Rate/Volume AnalysisThe following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); (iii) changes attributable to changes in rate/volume (change in rate multiplied by change in volume); and (iv) the net change.
| Three Months Ended September 30, 2005 | | Six Months Ended September 30, 2005 |
| Compared to | | Compared to |
| Three Months Ended September 30, 2004 | | Six Months Ended September 30, 2004 |
| | Increase (Decrease) | | Increase (Decrease) |
| Due to | | Due to |
| | Volume | | Rate | Rate/ Volume | | Net | | Volume | | Rate | Rate/ Volume | | Net |
| (In thousands) |
| | | | | | | | | | | | | |
Interest-earning assets: | | | | | | | | | | | | | |
Interest-earning deposits and
short-term investments | $ 36 | | 34 | 45 | | 115 | | $ 19 | | 107 | 38 | | 164 |
Investment securities, net | 15 | | 5 | - | | 20 | | 31 | | 15 | - | | 46 |
Mortgage-backed securities, net | (324 | ) | 97 | (13 | ) | (240 | ) | (602 | ) | 182 | (22 | ) | (442) |
Loans receivable, net | 1,972 | | 7,228 | 298 | | 9,498 | | 6,595 | | 12,080 | 856 | | 19,531 |
FHLB stock | (24 | ) | (131) | 5 | | (150 | ) | (30 | ) | (46) | 1 | | (75) |
Total interest-earning assets | 1,675 | | 7,233 | 335 | | 9,243 | | 6,013 | | 12,338 | 873 | | 19,224 |
| | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | |
Savings accounts | 1 | | 6 | - | | 7 | | 7 | | 9 | - | | 16 |
Money market savings accounts | 896 | | 1,836 | 655 | | 3,387 | | 1,571 | | 2,993 | 1,015 | | 5,579 |
NOW and other demand deposit accounts | (181 | ) | (254) | 44 | | (391 | ) | (322 | ) | (462) | 69 | | (715) |
Certificate accounts | 600 | | 1,937 | 205 | | 2,742 | | 1,097 | | 3,394 | 339 | | 4,830 |
FHLB advances and other borrowings | (1,061 | ) | 2,420 | (572 | ) | 787 | | (1,132 | ) | 4,393 | (617 | ) | 2,644 |
Junior subordinated debentures | 520 | | (4) | 10 | | 526 | | 975 | | (2) | 24 | | 997 |
Total interest-bearing liabilities | 775 | | 5,941 | 342 | | 7,058 | | 2,196 | | 10,325 | 830 | | 13,351 |
Change in net interest income | $ 900 | | 1,292 | (7 | ) | 2,185 | | $ 3,817 | | 2,013 | 43 | | 5,873 |
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Forward-Looking Statements
"Safe Harbor" statement under the Private Securities Litigation Reform Act of 1995: This Form 10-Q contains forward-looking statements that are subject to risks and uncertainties, including, but not limited to, changes in economic conditions in our market areas, changes in policies by regulatory agencies, the impact of competitive loan and deposit products, the quality or composition of our loan or investment portfolios, fluctuations in interest rates and changes in the relative differences between short and long-term interest rates, levels of nonperforming assets and operating results, the impact of domestic or world events on our loan and deposit inflows and outflows and other risks detailed from time to time in our filings with the Securities and Exchange Commission. We caution readers not to place undue reliance on forward-looking statements. We do not undertake and specifically disclaim any obligation to revise or update any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for fiscal year 2006 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us.
Critical Accounting Policies
Our management has established various accounting policies, which govern the application of accounting principles generally accepted in the United States of America in the preparation of our consolidated financial statements. The significant accounting policies are described in our Annual Report on Form 10-K for the year ended March 31, 2005 and there has not been any material change in those policies since that date, other than changes discussed in this report. Certain accounting policies require significant estimates and assumptions, which have a material impact on the carrying value of certain assets and liabilities, and these are considered to be critical accounting policies. The estimates and assumptions used are based on historical experience and other factors, which we believe are reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions which could have a material impact on the carrying values of assets and liabilities at the balance sheet dates and on the results of operations for the reporting periods. The following represents critical accounting policies that require the most significant estimates and assumptions that are particularly susceptible to significant change in the preparation of the consolidated financial statements:
Allowance for losses on loans, leases and foreclosed assets. For further information, see "Comparison of Financial Condition at September 30, 2005 and March 31, 2005" in this report and "Item 1 - Business - Lending Activities - Allowance for Loan and Lease Losses" in our March 31, 2005 Annual Report on Form 10-K.
Other-Than-Temporary-Impairment. For further information, see "Item 1 - Business - Investment Activities" in our March 31, 2005 Annual Report on Form 10-K and "Note 2 - New Accounting Pronouncements" under the Notes to Unaudited Consolidated Financial Statements in this Form 10-Q.
16
Comparison of Operating Results for the Three Months Ended September 30, 2005 and 2004
Overview
The following discussion compares the results of operations for the three months ended September 30, 2005 with the corresponding period of 2004. This discussion should be read in conjunction with the consolidated financial statements and footnotes included therein.
