UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2006
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File No: 000-49844
![logo](https://capedge.com/proxy/10-Q/0001157523-06-008194/largelogo.jpg)
TEMECULA VALLEY BANCORP INC.
(Exact name of registrant as specified in its charter)
California | 46-0476193 | |
(State or other jurisdiction of incorporate or organization) | (I.R.S. Employer Identification No.) |
27710 Jefferson Avenue, Suite A100
Temecula, California 92590
(Address of principal executive offices)(Zip Code)
(951) 694-9940
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated Filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of August 7, 2006, there were 9,145,755 shares of the registrant's common stock, no par value per share, outstanding.
![]() | TABLE OF CONTENTS |
2
TEMECULA VALLEY BANCORP INC.
(Unaudited)
June 30, 2006 | December 31, 2005 | ||||||
ASSETS | |||||||
Cash and Due from Banks | $ | 15,063,434 | $ | 18,311,714 | |||
Due from Banks - Time | 99,000 | - | |||||
Federal Funds Sold | 27,400,000 | 33,200,000 | |||||
TOTAL CASH AND CASH EQUIVALENTS | 42,562,434 | 51,511,714 | |||||
Loans Held for Sale | 116,124,928 | 82,813,405 | |||||
Loans: | |||||||
Commercial | 41,623,411 | 25,456,863 | |||||
Real Estate - Construction | 405,390,205 | 332,184,415 | |||||
Real Estate - Other | 269,578,202 | 248,026,312 | |||||
SBA | 93,280,898 | 65,294,324 | |||||
Consumer and other | 3,045,312 | 4,319,776 | |||||
TOTAL LOANS | 812,918,028 | 675,281,690 | |||||
Net Deferred Loan Fees | (4,539,073 | ) | (4,848,306 | ) | |||
Allowance for Loan Losses | (10,170,099 | ) | (9,039,155 | ) | |||
NET LOANS | 798,208,856 | 661,394,229 | |||||
Federal Reserve and Federal Home Loan Bank Stock, at Cost | 3,189,000 | 3,098,600 | |||||
Premises and Equipment | 5,068,274 | 4,885,015 | |||||
Other Real Estate Owned | 727,500 | 2,111,250 | |||||
Cash Surrender Value of Life Insurance | 21,595,034 | 17,590,733 | |||||
Deferred Tax Assets | 7,144,588 | 5,744,355 | |||||
SBA Servicing Assets | 8,569,660 | 8,169,273 | |||||
SBA Interest-Only Strips Receivable | 17,311,101 | 22,067,900 | |||||
Accrued Interest Receivable | 3,889,500 | 3,471,302 | |||||
Other Assets | 3,835,836 | 6,130,270 | |||||
TOTAL ASSETS | $ | 1,028,226,711 | $ | 868,988,046 | |||
LIABILITIES AND SHAREHOLDERS' EQUITY | |||||||
Deposits: | |||||||
Non Interest-Bearing Demand | $ | 158,857,579 | $ | 155,992,027 | |||
Money Market and NOW | 106,873,169 | 93,824,731 | |||||
Savings | 34,672,360 | 34,850,882 | |||||
Time Deposits, Under $100,000 | 298,135,523 | 217,748,575 | |||||
Time Deposits, $100,000 and Over | 323,402,886 | 240,015,724 | |||||
TOTAL DEPOSITS | 921,941,517 | 742,431,939 | |||||
FHLB Advances | - | 30,000,000 | |||||
Accrued Interest Payable | 1,263,380 | 957,246 | |||||
Junior Subordinated Debt | 28,868,000 | 28,868,000 | |||||
Other Liabilities | 8,222,031 | 8,550,551 | |||||
TOTAL LIABILITIES | 960,294,928 | 810,807,736 | |||||
Shareholders' Equity: | |||||||
Common Stock No Par Value; 40,000,000 Shares | |||||||
Authorized; 9,140,755 and 8,897,697 Shares Issued | |||||||
and Outstanding at June 30, 2006 and December 31, 2005 | 20,259,509 | 17,639,669 | |||||
Accumulated other comprehensive income(loss) | (969,702 | ) | 408,966 | ||||
Retained Earnings | 48,641,976 | 40,131,675 | |||||
TOTAL SHAREHOLDERS' EQUITY | 67,931,783 | 58,180,310 | |||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 1,028,226,711 | $ | 868,988,046 |
See accompanying notes to the consolidated financial statements
3
TEMECULA VALLEY BANCORP INC.
(Unaudited)
For the Three Months Ended June 30, | For the Six Months Ended June 30, | ||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||
INTEREST INCOME | |||||||||||||
Loans, including fees | $ | 21,761,721 | $ | 13,414,314 | $ | 41,059,832 | $ | 24,804,088 | |||||
Investment Securities | 2,670 | 1,507 | 5,402 | 2,184 | |||||||||
Federal Funds Sold | 146,969 | 38,573 | 266,589 | 58,666 | |||||||||
Due From Banks-Time | 217 | - | 217 | - | |||||||||
TOTAL INTEREST INCOME | 21,911,577 | 13,454,394 | 41,332,040 | 24,864,938 | |||||||||
INTEREST EXPENSE | |||||||||||||
Money Market and NOW | 534,539 | 137,593 | 1,019,592 | 265,242 | |||||||||
Savings Deposits | 34,409 | 37,729 | 61,010 | 80,854 | |||||||||
Time Deposits | 6,088,537 | 2,615,784 | 11,037,546 | 4,453,216 | |||||||||
Junior Subordinated Debt and Other Borrowings | 717,055 | 388,023 | 1,308,814 | 758,125 | |||||||||
TOTAL INTEREST EXPENSE | 7,374,540 | 3,179,129 | 13,426,962 | 5,557,437 | |||||||||
NET INTEREST INCOME | 14,537,037 | 10,275,265 | 27,905,078 | 19,307,501 | |||||||||
Provision for Loan Losses | 1,096,000 | 804,100 | 1,410,000 | 1,642,900 | |||||||||
NET INTEREST INCOME AFTER | |||||||||||||
PROVISION FOR LOAN LOSSES | 13,441,037 | 9,471,165 | 26,495,078 | 17,664,601 | |||||||||
NON INTEREST INCOME | |||||||||||||
Service Charges and Fees | 161,973 | 162,625 | 314,481 | 320,850 | |||||||||
Gain on Sale of Loans | 3,758,795 | 4,685,619 | 6,704,045 | 8,445,610 | |||||||||
Gain(Loss) on Other Assets and Other Real Estate Owned | 207,357 | (20,588 | ) | 232,339 | (29,512 | ) | |||||||
Servicing Income | 208,736 | 538,234 | 623,960 | 1,029,185 | |||||||||
Loan Broker Income | 1,037,406 | 1,031,096 | 1,657,326 | 1,634,845 | |||||||||
Loan Related Income | 678,984 | 777,879 | 1,199,919 | 1,303,898 | |||||||||
Other Income | 421,898 | 289,949 | 683,721 | 543,434 | |||||||||
TOTAL NON INTEREST INCOME | 6,475,149 | 7,464,814 | 11,415,791 | 13,248,310 | |||||||||
NON INTEREST EXPENSE | |||||||||||||
Salaries and Employee Benefits | 8,122,249 | 6,722,516 | 15,862,547 | 12,574,022 | |||||||||
Occupancy Expenses | 746,996 | 605,801 | 1,485,328 | 1,168,066 | |||||||||
Furniture and Equipment | 424,908 | 368,975 | 805,232 | 706,656 | |||||||||
Data Processing | 317,888 | 294,851 | 620,117 | 567,740 | |||||||||
Marketing and Business Promotion | 259,351 | 252,830 | 484,302 | 550,235 | |||||||||
Legal and Professional | 318,612 | 380,058 | 620,534 | 437,336 | |||||||||
Regulatory Assessments | 42,630 | 113,009 | 84,716 | 167,254 | |||||||||
Travel & Entertainment | 277,684 | 221,673 | 522,722 | 397,321 | |||||||||
Loan Related Expense | 765,922 | 400,326 | 1,227,591 | 880,728 | |||||||||
Office Expenses | 576,049 | 597,678 | 1,183,595 | 1,190,008 | |||||||||
Other Expenses | 201,164 | 222,403 | 234,165 | 377,446 | |||||||||
TOTAL NON INTEREST EXPENSE | 12,053,453 | 10,180,120 | 23,130,849 | 19,016,812 | |||||||||
INCOME BEFORE INCOME TAX EXPENSE | 7,862,733 | 6,755,859 | 14,780,020 | 11,896,099 | |||||||||
Income Tax expense | 3,332,958 | 2,812,818 | 6,269,719 | 4,951,378 | |||||||||
NET INCOME | $ | 4,529,775 | $ | 3,943,041 | $ | 8,510,301 | $ | 6,944,721 | |||||
Per Share Data : | |||||||||||||
Earnings Per Share - Basic | $ | 0.50 | $ | 0.45 | $ | 0.95 | $ | 0.79 | |||||
Earnings Per Share - Diluted | $ | 0.47 | $ | 0.41 | $ | 0.89 | $ | 0.73 | |||||
Average number of shares outstanding | 9,025,994 | 8,828,292 | 8,990,537 | 8,808,055 | |||||||||
Average number of shares and equivalents | 9,606,151 | 9,528,263 | 9,546,876 | 9,515,624 |
See accompanying notes to the consolidated financial statements
4
TEMECULA VALLEY BANCORP INC.
