UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10 - QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
Commission File Number: 333-118859
PACIFIC COAST NATIONAL BANCORP
(Exact name of registrant as specified in its charter)
California | 61-1453556 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) | |
| 905 Calle Amanecer, Suite 100, San Clemente, California 92673 | ||
| (Address of principal executive offices, including zip code) | ||
| (949) 361- 4300 | ||
| (Registrant’s telephone number, including area code) | ||
Indicate by check mark whether the registrant: (i) 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 (ii) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
The number of shares outstanding of the issuer’s Common Stock as of November 10, 2006, was 2,281,300 shares.
PACIFIC COAST NATIONAL BANCORP
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PACIFIC COAST NATIONAL BANCORP
ASSETS
| September 30, 2006 | December 31, | ||||||
| (unaudited) | 2005 | ||||||
| Cash and due from banks | $ | 2,427,611 | $ | 1,699,481 | |||
| Federal funds sold | 13,640,000 | 6,580,000 | |||||
TOTAL CASH AND CASH EQUIVALENTS | 16,067,611 | 8,279,481 | |||||
| Time deposits in other financial institutions | — | 2,750,000 | |||||
| Securities held to maturity | 9,937,974 | 7,997,943 | |||||
| Loans, net | 25,099,538 | 10,230,122 | |||||
| Premises and equipment, net | 1,220,760 | 1,154,066 | |||||
| Federal Reserve Bank stock, at cost | 493,800 | 553,700 | |||||
| Accrued interest and other assets | 292,832 | 244,853 | |||||
| $ | 53,112,515 | $ | 31,210,165 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY
| Deposits | |||||||
| Noninterest-bearing demand | $ | 11,038,864 | $ | 4,266,093 | |||
| Interest-bearing demand and NOW accounts | 3,059,495 | 788,633 | |||||
| Money market | 15,597,402 | 3,332,615 | |||||
| Savings | 108,797 | 86,283 | |||||
| Time certificates of deposit of $100,000 or more | 4,136,354 | 2,412,465 | |||||
| Other time certificates of deposit | 2,191,374 | 1,467,341 | |||||
TOTAL DEPOSITS | 36,132,286 | 12,353,430 | |||||
| Accrued interest and other liabilities | 264,985 | 146,509 | |||||
TOTAL LIABILITIES | 36,397,271 | 12,499,939 | |||||
| Shareholders' equity | |||||||
| Common stock - $0.01 par value; 10,000,000 shares authorized; | |||||||
| issued and outstanding: 2,281,300 shares at September 30, | |||||||
| 2006 and 2,280,000 shares at December 31, 2005 | 22,813 | 22,800 | |||||
| Additional paid-in capital | 24,506,139 | 23,271,720 | |||||
| Accumulated deficit | ( 7,813,708 | ) | ( 4,584,294 | ) | |||
TOTAL SHAREHOLDERS' EQUITY | 16,715,244 | 18,710,226 | |||||
| $ | 53,112,515 | $ | 31,210,165 | ||||
PACIFIC COAST NATIONAL BANCORP
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||
| 2006 | 2005 | 2006 | 2005 | ||||||||||
| Interest income | |||||||||||||
| Interest and fees on loans | $ | 469,616 | $ | 54,314 | $ | 1,090,568 | $ | 63,486 | |||||
| Federal funds sold | 210,010 | 151,018 | 381,630 | 226,314 | |||||||||
| Investment securities | 87,967 | 29,371 | 259,883 | 29,371 | |||||||||
| Other | 17,431 | 13,581 | 57,423 | 17,871 | |||||||||
| 785,024 | 248,284 | 1,789,504 | 337,042 | ||||||||||
| Interest expense | |||||||||||||
| Time certificates of $100,000 or more | 51,556 | 7,406 | 129,410 | 8,420 | |||||||||
| Other deposits | 150,480 | 22,136 | 269,538 | 23,552 | |||||||||
| 202,036 | 29,542 | 398,948 | 31,972 | ||||||||||
| Net interest income | 582,988 | 218,742 | 1,390,556 | 305,070 | |||||||||
| Provision for loan losses | 72,462 | 38,307 | 226,264 | 42,812 | |||||||||
| Net interest income after | |||||||||||||
| provision for loan losses | 510,526 | 180,435 | 1,164,292 | 262,258 | |||||||||
| Noninterest income | |||||||||||||
| Service charges and fees | 5,192 | 385 | 27,431 | 607 | |||||||||
| Other income | — | 1,521 | 87,318 | 1,521 | |||||||||
| 5,192 | 1,906 | 114,749 | 2,128 | ||||||||||
| Noninterest expense | |||||||||||||
| Salaries and employee benefits | 936,485 | 441,367 | 2,941,668 | 606,867 | |||||||||
| Occupancy | 203,622 | 194,641 | 576,300 | 243,152 | |||||||||
| Professional services | 39,984 | 30,154 | 143,804 | 43,283 | |||||||||
| Data processing | 99,062 | 92,710 | 311,369 | 143,050 | |||||||||
| Office expenses | 95,754 | 103,705 | 280,963 | 144,980 | |||||||||
| Marketing | 55,312 | 81,396 | 159,869 | 111,000 | |||||||||
| Other | 36,185 | 10,593 | 92,882 | 13,303 | |||||||||
| Pre-Opening Expenses | — | — | — | 1,216,950 | |||||||||
| 1,466,404 | 954,566 | 4,506,855 | 2,522,585 | ||||||||||
| Loss before income taxes | ( 950,686 | ) | ( 772,225 | ) | ( 3,227,814 | ) | ( 2,258,199 | ) | |||||
| Provision for income taxes | — | — | 1,600 | — | |||||||||
| Net loss | $ | ( 950,686 | ) | $ | ( 772,225 | ) | $ | ( 3,229,414 | ) | $ | ( 2,258,199 | ) | |
| Per share data: | |||||||||||||
| Weighted-average shares outstanding | 2,281,300 | 2,280,000 | 2,280,952 | 2,280,000 | |||||||||
| Net loss, basic | $ | ( 0.42 | ) | $ | ( 0.34 | ) | $ | ( 1.42 | ) | $ | ( 0.99 | ) | |
PACIFIC COAST NATIONAL BANCORP
| Nine Months Ended September 30, 2006 | Nine Months Ended September 30, 2005 | ||||||
| Cash flows from operating activities: | |||||||
| Net loss | $ | ( 3,229,414 | ) | $ | ( 2,258,199 | ) | |
| Adjustments to reconcile net loss to net cash | |||||||
| used by operating activities: | |||||||
| Depreciation and amortization | 281,816 | 62,671 | |||||
| Provision for loan losses | 226,264 | 43,501 | |||||
| Provision for off balance sheet contingencies | 5,205 | 5,067 | |||||
| Amortization (accretion) of investment securities | ( 1,311 | ) | 248 | ||||
| Gain on Sale of Loans | ( 87,318 | ) | — | ||||
| Stock-based compensation | 1,218,182 | — | |||||
| Noncash expense for organizer warrants | — | 494,520 | |||||
| Other items, net | 65,292 | ( 276,882 | ) | ||||
| Net cash used by operating activities | ( 1,521,284 | ) | ( 1,929,074 | ) | |||
| Cash flows from investing activities: | |||||||
| Purchase or maturity of time deposits in other financial institutions | 2,750,000 | ( 750,000 | ) | ||||
| Purchase of investment securities held to maturity | ( 3,938,720 | ) | ( 5,998,175 | ) | |||
| Maturity of investment securities held to maturity | 2,000,000 | — | |||||
| Purchase or redemption of FRB stock | 59,900 | ( 585,000 | ) | ||||
| Proceeds from Sale of Loans | 1,558,650 | — | |||||
| Loan Originations | ( 16,567,012 | ) | ( 4,951,854 | ) | |||
| Purchases of bank premises and equipment | ( 348,510 | ) | ( 1,158,311 | ) | |||
| Net cash used in investing activities | ( 14,485,692 | ) | ( 13,443,340 | ) | |||
| Cash flows from financing activities: | |||||||
| Net increase in demand deposits and savings accounts | 21,330,934 | 6,642,679 | |||||
| Net increase in time deposits | 2,447,922 | 1,975,034 | |||||
| Net change in borrowings | — | ( 1,560,000 | ) | ||||
| Proceeds from sale of common stock | 16,250 | 22,800,000 | |||||
| Net cash provided by financing activities | 23,795,106 | 29,857,713 | |||||
| Net increase in cash and cash equivalents | 7,788,130 | 14,485,299 | |||||
| Cash and cash equivalents at beginning of year | 8,279,481 | 57,270 | |||||
| Cash and cash equivalents at end of year | $ | 16,067,611 | $ | 14,542,569 | |||
| Supplemental disclosure of cash flow information: | |||||||
| Interest paid | $ | 280,012 | $ | 21,675 | |||
| Income taxes paid | $ | 1,600 | $ | — | |||
See accompanying condensed notes to unaudited consolidated financial statements
PACIFIC COAST NATIONAL BANCORP
Note 1 - Basis of Presentation
The consolidated financial statements include the amounts of Pacific Coast National Bancorp (the “Company”) and its wholly-owned subsidiary, Pacific Coast National Bank (the “Bank”). All significant inter-company accounts have been eliminated on consolidation. The Bank opened for business on May 16, 2005. Prior to May 16, 2005, the Company was a “Development-Stage Company” as defined by Statement on Financial Standards 7. The cumulative loss from operations through the Company’s development period (July 2, 2003 to May 16, 2005) was $2.2 million.
