UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q/A
x QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010
o TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE EXCHANGE ACT
For transition period to
Commission File Number: 000-51901
Santa Lucia Bancorp
(Exact name of registrant as specified in its charter)
California |
| 35-2267934 |
(State or other jurisdiction of incorporation) |
| (IRS Employer Identification No.) |
7480 El Camino Real, Atascadero, CA 93422
(Address of principal executive offices)
805-466-7087
(Registrant’s telephone number)
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 o
Indicate by check mark hether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Reg S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o yes o no
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o |
| Accelerated filer o |
|
|
|
Non- accelerated filer o |
| Smaller reporting Company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
APPLICABLE ONLY TO CORPORATE ISSUERS
Title of Class: Common Stock, no par value; shares outstanding as of August 11, 2010: 2,003,131.
Explanatory Note: The Company is filing this Amendment to its quarterly report on Form 10-Q for the periods ended June 30, 2010 to correct errors discovered in the Edgar version of the report filed with Securities and Exchange Commission on August 23, 2010. Specifically, the Per Share Data for Basic and Diluted Earnings Per Share on the Consolidated Statements of Income has been corrected to $(4.53) and $0.18 for the six months ended June, 2010, and June, 2009, respectively. Similar disclosure was also corrected in the “EXECUTIVE OVERVIEW - General” discussion on page 16. (Note - Per share data was previously incorrectly reported as $(4.49) and $0.19 for the respective periods.) In addition, certain errors were corrected in the selected financial information table on page 18 related to percentage change in net income, Basic and Dilutive Earnings Per Share, and Book Value Per Common Share. The errors occurred in the process of finalizing the document for EDGAR filing; elsewhere in the document, the earnings per share values were correctly reported.
PART I - - FINANCIAL INFORMATION
Santa Lucia Bancorp
(in thousands)
|
| 30-Jun-10 |
| 31-Dec-09 |
| ||
|
| (unaudited) |
|
|
| ||
Assets |
|
|
|
|
| ||
Cash and due from banks |
| $ | 6,772 |
| $ | 6,588 |
|
Federal funds sold |
| 2,700 |
| 2,500 |
| ||
Total cash and cash equivalents |
| 9,472 |
| 9,088 |
| ||
|
|
|
|
|
| ||
Due from financial institutions time deposits |
| 348 |
| — |
| ||
Securities available for sale |
| 38,800 |
| 40,990 |
| ||
Loans, net |
| 194,828 |
| 198,099 |
| ||
Premises and equipment, net |
| 7,978 |
| 8,223 |
| ||
Deferred income tax asset |
| — |
| 1,429 |
| ||
Cash surrender value of life insurance |
| 5,485 |
| 5,391 |
| ||
Federal Reserve Bank and Federal Home Loan Bank stock, at cost |
| 1,630 |
| 1,643 |
| ||
Other Real Estate Owned |
| 1,507 |
| 428 |
| ||
Accrued interest and other assets |
| 5,116 |
| 4,632 |
| ||
Total Assets |
| $ | 265,164 |
| $ | 269,923 |
|
|
|
|
|
|
| ||
Liabilities and Shareholders' Equity |
|
|
|
|
| ||
Deposits: |
|
|
|
|
| ||
Noninterest-bearing demand |
| $ | 65,744 |
| $ | 69,850 |
|
Interest-bearing demand and NOW accounts |
| 13,490 |
| 14,215 |
| ||