We recorded net earnings of $13.4 million or $0.54 per diluted share for the three months ended September 30, 2005 compared to net earnings of $13.2 million or $0.52 per diluted share for the comparable period of 2004 (adjusted for the three-for-two stock split effected in the form of a stock dividend paid on March 3, 2005 to shareholders of record on February 15, 2005). Excluding gains on sales of securities of $923,000 and $3.3 million during the quarter ended September 30, 2005 and 2004, respectively, earnings before income taxes increased 8 percent or $1.6 million to $22.3 million for the current quarter, compared to the comparable period of the prior year.
The increase in our earnings before income taxes between the quarters ended September 30, 2005 and 2004 reflected the following items with respect to our core community banking business:
Net interest income rose $2.2 million or 6 percent to $39.7 million for the current quarter compared to the same quarter of 2004. On a sequential quarter basis, net interest income increased $149,000. Net interest margin expanded 11 basis points to 4.18% between the quarters ended September 30, 2004 and 2005 and was up 1 basis point on a sequential quarter basis.
Lower cost passbook, money market, NOW and other demand accounts ("core deposits") increased $68.3 million during the current quarter and are up $178.7 million or 11 percent from one year ago. Non-interest bearing demand deposits, which totaled $314.5 million or 11 percent of total deposits at September 30, 2005, represented $55.7 million or 31 percent of the growth in core deposits over the past year.
- Construction, commercial business, commercial real estate and consumer loans (the "Four-Cs") increased $31.0 million during the current quarter (an annualized rate of 7 percent) to $1.82 billion and are up $193.4 million or 12 percent from one year ago.
Our asset focus continues to be on our Four-Cs portfolio. At September 30, 2005, the aggregate disbursed balance of the Four-Cs was $1.82 billion or 52 percent of loans and leases receivable, net, compared to $1.71 billion or 50 percent at March 31, 2005. One year ago, the Four-Cs were $1.63 billion or 47 percent of loans and leases receivable, net. Our Four-Cs originations increased 37 percent to $636.4 million or 87 percent of total originations for the current quarter compared to $465.1 million or 79 percent of total originations for the comparable period of the prior year.
On the liability side of our balance sheet, we are continuing to focus our deposit gathering activities on core deposits. At September 30, 2005, core deposits totaled $1.87 billion or 64 percent of total deposits, compared to $1.78 billion or 65 percent of total deposits at March 31, 2005 and $1.69 billion or 65 percent of total deposits one year ago. The funding cost advantage to core deposits over CDs and FHLB advances and other borrowings, continues to play a significant role in our strong net interest margin and increasing profitability.
Deposits, particularly core deposits, provide a more preferable source of funding than do FHLB advances and other borrowings. As a result of our strong deposit growth, we have been able to reduce our utilization of such borrowings from $782.6 million or 22 percent of total liabilities at June 30, 2005 to $620.0 million or 17 percent of total liabilities at September 30, 2005.
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Asset quality remained strong with non-accrual loans declining to $11.9 million or 0.28 percent of gross loans and leases at September 30, 2005 compared to $12.2 million or 0.30 percent of gross loans and leases at March 31, 2005 and $14.3 million or 0.36 percent of gross loans and leases at September 30, 2004. The non-accrual loan balance of $11.9 million as of September 30, 2005 primarily consists of three loans, a construction loan of $10.5 million located in Murrieta, California and two single family loans totaling $1.1 million.
We repurchased 328,890 shares of our common stock at a weighted-average price of $30.10 per share during the current quarter, bringing fiscal year-to-date repurchases to 610,030 shares at a weighted average price of $29.52 per share. At September 30, 2005, 128,240 shares remain under a 1,200,000-share repurchase authorization adopted by our Board of Directors on January 26, 2005. Subsequent to September 30, 2005, on October 26, 2005, the Company's Board of Directors authorized the addition of 1.0 million shares to the 128,240 shares remaining under previous repurchase authorizations. As of September 30, 2005 and March 31, 2005, our treasury stock was comprised of 50,400 shares and 126,200 shares of our common stock, respectively. During the quarter ended September 30, 2005, we retired 325,590 shares of our common stock that had been primarily repurchased during the three months ended September 30, 2005 and held as treasury stock.
At September 30, 2005, our consolidated capital to assets ratio was 8.71%. The Bank's core and risk-based capital ratios were 8.54% and 11.50%, respectively, compared to 5.00% and 10.00%, respectively, needed to be considered "Well Capitalized."
Net Interest Income
Net interest income is the difference between interest and dividends earned on loans and leases, mortgage-backed and other investment securities (collectively, "securities") and other interest-earning investments ("interest-earnings assets") and the interest paid on deposits and borrowings ("interest-bearing liabilities"). The spread between the yield on interest-earning assets and the cost of interest-bearing liabilities and the relative dollar amounts of these assets and liabilities are the principle items affecting net interest income.
Our net interest income totaled $39.7 million for the current quarter, up 6 percent or $2.2 million from $37.5 million for the quarter ended September 30, 2004. This increase was attributable primarily to a $110.5 million or 3 percent increase in average interest-earning assets from the comparable period of the prior year. Net interest spread increased 7 basis points to 4.02% for the current quarter from 3.95% for the quarter ended September 30, 2004.
