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W.H.E.C., INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
WITH
INDEPENDENT AUDITORS' REPORT
DECEMBER 31, 2001 and 2000
CONTENTS
INDEPENDENT AUDITORS' REPORT ON THE CONSOLIDATED FINANCIAL STATEMENTS | 2 | ||
CONSOLIDATED FINANCIAL STATEMENTS | |||
Consolidated Balance Sheets | 3 | ||
Consolidated Statements of Income | 4 | ||
Consolidated Statement of Changes in Shareholders' Equity | 5 | ||
Consolidated Statements of Cash Flows | 6 | ||
Notes to Consolidated Financial Statements | 7 through 19 | ||
[LETTERHEAD FROM VAVRINEK, TRINE, DAY & CO., LLP]
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
W.H.E.C., Inc. and Subsidiary
We have audited the consolidated balance sheets of W.H.E.C., Inc. and Subsidiary ("the Company") as of December 31, 2001 and 2000 and the related consolidated statements of income, changes in shareholders' equity, and cash flows of the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of W.H.E.C., Inc. and Subsidiary as of December 31, 2001 and 2000, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ Vavrinek, Trine, Day & Co., LLP
Laguna Hills, California
January 15, 2002
2
W.H.E.C., INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
| 2001 | 2000 | |||||
---|---|---|---|---|---|---|---|
ASSETS | |||||||
Cash and due from banks | $ | 6,250,353 | $ | 7,723,261 | |||
Federal funds sold | 14,380,000 | 30,545,000 | |||||
Total cash and cash equivalents | 20,630,353 | 38,268,261 | |||||
Certificates of deposit | 450,000 | 549,000 | |||||
Investment securities available for sale | 25,192,542 | 8,789,386 | |||||
Federal Reserve Bank stock, at cost | 119,050 | 119,050 | |||||
Loans—net | 92,129,990 | 72,368,322 | |||||
Bank premises and equipment — net | 1,225,289 | 1,384,770 | |||||
Accrued interest receivable | 715,553 | 588,028 | |||||
Cash surrender value of life insurance | 2,424,145 | 2,328,266 | |||||
Other assets | 591,763 | 652,114 | |||||
$ | 143,478,685 | $ | 125,047,197 | ||||
LIABILITIES & SHAREHOLDERS' EQUITY | |||||||
Deposits | |||||||
Demand—non-interest bearing | $ | 47,493,045 | $ | 40,315,230 | |||
Money market and NOW | 57,228,841 | 45,339,239 | |||||
Savings | 4,464,959 | 3,777,358 | |||||
Time certificates $100,000 or more | 12,604,680 | 11,694,536 | |||||
Other time certificates | 10,248,137 | 14,228,292 | |||||
Total deposits | 132,039,662 | 115,354,655 | |||||
Other liabilities | 954,114 | 866,685 | |||||
Total liabilities | 132,993,776 | 116,221,340 | |||||
Commitments and contingencies—Notes 4 and 12 | — | — | |||||
Shareholders' equity | |||||||
Common stock, $1.00 par value: authorized Shares-5,000,000 issued and outstanding 4,079,171 in 2001 and 4,015,341 in 2000 | 4,079,171 | 4,015,341 | |||||
Retained earnings | 6,158,693 | 4,810,232 | |||||
Accumulated other comprehensive income — unrecognized income on available-for-sale securities, net of taxes of $171,675 in 2001 and $197 in 2000 | 247,045 | 284 | |||||
Total shareholders' equity | 10,484,909 | 8,825,857 | |||||
$ | 143,478,685 | $ | 125,047,197 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
3
W.H.E.C., INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2001 and 2000
| 2001 | 2000 | |||||
---|---|---|---|---|---|---|---|
Interest income: | |||||||
Loans | $ | 7,114,417 | $ | 7,369,981 | |||
Investment securities | 1,043,997 | 441,683 | |||||
Federal funds sold | 723,416 | 1,005,035 | |||||
Deposits with financial institutions | 28,329 | 31,950 | |||||
Total interest income | 8,910,159 | 8,848,649 | |||||
Interest expense: | |||||||
Time certificates of deposit of $100,000 or more | 669,988 | 610,352 | |||||
Other deposits | 1,822,542 | 1,765,161 | |||||
Total interest expense | 2,492,530 | 2,375,513 | |||||