(Unaudited)
Accumulated | |||||||||||||||||||
Common | Other | ||||||||||||||||||
Comprehensive | Stock | Retained | Comprehensive | ||||||||||||||||
Income | Shares | & Surplus | Earnings | Income(Loss) | Total | ||||||||||||||
Balance at December 31, 2004 | 8,752,603 | $ | 16,724,128 | 26,178,410 | $ | (262,991 | ) | $ | 42,639,547 | ||||||||||
Exercise of Stock Options, | 59,680 | 149,870 | 149,870 | ||||||||||||||||
Net Income | 3,001,680 | 3,001,680 | 3,001,680 | ||||||||||||||||
Other comprehensive income(loss), net | 1,695,488 | 1,695,488 | 1,695,488 | ||||||||||||||||
Total comprehensive income | $ | 4,697,168 | |||||||||||||||||
Balance at March 31, 2005 | 8,812,283 | $ | 16,873,998 | $ | 29,180,090 | $ | 1,432,497 | $ | 47,486,585 | ||||||||||
Exercise of Stock Options, | 53,164 | 486,654 | 486,654 | ||||||||||||||||
Net Income | 3,943,041 | 3,943,041 | 3,943,041 | ||||||||||||||||
Other comprehensive income(loss), net | (128,145 | ) | (128,145 | ) | (128,145 | ) | |||||||||||||
Total comprehensive income | $ | 3,814,896 | |||||||||||||||||
Balance at June 30, 2005 | 8,865,447 | $ | 17,360,652 | $ | 33,123,131 | $ | 1,304,352 | $ | 51,788,135 | ||||||||||
Exercise of Stock Options, | |||||||||||||||||||
Including the Realization of Tax Benefits of $39,884 | 14,250 | 185,328 | 185,328 | ||||||||||||||||
Net Income | 3,285,162 | 3,285,162 | 3,285,162 | ||||||||||||||||
Other comprehensive income(loss), net | (1,014,591 | ) | (1,014,591 | ) | (1,014,591 | ) | |||||||||||||
Total comprehensive income | $ | 2,270,571 | |||||||||||||||||
Balance at September 30, 2005 | 8,879,697 | $ | 17,545,980 | $ | 36,408,293 | $ | 289,761 | $ | 54,244,034 | ||||||||||
Exercise of Stock Options, | 18,000 | 93,689 | 93,689 | ||||||||||||||||
Net Income | 3,723,382 | 3,723,382 | 3,723,382 | ||||||||||||||||
Other comprehensive income(loss), net | 119,205 | 119,205 | 119,205 | ||||||||||||||||
Total comprehensive income | $ | 3,842,587 | |||||||||||||||||
Balance at December 31, 2005 | 8,897,697 | $ | 17,639,669 | $ | 40,131,675 | $ | 408,966 | $ | 58,180,310 | ||||||||||
Exercise of Stock Options, | |||||||||||||||||||
Including the Realization of Tax Benefits of $242,603 | 80,074 | 559,156 | 559,156 | ||||||||||||||||
Stock-based compensation | 420,017 | 420,017 | |||||||||||||||||
Net Income | 3,980,526 | 3,980,526 | 3,980,526 | ||||||||||||||||
Other comprehensive income(loss), net | (317,953 | ) | (317,953 | ) | (317,953 | ) | |||||||||||||
Total comprehensive income | $ | 3,662,573 | |||||||||||||||||
Balance at March 31, 2006 | 8,977,771 | $ | 18,618,842 | $ | 44,112,201 | $ | 91,013 | $ | 62,822,056 | ||||||||||
Exercise of Stock Options, | |||||||||||||||||||
Including the Realization of Tax Benefits of $941,094 | 162,984 | 1,442,667 | 1,442,667 | ||||||||||||||||
Stock-based compensation | 198,000 | 198,000 | |||||||||||||||||
Net Income | 4,529,775 | 4,529,775 | 4,529,775 | ||||||||||||||||
Other comprehensive income(loss), net | (1,060,715 | ) | (1,060,715 | ) | (1,060,715 | ) | |||||||||||||
Total comprehensive income | $ | 3,469,060 | |||||||||||||||||
Balance at June 30, 2006 | 9,140,755 | $ | 20,259,509 | $ | 48,641,976 | $ | (969,702 | ) | $ | 67,931,783 |
See accompanying notes to the consolidated financial statements
5
TEMECULA VALLEY BANCORP INC.
(Unaudited)
For the Six Months Ended June 30, | |||||||
2006 | 2005 | ||||||
OPERATING ACTIVITIES | |||||||
Net Income | $ | 8,510,301 | $ | 6,944,721 | |||
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: | |||||||
Depreciation and Amortization | 4,833,731 | 4,613,497 | |||||
Share-based compensation expense | 618,017 | - | |||||
Amortization of debt issuance cost | 35,100 | 35,100 | |||||
Net (increase)decrease in deferred loan origination fees | (309,233 | ) | 1,009,750 | ||||
Provision for Loan Losses | 1,410,000 | 1,642,900 | |||||
Provision for Deferred Taxes | (400,000 | ) | (650,000 | ) | |||
Gain on Sale of Loans | (6,704,045 | ) | (8,445,610 | ) | |||
Loans Originated for Sale | (117,593,864 | ) | (120,590,413 | ) | |||
Proceeds from Loan Sales | 90,986,386 | 134,608,647 | |||||
Loss (Gain) on Sale of Other Real Estate Owned | (240,339 | ) | 27,512 | ||||
Net Increase in Cash Surrender Value of Life Insurance | (336,301 | ) | (186,000 | ) | |||
Federal Home Loan Bank Stock Dividends | (44,600 | ) | (29,400 | ) | |||
Net Change in Accrued Interest, Other Assets and Other Liabilities | (1,773,937 | ) | (1,416,167 | ) | |||
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES | (21,008,784 | ) | 17,564,537 | ||||
INVESTING ACTIVITIES | |||||||
Purchases of Held-to-Maturity Investments | (594,598 | ) | (597,816 | ) | |||
Purchases of Federal Reserve and Federal Home Loan Bank Stock | (45,800 | ) | (441,900 | ) | |||
Proceeds from Maturities of Held-to-Maturity Securities | 600,000 | 600,000 | |||||
Net Increase in Loans | (105,471,447 | ) | (107,109,717 | ) | |||
Purchase of Loans | (31,761,447 | ) | - | ||||
Purchase of Cash Surrender Value Life Insurance | (3,668,000 | ) | (3,690,000 | ) | |||
Proceeds from Sale of Premises and Equipment | 131,400 | 54,000 | |||||
Proceeds from Sale of Other Real Estate Owned | 2,351,589 | 275,186 | |||||
Purchases of Premises and Equipment | (993,593 | ) | (982,017 | ) | |||
NET CASH USED BY INVESTING ACTIVITIES | (139,451,896 | ) | (111,892,264 | ) | |||
FINANCING ACTIVITIES | |||||||
Net Increase in Demand Deposits and Savings Accounts | 15,735,468 | 11,518,660 | |||||
Net Increase in Time Deposits | 163,774,110 | 97,488,625 | |||||
Net Change in Federal Home Loan Bank Advances | (30,000,000 | ) | - | ||||
Proceeds from Exercise of Stock Options | 818,125 | 636,524 | |||||
Excess tax benefits from exercise of stock options | 1,183,697 | - | |||||
NET CASH PROVIDED BY FINANCING ACTIVITIES | 151,511,400 | 109,643,809 | |||||
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | (8,949,280 | ) | 15,316,082 | ||||
Cash and Cash Equivalents at Beginning of Year | 51,511,714 | 23,117,261 | |||||
CASH AND CASH EQUIVALENTS AT END OF PERIOD | $ | 42,562,434 | $ | 38,433,343 | |||
Supplemental Disclosures of Cash Flow Information: | |||||||
Interest Paid | $ | 13,120,827 | $ | 5,327,791 | |||
Income Taxes Paid | $ | 285,391 | $ | 4,277,189 | |||
Transfer of Loans to Other Real Estate Owned | $ | 727,500 | $ | - | |||
See accompanying notes to the consolidated financial statements |
6
TEMECULA VALLEY BANCORP INC.
(Unaudited)
For the six months ended June 30, 2006 and 2005
The accompanying unaudited consolidated financial statements have been prepared by Temecula Valley Bancorp Inc. pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and include the accounts of Temecula Valley Bancorp Inc. ("Company") and its wholly owned subsidiary, Temecula Valley Bank ("Bank"). All significant intercompany transactions have been eliminated.
The Company is also the common stockholder of Temecula Valley Statutory Trust I, Temecula Valley Statutory Trust II, Temecula Valley Statutory Trust III, and Temecula Valley Statutory Trust IV. In accordance with Financial Accounting Standards Board Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51”, these trusts are not included in the consolidated 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 reported period. Estimates associated with the allowance for loan losses, SBA servicing assets, and SBA interest-only strips receivable are particularly susceptible to material change in the near term. Actual results could differ from those estimates.
The results of operations for the six month period ended June 30, 2006, are not necessarily indicative of the results to be expected for the full year. These financial statements do not include all disclosures associated with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2005 filed with the Securities and Exchange Commission (“SEC”) and, accordingly, should be read in conjunction with such statements. In the opinion of management of the Company, the unaudited financial statements contain all adjustments (consisting only of normal, recurring accruals) necessary to fairly present the financial position of the Company on June 30, 2006. Certain prior year amounts have been reclassified to conform to the current period’s presentation.
Significant accounting policies followed by the Company are presented in Note A to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2005. There have been no significant changes to these accounting policies since December 31, 2005 except for the adoption of Financial Accounting Standards Board (“FASB”) No. 123R as described in Note 2 below.
At June 30, 2006, the Company has three fixed option plans under which 4,000,000 shares of the Company’s common stock may be issued. As of June 30, 2006, there were 215,250 shares available for grant under these plans. Following is a brief description of each plan.
· | An incentive stock option plan for officers and employees. Under this plan the Company may grant options for 1,800,000 shares of common stock at not less than 100% of the fair market value at the date the options are granted. |
· | A nonqualified stock option plan for directors of the Company. Under this plan, the Company may grant options for 1,500,000 shares of common stock at not less than 85% of the fair market value at the date the options are granted. |
· | An incentive/nonqualified stock option plan for directors, officers and employees. Under this plan the Company may grant options for 700,000 shares of common stock at not less than 100% of the fair market value for incentive stock options and 85% or greater of the fair market value for non qualified stock options as of the grant date. |
Options have a maximum ten-year life from the grant date and, with respect to incentive options, generally vest and become exercisable over three years after the date of grant. Non qualified options generally vest immediately.
Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25 and related Interpretations. We measured the compensation cost for stock options as the excess, if any, of the quoted market price of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock.
7
Effective January 1, 2006, we have adopted Financial Accounting Standards Board (“FASB”) SFAS No. 123R, “Share-Based Payment”. This Statement supersedes Accounting Principles Board ("APB") Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance and is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 123R establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions.
SFAS No. 123R requires all public companies to measure the cost of employee services received in exchange for award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). This applies to awards granted or modified on or after January 1, 2006 and grants that vest on or after January 1, 2006.
SFAS No. 123R allows for two alternative transition methods. The Company has elected to follow the modified-prospective transition method, which requires application of the new statement to new awards and to awards modified, repurchased, or cancelled after the required effective date. Prior periods were not restated to reflect the impact of adopting the new standard. Additionally, the compensation cost for the portion of awards for which the requisite service has not been rendered, that were outstanding as of the required effective date, will be recognized as the requisite services are rendered on or after the effective date. The compensation cost of that portion of awards will be based on the grant-date fair value of those awards as calculated for pro-forma disclosures under the original SFAS No. 123.
The grant-date fair value of employee share options and similar instruments is estimated using option-pricing models adjusted for unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.
The fair value of each option granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||
Expected life (years) | 4 | 5 | 4 | 5 | |||||||||
Risk free interest rate | 4.93 | % | 4.36 | % | 4.34 | % | 4.36 | % | |||||
Weighted Average Expected volatility | 42.14 | % | 24.30 | % | 27.29 | % | 24.30 | % | |||||
Expected annual dividends | none | none | none | none |
The expected life of the options represents the period of time that options granted are expected to be outstanding based primarily on the historical exercise behavior attributable to previous option grants. The risk free interest rate is based on a rate comparable with the expected life of the option. The expected volatility is determined based on the historical daily volatility of our stock price over a period equal to the expected life of the option.