Reflecting the higher interest rate environment and the sensitivity of our loan and lease portfolio to changes in rates, the average yield on loans and leases receivable, net, increased 87 basis points to 6.63% for the quarter ended September 30, 2005 as compared to the quarter ended September 30, 2004. Loan and lease principal repayments totaled $642.2 million for the quarter ended September 30, 2005 compared to $495.9 million for the comparable period of 2004. Expressed as an annualized percentage of average loans and leases receivable, net, this represented 75 percent of the portfolio compared to 60 percent for the quarter ended September 30, 2004. Premium amortization, net of discount accretion on the loan and lease portfolio for the quarters ended September 30, 2004 and 2005 was $552,000 and $510,000, respectively. Amortization of loan origination fees, net of direct costs of origination was $3.6 million for the quarter ended September 30, 2005 compared to $3.1 million for the comparable period of 2004. For the quarter ended September 30, 2005, this fee amortization increased yield on average loans receivable, net, and yield on average interest-earning assets by 42 basis points and 38 basis points, respectively, compared to 36 basis points and 32 basis points for the comparable period of 2004.
Our average cost of interest-bearing liabilities increased 74 basis points to 2.34% between the quarters ended September 30, 2004 and 2005. Our average cost of deposits rose 66 basis points between the quarter ended September 30, 2004 and 2005 while our average cost of FHLB advances, other borrowings and junior subordinated debentures rose 121 basis points. The increase in our average cost of interest-bearing liabilities was partially mitigated by the continued growth and increasing utilization of deposits as our principal and preferable source of funding. The average balance of our deposit portfolio increased $292.5 million or 12 percent to $2.83 billion or 80 percent of our average interest-bearing liabilities compared to 74 percent of our average interest-bearing liabilities for the comparable period of 2004. During the quarter ended September 30, 2005, we capitalized $70,000 of interest expense associated with our $10.2 million administrative facility we are developing in Rancho Cucamonga, California. This interest capitalization reduced average cost of interest-bearing liabilities for the quarter ended
18
September 30, 2005 by 1 basis point. We expect to capitalize a similar amount of interest expense each quarter through June 30, 2006.
Provision for Loan and Lease Losses
We recorded a $1.2 million provision for loan and lease losses for the current quarter compared to $1.1 million for the comparable period of 2004. At September 30, 2005, the allowance for loan and lease losses was $34.5 million or 0.82% of gross loans and leases and 290% of non-accrual loans compared to $33.3 million or 0.83% of gross loans and leases and 273% of non-accrual loans at March 31, 2005. We will continue to monitor and modify the allowance for loan and lease losses based upon economic conditions, loss experience, changes in portfolio composition, and other factors.
Non-Interest Income
Our total non-interest income was $8.2 million and $9.0 million for the quarters ended September 30, 2005 and 2004, respectively. The decrease was attributable to a $2.4 million reduction in gain on sales of securities, partially offset by a $796,000 increase in deposit and related fees and a $1.1 million increase in loan and servicing fees.
Deposit and Related Fees
Deposit and related fees increased 30 percent or $796,000 to $3.5 million for the current quarter. This increase reflects the continued growth in our core deposit transaction accounts and the fee income opportunities associated with those accounts. At September 30, 2005, we have approximately 68,000 transaction accounts compared to approximately 66,000 transaction accounts at September 30, 2004. The $796,000 increase is comprised principally of the following:
- Monthly service charges and overdraft fees increased $694,000 to $2.0 million for the current quarter.
- Automated Teller Machine ("ATM") fees increased $66,000 to $963,000 for the current quarter.
Loan and Servicing Fees
Loan and servicing fees rose 81 percent or $1.1 million between the quarters ended September 30, 2005 and 2004 to $2.4 million. The $1.1 million increase is comprised principally of the following:
- Amortization of extension fees on construction loans increased $928,000 to $1.3 million for the current quarter.
- Loan prepayment fees increased $168,000 to $456,000 for the current quarter.
At September 30, 2005, our mortgage servicing rights asset was $296,000.
Trust, Investment and Insurance Fees
Trust, investment and insurance fees decreased $130,000 or 11 percent to $1.0 million for the quarter ended September 30, 2005, primarily due to a decrease in annuity sales fees at Glencrest's subsidiary, Glencrest Insurance Services to $54,000 for the current quarter compared to $234,000 for the comparable period of 2004. Assets under management or advisory by Glencrest Investment Advisors, Inc. ("Glencrest") and the Bank's trust department rose to $577.6 million at September 30, 2005 compared to $393.8 million at September 30, 2004. These assets under management or advisory include $428.2 million managed or advised by Glencrest at September 30, 2005 compared to $242.1 million at September 30, 2004. While assets under management or advisory increased substantially, the average fee per dollar of assets managed or advised decreased from 19 basis points at September 30, 2004 to 14 basis points at September 30, 2005, reflecting growth in sub-advisory business.
