See accompanying notes to the unaudited consolidated financial statements.
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 December 31, 2005 | | Nine Months Ended December 31, 2005 |
| Compared to | | Compared to |
| Three Months Ended December 31, 2004 | | Nine Months Ended December 31, 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 | $ (48 | ) | 148 | (80 | ) | 20 | | $ (16 | ) | 227 | (26 | ) | 185 |
Investment securities, net | (46 | ) | 10 | (1 | ) | (37 | ) | (22 | ) | 30 | - | | 8 |
Mortgage-backed securities, net | (192 | ) | 166 | (12 | ) | (38 | ) | (799 | ) | 357 | (38 | ) | (480) |
Loans receivable, net | 460 | | 8,609 | 77 | | 9,146 | | 7,138 | | 20,519 | 1,020 | | 28,677 |
FHLB stock | (82 | ) | 186 | (42 | ) | 62 | | (136 | ) | 137 | (14 | ) | (13) |
Total interest-earning assets | 92 | | 9,119 | (58 | ) | 9,153 | | 6,165 | | 21,270 | 942 | | 28,377 |
| | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | |
Savings accounts | (1 | ) | - | - | | (1 | ) | 6 | | 9 | - | | 15 |
Money market savings accounts | 300 | | 1,525 | 129 | | 1,954 | | 1,973 | | 4,481 | 1,079 | | 7,533 |
NOW and other demand deposit accounts | (135 | ) | (140) | 22 | | (253 | ) | (459 | ) | (601) | 92 | | (968) |
Certificate accounts | 1,124 | | 2,162 | 397 | | 3,683 | | 2,194 | | 5,600 | 719 | | 8,513 |
FHLB advances and other borrowings | (1,321 | ) | 2,953 | (809 | ) | 823 | | (2,392 | ) | 7,195 | (1,336 | ) | 3,467 |
Junior subordinated debentures | 396 | | (30) | - | | 366 | | 1,402 | | (16) | (23 | ) | 1,363 |
Total interest-bearing liabilities | 363 | | 6,470 | (261 | ) | 6,572 | | 2,724 | | 16,668 | 531 | | 19,923 |
Change in net interest income | $ (271 | ) | 2,649 | 203 | | 2,581 | | $ 3,441 | | 4,602 | 411 | | 8,454 |
15
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 December 31, 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 December 31, 2005 and 2004
Overview
The following discussion compares the results of operations for the three months ended December 31, 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 $13.2 million or $0.53 per diluted share for the three months ended December 31, 2005 compared to net earnings of $9.6 million or $0.38 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).
Net interest income rose $2.6 million or 7 percent to $41.2 million for the current quarter compared to the same quarter of 2004. On a sequential quarter basis, net interest income increased $1.5 million or 4 percent. Net interest margin expanded 29 basis points to 4.32% between the quarters ended December 31, 2004 and 2005 and was up 14 basis points on a sequential quarter basis.
Construction, commercial business, commercial real estate and consumer loans (the "Four-Cs") increased $57.0 million during the current quarter to $1.88 billion or 53 percent of loans and leases receivable, net compared to $1.66 billion or 49 percent of loans and leases receivable, net, one year ago.
Our loan origination focus continues to be on the Four-Cs. Four-Cs originations totaled $472.4 million or 81 percent of total originations in the current quarter, compared to $582.1 million originated or 87 percent of total originations for the comparable period of the prior year. The Four-Cs origination figures include $31.2 million and $38.6 million originated by DBS during the quarters ended December 31, 2004 and 2005. At December 31, 2005, DBS has outstanding loans receivable of $76.1 million compared to $37.8 million one year ago. The majority of DBS's loans are classified as construction and land.
Average total deposits increased $34.7 million compared to the quarter ended September 30, 2005 and increased $198.6 million from the quarter ended December 31, 2004. The average balances of certificates of deposit ("CDs") and lower cost passbook, money market, NOW and other demand accounts ("core deposits") increased $166.6 million and $32.0 million, respectively, between the three months ended December 31,2004 and 2005.
