Item
2 - Management's Discussion and Analysis of Financial Condition and Results of
Operations
Overview
Certain
matters discussed or incorporated by reference in this Quarterly Report of Form
10-Q are forward-looking statements that are subject to risks and uncertainties
that could cause actual results to differ materially from those projected in the
forward-looking statements. Such risks and uncertainties include, but are not
limited to, those described in Management’s Discussion and Analysis of Financial
Condition and Results of Operations. Such risks and uncertainties include, but
are not limited to, the following factors: i) competitive pressures in the
banking industry and changes in the regulatory environment; ii) exposure to
changes in the interest rate environment and the resulting impact on the
Company’s interest rate sensitive assets and liabilities; iii) decline in the
health of the economy nationally or regionally which could reduce the demand for
loans or reduce the value of real estate collateral securing most of the
Company’s loans; iv) credit quality deterioration that could cause an increase
in the provision for loan losses; v) Asset/Liability matching risks and
liquidity risks; volatility and devaluation in the securities markets, vi)
expected cost savings from recent acquisitions are not realized, and, vii)
potential impairment of goodwill and other intangible assets. Therefore, the
information set forth therein should be carefully considered when evaluating the
business prospects of the Company. For additional information concerning risks
and uncertainties related to the Company and its operations, please refer to the
Company’s Annual Report on Form 10-K for the year ended December 31,
2008.
The
Company has made certain reclassifications to the 2008 financial information to
conform to the classifications used in 2009. Effective January 1, 2009, the
Company reclassified a contingent asset that represents a claim from an
insurance company related to a charged-off lease portfolio, including specific
reserves, from loans to other assets. Management believes the asset is better
reflected, given its nature, as an asset other than loans (see Note 1 for more
details). All periods presented have been retroactively adjusted for the
reclassification to other assets and therefore amounts have been excluded from
loans and reserves for credit losses, including impaired and nonaccrual balances
for periods prior to June 30, 2009. The contingent asset was ultimately settled
during the quarter ended June 30, 2009 resulting in a pretax gain of
$117,000.
The
Company currently has eleven banking branches, which provide financial services
in Fresno, Madera, Kern, and Santa Clara counties in the state of
California.
Trends
Affecting Results of Operations and Financial Position
The
following table summarizes the six-month and year-to-date averages of the
components of interest-bearing assets as a percentage of total interest-bearing
assets and the components of interest-bearing liabilities as a percentage of
total interest-bearing liabilities:
|
|
YTD
Average
|
|
|
YTD
Average
|
|
|
YTD
Average
|
|
|
|
6/30/09
|
|
|
12/31/08
|
|
|
6/30/08
|
|
Loans
and Leases
|
|
|
84.87
|
%
|
|
|
84.23
|
%
|
|
|
84.05
|
%
|
Investment
securities available for sale
|
|
|
13.79
|
%
|
|
|
14.30
|
%
|
|
|
15.10
|
%
|
Interest-bearing
deposits in other banks
|
|
|
1.34
|
%
|
|
|
1.39
|
%
|
|
|
0.69
|
%
|
Federal
funds sold
|
|
|
0.00
|
%
|
|
|
0.08
|
%
|
|
|
0.16
|
%
|
Total
earning assets
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW
accounts
|
|
|
8.50
|
%
|
|
|
7.92
|
%
|
|
|
8.12
|
%
|
Money
market accounts
|
|
|
20.05
|
%
|
|
|
22.89
|
%
|
|
|
23.08
|
%
|
Savings
accounts
|
|
|
6.99
|
%
|
|
|
7.50
|
%
|
|
|
7.73
|
%
|
Time
deposits
|
|
|
36.56
|
%
|
|
|
42.51
|
%
|
|
|
48.01
|
%
|
Other
borrowings
|
|
|
25.64
|
%
|
|
|
16.84
|
%
|
|
|
10.66
|
%
|
Subordinated
debentures
|
|
|
2.26
|
%
|
|
|
2.34
|
%
|
|
|
2.40
|
%
|
Total
interest-bearing liabilities
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
The
Company’s overall operations are impacted by a number of factors, including not
only interest rates and margin spreads, which impact results of operations, but
also the composition of the Company’s balance sheet. One of the primary
strategic goals of the Company is to maintain a mix of assets that will generate
a reasonable rate of return without undue risk, and to finance those assets with
a low-cost and stable source of funds. Liquidity and capital resources must also
be considered in the planning process to mitigate risk and allow for
growth.
Continued
weakness in the real estate markets and the general economy have impacted the
Company’s operations during the past several quarters although, the Company
continues its business development and expansion efforts throughout a diverse
market area.
With
market rates of interest declining 100 basis points during the fourth quarter of
2007, and another 400 basis points during the year ended December 31, 2008, the
Company continues to experience compression of its net interest margin. The
Company’s net interest margin was 4.39% for the six months ended June 30, 2009,
as compared to 4.36% for the year ended December 31, 2008, and 4.61% for the six
months ended June 30, 2008. With approximately 66% of the loan portfolio in
floating rate instruments at June 30, 2009, the effects of market rates continue
to impact loan yields. Loans yielded 5.77% during the six months ended June 30,
2009, as compared to 6.81% for the year ended December 31, 2008, and 7.48% for
the six months ended June 30, 2008. With the rapid decline in market rates of
interest experienced during 2008, deposit repricing was slow to follow the
decline in loan rates during the second half of 2008. However, with stock market
declines, combined with more substantial FDIC insurance coverage, deposit rates
declined during the fourth quarter of 2008 as investors sought safety in bank
deposits. Borrowing rates declined significantly during the fourth quarter of
2008 and have remained low during 2009, resulting in overnight and short-term
borrowing rates of less than 0.50% during the six months ended June 30, 2009.
The Company has benefited from these rate declines, as it has continued to
utilize overnight and short-term borrowing lines through the Federal Reserve and
Federal Home Loan Bank to a greater degree. The Company’s average cost of funds
was 1.55% for the six months ended June 30, 2009 as compared to 2.75% for the
year ended December 31, 2008, and 3.18% for the six months ended June 30,
2008.
Total
noninterest income of $2.4 million reported for the six months ended June 30,
2009 decreased $1.6 million or 40.3% as compared to the six months ended June
30, 2008, resulting in part to changes in SFAS No. 159 fair market value
adjustments between the two six-month periods on the Company’s junior
subordinated debt. Noninterest income continues to be driven by customer service
fees, which totaled $2.0 million for the six months ended June 30, 2009,
representing a decrease of $461,000 or 18.7% over the $2.5 million in customer
service fees reported for the six months ended June 30, 2008. Although we
believe the decline in current economic conditions has had an impact on the
level of customer service fees, decreases in ATM fees between the two periods
presented resulting from the loss of a contract during 2008 to provide multiple
ATM’s in a single location have also adversely impacted the level of customer
service fees. Customer service fees represented 83.0% and 60.9% of total
noninterest income for the six-month periods ended June 30, 2009 and 2008,
respectively.
Noninterest
expense increased approximately $2.9 million or 24.5% between the six-month
periods ended June 30, 2008 and June 30, 2009. The primary reason for the
increase in noninterest expense experienced during the first six months of 2009
was the result of a goodwill impairment loss totaling $3.0 million recognized
during the quarter ended June 30, 2009. While impairment losses on
the Company’s core deposit intangible assets decreased $567,000 between the
six-month periods ended June 30, 2008 and 2009, the Company took impairment
charges of $503,000 during the first six months of 2009 on real estate owned
through foreclosure, and $403,000 on investment securities. Salary expense
decreased $1.5 million or 25.4% between the six months ended June 30, 2008 and
June 30, 2009, primarily as the result of declines in accrued bonuses and
employee incentives between the two periods.
On June
23, 2009, the Company’s Board of Directors again declared a one-percent (1%)
stock dividend on the Company’s outstanding common stock. The stock dividend
replaces quarterly cash dividends and reflects a similar value. Although the
Company's capital position remains strong, the change in the dividend from cash
to stock begun during the third quarter of 2008 was employed as a precaution
against uncertainties in the 1-4 family residential real estate market and the
potential impact on the Company's construction and related land and lot loan
portfolio. The Company believes, given the current uncertainties in the economy
and unprecedented declines in real estate valuations in our markets, it is
prudent to retain capital in this environment, and better position the Company
for future growth opportunities. Based upon the number of outstanding common
shares on the record date of July 10, 2009, an additional 120,788 shares were
issued to shareholders on July 22, 2009. For purposes of earnings per share
calculations, the Company’s weighted average shares outstanding and potentially
dilutive shares used in the computation of earnings per share have been restated
after giving retroactive effect to the 1% stock dividend to shareholders for all
periods presented.
The
Company has sought to maintain a strong, yet conservative balance sheet during
the six months ended June 30, 2009 with only modest increases in net loans
during the period. Total assets decreased approximately $22.5 million during the
six months ended June 30, 2009, with a decrease of $27.8 million in
interest-bearing deposits in other banks and investment securities as the
Company decreased its borrowing exposure during 2009. Average loans comprised
approximately 86% of overall average earning assets during the six months ended
June 30, 2009.
Nonperforming
assets, which are primarily related to the real estate portfolio, remained high
during the six months ended June 30, 2009 as real estate markets continue to
suffer from the mortgage crisis which began during mid-2007. Nonaccrual loans
increased $10.5 million from the balance reported at December 31, 2008, and
increased $17.5 million from the balance reported at June 30, 2008, to a balance
of $56.2 million at June 30, 2009. In determining the adequacy of the underlying
collateral related to these loans, management monitors trends within specific
geographical areas, loan-to-value ratios, appraisals, and other credit issues
related to the specific loans. Impaired loans increased $18.2 million
during the six months ended June 30, 2009 to a balance of $67.2 million at June
30, 2009, and increased $9.1 million during the quarter ended June 30, 2009.
Other real estate owned through foreclosure increased $6.9 million between
December 31, 2008 and June 30, 2009, as sales of existing OREO properties were
more than offset by the transfer of the $10.3 million in loans to other real
estate owned during the six months ended June 30, 2009. As a result of these
events, nonperforming assets as a percentage of total assets increased from
9.96% at December 31, 2008 to 14.03% at June 30, 2009.
As the
economy has declined along with asset valuations, increased emphasis has been
placed on impairment analysis of both tangible and intangible assets on the
balance sheet. As of March 31, 2009, the Company conducted annual impairment
testing on the largest component of its outstanding balance of goodwill, that of
the Campbell operating unit (resulting from the Legacy merger during February
2007.) In part, as a result of the severe decline in interest rates and other
economic factors within the industry, we could not conclude at March 31, 2009
that there was not a possibility of goodwill impairment under the current
economic conditions. During the second quarter of 2009, the Company utilized an
independent valuation service to determine the aggregate fair value of the
individual assets, liabilities, and identifiable intangible assets of the
Campbell operating unit in question to determine if the goodwill related to that
operating unit was impaired, and if so, how much the impairment was. Management,
with the assistance of the independent third-party, concluded that there was
impairment of the goodwill related to the Campbell operating unit, and as a
result the Company recognized an impairment loss of $3.0 million or $0.25 per
share (pre-tax and after-tax) for the quarter ended June 30, 2009.
Management
continues to monitor economic conditions in the real estate market for signs of
further deterioration or improvement which may impact the level of the allowance
for loan losses required to cover identified losses in the loan portfolio.