Gain on Sale of Loans
Our community banking business strategy does not include aggressively pursuing the origination of loans for sale. Accordingly, the principal balances of loans sold during the quarters ended September 30, 2005 and 2004 were $4.4 million and $13.5 million, respectively. This activity generated net gain on sales of $36,000 and $81,000 for the quarters ended September 30, 2005 and 2004, respectively.
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Gain on Sale of Securities
We generally follow a "buy and hold" strategy with respect to our securities portfolio. While the overwhelming majority of our securities portfolio is classified as "available for sale", our securities sales activity has been and is expected to continue to be infrequent. Securities with a cost basis aggregating $393,000 and $2.9 million were sold during the quarter ended September 30, 2005 and 2004, respectively, generating gain on sales of $923,000 and $3.3 million. The current quarters sales consisted entirely of an investment in a single equity security, the entire balance of which was sold prior to September 30, 2005.
Non-Interest Expense
Non-interest expense increased $2.1 million to $23.4 million for the quarter ended September 30, 2005 as compared to the same period last year. General and administrative ("G&A") expense increased $2.0 million or 10 percent between the quarters ended September 30, 2005 and 2004 to $23.4 million. Compensation and benefits expense accounted for approximately 62 percent of the increase in total G&A expense. Approximately, $684,000 or 34 percent of the incremental increase in G&A expense for the quarter ended September 30, 2005, as compared to the same period last year, was attributable to the operating costs of the four new full service branches opened since November 2004. Employee Stock Ownership Plan ("ESOP") expense was $758,000 for the current quarter compared to $2.4 million, for the comparable quarter of 2004, reflecting a reduction in the number of shares amortized from 95,771 for the quarter ended September 30, 2004 to 25,658 for the current quarter. The non-cash charge associated with our Supplemental Executive Retirement Plan ("SERP") was $9,000 for the quarter ended September 30, 2005, compared to $117,000 for the quarter ended September 30, 2004. SERP expense or credit is a function of the change in the average market price of our common stock during the period. Our SERP serves only to deliver benefits that would otherwise be reduced below the level available to all other employees of the Company because of salary limitations imposed by law on our "qualified" benefit plans (e.g. ESOP and 401k).
The ratio of G&A expense to average assets increased to 2.37%, on an annualized basis for the quarter ended September 30, 2005 compared to 2.25% for the comparable period of 2004. Our efficiency ratio was 48.87% for the current quarter compared to 45.91% for the comparable period of 2004. Excluding gains on sales of securities, our efficiency ratios would have been 49.83% and 49.45% for the quarters ended September 30, 2005 and 2004, respectively.
Income Taxes
Our effective income tax rate improved from 45.1 percent for the quarter ended September 30, 2004 to 42.5 percent for the current quarter. The reduction in our effective tax rate was attributable principally to the reduction in ESOP expense, a significant portion of which is non-deductible for income tax purposes.
Comparison of Operating Results for the Six Months Ended September 30, 2005 and 2004
Overview
The following discussion compares the results of operations for the six months ended September 30, 2005 with the corresponding period of 2004. This discussion should be read in conjunction with the consolidated financial statements and footnotes included therein.
We recorded net earnings of $25.7 million or $1.03 per diluted share for the six months ended September 30, 2005 compared to net earnings of $24.0 million or $0.95 per diluted share for the comparable period of 2004 (adjusted for the three-for-two stock split effected in the form of a stock dividend paid on March 3, 2005 to shareholders of record on February 15, 2005). Excluding gains on sales of securities of $923,000 and $4.8 million during the six months ended September 30, 2005 and 2004, respectively, earnings before income taxes increased $6.0 million or 15 percent to $45.6 million for the six months ended September 30, 2005, compared to $39.6 million for the comparable period of the prior year.
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Net Interest Income
Our net interest income totaled $79.3 million for the six months ended September 30, 2005, up 8 percent or $5.9 million from $73.4 million for the comparable period of 2004. Average interest earning assets increased $200.4 million or 6 percent between the six months ended September 30, 2004 and 2005 and net interest spread increased 4 basis points to 4.02% for the six months ended September 30, 2005 from 3.98% for the same period of 2004.
Reflecting the higher interest rate environment and the sensitivity of our loan portfolio to changes in rates, the average yield on loans and leases receivable, net increased 75 basis points between the six months ended September 30, 2004 and 2005 to 6.50%. Loan and lease principal repayments totaled $1.25 billion for the six months ended September 30, 2005 compared to $1.20 billion for the comparable period of 2004. Expressed as an annualized percentage of average loans and leases receivable, net, this represented 72 percent of the portfolio compared to 75 percent for the six months ended September 30, 2004. Premium amortization, net of discount accretion on the loan and lease portfolio for the six months ended September 30, 2005 was $830,000 compared to $2.0 million for the comparable period of 2004. Amortization of loan origination fees, net of direct costs of origination was $7.3 million for the six months ended September 30, 2005 compared to $6.4 million for the comparable period of 2004. For the six months ended September 30, 2005, this fee amortization increased yield on average loans receivable, net, and interest earning assets by 43 basis points and 38 basis points, respectively, compared to 40 basis points and 36 basis points for the comparable period of 2004.