The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America (GAAP) and with general practices within the banking industry. In preparing financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from those estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses, the estimation of compensation expense related to stock options granted to employees and directors, the valuation of real estate acquired in connection with or in lieu of foreclosure on loans, and valuation allowances associated with deferred tax assets, the recognition of which are based on future taxable income.
The consolidated interim financial statements included in this report are unaudited but reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the period ended September 30, 2006, are not necessarily indicative of the results of a full year’s operations. For further information, refer to the financial statements and footnotes included in the Company’s annual report on Form 10-KSB for the year ended December 31, 2005.
Note 2 - Loss Per Share
Loss per common share is based on the weighted average number of common shares outstanding during the period. The effects of potential common shares outstanding during the period would be included in diluted loss per share; however, the effect of potential shares would be antidilutive during all periods presented.
Note 3 - Stock-Based Compensation
The Company accounts for stock options and warrants issued to non-employees in accordance with Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling, Goods and Services.”
The Company accounts for stock-based employee compensation as prescribed by SFAS No. 123 (Revised), Share-Based Payment. This standard revises SFAS No. 123, APB Opinion No. 25 and related accounting interpretations, and eliminates the use of the intrinsic value method for employee stock-based compensation. SFAS No. 123 (R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award. Prior to January 1, 2006, the Company used the intrinsic value method of APB Opinion No. 25 to value share-based options granted to employees and board members. The new standard requires the expensing of all share-based compensation, including options, using the fair value-based method. The effective date of this standard for the Company was January 1, 2006.
During 2005 and 2006, the Company granted options to employees from its 2005 Stock Incentive Plan that received shareholder approval on April 17, 2006. The Company began to record compensation expense in accordance with SFAS 123 (Revised) in the second quarter of 2006. The Company is unable to estimate the impact of this Statement on its financial condition and results of operations as the decision to grant option awards is made annually on a case-by-case basis. The actual amount of expense will be based on the fair value of the Company’s stock when the Plan was approved and will be increased for any additional grants that are made in the future. However, based on the current fair value of the Company’s stock, a risk-free rate between 3.95% and 5.05%, expected volatility of 25%, and an expected life of between 6.5 and 8.5 years, the amount of compensation expense in 2006 related to options granted to date is estimated to be approximately $1.5 million for 2006, $750 thousand for 2007, and $200 thousand for 2008. These amounts are reflected in the financial statements as a part of current operating expenses, however they are returned to shareholders’ equity in the form of additional paid-in capital, resulting in no impact on total capital.
Note 4 - Current Accounting Pronouncements
As discussed in the preceding note, SFAS No.123 (R) became effective January 1, 2006 and has been fully implemented by the Company.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140.” The statement amends SFAS No. 140 by (1) requiring the separate accounting for servicing assets and servicing liabilities, which arise from the sale of financial assets; (2) requiring all separately recognized serving assets and servicing liabilities to be initially measured at fair value, if practicable; and (3) permitting an entity to choose between an amortization method or a fair value method for subsequent measurement for each class of separately recognized servicing assets and servicing liabilities. The Company must adopt the statement no later than January 1, 2007. Management does not expect that the adoption of this new standard will have a material impact on the Company’s financial position, results of operations or cash flows.
In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes.” This interpretation applies to all tax positions accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 clarifies the application of SFAS No. 109 by defining the criteria that an individual tax position must meet in order for the position to be recognized within the financial statements and provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition for tax positions. The Company must adopt the interpretation by January 1, 2007. Management does not expect that the adoption of this new interpretation will have a material impact on the Company’s financial position, results of operations or cash flows.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis presents the Company’s consolidated financial condition as of September 30, 2006 and results of operations for the three and nine months ended September 30, 2006 and 2005. The discussion should be read in conjunction with the financial statements and the notes related thereto which appear elsewhere in this Quarterly Report on Form 10-QSB.
This report contains certain statements that are forward-looking within the meaning of section 21E of the Securities Exchange Act of 1934, as amended. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from those expressed in, or implied by, the forward-looking statements. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “will continue,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” and other similar expressions or future or conditional verbs. Readers of this quarterly report should not rely solely on the forward-looking statements and should consider all uncertainties and risks throughout this report. The statements are representative only as of the date they are made, and the Company undertakes no obligation to update any forward-looking statement.
These forward-looking statements, implicitly and explicitly, include the assumptions underlying the statements and other information with respect to the Company’s beliefs, plans, objectives, goals, expectations, anticipations, estimates, financial condition, results of operations, future performance and business, including management’s expectations and estimates with respect to revenues, expenses, return on equity, return on assets, efficiency ratio, asset quality and other financial data and capital and performance ratios.
Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, these statements involve risks and uncertainties that are subject to change based on various important factors, some of which are beyond the control of the Company and the Board. The following factors, among others, could cause the Company’s results or financial performance to differ materially from its goals, plans, objectives, intentions, expectations and other forward-looking statements:
| · | the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels; |
| · | the failure of assumptions underlying the establishment of and provisions made to the allowance for credit losses; |
| · | changes in various monetary and fiscal policies and regulations, including those determined by the Board of Governors of the Federal Reserve System (FRB), the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC); |
| · | changes in general economic conditions and economic conditions in the geographic regions and industries in which the Bank operates which may affect, among other things, the level of nonperforming assets, charge-offs and provision expense; |
| · | adverse changes in the local real estate market, which is where most of the Bank’s loans are concentrated, the substantial majority of which have real estate as collateral; |
| · | changes in the availability of funds resulting in increased costs or reduced liquidity; |
| · | geopolitical conditions, including acts or threats of terrorism, actions taken by the United States or other governments in response to acts or threats of terrorism and/or military conflicts which could impact business and economics in the United States and abroad; |
| · | changes in market rates and prices which may adversely impact the value of financial products including securities, loans, deposits, debt and derivative financial instruments and other similar financial instruments; |
| · | changes in the interest rate environment, which may reduce interest margins and impact funding sources; |
| · | increased asset levels and changes in the composition of assets and the resulting impact on the capital levels and regulatory capital ratios of the Company or the Bank; |
| · | competition with other banks, thrifts, credit unions and other nonbank financial institutions and the willingness of users to substitute competitors’ products and services for the products and services offered by the Bank; |
| · | the ability to develop and introduce new banking-related products, services and enhancements and gain market acceptance of such products; |
| · | the ability to grow the Bank’s core businesses; |
| · | decisions to change or adopt new business strategies; |
| · | changes in tax laws, rules and regulations as well as Internal Revenue Service (IRS) and other governmental agencies’ interpretations thereof; |
| · | technological changes; |
| · | changes in consumer spending and savings habits; and |
| · | management’s ability to manage these and other risks. |
These factors and the risk factors referred to in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2005 could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by the Company, and you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made and the Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, management cannot assess the impact of each factor on business of the Company or the Bank or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Critical Accounting Policies
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. For example, the Company’s determination of the adequacy of its allowance for loan losses is particularly susceptible to management’s judgment and estimates. The following is a brief description of the Company’s current accounting policies involving significant management valuation judgments.
Allowance for Loan Losses
The allowance for loan losses represents management’s best estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. The allowance for loan losses is determined based on management’s assessment of several factors: reviews and evaluation of individual loans, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry groups, historical loan loss experiences and the levels of classified and nonperforming loans.
Loans are considered impaired if, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. In measuring the fair value of the collateral, management uses assumptions and methodologies consistent with those that would be utilized by unrelated third parties.
Changes in the financial condition of individual borrowers, in economic conditions, in historical loss experience and in the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for loan losses and the associated provision for loan losses.
Stock-Based Compensation
The Company accounts for stock-based employee compensation as prescribed by SFAS No. 123 (Revised), Share-Based Payment. This standard revises SFAS No. 123, APB Opinion No. 25 and related accounting interpretations, and eliminates the use of the intrinsic value method for employee stock-based compensation. SFAS No. 123 (R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award.
The estimates that are a part of the calculation for the compensation costs include the average life of the stock options, the future price of the Company’s stock when the options are exercised, and the average forfeiture of pre-vested options. These estimates have significant influence over the final expense and the Company does not have a history on which to base these assumptions. Please refer to Note 3 - Stock-Based Compensation of the Condensed Notes to the Unaudited Consolidated Financial Statements.
Deferred Tax Assets
Management estimates the need for a valuation allowance on deferred tax assets by comparing the total recorded to the amount available for carry back and the amount that will be utilized by estimated future earnings.
Executive Overview
Introduction
Pacific Coast National Bancorp is a bank holding company headquartered in San Clemente, California, offering a broad array of banking services through its wholly owned banking subsidiary, Pacific Coast National Bank. The Bank’s principal markets include the coastal regions of Southern Orange County and Northern San Diego County. As of September 30, 2006, the Company had, on a consolidated basis, total assets of $53.1 million, net loans of $25.1 million, total deposits of $36.1 million, and shareholders’ equity of $16.7 million. The Bank currently operates through a main office located at 905 Calle Amanecer in San Clemente, California and a branch office at 499 North El Camino Real in Encinitas, California.
The Company was incorporated under the laws of the State of California on July 2, 2003, to organize and serve as the holding company for the Bank. In 2005, the Company completed an initial public offering of its common stock, issuing 2,280,000 shares at a price of $10.00 per share. The net proceeds received from the offering were approximately $20.5 million. The Bank opened for business on May 16, 2005.
The following discussion focuses on the Company’s financial condition as of September 30, 2006 and results of operations for the three and nine months ended September 30, 2006 and 2005. The Company’s principal operations for this time period during 2006 consisted primarily of the operations of Pacific Coast National Bank. The Company’s principal operations for this time period during 2005 included four and one half months of operations related to raising capital and organizing the Bank, and four and one half months of Bank operations. Comparisons made here will relate to Bank operations and not the organizational phase of the Company.
Results of Operations
Net Interest Income and Net Interest Margin
Net interest income is the difference between interest income, principally from loan, lease and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Net interest income is our principal source of earnings. Changes in net interest income result from changes in volume, spread and margin. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Margin refers to net interest income divided by average interest-earning assets, and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.
Net interest income was $583 thousand for the three months ended September 30, 2006 compared to $219 thousand for the same time period in 2005. The net interest margin increased to 5.03% for the third quarter of 2006 from 3.60% for the third quarter of 2005. The Company earned 6.77% on its average interest-earning assets of $46.0 million for the third quarter of 2006 compared to 4.08% on $24.0 million in average earning assets for the third quarter of 2005. The growth in the loan portfolio and the investment portfolio as well as the increase in the overnight fund’s rate accounted for the increase in interest income from $248 thousand in 2005 to $785 thousand in 2006.
During the third quarter of 2006, loans accounted for 47% of earning assets, with an average yield of 8.63%, compared to the third quarter of 2005 when slightly more than 10% of the average earning assets were loans, with a yield of 8.59%. Total loan income, including loan fees of $42 thousand, was $470 thousand for the third quarter of 2006 compared to $54 thousand in total loan income, including $3 thousand in loan fees, in the third quarter of 2005.
Interest-bearing liabilities, consisting entirely of deposits, averaged $21.7 million with an average yield of 3.70% during the third quarter of 2006, compared with $5.1 million in interest-bearing deposits at a yield of 2.27% for the same period in 2005. The increase in yield on deposit products is the result of an increase in market rates and competitive pressures within the Bank’s market areas. Average non-interest bearing demand accounts increased as a percentage of average total deposits from 22% in the third quarter of 2005 to 31% in the third quarter of 2006.
The following table sets forth the Company’s average balances of assets, liabilities and shareholders’ equity, in addition to the major components of net interest income and the net interest margin for the quarters indicated.
Three Months Ended September 30, | |||||||||||||||||||
2006 | 2005 | ||||||||||||||||||
| ASSETS: | Average Balance | Income / Expense | Average Rate or Yield | Average Balance | Income / Expense | Average Rate or Yield | |||||||||||||
| (Dollars in Thousands) | (Dollars in Thousands) | ||||||||||||||||||
| Interest-earning assets: | |||||||||||||||||||
| Net loans and leases | $ | 21,581 | $ | 470 | 8.63 | % | $ | 2,493 | $ | 54 | 8.59 | % | |||||||
| Securities of U.S. government agencies | 7,811 | 88 | 4.47 | % | 2,760 | 29 | 4.22 | % | |||||||||||
| Other investment securities | 501 | 17 | 13.46 | % | 1,107 | 14 | 4.87 | % | |||||||||||
| Federal funds sold | 16,101 | 210 | 5.17 | % | 17,640 | 151 | 3.37 | % | |||||||||||
| Total interest-earning assets | 45,994 | 785 | 6.77 | % | 24,000 | 248 | 4.08 | % | |||||||||||
| Total noninterest-earning assets | 2,857 | 2,436 | |||||||||||||||||
| TOTAL ASSETS | $ | 48,851 | $ | 26,436 | |||||||||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY: | |||||||||||||||||||
| Interest-bearing liabilities: | |||||||||||||||||||
| NOW deposits | $ | 2,479 | $ | 9 | 1.44 | % | $ | 659 | $ | 1 | 0.60 | % | |||||||
| Money market and Savings deposits | 12,337 | 123 | 3.96 | % | 3,070 | 16 | 0.91 | % | |||||||||||
| Time certificates of deposit in denominations of $100,000 or more | 4,369 | 52 | 4.68 | % | 885 | 7 | 3.30 | % | |||||||||||
| Other time deposits | 2,466 | 18 | 2.97 | % | 505 | 5 | 3.58 | % | |||||||||||
| Total interest-bearing liabilities | 21,651 | 202 | 3.70 | % | 5,119 | 29 | 2.27 | % | |||||||||||
| Noninterest-bearing liabilities: | |||||||||||||||||||
| Noninterest-bearing deposits | 9,853 | 202 | 0 | 1,449 | 29 | 0 | |||||||||||||
| Other liabilities | 280 | 22 | |||||||||||||||||
| Total noninterest-bearing liabilities | 10,133 | 1,471 | |||||||||||||||||
| SHAREHOLDERS’ EQUITY | 17,067 | 19,846 | |||||||||||||||||
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 48,851 | $ | 26,436 | |||||||||||||||
| Net interest income | $ | 583 | $ | 219 | |||||||||||||||
| Net interest spread | 3.07 | % | 1.81 | % | |||||||||||||||
| Net interest margin | 5.03 | % | 3.60 | % | |||||||||||||||
The following table sets forth the Company’s average balances of assets, liabilities and shareholders’ equity, in addition to the major components of net interest income and the net interest margin for the nine month periods indicated.