Money market |
| 46,760 |
| 37,396 |
| ||
Savings |
| 28,371 |
| 27,478 |
| ||
Time certificates of deposit of $100,000 or more |
| 52,476 |
| 52,146 |
| ||
Other time certificates |
| 36,376 |
| 37,638 |
| ||
Total Deposits |
| 243,217 |
| 238,723 |
| ||
Short-term borrowings |
| — |
| — |
| ||
Long-term debt |
| 5,821 |
| 6,155 |
| ||
Accrued interest and other liabilities |
| 2,114 |
| 2,015 |
| ||
Total Liabilities |
| 251,152 |
| 246,893 |
| ||
Commitments and contingencies |
| — |
| — |
| ||
Shareholders' equity |
|
|
|
|
| ||
Preferred Stock - Series A |
| 3,859 |
| 3,839 |
| ||
Common stock - no par value; authorized 20,000,000 shares; Issued and outstanding, 2,003,131 shares at June 30, 2010 and 1,961,334 shares at December 31, 2009 |
| 10,665 |
| 10,350 |
| ||
Additional Paid-in Capital |
| 883 |
| 814 |
| ||
Retained earnings (Accumulated deficit) |
| (1,681 | ) | 7,698 |
| ||
Accumulated other comprehensive income-net unrealized gains on available-for-sale securities, net of taxes |
| 286 |
| 329 |
| ||
Total shareholders' equity |
| 14,012 |
| 23,030 |
| ||
Total liabilities and shareholders' equity |
| $ | 265,164 |
| $ | 269,923 |
|
(see accompanying notes)
Santa Lucia Bancorp
Consolidated Statements of Income
(in thousands except per share data)
|
| For the three month period ending |
| For the six month period ending |
| ||||||||
|
| 30-Jun-10 |
| 30-Jun-09 |
| 30-Jun-10 |
| 30-Jun-09 |
| ||||
|
| (unaudited) |
| (unaudited) |
| (unaudited) |
| (unaudited) |
| ||||
Interest Income |
|
|
|
|
|
|
|
|
| ||||
Interest and fees on loans |
| $ | 2,901 |
| $ | 3,202 |
| $ | 5,924 |
| $ | 6,252 |
|
Federal funds sold |
| 2 |
| 1 |
| 3 |
| 1 |
| ||||
Investment securities |
| 306 |
| 369 |
| 620 |
| 782 |
| ||||
|
| 3,209 |
| 3,572 |
| 6,547 |
| 7,035 |
| ||||
Interest expense |
|
|
|
|
|
|
|
|
| ||||
Interest-bearing demand deposits |
| 10 |
| 15 |
| 21 |
| 25 |
| ||||
Money Market |
| 170 |
| 144 |
| 333 |
| 276 |
| ||||
Savings |
| 17 |
| 17 |
| 34 |
| 33 |
| ||||
Time certificates of deposit |
| 398 |
| 530 |
| 837 |
| 1,042 |
| ||||
Short-term borrowings |
| — |
| 36 |
| — |
| 74 |
| ||||
Long-term debt |
| 33 |
| 52 |
| 67 |
| 109 |
| ||||
|
| 628 |
| 794 |
| 1,292 |
| 1,559 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net interest income |
| 2,581 |
| 2,778 |
| 5,255 |
| 5,476 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Provision for credit losses |
| — |
| 110 |
| 8,748 |
| 350 |
| ||||
Net interest income after provision for loan losses |
| 2,581 |
| 2,668 |
| (3,493 | ) | 5,126 |
| ||||
Noninterest income |
|
|
|
|
|
|
|
|
| ||||
Service charges and fees |
| 121 |
| 130 |
| 241 |
| 251 |
| ||||
Gain on sale of investment securities |
| 215 |
| — |
| 215 |
| 92 |
| ||||
Other income |
| 136 |
| 112 |
| 229 |
| 222 |
| ||||
|
| 472 |
| 242 |
| 685 |
| 565 |
| ||||
Noninterest expense |
|
|
|
|
|
|
|
|
| ||||
Salaries and employee benefits |
| 1,276 |
| 1,351 |
| 2,656 |
| 2,731 |
| ||||
Occupancy |
| 161 |
| 156 |
| 319 |
| 323 |
| ||||
Equipment |
| 141 |
| 155 |
| 285 |
| 320 |
| ||||
Professional services |
| 195 |
| 159 |
| 332 |
| 312 |
| ||||
Data processing |
| 124 |
| 142 |
| 243 |
| 274 |
| ||||
Office related expenses |
| 104 |
| 106 |
| 208 |
| 208 |
| ||||
Marketing |
| 93 |
| 101 |
| 174 |
| 202 |
| ||||