Net interest income | 6,417,629 | 6,473,136 | |||||
Provision for loan losses | 95,000 | 125,000 | |||||
Net interest income after provision for loan losses | 6,322,629 | 6,348,136 | |||||
Noninterest income: | |||||||
Service charges on deposit accounts | 954,908 | 892,483 | |||||
Gain on sale of mortgage loans | 38,870 | 30,843 | |||||
Dividends on cash surrender value life insurance | 111,427 | 109,829 | |||||
Other | 511,533 | 360,697 | |||||
1,616,738 | 1,393,852 | ||||||
Noninterest expense: | |||||||
Compensation and employee benefits | 3,090,319 | 3,246,497 | |||||
Occupancy expense of bank premises | 642,220 | 620,629 | |||||
Equipment expenses | 289,687 | 303,830 | |||||
Other administrative | 1,366,205 | 1,375,944 | |||||
5,388,431 | 5,546,900 | ||||||
Income before income tax provision | 2,550,936 | 2,195,088 | |||||
Income tax provision | 919,150 | 865,390 | |||||
NET INCOME | $ | 1,631,786 | $ | 1,329,698 | |||
Per share data: | |||||||
Net income—basic | $ | 0.41 | $ | 0.33 | |||
Net income—diluted | $ | 0.36 | $ | 0.31 | |||
The accompanying notes are an integral part of these consolidated financial statements.
4
W.H.E.C., INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2001 and 2000
| Common Stock | | | | | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Accumulated Other Comprehensive Income | | |||||||||||||||
| Number of Shares | Amount | Comprehensive Income | Retained Earnings | Total | ||||||||||||||
Balance at January 1, 2000 | 4,015,341 | $ | 4,015,341 | $ | 3,480,534 | $ | (120,513 | ) | $ | 7,375,362 | |||||||||
Comprehensive Income: | |||||||||||||||||||
Net income | $ | 1,329,698 | 1,329,698 | 1,329,698 | |||||||||||||||
Net unrealized appreciation on available-for-sale securities, net of taxes of $83,944 | 120,797 | 120,797 | 120,797 | ||||||||||||||||
Total Comprehensive Income | $ | 1,450,495 | |||||||||||||||||
Balance at December 31, 2000 | 4,015,341 | 4,015,341 | 4,810,232 | 284 | 8,825,857 | ||||||||||||||
Comprehensive Income: | |||||||||||||||||||
Dividends paid | (282,460 | ) | (282,460 | ) | |||||||||||||||
Exercise of stock options | 63,830 | 63,830 | (865 | ) | 62,965 | ||||||||||||||
Net income | $ | 1,631,786 | 1,631,786 | 1,631,786 | |||||||||||||||
Net unrealized appreciation on available-for-sale securities, net of taxes of $171,478 | 246,761 | 246,761 | 246,761 | ||||||||||||||||
Total Comprehensive Income | $ | 1,878,547 | |||||||||||||||||
Balance at December 31, 2001 | 4,079,171 | $ | 4,079,171 | $ | 6,158,693 | $ | 247,045 | $ | 10,484,909 | ||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
5
W.H.E.C., INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2001 and 2000
| 2001 | 2000 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
Cash flows from operating activities: | ||||||||||
Net income | $ | 1,631,786 | $ | 1,329,698 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||
�� | Depreciation and amortization | 270,876 | 278,490 | |||||||
Provision for loan losses | 95,000 | 125,000 | ||||||||
Gain on sales of loans | (38,870 | ) | (30,843 | ) | ||||||
Deferred income taxes | (121,000 | ) | (158,000 | ) | ||||||
Net increase in cash surrender value life insurance | (95,879 | ) | (95,190 | ) | ||||||
Changes in operating assets and liabilities: | ||||||||||
Accrued interest receivable | (127,525 | ) | (94,237 | ) | ||||||
Other assets | 190,865 | 228,125 | ||||||||
Other liabilities | 87,429 | 229,732 | ||||||||
Net cash provided by operating activities | 1,892,682 | 1,812,775 | ||||||||
Cash flows from investing activities: | ||||||||||
Net increase in certificates of deposit | 99,000 | — | ||||||||
Purchases of available-for-sale investment securities | (22,114,943 | ) | — | |||||||