2006 | 2005 | ||||||||||||||||||
| ASSETS: | Average Balance | Income / Expense | Average Rate or Yield | Average Balance | Income / Expense | Average Rate or Yield | |||||||||||||
| (Dollars in Thousands) | (Dollars in Thousands) | ||||||||||||||||||
| Interest-earning assets: | |||||||||||||||||||
| Net loans and leases | $ | 17,609 | $ | 1,090 | 8.27 | % | $ | 1,990 | $ | 63 | 8.44 | % | |||||||
| Securities of U.S. government agencies | 7,934 | 260 | 4.38 | % | 1,897 | 29 | 4.07 | % | |||||||||||
| Other investment securities | 1,700 | 57 | 4.52 | % | 578 | 18 | 8.30 | % | |||||||||||
| Federal funds sold | 10,214 | 382 | 5.00 | % | 17,117 | 226 | 3.52 | % | |||||||||||
| Total interest-earning assets | 37,457 | 1,789 | 6.38 | % | 21,581 | 336 | 4.15 | % | |||||||||||
| Total noninterest-earning assets | 2,731 | 2,124 | |||||||||||||||||
| TOTAL ASSETS | $ | 40,188 | $ | 23,705 | |||||||||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY: | |||||||||||||||||||
| Interest-bearing liabilities: | |||||||||||||||||||
| NOW deposits | $ | 1,676 | $ | 17 | 1.36 | % | $ | 515 | $ | 1 | 0.52 | % | |||||||
| Money market and Savings deposits | 7,621 | 193 | 3.39 | % | 2,470 | 17 | 1.83 | % | |||||||||||
| Time certificates of deposit in denominations of $100,000 or more | 3,809 | 60 | 2.11 | % | 552 | 9 | 4.35 | % | |||||||||||
| Other time deposits | 2,360 | 128 | 7.25 | % | 637 | 5 | 2.09 | % | |||||||||||
| Total interest-bearing liabilities | 15,466 | 399 | 3.45 | % | 4,174 | 32 | 2.04 | % | |||||||||||
| Noninterest-bearing liabilities: | |||||||||||||||||||
| Noninterest-bearing deposits | 6,801 | 399 | 0 | 1,175 | 32 | 0 | |||||||||||||
| Other liabilities | 227 | 17 | |||||||||||||||||
| Total noninterest-bearing liabilities | 7,028 | 1,192 | |||||||||||||||||
| SHAREHOLDERS’ EQUITY | 17,694 | 18,339 | |||||||||||||||||
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 40,188 | $ | 23,705 | |||||||||||||||
| Net interest income | $ | 1,391 | $ | 305 | |||||||||||||||
| Net interest spread | 2.93 | % | 2.11 | % | |||||||||||||||
| Net interest margin | 4.96 | % | 3.77 | % | |||||||||||||||
The average balances shown for 2005 were calculated using only the days that the Bank was open for business. Therefore, the year-to-date averages for 2005 include approximately 137 days’ average balances. Calculating the averages using the number of days in the year, while mathematically correct, would not produce a meaningful result.
Changes in volume and changes in interest rates affect the Company’s interest income and interest expense. The effect of these changes is typically displayed in a volume, mix and rate analysis table which compares the changes in income and expense over periods. Since the Company has a limited operating history, comparisons are not yet meaningful.
Provision for Loan Losses
A provision for loan losses is determined that is considered sufficient to maintain an allowance to absorb probable losses inherent in the loan portfolio as of the balance sheet date. For additional information concerning this determination, see the section of this discussion and analysis captioned “Allowance for Loan Losses.”
In the three and nine months ended September 30, 2006, the provision for loan and lease losses was $72 thousand and $226 thousand respectively. Because the Bank has no loss history on which to build assumptions for future loan losses, a national bank peer group average was used. There were no charge-offs through September 30, 2006. One non-performing loan was identified during the fourth quarter of 2006, for $5 thousand, and has been subsequently charged off.
Noninterest Income
The non-interest income for the quarter ended September 30, 2006, was $5 thousand, related entirely service charges on deposit accounts and merchant discount income. For the nine months ended September 30, 2006, noninterest income was $115 thousand including $87 thousand on gain on sale of SBA loans. Fees on deposit accounts and merchant discount income make up the remainder of the noninterest income. For the period ended September 30, 2005, $2 thousand in fee income was collected in service charges.
Noninterest Expense
Total noninterest expense was $1.5 million in the third quarter of 2006 and $4.5 million for the first three quarters of 2006. Included in this expense are $284 thousand and $1.2 million representing a portion of the expense for the employee and director stock options granted from May 16, 2005 through September 30, 2006. For additional information concerning this accounting treatment, see Condensed Notes to the Unaudited Financials Statements, Note 3 - Stock-Based Compensation.
For the same periods in 2005, noninterest expense was $955 thousand and $2.5 million respectively. Of that expense, $1.2 million was attributable to pre-opening costs for the nine months ended September 30, 2005. Therefore comparisons of the two years’ noninterest expenses are not meaningful.
The major components of the 2006 expense are discussed below. As the Bank grows, management is committed to controlling costs and expects to moderate noninterest expenses relative to revenue growth.
Salaries and employee benefits totaled $936 thousand for the third quarter and $2.9 million for the first three quarters of 2006. Included in this category, representing a portion of the expense for the employee stock options granted from May 16, 2005, through September 30, 2006, is $276 thousand for the third quarter of 2006, and $1.2 million year to date. SFAS No. 123 (R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award.
Employee benefit costs including employer taxes and group insurance accounted for approximately 10% of this expense for the third quarter and first three quarters of 2006. The Bank employed 29 full-time equivalent (FTE) employees as of September 30, 2006 compared to 21 FTE as of September 30, 2005. The volume of assets per employee as of the end of the third quarter of 2006 was $1,831,000 compared to $1,338,000 at the end of September 2005.
Occupancy and equipment expenses totaled $204 thousand and $576 thousand for the three and nine month periods ended September 30, 2006, attributable primarily to lease costs of $91 thousand and $259 thousand, and depreciation expense of fixed asset and tenant improvement of $81 thousand and $235 thousand respectively.
Professional fees of $40 thousand for the third quarter of 2006 were primarily attributable to internal and external auditing fees of $25 thousand, expenses related to the annual shareholders’ meeting of $6 thousand, and legal fees of $4 thousand. For the first three quarters of 2006, professional fees totaled $144 thousand, consisting of $45 thousand in legal fees, $56 thousand in accounting and audit fees, $17 thousand in compliance fees, and $26 thousand in expenses related to the preparation of the 10-KSB and the annual shareholders’ meeting.