Reflecting a widening rate differential between CDs and interest bearing liquid accounts arising from increases in the general level of interest rates, the average balance of CDs increased $83.8 million during the quarter, while core deposits decreased $49.1 million. At December 31, 2005, core deposits totaled $1.74 billion or 60 percent of total deposits, compared to $1.78 billion or 65 percent of total deposits at March 31, 2005 and $1.78 billion or 66 percent of total deposits one year ago. The average balance of non-interest-bearing demand deposits increased $18.9 million during the current quarter to $304.5 million or 11 percent of total deposits at December 31, 2005, and is up $44.7 million or 17 percent from the comparable quarter of the prior year.
Deposits, particularly core deposits, provide a more preferable source of funding than do FHLB advances and other borrowings. However, as and to the extent competitive or market factors do not allow us to meet our funding needs with deposits, FHLB advances and other borrowings provide a readily available source of liquidity. At December 31, 2005, FHLB advances and other borrowings increased to $728.9 million or 20 percent of total liabilities from $620.0 million or 17 percent of total liabilities at September 30, 2005.
Asset quality remained strong with non-accrual loans declining to $1.6 million or 0.04 percent of gross loans and leases at December 31, 2005 compared to $12.2 million or 0.30 percent of gross loans and leases at March 31, 2005 and $13.1 million or 0.33 percent of gross loans and leases at December 31, 2004. The distribution of the non-accrual loan balance of $1.6 million as of December 31, 2005 by loan type is $804,000 single-family, $577,000 commercial and $188,000 consumer.
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During the quarter ended December 31, 2005, we were successful in having a receiver appointed to oversee the completion of a 20 home development in Murrieta, California on which we had a loan of $10.3 million and a specific valuation allowance of $2.1 million. Fifteen of the twenty homes were pre-sold ("Buyer's Group") prior to the commencement of initial construction and remain in that status. Difficulties encountered between the original equity provider, developer and contractor resulted in long delays and the problems were compounded when mold was discovered in the uncompleted units. The Bank has advanced $250,000 to the receiver to date for upfront costs. PFF and the Buyer's Group have agreed to a sharing of completion costs with 50% to be paid by each (pro data). This loan had been on non-accrual status since July 2002 when a dispute arose between the developer and the third party equity provider. Upon appointment of the receiver, the $2.1 million specific valuation allowance was charged-off and the resulting $8.2 million net loan balance was transferred to assets acquired through foreclosure, net. This transfer to assets acquired through foreclosure reduced our ratio of non-performing loans to gross loans and leases by 24 basis points, based on December 31, 2005 balances. At December 31, 2005, that ratio is 0.04 percent compared to 0.30 percent at March 31, 2005. We expect the project will be completed during calendar 2006 at no additional loss to the Company.
We repurchased 173,930 shares of our common stock at a weighted-average price of $30.71 per share during the current quarter, bringing fiscal year-to-date repurchases to 783,960 shares at a weighted average price of $29.79 per share. At December 31, 2005, 954,310 shares remain under a 1.0 million share repurchase authorization adopted by our Board of Directors on October 26, 2005. As of December 31, 2005 and March 31, 2005, our treasury stock was comprised of 150,100 shares and 126,200 shares of our common stock, respectively. During the quarter ended December 31, 2005, we retired 74,230 shares of our common stock that had been primarily repurchased during the quarter ended December 31, 2005 and held as treasury stock.
At December 31, 2005, our consolidated capital to assets ratio was 8.64%. The Bank's core and total risk-based capital ratios were 8.43% and 11.28%, respectively, compared to 5.00% and 10.00%, respectively, needed to be considered "Well Capitalized." Our internal target floors for the Bank's core and total risk-based capital ratios are 7.75% and 11%, respectively.
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 $41.2 million for the current quarter, up 7 percent or $2.6 million from $38.7 million for the quarter ended December 31, 2004. The increase was primarily attributable to an increase in the net interest spread by 24 basis points to 4.14% for the current quarter from 3.90% for the quarter ended December 31, 2004. Average interest-earning assets decreased $15.4 million between the quarters ended December 31, 2004 and 2005. The average balance of loans and leases receivable, net increased $31.0 million. The average balance of the Four-Cs increased $146.9 million or 9 percent between the quarters ended December 31, 2004 and 2005.