Regulatory assessments |
| 116 |
| 180 |
| 227 |
| 225 |
| ||||
Directors' fees and expenses |
| 87 |
| 90 |
| 176 |
| 178 |
| ||||
Other real estate owned expenses |
| 495 |
| 5 |
| 498 |
| 5 |
| ||||
Other |
| 116 |
| 101 |
| 210 |
| 199 |
| ||||
|
| 2,908 |
| 2,546 |
| 5,328 |
| 4,977 |
| ||||
Earnings before income taxes |
| 145 |
| 364 |
| (8,136 | ) | 714 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Income taxes |
| — |
| 127 |
| 807 |
| 246 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net Earnings |
| $ | 145 |
| $ | 237 |
| $ | (8,943 | ) | $ | 468 |
|
|
|
|
|
|
|
|
|
|
| ||||
Per Share Data |
|
|
|
|
|
|
|
|
| ||||
Net earnings - basic |
| $ | 0.04 |
| $ | 0.09 |
| $ | (4.53 | ) | $ | 0.18 |
|
Net Earnings - diluted |
| $ | 0.04 |
| $ | 0.09 |
| $ | (4.53 | ) | $ | 0.18 |
|
(see accompanying notes)
Santa Lucia Bancorp
Consolidated Statements of Cash Flow
(in thousands)
|
| (For the six month period ended) |
| ||||
|
| 30-Jun-10 |
| 30-Jun-09 |
| ||
Cash flows from operating activities: |
|
|
|
|
| ||
Net earnings (loss) |
| $ | (8,943 | ) | $ | 468 |
|
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities: |
|
|
|
|
| ||
Depreciation and amortization |
| 278 |
| 304 |
| ||
Provision for loan losses |
| 8,748 |
| 350 |
| ||
Write-down on other real estate owned |
| 258 |
| — |
| ||
Stock-based compensation expense |
| 70 |
| 68 |
| ||
Gain on sale of investment securities |
| (215 | ) | (92 | ) | ||
Other items, net |
| 979 |
| 442 |
| ||
Net cash provided by operating activities |
| 1,175 |
| 1,540 |
| ||
|
|
|
|
|
| ||
Cash flows from investing activities: |
|
|
|
|
| ||
Purchase of due from time deposits |
| (348 | ) | — |
| ||
Proceeds from maturities of investment securities |
| 7,260 |
| 7,039 |
| ||
Proceeds from sale of investment securities |
| 2,793 |
| 2,438 |
| ||
Purchase of investment securities |
| (7,721 | ) | (5,127 | ) | ||
Net change in loans |
| (6,816 | ) | (10,512 | ) | ||
Purchase of bank premises and equipment |
| (19 | ) | (99 | ) | ||
Net cash used in investing activities |
| (4,851 | ) | (6,261 | ) | ||
|
|
|
|
|
| ||
Cash flows from financing activities: |
|
|
|
|
| ||
Net change in deposits |
| 4,495 |
| 20,083 |
| ||
Net change in borrowings |
| (334 | ) | (334 | ) | ||
Dividends paid on Preferred Stock |
| (100 | ) | (81 | ) | ||
Cash dividends paid |
| (1 | ) | (481 | ) | ||
Net cash provided by financing activities |
| 4,060 |
| 19,187 |
| ||
|
|
|
|
|
| ||
Net increase (decrease) in cash and cash equivalents |
| 384 |
| 14,466 |
| ||
|
|
|
|
|
| ||
Cash and cash equivalents at beginning of period |
| 9,088 |
| 8,220 |
| ||
Cash and cash equivalents at end of period |
| $ | 9,472 |
| $ | 22,686 |
|
|
|
|
|
|
| ||
Supplemental disclosure of cash flow information: |
|
|
|
|
| ||
Interest paid |
| $ | 1,287 |
| $ | 1,598 |
|
Income taxes paid |
| $ | — |
| $ | — |
|
Transfer of loans to Other Real Estate Owned |
| $ | 1,303 |
| $ | 464 |
|
(see accompanying notes)
Santa Lucia Bancorp
Consolidated Statement of Shareholders’ Equity
(in thousands except shares outstanding)
For year ending December 31, 2009 and the period ending June 30, 2010
|
|
|
|
|
|
|
|
|
|
|
| Retained |
| Accumulated |
| ||||||
|
|
|
|
|
| Common Stock |
| Additional |
| Earnings |
| Other |
| ||||||||
|
| Comprehensive |
|
|