Increased charge-offs and significant provisions for loan losses made during the
first two quarters of 2009 materially impacted earnings, but the provisions made
to the allowance for credit losses, totaling $1.4 million during the first
quarter of 2009 and $6.8 million during the second quarter of 2009, along with
the allowance for loan losses, is adequate to cover inherent losses in the loan
portfolio. Loan and lease charge-offs totaling $4.1 million during the six
months ended June 30, 2009 included $2.6 million during the quarter ended March
31, 2009 and an additional $1.5 million during the quarter ended June 30,
2009.
Deposits
increased by $2.4 million during the six months ended June 30, 2009, with
increases experienced in both interest-bearing checking accounts and time
deposits.
The
Company continues to utilize overnight borrowings and other term credit lines to
a large degree, with borrowings totaling $135.3 million at June 30, 2009 as
compared to $155.0 million at December 31, 2008. The average rate of those term
borrowings was 0.60% at June 30, 2009 as compared to 0.93% at December 31, 2008,
representing a cost reduction of 33 basis points between the two period-ends.
Although the Company continues to realize significant interest expense
reductions by utilizing these overnight and term borrowings lines, the use of
such lines are monitored closely to ensure sound balance sheet management in
light of the current economic and credit environment.
The cost
of the Company’s subordinated debentures issued by USB Capital Trust II has
remained low as market rates have actually declined during the first six months
of 2009. With pricing at 3-month-LIBOR plus 129 basis points, the effective cost
of the subordinated debt was 1.91% at June 30, 2009, representing a rate
reduction of 62 basis points between March 31, 2009 and June 30, 2009, and a
rate reduction of 85 basis points between December 31, 2008 and June 30, 2009.
Pursuant to SFAS No. 159, the Company has recorded $105,000 in pretax fair value
losses ($62,000 net of tax) on its junior subordinated debt during the six
months ended June 30, 2009, bringing the total cumulative gain recorded on the
debt to $3.6 million at June 30, 2009.
The
Company continues to emphasize relationship banking and core deposit growth, and
has focused greater attention on its market area of Fresno, Madera, and Kern
Counties, as well as Campbell, in Santa Clara County. The San Joaquin Valley and
other California markets continue to exhibit weak demand for construction
lending and commercial lending from small and medium size businesses, as
commercial and residential real estate markets declined during much of 2008, a
condition which still persists at this time. The past year has presented
significant challenges for the banking industry with tightening credit markets,
weakening real estate markets, and increased loan losses adversely affecting the
industry.
The
Company continually evaluates its strategic business plan as economic and market
factors change in its market area. Balance sheet management, enhancing revenue
sources, and maintaining market share will be of primary importance during 2009
and beyond. The banking industry is currently experiencing continued pressure on
net margins as well as asset quality resulting from conditions in the real
estate market, and a general deterioration in credit markets. As a result,
market rates of interest and asset quality will continue be an important factor
in the Company’s ongoing strategic planning process.
Results
of Operations
For the
six months ended June 30, 2009, the Company reported a net loss of $4.8 million
or $0.39 per share ($0.39 diluted) as compared to net income of $4.6 million or
$0.37 per share ($0.37 diluted) for the six months ended June 30, 2008. The
decline in earnings between the two six month periods ended June 30, 2008 and
2009 is primarily the result of significant increases in provisions for loan
losses and impairment losses taken during 2009, combined with continued declines
in interest rate margins.
The
Company’s return on average assets was -1.30% for the six months ended June 30,
2009 as compared to 1.19% for the six months ended June 30, 2008, and was -3.11%
for the quarter months ended June 30, 2009 as compared to 1.09% for the quarter
ended June 30, 2008. The Bank’s return on average equity was -12.00% for the six
months ended June 30, 2009 as compared to 10.98% for the same six-month period
of 2008, and was -28.45% for the quarter ended June 30, 2009 as compared to
10.11% for the quarter ended June 30, 2008.
Net
Interest Income
Net
interest income before provision for credit losses totaled $13.9 million for the
six months ended June 30, 2009, representing a decrease of $1.8 million, or
11.3% when compared to the $15.7 million reported for the same six months of the
previous year. The decrease in both the annual and quarterly net interest income
between 2008 and 2009 is primarily the result of decreased yields on
interest-earning assets, which more than offset the decreased costs of
interest-bearing liabilities. Additionally, the Company experienced decreases in
the volume of interest-earning assets.
The
Bank's net interest margin, as shown in Table 1, decreased to 4.39% at June 30,
2009 from 4.61% at June 30, 2008, a decrease of 22 basis point (100 basis points
= 1%) between the two periods. Average market rates of interest have decreased
significantly between the six-month periods ended June 30, 2008 and 2009. The
prime rate averaged 3.25% for the six months ended June 30, 2009 as compared to
5.65% for the comparative six months of 2008.
Table 1. Distribution of
Average Assets, Liabilities and Shareholders’ Equity:
Interest
rates and Interest Differentials
Six
Months Ended June 30, 2009 and 2008
|
|
2009
|
|
|
2008
|
|
|
|
Average
|
|
|
|
|
|
Yield/
|
|
|
Average
|
|
|
|
|
|
Yield/
|
|
(dollars
in thousands)
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning
assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
and leases (1)
|
|
$
|
543,310
|
|
|
$
|
15,543
|
|
|
|
5.77
|
%
|
|
$
|
576,410
|
|
|
$
|
21,435
|
|
|
|
7.48
|
%
|
Investment
Securities – taxable
|
|
|
87,066
|
|
|
|
2,304
|
|
|
|
5.34
|
%
|
|
|
101,929
|
|
|
|
2,600
|
|
|
|
5.13
|
%
|
Investment
Securities – nontaxable (2)
|
|
|
1,252
|
|
|
|
29
|
|
|
|
4.67
|
%
|
|
|
1,649
|
|
|
|
39
|
|
|
|
4.76
|
%
|
Interest-bearing deposits
in other banks
|
|
|
8,587
|
|
|
|
77
|
|
|
|
1.81
|
%
|
|
|
4,725
|
|
|
|
84
|
|
|
|
3.58
|
%
|
Federal
funds sold and reverse repos
|
|
|
22
|
|
|
|
0
|
|
|
|
0.00
|
%
|
|
|
1,073
|
|
|
|
17
|
|
|
|
3.19
|
%
|
Total
interest-earning assets
|
|
|
640,237
|
|
|
$
|
17,953
|
|
|
|
5.65
|
%
|
|
|
685,786
|
|
|
$
|
24,175
|
|
|
|
7.09
|
%
|
Allowance
for credit losses
|
|
|
(10,882
|
)
|
|
|
|
|
|
|
|
|
|
|
(7,418
|
)
|
|
|
|
|
|
|
|
|
Noninterest-bearing
assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and due from banks
|
|
|
17,591
|
|
|
|
|
|
|
|
|
|
|
|
21,275
|
|
|
|
|
|
|
|
|
|
Premises
and equipment, net
|
|
|
14,003
|
|
|
|
|
|
|
|
|
|
|
|
15,320
|
|
|
|
|
|
|
|
|
|
Accrued
interest receivable
|
|
|
2,472
|
|
|
|
|
|
|
|
|
|
|
|
3,101
|
|
|
|
|
|
|
|
|
|
Other
real estate owned
|
|
|
31,208
|
|
|
|
|
|
|
|
|
|
|
|
7,576
|
|
|
|
|
|
|
|
|
|
Other
assets
|
|
|
50,274
|
|
|
|
|
|
|
|
|
|
|
|
45,715
|
|
|
|
|
|
|
|
|
|
Total
average assets
|
|
$
|
744,903
|
|
|
|
|
|
|
|
|
|
|
$
|
771,355
|
|
|
|
|
|
|
|
|
|
Liabilities
and Shareholders' Equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW
accounts
|
|
$
|
44,305
|
|
|
$
|
103
|
|
|
|
0.47
|
%
|
|
$
|
43,514
|
|
|
$
|
114
|
|
|
|
0.53
|
%
|
Money
market accounts
|
|
|
104,525
|
|
|
|
1,004
|
|
|
|
1.94
|
%
|
|
|
123,683
|
|
|
|
1,513
|
|
|
|
2.46
|
%
|
Savings
accounts
|
|
|
36,458
|
|
|
|
128
|
|
|
|
0.71
|
%
|
|
|
41,404
|
|
|
|
284
|
|
|
|
1.38
|
%
|
Time
deposits
|
|
|
190,609
|
|
|
|
2,039
|
|
|
|
2.16
|
%
|
|
|
257,238
|
|
|
|
5,310
|
|
|
|
4.15
|
%
|
Other
borrowings
|
|
|
133,702
|
|
|
|
539
|
|
|
|
0.81
|
%
|
|
|
57,105
|
|
|
|
860
|
|
|
|
3.03
|
%
|
Junior
subordinated debentures
|
|
|
11,758
|
|
|
|
198
|
|
|
|
3.40
|
%
|
|
|
12,886
|
|
|
|
380
|
|
|
|
5.93
|
%
|
Total
interest-bearing liabilities
|
|
|
521,357
|
|
|
$
|
4,011
|
|
|
|
1.55
|
%
|
|
|
535,830
|
|
|
$
|
8,461
|
|
|
|
3.18
|
%
|
Noninterest-bearing
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-bearing
checking
|
|
|
136,287
|
|
|
|
|
|
|
|
|
|
|
|
143,947
|
|
|
|
|
|
|
|
|
|
Accrued
interest payable
|
|
|
654
|
|
|
|
|
|
|
|
|
|
|
|
1,277
|
|
|
|
|
|
|
|
|
|
Other
liabilities
|
|
|
5,885
|
|
|
|
|
|
|
|
|
|
|
|
6,600
|
|
|
|
|
|
|
|
|
|
Total
Liabilities
|
|
|
664,183
|
|
|
|
|
|
|
|
|
|
|
|
687,654
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
shareholders' equity
|
|
|
80,720
|
|
|
|
|
|
|
|
|
|
|
|
83,701
|
|
|
|
|
|
|
|
|
|
Total
average liabilities and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
shareholders'
equity
|
|
$
|
744,903
|
|
|
|
|
|
|
|
|
|
|
$
|
771,355
|
|
|
|
|
|
|
|
|
|
Interest
income as a percentage
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of
average earning assets
|
|
|
|
|
|
|
|
|
|
|
5.65
|
%
|
|
|
|
|
|
|
|
|
|
|
7.09
|
%
|
Interest
expense as a percentage
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of
average earning assets
|
|
|
|
|
|
|
|
|
|
|
1.26
|
%
|
|
|
|
|
|
|
|
|
|
|
2.48
|
%
|
Net
interest margin
|
|
|
|
|
|
|
|
|
|
|
4.39
|
%
|
|
|
|
|
|
|
|
|
|
|
4.61
|
%
|
(1)
|
Loan
amounts include nonaccrual loans, but the related interest income has been
included only if collected for the period prior to the loan being
placed on a nonaccrual basis. Loan interest income includes loan fees of
approximately $755,000 and $1,876,000 for the six months ended June 30,
2009 and 2008, respectively.
|
(2)
|
Applicable
nontaxable securities yields have not been calculated on a tax-equivalent
basis because they are not material to the Company’s results of
operations.
|
Both the
Company's net interest income and net interest margin are affected by changes in
the amount and mix of interest-earning assets and interest-bearing liabilities,
referred to as "volume change." Both are also affected by changes in yields on
interest-earning assets and rates paid on interest-bearing liabilities, referred
to as "rate change". The following table sets forth the changes in interest
income and interest expense for each major category of interest-earning asset
and interest-bearing liability, and the amount of change attributable to volume
and rate changes for the periods indicated.