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 99 basis points to 6.92% for the quarter ended December 31, 2005 as compared to the quarter ended December 31, 2004. Loan and lease principal repayments totaled $605.3 million for the quarter ended December 31, 2005 compared to $660.7 million for the comparable period of 2004. Expressed as an annualized percentage of average loans and leases receivable, net, this represented 70 percent of the portfolio compared to 77 percent for the quarter ended December 31, 2004. Premium amortization, net of discount accretion on the loan and lease portfolio for the quarters ended December 31, 2004 and 2005 was $342,000 and $253,000, respectively. Amortization of loan origination fees, net of direct costs of origination was $3.5 million for the quarter ended December 31, 2005 compared to $3.6 million for the comparable period of 2004. For the quarter ended December 31, 2005, this fee amortization increased yield on average loans receivable, net, and yield on average interest-earning assets by 40 basis points and 37 basis points, respectively, compared to 42 basis points and 37 basis points for the comparable period of 2004.
18
Our average cost of interest-bearing liabilities increased 74 basis points to 2.52% between the quarters ended December 31, 2004 and 2005. Our average cost of deposits rose 63 basis points between the quarter ended December 31, 2004 and 2005 while our average cost of FHLB advances, other borrowings and junior subordinated debentures rose 141 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 $198.6 million or 7 percent to $2.86 billion or 81 percent of our average interest-bearing liabilities compared to 75 percent of our average interest-bearing liabilities for the comparable period of 2004. During the quarter ended December 31, 2005, we capitalized $48,000 of interest expense associated with our $10.2 million administrative facility we are developing in Rancho Cucamonga, California. This interest capitalization had less than 1 basis point effect on the average cost of interest-bearing liabilities for the quarter ended December 31, 2005. 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 $1.9 million provision for loan and lease losses for the current quarter compared to $1.0 million for the comparable period of 2004. At December 31, 2005, the allowance for loan and lease losses was $33.8 million or 0.80% of gross loans and leases and 2,157% 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 $2.1 million charge-off on the Murrieta development loan discussed above represented 5 basis points of gross loans and leases. Annualized net charge-offs to average loans and leases receivable, net, were 0.29 percent for the current quarter, 0.24 percent of which was represented by the $2.1 million charge-off. 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
Total non-interest income increased $1.5 million or 25 percent to $7.3 million between the quarters ended December 31, 2005 and 2004.
Deposit and Related Fees
Deposit and related fees increased 25 percent or $650,000 to $3.3 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 December 31, 2005, we have approximately 69,200 transaction accounts compared to approximately 67,200 transaction accounts at December 31, 2004. The $650,000 increase is comprised principally of the following:
- Monthly service charges and overdraft fees increased $521,000 to $1.8 million for the current quarter.
- Automated Teller Machine ("ATM") fees increased $79,000 to $970,000 for the current quarter.
Loan and Servicing Fees
Loan and servicing fees rose 37 percent or $673,000 between the quarters ended December 31, 2005 and 2004 to $2.5 million. The $673,000 increase is comprised principally of the following:
- Amortization of extension fees on construction loans increased $417,000 to $1.1 million for the current quarter.
- Loan prepayment fees increased $253,000 to $684,000 for the current quarter.
At December 31, 2005, our mortgage servicing rights asset was $294,000.
Trust, Investment and Insurance Fees
Trust, investment and insurance fees increased $113,000 or 11 percent to $1.2 million for the quarter ended December 31, 2005. This reflects an increase in market value of trust and investment assets under management or advisory by Glencrest and the Bank's trust department to $603.7 million at December 31, 2005, compared to $422.4 million at December 31, 2004. These assets under management or advisory include $451.1 million
19
managed or advised by Glencrest at December 31, 2005 compared to $255.2 million at December 31, 2004. The average annual fee per dollar of assets managed or advised by Glencrest and the Bank's trust department was approximately 54 basis points for the quarter ended December 31, 2005 compared to 74 basis points for the comparable period of 2004.
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 December 31, 2005 and 2004 were $3.5 million and $8.7 million, respectively. This activity generated net gain on sales of $31,000 and $136,000 for the quarters ended December 31, 2005 and 2004, respectively.