Data processing expense was $99 thousand for the third quarter of 2006, attributable primarily to costs associated with the core processing system of $35 thousand, network maintenance and security of $21 thousand, software amortization of $16 thousand, and website maintenance of $15 thousand. For the first three quarters of 2006, data processing expense was $311 thousand, attributable primarily to costs associated with the core processing system of $112 thousand, network maintenance and security of $68 thousand, software amortization of $47 thousand, and website maintenance of $40 thousand. Most of these expenses are routine in nature and are expected to be fairly consistent. Network administration and security expense can fluctuate as new employees and new products are added.
Office expenses of $96 thousand for the third quarter of 2006 included auto and mileage expense of $21 thousand; office supplies of $19 thousand; waived check printing charges of $11 thousand; fidelity bond and other insurance premiums of $10 thousand; regulatory assessments of $7 thousand; armored car and courier expense of $6 thousand; recruiting expenses of $5 thousand; and workers compensation insurance premiums of $3 thousand. For the nine months ended September 30, 2006, these same expenses were $281 thousand consisting of auto and mileage expense of $60 thousand; office supplies of $49 thousand; fidelity bond and other insurance premiums of $32 thousand; workers compensation insurance premiums of $33 thousand; armored car and courier expense of $24 thousand; waived check printing charges of $24 thousand; recruiting expenses of $13 thousand; and regulatory assessments of $20 thousand.
Promotional expenses were $55 thousand for the third quarter of 2006. This included expenses related to direct mail campaigns to local businesses, sponsorship of key community events, and specific officer-calling programs in the bank’s target market. For the nine months ended September 30, 2006, promotional expenses were $160 thousand.
Other expenses for the third quarter of 2006 of $36 thousand consisted of $13 thousand in loan production costs, such as appraisals and credit reports, many of which will be reimbursed at the time the loans are funded, $8 thousand related to the annual meeting costs, $6 thousand related to director training, and $8 thousand related to the directors’ stock options as outlined in FAS 123(R). For the nine months ended September 30, 2006, other expenses totaled $93 thousand which included $5 thousand for contingent liabilities, $22 thousand in loan-related costs, and $36 thousand related to the annual meeting notification, $15 thousand related to director training, and $14 thousand related to director stock option expense.
Income Taxes
$2 thousand in state taxes were paid during the second quarter of 2006. No federal tax expense or federal or state tax benefit has been recorded for the quarter ended September 30, 2006 based upon net operating losses. The Company will begin to recognize income tax benefit at the time it becomes profitable.
Financial Condition as of September 30, 2006
Total assets as of September 30, 2006, were $53.1 million, consisting primarily of cash and investments of $26.0 million and net loans of $25.1 million. Total deposits were $36.1 million and shareholder’s equity was $16.7 million.
Short-Term Investments and Interest-bearing Deposits in Other Financial Institutions
At September 30, 2006, the Bank had $13.6 million in federal funds (“fed funds”) sold. Federal funds sold allow the Bank to meet liquidity requirements and provide temporary holdings until the funds can be otherwise deployed or invested. At December 31, 2005, the Bank had an interest-bearing deposit of $2 million with Union Bank of California pledged as collateral for a financial letter of credit issued on behalf of one of the Bank’s customers. This deposit had a term of 180 days and a rate of 4%. This time deposit matured on May 22, 2006, and was moved into the Bank’s fed funds investment. Also at December 31, 2005, the holding company had a time deposit of $750 thousand at The Independent BankersBank. This deposit matured on January 25, 2006 and was not renewed.
Investment Securities
The investment portfolio serves primarily as a source of interest income and, secondarily, as a source of liquidity and a management tool for the Bank’s interest rate sensitivity. The investment portfolio is managed according to a written investment policy established by the Bank’s Board of Directors and implemented by the Investment/Asset-Liability Committee.
At September 30, 2006, the Bank’s investment securities consisted of $10.0 million in U.S. government-sponsored agencies, with a book value of $9.9 million, an estimated fair value of $9.90 million and a weighted average yield of 4.7%, and $494 thousand in Federal Reserve Bank Stock, having a book value of $494 thousand, an estimate fair value of $494 thousand, and a weighted average yield of 6.0%. At September 30, 2006, none of these investment securities were pledged as collateral for any purpose.
The table below sets forth the amounts and distribution of the investment securities and the weighted average yields as of the dates indicated.
As of September 30, 2006: | Book Value | Market Value | Weighted Average Yield | |||||||
Securities held to maturity | ||||||||||
U.S. Government and Agency Securities: | ||||||||||
| Within One Year | $ | 3,998,230 | $ | 3,980,020 | 4.26 | % | ||||
| One to Five Years | 5,939,744 | 5,939,744 | 4.96 | % | ||||||
Total Securities held to maturity | $ | 9,937,974 | $ | 9,919,764 | 4.68 | % | ||||
As of December 31, 2005: | Book Value | Market Value | Weighted Average Yield | |||||||
Securities held to maturity | ||||||||||
U.S. Government and Agency Securities: | ||||||||||
| Within One Year | $ | 6,001,108 | $ | 5,984,120 | 4.17 | % | ||||
| One to Five Years | 1,996,835 | 1,983,760 | 4.35 | % | ||||||
Total Securities held to maturity | $ | 7,997,943 | $ | 7,967,880 | 4.22 | % | ||||
Loan Portfolio
The Bank’s primary source of income is interest on loans. The following table presents the composition of the loan portfolio by category as of the dates indicated:
| September 30, 2006 | December 31, 2005 | ||||||
| Real estate | |||||||
| Commercial | $ | 13,499,960 | $ | 7,249,730 | |||
| Construction | 2,210,514 | - | |||||
| 1-4 Family - Revolving | 1,492,074 | 541,382 | |||||
| Commercial | 8,217,692 | 2,483,127 | |||||
| Consumer | 77,750 | 72,259 | |||||
| Gross Loans | 25,497,990 | 10,346,498 | |||||
| Deferred loan fees | ( 84,980 | ) | ( 29,168 | ) | |||
| Allowance for loan losses | ( 313,472 | ) | ( 87,208 | ) | |||
| Net Loans | $ | 25,099,538 | $ | 10,230,122 | |||
Net loans as a percentage of total assets were 47.3% as of September 30, 2006, and 32.8% as of December 31, 2005.
The real estate loan portfolio is comprised of short-term mortgage loans secured typically by commercial properties, occupied by the borrower, have terms of three to seven years with both fixed and floating rates, and revolving lines of credit granted to consumers, secured by equity in residential properties, as well as construction loans. Construction loans consist primarily of single-family residential properties, have a term of less than one year and have floating rates and commitment fees. Construction loans are typically made to builders that have an established record of successful project completion and loan repayment. At September 30, 2006, the Bank held $13.5 million in commercial real estate loans outstanding, representing 52.9% of gross loans receivable, with undisbursed commitments of $1.3 million, $2.2 million in construction loans representing 8.7% of gross loans receivable with undisbursed commitments of $1.2 million, and $1.5 million in revolving lines secured by 1-4 family residences representing 5.9% of gross loans receivable with undisbursed commitments of $2.1 million.
The commercial loan portfolio is comprised of lines of credit for working capital and term loans to finance equipment and other business assets. The lines of credit typically are limited to a percentage of the value of the assets securing the line. Lines of credit and term loans typically are reviewed annually and can be supported by accounts receivable, inventory, equipment and other assets of the client’s businesses. At September 30, 2006, the Bank held $8.2 million in commercial loans outstanding, representing 32.2% of gross loans receivable, and undisbursed commitments of $3.6 million.