Table 2. Rate and
Volume Analysis
|
|
Increase
(decrease) in the six months ended
|
|
|
|
June
30, 2009 compared to June 30, 2008
|
|
(In
thousands)
|
|
Total
|
|
|
Rate
|
|
|
Volume
|
|
Increase
(decrease) in interest income:
|
|
|
|
|
|
|
|
|
|
Loans
and leases
|
|
$
|
(5,892
|
)
|
|
$
|
(4,718
|
)
|
|
$
|
(1,174
|
)
|
Investment
securities available for sale
|
|
|
(306
|
)
|
|
|
94
|
|
|
|
(400
|
)
|
Interest-bearing
deposits in other banks
|
|
|
(7
|
)
|
|
|
(20
|
)
|
|
|
13
|
|
Federal
funds sold and securities purchased
|
|
|
|
|
|
|
|
|
|
|
|
|
under
agreements to resell
|
|
|
(17
|
)
|
|
|
(9
|
)
|
|
|
(8
|
)
|
Total
interest income
|
|
|
(6,222
|
)
|
|
|
(4,653
|
)
|
|
|
(1,569
|
)
|
Increase
(decrease) in interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
demand accounts
|
|
|
(520
|
)
|
|
|
(355
|
)
|
|
|
(165
|
)
|
Savings
accounts
|
|
|
(156
|
)
|
|
|
(125
|
)
|
|
|
(31
|
)
|
Time
deposits
|
|
|
(3,271
|
)
|
|
|
(2,127
|
)
|
|
|
(1,144
|
)
|
Other
borrowings
|
|
|
(321
|
)
|
|
|
(928
|
)
|
|
|
607
|
|
Subordinated
debentures
|
|
|
(182
|
)
|
|
|
(151
|
)
|
|
|
(31
|
)
|
Total
interest expense
|
|
|
(4,450
|
)
|
|
|
(3,686
|
)
|
|
|
(764
|
)
|
Increase
(decrease) in net interest income
|
|
$
|
(1,772
|
)
|
|
$
|
(967
|
)
|
|
$
|
(805
|
)
|
For the
six months ended June 30, 2009, total interest income decreased approximately
$6.2 million, or 25.7% as compared to the six-month period ended June 30, 2008.
Earning asset volumes decreased in all earning-asset categories, except
interest-bearing deposits in other banks, between the six month periods, with
the largest decrease experienced in loans.
For the
six months ended June 30, 2009, total interest expense decreased approximately
$4.5 million, or 52.6% as compared to the six-month period ended June 30, 2008.
Between those two periods, average interest-bearing liabilities decreased by
$14.5 million, and the average rates paid on these liabilities decreased by 163
basis points.
Provisions
for credit losses are determined on the basis of management's periodic credit
review of the loan portfolio, consideration of past loan loss experience,
current and future economic conditions, and other pertinent factors. Such
factors consider the allowance for credit losses to be adequate when it covers
estimated losses inherent in the loan portfolio. Based on the condition of the
loan portfolio, management believes the allowance is sufficient to cover risk
elements in the loan portfolio. For the six months ended June 30, 2009, the
provision to the allowance for credit losses amounted to $8.2 million as
compared to $716,000 for the six months ended June 30, 2008 (see Asset Quality
and Allowance for Credit Losses for further discussion of provisions to the
allowance for credit losses.) The amount provided to the allowance for credit
losses during the first six months of 2009 brought the allowance to 2.89% of net
outstanding loan balances at June 30, 2009, as compared to 2.12% of net
outstanding loan balances at December 31, 2008, and 1.31% at June 30,
2008.
Noninterest
Income
Table 3. Changes in
Noninterest Income
The
following table sets forth the amount and percentage changes in the categories
presented for the six months ended June 30, 2009 as compared to the six months
ended June 30, 2008:
(In
thousands)
|
|
2009
|
|
|
2008
|
|
|
Amount
of Change
|
|
|
Percent
Change
|
|
Customer
service fees
|
|
$
|
2,008
|
|
|
$
|
2,469
|
|
|
$
|
(461
|
)
|
|
|
-18.67
|
%
|
Gain
on redemption of securities
|
|
|
0
|
|
|
|
24
|
|
|
|
(24
|
)
|
|
|
-100.00
|
%
|
(Loss)
gain on sale of OREO
|
|
|
(145
|
)
|
|
|
67
|
|
|
|
(212
|
)
|
|
|
-316.42
|
%
|
Loss
on swap ineffectiveness
|
|
|
0
|
|
|
|
9
|
|
|
|
(9
|
)
|
|
|
-100.00
|
%
|
(Loss)
gain on fair value of financial liabilities
|
|
|
(105
|
)
|
|
|
501
|
|
|
|
(606
|
)
|
|
|
-120.96
|
%
|
Shared
appreciation income
|
|
|
23
|
|
|
|
143
|
|
|
|
(120
|
)
|
|
|
-83.92
|
%
|
Other
|
|
|
638
|
|
|
|
841
|
|
|
|
(203
|
)
|
|
|
-24.14
|
%
|
Total
noninterest income
|
|
$
|
2,419
|
|
|
$
|
4,054
|
|
|
$
|
(1,635
|
)
|
|
|
-40.33
|
%
|
Noninterest
income for the six months ended June 30, 2009 decreased $1.7 million or 40.33%
when compared to the same period of 2008. Net decreases in total noninterest
income experienced during 2009 were in large part the result of SFAS No. 157
fair value loss adjustments on the Company’s junior subordinated debt totaling
$105,000 during the six months ended June 30, 2009, which represents a decrease
of $606,000 from the fair market value gains recognized during the six months
ended June 30, 2008. Customer service fees decreased $461,000 or 18.7% between
the two six-month periods presented, primarily resulting from decreases in ATM
fees as well as declining revenues from the Company’s financial services
department, which more than offset increases in service fees on deposit
accounts. Decreases in ATM fees between the two periods presented are primarily
the result of the loss of a contract during 2008 to provide multiple ATM’s in a
single location.
Noninterest
Expense
The
following table sets forth the amount and percentage changes in the categories
presented for the six months ended June 30, 2009 as compared to the six months
ended June 30, 2008:
Table 4. Changes in
Noninterest Expense
(In
thousands)
|
|
2009
|
|
|
2008
|
|
|
Amount
of Change
|
|
|
Percent
Change
|
|
Salaries
and employee benefits
|
|
$
|
4,286
|
|
|
$
|
5,745
|
|
|
$
|
(1,459
|
)
|
|
|
-25.40
|
%
|
Occupancy
expense
|
|
|
1,881
|
|
|
|
1,960
|
|
|
|
(79
|
)
|
|
|
-4.03
|
%
|
Data
processing
|
|
|
65
|
|
|
|
149
|
|
|
|
(84
|
)
|
|
|
-56.38
|
%
|
Professional
fees
|
|
|
811
|
|
|
|
717
|
|
|
|
94
|
|
|
|
13.11
|
%
|
Directors
fees
|
|
|
128
|
|
|
|
131
|
|
|
|
(3
|
)
|
|
|
-2.29
|
%
|
FDIC/DFI
insurance assessments
|
|
|
616
|
|
|
|
243
|
|
|
|
373
|
|
|
|
153.50
|
%
|
Amortization
of intangibles
|
|
|
451
|
|
|
|
535
|
|
|
|
(84
|
)
|
|
|
-15.70
|
%
|
Correspondent
bank service charges
|
|
|
208
|
|
|
|
226
|
|
|
|
(18
|
)
|
|
|
-7.96
|
%
|
Impairment
loss on core deposit intangible
|
|
|
57
|
|
|
|
624
|
|
|
|
(567
|
)
|
|
|
-90.87
|
%
|
Impairment
loss on investment securities
|
|
|
403
|
|
|
|
0
|
|
|
|
403
|
|
|
|
--
|
|
Impairment
loss on goodwill
|
|
|
3,026
|
|
|
|
0
|
|
|
|
3,026
|
|
|
|
--
|
|
Impairment
loss on OREO
|
|
|
503
|
|
|
|
31
|
|
|
|
472
|
|
|
|
1,522.58
|
%
|
Loss
on California tax credit partnership
|
|
|
214
|
|
|
|
216
|
|
|
|
(2
|
)
|
|
|
-0.93
|
%
|
OREO
expense
|
|
|
843
|
|
|
|
80
|
|
|
|
763
|
|
|
|
953.75
|
%
|
Other
|
|
|
1,272
|
|
|
|
1,200
|
|
|
|
72
|
|
|
|
6.00
|
%
|
Total
expense
|
|
$
|
14,764
|
|
|
$
|
11,857
|
|
|
$
|
2,907
|
|
|
|
24.52
|
%
|
The net
increase in noninterest expense between the six months ended June 30, 2008 and
2009 is primarily the result of $3.0 million in goodwill impairment losses taken
during second quarter of 2009. Other changes in noninterest expense are
comprised of reductions in salaries, bonus incentives, and overhead expenses,
increases in OREO, legal, FDIC insurance assessments, and other expenses
associated with nonperforming and foreclosed loans, as well as changes in the
components of other impairment losses taken on various assets of the Company. As
the economy has declined over the past year, the Company has streamlined certain
departments to more effectively control salary and employee benefit costs where
the levels of business are lower than they have been historically.
While
impairment losses on core deposit intangible assets decreased $567,000 or 90.9%
between the six months ended June 30, 2008 and 2009, additional impairment
losses were recorded during 2009 on other of the Company’s assets. Impairment
losses totaling $503,000 were realized on OREO during the six months ended June
30, 2009 as OREO properties were further written-down to fair value as new
valuations were received. In addition, the Company recognized $403,000 in
impairment losses ($163,000 during the first quarter of 2009 and $240,000 during
the second quarter of 2009) on two of its non-agency collateralized mortgage
obligations which were determined to be other-than-temporarily impaired. The
amount expensed as impairment losses on the two securities represents the
identified credit-related portion of the impairment pursuant to FSP FAS 115-2
which the Company adopted effective March 31, 2009. Although there are some
indications of improvement in current economic conditions, a prolonged
recessionary period could result in additional impairment losses in the
future.
The
Company recognized stock-based compensation expense of $27,000 and $62,000 for
the six months ended June 30, 2009 and 2008, respectively. This expense is
included in noninterest expense under salaries and employee benefits. The
Company expects stock-based compensation expense to be about $13,000 per quarter
during the remainder of 2009. Under the current pool of stock options,
stock-based compensation expense will decline to approximately $6,000 per
quarter during 2010, then decline after that through 2011. If new stock options
are issued, or existing options fail to vest, for example, due to unexpected
forfeitures, actual stock-based compensation expense in future periods will
change.
Income Taxes
On
January 1, 2007 the Company adopted Financial Accounting Standards Board (FASB)
Interpretation 48 (FIN 48),
“
Accounting for Uncertainty
in Income Taxes: an interpretation of FASB Statement No. 109”
.
FIN 48 clarifies SFAS No.
109,
“
Accounting for
Income Taxes”
,
to
indicate a criterion that an individual tax position would have to meet for some
or all of the income tax benefit to be recognized in a taxable entity’s
financial statements. Under the guidelines of FIN48, an entity should recognize
the financial statement benefit of a tax position if it determines that it is
more likely than not
that the position will be sustained on examination. The term “more likely
than not” means a likelihood of more than 50 percent.” In assessing whether the
more-likely-than-not criterion is met, the entity should assume that the tax
position will be reviewed by the applicable taxing authority.
