair
value of $6,647 and $5,979 at March
31, 2005 and 2004)
Investment securities                   93,820      59,137
available-for-sale, at fair
Mortgage-backed securities              196,580     302,964
available-for-sale, at fair value
Collateralized mortgage obligations     62,778      82,315
available-for-sale, at fair value
Trading securities, at fair value        2,334       2,375
Loans held-for-sale value                 106         583
Loans and leases receivable, net       2,494,667   2,285,307
Federal Home Loan Bank (FHLB)           35,133      46,121
Accrued interest receivable stock,      15,653      18,466
at cost
Assets acquired through                   507         351
foreclosure, net
Property and equipment, net             21,575      22,946
Prepaid expenses and other assets       13,111      13,638

Total assets                           3,042,932   2,886,431
Liabilities and Stockholders' Equity
Liabilities:
Deposits                               2,168,964   2,021,261
FHLB advances and other borrowings      558,000     575,000
Junior subordinated debentures            --
Deferred income tax liability            6,849       7,849
Accrued expenses and other              25,042      24,323
liabilities

Total liabilities                      2,758,855   2,628,433

Commitments and contingencies
       Stockholders' equity:
Common stock, $.01 par value.             203         200
Additional paid-in capital              135,540     131,919
Retained earnings, substantially        161,123     137,703
restricted
Unearned stock-based compensation       -5,750      -8,953
Treasury stock (126,200 and 419,550       -73         -68
shares at March 31, 2005 and 2004,
respectively)
Accumulated other comprehensive         -6,966      -2,803
income (losses)

Total stockholders' equity              284,077     257,998

Total liabilities and stockholders'    3,042,932   2,886,431
equity

Source: PFF Bancorp

Exhibit 2: PFF Bancorp, Inc. and Subsidiaries Consolidated Statements
of Earnings

                                          Year Ended March 31,
                                          (Dollars in thousands,
                                          except per-share data)

                                           2005        2004

Interest income:
Loans and leases receivable               #######    167,309
Mortgage-backed securities                 9,944      9,219
Collateralized mortgage obligations         --         (327
Investment securities and deposits         4,600      4,123
Total interest income                     209,934    180,324

Interest on deposits                      39,934      36,770
Interest on borrowings                    18,326      12,559
Total interest expense                    58,260      49,329

Net interest income                       151,674    130,995
Provision for loan and lease losses        2,654      2,725
Net interest income after provision for   149,020    128,270
loan and lease losses

Non-interest income:
Deposit and related fees                  10,514      10,027
Loan and servicing fees                    6,471      6,595
Trust, investment and insurance fees       4,419      3,806
Gain on sale of loans, net                  321        809
Gain on sale of securities, net            4,771      1,795
Loss on trading securities, net             --          --
Other non-interest income                   979       2,006
Total non-interest income                 27,475      25,038

Non-interest expense:
General and administrative:
Compensation and benefits                 51,733      47,179
Occupancy and equipment                   14,654      12,706
Marketing and professional services        9,985      8,027
Other general and administrative          14,120      11,990
Total general and administrative          90,492      79,902
Foreclosed asset operations, net            75         339
Total non-interest expense                90,567      80,241

Earnings before income taxes              85,928      73,067
Income taxes                              40,155      32,118
Net earnings                              $45,773     40,949

Basic earnings per share                   $1.86       1.7
Weighted average shares outstanding for   #######   24,090,768
basic earnings per share
Diluted earnings per share                 $1.81       1.63
Weighted average shares outstanding for   #######   25,063,509
diluted earnings per share

                                          Year Ended March 31,
                                          (Dollars in thousands,
                                          except per-share data)

                                             2003        2002

Interest income:
Loans and leases receivable                169,954     188,131
Mortgage-backed securities                  8,203       15,610
Collateralized mortgage obligations           92        3,214
Investment securities and deposits          7,127       8,776
Total interest income                      185,376     215,731

Interest on deposits                        52,791      76,015
Interest on borrowings                      19,456      28,609
Total interest expense                      72,247     104,624

Net interest income                        113,129     111,107
Provision for loan and lease losses         4,840       5,000
Net interest income after provision for    108,289     106,107
loan and lease losses

Non-interest income:
Deposit and related fees                    8,815       9,427
Loan and servicing fees                     5,262       4,972
Trust, investment and insurance fees        3,888       2,086
Gain on sale of loans, net                   559         359
Gain on sale of securities, net             1,343         25
Loss on trading securities, net              -575        -107
Other non-interest income                    606         281
Total non-interest income                   19,898      17,043

Non-interest expense:
General and administrative:
Compensation and benefits                   37,323      34,319
Occupancy and equipment                     12,158      11,905
Marketing and professional services         7,787       6,969
Other general and administrative            10,198      8,934
Total general and administrative            67,466      62,127
Foreclosed asset operations, net             -190        -102
Total non-interest expense                  67,276      62,025

Earnings before income taxes                60,911      61,125
Income taxes                                25,489      25,761
Net earnings                                35,422      35,364

Basic earnings per share                     1.4         2.03
Weighted average shares outstanding for   25,302,080   ########
basic earnings per share
Diluted earnings per share                   1.35        1.96
Weighted average shares outstanding for   26,300,936   ########
diluted earnings per share

                                          Year Ended March 31,
                                          (Dollars in thousands,
                                          except per-share data)

                                                   2001

Interest income:
Loans and leases receivable                      199,511
Mortgage-backed securities                        22,274
Collateralized mortgage obligations               6,393
Investment securities and deposits                11,771
Total interest income                            239,949

Interest on deposits                              94,989
Interest on borrowings                            48,482
Total interest expense                           143,471

Net interest income                               96,478
Provision for loan and lease losses               5,004
Net interest income after provision for           91,474
loan and lease losses

Non-interest income:
Deposit and related fees                          8,969
Loan and servicing fees                           3,854
Trust, investment and insurance fees              1,846
Gain on sale of loans, net                         390
Gain on sale of securities, net                    -16
Loss on trading securities, net                   -1,490
Other non-interest income                          766
Total non-interest income                         14,319

Non-interest expense:
General and administrative:
Compensation and benefits                         30,332
Occupancy and equipment                           11,792
Marketing and professional services               6,310
Other general and administrative                  8,632
Total general and administrative                  57,066
Foreclosed asset operations, net                   -324
Total non-interest expense                        56,742

Earnings before income taxes                      49,051
Income taxes                                      20,791
Net earnings                                      28,260

Basic earnings per share                           2.32
Weighted average shares outstanding for         12,182,855
basic earnings per share
Diluted earnings per share                         2.24
Weighted average shares outstanding for         12,640,281
diluted earnings per share

Source: PFF Bancorp