The consumer loan portfolio consists of personal lines of credit and loans to acquire personal assets such as automobiles and boats. The lines of credit generally have terms of one year and the term loans generally have terms of three to five years. The lines of credit typically have floating rates. At September 30, 2006, consumer loans totaled $78 thousand, representing 0.3% of gross loans receivable and undisbursed commitments of $43 thousand.
Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. The Bank has established select concentrations percentages within the loan portfolio. It also includes families of credit considered of either higher risk or worthy of further review as part of its concentration reporting. While the framework has been set in place to evaluate the Bank’s potential risk in its portfolio, the overall concentration results are not yet meaningful.
Management may renew loans at maturity when requested by a customer whose financial strength appears to support such a renewal or when such a renewal appears to be in the best interest of the Bank. The Bank requires payment of accrued interest in such instances and may adjust the rate of interest, require a principal reduction, or modify other terms of the loan at the time of renewal. Loan terms vary according to loan type. The following table shows the maturity distribution of loans and leases as of September 30, 2006:
As of September 30, 2006 | |||||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||
One Year | Over 1 Year | ||||||||||||||||||
or Less | through 5 Years | Over 5 Years | Total | ||||||||||||||||
Fixed Rate | Floating or Adjustable Rate | Fixed Rate | Floating or Adjustable Rate | ||||||||||||||||
| Real estate — construction | $ | 2,211 | $ | — | $ | — | $ | — | $ | — | $ | 2,211 | |||||||
| Real estate — secured | 4,695 | — | 10,297 | — | — | 14,992 | |||||||||||||
| Commercial and industrial | 3,286 | 3,932 | 324 | 675 | — | 8,217 | |||||||||||||
| Consumer | �� | 8 | 70 | — | — | — | 78 | ||||||||||||
| Total | $ | 10,200 | $ | 4,002 | $ | 10,621 | $ | 675 | $ | — | $ | 25,498 | |||||||
Nonperforming Loans, Leases and Assets
Nonperforming assets consist of loans and leases on nonaccrual status, loans 90 days or more past due and still accruing interest, loans that have been restructured resulting in a reduction or deferral of interest or principal, OREO, and other repossessed assets. As of September 30, 2006, there were no nonperforming assets.
A potential problem loan is defined as a loan where information about possible credit problems of the borrower is known, causing management to have serious doubts as to the ability of the borrower to comply with the present loan payment terms and which may result in the inclusion of such loan in one of the nonperforming asset categories. An internally classified loan list is maintained that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. Loans classified as “special mention” are those that contain a weakness that, if left unattended, could develop into a problem affecting the ultimate collectibility of the loan. Loans classified as “substandard” are those loans with clear and defined weaknesses, such as highly leveraged positions, unfavorable financial ratios, uncertain repayment resources or poor financial condition, which may jeopardize recoverability of the loan. Loans classified as “doubtful” are those loans that have characteristics similar to substandard loans, but also have an increased risk that loss may occur or at least a portion of the loan may require a charge-off if liquidated at present. Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans may include some loans that are past due at least 90 days, are on nonaccrual status or have been restructured. Loans classified as “loss” are those loans that are in the process of being charged-off. The Bank had no loans classified in these categories at September 30, 2006.
Allowance for Loan Losses
Implicit in the Bank’s lending activities is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made and the creditworthiness of the borrower over the term of the loan. To reflect the currently perceived risk of loss associated with the loan portfolio, additions are made to the allowance for loan losses in the form of direct charges against income to ensure that the allowance is available to absorb possible loan losses. The factors that influence the amount include, among others, the remaining collateral and/or financial condition of the borrowers, historical loan loss, changes in the size and composition of the loan portfolio, and general economic conditions.
The amount of the allowance equals the cumulative total of the provisions made from time to time, reduced by loan charge-offs and increased by recoveries of loans previously charged-off. Beginning with the second quarter of 2006, the adequacy of the Bank’s allowance for loan losses has been determined through a comparison to the Bank’s peer group as defined by the OCC. The Bank will continue to maintain an equivalent allowance until management has adequate historical data upon which to base a different level. The peer group currently maintains an average allowance for loan losses of approximately 1.22% of the outstanding principal. The Bank’s allowance was $313 thousand, or 1.23% of outstanding principal as of September 30, 2006. The Bank had not incurred any loan losses as of September 30, 2006.
The following table sets forth information concerning the allocation of the allowance for loan losses, which is maintained on the Bank’s loan portfolio, by loan category at September 30, 2006.
| Amount | Percentage of loans in each category to total loans | Percentage of allowance at September 30, 2006 | Percentage of reserves to net loans by category | ||||||||||
| Real estate | $ | 128,801 | 67.5 | % | 41.1 | % | 0.7 | % | |||||
| Commercial | 51,203 | 32.2 | % | 16.3 | % | 0.6 | % | ||||||
| Consumer | 6,143 | 0.3 | % | 2.0 | % | 7.9 | % | ||||||
| Unallocated | 127,325 | 40.6 | % | ||||||||||
| Total Allowance for Loan Losses | $ | 313,472 | 100.0 | % | 100.0 | % | 1.23 | % | |||||
In addition, a separate allowance for credit losses on off-balance sheet credit exposures is maintained for the undisbursed portion of approved loans. Although the loss exposure to the Bank is reduced because the funds have not been released to the borrower, under certain circumstances the Bank may be required to continue to disburse funds on a troubled credit. As of September 30, 2006, this allowance was $21 thousand.
Credit and loan decisions are made by management and the Board of Directors in conformity with loan policies established by the board of directors. The Bank’s practice is to charge-off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower’s failure to meet repayment terms, the borrower’s deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loan’s classification as a loss by regulatory examiners, or other reasons. During the third quarter of 2006, there were no charge-offs.
Nonearning Assets
Premises, leasehold improvements and equipment totaled $1.2 million at September 30, 2006, net of accumulated depreciation of $405 thousand. There are no definitive agreements regarding acquisition or disposition of owned or leased facilities.
Deposits
Deposits are the Bank’s primary source of funds. The following table sets forth, for the period indicated, the distribution of the average deposit account balances and average cost of funds on each category of deposits:
Three Months Ended September 30, 2006 | ||||||||||
Average Balance | Percent of Deposits | Average Rate | ||||||||
(Dollars in thousands) | ||||||||||
| Noninterest-bearing demand deposits | $ | 10,775 | 33 | % | 0 | % | ||||
| Money market deposits | 12,228 | 38 | % | #REF! | ||||||
| NOW deposits | 2,479 | 8 | % | 1.44 | % | |||||
| Savings deposits | 109 | 0 | % | 3.96 | % | |||||
| Time certificates of deposit in denominations of $100,000 or more | 4,369 | 13 | % | 4.68 | % | |||||
| Other time deposits | 2,466 | 8 | % | 3.70 | % | |||||
| Total deposits | $ | 32,426 | 100 | % | 2.54 | % | ||||
The following table sets forth the amount and maturities of the time deposits as of September 30, 2006:
At September 30, 2006 | ||||||||||
Time Deposits of $100,000 or more | Other Time Deposits | Total Time Deposits | ||||||||
(Dollars in thousands) | ||||||||||
| Three months or less | $ | 2,501 | 727 | $ | 3,228 | |||||
| Over three months through six months | 801 | 619 | 1,420 | |||||||
| Over six months through 12 months | 834 | 733 | 1,567 | |||||||
| Over 12 months | — | 112 | 112 | |||||||
| Total | $ | 4,136 | $ | 2,191 | $ | 6,327 | ||||
Return on Equity and Assets
The following table sets forth certain information regarding the Company’s return on equity and assets for the nine months ended September 30, 2006:
| Return on average assets | -10.74 | % | ||
| Return on average equity | -24.40 | % | ||
| Dividend payout ratio | 0 | % | ||
| Equity to assets ratio | 32.1 | % | ||
Off-Balance Sheet Arrangements and Loan Commitments
In the ordinary course of business, the Bank enters into various off-balance sheet commitments and other arrangements to extend credit that are not reflected in the consolidated balance sheets of the Company. The business purpose of these off-balance sheet commitments is the routine extension of credit. As of September 30, 2006, commitments to extend credit included approximately $10 thousand for letters of credit, $5.2 million for revolving lines of credit arrangements including $2.1 million in real-estate secured lines, and $3.0 million in unused commitments for commercial and real estate secured loans. The Bank faces the risk of deteriorating credit quality of borrowers to whom a commitment to extend credit has been made; however, no significant credit losses are expected from these commitments and arrangements.