Pursuant
to FIN 48, the Company reviewed its REIT tax position as of January 1, 2007
(adoption date), and then has again reviewed its position each subsequent
quarter since adoption. The Bank, with guidance from advisors, believes that the
case has merit with regard to points of law, and that the tax law at the time
allowed for the deduction of the consent dividend. However, the Bank, with the
concurrence of advisors, cannot conclude that it is “more than likely” (as
defined in FIN48) that the Bank will prevail in its case with the FTB. As a
result of this determination, effective January 1, 2007 the Company recorded an
adjustment of $1.3 million to beginning retained earnings upon adoption of FIN48
to recognize the potential tax liability under the guidelines of the
interpretation. The adjustment includes amounts for assessed taxes, penalties,
and interest. During the years ended December 31, 2008 and 2007, the Company
increased the unrecognized tax liability by an additional $87,000 in interest
for each of the two years, bringing the total recorded tax liability under FIN48
to $1.5 million at December 31, 2008. The Company has determined that there has
been no material change to its position on the REIT from that at December 31,
2008, and as a result recorded additional interest liability of $43,000 during
the six ended June 30, 2009. It is the Company’s policy to recognize interest
and penalties under FIN48 as a component of income tax expense. The Company has
reviewed all of its tax positions as of June 30, 2009, and has determined that,
other than the REIT, there are no other material amounts that should be recorded
under the guidelines of FIN48.
Financial
Condition
Total
assets decreased $22.5 million, or 2.96% to a balance of $738.5 million at June
30, 2009, from the balance of $761.1 million at December 31, 2008, and decreased
$34.3 million or 4.44% from the balance of $772.9 million at June 30, 2008.
Total deposits of $510.9 million at June 30, 2009 increased $2.4 million, or
0.47% from the balance reported at December 31, 2008, but decreased $47.8
million from the balance of $558.7 million reported at June 30, 2008. Between
December 31, 2008 and June 30, 2009, loans increased $4.2 million, or 0.76% to a
balance of $548.7 million, while investment securities decreased by $11.0
million, or 11.84%, and interest-bearing deposits in other banks decreased $16.8
million or 82.36%.
Earning
assets averaged approximately $640.2 million during the six months ended June
30, 2009, as compared to $685.8 million for the same six-month period of 2008.
Average interest-bearing liabilities decreased to $521.4 million for the six
months ended June 30, 2009, as compared to $535.8 million for the comparative
six-month period of 2008.
Loans
and Leases
The
Company's primary business is that of acquiring deposits and making loans, with
the loan portfolio representing the largest and most important component of its
earning assets. Loans totaled $548.7 million at June 30, 2009, an increase of
$4.2 million or 0.76% when compared to the balance of $544.6 million at December
31, 2008, and a decrease of $35.01 million or 6.00% when compared to the balance
of $583.7 million reported at June 30, 2008. Loans on average decreased $33.1
million or 5.74% between the six-month periods ended June 30, 2008 and June 30,
2009, with loans averaging $543.3 million for the six months ended June 30,
2009, as compared to $576.4 million for the same six-month period of
2008.
During
the first six months of 2009, increases were experienced primarily in commercial
and industrial loans, and to a lesser degree, in real estate mortgage and
agricultural loans. The largest declines were experienced in construction loans
as a result of soft real estate markets and declines in new home sales within
the Company’s market area. The following table sets forth the amounts of loans
outstanding by category at June 30, 2009 and December 31, 2008, the category
percentages as of those dates, and the net change between the two periods
presented.
Table 5.
Loans
|
|
June
30, 2009
|
|
|
December
31, 2008
|
|
|
|
|
|
|
|
|
|
Dollar
|
|
|
%
of
|
|
|
Dollar
|
|
|
%
of
|
|
|
Net
|
|
|
%
|
|
(In
thousands)
|
|
Amount
|
|
|
Loans
|
|
|
Amount
|
|
|
Loans
|
|
|
Change
|
|
|
Change
|
|
Commercial
and industrial
|
|
$
|
248,893
|
|
|
|
45.3
|
%
|
|
$
|
223,581
|
|
|
|
41.1
|
%
|
|
$
|
25,312
|
|
|
|
11.32
|
%
|
Real
estate – mortgage
|
|
|
128,977
|
|
|
|
23.5
|
%
|
|
|
126,689
|
|
|
|
23.3
|
%
|
|
|
2,288
|
|
|
|
1.81
|
%
|
Real
estate – construction
|
|
|
91,557
|
|
|
|
16.7
|
%
|
|
|
119,884
|
|
|
|
21.9
|
%
|
|
|
(28,327
|
)
|
|
|
-23.63
|
%
|
Agricultural
|
|
|
57,992
|
|
|
|
10.6
|
%
|
|
|
52,020
|
|
|
|
9.6
|
%
|
|
|
5,972
|
|
|
|
11.48
|
%
|
Installment/other
|
|
|
20,195
|
|
|
|
3.7
|
%
|
|
|
20,782
|
|
|
|
3.8
|
%
|
|
|
(587
|
)
|
|
|
-2.83
|
%
|
Lease
financing
|
|
|
1,087
|
|
|
|
0.2
|
%
|
|
|
1,595
|
|
|
|
0.3
|
%
|
|
|
(508
|
)
|
|
|
-31.85
|
%
|
Total
Gross Loans
|
|
$
|
548,701
|
|
|
|
100.0
|
%
|
|
$
|
544,551
|
|
|
|
100.0
|
%
|
|
$
|
4,150
|
|
|
|
-0.76
|
%
|
The
overall average yield on the loan portfolio was 5.77% for the six months ended
June 30, 2009, as compared to 7.48% for the six months ended June 30, 2008, and
decreased between the two periods primarily as the result of a significant
decline in average market rates of interest between the two periods. At June 30,
2009, 66.4% of the Company's loan portfolio consisted of floating rate
instruments, as compared to 64.0% of the portfolio at December 31, 2008, with
the majority of those tied to the prime rate.
Deposits
Total
deposits increased during the period to a balance of $510.9 million at June 30,
2009 representing an increase of $2.4 million, or 0.47% from the balance of
$508.5 million reported at December 31, 2008, and a decrease of $47.8 million,
or 8.56% from the balance reported at June 30, 2008. During the first six months
of 2009, increases were experienced in interest-bearing checking accounts as
well as time deposits. The decrease of $47.8 million in total deposits between
the six months ended June 30, 2008 and 2009 was largely the result of a decrease
in brokered time deposits, as maturing brokered deposits were replaced with less
expensive overnight and short-term borrowings.
The
following table sets forth the amounts of deposits outstanding by category at
June 30, 2009 and December 31, 2008, and the net change between the two periods
presented.
Table 6.
Deposits
|
|
June
30,
|
|
|
December
31,
|
|
|
Net
|
|
|
Percentage
|
|
(In
thousands)
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
Change
|
|
Noninterest
bearing deposits
|
|
$
|
126,881
|
|
|
$
|
149,529
|
|
|
$
|
(22,648
|
)
|
|
|
-15.15
|
%
|
Interest
bearing deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW
and money market accounts
|
|
|
156,903
|
|
|
|
136,612
|
|
|
|
20,291
|
|
|
|
14.85
|
%
|
Savings
accounts
|
|
|
36,009
|
|
|
|
37,586
|
|
|
|
(1,577
|
)
|
|
|
-4.19
|
%
|
Time
deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Under
$100,000
|
|
|
68,668
|
|
|
|
66,128
|
|
|
|
2,540
|
|
|
|
3.84
|
%
|
$100,000
and over
|
|
|
122,412
|
|
|
|
118,631
|
|
|
|
3,781
|
|
|
|
3.19
|
%
|
Total
interest bearing deposits
|
|
|
383,992
|
|
|
|
358,957
|
|
|
|
25,035
|
|
|
|
6.97
|
%
|
Total
deposits
|
|
$
|
510,873
|
|
|
$
|
508,486
|
|
|
$
|
2,387
|
|
|
|
0.47
|
%
|
The
Company's deposit base consists of two major components represented by
noninterest-bearing (demand) deposits and interest-bearing deposits.
Interest-bearing deposits consist of time certificates, NOW and money market
accounts and savings deposits. Total interest-bearing deposits increased $25.0
million, or 6.97% between December 31, 2008 and June 30, 2009, while
noninterest-bearing deposits decreased $22.6 million, or 15.15% between the same
two periods presented.
Core
deposits, consisting of all deposits other than time deposits of $100,000 or
more, and brokered deposits, continue to provide the foundation for the
Company's principal sources of funding and liquidity. These core deposits
amounted to 70.8% and 71.9% of the total deposit portfolio at June 30, 2009 and
December 31, 2008, respectively. Brokered deposits totaled $99.3 million at June
30, 2009 as compared to $93.4 million at December 31, 2008 and $46.1 million at
June 30, 2008. The Company continues to utilize more cost-effective overnight
borrowing lines through Federal Reserve Discount Window, but in an effort to
reduce its reliance on borrowed funds, the Company has recently increased the
level of brokered deposits as rates of those deposits have become more
attractive.
On a
year-to-date average (refer to Table 1), the Company experienced a decrease of
$97.6 million or 16.01% in total deposits between the six-month periods ended
June 30, 2008 and June 30, 2009. Between these two periods, average
interest-bearing deposits decreased $89.9 million or 19.31%, while total
noninterest-bearing checking decreased $7.7 million or 5.32% on a year-to-date
average basis.
Short-Term
Borrowings
The
Company had collateralized and uncollateralized lines of credit aggregating
$184.4 million, as well as FHLB lines of credit totaling $69.7 million at June
30, 2009. These lines of credit generally have interest rates tied to the
Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR.
All lines of credit are on an “as available” basis and can be revoked by the
grantor at any time. At June 30, 2009, the Company had $64.0 million borrowed
against its FHLB lines of credit, and $71.3 million in overnight borrowings at
the Federal Reserve Discount Window. The $64.0 million in FHLB borrowings
outstanding at June 30, 2009 is summarized below. The Company had collateralized
and uncollateralized lines of credit aggregating $242.7 million, as well as FHLB
lines of credit totaling $97.1 million at December 31, 2008.
FHLB term borrowings
at June 30, 2009 (in 000’s):
|
Term
|
|
Balance
at 6/30/09
|
|
|
Rate
|
|
Maturity
|
2
months
|
|
$
|
20,000
|
|
|
|
0.33
|
%
|
8/31/09
|
2
months
|
|
|
33,000
|
|
|
|
0.31
|
%
|
8/31/09
|
2
year
|
|
|
11,000
|
|
|
|
2.67
|
%
|
2/11/10
|
|
|
$
|
64,000
|
|
|
|
0.72
|
%
|
|
Asset
Quality and Allowance for Credit Losses
Lending
money is the Company's principal business activity, and ensuring appropriate
evaluation, diversification, and control of credit risks is a primary management
responsibility. Implicit in lending activities is the fact that losses will be
experienced and that the amount of such losses will vary from time to time,
depending on the risk characteristics of the loan portfolio as affected by local
economic conditions and the financial experience of borrowers.