Gain on Sale of Securities
We generally follow a "buy and hold" strategy with respect to our securities portfolio. While 98 percent of our securities portfolio is classified as "available for sale", our securities sales activity has been and is expected to continue to be infrequent.
Non-Interest Expense
Non-interest expense decreased $1.1 million to $23.5 million for the quarter ended December 31, 2005 as compared to the same period last year. General and administrative ("G&A") expense decreased $1.0 million or 4 percent between the quarters ended December 31, 2005 and 2004 to $23.5 million. Employee Stock Ownership Plan ("ESOP") expense was $747,000 for the current quarter compared to $2.8 million, for the comparable quarter of 2004, reflecting a reduction in the number of shares amortized from 95,771 for the quarter ended December 31, 2004 to 25,658 for the current quarter. Excluding the reduction in ESOP expense, total G&A expense increased $1.0 million or 5 percent between the quarters ended December 31, 2004 and 2005. The non-cash charge associated with our Supplemental Executive Retirement Plan ("SERP") was $101,000 for the quarter ended December 31, 2005, compared to $854,000 for the quarter ended December 31, 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 improved to 2.36%, on an annualized basis for the quarter ended December 31, 2005 compared to 2.48% for the comparable period of 2004. Our efficiency ratio improved to 48.46% for the current quarter compared to 55.17% for the comparable period of 2004.
Income Taxes
Our effective income tax rate decreased from 49.3 percent for the quarter ended December 31, 2004 to 43.0 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 Nine Months Ended December 31, 2005 and 2004
Overview
The following discussion compares the results of operations for the nine months ended December 31, 2005 with the corresponding period of 2004. This discussion should be read in conjunction with the consolidated financial statements and footnotes included herein.
We recorded net earnings of $38.9 million or $1.56 per diluted share for the nine months ended December 31, 2005 compared to net earnings of $33.6 million or $1.33 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 nine months ended December 31, 2005 and 2004, respectively, earnings before income taxes increased $10.3 million or 18 percent to $68.7 million for the nine months ended December 31, 2005, compared to $58.5 million for the comparable period of the prior year.
20
Net Interest Income
Our net interest income totaled $120.5 million for the nine months ended December 31, 2005, up 8 percent or $8.5 million from $112.0 million for the comparable period of 2004. Average interest-earning assets increased $127.9 million or 3 percent between the nine months ended December 31, 2004 and 2005 and net interest spread increased 11 basis points to 4.06% for the nine months ended December 31, 2005 from 3.95% for the same period of 2004. The average balance of loans and leases receivable, net increased $163.1 million between the nine months ended December 31, 2004 and 2005. The average balance of the Four-Cs increased $213.3 million or 14 percent between the nine months ended December 31, 2004 and 2005.
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 83 basis points between the nine months ended December 31, 2004 and 2005 to 6.64%. Loan and lease principal repayments totaled $1.85 billion for the nine months ended December 31, 2005 compared to $1.86 billion for the comparable period of 2004. Expressed as an annualized percentage of average loans and leases receivable, net, this represented 72 percent and 75 percent of the portfolio for the nine months ended December 31, 2005 and 2004. Premium amortization, net of discount accretion on the loan and lease portfolio for the nine months ended December 31, 2005 was $1.1 million compared to $2.3 million for the comparable period of 2004. Amortization of loan origination fees, net of direct costs of origination was $10.7 million for the nine months ended December 31, 2005 compared to $10.0 million for the comparable period of 2004. For the nine months ended December 31, 2005, this fee amortization increased yield on average loans receivable, net, and interest earning assets by 42 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 69 basis points to 2.32% between the nine months ended December 31, 2004 and 2005. Our average cost of deposits rose 58 basis points, while our average cost of FHLB advances, other borrowings and junior subordinated debentures rose 122 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 total deposits increased $253.6 million or 10 percent to $2.80 billion or 79 percent of average interest-bearing liabilities compared to 75 percent of average interest-bearing liabilities for the comparable period of 2004. The average balances of total core and non-interest bearing deposits increased $92.0 million and $46.7 million, respectively, between the nine months ended December 31, 2004 and 2005.
The $118,000 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 nine months ended December 31, 2005.