Our average cost of interest-bearing liabilities increased 67 basis points to 2.22% between the six months ended September 30, 2004 and 2005. Our average cost of deposits rose 55 basis points, while our average cost of FHLB advances, other borrowings and junior subordinated debentures rose 116 basis points. The increase in our average cost of interest-bearing liabilities was partially mitigated by the continued growth and increasing utilization of deposits as our principal and preferable source of funding. The average balance of our deposit portfolio increased $281.3 million to $2.77 billion or 78 percent of our average interest-bearing liabilities compared to 74 percent of our average interest-bearing liabilities for the comparable period of 2004. The $70,000 of interest capitalized on our administrative facility discussed above had a less than 1 basis point effect on the average cost of interest-bearing liabilities during the six months ended September 30, 2005.
Provision for Loan and Lease Losses
We recorded a $1.2 million provision for loan and lease losses for the six months ended September 30, 2005 compared to $1.7 million for the comparable period of 2004. The decrease in the provision for loan and lease losses between the six-month periods ended September 30, 2004 and 2005 was primarily attributable to declines in our non-accrual loans and classified assets. We will continue to monitor and modify the allowance for loan and lease losses based upon economic conditions, loss experience, changes in portfolio composition, and other factors.
Non-Interest Income
Our total non-interest income was $14.6 million and $15.9 million for the six months ended September 30, 2005 and 2004, respectively. The $1.3 million decrease was attributable to a $3.8 million net reduction in gain on sales of securities, partially offset by a $1.2 million increase in deposit and related fees and a $1.5 million increase in loan and servicing fees.
Deposit and Related Fees
Deposit and related fees totaled $6.4 million for the six months ended September 30, 2005, up $1.2 million or 23 percent from the comparable six months in 2004. This increase reflects the continued growth in our transaction accounts. The $1.2 million increase is principally comprised of the following:
- Monthly service charges and overdraft fees increased $915,000 to $3.6 million for the six months ended September 30, 2005.
- ATM fees increased $157,000 to $1.9 million for the six months ended September 30, 2005.
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Loan and Servicing Fees
Loan and servicing fees rose $1.5 million or 51 percent between the six months ended September 30, 2005 and 2004 to $4.5 million. The $1.5 million increase is comprised principally of the following items:
- Amortization of extension fees on construction loans increased $1.2 million to $2.0 million for the six months ended September 30, 2005.
- Loan prepayment fees increased $479,000 to $1.2 million for the six months ended September 30, 2005.
Trust, Investment and Insurance Fees
Trust, investment and insurance fees were relatively flat at $2.2 million for the six months ended September 30, 2005 and 2004.
Gain on Sale of Loans
The net gain on sale of loans was $103,000 on $9.2 million of principal sold for the six months ended September 30, 2005 compared to a net gain of $124,000 on $17.2 million of principal sold for the same period last year.
Gain on Sale of Securities
Securities with a cost basis aggregating $392,500 and $3.2 million were sold during the six months ended September 30, 2005 and 2004, respectively, generating gains on sales of $923,000 and $4.8 million, respectively.
Non-Interest Expense
Non-interest expense increased $2.8 million to $46.1 million for the six months ended September 30, 2005 as compared to the same period last year. G&A expense increased $2.8 million or 7 percent between the six months ended September 30, 2005 and 2004 to $46.1 million. Compensation and benefits expense accounted for approximately 63 percent of the increase in total G&A. ESOP expense was $1.5 million for the six months ended September 30, 2005, compared to $4.8 million for the comparable quarter of 2004, reflecting a reduction in the number of shares amortized for the six months ended September 30, 2005, as compared to the same period last year. The non-cash charge associated with our SERP was $452,000 for the six months ended September 30, 2005, compared to expense of $53,000 for the comparable period in 2004.
The ratio of G&A expense to average assets increased to 2.34%, on an annualized basis for the six months ended September 30, 2005 compared to 2.31% for the comparable period of 2004. Our efficiency ratio was 49.09% for the six months ended September 30, 2005 compared to 48.41% for the comparable period of 2004. Excluding gains on sales of securities, our efficiency ratios would have been 49.58% and 51.14% for the six months ended September 30, 2005 and 2004, respectively.
Income Taxes
Income taxes and the effective tax rates were $20.8 million and 44.7 percent, respectively, for the six months ended September 30, 2005 compared to $20.4 million and 46.0 percent, respectively, for the comparable period last year. The reduction in our effective tax rate was attributable principally to the reduction in ESOP expense, a significant portion of which is non-deductible for income tax purposes.
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Comparison of Financial Condition at September 30, 2005 and March 31, 2005
Total assets were $3.95 billion at September 30, 2005 compared to $3.91 billion at March 31, 2005. Loans and leases receivable, net, totaled $3.47 billion at September 30, 2005, a slight increase from $3.43 billion at March 31, 2005. However, the balance of the Four-Cs increased $110.5 million or 6 percent from $1.71 billion at March 31, 2005 to $1.82 billion at September 30, 2005. Additionally, because of a $150.5 million increase in the balance of undisbursed construction funds over the past six months to $705.0 million at September 30, 2005, the balance of the Four-Cs, including undisbursed construction funds, increased $261.0 million or 12 percent between March 31 and September 30, 2005.