The
allowance for credit losses is maintained at a level deemed appropriate by
management to provide for known and inherent risks in existing loans and
commitments to extend credit. The adequacy of the allowance for credit losses is
based upon management's continuing assessment of various factors affecting the
collectibility of loans and commitments to extend credit; including current
economic conditions, past credit experience, collateral, and concentrations of
credit. There is no precise method of predicting specific losses or amounts
which may ultimately be charged off on particular segments of the loan
portfolio. The conclusion that a loan may become uncollectible, either in part
or in whole is judgmental and subject to economic, environmental, and other
conditions which cannot be predicted with certainty. When determining the
adequacy of the allowance for credit losses, the Company follows, in accordance
with GAAP, the guidelines set forth in the Revised Interagency Policy Statement
on the Allowance for Loan and Lease Losses (“Statement”) issued by banking
regulators during December 2006. The Statement is a revision of the previous
guidance released in July 2001, and outlines characteristics that should be used
in segmentation of the loan portfolio for purposes of the analysis including
risk classification, past due status, type of loan, industry or collateral. It
also outlines factors to consider when adjusting the loss factors for various
segments of the loan portfolio, and updates previous guidance that describes the
responsibilities of the board of directors, management, and bank examiners
regarding the allowance for credit losses. Securities and Exchange Commission
Staff Accounting Bulletin No. 102 was released during July 2001, and represents
the SEC staff’s view relating to methodologies and supporting documentation for
the Allowance for Loan and Lease Losses that should be observed by all public
companies in complying with the federal securities laws and the Commission’s
interpretations. It is also generally consistent with the guidance
published by the banking regulators. The Company segments the loan and lease
portfolio into eleven (11) segments, primarily by loan class and type, that have
homogeneity and commonality of purpose and terms for analysis under SFAS No. 5.
Those loans, which are determined to be impaired under SFAS No. 114, are not
subject to the general reserve analysis under SFAS No. 5, and evaluated
individually for specific impairment.
The
Company’s methodology for assessing the adequacy of the allowance for credit
losses consists of several key elements, which include:
In
addition, the allowance analysis also incorporates the results of measuring
impaired loans as provided in:
The
formula allowance is calculated by applying loss factors to outstanding loans
and certain unfunded loan commitments. Loss factors are based on the Company’s
historical loss experience and on the internal risk grade of those loans and,
may be adjusted for significant factors that, in management's judgment, affect
the collectibility of the portfolio as of the evaluation date. Management
determines the loss factors for problem graded loans (substandard, doubtful, and
loss), special mention loans, and pass graded loans, based on a loss migration
model. The migration analysis incorporates loan losses over the past twelve
quarters (three years) and loss factors are adjusted to recognize and quantify
the loss exposure from changes in market conditions and trends in the Company’s
loan portfolio. For purposes of this analysis, loans are grouped by internal
risk classifications, which are “pass”, “special mention”, “substandard”,
“doubtful”, and “loss”. Certain loans are homogenous in nature and are therefore
pooled by risk grade. These homogenous loans include consumer installment and
home equity loans. Special mention loans are currently performing but are
potentially weak, as the borrower has begun to exhibit deteriorating trends,
which if not corrected, could jeopardize repayment of the loan and result in
further downgrade. Substandard loans have well-defined weaknesses which, if not
corrected, could jeopardize the full satisfaction of the debt. A loan classified
as “doubtful” has critical weaknesses that make full collection of the
obligation improbable. Classified loans, as defined by the Company, include
loans categorized as substandard, doubtful, and loss. At June 30, 2009 problem
graded or “classified” loans totaled $84.8 million or 15.5% of gross loans as
compared to $82.7 million or 15.0% of gross loans at December 31,
2008.
Specific
allowances are established based on management’s periodic evaluation of loss
exposure inherent in classified loans, impaired loans, and other loans in which
management believes there is a probability that a loss has been incurred in
excess of the amount determined by the application of the formula
allowance.
The
unallocated portion of the allowance is based upon management’s evaluation of
various conditions that are not directly measured in the determination of the
formula and specific allowances. The conditions may include, but are not limited
to, general economic and business conditions affecting the key lending areas of
the Company, credit quality trends, collateral values, loan volumes and
concentrations, and other business conditions.
The
following table summarizes the specific allowance, formula allowance, and
unallocated allowance at June 30, 2009, March 31, 2009, and December 31, 2008,
as well as classified loans at those period-ends.
|
|
June
30,
|
|
|
March
31,
|
|
|
December
31,
|
|
(in
000's)
|
|
2009
|
|
|
2009
|
|
|
2008
|
|
Specific
allowance – impaired loans
|
|
$
|
7,819
|
|
|
$
|
4,393
|
|
|
$
|
4,972
|
|
Formula
allowance – classified loans not impaired
|
|
|
2,105
|
|
|
|
1,645
|
|
|
|
2,113
|
|
Formula
allowance – special mention loans
|
|
|
1,104
|
|
|
|
732
|
|
|
|
752
|
|
Total
allowance for special mention and classified loans
|
|
|
11,028
|
|
|
|
6,770
|
|
|
|
7,837
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Formula
allowance for pass loans
|
|
|
4,814
|
|
|
|
3,677
|
|
|
|
3,551
|
|
Unallocated
allowance
|
|
|
0
|
|
|
|
1
|
|
|
|
142
|
|
Total
allowance for loan losses
|
|
$
|
15,842
|
|
|
$
|
10,448
|
|
|
$
|
11,530
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired
loans
|
|
|
67,158
|
|
|
|
58,030
|
|
|
|
48,946
|
|
Classified
loans not considered impaired
|
|
|
17,675
|
|
|
|
23,157
|
|
|
|
33,758
|
|
Total
classified loans
|
|
$
|
84,833
|
|
|
$
|
81,187
|
|
|
$
|
82,704
|
|
Special
mention loans
|
|
$
|
44,295
|
|
|
$
|
34,043
|
|
|
$
|
32,285
|
|
Impaired
loans increased approximately $18.2 million between December 31, 2008 and June
30, 2009, and increased $9.1 million between March 31, 2009 and June 30, 2009.
Components of the change in impaired loans during the quarter ended June 30,
2009 include transfers from impaired loans to other real estate owned of $9.6
million, and reclassification as impaired of approximately $16.8 million in
loans previously classified as substandard and segregated for purposes of loan
loss reserve analysis (see discussion below). The specific allowance related to
those impaired loans increased $2.8 million between December 31, 2008 and June
30, 2009. The formula allowance related to loans that are not impaired
(including special mention and substandard) increased approximately $344,000
between December 31, 2008 and June 30, 2009, as the result of increases in the
volume of substandard and special mention loans, as well as increases in the
loss factors applied to those loan categories. Although the level of “pass”
loans has declined slightly between December 31, 2008 and June 30, 2009 the
related formula allowance increased $1.3 million during the period as the result
of increases in qualitative and other loss factors associated with those
loans.
At March
31, 2009, the Company had segregated approximately $19.4 million of the total
$77.9 million in substandard classified loans at that time for purposes of the
quarterly analysis of the adequacy of the allowance for credit losses under SFAS
No. 5. Many of these loans had been downgraded to substandard because the
borrowers had other direct or indirect lending relationships which were
classified as substandard or impaired. The $19.4 million in substandard loans at
March 31, 2009 consisted of ten borrowing relationships, which although
classified as substandard, the Company believed were performing at the time and
therefore did not warrant the same loss factors as other substandard loans in
the portfolio. The adequacy of the allowance for credit losses related to this
$19.4 million pool of substandard loans was based upon current payment history,
loan-to-value ratios, future anticipated performance, and other various factors.
The formula allowance for credit losses related to these substandard loans
totaled $1.2 million at both March 31, 2009 and December 31, 2008. During the
second quarter of 2009, the performance of the segregated substandard loan
portfolio deteriorated to a point where management determined that the loans
were either impaired or subject to the higher loss factors traditionally applied
to other substandard loans. As a result, approximately $16.8 million of the
previously segregated substandard loans were transferred to impaired loans, and
the remainder analyzed using applicable formula loss factors related to their
risk ratings. The increase in the reserve for impaired loans related to this
transfer totaled $1.8 million during the quarter ended June 30, 2009 and an
increase of approximately $225,000 in other reserve categories during the same
period.
The
Company’s methodology includes features that are intended to reduce the
difference between estimated and actual losses. The specific allowance portion
of the analysis is designed to be self-correcting by taking into account the
current loan loss experience based on that portion of the portfolio. By
analyzing the probable estimated losses inherent in the loan portfolio on a
quarterly basis, management is able to adjust specific and inherent loss
estimates using the most recent information available. In performing the
periodic migration analysis, management believes that historical loss factors
used in the computation of the formula allowance need to be adjusted to reflect
current changes in market conditions and trends in the Company’s loan portfolio.
There are a number of other factors which are reviewed when determining
adjustments in the historical loss factors. They include 1) trends in delinquent
and nonaccrual loans, 2) trends in loan volume and terms, 3) effects of changes
in lending policies, 4) concentrations of credit, 5) competition, 6) national
and local economic trends and conditions, 7) experience of lending staff, 8)
loan review and Board of Directors oversight, 9) high balance loan
concentrations, and 10) other business conditions. Other than for the
elimination of the segregation of approximately $19.1 million in substandard
loans at June 30, 2009 discussed above, there were no changes in estimation
methods or assumptions that affected the methodology for assessing the adequacy
of the allowance for credit losses during the six months ended June 30,
2009.
Management
and the Company’s lending officers evaluate the loss exposure of classified and
impaired loans on a weekly/monthly basis and through discussions and officer
meetings as conditions change. The Company’s Loan Committee meets weekly and
serves as a forum to discuss specific problem assets that pose significant
concerns to the Company, and to keep the Board of Directors informed through
committee minutes. All special mention and classified loans are reported
quarterly on Criticized Asset Reports which are reviewed by senior management.
With this information, the migration analysis and the impaired loan analysis are
performed on a quarterly basis and adjustments are made to the allowance as
deemed necessary.
Impaired
loans are calculated under SFAS No. 114, and are measured based on the present
value of the expected future cash flows discounted at the loan's effective
interest rate or the fair value of the collateral if the loan is collateral
dependent. The amount of impaired loans is not directly comparable to the amount
of nonperforming loans disclosed later in this section. The primary differences
between impaired loans and nonperforming loans are: i) all loan categories are
considered in determining nonperforming loans while impaired loan recognition is
limited to commercial and industrial loans, commercial and residential real
estate loans, construction loans, and agricultural loans, and ii) impaired loan
recognition considers not only loans 90 days or more past due, restructured
loans and nonaccrual loans but also may include problem loans other than
delinquent loans.
The
Company considers a loan to be impaired when, based upon current information and
events, it believes it is probable the Company will be unable to collect all
amounts due according to the contractual terms of the loan
agreement. Impaired loans include nonaccrual loans, restructured
debt, and performing loans in which full payment of principal or interest is not
expected. Management bases the measurement of these impaired loans on the fair
value of the loan's collateral or the expected cash flows on the loans
discounted at the loan's stated interest rates. Cash receipts on impaired loans
not performing to contractual terms and that are on nonaccrual status are used
to reduce principal balances. Impairment losses are included in the allowance
for credit losses through a charge to the provision, if applicable.