| Shares |
|
|
| Paid-in |
| (Accululated |
| Comprehensive |
| ||||||
|
| Income |
| Preferred Stock |
| Outstanding |
| Amount |
| Capital |
| deficit) |
| Income |
| ||||||
Balance at December 31, 2008 |
|
|
| $ | 3,799,003 |
| 1,923,053 |
| $ | 9,894,507 |
| $ | 676,734 |
| $ | 10,682,922 |
| $ | 497,531 |
| |
Dividends Preferrred Stock |
|
|
|
|
|
|
|
|
|
|
| (181,111 | ) |
|
| ||||||
Cash dividends - $0.25 per share |
|
|
|
|
|
|
|
|
|
|
| (480,763 | ) |
|
| ||||||
Stock Dividend - 2% |
|
|
|
|
| 38,281 |
| 455,161 |
|
|
| (455,161 | ) |
|
| ||||||
Cash in lieu for fractional shares |
|
|
|
|
|
|
|
|
|
|
| (2,142 | ) |
|
| ||||||
Accretion on Preferred Stock |
|
|
| 40,199 |
|
|
|
|
|
|
| (40,199 | ) |
|
| ||||||
Stock Option Compensation Expense |
|
|
|
|
|
|
|
|
| 136,272 |
|
|
|
|
| ||||||
Comprehensive Income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net earnings (losses) for the year |
| $ | (1,825,475 | ) |
|
|
|
|
|
|
|
| (1,825,475 | ) |
|
| |||||
Change in unrealized gain on available-for-sale securities, net of taxes of $210,949 |
| (300,441 | ) |
|
|
|
|
|
|
|
|
|
| (300,441 | ) | ||||||
Less reclassification adjustment for gains included in net income, deferred of tax of ($92,761) |
| 132,114 |
|
|
|
|
|
|
|
|
|
|
| 132,114 |
| ||||||
Refund TARP expenses |
|
|
|
|
|
|
|
|
| 759 |
|
|
|
|
| ||||||
Total Comprehensive Income |
| $ | (1,993,802 | ) |
|
|
|
|
|
|
|
|
|
|
|
| |||||
Balance at December 31, 2009 |
|
|
| $ | 3,839,202 |
| 1,961,334 |
| $ | 10,349,668 |
| $ | 813,765 |
| $ | 7,698,071 |
| $ | 329,204 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Dividend Preferred Stock |
|
|
|
|
|
|
|
|
|
|
| (100,000 | ) |
|
| ||||||
Stock Dividend - 2% |
|
|
|
|
| 39,096 |
| 293,220 |
|
|
| (293,220 | ) |
|
| ||||||
Cash in lieu for fractional shares |
|
|
|
|
|
|
|
|
|
|
| (1,385 | ) |
|
| ||||||
Accretion on Preferred Stock |
|
|
| 20,100 |
|
|
|
|
|
|
| (20,100 | ) |
|
| ||||||
Exercise of Stock Options |
|
|
|
|
| 2,701 |
| 21,681 |
|
|
| (21,681 | ) |
|
| ||||||
Stock Option Compensation Expense |
|
|
|
|
|
|
|
|
| 69,650 |
|
|
|
|
| ||||||
Comprehensive Income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net earnings for the year |
| $ | (8,942,503 | ) |
|
|
|
|
|
|
|
| (8,942,503 | ) |
|
| |||||
Change in unrealized gain on available-for-sale securities, net of taxes of $118,584 |
| (168,891 | ) |
|
|
|
|
|
|
|
|
|
| (168,891 | ) | ||||||
Less reclassification adjustment for gains included in net income, deferred of tax of ($88,539) |
| 126,100 |
|
|
|
|
|
|
|
|
|
|
| 126,100 |
| ||||||
Total Comprehensive Income |
| $ | (8,985,294 | ) |
|
|
|
|
|
|
|
|
|
|
|
| |||||
Balance at June 30, 2010 |
|
|
| $ | 3,859,302 |
| 2,003,131 |
| $ | 10,664,569 |
| $ | 883,415 |
| $ | (1,680,818 | ) | $ | 286,413 |
|
SANTA LUCIA BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
Note 1 Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements of Santa Lucia Bancorp (the “Company”) and its subsidiary Santa Lucia Bank (the”Bank”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such SEC rules and regulations. Nevertheless, the Company believes that the disclosures are adequate to make the information presented not misleading. These interim condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Bank’s 2009 Annual Report as filed on Form 10-K.