At September 30, 2005, the allowance for loan and lease losses was $34.5 million or 0.82% of gross loans and leases and 290% of non-accrual loans compared to $33.3 million or 0.83% of gross loans and leases and 273% of non-accrual loans at March 31, 2005. The slight decrease in the ratio of the allowance for loan and lease losses to gross loans and leases between March 31 and September 30, 2005 reflects an improvement in the level and severity of non-accrual loans and classified assets as well as improvement in historical loss experience relating to charge-offs. The improvement in charge-offs is reflected in the table below. Assets classified "Substandard" and "Doubtful" under our Internal Asset Review ("IAR") system were $24.2 million and none, respectively at September 30, 2005 compared to $27.0 million and none, respectively at March 31, 2005.
The allowance for loan and lease losses is maintained at an amount management considers adequate to cover probable losses on loans and leases receivable. The determination of the adequacy of the allowance for loan and lease losses is influenced to a significant degree by the evaluation of the loan and lease portfolio by our IAR function. The IAR system is designed to identify problem loans and leases and probable losses. As our loan and lease portfolio has become comprised to a greater degree by the Four-Cs, the IAR function has become increasingly important not only for the timely and accurate identification of probable losses, but also to minimize our exposure to such losses through early intervention. Among the factors taken into account by the IAR function in identifying probable losses and determining the adequacy of the allowance for loan and lease losses are the nature, level and severity of classified assets, historical loss experience adjusted for current economic conditions, and composition of the loan and lease portfolio by type. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan and lease losses. Such agencies may require the Bank to make additional provisions for loan and lease losses based upon information available at the time of the review. We will continue to monitor and modify our allowance for loan and lease losses as economic conditions, loss experience, changes in asset quality, portfolio composition and other factors dictate.
The following table sets forth activity in our allowance for loan and leases losses.
| Three Months Ended | Six Months Ended | |
| September 30, | September 30, | |
| 2005 | 2004 | 2005 | 2004 | |
| (Dollars in thousands) | |
| Beginning balance |
$ | 33,192 | | $ | 31,048 | | $ | 33,302 | | $ | 30,819 | | | Provision for loan losses | |
1,220 | | | 1,140 | | | 1,220 | | | 1,664 | | | Charge-offs | |
(29) | | | (340) | | | (167) | | | (724) | | | Recoveries | |
99 | | | 39 | | | 127 | | | 128 | | | Ending balance |
$ | 34,482 | | $ | 31,887 | | $ | 34,482 | | $ | 31,887 | | | | | | | | | | | | | | |
The charge-offs of $167,000 for the six months ended September 30, 2005 primarily related to commercial business loans. The charge-offs of $724,000 for the six months ended September 30, 2004 included $480,000 related to a commercial business loan and $244,000 related to consumer loans.
Total liabilities increased $36.4 million to $3.61 billion at September 30, 2005 from $3.57 billion at March 31, 2005. Deposits increased $158.6 million or 6 percent to $2.89 billion or 80 percent of total liabilities at September 30, 2005 compared to 77 percent of total liabilities at March 31, 2005. Since March 31, 2005, we have opened three new full service branches in Rancho Cucamonga, Riverside and Mira Loma, California bringing our total to 30 branches. Core deposits increased $81.6 million during the past six months. Non-interest bearing demand deposits increased $33.1 million or 12 percent during the past six months to
23
$314.5 million or 11 percent of total deposits at September 30, 2005. During the six months ended September 30, 2005, we issued $25.8 million of junior subordinated debentures. See Note 5 to the Accompanying Unaudited Financial Statements.
Total stockholders' equity increased $7.4 million to $344.4 million at September 30, 2005 compared to $336.9 million at March 31, 2005. The increase in total stockholders' equity was comprised principally of a $6.0 million increase in additional paid-in-capital and, a $3.3 million increase in retained earnings, substantially restricted, partially offset by a $1.7 million increase in unearned stock based compensation and $114,000 increase in accumulated other comprehensive losses.
The $6.0 million increase in additional paid-in-capital reflects the following:
- A net increase of $6.6 million attributable to the exercise of 179,683 stock options, along with the associated tax benefit and the amortization of shares under our stock-based compensation plans,
- An increase of $2.3 million attributable to the issuance of 81,000 shares related to the 2004 Equity Incentive Plan,
- A decrease of $2.9 million representing the original issuance price of 610,030 shares of our common stock repurchased during the six months ended September 30, 2004.
The $1.7 million net increase in unearned stock-based compensation is comprised of a $2.0 million increase related to the unearned portion of stock issued under the 2004 Equity Incentive Plan and a reduction of $302,000 related to amortization under the Company's stock based compensation plans.
The $3.3 million increase in retained earnings, substantially restricted, is comprised of:
- An increase of $25.7 million representing net earnings for the six months ended September 30, 2005,
- A decrease of $15.1 million representing amounts paid in excess of the original issuance price for 610,030 shares of our common stock repurchased during the period; and
- A decrease of $7.3 million representing quarterly cash dividends of $0.15 per common share paid on June 24 and September 30, 2005 to shareholders of record as of June 10 and September 10, 2005.