Proceeds from maturities and calls of issuer of available-for-sale investment securities | 5,949,034 | 206,552 | ||||||||
Net increase in loans made to customers | (19,817,798 | ) | (8,804,541 | ) | ||||||
Capital expenditures | (111,395 | ) | (353,585 | ) | ||||||
Net cash used for investing activities | (35,996,102 | ) | (8,951,574 | ) | ||||||
Cash flows from financing activities: | ||||||||||
Net increase in demand and savings deposits | 19,755,018 | 23,752,643 | ||||||||
Net decrease in time deposits | (3,070,011 | ) | (1,981,752 | ) | ||||||
Dividends paid | (282,460 | ) | — | |||||||
Proceeds from the issuance of common stock | 62,965 | — | ||||||||
Net cash provided by financing activities | 16,465,512 | 21,770,891 | ||||||||
Net increase (decrease) in cash and cash equivalents | (17,637,908 | ) | 14,632,092 | |||||||
Cash and cash equivalents at beginning of year | 38,268,261 | 23,636,169 | ||||||||
Cash and cash equivalents at end of year | $ | 20,630,353 | $ | 38,268,261 | ||||||
Cash paid during the year for: | ||||||||||
Interest | $ | 2,538,473 | $ | 2,358,757 | ||||||
Income taxes | $ | 1,031,964 | $ | 934,080 |
The accompanying notes are an integral part of these consolidated financial statements.
6
W.H.E.C., INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Details of Consolidation
The financial statements include the accounts of W.H.E.C., Inc. (the "Company") and Capital Bank of North County (the "Bank"). W.H.E.C., Inc. has no significant business operations other than holding the stock of Capital Bank of North County.
Nature of Operations
The Bank has been organized and operates as a single reporting segment and operates five branches and one loan production office in San Diego County. The Bank's principal lines of business are real estate, commercial and SBA guaranteed loans. The Bank's commercial loan portfolio is diverse as to the industries represented. The real estate portfolio includes credits to many different borrowers for a variety of projects and for residential real estate.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash, due from banks and federal funds sold. Generally, federal funds are sold for one day periods.
Cash and Due From Banks
Banking regulations require that all banks maintain a percentage of their deposits as reserves in cash or on deposit with the Federal Reserve Bank. The Bank complied with the reserve requirements as of December 31, 2001.
The Bank maintains amounts due from banks, which exceed federally insured limits. The Bank has not experienced any losses in such accounts.
Investment Securities
Bonds, notes, and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity.
Investments not classified as trading securities nor as held to maturity securities are classified as available-for-sale securities and recorded at fair value. Unrealized gains or losses on available-for-sale securities are excluded from net income and reported as an amount net of taxes as a separate component of other comprehensive income included in shareholders' equity. Premiums or discounts on held-to-maturity and available-for-sale securities are amortized or accreted into income using the interest method. Realized gains or losses on sales of held-to-maturity or available-for-sale securities are recorded using the specific identification method.
7
Loans Held for Sale
Mortgage and SBA loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income.
Loans
Loans receivable that management has the intent and ability to hold for the foreseeable future, or until maturity or payoff, are reported at their outstanding unpaid principal balances reduced by any charge-offs or specific valuation accounts and net of any deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans.
Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan.
The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received.
For impairment recognized in accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, the entire change in the present value of expected cash flows is reported as either provision for loan losses in the same manner in which impairment initially was recognized, or as a reduction in the amount of provision for loan losses that otherwise would be reported.
Allowance for Loan Losses
The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions.
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives, which ranges from three to ten years for furniture and fixtures. Leasehold improvements are amortized using the straight-line method over the estimated useful lives of the improvements or the remaining lease term, whichever is shorter. Expenditures for betterments or major repairs are capitalized and those for ordinary repairs and maintenance are charged to operations as incurred.
Other Real Estate Owned
Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of cost or fair value minus estimated costs to sell. Revenue and expenses from operations and additions to the valuation allowance are included in other expenses.
8
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Financial Instruments
In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
Disclosure About Fair Value of Financial Instruments
SFAS No. 107 specifies the disclosure of the estimated fair value of financial instruments. The Bank's estimated fair value amounts have been determined by the Bank using available market information and appropriate valuation methodologies.
However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates are not necessarily indicative of the amounts the Bank could have realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since the balance sheet date and, therefore, current estimates of fair value may differ significantly from the amounts presented in the accompanying notes.
Earnings Per Shares (EPS)
Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
Current Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 142,"Accounting for Goodwill and Other Intangible Assets"effective starting with fiscal years beginning after December 15, 2001. This statement establishes new accounting standards for goodwill and continues to require the recognition of goodwill as an asset but does not permit amortization of goodwill as previously required by the Accounting Principles Board (APB) Opinion No. 17. The statement also establishes a new method of testing goodwill for impairment. It requires goodwill to be separately tested for impairment at a reporting unit level. The amount of goodwill determined to be impaired would be expensed to current operations. Management believes that the adoption of the statement will not have a material effect on the Bank's financial statements
Reclassifications
Certain reclassifications were made to prior years' presentations to conform to the current year. These classifications are of a normal recurring nature.
9
NOTE 2—INVESTMENTS
Debt and equity securities have been classified according to management's intent. The carrying amount of securities and their approximate fair value at December 31 were as follows:
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Market Value | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Available-for-sale: | ||||||||||||||
December 31, 2001 | ||||||||||||||
US Treasury securities and obligations of US government | $ | 13,027,476 | $ | 226,422 | $ | — | $ | 13,253,898 | ||||||
Municipalities | 11,737,222 | 200,999 | 8,336 | 11,929,885 | ||||||||||
Mortgage-backed securities | 9,124 | — | 365 | 8,759 | ||||||||||
Total securities available-for-sale | $ | 24,773,822 | $ | 427,421 | $ | 8,701 | $ | 25,192,542 | ||||||
December 31, 2000 | ||||||||||||||
US Treasury securities and obligations of US government | $ | 5,048,083 | $ | 9,094 | $ | 2,284 | $ | 5,054,893 | ||||||
Municipalities | 3,725,559 | 7,797 | 13,822 | 3,719,534 | ||||||||||
Mortgage-backed securities | 15,264 | — | 305 | 14,959 | ||||||||||
Total securities available-for-sale | $ | 8,788,906 | $ | 16,891 | $ | 16,411 | $ | 8,789,386 | ||||||
Investment securities carried at approximately $10,735,000 and $7,655,000 at December 31, 2001 and December 31, 2000, respectively, were pledged to secure public deposits and other purposes as required by law.