Provision for Loan and Lease Losses
We recorded a $3.1 million provision for loan and lease losses for the nine months ended December 31, 2005 compared to $2.7 million for the comparable period of 2004. The increase in provision for loan and lease losses between the nine- month periods was primarily attributable to an increase in construction and land loans. 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 $21.8 million and $21.7 million for the nine months ended December 31, 2005 and 2004, respectively. The increase was attributable to a $1.8 million increase in deposit and related fees and a $2.2 million increase in loan and servicing fees, partially offset by a $3.8 million reduction in gain on sales of securities.
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Deposit and Related Fees
Deposit and related fees totaled $9.7 million for the nine months ended December 31, 2005, up $1.8 million or 23 percent from the comparable nine months in 2004. This increase reflects the continued growth in our transaction accounts. The $1.8 million increase is principally comprised of the following:
- Monthly service charges and overdraft fees increased $1.4 million to $5.4 million for the nine months ended December 31, 2005.
- ATM fees increased $236,000 to $2.8 million for the nine months ended December 31, 2005.
Loan and Servicing Fees
Loan and servicing fees rose $2.2 million or 45 percent between the nine months ended December 31, 2005 and 2004 to $7.0 million. The $2.2 million increase is comprised principally of the following items:
- Amortization of extension fees on construction loans increased $1.7 million to $3.1 million for the nine months ended December 31, 2005.
- Loan prepayment fees increased $732,000 to $1.8 million for the nine months ended December 31, 2005.
Trust, Investment and Insurance Fees
Trust, investment and insurance fees were relatively flat at $3.3 million for the nine months ended December 31, 2005 and 2004.
Gain on Sale of Loans
The net gain on sale of loans was $134,000 on $12.7 million of principal sold for the nine months ended December 31, 2005 compared to a net gain of $260,000 on $26.0 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 nine months ended December 31, 2005 and 2004, respectively, generating gains on sales of $923,000 and $4.8 million, respectively. The gain on sales for the nine months ended December 31, 2004 and 2005 consisted entirely of an investment in a single equity security and a hedge fund investment, the entire balances of which were sold prior to December 31, 2005.
Non-Interest Expense
Non-interest expense increased $1.8 million to $69.6 million for the nine months ended December 31, 2005 as compared to the same period last year. G&A expense increased $1.8 million or 3 percent between the nine months ended December 31, 2005 and 2004 to $69.6 million. Compensation and benefits expense accounted for approximately 47 percent of the increase in total G&A. ESOP expense was $2.3 million for the nine months ended December 31, 2005, compared to $7.5 million for the comparable quarter of 2004, reflecting a reduction in the number of shares amortized for the nine months ended December 31, 2005, as compared to the same period last year. The non-cash charge associated with our SERP was $553,000 for the nine months ended December 31, 2005, compared to $907,000 for the comparable period in 2004.
The ratio of G&A expense to average assets improved to 2.34%, on an annualized basis for the nine months ended December 31, 2005 compared to 2.38% for the comparable period of 2004. Our efficiency ratio was 48.88% for the nine months ended December 31, 2005 compared to 50.66% for the comparable period of 2004. Excluding gains on sales of securities, our efficiency ratios would have been 49.20% and 52.53% for the nine months ended December 31, 2005 and 2004, respectively.
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Income Taxes
Our effective tax rates were 44.2 percent and 46.9 percent, respectively, for the nine months ended December 31, 2005 and 2004. 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 Financial Condition at December 31, 2005 and March 31, 2005
Total assets were $4.06 billion at December 31, 2005 compared to $3.91 billion at March 31, 2005. Loans and leases receivable, net, totaled $3.53 billion at December 31, 2005, a $100.4 million increase from $3.43 billion at March 31, 2005. The balance of the Four-Cs increased $167.5 million or 10 percent from $1.71 billion at March 31, 2005 to $1.88 billion at December 31, 2005. These loan balances are shown net of undisbursed construction loan funds of $641.3 million and $554.5 million at December 31 and March 31, 2005, respectively. These undisbursed balances represent funds that will be disbursed and begin earning interest as construction progresses on projects.