Borrowings
The Company has access to a variety of borrowing sources including federal funds purchased. As of September 30, 2006, there were no borrowings outstanding.
Capital Resources and Capital Adequacy Requirements
Risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Under the regulations, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk weighted assets and off-balance sheet items. Under the prompt corrective action regulations, to be adequately capitalized a bank must maintain minimum ratios of total capital to risk-weighted assets of 8.00%, Tier 1 capital to risk-weighted assets of 4.00%, and Tier 1 capital to total assets of 4.00%. Failure to meet these capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements.
As of September 30, 2006, the Bank was categorized as well-capitalized. A well-capitalized institution must maintain a minimum ratio of total capital to risk-weighted assets of at least 10.00%, a minimum ratio of Tier 1 capital to risk weighted assets of at least 6.00%, and a minimum ratio of Tier 1 capital to total assets of at least 5.00% and must not be subject to any written order, agreement, or directive requiring it to meet or maintain a specific capital level.
The following table sets forth the Bank’s capital ratios as of the dates specified:
| To Be Well | |||||||||||||||||||
| Capitalized Under | |||||||||||||||||||
| For Capital | Prompt Corrective | ||||||||||||||||||
| Actual | Adequacy Purposes | Action Provisions | |||||||||||||||||
| Amount | Amount | Amount | |||||||||||||||||
| (Thousands) | Ratio | (Thousands) | Ratio | (Thousands) | Ratio | ||||||||||||||
As of September 30, 2006: | |||||||||||||||||||
| Total Capital (to Risk-Weighted Assets) | $ | 16,141 | 62.6 | % | $ | 2,064 | 8.0 | % | $ | 2,580 | 10.0 | % | |||||||
| Tier 1 Capital (to Risk-Weighted Assets) | $ | 15,809 | 61.3 | % | $ | 1,032 | 4.0 | % | $ | 1,548 | 6.0 | % | |||||||
| Tier 1 Capital (to Average Assets) | $ | 15,809 | 32.4 | % | $ | 1,954 | 4.0 | % | $ | 2,443 | 5.0 | % | |||||||
As of December 31, 2005: | |||||||||||||||||||
| Total Capital (to Risk-Weighted Assets) | $ | 17,841 | 101.7 | % | $ | 1,403 | 8.0 | % | $ | 1,754 | 10.0 | % | |||||||
| Tier 1 Capital (to Risk-Weighted Assets) | $ | 17,738 | 101.2 | % | $ | 701 | 4.0 | % | $ | 1,052 | 6.0 | % | |||||||
| Tier 1 Capital (to Average Assets) | $ | 17,738 | 64.1 | % | $ | 1,108 | 4.0 | % | $ | 1,385 | 5.0 | % | |||||||
Liquidity Management
At September 30, 2006, the Company (excluding the Bank) had approximately $907 thousand in cash. These funds can be used for Company operations, investment and for later infusion into the Bank and other corporate activities. The primary source of liquidity for the Company will be dividends paid by the Bank. The Bank is currently restricted from paying dividends without regulatory approval that will not be granted until the accumulated deficit has been eliminated.
The Bank’s liquidity is monitored by its staff, the Investment/Asset-Liability Committee and the Board of Directors, who review historical funding requirements, current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments.
The Bank’s primary sources of funds is retail and commercial deposits, loan and securities repayments, other short-term borrowings, and other funds provided by operations. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan prepayments are more influenced by interest rates, general economic conditions, and competition. The Bank maintains investments in liquid assets based upon management’s assessment of (1) the need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets, and (4) objectives of the asset/liability management program.
As loan demand increases, greater pressure will be exerted on the Bank’s liquidity. However, it is management’s intention to maintain a conservative loan to deposit ratio in the range of 80% - 85% over time. Given this goal, the Bank will not aggressively pursue lending opportunities if sufficient funding sources (i.e., deposits, Fed Funds, etc.) are not available, nor will the Bank seek to attract transient volatile, non-local deposits with above market interest rates. As of September 30, 2006, the loan to deposit ratio was 71%.
The Bank had cash and cash equivalents of $16.1 million, or 30% of total Bank assets, at September 30, 2006. Management feels that the Bank has adequate liquidity to meet anticipated future funding needs.
The Bank is subject to various regulatory capital requirements administered by federal and state banking agencies, which could affect its ability to pay dividends to the Company. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on our financial statements. The minimum ratios required for the Bank to be considered “well capitalized” for regulatory purposes, and therefore eligible to consider the payment of dividends to the Company, will be 10% total capital to risk weighted assets, 6% tier 1 capital to risk weighted assets and 5% tier 1 capital to average assets. At September 30, 2006, the Bank was considered “well capitalized” by regulatory standards.
Quantitative and Qualitative Disclosure About Market Risks
Interest rate risk is the most significant market risk affecting the Bank. Other types of market risk, such as foreign currency risk and commodity price risk, do not arise in the normal course of the Bank’s business activities. Interest rate risk can be defined as the exposure to a movement in interest rates that could have an adverse effect on the net interest income or the market value of the Bank’s financial instruments. The ongoing monitoring and management of this risk is an important component of the asset and liability management process, which is governed by policies established by the Company’s Board of Directors and carried out by the Bank’s Investment/Asset-liability Committee. The Investment/Asset-liability Committee’s objectives are to manage the exposure to interest rate risk over both the one year planning cycle and the longer term strategic horizon and, at the same time, to provide a stable and steadily increasing flow of net interest income.
The primary measurement of interest rate risk is earnings at risk, which is determined through computerized simulation modeling. The primary simulation model assumes a static balance sheet, using the balances, rates, maturities and repricing characteristics of all of the Bank’s existing assets and liabilities. Net interest income is computed by the model assuming market rates remaining unchanged and comparing those results to other interest rate scenarios with changes in the magnitude, timing and relationship between various interest rates. At September 30, 2006, an analysis was performed using the ALXpert model provided through ALX Consulting, Inc. and utilizing the Bank’s quarterly Call Report data. The table below shows the impact of rising and declining interest rate simulations in 100 basis point increments over a 12-month period. Changes in net interest income in the rising and declining rate scenarios are measured against the current net interest income. The changes in equity capital represent the changes in the present value of the balance sheet without regards to business continuity, otherwise known as “liquidation value”. Because the Bank is asset-sensitive, the net interest margin improves as rates rise and declines as rates decline.
| Interest Rate Shock | ||||||||||||||||
| Shock | -2% | -1% | Annualized* | +1% | +2% | |||||||||||
| Fed Funds Rate | 3.25% | 4.25% | 5.25% | 6.25% | 7.25% | |||||||||||
| Net Interest Income Change | (289 | ) | (144 | ) | — | 144 | 289 | |||||||||
| % Change | -12.5 | % | -6.3 | % | — | 6.3 | % | 12.5 | % | |||||||
| Equity Capital Change % | -2.2 | % | — | 2.2 | % | |||||||||||
| Net Interest Margin | 4.4 | % | 4.7 | % | 5.0 | % | 5.4 | % | 5.7 | % | ||||||
The following table sets forth, on a stand-alone basis, the Bank’s amounts of interest-earning assets and interest-bearing liabilities outstanding at September 30, 2006, which are anticipated, based upon certain assumptions, to reprice or mature in each of the future time periods shown. The projected repricing of assets and liabilities anticipates prepayments and scheduled rate adjustments, as well as contractual maturities under an interest rate unchanged scenario within the selected time intervals. While it is believed that such assumptions are reasonable, there can be no assurance that assumed repricing rates will approximate actual future deposit activity.