At June
30, 2009 and 2008, the Company's recorded investment in loans for which
impairment has been identified totaled $67.2 million and $35.3 million,
respectively. Included in total impaired loans at June 30, 2009, are $35.0
million of impaired loans for which the related specific allowance is $7.8
million, as well as $32.2 million of impaired loans that as a result of
write-downs or the sufficiency of the fair value of the collateral, did not have
a specific allowance. Total impaired loans at June 30, 2008 included $3.1
million of impaired loans for which the related specific allowance is $602,000,
as well as $32.2 million of impaired loans that, as a result of write-downs or
the sufficiency of the fair value of the collateral, did not have a specific
allowance. The average recorded investment in impaired loans was $59.9 million
during the first six months of 2009 and $20.4 million during the first six
months of 2008. In most cases, the Company uses the cash basis method of income
recognition for impaired loans. In the case of certain troubled debt
restructuring, for which the loan has been performing for a prescribed period of
time under the current contractual terms, income is recognized under the accrual
method. For the six months ended June 30, 2009 and 2008, the Company recognized
no income on such loans.
As with
nonaccrual loans, the greatest volume in impaired loans during the six months
ended June 30, 2009 is in real estate construction loans, with that loan
category comprising more than 49% of total impaired loans at June 30, 2009.
Although construction loans are generally collateral dependent and the related
collateral is considered adequate to cover the loan’s carrying value in many
cases, the specific reserve related to impaired construction loans has increased
approximately $365,000 since December 31, 2008 as property valuations continued
to decline. Impaired loans classified as commercial and industrial increased
$8.3 million during the quarter ended June 30, 2009 and increased $13.4 million
during the six months ended June 30, 2009. Of the $25.7 million in commercial
and industrial impaired loans reported at June 30, 2009, approximately $18.5
million or 72.2% are secured by real estate. Specific collateral related to
impaired loans is reviewed for current appraisal information, economic trends
within geographic markets, loan-to-value ratios, and other factors that may
impact the value of the loan collateral. Adjustments are made to collateral
values as needed for these factors. Of total impaired loans, approximately $56.5
million or 84.1% are secured by real estate, and $58.7 million of total impaired
loans are for the purpose of residential construction, residential and
commercial acquisition and development, and land development. Residential
construction loans are made for the purpose of building residential 1-4 single
family homes. Residential and commercial acquisition and development loans are
made for the purpose of purchasing land, and developing that land if required,
and to develop real estate or commercial construction projects on those
properties. Land development loans are made for the purpose of converting raw
land into construction-ready building sites. The following table summarizes the
components of impaired loans and their related specific reserves at June 30,
2009, March 31, 2009, and December 31, 2008.
|
|
Balance
|
|
|
Reserve
|
|
|
Balance
|
|
|
Reserve
|
|
|
Balance
|
|
|
Reserve
|
|
(in 000’s)
|
|
6/30/2009
|
|
|
6/30/2009
|
|
|
3/31/2009
|
|
|
3/31/2009
|
|
|
12/31/2008
|
|
|
12/31/2008
|
|
Commercial
and industrial
|
|
$
|
25,681
|
|
|
$
|
4,118
|
|
|
$
|
17,346
|
|
|
$
|
1,382
|
|
|
$
|
12,244
|
|
|
$
|
2,340
|
|
Real
estate – mortgage
|
|
|
4,219
|
|
|
|
229
|
|
|
|
2,490
|
|
|
|
225
|
|
|
|
3,689
|
|
|
|
226
|
|
Real
estate – construction
|
|
|
32,952
|
|
|
|
2,703
|
|
|
|
34,025
|
|
|
|
2,719
|
|
|
|
28,927
|
|
|
|
2,338
|
|
Agricultural
|
|
|
4,129
|
|
|
|
769
|
|
|
|
4,169
|
|
|
|
68
|
|
|
|
4,086
|
|
|
|
68
|
|
Installment/other
|
|
|
177
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Lease
financing
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Total
|
|
$
|
67,158
|
|
|
$
|
7,819
|
|
|
$
|
58,030
|
|
|
$
|
4,394
|
|
|
$
|
48,946
|
|
|
$
|
4,972
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
Company focuses on competition and other economic conditions within its market
area and other geographical areas in which it does business, which may
ultimately affect the risk assessment of the portfolio. The Company continues to
experience increased competition from major banks, local independents and
non-bank institutions creating pressure on loan pricing. With interest rates
decreasing 100 basis points during the fourth quarter of 2007, another 400 basis
points during 2008, indications are that the economy will continue to suffer in
the near future as a result of sub-prime lending problems, a weakened real
estate market, and tight credit markets. Both business and consumer spending
have slowed during the past several quarters, and current GDP projections for
the next year have softened significantly. It is difficult to determine to what
degree the Federal Reserve will adjust short-term interest rates in its efforts
to influence the economy, or what magnitude government economic support programs
will reach. It is likely that the business environment in California will
continue to be influenced by these domestic as well as global events. The local
market has remained relatively more stable economically during the past several
years than other areas of the state and the nation, which have experienced more
volatile economic trends, including significant deterioration of residential
real estate markets. Although the local area residential housing markets have
been hit hard, they continue to perform better than other parts of the state,
which should bode well for sustained, but slower growth in the Company’s market
areas of Fresno and Madera, Kern, and Santa Clara Counties. Local unemployment
rates in the San Joaquin Valley remain high primarily as a result of the areas’
agricultural dynamics, however unemployment rates have increased recently as the
national economy has declined. It is difficult to predict what impact this will
have on the local economy. The Company believes that the Central San Joaquin
Valley will continue to grow and diversify as property and housing costs remain
reasonable relative to other areas of the state. Management
recognizes increased risk of loss due to the Company's exposure from local and
worldwide economic conditions, as well as potentially volatile real estate
markets, and takes these factors into consideration when analyzing the adequacy
of the allowance for credit losses.
The
following table provides a summary of the Company's allowance for possible
credit losses, provisions made to that allowance, and charge-off and recovery
activity affecting the allowance for the periods indicated.
Table 7. Allowance for
Credit Losses - Summary of Activity (unaudited)
|
|
June
30,
|
|
|
June
30,
|
|
(In
thousands)
|
|
2009
|
|
|
2008
|
|
Total
loans outstanding at end of period before
|
|
|
|
|
|
|
deducting
allowances for credit losses
|
|
$
|
547,754
|
|
|
$
|
582,231
|
|
Average
net loans outstanding during period
|
|
|
543,310
|
|
|
|
576,410
|
|
|
|
|
|
|
|
|
|
|
Balance
of allowance at beginning of period
|
|
|
11,529
|
|
|
|
7,431
|
|
Loans
charged off:
|
|
|
|
|
|
|
|
|
Real
estate
|
|
|
(1,123
|
)
|
|
|
(289
|
)
|
Commercial
and industrial
|
|
|
(2,812
|
)
|
|
|
(60
|
)
|
Lease
financing
|
|
|
(76
|
)
|
|
|
(186
|
)
|
Installment
and other
|
|
|
(74
|
)
|
|
|
(30
|
)
|
Total
loans charged off
|
|
|
(4,085
|
)
|
|
|
(565
|
)
|
Recoveries
of loans previously charged off:
|
|
|
|
|
|
|
|
|
Real
estate
|
|
|
0
|
|
|
|
1
|
|
Commercial
and industrial
|
|
|
229
|
|
|
|
68
|
|
Lease
financing
|
|
|
1
|
|
|
|
0
|
|
Installment
and other
|
|
|
10
|
|
|
|
4
|
|
Total
loan recoveries
|
|
|
240
|
|
|
|
73
|
|
Net
loans charged off
|
|
|
(3,845
|
)
|
|
|
(492
|
)
|
|
|
|
|
|
|
|
|
|
Provision
charged to operating expense
|
|
|
8,158
|
|
|
|
716
|
|
Balance
of allowance for credit losses
|
|
|
|
|
|
|
|
|
at
end of period
|
|
$
|
15,842
|
|
|
$
|
7,655
|
|
|
|
|
|
|
|
|
|
|
Net
loan charge-offs to total average loans (annualized)
|
|
|
1.43
|
%
|
|
|
0.17
|
%
|
Net
loan charge-offs to loans at end of period (annualized)
|
|
|
1.42
|
%
|
|
|
0.17
|
%
|
Allowance
for credit losses to total loans at end of period
|
|
|
2.89
|
%
|
|
|
1.31
|
%
|
Net
loan charge-offs to allowance for credit losses
(annualized)
|
|
|
48.94
|
%
|
|
|
12.92
|
%
|
Net
loan charge-offs to provision for credit losses
(annualized)
|
|
|
47.13
|
%
|
|
|
68.72
|
%
|
At June
30, 2009 and 2008, $246,000 and $426,000, respectively, of the formula allowance
is allocated to unfunded loan commitments and is, therefore, carried separately
in other liabilities. Management believes that the 2.89% credit loss allowance
at June 30, 2009 is adequate to absorb known and inherent risks in the loan
portfolio. No assurance can be given, however, that the economic conditions
which may adversely affect the Company's service areas or other circumstances
will not be reflected in increased losses in the loan portfolio.
It is the
Company's policy to discontinue the accrual of interest income on loans for
which reasonable doubt exists with respect to the timely collectibility of
interest or principal due to the ability of the borrower to comply with the
terms of the loan agreement. Such loans are placed on nonaccrual status whenever
the payment of principal or interest is 90 days past due or earlier when the
conditions warrant, and interest collected is thereafter credited to principal
to the extent necessary to eliminate doubt as to the collectibility of the net
carrying amount of the loan. Management may grant exceptions to this policy if
the loans are well secured and in the process of collection.
Table 8. Nonperforming
Assets
|
|
June
30,
|
|
|
December
31,
|
|
(In
thousands)
|
|
2009
|
|
|
2008
|
|
Nonaccrual
Loans
|
|
$
|
56,170
|
|
|
$
|
45,671
|
|
Restructured
Loans (1)
|
|
|
10,377
|
|
|
|
0
|
|
Total
nonperforming loans
|
|
|
66,547
|
|
|
|
45,671
|
|
Other
real estate owned
|
|
|
37,065
|
|
|
|
30,153
|
|
Total
nonperforming assets
|
|
$
|
103,612
|
|
|
$
|
75,824
|
|
|
|
|
|
|
|
|
|
|
Loans
past due 90 days or more, still accruing
|
|
$
|
0
|
|
|
$
|
680
|
|
Nonperforming
loans to total gross loans
|
|
|
12.13
|
%
|
|
|
8.39
|
%
|
Nonperforming
assets to total gross loans
|
|
|
18.88
|
%
|
|
|
13.92
|
%
|
|
|
(1)
Included in nonaccrual loans at June 30, 2009 are restructured loans
totaling $7.5 million.
|
|
Non-performing assets have
increased $27.8 million or 36.65% between December 31, 2008 and June 30, 2009 as
depressed real estate
markets and related sectors continue to impact
credit markets and the general economy. Nonaccrual loans increased $10.5 million
between December 31, 2008 and June 30, 2009, with construction loans comprising
approximately 56% of total nonaccrual loans at June 30, 2009, and commercial and
industrial loans comprising an additional 30%. The following table summarizes
the nonaccrual totals by loan category for the periods shown.
|
|
Balance
|
|
|
Balance
|
|
|
Balance
|
|
|
Change
from
|
|
|
Change
from
|
|
Nonaccrual Loans (in
000's):
|
|
June
30,
2009
|
|
|
March
31,
2009
|
|
|
December
31,
2008
|
|
|
March
31,
2009
|
|
|
December
31,
2008
|
|
Commercial
and industrial
|
|
$
|
17,026
|
|
|
$
|
14,083
|
|
|
$
|
9,507
|
|
|
$
|
2,943
|
|
|
$
|
7,519
|
|
Real
estate - mortgage
|
|
|
2,938
|
|
|
|
2,188
|
|
|
|
3,714
|
|
|
|
750
|
|
|
|
(776
|
)
|
Real
estate - construction
|
|
|
31,721
|
|
|
|
32,131
|
|
|
|
28,928
|
|
|
|
(410
|
)
|
|
|
2,793
|
|
Agricultural
|
|
|
4,129
|
|
|
|
4,169
|
|
|
|
3,406
|
|
|
|
(40
|
)
|
|
|
723
|
|
Installment/other
|
|
|
185
|
|
|
|
0
|
|
|
|
55
|
|
|
|
185
|
|
|
|
130
|
|
Lease
financing
|
|
|
171
|
|
|
|
48
|
|
|
|
61
|
|
|
|
123
|
|
|
|
110
|
|
Total
Nonaccrual Loans
|
|
$
|
56,170
|
|
|
$
|
52,619
|
|
|
$
|
45,671
|
|
|
$
|
3,551
|
|
|
$
|
10,499
|
|
Increases
in nonaccrual construction loans are the result of a significant slowdown in new
housing starts and the resultant depreciation in land, and both partially
completed and completed construction projects. As with impaired loans, a large
percentage of nonaccrual loans were made for the purpose of residential
construction, residential and commercial acquisition and development, and land
development. Non-performing assets totaled 18.88% of total loans at June 30,
2009 as compared to 15.31% and 13.92% of total loans at March 31, 2009 and
December 31, 2008, respectively.