8
A summary of stock option activity for the six months ended June 30, 2006 and 2005 is presented below:
Stock Options | Weighted-Average Exercise Price | Aggregate Intrinsic Value | Weighted-Average Remaining Contractual Life | ||||||||||
Outstanding as of 12/31/2005 | 1,572,961 | $ | 7.41 | ||||||||||
Granted | 126,000 | $ | 20.33 | ||||||||||
Exercised | (243,058 | ) | $ | 3.37 | |||||||||
Forfeited, expired or cancelled | (19,336 | ) | $ | 17.99 | |||||||||
Outstanding as of 6/30/2006 | 1,436,567 | $ | 9.05 | $ | 16,051,874 | 5.69 | |||||||
Shares exercisable as of 6/30/2006 | 1,096,642 | $ | 6.30 | $ | 15,840,818 | 5.29 | |||||||
Stock Options | Weighted-Average Exercise Price | Aggregate Intrinsic Value | Weighted-Average Remaining Contractual Life | ||||||||||
Outstanding as of 12/31/2004 | 1,579,723 | $ | 6.04 | ||||||||||
Granted | 138,000 | $ | 18.06 | ||||||||||
Exercised | (112,844 | ) | $ | 5.64 | |||||||||
Forfeited, expired or cancelled | (26,668 | ) | $ | 10.64 | |||||||||
Outstanding as of 6/30/2005 | 1,578,211 | $ | 7.06 | $ | 20,823,187 | 5.86 | |||||||
Shares exercisable as of 6/30/2005 | 1,203,916 | $ | 4.41 | $ | 18,604,708 | 5.13 |
The weighted-average grant-date fair value of options granted during the six months ended June 30, 2006 was $6.74 with an aggregate total value of $849,657. The weighted-average grant-date fair value of options granted during the six months ended June 30, 2005 was $5.53 with an aggregate total value of $760,478. SFAS No. 123R requires that an estimate of forfeitures be made when the awards are granted and thereafter updated if information becomes available indicating that actual forfeitures will differ. Based on historical information, the average annual forfeiture rate used for awards granted was 4.17%. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005 was $4.5 million and $1.4 million, respectively.
The weighted-average grant-date fair value of options granted during the three months ended June 30, 2006 was $8.36 with an aggregate total value of $33,372. The weighted-average grant-date fair value of options granted during the three months ended June 30, 2005 was $5.60 with an aggregate total value of $435,656. The total intrinsic value of options exercised during the three months ended June 30, 2006 and 2005 was $3.0 million and $521,500, respectively.
As a result of the adoption of SFAS No. 123R, we have recognized compensation expense for awards on a straight-line basis over the vesting period of the award. For the six months ended June 30, 2006, the Company recognized stock-based compensation expenses of $618,017 for all share-based payments granted on or prior to June 30, 2006 and vested in the first six months of 2006. As of June 30, 2006, there was approximately $1.3 million of total unrecognized compensation expense for non-vested options granted under all of the Company’s plans.
The following table illustrates the effect on net income and earnings per share information had the Company accounted for share-based compensation in accordance with SFAS No. 123R for the three and six months ended June 30, 2005.
9
Three Months Ended June 30, 2005 | Six Months Ended June 30, 2005 | ||||||
Net income, as reported | $ | 3,943,041 | $ | 6,944,721 | |||
Deduct: Total stock-based employee compensation expense | |||||||
determined under fair value based method for all awards, | |||||||
net of related tax effects | (124,396 | ) | (244,568 | ) | |||
Pro Forma Net Income | $ | 3,818,645 | $ | 6,700,153 | |||
Per Share Data: | |||||||
Basic income per share, as reported | $ | 0.45 | $ | 0.79 | |||
Basic income per share, proforma | $ | 0.43 | $ | 0.76 | |||
Diluted income per share, as reported | $ | 0.41 | $ | 0.73 | |||
Diluted income per share, proforma | $ | 0.40 | $ | 0.70 |
On March 1, 2006, the Board of Directors approved in principal the adoption of an Employee Stock Ownership Plan (“ESOP”). On June 28, 2006, the Board of Directors approved the adoption of the ESOP for the benefit of eligible employees of the Bank and their beneficiaries. The ESOP is intended to constitute a stock bonus employee stock ownership plan within the meaning of Sections 4975(e)(7) and 407(d)(6) of the Employee Retirement Income Security Act of 1974. The amount to be contributed to ESOP by the Bank will be determined by the Board of Directors with such contributions principally invested in the stock of Temecula Valley Bancorp Inc. Contributions will be at the discretion of the Board. Currently, the Bank plans to have the ESOP non-leveraged. The employee benefit expense to the Company will be recognized based on the number of shares contributed at fair market value and cash contributions. Eligible employees automatically become participants in the ESOP and, if eligible, may receive distributions from the trustee of the ESOP upon termination of employment.
On June 28, 2006, the Board of Directors of the Bank adopted the Executive Nonqualified Excess Plan ("Executive Nonqualified Plan") and related documents. The Executive Nonqualified Plan is an unfunded, nonqualified deferred compensation plan intended to comply with the requirements of Section 409A of the Internal Revenue Code and regulations promulgated thereunder, and will apply to amounts deferred after January 1, 2005 under the Executive Nonqualified Plan. The purpose of the Executive Nonqualified Plan is to encourage selected key managerial employees to maintain their employment with the Bank by allowing them to defer compensation. The key managerial employees of the Bank eligible to participate in the Executive Nonqualified Plan are determined at the sole discretion of the Board of Directors. The plan provides for discretionary matching contributions. No such contributions have been approved by the Company.
Temecula Valley Bank is a Nationwide SBA "Preferred Lender". As a Preferred Lender we can approve a loan within the authority given to us by the SBA without prior approval from the SBA. Preferred Lenders approve, package, fund, and service SBA loans within a range of authority that is not available to other SBA lenders without the "Preferred Lender" designation.
The Bank originates loans to customers under the SBA 7(a) program that generally provides for SBA guarantees up to 85% of each loan. We generally sell the guaranteed piece as well as a part of the unguaranteed portion of each loan. Approximately 5% of the 7(a) loans are required to stay on the books of the Bank. Funding for these loans has come principally from retail deposit sources.
Mortgage loans and SBA loans, originated and intended for sale in the secondary market, are carried at the lower of cost or market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. The strategy of selling both the guaranteed and unguaranteed portion of the 7(a) loans assist us in managing our capital levels and meeting out funding needs relative to local community loan demand.
10
The Bank retains the servicing on the sold guaranteed portion of 7(a) loans. Upon sale in the secondary market, the purchaser of the guaranteed portion of 7(a) loans pays a premium to the Bank, which generally is between 8% and 10% of the guaranteed amount, and in the case of a sale of the unguaranteed portion, the premium is usually between 1% and 4%. When we retain servicing after the sale, we also receive a servicing fee equal to 1% to 5% of the guaranteed amount sold in the secondary market.
Servicing assets are recognized when loans are sold with servicing retained. Servicing assets are amortized in proportion to and over the period of estimated future net servicing income. The fair value of servicing assets is estimated by discounting the future cash flows at estimated future current market rates for the expected life of the loans. The Company uses industry prepayment statistics in estimating the expected life of the loan. Management evaluates servicing assets for impairment on a quarterly basis. For purposes of measuring impairment, the rights are stratified based on original term to maturity. The amount of impairment recognized is the amount by which the servicing asset for a stratum exceeds its fair value.
Rights to future interest income from serviced loans that exceed contractually specified servicing fees are classified as interest-only strips. The interest-only strips are classified as available-for-sale and recorded at fair value with any unrealized gains or losses recorded through other comprehensive income in the period of change of fair value. See Management’s Discussion and Analysis of Financial Conditions and Results of Operations in this report for additional information.
In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN No. 48”) “Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109.” This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective as of the beginning of fiscal years that begin after December 15, 2006. We do not expect the adoption of this standard will have a significant impact on our financial condition or results of operations.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets” which amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. SFAS No. 156 clarifies when a servicer should separately recognize servicing assets and servicing liabilities and permits an entity to choose either the “Amortization Method” or “Fair Value Measurement Method” for subsequent measurement of each class of such assets and liabilities. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not issued financial statements. We will implement this standard as of the beginning of our fiscal year 2007. We currently use the amortization method to account for our servicing rights and we expect to continue this practice after implementation of SFAS No. 156. Therefore, we do not expect the adoption of this standard will have a significant impact on our financial condition or results of operations.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. SFAS No. 155, amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, and SFAS 140, “Accounting for Transfers of Financial Assets and Extinguishments of Liabilities”. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140 including which interest-only strips are not subject to the requirements of SFAS No. 133. This statement is effective for all financial instruments acquired or issued after January 1, 2007 with earlier adoption permitted. We do not expect the adoption of this standard will have a significant impact on our financial condition or results of operations.
11
AND RESULTS OF OPERATIONS
Management’s discussion is intended to provide additional information regarding the significant changes and trends in the Company’s Financial Condition, Statements of Income, Funds Management and Capital Planning. Statements made in this Report that state the intentions, beliefs, expectations or predictions of the future by Temecula Valley Bancorp Inc. (the "Company") or its management are forward-looking statements. The Company's actual results could differ materially from those projected in such forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the Company's Form 10-K and other filings made by the Company with the Securities and Exchange Commission (“SEC”). Copies of such filings may be obtained by contacting the Company or accessing the Company's filings at www.sec.gov.
Temecula Valley Bancorp Inc. ("Company") was formed in 2002 to serve as a holding company for Temecula Valley Bank ("Bank"). The Bank was formed in 1996 as a locally owned and managed financial institution that assumes an active community role.
The Bank focuses primarily upon local banking services and community needs, as well as nationwide SBA loan origination and Real Estate Industries Group Construction lending in California. The Bank’s marketing strategy stresses its local ownership and commitment to serve the banking needs of the people and businesses in Temecula Valley, and the Interstate 15 corridor and surrounding areas, as well as originating loans through the SBA network nationwide.
The Bank operates eight full service offices in California. As a Nationwide Preferred Lender, the Bank has SBA loan production offices in Arizona, California, Colorado, Connecticut, Florida, Georgia, Illinois, Nebraska, New Jersey, North Carolina, Ohio, Oregon, Pennsylvania, Texas, and Washington. Since the Bank opened, it has experienced substantial annual growth. It is anticipated that growth will remain strong for 2006 with full service branches anticipated to open in Solana Beach in the third quarter and Ontario in the fourth quarter of 2006. The Bank plans to continue to expand through new full service and/or loan production office locations if they make good business sense and are located within the Bank’s geographic service area.