At December 31, 2005, the allowance for loan and lease losses was $33.8 million or 0.80% of gross loans and leases and 2,157% 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 charge-off of the $2.1 million in connection with the transfer of our Murrieta construction loan to assets acquired through foreclosure, net, reduced the ratio of allowance for loan and lease losses to gross loans and leases by 5 basis points based on December 31, 2005 balances contributing to a reduction in that ratio from 0.82% at September 30, 2005 to 0.80% at December 31, 2005. Assets classified "Substandard" and "Doubtful" under our Internal Asset Review ("IAR") system were $23.2 million and none, respectively at December 31, 2005 compared to $27.0 million and none, respectively at March 31, 2005. The $23.2 million primarily consists of 27 commercial business loans totaling $13.4 million, four single-family loans totaling $804,000, a commercial real estate loan of $452,000, and the Murrieta asset acquired through foreclosure of $8.2 million.
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 the percentage of our loan and lease portfolio comprised by the Four-Cs has increased, 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 | Nine Months Ended | |
| December 31, | December 31, | |
| 2005 | 2004 | 2005 | 2004 | |
| (Dollars in thousands) | |
| Beginning balance |
$ | 34,482 | | $ | 31,887 | | $ | 33,302 | | $ | 30,819 | | | Provision for loan losses | |
1,875 | | | 1,030 | | | 3,095 | | | 2,694 | | | Charge-offs | |
(2,553 | ) | | (268 | ) | | (2,721 | ) | | (992 | ) | | Recoveries | |
35 | | | 68 | | | 163 | | | 196 | | | Ending balance |
$ | 33,839 | | $ | 32,717 | | $ | 33,839 | | $ | 32,717 | | | | | | | | | | | | | | |
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The charge-offs of $2.7 million for the nine months ended December 31, 2005 includes $2.1 million applicable to the construction loan moved to assets acquired through foreclosure. The charge-offs of $992,000 for the nine months ended December 31, 2004 included $510,000 related to commercial business loans and $482,000 related to consumer loans.
Total liabilities increased $138.0 million to $3.71 billion at December 31, 2005 from $3.57 billion at March 31, 2005. Deposits increased $149.9 million or 5 percent to $2.89 billion or 78 percent of total liabilities at December 31, 2005 compared to $2.74 billion or 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. Reflecting a widening rate differential between certificate accounts and interest-bearing liquid accounts arising from increases in the general level of interest rates, core deposits decreased $40.4 million while certificates of deposits increased $190.3 million during the past nine months. Non-interest bearing demand deposits increased $65.3 million or 23 percent during the past nine months to $346.6 million or 12 percent of total deposits at December 31, 2005. The three branches opened during the past nine months have been open an average of approximately 7 months and have aggregate total deposits of $35.7 million as of December 31, 2005.
Total stockholders' equity increased $14.3 million to $351.2 million at December 31, 2005 compared to $336.9 million at March 31, 2005. The increase in total stockholders' equity was comprised principally of a $7.9 million increase in additional paid-in-capital and a $8.3 million increase in retained earnings, substantially restricted, partially offset by a $1.4 million increase in unearned stock based compensation and $454,000 increase in accumulated other comprehensive losses.
The $7.9 million increase in additional paid-in-capital reflects the following:
- A net increase of $9.3 million attributable to the exercise of 259,697 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 $3.7 million representing the original issuance price of 783,960 shares of our common stock repurchased during the nine months ended December 31, 2005.
The $1.4 million net increase in unearned stock-based compensation is comprised of a $1.8 million increase related to the unearned portion of stock issued under the 2004 Equity Incentive Plan and a reduction of $352,000 related to amortization under the Company's stock based compensation plans.
The $8.3 million increase in retained earnings, substantially restricted, is comprised of:
- An increase of $38.9 million representing net earnings for the nine months ended December 31, 2005,
- A decrease of $19.6 million representing amounts paid in excess of the original issuance price for 783,960 shares of our common stock repurchased during the period; and
- A decrease of $11.0 million representing quarterly cash dividends of $0.15 per common share paid on June 24, September 30 and December 28, 2005 to shareholders of record as of June 10, September 10 and December 15, 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.