The
Company purchased a schedule of payments collateralized by Surety Bonds and
lease payments in September 2001 that have a current balance owing of $5.4
million plus interest. The leases have been nonperforming since June 2002 (
see “Asset Quality and Allowance for
Credit Losses” section of Management’s Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company’s 2007 Annual
Report on Form 10-K
). For reporting purposes at December 31, 2008, the
impaired lease portfolio was on non-accrual status and had a specific allowance
allocation of $3.5 million, and a net carrying value of $1.9 million. During the
first quarter of 2009, the Company evaluated its position with regard to the
nonperforming lease portfolio, and determined that because the ultimate payoff
of the lease portfolio would come from the underlying surety bonds rather than
individual leases, the portfolio was better classified as a receivable to be
included in other assets rather than classified as loans. As a result, the
Company reclassified the net lease amount of $1.9 million ($5.4 million in gross
leases less $3.5 million is specific reserve) from loans to other assets
effective January 1, 2009. All periods presented in this 10-Q for the period
ended June 30, 2009 have been restated to reflect the transfer of the
nonperforming lease portfolio from loans to other assets. During June 2009, the
Company agreed to settle with the insurance company issuing the surety bonds for
a total settlement amount of $2.0 million. At June 30, 2009, the Company
increased the lease receivable classified in other assets to reflect the $2.0
million settlement amount, and recorded a gain of $117,000 for the difference
between the carrying amount previously recorded and the settlement amount. The
Company received the proceeds from the settlement during July 2009.
Loans
past due more than 30 days are receiving increased management attention and are
monitored for increased risk. The Company continues to move past due loans to
nonaccrual status in its ongoing effort to recognize loan problems at an earlier
point in time when they may be dealt with more effectively. As impaired loans,
nonaccrual and restructured loans are reviewed for specific reserve allocations
and the allowance for credit losses is adjusted accordingly.
Except
for the loans included in the above table, or those otherwise included in the
impaired loan totals, there were no loans at June 30, 2009 where the known
credit problems of a borrower caused the Company to have serious doubts as to
the ability of such borrower to comply with the present loan repayment terms and
which would result in such loan being included as a nonaccrual, past due, or
restructured loan at some future date.
Asset/Liability Management –
Liquidity and Cash Flow
The
primary function of asset/liability management is to provide adequate liquidity
and maintain an appropriate balance between interest-sensitive assets and
interest-sensitive liabilities.
Liquidity
Liquidity
management may be described as the ability to maintain sufficient cash flows to
fulfill financial obligations, including loan funding commitments and customer
deposit withdrawals, without straining the Company’s equity structure. To
maintain an adequate liquidity position, the Company relies on, in addition to
cash and cash equivalents, cash inflows from deposits and short-term borrowings,
repayments of principal on loans and investments, and interest income received.
The Company's principal cash outflows are for loan origination, purchases of
investment securities, depositor withdrawals and payment of operating
expenses.
The
Company continues to emphasize liability management as part of its overall
asset/liability strategy. Through the discretionary acquisition of short term
borrowings, the Company has been able to provide liquidity to fund asset growth
while, at the same time, better utilizing its capital resources, and better
controlling interest rate risk. The borrowings are generally
short-term and more closely match the repricing characteristics of floating rate
loans, which comprise approximately 66.0% of the Company’s loan portfolio at
June 30, 2009. This does not preclude the Company from selling assets such as
investment securities to fund liquidity needs but, with favorable borrowing
rates, the Company has maintained a positive yield spread between borrowed
liabilities and the assets which those liabilities fund. If, at some time, rate
spreads become unfavorable, the Company has the ability to utilize an asset
management approach and, either control asset growth or, fund further growth
with maturities or sales of investment securities.
The
Company's liquid asset base which generally consists of cash and due from banks,
federal funds sold, securities purchased under agreements to resell (“reverse
repos”) and investment securities, is maintained at a level deemed sufficient to
provide the cash outlay necessary to fund loan growth as well as any customer
deposit runoff that may occur. Additional liquidity requirements may be funded
with overnight or term borrowing arrangements with various correspondent banks,
FHLB and the Federal Reserve Bank. Within this framework is the objective of
maximizing the yield on earning assets. This is generally achieved by
maintaining a high percentage of earning assets in loans, which historically
have represented the Company's highest yielding asset. At June 30, 2009, the
Bank had 72.0% of total assets in the loan portfolio and a loan to deposit ratio
of 107.2%, as compared to 69.9% of total assets in the loan portfolio and a loan
to deposit ratio of 106.8% at December 31, 2008. Liquid assets at June 30, 2009
include cash and cash equivalents totaling $16.5 million as compared to $19.4
million at December 31, 2008. Other sources of liquidity include collateralized
and uncollateralized lines of credit from other banks, the Federal Home Loan
Bank, and from the Federal Reserve Bank totaling $254.1 million at June 30,
2009.
The
liquidity of the parent company, United Security Bancshares, is primarily
dependent on the payment of cash dividends by its subsidiary, United Security
Bank, subject to limitations imposed by the Financial Code of the State of
California. The Bank currently has limited ability to pay dividends or make
capital distributions (see Dividends section included in Regulatory Matters of
this Management’s Discussion.) The limited ability of the Bank to pay dividends
may impact the ability of the Company to fund its ongoing liquidity requirements
including ongoing operating expenses, as well as quarterly interest payments on
the Company’s junior subordinated debt (Trust Preferred Securities.) To conserve
cash and capital resources, the Company has the ability to defer the payment of
interest on its junior subordinated debt for up to five years (20 quarters), as
permitted under the terms of the securities. During such deferral periods,
the Company would be prohibited from paying dividends on its common stock
(subject to certain exceptions) and would continue to accrue interest payable on
the junior subordinated debt. During the six months ended June 30,
2009, cash dividends paid by the Bank to the parent company totaled
$200,000.
Cash
Flow
Cash and
cash equivalents have declined during the two three-month periods ended June 30,
2008 and 2009 with period-end balances as follows (
from Consolidated Statements of Cash
Flows – in 000’s):
|
|
Balance
|
|
December
31, 2007
|
|
$
|
25,300
|
|
June
30, 2008
|
|
$
|
23,439
|
|
December
31, 2008
|
|
$
|
19,426
|
|
June
30, 2009
|
|
$
|
16,458
|
|
Cash and
cash equivalents decreased $1.9 million during the six months ended June 30,
2009, as compared to a decrease of $3.0 million during the six months ended June
30, 2008.
The
Company has maintained positive cash flows from operations, which amounted to
$6.3 million, and $7.2 million for the six months ended June 30, 2009, and June
30, 2008, respectively. The Company experienced net cash inflows from investing
activities totaling $8.1 million during the six months ended June 30, 2009, as
maturities of interest-bearing deposits in other banks, and principal paydowns
on investment securities, exceeded other investing requirements during the
period. The Company experienced net cash outflows from investing activities
totaling $7.6 million during the six months ended June 30, 2008 as purchases of
investment securities exceeded loan paydowns and principal paydowns on
investment securities during that six-month period.
Net cash
flows from financing activities, including deposit growth and borrowings, have
traditionally provided funding sources for loan growth, but during the six ended
June 30, 2009 and 2008, the Company experienced net cash outflows totaling $17.3
million and $1.5 million, respectively. For the six months ended June 30, 2009,
reductions in borrowings exceeded increases in deposits, while for the six
months ended June 30, 2008, declines in time deposits exceeded increases in
demand deposit and savings accounts, as well as overnight and longer-term
borrowings. The Company has the ability to decrease loan growth, increase
deposits and borrowings, or a combination of both to manage balance sheet
liquidity.
Regulatory
Matters
C
apital Adequacy
The Board
of Governors of the Federal Reserve System (“Board of Governors”) has adopted
regulations requiring insured institutions to maintain a minimum leverage ratio
of Tier 1 capital (the sum of common stockholders' equity, noncumulative
perpetual preferred stock and minority interests in consolidated subsidiaries,
minus intangible assets, identified losses and investments in certain
subsidiaries, plus unrealized losses or minus unrealized gains on available for
sale securities) to total assets. Institutions which have received the highest
composite regulatory rating and which are not experiencing or anticipating
significant growth are required to maintain a minimum leverage capital ratio of
3% Tier 1 capital to total assets. All other institutions are required to
maintain a minimum leverage capital ratio of at least 100 to 200 basis points
above the 3% minimum requirement.
The Board
of Governors has also adopted a statement of policy, supplementing its leverage
capital ratio requirements, which provides definitions of qualifying total
capital (consisting of Tier 1 capital and Tier 2 supplementary capital,
including the allowance for loan losses up to a maximum of 1.25% of
risk-weighted assets) and sets forth minimum risk-based capital ratios of
capital to risk-weighted assets. Insured institutions are required to maintain a
ratio of qualifying total capital to risk weighted assets of 8%, at least
one-half (4%) of which must be in the form of Tier 1 capital.
The Bank
has agreed with the California Department of Financial Institutions, to maintain
Tier I capital and leverage ratios that are at or in excess of 9.00%. In
addition, the Bank as agreed to maintain total risk-based capital ratios at or
in excess of 10.00% (at or above “Well Capitalized” levels as defined.) The
Company is not subject to “Well Capitalized” guidelines under regulatory Prompt
Corrective Action Provisions.
The
following table sets forth the Company’s and the Bank's actual capital positions
at June 30, 2009, as well as the minimum capital requirements and requirements
to be well capitalized under prompt corrective action provisions (Bank only)
under the regulatory guidelines discussed above:
Table 9. Capital
Ratios
|
|
Company
|
|
|
Bank
|
|
|
|
|
|
To
be Well
Capitalized
under Prompt
|
|
|
|
Actual
|
|
|
Actual
|
|
|
Minimum
|
|
|
Corrective
|
|
|
|
Capital
|
|
|
Capital
|
|
|
Capital
|
|
|
Action
|
|
|
|
Ratios
|
|
|
Ratios
|
|
|
Ratios
|
|
|
Provisions
|
|
Total
risk-based capital ratio
|
|
|
13.03
|
%
|
|
|
12.56
|
%
|
|
|
10.00
|
%
|
|
|
10.00
|
%
|
Tier
1 capital to risk-weighted assets
|
|
|
11.77
|
%
|
|
|
11.34
|
%
|
|
|
9.00
|
%
|
|
|
6.00
|
%
|
Leverage
ratio
|
|
|
11.24
|
%
|
|
|
10.84
|
%
|
|
|
9.00
|
%
|
|
|
5.00
|
%
|
As is
indicated by the above table, the Company and the Bank exceeded all applicable
regulatory capital guidelines at June 30, 2009. Management believes that, under
the current regulations, both will continue to meet their minimum capital
requirements in the foreseeable future.