We continued to have strong growth in loans and core deposits. Revenue growth again exceeded expense growth, credit quality remained excellent, and our net interest margin improved further in the quarter. The following table highlights selected financial data for the three and six month periods ended June 30, 2006 and June 30, 2005 and the year ended December 31, 2005:
12
For the Three Months Ended June 30, | For the Six Months Ended June 30, | ||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||
Income Statement: | |||||||||||||
Interest income | $ | 21,911,577 | $ | 13,454,394 | $ | 41,332,040 | $ | 24,864,938 | |||||
Interest expense | 7,374,540 | 3,179,129 | 13,426,962 | 5,557,437 | |||||||||
Net interest income | 14,537,037 | 10,275,265 | 27,905,078 | 19,307,501 | |||||||||
Provision for loan losses | 1,096,000 | 804,100 | 1,410,000 | 1,642,900 | |||||||||
Net interest income after provision for loan losses | 13,441,037 | 9,471,165 | 26,495,078 | 17,664,601 | |||||||||
Non interest income | 6,475,149 | 7,464,814 | 11,415,791 | 13,248,310 | |||||||||
Non interest expense | 12,053,453 | 10,180,120 | 23,130,849 | 19,016,812 | |||||||||
Income before income taxes | 7,862,733 | 6,755,859 | 14,780,020 | 11,896,099 | |||||||||
Provision for income taxes | 3,332,958 | 2,812,818 | 6,269,719 | 4,951,378 | |||||||||
Net income | $ | 4,529,775 | $ | 3,943,041 | $ | 8,510,301 | $ | 6,944,721 | |||||
Per Share Data: | |||||||||||||
Basic earnings per share | $ | 0.50 | $ | 0.45 | $ | 0.95 | $ | 0.79 | |||||
Diluted earnings per share | $ | 0.47 | $ | 0.41 | $ | 0.89 | $ | 0.73 | |||||
Selected Ratios: | |||||||||||||
Net Interest Margin | 6.79 | % | 6.78 | % | 6.81 | % | 6.67 | % | |||||
Return on average assets | 1.90 | % | 2.27 | % | 1.86 | % | 2.10 | % | |||||
Return on average equity | 27.71 | % | 32.87 | % | 27.19 | % | 30.10 | % |
June 30, 2006 | December 31, 2005 | |||||||
Net Charge offs | $ | 279,056 | $ | 220,379 | ||||
Net Charge offs / average total loans | 0.03 | % | 0.03 | % | ||||
Gross non-performing loans | $ | 8,257,182 | $ | 7,950,601 | ||||
Gross non-performing loans / average total loans | 1.01 | % | 1.43 | % | ||||
Other Real Estate Owned | 727,500 | 2,111,250 | ||||||
Allowance for loan loss | $ | 10,170,099 | $ | 9,039,155 | ||||
Allowance for loan loss/net loans and loans held-for-sale | 1.10 | % | 1.20 | % | ||||
Allowance for loan loss/net loans excluding loans held-for-sale | 1.26 | % | 1.35 | % | ||||
Allowance for loan loss/gross nonperforming loans | 123.17 | % | 113.69 | % | ||||
Tier I leverage ratio | 9.37 | % | 9.28 | % | ||||
Tier I risk based ratio | 8.72 | % | 8.93 | % | ||||
Total risk based ratio | 10.26 | % | 11.02 | % |
13
Total assets increased from $869.0 million at December 31, 2005 to $1.03 billion at June 30, 2006, an 18.32% increase. Total loans, excluding loans held-for-sale, increased from $675.3 million at December 31, 2005 to $812.9 million at June 30, 2006, a 20.38% increase. Total deposits increased from $742.4 million at December 31, 2005 to $921.9 million at June 30, 2006, a 24.18% increase. Total shareholders’ equity increased from $58.2 million at December 31, 2005 to $67.9 million at June 30, 2006, a 16.76% increase.
Cash and cash equivalents, which for us are Federal Funds Sold only, decreased from $33.2 million at December 31, 2005 to $27.4 million at June 30, 2006. The decrease in the first six months of 2006 is largely attributable to a $179.5 million increase in total deposits offset by a $137.6 million increase in total loans, a $33.3 million increase in loans held-for-sale, and a $4.0 million increase in cash surrender value of life insurance.
Total loans, excluding loans held-for-sale, increased from $675.3 million at December 31, 2005 to $812.9 million at June 30, 2006, an increase of $137.6 million or 20.38%. Contributing to the increase was the purchase of the unguaranteed portion of 7(a) loans during the second quarter of 2006 of $31.85 million. Without the purchase of these loans, the increase in total loans, excluding loans held-for-sale, would have been $105.9 million or 15.68%.
The loan portfolio composition is primarily construction, commercial, and real estate secured loans. SBA loans, of which the Bank is an active originator, comprise approximately 14% of net loans outstanding as of June 30, 2006 and 13% of net loans outstanding as of December 31, 2005. Typical of community bank loan markets, a significant portion of our portfolio is real estate secured. Approximately 96% of the loan portfolio at June 30, 2006 was real estate secured, compared to 95% at December 31, 2005. The loan growth is expected to remain strong for the remainder of 2006 due to expected increases in SBA production, construction and real estate lending, as well as loan production from the new branches in Solana Beach and Ontario.
The allowance for loan losses is a valuation allowance for probable incurred credit losses established through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequently, any recoveries are credited to the allowance.
Quarterly detailed reviews are performed to identify the risks inherent in the loan portfolio, assess the overall quality of the loan portfolio and the related provision for loan losses to be charged to expense. The analysis considers general factors such as evaluation of collateral securing the credit, changes in lending policies and procedures, economic trends, loan volume trends, changes in lending management and staff, trends in delinquencies, nonaccruals and charge-offs, changes in loan review and Board oversight, the effects of competition, legal and regulatory requirements and factors inherent to each loan pool. Allocations of the allowance may be made for specific loans or pool of loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.
The allowance for loan losses increased from $9.0 million at December 31, 2005 to $10.2 million at June 30, 2006. The allowance for loan losses as a percentage of net loans outstanding and loans held-for-sale was 1.20% as of December 31, 2005 and 1.10% as of June 30, 2006. The allowance for loan losses as a percentage of net loans outstanding excluding loans held-for-sale was 1.35% as of December 31, 2005, and 1.26% as of June 30, 2006. A summary of the allowance for loan losses for the six months ended June 30, 2006 and June 30, 2005 and the year ended December 31, 2005 follows:
14
Allowance for Loan Losses | Six Months Ended June 30, 2006 | Year End December 31, 2005 | Six Months Ended June 30, 2005 | |||||||
(Dollars in Thousands) | ||||||||||
Loans outstanding and loans held-for-sale, net of fees | $ | 924,504 | $ | 753,247 | $ | 628,212 | ||||
Average amount of loans outstanding | 814,446 | 634,731 | 598,298 | |||||||
Balance of allowance for loan losses, beginning of periods | 9,039 | 6,362 | 6,362 | |||||||
Loans charged off: | ||||||||||
Commercial | (203 | ) | (250 | ) | (117 | ) | ||||
Real Estate - Construction | (10 | ) | - | - | ||||||
Real Estate - Other | (82 | ) | (286 | ) | (286 | ) | ||||
Consumer | (1 | ) | (4 | ) | (2 | ) | ||||
Total loans charged off | $ | (296 | ) | $ | (540 | ) | $ | (405 | ) | |
Recoveries of loans previously charged off: | ||||||||||
Commercial | 16 | 281 | 219 | |||||||
Real Estate - Construction | - | - | - | |||||||
Real Estate - Other | - | 39 | 20 | |||||||
Consumer | 1 | - | - | |||||||
Total loan recoveries | $ | 17 | $ | 320 | $ | 239 | ||||
Net loans charged off | (279 | ) | (220 | ) | (166 | ) | ||||
Provision for loan loss expense | 1,410 | 2,897 | 1,643 | |||||||
Balance, end of period | $ | 10,170 | $ | 9,039 | $ | 7,839 | ||||
Ratio of net charge-offs to average loans | 0.03 | % | 0.03 | % | 0.03 | % |
For the six months ended June 30, 2006, nonaccrual loans totaled $8.3 million, a $306,581 or 3.86% increase from nonaccrual loans of $7.9 million at December 31, 2005. There were no changes to Other Real Estate Owned (“OREO) during the second quarter of 2006. The OREO balance at June 30, 2006 was $727,500 compared to $2.1 million at December 31, 2005, a decrease of $1.4 million or 65.54%. At June 30, 2006 and December 31, 2005, there were no accruing loans contractually past due 90 days or more and no restructured loans. The following table presents information relating to nonaccrual loans and OREO for the periods ending June 30, 2006 and December 31, 2005.
Six Months Ended June 30, 2006 | Year End December 31, 2005 | ||||||||||||||||||
Gross | Government | Net | Gross | Government | Net | ||||||||||||||
Balance | Guaranteed | Balance | Balance | Guaranteed | Balance | ||||||||||||||
(Dollars in Thousands) | |||||||||||||||||||
Nonaccrual loans (Gross): | |||||||||||||||||||
Commercial | $ | 2,263 | $ | (1,894 | ) | $ | 369 | $ | 2,259 | $ | (2,178 | ) | $ | 81 | |||||
Real Estate - Construction | 526 | (395 | ) | 131 | - | - | - | ||||||||||||
Real Estate - Other | 5,468 | (4,543 | ) | 925 | 5,692 | (4,336 | ) | 1,356 | |||||||||||
Installment | - | - | - | - | - | - | |||||||||||||
Total | 8,257 | (6,832 | ) | 1,425 | 7,951 | (6,514 | ) | 1,437 | |||||||||||
OREO | 728 | (409 | ) | 319 | 2,111 | (604 | ) | 1,507 | |||||||||||
Total nonaccrual loans and OREO | $ | 8,985 | $ | (7,241 | ) | $ | 1,744 | $ | 10,062 | $ | (7,118 | ) | $ | 2,944 | |||||
Gross nonaccrual loans as a percentage of total loans | 0.89 | % | 1.06 | % | |||||||||||||||
Gross nonaccrual loans and OREO as a percentage of total loans and OREO | 0.97 | % | 1.34 | % | |||||||||||||||
Allowance for loan losses to total net loans (including held-for-sale) | 1.10 | % | 1.20 | % | |||||||||||||||
Allowance for loan losses to total net loans (excluding held-for-sale) | 1.26 | % | 1.35 | % | |||||||||||||||
Allowance for loan losses to gross nonaccrual loans | 123.2 | % | 113.7 | % |
15
The cash surrender value of life insurance is bank owned life insurance (“BOLI”). The BOLI death benefit provides key man insurance for the Bank, as well as providing coverage for the unaccrued liability, in the event of the death of the executive that is a party to a Salary Continuation Plan (“SCP”). The BOLI had a balance of $21.6 million at June 30, 2006, compared to $17.6 million at December 31, 2005, an increase of $4.0 million. The largest component of the increase was the purchase of additional key man insurance in the amount of $3.7 million.
The Bank's goal is to maintain at least 90% of its assets as interest-earning assets. Our largest component of non interest-earning assets is the SBA servicing and SBA interest-only (I/O) strip receivable assets (collectively “the servicing assets”). At June 30, 2006, the Bank was servicing approximately $488.3 million in loans previously sold with a weighted-average servicing rate of 2.24%. The servicing portfolio balance as of December 31, 2005 was $503.2 million with a weighted-average servicing rate of 2.46%. The servicing rate decreased due to a majority of loans being sold during the first six months at a cash premium instead of a par premium. The par premium carries a higher servicing rate than the cash premium.
The Bank may also receive a portion of subsequent interest collections on loans sold that exceed the contractual servicing fee. In that case, the Bank records an interest-only strip based on the relative fair market value of it and the other components of the loan. At June 30, 2006 and December 31, 2005, the Bank had interest-only strips of $17.3 million, and $22.1 million, respectively, which approximates fair value. Fair value is estimated by discounting estimated future cash flows from the interest-only strips using assumptions similar to those used in valuing servicing assets.