In the opinion of management, all adjustments, including normal recurring adjustments necessary to present fairly the financial position of the Company with respect to the interim consolidated financial statements and the results of its operations for the interim period ended June 30, 2010, have been included. The results of operations for interim periods are not necessarily indicative of the results for a full year. Certain reclassifications were made to prior year’s presentations to conform to the current year. These reclassifications had no material impact to the Company’s previously reported financial statements.
Restatement of March 31, 2010, Quarterly Results. As disclosed on Form 8-K filed August 16, 2010, the Company determined that the previously issued unaudited consolidated financial statements for the quarter ended March 31, 2010, contained in our Quarterly Report on Form 10-Q filed May 12, 2010, should be restated, primarily to reflect an additional provision to our allowance for loan losses of $7.3 million and to increase the valuation allowance for deferred tax assets by $1.1 million. Accordingly, the previously issued consolidated financial statements for such period should not be relied upon. This Form 10-Q for the periods ending June 30, 2010, includes retroactive restatement to reflect these adjustments in the quarter ended in March. The changes noted above will be reflected in a Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2010, which we intend to file with the Securities and Exchange Commission as soon as practicable. See “Item 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — EXPLANATORY NOTE” for further explanation of these adjustments.
Note 2 Recently Issued Accounting Pronouncements:
In February 2010, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2010-09, Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements. The amendments remove the requirement for an SEC registrant to disclose the date through which subsequent events were evaluated as this requirement would have potentially conflicted with SEC reporting requirements. Removal of the disclosure requirement is not expected to affect the nature or timing of subsequent events evaluations performed by the Company. This ASU became effective upon issuance.
In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 which added disclosure requirements about significant transfers into and out of Levels 1 and 2, clarified existing fair value disclosure requirements about the appropriate level of disaggregation, and clarified that a description of the valuation techniques and inputs used to measure fair value was required for recurring and nonrecurring Level 2 and 3 fair value measurements. The Company adopted these provisions of the ASU in preparing the Consolidated Financial Statements for the period ended June 30, 2010. The adoption of these provisions of this ASU, which was subsequently codified into Accounting Standards Codification Topic 820, “Fair Value Measurements and Disclosures,” only affected the disclosure requirements for fair value measurements and as a result had no impact on the Company’s statements of income and condition. See Note 3 and 8 to the Consolidated Financial Statements for the disclosures required by this ASU.