Liquidity and Capital Resources
The objective of liquidity management is to ensure that we have the continuing ability to meet our funding needs on a cost-effective basis. Our most liquid assets are cash and short-term investments. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period.
Our primary sources of funds are deposits, principal and interest payments on loans, leases and securities, FHLB advances and other borrowings, and to a lesser extent, proceeds from the sale of loans and securities. While maturities and scheduled amortization of loans, leases and securities are predictable sources of funds, deposit flows and loan and security prepayments are greatly influenced by the general level of interest rates, economic conditions and competition.
The Office of Thrift Supervision has no statutory liquidity requirement, but rather a policy, consistent with that of the other Federal banking regulatory agencies, that liquidity be maintained at a level which provides for safe and sound banking practices and financial flexibility. Our internal policy is to seek to maintain at approximately three percent the ratio of cash and readily marketable debt securities with final maturities of one year or less to total deposits, FHLB advances and other borrowings maturing within one year (our "defined liquidity ratio"). In determining the adequacy of liquidity and borrowing capacity, we also consider large customer deposit concentrations, particularly with respect to core deposits, which provide immediate withdrawal opportunity. At September 30, 2005, our largest core deposit relationship was $27.4 million and our ten largest core deposit relationships aggregated $133.5 million. At September 30, 2005, our defined liquidity ratio was 3.58% and our average defined liquidity ratio for the quarter ended September 30, 2005 was 3.79%. At September 30, 2005, cash and short-term investments totaled $53.2 million. As an additional component of liquidity management, we seek to maintain sufficient mortgage loan and securities collateral at the FHLB to enable us to immediately borrow an amount equal to at least five percent of the Bank's total assets. At September 30, 2005, our immediate borrowing capacity from the FHLB was $420.2 million or 11 percent of the Bank's total
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assets. Additionally, we have the capability to borrow funds from the Federal Reserve Bank discount window. As of September 30, 2005, our borrowing capacity at the Federal Reserve Bank was approximately $14.5 million.
Our strategy is to manage liquidity by investing excess cash flows in higher yielding interest-earning assets, such as loans, leases and securities, or paying down FHLB advances and other borrowings, depending on market conditions. Conversely, if the need for funds is not met through deposits and cash flows from loans, leases and securities, we initiate FHLB advances and other borrowings or, if necessary and of economic benefit, sell loans and/or securities. Only when no other alternatives exist will we constrain loan and lease originations as a means of addressing a liquidity shortfall. We have not found it necessary to constrain loan and lease originations due to liquidity considerations.
Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities and financing activities.
Net cash provided by operating activities was $37.9 million and $27.0 million for the six months ended September 30, 2005 and 2004, respectively. The increase in net cash provided by operating activities is primarily due to an increase in net earnings between the six months ended September 30, 2004 and 2005, an increase in net deferred loan fees collected on loan originations during the six months ended September 30, 2005 and a change in our current income tax position from a receivable at March 31, 2005 to a payable at September 30, 2005.
Investing activities consist primarily of disbursements for loan and lease originations, purchases of loans, leases and securities, offset by principal collections on loans, leases and securities and to a lesser degree proceeds from the sale of securities. The levels of cash flows from investing activities are influenced by the general level of interest rates.
Net cash used in investing activities was $40.5 million for the six months ended September 30, 2005 compared to $284.1 million for the comparable period of the prior year. The decrease in net cash used in investing activities during the six months ended September 30, 2005 was attributable to decreases in purchases of single-family loans held-for-investment and purchases of investment securities and mortgage-backed securities, partially offset by increases in loans and leases originated for investment, construction loans in process and an increase in purchases of property and equipment. The increase in loan and lease originations and construction in progress was primarily due to the continuing demand for housing construction and the strong growth in the economy of Southern California. The increase in purchases of property and equipment was primarily related to a $10.0 million purchase of a commercial office building in Rancho Cucamonga, California to be used for consolidating our administrative functions. The net book value of that administrative building, land and capitalized costs is $10.2 million at September 30, 2005.
Cash flows provided by financing activities were $10.9 million for the six months ended September 30, 2005 compared to $288.1 million for the comparable period of the prior year. Financing activities consist primarily of net activity in deposit accounts and FHLB advances and other borrowings. Our net increases in deposits were $158.6 million and $131.6 million for the six months ended September 30, 2005 and 2004, respectively. With our strong growth in deposits during the six months ended September 30, 2005, we were able to decrease our use of FHLB advances and other borrowings by a net $149.4 million compared to a net increase of $140.6 million for the comparable period of 2004.
At September 30, 2005, the Bank exceeded all of its regulatory capital requirements with tangible capital of $332.1 million, or 8.54% of adjusted total assets, which is above the required level of $58.3 million, or 1.5%; core capital of $332.1 million, or 8.54% of adjusted total assets, which is above the required level of $155.5 million, or 4.0%; and total risk-based capital of $363.4 million, or 11.50% of risk-weighted assets, which is above the required level of $252.7 million, or 8.0%.