Dividends
The
primary source of funds with which dividends will be paid to shareholders is
from cash dividends received by the Company from the Bank. During the first six
months of 2009, the Company has received $200,000 in cash dividends from the
Bank, from which the Company paid $6,000 in cash dividends to
shareholders.
Under
California state banking law, the Bank may not pay cash dividends in an amount
which exceeds the lesser of the retained earnings of the Bank or the Bank’s net
income for the last three fiscal years (less the amount of distributions to
shareholders during that period of time). If the above test is not met, cash
dividends may only be paid with the prior approval of the California State
Department of Financial Institutions, in an amount not exceeding the greater of:
(i) the Bank’s retained earnings; (ii) its net income for the last fiscal year;
or (iii) its net income for the current fiscal year. During 2008, the Bank paid
dividends of $4.3 million to the Company. Because the distributions made by the
Bank to the Holding Company over the past three fiscal years equal the amount of
the Bank’s net income for the last three years, at December 31, 2008, the Bank
has been required during 2009 to gain approval of the California State
Department of Financial Institutions before paying dividends to the holding
company.
Reserve
Balances
The Bank
is required to maintain average reserve balances with the Federal Reserve Bank.
At June 30, 2009 the Bank's qualifying balance with the Federal Reserve was
approximately $25,000 consisting of balances held with the Federal
Reserve.
Item
3. Quantitative and Qualitative Disclosures about Market Risk
Interest
Rate Sensitivity and Market Risk
There
have been no material changes in the Company’s quantitative and qualitative
disclosures about market risk as of June 30, 2009 from those presented in the
Company’s Annual Report on Form 10-K for the year ended December 31,
2008.
The Board
of Directors has adopted an interest rate risk policy which establishes maximum
decreases in net interest income of 12% and 15% in the event of a 100 BP and 200
BP increase or decrease in market interest rates over a twelve month period.
Based on the information and assumptions utilized in the simulation model at
June 30, 2009, the resultant projected impact on net interest income falls
within policy limits set by the Board of Directors for all rate scenarios
run.
The
Company's interest rate risk policy establishes maximum decreases in the
Company's market value of equity of 12% and 15% in the event of an immediate and
sustained 100 BP and 200 BP increase or decrease in market interest rates. As
shown in the table below, the percentage changes in the net market value of the
Company's equity are within policy limits for both rising and falling rate
scenarios.
The
following sets forth the analysis of the Company's market value risk inherent in
its interest-sensitive financial instruments as they relate to the entire
balance sheet at June 30, 2009 and December 31, 2008 ($ in thousands). Fair
value estimates are subjective in nature and involve uncertainties and
significant judgment and, therefore, cannot be determined with absolute
precision. Assumptions have been made as to the appropriate discount rates,
prepayment speeds, expected cash flows and other variables. Changes in these
assumptions significantly affect the estimates and as such, the obtained fair
value may not be indicative of the value negotiated in the actual sale or
liquidation of such financial instruments, nor comparable to that reported by
other financial institutions. In addition, fair value estimates are based on
existing financial instruments without attempting to estimate future
business.
|
|
June
30, 2009
|
|
December
31, 2008
|
|
Change
in
|
|
Estimated
MV
|
|
|
Change
in MV
|
|
|
Change
in MV
|
|
|
Estimated
MV
|
|
|
Change
in MV
|
|
|
Change
in MV
|
|
Rates
|
|
of
Equity
|
|
|
of
Equity $
|
|
|
of
Equity $
|
|
|
Of
Equity
|
|
|
of
Equity $
|
|
|
of
Equity %
|
|
+
200 BP
|
|
$
|
73,074
|
|
|
$
|
9,022
|
|
|
|
14.09
|
%
|
|
$
|
78,206
|
|
|
$
|
2,935
|
|
|
|
3.90
|
%
|
+
100 BP
|
|
|
71,149
|
|
|
|
7,097
|
|
|
|
11.08
|
%
|
|
|
77,483
|
|
|
|
2,212
|
|
|
|
2.94
|
%
|
0
BP
|
|
|
64,052
|
|
|
|
0
|
|
|
|
0.00
|
%
|
|
|
75,270
|
|
|
|
0
|
|
|
|
0.00
|
%
|
-
100 BP
|
|
|
64,444
|
|
|
|
392
|
|
|
|
0.61
|
%
|
|
|
76,528
|
|
|
|
1,258
|
|
|
|
1.67
|
%
|
-
200 BP
|
|
|
67,189
|
|
|
|
3,137
|
|
|
|
4.90
|
%
|
|
|
78,732
|
|
|
|
3,462
|
|
|
|
4.60
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Item
4. Controls and Procedures
a) As of
the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company’s
management, including the Chief Executive Officer and the Chief Financial
Officer, of the effectiveness of the design and operation of the Company’s
disclosure controls and procedures, as defined in the Securities and Exchange
Act Rule 13(a)-15(e). Based on that evaluation, the Chief Executive Officer and
the Chief Financial Officer concluded that the Company’s disclosure controls and
procedures are effective on a timely manner to alert them to material
information relating to the Company which is required to be included in the
Company’s periodic Securities and Exchange Commission filings.
(b)
Changes in Internal Controls over Financial Reporting: During the quarter ended
June 30, 2009, the Company did not make any significant changes in, nor take any
corrective actions regarding, its internal controls over financial reporting or
other factors that could significantly affect these controls.
The
Company does not expect that its disclosure controls and procedures and internal
control over financial reporting will prevent all error and fraud. A
control procedure, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control procedure
are met. Because of the inherent limitations in all control procedures, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected.
These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns in controls or procedures can
occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any
control procedure is based in part upon certain assumptions about the likelihood
of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
controls become inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control procedure, misstatements due to
error or fraud may occur and not be detected.
PART II. Other
Information
Item 1.
Not
applicable
Item 1A.
There have been no
material changes to the risk factors disclosed in our Annual Report on Form 10-K
for the fiscal year ended December 31, 2008.
Item
2. Unregistered Sales of Equity Securities and Use of Proceeds
On August
30, 2001 the Company announced that its Board of Directors approved a plan to
repurchase, as conditions warrant, up to 280,000 shares (560,000 shares adjusted
for May 2006 stock split) of the Company's common stock on the open market or in
privately negotiated transactions. The duration of the program was open-ended
and the timing of purchases was dependent on market conditions. A total of
215,423 shares (430,846 shares adjusted for May 2006 stock split) had been
repurchased under that plan as of December 31, 2003, at a total cost of $3.7
million.
On
February 25, 2004 the Company announced a second stock repurchase plan under
which the Board of Directors approved a plan to repurchase, as conditions
warrant, up to 276,500 shares (553,000 shares adjusted for May 2006 stock split)
of the Company's common stock on the open market or in privately negotiated
transactions. As with the first plan, the duration of the new program is
open-ended and the timing of purchases will depend on market conditions.
Concurrent with the approval of the new repurchase plan, the Board terminated
the 2001 repurchase plan and canceled the remaining 64,577 shares (129,154
shares adjusted for May 2006 stock split) yet to be purchased under the earlier
plan.
On May
16, 2007, the Company announced another stock repurchase plan to repurchase, as
conditions warrant, up to 610,000 shares of the Company's common stock on the
open market or in privately negotiated transactions. The repurchase plan
represents approximately 5.00% of the Company's currently outstanding common
stock. The duration of the program is open-ended and the timing of purchases
will depend on market conditions. Concurrent with the approval of the new
repurchase plan, the Company canceled the remaining 75,733 shares available
under the 2004 repurchase plan. During the year ended December 31, 2007, 512,332
shares were repurchased at a total cost of $10.1 million and an average per
share price of $19.71. Of the shares repurchased during 2007, 166,660 shares
were repurchased under the 2004 plan at an average cost of $20.46 per shares,
and 345,672 shares were repurchased under the 2007 plan at an average cost of
$19.35 per share. During the year ended December 31, 2008, 89,001 shares were
repurchased at a total cost of $1.2 million and an average per share price of
$13.70.
During
the six months ended June 30, 2009, 488 shares were repurchased at a total cost
of $3,600 at an average per share price of $7.50. There were no shares
repurchased during the quarter ended June 30, 2009. The maximum number of shares
that may be yet be repurchased under the stock repurchase plan totaled 174,839
shares at June 30, 2009.
Item 3
.
Not applicable
Item 4.
The
Company’s Annual Shareholder’s Meeting was held on Wednesday May 20, 2009 in
Fresno, California. Shareholders were asked to vote on the following
matter:
1) The
shareholders were asked to vote on the election of eleven nominees to serve on
the Company’s Board of Directors. Such Directors nominate for election will
serve on the Board until the 2010 annual meeting of shareholders and until their
successors are elected and have been qualified. Votes regarding the election of
Directors were as follows:
|
Director
Nominee
|
Votes
For
|
Votes
Withheld
|
|
|
Robert
G. Bitter, Pharm. D.
|
9,347,179
|
59,870
|
|
|
Stanley
J. Cavalla
|
9,340,734
|
66,315
|
|
|
Tom
Ellithorpe
|
9,001,466
|
405,583
|
|
|
R.
Todd Henry
|
9,135,449
|
271,600
|
|
|
Gary
Luke Hong
|
9,340,734
|
66,315
|
|
|
Ronnie
D. Miller
|
9,319,487
|
87,562
|
|
|
Robert
M. Mochizuki
|
9,340,439
|
66,610
|
|
|
Walter
Reinhard
|
9,314,033
|
93,016
|
|
|
John
Terzian
|
9,243,387
|
163,662
|
|
|
Dennis
R. Woods
|
9,201,228
|
205,821
|
|
|
Michael
T. Woolf, D.D.S.
|
9,300,009
|
107,040
|
|
Item 5.
Not
applicable
Item 6.
Exhibits:
|
11
|
Computation
of Earnings per Share*
|
|
31.1
|
Certification
of the Chief Executive Officer of United Security Bancshares pursuant to
Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
31.2
|
Certification
of the Chief Financial Officer of United Security Bancshares pursuant to
Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
32.1
|
Certification
of the Chief Executive Officer of United Security Bancshares pursuant to
Section 906 of the
Sarbanes-Oxley Act of 2002
|
|
32.2
|
Certification
of the Chief Financial Officer of United Security Bancshares pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002
|
* Data
required by Statement of Financial Accounting Standards No. 128,
Earnings per Share
, is
provided in Note 7 to the consolidated financial statements in this
report.
Signatures
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
|
United
Security Bancshares
|
|
|
|
|
|
Date: August
14, 2009
|
|
/S/
Dennis R. Woods
|
|
|
|
Dennis
R. Woods
|
|
|
|
President
and
|
|
|
|
Chief
Executive Officer
|
|
|
|
|
|
|
|
|
|
|
|
/S/
Kenneth L. Donahue
|
|
|
|
Kenneth
L. Donahue
|
|
|
|
Senior
Vice President and
|
|
|
|
Chief
Financial Officer
|
|