For the first six months of 2006, the Bank had an unrealized loss of $1.7 million, which decreased the I/O strip receivable to $17.3 million. At December 31, 2005, the Bank had an unrealized gain of $705,672. A summary of the changes in the related servicing assets and interest-only strips receivable are as follows:
Servicing Assets | |||||||
Six Months Ended June 30, 2006 | Year End December 31, 2005 | ||||||
Balance at Beginning of Period | $ | 8,169,273 | $ | 7,585,712 | |||
Increase from Loan Sales | 1,194,741 | 2,597,873 | |||||
Amortization Charged to Income | (794,354 | ) | (2,014,312 | ) | |||
Balance at End of Period | $ | 8,569,660 | $ | 8,169,273 | |||
Interest-Only Strips Receivable | |||||||
June 30, 2006 | December 31, 2005 | ||||||
Balance at Beginning Period | $ | 22,067,900 | $ | 24,679,520 | |||
Increase from Loan Sales | 949,759 | 2,160,246 | |||||
Amortization Charged to Income | (3,327,658 | ) | (5,477,538 | ) | |||
Unrealized gain(loss) on I/O Strips Receivable | (2,378,900 | ) | 705,672 | ||||
Balance at End of Period | $ | 17,311,101 | $ | 22,067,900 |
The servicing assets are tested for impairment by computing the net present value of the amount of servicing income in excess of normal servicing costs over the expected average life of the loan. Normal servicing, in accordance with industry standards, is 40 basis points of the principal balance sold. The expected life assumes 30 percent of the note life if the note has an original term of less than 10 years, and 25% if the original term is 10 years or more.
The servicing calculations contain certain assumptions such as expected life of the loan and the discount rate used to compute the present value of future cash flows. The exposure of the loan life assumption is if loans prepay faster than expected. The exposure to the discount rate assumption is if rates adjust severely and permanently. Such exposure can cause adjustments to the income statement. The Bank, with the assistance of quarterly external appraisals, reviews for possible impairment of the servicing assets and records the I/O Strips at fair value. Fair value is estimated by discounting estimated future cash flows from the interest-only strips using assumptions similar to those used in valuing servicing assets.
16
The table below summarizes the repayment rates for national SBA pools based on their maturities:
SBA Pools - Constant Prepayment Rates | ||||||||||||||||
Variable Rate Pools | ||||||||||||||||
Issue Date | < 8 Yr Life CPR | 8-11 Yr Life CPR | 11-16 Yr Life CPR | 16-21 Yr Life CPR | > 21 Yr Life CPR | |||||||||||
Year 1 | 8.25 | 5.91 | 4.63 | 3.99 | 4.13 | |||||||||||
Year 2 | 14.30 | 11.33 | 10.05 | 12.37 | 9.62 | |||||||||||
Year 3 | 18.38 | 16.39 | 15.34 | 15.92 | 16.90 | |||||||||||
Year 4 | 18.81 | 17.30 | 18.10 | 19.96 | 21.09 | |||||||||||
Year 5 | 16.66 | 16.20 | 19.01 | 19.17 | 20.90 | |||||||||||
Year 6 | 14.35 | 16.00 | 18.17 | 17.88 | 20.10 | |||||||||||
Year 7 | 12.46 | 13.82 | 17.62 | 18.30 | 18.64 | |||||||||||
Year 8 | 7.68 | 10.70 | 13.20 | 13.38 | 18.95 | |||||||||||
Year 9 | 3.73 | 9.43 | 12.23 | 20.50 | 18.40 | |||||||||||
Year 10 | 1.90 | 5.75 | 14.10 | 11.80 | 16.00 | |||||||||||
Year 11+ | 0.00 | 2.70 | 14.70 | 11.90 | 17.90 |
The value of the servicing assets would decrease $1.4 million and $2.7 million if prepayment speeds increased 10% and 20%, respectively.
The overall average life of the servicing portfolio is 4.24 years. The following schedule displays the weighted-average discount rates for each SBA pool after applying the CPRs identified above and our estimated discount rates for each Bank SBA pool at June 30, 2006 based on assessing each component.
Original Maturity | Disc Rate Excess | �� | Disc Rate I/O | |||||||
< 8 | Years | 9.16 | % | 9.16 | % | |||||
8-11 | Years | 9.16 | % | 9.16 | % | |||||
11-16 | Years | 9.13 | % | 9.13 | % | |||||
16-21 | Years | 9.11 | % | 9.11 | % | |||||
> 21 | Years | 9.10 | % | 9.10 | % |
The servicing assets value would decrease $799,396 and $1.6 million if the discount rate increased 1% and 2%, respectively.
Premises and equipment, accrued interest, and deferred tax assets are major components of other assets. Following is a summary of these items as of June 30, 2006 and December 31, 2005.
· | At June 30, 2006, premises and equipment was $5.1 million, accrued interest was $3.9 million and the deferred tax asset was $7.1 million. |
· | At December 31, 2005, premises and equipment was $4.9 million accrued interest was $3.5 million and the deferred tax asset was $5.7 million. |
Deposits increased from $742.4 million at December 31, 2005 to $921.9 million at June 30, 2006, a 24.18% increase. Money market and NOW accounts increased $13.0 million, savings decreased $178,522, demand deposits increased 2.9 million, and certificate of deposits (CD's) increased $163.8 million, of which $20.6 million were brokered deposits. Demand deposits comprised approximately 17% of deposits at June 30, 2006 compared to 21% at December 31, 2005.
At June 30, 2006, more than 57% of deposits had balances of $100,000 or more. At June 30, 2006, the Bank had one customer with balances of $20.6 million. The Bank prefers core deposits as a source of funds for the loan portfolio. Consequently, the Bank tries to attract solid core accounts yet maintain a reasonable funding cost. The Bank will continue to solicit core deposits to diminish reliance on volatile funds.
17
Borrowings - At June 30, 2006 and 2005, there were no short-term advances from the Federal Home Loan Bank. As of December 31, 2005, the Company had a Federal Home Loan Bank Advance of $30.0 million which matured on January 3, 2006 and accrued interest at 4.21%. The borrowing capacity at the Federal Home Loan Bank as of December 31, 2005 was $30.1 million and at June 30, 2006 was $52.0 million.
Junior Subordinated Debt - Pursuant to rulings of the Federal Reserve Board, bank holding companies are permitted to issue long-term subordinated debt instruments that will, subject to certain conditions, qualify as and, therefore, augment capital for regulatory purposes. The Subordinated Debentures are subordinated to all of our existing and future borrowings. The table below summarizes the terms of each issuance:
Series | Amount | Date Issued | Rate Adjustor | Effective Rate | Maturity Date | |||||||||||
Temecula Valley Statutory Trust I | $ | 7,217,000 | June 2002 | 3-month LIBOR +3.45 | % | 9.03 | % | 2032 | ||||||||
Temecula Valley Statutory Trust II | 5,155,000 | September 2003 | 3-month LIBOR +2.95 | % | 8.46 | % | 2033 | |||||||||
Temecula Valley Statutory Trust III | 8,248,000 | September 2004 | 3-month LIBOR +2.20 | % | 7.72 | % | 2034 | |||||||||
Temecula Valley Statutory Trust IV | 8,248,000 | September 2005 | 3-month LIBOR +1.40 | % | 6.82 | % | 2035 | |||||||||
Total | $ | 28,868,000 |
The Federal Reserve Board has ruled that these mandatorily redeemable preferred securities qualify as capital. As of June 30, 2006 we have included the net junior subordinated debt in our capital for regulatory capital purposes.
Total capital was $67.9 million at June 30, 2006 compared to $58.2 million at December 31, 2005. For the first half of 2006, the $9.8 million increase consisted of $8.5 million of net income, a reduction of $1.4 million in other comprehensive income, $2.0 million on the exercise of stock options, and $618,017 for stock-based compensation. The other comprehensive income reduction was due to the valuation of the SBA interest-only strip receivable.
The table below presents the risk-based and leverage capital ratios of the Company and the Bank as of June 30, 2006 and December 31, 2005.
Required | ||||||||||||||||
Minimum | June 30, 2006 | December 31, 2005 | ||||||||||||||
Ratio | Company | Bank | Company | Bank | ||||||||||||
Capital Ratios | ||||||||||||||||
Total Risk-Based Capital (to Risk-Weighted Assets) | 8.00 | % | 10.26 | % | 10.07 | % | 11.02 | % | 10.81 | % | ||||||
Tier 1 Risk-Based Capital (to Risk-Weighted Assets) | 4.00 | % | 8.72 | % | 9.08 | % | 8.93 | % | 9.75 | % | ||||||
Tier 1 Leverage Ratio (to Average Assets) | 4.00 | % | 9.37 | % | 9.79 | % | 9.28 | % | 10.17 | % |
At June 30, 2006 and December 31, 2005 the Bank and the Company were in the regulatory "well capitalized" category.
18
For the first six months of 2006, the Company earned $8.5 million, compared to $6.9 million for the first six months of 2005. The increase in net income was the result of an increase in net interest income of $8.6 million offset by an increase in non-interest expense of $4.1 million and a decrease in non-interest income of $1.8 million. Net income in the first six months of 2006 and 2005 was augmented by the sale of the unguaranteed portion of SBA loans. These sales increased net income before taxes by $1.8 million or $1.0 million after taxes for the first six months of 2006 compared to $3.6 million or $2.1 million after taxes for the first six months of 2005.
For the second quarter of 2006, the Company earned $4.5 million, compared to $3.9 million for the second quarter of 2005. The increase in net income was due to an increase in net interest income of $4.3 million offset by an increase in non-interest expense of $1.9 million and a decrease in non-interest income of $989,665. The sale of the unguaranteed portion of SBA loans increased net income before taxes by $290,293 or $167,240 after taxes in the second quarter of 2006 compared to $2.4 million or $1.4 million after taxes in the second quarter of 2005. The sale of the unguaranteed portion of SBA loans in the second quarter of 2005 was high due to a larger portfolio of seasoned SBA 7(a) loans outstanding during the second quarter of 2005.
Net income per diluted share for the first half of the year was $0.89 in 2006 compared to $0.73 for the same period in 2005. Net income per basic share was $0.95 per share for the first half of 2006 compared to $0.79 in 2005. Net income per diluted share for the three months ended June 30, 2006 was $0.47 compared to $0.41 for the same period in 2005. Net income per basic share was $0.50 per share for the three months ended June 30, 2006 compared to $0.45 in 2005.
The return on average assets was 1.86% for the first half of 2006, compared to 2.10% for the first half of 2005. The return on average equity was 27.19% for the first half of 2006, compared to 30.10% for the first half of 2005. The return on average assets was 1.90% for the second quarter of 2006, compared to 2.28% for the second quarter of 2005. The return on average equity was 27.71% for the second quarter of 2006, compared to 32.87% for the second quarter of 2005.
Net interest income is the most significant component of our income from operations. Net interest income is the difference between the interest and fees earned on loans and investments (interest-earning assets) and the interest paid on deposits and other borrowings (interest-bearing liabilities). Net interest income depends on the volume of and interest rate earned on interest-earning assets and the volume of and interest rate paid on interest-bearing liabilities.