The amortized cost and estimated market value of investment securities available for sale at December 31, 2001, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| Amortized Cost | Estimated Market Value | ||||
---|---|---|---|---|---|---|
Due in one year or less | $ | 4,015,976 | $ | 4,094,999 | ||
Due in one year to five years | 12,533,243 | 12,755,690 | ||||
Due in five years to ten years | 7,266,480 | 7,373,207 | ||||
Due in greater than ten years | 948,999 | 959,887 | ||||
Mortgage-backed securities | 9,124 | 8,759 | ||||
$ | 24,773,822 | $ | 25,192,542 | |||
NOTE 3—LOANS
The Bank's loan portfolio consists primarily of loans to borrowers within San Diego County in Southern California. Although the Bank seeks to avoid concentrations of loans to a single industry or based upon a single class of collateral, commercial and industrial loans are among the principal industries in the Bank's market area, and as a result, the Bank's loan portfolio and related collateral are, to some degree, concentrated in those industries.
10
Loans consist of the following:
| December 31, | |||||||
---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | ||||||
Real estate loans: | ||||||||
Construction | $ | 21,242,096 | $ | 13,135,824 | ||||
Other | 32,334,178 | 24,254,107 | ||||||
Commercial and industrial loans | 36,724,786 | 33,275,771 | ||||||
Consumer and other | 2,807,404 | 2,717,197 | ||||||
93,108,464 | 73,382,899 | |||||||
Less allowance for loan losses | (928,678 | ) | (838,678 | ) | ||||
Less deferred loan fees | (49,796 | ) | (175,899 | ) | ||||
$ | 92,129,990 | $ | 72,368,322 | |||||
Activity in the allowance for loan losses is as follows:
| Year ended December 31, | |||||
---|---|---|---|---|---|---|
| 2001 | 2000 | ||||
Balance at beginning of year | $ | 838,678 | $ | 691,658 | ||
Provision for loan losses charged to expense | 95,000 | 125,000 | ||||
Loans charged off | (5,000 | ) | — | |||
Recoveries | — | 22,020 | ||||
Balance at end of year | $ | 928,678 | $ | 838,678 | ||
The following is a summary of the investment in impaired loans, the related allowance for loan losses, and income recognized thereon as of December 31:
| 2001 | 2000 | ||||
---|---|---|---|---|---|---|
Recorded investment in impaired loans | $ | 49,000 | $ | 12,000 | ||
Related allowance for loan losses | $ | 8,500 | $ | 3,300 | ||
Average recorded investment in impaired loans | $ | 1,420,000 | $ | 98,000 | ||
Interest income recognized for cash payments | $ | 213,000 | None |
11
The Bank also originates loans for sale to governmental agencies and institutional investors. At December 31, 2001 and 2000, the Bank was servicing approximately $9,757,000 and $12,957,000, respectively in loans previously sold.
NOTE 4—BANK PREMISES AND EQUIPMENT
Bank premises and equipment consist of the following:
| December 31, | ||||||
---|---|---|---|---|---|---|---|
| 2001 | 2000 | |||||
Leasehold improvements | $ | 962,094 | $ | 989,808 | |||
Furniture, fixtures and equipment | 1,336,040 | 1,338,159 | |||||
2,298,134 | 2,327,967 | ||||||
Less accumulated depreciation and amortization | (1,072,845 | ) | (943,197 | ) | |||
Total | $ | 1,225,289 | $ | 1,384,770 | |||
The Bank leases its facilities under non-cancelable operating leases expiring through 2011. Rent expense was $401,680 and $393,148 for 2001 and 2000, respectively.