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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 December 31, 2005, our largest core deposit relationship was $28.6 million and our ten largest core deposit relationships aggregated $125.1 million. At December 31, 2005, our defined liquidity ratio was 3.12% and our average defined liquidity ratio for the quarter ended December 31, 2005 was 3.33%. At December 31, 2005, cash and short-term investments totaled $77.9 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 December 31, 2005, our immediate borrowing capacity from the FHLB was $333.7 million or 8 percent of the Bank's total assets. Additionally, we have the capability to borrow funds from the Federal Reserve Bank discount window. As of December 31, 2005, our borrowing capacity at the Federal Reserve Bank was approximately $16.9 million. We also have $11.1 million of immediate borrowing capacity at December 31, 2005, under commercial lines of credit at the Bancorp and DBS aggregating $25.0 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 $63.8 million and $25.3 million for the nine months ended December 31, 2005 and 2004, respectively. The increase in net cash provided by operating activities is primarily due to an increase in net earnings between the nine months ended December 31, 2004 and 2005, an increase in net deferred loan fees collected on loan originations, a net increase in interest payable, a decrease in income tax receivable, and an increase of assets acquired through foreclosure.
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 $136.9 million for the nine months ended December 31, 2005 compared to $218.4 million for the comparable period of the prior year. The decrease in net cash used in investing activities during the nine months ended December 31, 2005 was attributable principally to a decrease in purchases of loans held-for-investment. The generally lower yields on loans available for purchase as compared to internal originations along with the importance to us of having a customer relationship associated with the loans in our portfolio has prompted us to deemphasize loan purchases in favor of internal originations. This strategic focus is also reflected in the increase in loan and lease originations. 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 $10.4 million at December 31, 2005.
Cash flows provided by financing activities were $106.1 million for the nine months ended December 31, 2005 compared to $178.6 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 $149.9 million and $249.6 million for the nine months ended December 31, 2005 and 2004, respectively. During the nine months ended December 31, 2005, we were able to decrease our use of FHLB advances and other borrowings by a net $40.5 million compared to a net decrease of $95.4 million for the comparable period of 2004.
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At December 31, 2005, the Bank exceeded all of its regulatory capital requirements with tangible capital of $335.0 million, or 8.43% of adjusted total assets, which is above the required level of $59.6 million, or 1.5%; core capital of $335.0 million, or 8.43% of adjusted total assets, which is above the required level of $159.0 million, or 4.0%; and total risk-based capital of $367.0 million, or 11.28% of risk-weighted assets, which is above the required level of $260.3 million, or 8.0%.
We currently have no material contractual obligations or commitments for capital expenditures. At December 31, 2005, we had outstanding commitments to originate and purchase loans of $286.0 million and $10.4 million, respectively, compared to $167.8 million and none, respectively, at December 31, 2004. Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. At December 31, 2005 and 2004, we had standby letters of credit of $40.8 million and $22.5 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 December 31, 2005 totaled $884.4 million. We expect that we will retain a substantial portion of the funds from maturing certificates of deposit ("CDs") at maturity either in 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 nine months ended December 31, 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 December 31, 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 December 31, 2005. |
| Common Stock Repurchased | |
| | | | |
Period | Total Number of Shares Purchased (2) | Average Price Paid Per Share | Total Shares Purchased Under Repurchase Program | Total Shares Remaining Under Repurchase Program (1) (3) |
| | | | |
October 1, 2005 through October 31, 2005 | - | $ | - | - | 1,128,240 |
November 1, 2005 through November 30, 2005 | 23,830 | $ | 29.94 | 23,830 | 1,104,410 |
December 1, 2005 through December 31, 2005 | 150,100 | $ | 30.84 | 150,100 | 954,310 |
| | | | | |
(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 December 31, 2005, we repurchased 128,240 shares under that program. At October 1, 2005, 128,240 shares remained under that program. 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.
(2) During quarter ended December 31, 2005 and 2004, we repurchased 173,930 and none of our common shares, respectively, at weighted average prices of $30.71.
(3) At December 31, 2005, the maximum amount of our common shares that can be repurchased was 954,310 shares.
Item 3. | Defaults Upon Senior Securities. |
| None |
| |
| Item 4. | Submission of Matters to a Vote of Security Holders. |
| None |
| |
| 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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