We currently have no material contractual obligations or commitments for capital expenditures. At September 30, 2005, we had outstanding commitments to originate and purchase loans of $134.0 million and $17.3 million, respectively, compared to $174.1 million and none, respectively, at September 30, 2004. Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. At September 30, 2005 and 2004, we had standby letters of credit of $26.6 million and $21.1 million, respectively. We anticipate that we will have sufficient funds available to meet our commitments. Certificate accounts that are scheduled to mature in less than one year from September 30, 2005 totaled $752.5 million. We expect that we will retain a substantial portion of the funds from maturing CDs at maturity either in
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certificate or liquid accounts. The low interest rate environment through the early stages of fiscal 2005 resulted in a reduction in the differential between CDs and more liquid instruments such as money market accounts. Accordingly, a portion of our maturing CDs were reinvested by customers into more liquid accounts until such time as the rate differential between CDs and liquid accounts increased. Increases in interest rates over the past year have eliminated this rate differential. As a result, we have begun seeing and expect to continue to experience some shift of deposits back into CDs from liquid accounts. While we believe this change in customer preference will create an additional upward bias to our cost of deposits, we also believe that our continued growth in non-interest bearing and lower cost core deposits should mitigate some of the earnings pressure that will arise from the migration of interest-bearing core deposits into CDs.
Segment Reporting
Through our branch network, lending operations and investment advisory offices, we provide a broad range of financial services to individuals and companies located primarily in Southern California. These services include demand, time, and savings deposits; real estate, business and consumer lending; cash management; trust services; investment advisory services and diversified financial services for homebuilders. While our chief decision makers monitor the revenue streams of our various products and services, operations are managed and financial performance is evaluated on a company-wide basis. Accordingly, we consider all of our operations are aggregated in one reportable operating segment.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We believe there have been no significant changes to our qualitative and quantitative disclosures of market risk (consisting primarily of interest rate risk) during the six months ended September 30, 2005.
Item 4. Controls and Procedures
Our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d - 15(e)) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective, as of September 30, 2005, to ensure that information relating to us, which is required to be disclosed in the reports we file with the Securities and Exchange Commission under the Exchange Act, is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.
There has been no change in our internal control over financial reporting identified in connection with the evaluation that occurred during our last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.
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PART II -- OTHER INFORMATION |
PFF BANCORP, INC. AND SUBSIDIARIES |
|
| Item 1. | Legal Proceedings. |
Other than ordinary routine litigation incidental to our business, neither we, nor any of our subsidiaries or any of their properties, are the subject of any material pending legal proceeding and, to the best of our knowledge, no such proceedings are contemplated by any governmental authorities.
|
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. This table provides certain information with respect to our purchases of common stock during the quarter ended September 30, 2005. |
| Common Stock Repurchased (1) | |
Period | Total Number of Shares Purchased (2) | Average Price Paid Per Share | Total Shares Purchased Under Repurchase Program | Total Shares Remaining Under Repurchase Program (3) (4) |
| | | | |
July 1, 2005 through July 31, 2005 | - | $ | - | - | 457,130 |
August 1, 2005 through August 31, 2005 | 149,790 | $ | 30.18 | 149,790 | 307,340 |
September 1, 2005 through September 30, 2005 | 179,100 | $ | 30.03 | 179,100 | 128,240 |
(1) On January 26, 2005, our Board of Directors authorized the repurchase of 1,200,000 shares (adjusted for
the three-for-two stock split effected in the form of a stock dividend paid on March 3, 2005 to
shareholders of record on February 15, 2005). During the quarter ended September 30, 2005, we
repurchased 328,890 shares under that program.
(2) During quarter ended September 30, 2005 and 2004, we repurchased 328,890 and 277,800 of our
common shares, respectively, at weighted average prices of $30.10 and $23.63, respectively.
(3) At September 30, 2005, the maximum amount of our common shares that can be repurchased was
128,240 shares.
(4) On October 26, 2005 the Company's Board of Directors authorized the addition of 1.0 million shares to
the 128,240 shares remaining under previous repurchase authorizations.
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Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its annual meeting on September 13, 2005. The proposals submitted to
shareholders and the tabulation of votes for each proposal were as follows:
1.) Election of directors of the Company for three-year terms.
Number of Votes
Nominees Number of Votes For Withheld
Robert W. Burwell 22,277,353 795,561
Curtis W. Morris 22,304,544 768,370
The directors whose terms continued and the years their terms expire are as follows:
Continuing Year Term
Directors Expires
Stephen C. Morgan 2006
Jil H. Stark 2006
Royce A. Stutzman 2006
Larry M. Rinehart 2007
Richard P. Crean 2007
2.) Ratification of KPMG LLP as the Company's independent auditors.
Number of Votes Number of Votes
Number of Votes For Against Abstaining
22,638,197 380,650 54,067
Item 5. Other Information.
None
Item 6. Exhibits.
31.1 Rule 13a-14(a)/15d-14(a) Certifications
32.1 Section 1350 Certifications
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