Net interest income was $27.9 million in the first six months of 2006, compared to $19.3 million in the same period in 2005. The following is a summation of various yields for interest-earning assets and liabilities for the first six months ending June 30, 2006 and 2005:
· | Net interest margin increased from 6.67% for the first half of 2005 to 6.81% for the first half of 2006. |
· | Loan to deposit ratio increased from 97.58% at June 30, 2005 to 100.28% at June 30, 2006. |
· | Yield on loans increased from 8.64% for the first half of 2005 to 10.17% for the first half of 2006. |
· | Yield on investments, Federal Funds Sold and U.S. Treasuries, increased from 2.76% for the first half of 2005 to 4.65% for the first half of 2006. |
· | Cost of interest-bearing deposits increased from 2.21% for the first half of 2005 to 3.72% for the first half of 2006. |
· | Cost of other borrowings, Federal Home Loan Bank advances and junior subordinated debt borrowings, increased from 5.00% for the first half of 2005 to 6.92% for the first half of 2006. |
The following table shows average balances with corresponding interest income and interest expense as well as average yield and cost information for the six months ending June 30, 2006 and 2005. Average balances are derived from daily balances, and nonaccrual loans are included as interest-bearing loans for the purposes of these tables.
19
Average Balances with Rates Earned and Paid | ||||||||||||||||||||
Six-month period ended June 30, | ||||||||||||||||||||
2006 | 2005 | |||||||||||||||||||
Interest | Average | Interest | Average | |||||||||||||||||
Average | Income/ | Interest | Average | Income/ | Interest | |||||||||||||||
Balance | Expense | Rate | Balance | Expense | Rate | |||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||
Assets | ||||||||||||||||||||
Securities-HTM (1) | $ | 257 | $ | 5 | 4.24 | % | $ | 179 | $ | 2 | 2.46 | % | ||||||||
Due from Banks-Time | 9 | - | 5.00 | % | - | - | 0.00 | % | ||||||||||||
Federal Funds Sold | 11,558 | 267 | 4.65 | % | 4,285 | 59 | 2.76 | % | ||||||||||||
Total Investments | 11,824 | 272 | 4.64 | % | 4,464 | 61 | 2.75 | % | ||||||||||||
Total Loans (2) | 814,446 | 41,060 | 10.17 | % | 579,192 | 24,804 | 8.64 | % | ||||||||||||
Total Interest Earning Assets | 826,270 | 41,332 | 10.09 | % | 583,656 | 24,865 | 8.59 | % | ||||||||||||
Allowance for Loan Loss | (9,385 | ) | (6,935 | ) | ||||||||||||||||
Cash & Due From Banks | 27,328 | 28,659 | ||||||||||||||||||
Premises & Equipment | 5,128 | 4,577 | ||||||||||||||||||
Other Assets | 71,441 | 56,820 | ||||||||||||||||||
Total Assets | $ | 920,782 | $ | 666,777 | ||||||||||||||||
Liabilities and Shareholders’ Equity | ||||||||||||||||||||
Interest Bearing Demand | $ | 31,995 | 24 | 0.15 | % | $ | 32,215 | 24 | 0.15 | % | ||||||||||
Money Market | 74,431 | 995 | 2.70 | % | 40,804 | 241 | 1.19 | % | ||||||||||||
Savings | 32,439 | 61 | 0.38 | % | 39,406 | 81 | 0.41 | % | ||||||||||||
Time Deposits under $100,000 | 256,592 | 5,500 | 4.32 | % | 154,591 | 2,091 | 2.73 | % | ||||||||||||
Time Deposits $100,000 or more | 261,573 | 5,538 | 4.27 | % | 170,527 | 2,362 | 2.79 | % | ||||||||||||
Other Borrowings | 38,150 | 1,309 | 6.92 | % | 30,570 | 758 | 5.00 | % | ||||||||||||
Total Interest Bearing Liabilities | 695,180 | 13,427 | 3.89 | % | 468,113 | 5,557 | 2.39 | % | ||||||||||||
Non-interest Demand Deposits | 153,186 | 144,758 | ||||||||||||||||||
Other Liabilities | 9,288 | 7,117 | ||||||||||||||||||
Shareholders' Equity | 63,128 | 46,789 | ||||||||||||||||||
Total Liabilities and Shareholders' equity | $ | 920,782 | $ | 666,777 | ||||||||||||||||
Net Interest Income | $ | 27,905 | $ | 19,308 | ||||||||||||||||
Interest Spread (3) | 6.19 | % | 6.20 | % | ||||||||||||||||
Net Interest Margin (4) | 6.81 | % | 6.67 | % | ||||||||||||||||
(1) There are no tax exempt investments in any of the reported periods. | ||||||||||||||||||||
(2) Average balances are net of deferred fees/gains that are amortized to interest income over the term of the respective loan. | ||||||||||||||||||||
(3) Net interest spread is the yield earned on interest-earning assets less the rate paid on interest-bearing liabilities. | ||||||||||||||||||||
(4) Net interest margin is the net interest income divided by the interest-earning assets. |
20
Net interest income was $14.5 million in the second quarter of 2006, compared to $10.3 million in the same period in 2005. The following is a summation of various yields for interest-earning assets and liabilities for the second quarter of June 30, 2006 and 2005:
· | Net interest margin increased from 6.78% for the second quarter of 2005 to 6.79% for the second quarter of 2006. |
· | Loan to deposit ratio increased from 97.69% at June 30, 2005 to 100.23% at June 30, 2006. |
· | Yield on loans increased from 8.93% for the second quarter of 2005 to 10.31% for the second quarter of 2006. |
· | Yield on investments, Federal Funds Sold and U.S. Treasuries, increased from 2.98% for the second quarter of 2005 to 4.77% for the second quarter of 2006. |
· | Cost of interest-bearing deposits increased from 2.41% for the second quarter of 2005 to 3.89% for the second quarter of 2006. |
· | Cost of other borrowings, Federal Home Loan Bank advances and junior subordinated debt borrowings, increased from 5.85% for the second quarter of 2005 to 6.97% for the second quarter of 2006. |
The following table shows average balances with corresponding interest income and interest expense as well as average yield and cost information for the three months ending June 30, 2006 and 2005. Average balances are derived from daily balances, and nonaccrual loans are included as interest-bearing loans for the purposes of these tables.
21
Average Balances with Rates Earned and Paid | ||||||||||||||||||||
Three-month period ended June 30, | ||||||||||||||||||||
2006 | 2005 | |||||||||||||||||||
Interest | Average | Interest | Average | |||||||||||||||||
Average | Income/ | Interest | Average | Income/ | Interest | |||||||||||||||
Balance | Expense | Rate | Balance | Expense | Rate | |||||||||||||||
Assets | (Dollars in Thousands) | |||||||||||||||||||
Securities-HTM (1) | $ | 237 | $ | 3 | 4.51 | % | $ | 231 | $ | 2 | 2.62 | % | ||||||||
Due from Banks-Time | 17 | - | 5.00 | % | - | - | 0.00 | % | ||||||||||||
Federal Funds Sold | 12,367 | 147 | 4.77 | % | 5,191 | 39 | 2.98 | % | ||||||||||||
Total Investments | 12,621 | 150 | 4.76 | % | 5,422 | 41 | 2.97 | % | ||||||||||||
Total Loans (2) | 846,206 | 21,762 | 10.31 | % | 602,804 | 13,413 | 8.93 | % | ||||||||||||
Total Interest Earning Assets | 858,827 | 21,912 | 10.23 | % | 608,226 | 13,454 | 8.87 | % | ||||||||||||
Allowance for Loan Loss | (9,429 | ) | (7,222 | ) | ||||||||||||||||
Cash & Due From Banks | 27,895 | 25,811 | ||||||||||||||||||
Premises & Equipment | 5,239 | 4,733 | ||||||||||||||||||
Other Assets | 73,011 | 63,210 | ||||||||||||||||||
Total Assets | $ | 955,543 | $ | 694,758 | ||||||||||||||||
Liabilities and Shareholders’ Equity | ||||||||||||||||||||
Interest Bearing Demand | $ | 32,365 | 13 | 0.16 | % | $ | 33,142 | 12 | 0.15 | % | ||||||||||
Money Market | 76,771 | 522 | 2.73 | % | 40,192 | 125 | 1.25 | % | ||||||||||||
Savings | 32,946 | 34 | 0.42 | % | 39,347 | 38 | 0.38 | % | ||||||||||||
Time Deposits under $100,000 | 269,706 | 3,030 | 4.51 | % | 165,815 | 1,228 | 2.97 | % | ||||||||||||
Time Deposits $100,000 or more | 274,652 | 3,059 | 4.47 | % | 185,824 | 1,388 | 3.00 | % | ||||||||||||
Other Borrowings | 41,254 | 717 | 6.97 | % | 26,609 | 388 | 5.85 | % | ||||||||||||
Total Interest Bearing Liabilities | 727,694 | 7,375 | 4.06 | % | 490,929 | 3,179 | 2.60 | % | ||||||||||||
Non-interest Demand Deposits | 153,161 | 148,142 | ||||||||||||||||||
Other Liabilities | 9,127 | 6,889 | ||||||||||||||||||
Shareholders' Equity | 65,561 | 48,798 | ||||||||||||||||||
Total Liabilities and Shareholders' equity | $ | 955,543 | $ | 694,758 | ||||||||||||||||
Net Interest Income | $ | 14,537 | $ | 10,275 | ||||||||||||||||
Interest Spread (3) | 6.17 | % | 6.28 | % | ||||||||||||||||
Net Interest Margin (4) | 6.79 | % | 6.78 | % | ||||||||||||||||
(1) There are no tax exempt investments in any of the reported periods. | ||||||||||||||||||||
(2) Average balances are net of deferred fees/gains that are amortized to interest income over the term of the respective loan. | ||||||||||||||||||||
(3) Net interest spread is the yield earned on interest-earning assets less the rate paid on interest-bearing liabilities. | ||||||||||||||||||||
(4) Net interest margin is the net interest income divided by the interest-earning assets. |
22
The following table shows a comparison of interest income and interest expense as the result of changes in the volumes and rates on average interest-earning assets and average interest-bearing liabilities for the three and six months ended June 30, 2006 and 2005.
Rate/Volume Analysis | |||||||||||||||||||
Increase/Decrease in Net Interest Income | |||||||||||||||||||
Three month period ended | Six month period ended | ||||||||||||||||||
June 30, 2006 and 2005 | June 30, 2006 and 2005 | ||||||||||||||||||
Volume | Rate | Total | Volume | Rate | Total | ||||||||||||||
(Dollars in Thousands) | |||||||||||||||||||
Assets | |||||||||||||||||||
Securities-HTM (1) | $ | - | $ | 1 | $ | 1 | $ | 1 | $ | 2 | $ | 3 | |||||||
Federal Funds Sold | 53 | 55 | 108 | 100 | 108 | 208 | |||||||||||||
Total Investments | 53 | 56 | 109 | 101 | 110 | 211 | |||||||||||||
Total Loans (2) | 5,416 | 2,931 | 8,347 | 10,251 | 6,005 | 16,256 | |||||||||||||
Total Interest Earning Assets | $ | 5,469 | $ | 2,987 | $ | 8,456 | $ | 10,352 | $ | 6,115 | $ | 16,467 | |||||||
Liabilities and | |||||||||||||||||||
Shareholders' Equity | |||||||||||||||||||
Interest Bearing Demand | - | 1 | 1 | - | 1 | 1 | |||||||||||||
Money Market | 114 | 282 | 396 | 199 | 554 | 753 | |||||||||||||
Savings | (6 | ) | 3 | (3 | ) | (14 | ) | (6 | ) | (20 | ) | ||||||||
Time Deposits under $100,000 | 769 | 1,032 | 1,801 | 1,380 | 2,029 | 3,409 | |||||||||||||
Time Deposits $100,000 or more | 664 | 1,006 | 1,670 | 1,261 | 1,914 | 3,175 | |||||||||||||
Other Borrowings | 214 | 115 | 329 | 240 | 311 | 551 | |||||||||||||
Total Interest Bearing Liabilities | 1,755 | 2,439 | 4,194 | 3,066 | 4,803 | 7,869 | |||||||||||||
Net Interest Income | $ | 3,714 | $ | 548 | $ | 4,262 | $ | 7,286 | $ | 1,312 | $ | 8,598 | |||||||
(1) There are no tax exempt investments in any of the reported periods. | |||||||||||||||||||
(2) Average balances are net of deferred fees/gains that are amortized to interest income over the term of the respective loan. |
The allowance for loan losses represents management’s best estimate of probable incurred losses in the loan portfolio. The Bank has established a monitoring system for loans in order to identify impaired loans and potential problem loans to facilitate periodic evaluation of impairment and the amount of the allowance for loan losses in a timely manner.