At December 31, 2001, the future minimum annual payments for these leases are as follows:
Year | Amount | ||
---|---|---|---|
2002 | $ | 432,000 | |
2003 | 422,000 | ||
2004 | 267,000 | ||
2005 | 167,000 | ||
2006 | 167,000 | ||
Thereafter | 381,000 | ||
$ | 1,836,000 | ||
NOTE 5—DEPOSITS
At December 31, 2001, the scheduled maturities of time deposits are as follows:
2002 | $ | 20,627,473 | |
2003 to 2004 | 2,136,886 | ||
Thereafter | 88,458 | ||
$ | 22,852,817 | ||
12
NOTE 6—OTHER ADMINISTRATIVE EXPENSES
Other administrative expenses are as follows:
| 2001 | 2000 | ||||
---|---|---|---|---|---|---|
Data processing | $ | 384,505 | $ | 302,738 | ||
Promotional expenses | 262,248 | 348,992 | ||||
Telephone and postage | 152,228 | 152,160 | ||||
Professional fees | 118,851 | 147,153 | ||||
Stationery and supplies | 91,100 | 83,035 | ||||
Insurance | 78,464 | 66,481 | ||||
Messenger service | 71,756 | 73,045 | ||||
Other | 207,053 | 202,340 | ||||
$ | 1,366,205 | $ | 1,375,944 | |||
NOTE 7—INCOME TAXES
The provision for income taxes is comprised of the following:
| Year Ended December 31, | |||||||
---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | ||||||
Taxes—current | ||||||||
Federal | $ | 748,101 | $ | 749,239 | ||||
State | 292,049 | 274,151 | ||||||
Total current | 1,040,150 | 1,023,390 | ||||||
Deferred taxes | (121,000 | ) | (158,000 | ) | ||||
Total income tax expense | $ | 919,150 | $ | 865,390 | ||||
A comparison of the federal statutory income tax rates to the effective income tax rates follows:
| 2001 | 2000 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
| Amount | Rate | Amount | Rate | |||||||
Federal tax rate | $ | 867,318 | 34.0 | % | $ | 746,330 | 34.0 | % | |||
California franchise taxes, net of federal tax benefit | 178,254 | 7.0 | % | 153,945 | 7.0 | % | |||||
Tax savings from exempt loan and investment income | (116,083 | ) | (4.6 | )% | (48,498 | ) | (2.2 | )% | |||
Other items—net | (10,339 | ) | (0.4 | )% | 13,613 | 0.6 | % | ||||
$ | 919,150 | 36.0 | % | $ | 865,390 | 39.4 | % | ||||
13
The tax effected temporary differences giving rise to the deferred tax assets and liabilities at December 31, are as follows:
| 2001 | 2000 | |||||
---|---|---|---|---|---|---|---|
Deferred tax assets: | |||||||
Allowance for loan losses | $ | 252,000 | $ | 213,000 | |||
Deferred compensation | 367,000 | 294,000 | |||||
California franchise tax | 103,000 | 93,000 | |||||
Other | 58,000 | 64,000 | |||||
780,000 | 664,000 | ||||||
Less deferred tax liabilities: | |||||||
Accumulated depreciation | 51,000 | 56,000 | |||||
Market value adjustment on investment securities | 172,000 | — | |||||
223,000 | 56,000 | ||||||
Net deferred tax asset | $ | 557,000 | $ | 608,000 | |||
NOTE 8—STOCK OPTION PLAN
Employees and Directors of the Company are eligible to participate in two fixed option plans. The Company applies APB Opinion No. 25 and related Interpretations in accounting for its participation in these plans. Accordingly, no compensation cost has been recognized. Had compensation costs for these plans been determined based on the fair value at the grant dates consistent with the method of SFAS No. 123, the impact would not have materially affected net income.
The Company has an expired stock option plan under which options were previously granted to key employees. Options were granted at prices equal to at least 100% of the market price of the shares at date of grant and are exercisable at time of grant. No further grants may be made under the plan at this time, however existing options may be exercised.
In December 1997, the shareholders approved the 1997 Stock Option Plan. Under the terms of this plan, directors are granted nonqualified stock options and employees may be granted either nonqualified or incentive stock options. Options to purchase 383,100 shares of common stock are available for grant at a price not less than 100% of the fair market value of the Parent's stock on the date of grant. All options expire no later than ten years from the date of grant.
In November 2000, the shareholders approved the 2000 Stock Option Plan. The terms of the 2000 Stock Option are substantially the same as those of the 1997 Stock Option Plan. There are 50,000 options available for future grants under the 2000 Stock Option Plan.
The fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions; risk-free rates of 6.0%, no dividends, disregarding volatility and expected lives of 10 years. The weighted-average fair value of options granted during 2000 was $0.96.
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A summary of the status of the Company's participation in these plans as of December 31, 2001 and 2000 and changes during the years ending on those dates is presented below:
| 2001 | 2000 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
| Shares | Weighted Average Exercise Price | Shares | Weighted Average Exercise Price | ||||||
Outstanding at Beginning of Year | 741,600 | $ | 1.25 | 718,100 | $ | 1.21 | ||||
Granted | — | — | 31,000 | 2.17 | ||||||
Exercised | (63,830 | ) | 0.99 | — | — | |||||
Forfeited | (2,000 | ) | 2.17 | (7,500 | ) | 1.37 | ||||
Outstanding at End of Year | 675,770 | 1.27 | 741,600 | 1.25 | ||||||
At December 31, 2001, all options were exercisable with a weighted-average exercise price of $1.27 and a weighted-average remaining contractual life of 5.0 years.
NOTE 9—EARNINGS PER SHARE (EPS)
The following is a reconciliation of net income and shares outstanding to the income and number of share used to compute EPS:
| 2001 | 2000 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
| Income | Shares | Income | Shares | ||||||
Net Income as Reported | $ | 1,631,786 | $ | 1,329,698 | ||||||
Shares Outstanding at Year End | 4,079,171 | 4,015,341 | ||||||||
Impact of Weighting Shares Purchased During the Year | (51,224 | ) | — | |||||||
Used in Basic EPS | 1,631,786 | 4,027,947 | 1,329,698 | 4,015,341 | ||||||
Dilutive Effect of Outstanding Stock Options | 503,699 | 314,107 | ||||||||
Used in Dilutive EPS | $ | 1,631,786 | 4,531,646 | $ | 1,329,698 | 4,329,448 | ||||
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NOTE 10—FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on financial instruments both on and off the balance sheet without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Additionally, tax consequences related to the realization of the unrealized gains and losses can have a potential effect on fair value estimates and have not been considered in many of the estimates.
The following methods and assumptions were used to estimate the fair value of significant financial instruments:
Financial Assets
The carrying amounts of cash, short term investments, due from customers on acceptances, and Bank acceptances outstanding are considered to approximate fair value. Short term investments include federal funds sold, securities purchased under agreements to resell, and interest bearing deposits with Banks. The fair values of investment securities, including available-for-sale, are generally based on quoted market prices. The fair value of loans are estimated using a combination of techniques, including discounting estimated future cash flows and quoted market prices of similar instruments where available.
Financial Liabilities
The carrying amounts of deposit liabilities payable on demand, commercial paper, and other borrowed funds are considered to approximate fair value. For fixed maturity deposits, fair value is estimated by discounting estimated future cash flows using currently offered rates for deposits of similar remaining maturities. The fair value of long term debt is based on rates currently available to the Bank for debt with similar terms and remaining maturities.
Off-Balance Sheet Financial Instruments
The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements. The fair value of these financial instruments is not material.
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The estimated fair value of financial instruments is summarized as follows: (dollar amounts in thousands)
| December 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | |||||||||||
| Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||
Financial Assets: | |||||||||||||
Cash and due from banks | $ | 6,269 | $ | 6,269 | $ | 7,723 | $ | 7,723 | |||||
Federal funds sold | 14,380 | 14,380 | 30,545 | 30,545 | |||||||||
Interest-bearing deposits | 450 | 450 | 549 | 549 | |||||||||
Investment securities, available for sale | 25,193 | 25,193 | 8,789 | 8,789 | |||||||||
Federal reserve bank stock | 119 | 119 | 119 | 119 | |||||||||
Loans, net | 92,112 | 92,223 | 72,368 | 72,527 | |||||||||
Accrued interest receivable | 716 | 716 | 588 | 588 | |||||||||
Cash value of life insurance | 2,424 | 2,424 | 2,328 | 2,328 | |||||||||
Financial Liabilities: | |||||||||||||
Deposits | 132,040 | 132,453 | 115,355 | 115,385 | |||||||||
Other liabilities | 1,126 | 1,126 | 867 | 867 |
NOTE 11—DEFERRED COMPENSATION BENEFITS
In January 1996, the Bank established a deferred compensation plan for certain senior officers providing for fixed annual benefits ranging from $10,000 to $17,000 payable over 5 or 10 years in the event of death, full disability, or retirement at age 65. Under the Plan, participants defer a portion of their current compensation and the Bank provides a matching contribution. During the year ended December 31, 2001, the Bank's matching contribution was $22,692. This amount is charged to expense. Benefits will be funded by life insurance contracts purchased by the Bank.