As of September 30, 2006 | ||||||||||||||||||||||
Volumes Subject to Repricing Within | ||||||||||||||||||||||
0-1 Days | 2-90 Days | 91-365 Days | 1-3 Years | Over 3 Years | Non-Interest Sensitive | Total | ||||||||||||||||
Assets: | (Dollars in thousands) | |||||||||||||||||||||
| Cash, fed funds and other | $ | 13,640 | $ | — | $ | — | $ | — | $ | — | $ | 2,428 | $ | 16,068 | ||||||||
| Investments and FRB Stock (1) | — | 4,000 | 1,998 | 1,980 | 2,455 | — | 10,433 | |||||||||||||||
| Loans (2) | — | 8,033 | 2,168 | 5,429 | 9,868 | — | 25,498 | |||||||||||||||
| Fixed and other assets | — | — | — | — | — | 1,113 | 1,113 | |||||||||||||||
| Total Assets | $ | 13,640 | $ | 12,033 | $ | 4,166 | $ | 7,409 | $ | 12,323 | $ | 3,541 | $ | 53,113 | ||||||||
Liabilities and Stockholders’ Equity: | ||||||||||||||||||||||
| Interest-bearing checking, savings and money market accounts | $ | 18,767 | $ | — | $ | — | $ | — | $ | — | $ | 11,039 | $ | 29,806 | ||||||||
| Certificates of deposit | — | 3,228 | 2,987 | 32 | 80 | — | 6,327 | |||||||||||||||
| Borrowed funds | — | — | — | — | — | — | — | |||||||||||||||
| Other liabilities | — | — | — | — | — | 265 | 265 | |||||||||||||||
| Stockholders’ equity | — | — | — | — | — | 16,715 | 16,715 | |||||||||||||||
| Total liabilities and stockholders’ equity | $ | 18,767 | $ | 3,228 | $ | 2,987 | $ | 32 | $ | 80 | $ | 28,019 | $ | 53,113 | ||||||||
| Interest rate sensitivity gap | $ | (5,127 | ) | $ | 8,805 | $ | 1,179 | $ | 7,377 | $ | 12,243 | |||||||||||
| Cumulative interest rate sensitivity gap | $ | (5,127 | ) | $ | 3,678 | $ | 4,857 | $ | 12,234 | $ | 24,477 | |||||||||||
| Cumulative gap to total assets | -9.7 | % | 6.9 | % | 9.1 | % | 23.0 | % | 46.1 | % | ||||||||||||
| Cumulative interest-earning assets to cumulative interest-bearing liabilities | 72.7 | % | 116.7 | % | 119.4 | % | 148.9 | % | 197.5 | % | ||||||||||||
(1) Excludes investments' mark-to-market adjustments
(2) Excludes deferred fees and allowance for loan losses
Certain shortcomings are inherent in the method of analysis presented in the gap table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Additionally, certain assets, such as adjustable-rate loans, have features that restrict changes in interest rates, both on a short-term basis and over the life of the asset. More importantly, changes in interest rates, prepayments and early withdrawal levels may deviate significantly from those assumed in the calculations in the table. As a result of these shortcomings, the Bank will focus more on earnings at risk simulation modeling than on gap analysis. Even though the gap analysis reflects a ratio of cumulative gap to total assets within acceptable limits, the earnings at risk simulation modeling is considered by management to be more informative in forecasting future income at risk.
With the participation of management, the Company’s chief executive officer and the chief financial officer reviewed and evaluated the Company’s disclosure controls and procedures as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on this evaluation, the chief executive officer and chief financial officer concluded that the disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported to the Company’s management within the time periods specified in the Securities and Exchange Commission’s rules and forms.
During the period covered by this report, the Company revised its internal controls and procedures as they relate to the implementation of new accounting pronouncements, in light of the error resulting from an incorrect interpretation of Statement of Financial Accounting Standards No. 123 (revised), “Share-Based Payments” in connection with the preparation of the its Form 10-QSB for the quarter ended June 30, 2006. Accordingly, the Company will monitor all new accounting pronouncements and make a determination whether sufficient expertise exists within the company to evaluate and apply the standards set forth in such new accounting pronouncements. In the event that management determines that additional resources are necessary to evaluate the impact of the new accounting pronouncements on the company's financial statements, management will engage a qualified accounting firm to assist management in the implementation of the new accounting pronouncements.
Except as described above, there have been no significant changes in the Company’s internal controls for financial reporting or in other factors that could significantly affect these controls, including any significant deficiencies or material weaknesses of internal controls that would require corrective action. However, the Company periodically reviews and documents its disclosure controls and procedures, including its internal accounting controls, and may from time to time make changes aimed at enhancing their effectiveness and ensuring that the Company’s systems evolve with its business.
With the participation of management, the Company’s chief executive officer and the chief financial officer reviewed and evaluated the Company’s disclosure controls and procedures as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on this evaluation, the chief executive officer and chief financial officer concluded that the disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported to the Company’s management within the time periods specified in the Securities and Exchange Commission’s rules and forms.
On October 30, 2006, Pacific Coast National Bancorp filed an amended Quarterly Report on Form 10-QSB for the quarter ended June 30, 2006 to restate it’s previously issued unaudited financial statements at and for the quarter and six months ended June 30, 2006 to correct errors related to accounting for stock-based compensation expenses. The error did not affect the financial statements for any prior periods.
In light of the restatement of the company's consolidated financial statements, the company has concluded that as of June 30, 2006 effective disclosure controls and procedures were not maintained over the amounts to be expensed attributable to employee stock options in its consolidated statements of operations. Accordingly, management determined that this control deficiency constitutes a material weakness. A material weakness is a control deficiency, or a combination of control deficiencies, that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
As of the date of this press release, the company has fully remediated this material weakness. The company will monitor all new accounting pronouncements and make a determination whether sufficient expertise exists within the company to evaluate and apply the standards set forth in such new accounting pronouncements. In the event that management determines that additional resources are necessary to evaluate the impact of the new accounting pronouncements on the company's financial statements, management will engage a qualified accounting firm to assist management in the implementation of the new accounting pronouncements.
There are no material pending legal proceedings to which the Company or the Bank is a party or to which any of their respective properties are subject; nor are there material proceedings known to the Company, in which any director, officer or affiliate or any principal shareholder is a party or has an interest adverse to the Company or the Bank.
None.
None.
None.
Not applicable.
| (a) | Exhibits |
Exhibit Number | Description of Exhibit | |
| Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
| Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
| Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
PACIFIC COAST NATIONAL BANCORP
Date: November 13, 2006
By: /s/ Colin M. Forkner
Colin M. Forkner
Chief Executive Officer
Date: November 13, 2006
By: /s/ Terry Stalk
Terry Stalk
Chief Financial Officer
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