The monitoring system and allowance for loan losses methodology has evolved over a period of years, and loan classifications have been incorporated into the determination of the allowance for loan losses. The monitoring system and allowance methodology include an assessment of individual classified loans, as well as applying loss factors to all loans not individually classified. Classified loans are reviewed individually to estimate the amount of probable loss that needs to be included in the allowance. These reviews include analysis of financial information as well as evaluation of collateral securing the credit. The analysis considers general factors such as changes in lending policies and procedures, economic trends, loan volume trends, changes in lending management and staff, trends in delinquencies, nonaccruals and charge-offs, changes in loan review and Board oversight, the effects of competition, legal and regulatory requirements, and factors inherent to each loan pool.
The provision was $1.6 million and $1.4 million for the first six months of 2005 and 2006, respectively. For the second quarter, the provision was $804,100 and $1.1 million for 2005 and 2006, respectively. The provision for loan losses for the first six months of 2006 decreased as a result of a reduction in the percentage of nonperforming loans since December 31, 2005 and a continued low level of charge-offs.
Non-interest income is an important source of revenue for the Company. Non-interest income consists of service charges and fees, gain on sale of loans and other assets, and loan servicing, broker and other loan related income. Non-interest income was $11.4 million for the first half of 2006 compared to $13.2 million for the same period in 2005, a $1.8 million decrease. Non-interest income for the second quarter of 2006 was $6.5 million compared to $7.5 million for the same period in 2005, a $989,665 decrease.
The primary contributors to the decrease are the gain on sale of loans and servicing income. The following table summarizes the components of non-interest income for the three and six months ended June 30, 2006 and 2005. As a result of most loans being sold at a cash premium instead of a par premium (par premiums carry a higher servicing rate) the weighted average rate of servicing assets has been decreasing. At June 30, 2006, the Bank was servicing approximately $488.3 million in loans previously sold with a weighted-average servicing rate of 2.24%. The servicing portfolio balance as of December 31, 2005 was $503.2 million with a weighted-average servicing rate of 2.46%.
23
Fees and Other Income | Fees and Other Income | ||||||||||||
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||
(Dollars in Thousands) | |||||||||||||
Service Charges and Fees | $ | 162 | $ | 163 | $ | 314 | $ | 321 | |||||
Gain on Sale of Loans | 3,759 | 4,686 | 6,704 | 8,446 | |||||||||
Gain(Loss) on Other Assets and Other Real Estate Owned | 207 | (21 | ) | 232 | (30 | ) | |||||||
Servicing Income | 209 | 538 | 624 | 1,029 | |||||||||
Loan Broker Income | 1,037 | 1,031 | 1,657 | 1,635 | |||||||||
Loan Related Income | 679 | 778 | 1,200 | 1,304 | |||||||||
Other Income | 422 | 290 | 684 | 543 | |||||||||
$ | 6,475 | $ | 7,465 | $ | 11,415 | $ | 13,248 |
The gain on sale of loans decreased from $8.4 million in the first six months of 2005 to $6.7 million in the same period in 2006. For the second quarter of 2006, the gain on sale of loans was $3.8 million compared to $4.7 million for the second quarter of 2005. The following table summarizes the gain on sale of loans and other assets for the three and six months ended June 30, 2006 and 2005.
Gain on Sale of Loans / Assets | Gain on Sale of Loans / Assets | ||||||||||||
Three months ended June 30, | Six months ended June 30, | ||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||
(Dollars in Thousands) | |||||||||||||
SBA 7(a) Unguaranteed Sales | $ | 290 | $ | 2,439 | $ | 1,757 | $ | 3,558 | |||||
SBA 7(a) Guaranteed Sales | 1,326 | 1,831 | 2,502 | 3,790 | |||||||||
SBA 504 Sales | 1,048 | 36 | 1,048 | 230 | |||||||||
Mortgage Sales | - | 85 | - | 278 | |||||||||
Other Loan Related | 1,095 | 294 | 1,397 | 589 | |||||||||
REO Gain (Loss) | 215 | (21 | ) | 240 | (28 | ) | |||||||
Fixed Assets | (8 | ) | - | (8 | ) | (2 | ) | ||||||
Total | $ | 3,966 | $ | 4,664 | $ | 6,936 | $ | 8,415 |
Non-interest expenses consist of salaries and benefits, occupancy, furniture and equipment, processing, office expense and professional costs such as legal and auditing, marketing and regulatory fees. These expenses are closely reviewed and controlled to maintain the Bank at its most cost effective operational level.
Non-interest expense was $23.1 million in the first six months of 2006 compared to $19.0 million in the first six months of 2005, a $4.1 million increase. The main contributors to the increase were salaries and employee benefits, occupancy expense, and loan funding expense.
Salaries and benefits increased from $12.6 million in the first six months of 2005 to $15.9 million for the same period in 2006, a $3.3 million increase. The increase in salaries and benefits is a result of the expansion of the Risk Management, Information Technology, and Appraisal Departments as well as the opening of the Corona/Ontario and Carlsbad offices. At June 30, 2006, the Bank had 293 employees (289 full-time equivalent), of which 278 were full time. At June 30, 2005, the Bank had 256 employees (251 full-time equivalent), of which 239 were full time. Included in the salaries and benefits expense is $618,017 for stock-based compensation for all share-based payments granted on or prior to June 30, 2006 and vested in the first half of 2006 as a result of the adoption of SFAS No. 123R.
Occupancy expense increased from $1.2 million for the first six months of 2005 to $1.5 million for the same period in 2006, a $317,262 increase. Contributing to the increase are the costs related to the opening of the Solana Beach branch, scheduled to open in the third quarter of 2006, and the Ontario Branch scheduled to open in the fourth quarter of 2006.
24
Loan funding expenses increased from $880,728 for the first six months of 2005 to $1.2 million for the same period in 2006, a $346,863 increase. The increase is a result of a significant increase in loan production for the first six months of 2006 compared to the same period in 2005.
For the second quarter of 2006, non-interest expense was $12.1 million compared to $10.2 million for the second quarter of 2005. The main contributors to the increase were salaries and employee benefits and loan funding expense.
Salaries and benefits increased from $6.7 million in the second quarter of 2005 to $8.1 million for the same period in 2006, a $1.4 million increase. Included in salaries and benefits expense is $198,000 for stock-based compensation expense per SFAS No. 123R.
Loan funding expenses increased from $400,326 in the second quarter of 2005 to $765,922 for the same period in 2006, a $365,596 increase.
The following table summarizes the components of non-interest expense for the three and six months ended June 30, 2006 and 2005.
Other Expenses | Other Expenses | ||||||||||||
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||
(Dollars in Thousands) | |||||||||||||
Salaries and Employee Benefits | $ | 8,122 | $ | 6,723 | $ | 15,863 | $ | 12,573 | |||||
Occupancy Expenses | 747 | 606 | 1,485 | 1,168 | |||||||||
Furniture and Equipment | 425 | 369 | 805 | 707 | |||||||||
Data Processing | 318 | 295 | 620 | 568 | |||||||||
Marketing and Business Promotion | 259 | 253 | 484 | 550 | |||||||||
Legal and Professional | 319 | 380 | 621 | 437 | |||||||||
Regulatory Assessments | 43 | 113 | 85 | 167 | |||||||||
Travel & Entertainment | 278 | 222 | 523 | 397 | |||||||||
Loan Related Expense | 766 | 400 | 1,228 | 881 | |||||||||
Office Expenses | 576 | 598 | 1,184 | 1,190 | |||||||||
Other Expenses | 201 | 222 | 234 | 379 | |||||||||
$ | 12,054 | $ | 10,181 | $ | 23,132 | $ | 19,017 |
Income tax expense totaled $6.3 million for the first six months of 2006 and $5.0 million for the first six months of 2005. The effective rate was 42.42% and 41.62% for 2006 and 2005, respectively. The increase in the effective tax rate for 2006 is due to the non-deductibility of the incentive stock option portion of the stock-based compensation expense. Deferred tax assets totaled $7.1 million at June 30, 2006 compared to $5.7 million at December 31, 2005. Over half of the deferred tax asset is due to the tax deductibility timing difference of the provision for loan loss.
Income tax expense totaled $3.3 million for second quarter of 2006 and $2.8 million for second quarter of 2005. The effective rate was 42.39% and 41.64% for 2006 and 2005, respectively.
Banks are in the business of managing money. Consequently, funds management is essential to the ongoing profitability of a bank. A bank must attract funds at a reasonable rate and deploy the funds at an appropriate rate of return, while taking into account risk factors, interest rates, short- and long-term liquidity positions and profitability needs. Liquidity management involves our ability to meet cash flow requirements arising from fluctuations in deposit levels and demands of daily operations, which include providing for customers’ credit needs and ongoing repayment of borrowings.
The Bank’s cash position is determined on a daily basis. On a monthly basis, the Board of Directors reviews the Bank's liquidity position. One analysis measures the liquidity gap and Bank guidelines state a 2% positive liquidity gap position should be maintained. Another analysis measures an industry standard liquidity ratio and Bank guidelines state a 10% ratio or more should be maintained. At June 30, 2006 the ratio was 15.86%.
25
Our primary sources of liquidity are derived from financing activities which includes Federal Funds lines of credit at correspondent banks, Federal Home Loan Bank Advances, and growth in customer deposits. The Bank maintains Federal Funds lines of credit of $18.0 million for short-term liquidity. In addition, the Bank has created a borrowing capacity at the Federal Home Loan Bank that fluctuates with loan balances pledged as collateral. At June 30, 2006, the Bank's borrowing capacity with the Federal Home Loan Bank was $52.0 million and at December 31, 2005 was $30.1 million. These funding sources are augmented by payments of principal and interest on loans and sales and participations of eligible loans. Primary uses of funds include withdrawal of deposits, interest paid on deposits and borrowings, originations of loans, and payment of operating expenses.
Net cash used by operating activities totaled $21.0 million for the first six months of 2006, compared to net cash provided by operating activities of $17.6 million for the same period last year. The decrease was primarily the result of a decrease in proceeds from loan sales.
Net cash used in investing activities totaled $139.5 million for the first six months of 2006, compared to $111.9 million for the same period in 2005. The increase was primarily the result of growth in our loan portfolio.