In March 1998, the Bank entered into retirement benefit agreements with certain officers providing for future benefits aggregating approximately $6,600,000, payable in equal annual installments for twenty years from the death or retirement dates of each participating officer. During 2001, $140,921 has been accrued in conjunction with these agreements. This amount is charged to expense. Benefits will be funded by life insurance contracts purchased by the Bank.
NOTE 12—COMMITMENTS AND CONTINGENCIES
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include loan commitments and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements.
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amount of those instruments. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management's credit evaluation of the counter-party. Collateral held
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varies but may include accounts receivable, inventory, property, plant, and equipment, and other income-producing commercial properties.
At December 31, 2001, the Bank had standby letters of credit of approximately $462,000 and commitments to extend credit of approximately $29,193,000. Management does not anticipate that any material losses will result from these commitments.
NOTE 13—REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2001 that the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 2001 the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action (there are no conditions or events since that notification that management believes have changed the Bank's category). To be categorized as well-capitalized, the Bank must maintain minimum ratios as set forth in the table below. The following table also sets forth the Bank's actual capital amounts and ratios (dollar amounts in thousands):
| | | Amount of Capital Required | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Actual | To Be Adequately Capitalized | To Be Well- Capitalized | ||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||
As of December 31, 2000: | |||||||||||||||||
Total Capital (to Risk-Weighted Assets) | $ | 11,127 | 11.9 | % | $ | 7,513 | 8.0 | % | $ | 9,392 | 10.0 | % | |||||
Tier 1 Capital (to Risk-Weighted Assets) | $ | 10,198 | 10.9 | % | $ | 3,757 | 4.0 | % | $ | 5,635 | 6.0 | % | |||||
Tier 1 Capital (to Average Assets) | $ | 10,198 | 7.4 | % | $ | 5,529 | 4.0 | % | $ | 6,912 | 5.0 | % | |||||
As of December 31, 2001: | |||||||||||||||||
Total Capital (to Risk-Weighted Assets) | $ | 9,649 | 12.0 | % | $ | 6,433 | 8.0 | % | $ | 8,041 | 10.0 | % | |||||
Tier 1 Capital (to Risk-Weighted Assets) | $ | 8,810 | 11.0 | % | $ | 3,216 | 4.0 | % | $ | 4,825 | 6.0 | % | |||||
Tier 1 Capital (to Average Assets) | $ | 8,810 | 7.5 | % | $ | 4,724 | 4.0 | % | $ | 5,905 | 5.0 | % |
The California Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of the lesser of the Bank's undivided profits or the profits of the Bank's net income for its last three fiscal years less the amount of any distribution made by the Bank to shareholders during the same period.
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NOTE 14—PROPOSED MERGER
On November 13, 2001, the Company announced the signing of a definitive merger agreement ("the Agreement") whereby First Community Bancorp will acquire all of the outstanding common stock of the Company.
The Agreement provides that the shareholders of the outstanding common shares will receive approximately 1.08 million shares of First Community Bancorp common stock for a total purchase price of approximately $21 million. The merger is subject to standard conditions, including the approval of the shareholders of the Company and bank regulatory agencies. The transaction is expected to close in the first quarter of 2002.
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