Net cash provided by financing activities totaled $151.5 million for the first six months of 2006, compared to $109.6 million for the same period last year. The increase was primarily the result of repayment of FHLB advances offset by increases in time deposits.
At June 30, 2006, cash and cash equivalents totaled $42.6 million compared to $38.4 million at June 30, 2005 an increase of $4.1 million, or 10.74%. As of June 30, 2006, management is not aware of any current recommendations by regulatory authorities, which, if they were implemented, would have or would be reasonably likely to have a materially adverse effect on the Company's liquidity, capital resources, or operations.
It is the goal of the Company and the Bank to maintain capital levels within the regulatory “well capitalized” category. The Company updates its multiple-year capital plan annually in conjunction with the preparation of the annual budget. Capital levels are always a primary concern of the federal regulatory authorities, and the Bank submits capital plans to them when requested. It is the Bank’s strategy to maintain an adequate level of capital, which by definition excludes excessive as well as inadequate capital. The following tables set forth the actual capital amounts and ratios for the Company and the Bank (dollar amounts in thousands).
Amount of Capital Required | |||||||||||||
Temecula Valley Bancorp | For Capital Adequacy Purposes | ||||||||||||
Amount | Ratio | Amount | Ratio | ||||||||||
As of June 30, 2006: | |||||||||||||
Total Risk-Based Capital (to Risk-Weighted Assets) | $ | 105,265 | 10.26 | % | $ | 82,097 | 8.00 | % | |||||
Tier 1 Risk-Based Capital (to Risk-Weighted Assets) | $ | 89,433 | 8.72 | % | $ | 41,048 | 4.00 | % | |||||
Tier 1 Leverage Ratio (to Average Assets) | $ | 89,433 | 9.37 | % | $ | 38,222 | 4.00 | % | |||||
As of December 31, 2005: | |||||||||||||
Total Risk-Based Capital (to Risk-Weighted Assets) | $ | 94,422 | 11.02 | % | $ | 68,553 | 8.00 | % | |||||
Tier 1 Risk-Based Capital (to Risk-Weighted Assets) | $ | 76,484 | 8.93 | % | $ | 34,276 | 4.00 | % | |||||
Tier 1 Leverage Ratio (to Average Assets) | $ | 76,484 | 9.28 | % | $ | 32,970 | 4.00 | % |
26
Amount of Capital Required | |||||||||||||||||||||
Temecula Valley Bank | For Capital Adequacy Purposes | To Be Well Capitalized Under Prompt Corrective Provisions | |||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||
As of June 30, 2006: | |||||||||||||||||||||
Total Risk-Based Capital (to Risk-Weighted Assets) | $ | 103,267 | 10.07 | % | $ | 82,019 | 8.00 | % | $ | 102,524 | 10.00 | % | |||||||||
Tier 1 Risk-Based Capital (to Risk-Weighted Assets) | $ | 93,077 | 9.08 | % | $ | 41,010 | 4.00 | % | $ | 61,514 | 6.00 | % | |||||||||
Tier 1 Leverage Ratio (to Average Assets) | $ | 93,077 | 9.79 | % | $ | 38,080 | 4.00 | % | $ | 47,600 | 5.00 | % | |||||||||
As of December 31, 2005: | |||||||||||||||||||||
Total Risk-Based Capital (to Risk-Weighted Assets) | $ | 92,550 | 10.81 | % | $ | 68,472 | 8.00 | % | $ | 85,590 | 10.00 | % | |||||||||
Tier 1 Risk-Based Capital (to Risk-Weighted Assets) | $ | 83,491 | 9.75 | % | $ | 34,236 | 4.00 | % | $ | 51,354 | 6.00 | % | |||||||||
Tier 1 Leverage Ratio (to Average Assets) | $ | 83,491 | 10.17 | % | $ | 32,842 | 4.00 | % | $ | 41,053 | 5.00 | % |
Our accounting policies are integral to understanding the results reported. In preparing its consolidated financial statements, the Company is required to make judgments and estimates that may have a significant impact upon its financial results. Certain accounting policies require the Company to make significant estimates and assumptions, which have a material impact on the carrying value of certain assets and liabilities, and are considered critical accounting policies. The estimates and assumptions used are based on the historical experiences and other factors, which are believed to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and results of operations for the reporting periods.
Two critical accounting policies are noteworthy. They concern the allowance for loan loss and the SBA servicing assets. They are considered critical due to the assumptions that are contained in their calculation, as well as external factors that can affect their value. Through quarterly review and analysis, valuations and calculations are tested for reasonableness. For a discussion of our critical accounting policies, see Item 7 "Management Discussion and Analysis" of the Company's report on Form 10-K for the year-ended December 31, 2005. There were no changes in our critical accounting policies and estimates in the six months ended June 30, 2006.
In the normal course of business, the Bank enters into off-balance sheet financial commitments to meet the financing needs of its customers. These financial commitments include commitments to extend credit and standby letters of credit. Those instruments involve to varying degrees, elements of credit and interest rate risk not recognized in the statement of financial position. Our exposure to loan loss in the event of nonperformance on commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments as it does for loans reflected in the financial statements.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments to guarantee the performance of a Company customer to a third party. Since many of the commitments and standby letters of credit are expected to expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the customer.
The Bank conducts business at eight full-service banking offices in Southern California and multiple loan production offices in twelve states, including California. The main office facilities are located at 27710 Jefferson Avenue, Suite A100, Temecula, California. As of June 30, 2006, the Bank owned the property at one of its branch locations. The remaining banking offices and other offices are leased by the Bank. Most of the leases contain multiple renewal options and provisions for rental increases, principally for changes in the cost of living index, property taxes and maintenance. Total future annual rental payments (exclusive of operating charges and real property taxes) are approximately $5.7 million, with lease expiration dates ranging from 2006 to 2014, exclusive of renewal options.
27
The following table summarizes our aggregate contractual obligations and their maturities as of June 30, 2006.
Loan Commitments and Related Financial Instruments | Maturity by period | |||||||||||||||
Total | One year or less | More than 1 year to 3 years | More than 3 years to 5 years | More than 5 years | ||||||||||||
(Dollars in Thousands) | ||||||||||||||||
Commitments to Extend Credit | $ | 421,237 | $ | 274,035 | $ | 101,179 | $ | 1,150 | $ | 44,873 | ||||||
Letters of Credit | 4,218 | 4,182 | 36 | - | - | |||||||||||
Loan Commitments Outstanding | 425,455 | 278,217 | 101,215 | 1,150 | 44,873 | |||||||||||
Junior Subordinated Debt | 28,868 | - | - | - | 28,868 | |||||||||||
Operating Lease Obligations | 5,707 | 1,750 | 2,682 | 905 | 370 | |||||||||||
Other Commitments Outstanding | 34,575 | 1,750 | 2,682 | 905 | 29,238 | |||||||||||
Total Outstanding Commitments | $ | 460,030 | $ | 279,967 | $ | 103,897 | $ | 2,055 | $ | 74,111 |
Market risk is the possible chance of loss from unfavorable changes in market prices and rates. These changes may result in a reduction of current and future period net interest income, which is the favorable spread earned from the excess of interest income on interest-earning assets over interest expense on interest-bearing liabilities.
The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Board of Directors. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange risk, equity price risk and commodity price risk, are not significant in the normal course of the Company's business activities.
The ongoing monitoring and management of both interest rate risk and liquidity, in the short- and long-term time horizon, is an important component of the Company's asset/liability management process, which is governed by limits established in the policies reviewed and approved annually by the Board of Directors. As the Company does not believe it is possible to reliably predict future interest rate movements, it has maintained an appropriate process and set of measurement tools which enable it to identify and quantify sources of interest rate risk in varying rate environments. The primary tool used by the Company in managing interest rate risk is the effect of interest rate shocks on the net interest income.
The following reflects the Company's one year net interest income sensitivity based on asset and liability levels using the budgeted 2006 net interest income as a starting point. For purposes of this table, there is assumed to be zero growth in loans, investments, deposits, or other components of the balance sheet.
June 30, 2006 | |||||||||||||
Changes in | Projected Net | Change from | % Change from | ||||||||||
Rates | Interest Income | Base Case | base Case | ||||||||||
(Dollars in Thousands) | |||||||||||||
+300 bp | $ | 66,828 | $ | 13,364 | 25.00 | % | |||||||
+200 bp | 62,384 | 8,920 | 16.68 | % | |||||||||
+100 bp | 57,927 | 4,463 | 8.35 | % | |||||||||
0 bp | 53,464 | - | 0.00 | % | |||||||||
-100 bp | 49,190 | (4,274 | ) | (7.99 | %) | ||||||||
-200 bp | 44,922 | (8,542 | ) | (15.98 | %) | ||||||||
-300 bp | 40,530 | (12,934 | ) | (24.19 | %) |
28
In the model, a rising rate environment will increase net interest income (NII) from a flat rate environment. A lower rate environment will decrease net interest income. The analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon various assumptions. While the assumptions are developed upon current economic and market conditions, we cannot make ant assurances as to the predictive nature of these assumptions. Furthermore, the sensitivity analysis does not reflect actions the Board might take in responding to or anticipating changes in interest rates.
As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company's principal executive officer and principal financial officer, of the effectiveness (as defined in Rules 13a through15(e) of the design and operation of our disclosure controls and procedures and have concluded that the Company's disclosure controls and procedures are effective in timely alerting then to the material information relating to the Company (including its consolidated subsidiary) required to be included in our periodic SEC filings. It should be noted that the design of the Company's disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company's principal executive and financial officers have concluded that the Company's disclosure controls and procedures are, in fact, effective at a reasonable assurance level.
In addition, there have been no changes in the Company's internal control over financial reporting identified in connection with the evaluation described in the above paragraph that occurred during the Company's last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
29
As of June 30, 2006 the Company is not party to any litigation that is considered likely to have a material adverse effect on the Company.
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
None
None
On May 23, 2006, the Company held its annual meeting of security holders. The following individuals were elected for a one-year term, until their successors are duly elected and qualified, and the results were as follows:
For | Withheld | ||||||
Dr. Steven W. Aichle | 8,006,674 | 0 | |||||
Dr. Robert P. Beck | 8,006,674 | 0 | |||||
Neil M. Cleveland | 8,006,674 | 0 | |||||
George Cossolias | 8,006,674 | 0 | |||||
Luther J. Mohr | 8,006,674 | 0 | |||||
Stephen H. Wacknitz | 8,006,674 | 0 | |||||
Richard W. Wright | 8,006,674 | 0 |
(a) None
(b) None.
31.1 | Rule 13a-14(a) Certification of Chief Executive Officer | |
31.2 | Rule 13a-14(a) Certification of Chief Financial Officer | |
32.1 | Section 1350 Certifications | |
10.42 | Employee Stock Ownership Plan | |
10.43 | Executive Nonqualified Excess Plan |
30
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TEMECULA VALLEY BANCORP INC. | ||||
DATE: August 8, 2006 | BY: /s/ Stephen H. Wacknitz | |||
Stephen H. Wacknitz, | ||||
President/CEO, Chairman of the Board | ||||
BY: /s/ Donald A. Pitcher | ||||
Donald A. Pitcher, | ||||
Executive Vice President | ||||
Chief Financial Officer |
31