This ASU also requires that Level 3 activity about purchases, sales, issuances, and settlements be presented on a gross basis rather than as a net number as currently permitted. This provision of the ASU is effective for the Company’s reporting period ending March 31, 2011. As this provision amends only the disclosure requirements for fair value measurements, the adoption will have no impact on the Company’s statements of income and condition.
Note 3 Investment Securities:
The amortized cost, carrying value and estimated fair values of investment securities available for sale as of June 30, 2010 and December 31, 2009 are as follows:
|
| June 30, 2010 |
| ||||||||||
|
| Amortized |
| Unrealized |
| Unrealized |
| Estimated |
| ||||
|
| cost |
| gains |
| losses |
| fair value |
| ||||
Securities Available for Sale: |
|
|
|
|
|
|
|
|
| ||||
U.S. government and agency securities |
| $ | 23,838,808 |
| $ | 265,195 |
| $ | — |
| $ | 24,104,003 |
|
States and political subdivisions |
| 3,489,247 |
| 95,669 |
| (7,541 | ) | $ | 3,577,375 |
| |||
Mortgage-backed securities |
| 7,507,479 |
| 143,445 |
| — |
| $ | 7,650,924 |
| |||
GNMA Securities |
| 3,476,854 |
| 60 |
| (9,317 | ) | $ | 3,467,597 |
| |||
|
| $ | 38,312,388 |
| $ | 504,369 |
| $ | (16,858 | ) | $ | 38,799,899 |
|
|
| December 31, 2009 |
| ||||||||||
|
| Amortized |
| Unrealized |
| Unrealized |
| Estimated |
| ||||
|
| cost |
| gains |
| losses |
| fair value |
| ||||
Securities Available for Sale: |
|
|
|
|
|
|
|
|
| ||||
U.S. government and agency securities |
| $ | 21,824,979 |
| $ | 217,016 |
| $ | (8,531 | ) | $ | 22,033,464 |
|
States and political subdivisions |
| 3,714,014 |
| 95,484 |
| (5,416 | ) | 3,804,082 |
| ||||
Mortgage-backed securities |
| 11,240,354 |
| 294,505 |
| (31,845 | ) | 11,503,014 |
| ||||
GNMA Securities |
| 3,650,205 |
| — |
| (866 | ) | 3,649,339 |
| ||||
|
| $ | 40,429,552 |
| $ | 607,005 |
| $ | (46,658 | ) | $ | 40,989,899 |
|
The carrying value of investment securities pledged to secure public funds, borrowings and for other purposes as required or permitted by law amounts to approximately $12,415,000 at June 30, 2010 and $12,368,000 at December 31, 2009. During the six months ended June 30, 2009 the Company had proceeds from the sale of $2.5 million in mortgage-backed securities and gross gains of $92,000. During the six months ended June, 2010, the Company had proceeds from the sale of $2.8 million in mortgage-backed securities and gross gains of $215,000.
The amortized cost and estimated fair value of debt securities at June 30, 2010, by contractual maturity, are shown below. Mortgage-backed securities are classified in accordance with their estimated lives. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations.
|
| Amortized |
| Estimated |
| ||
|
| cost |
| fair value |
| ||
Securities available for sale: |
|
|
|
|
| ||
Due in one year or less |
| $ | 6,465,332 |
| $ | 6,533,778 |
|
Due after one year through five years |
| 20,378,389 |
| 20,613,199 |
| ||
Due after five years through ten years |
| 8,381,530 |
| 8,552,460 |
| ||
Due after ten years |
| 3,087,137 |
| 3,100,462 |
| ||
|
| $ | 38,312,388 |
| $ | 38,799,899 |
|
The gross unrealized loss and related estimated fair value of investment securities that have been in a continuous loss position for less than twelve months and over twelve months at June 30, 2010, and December 31, 2009 are as follows:
|
| Less than twelve months |
| Over twelve months |
| Total |
| ||||||||||||
|
| Unrealized |
| Estimated |
| Unrealized |
| Estimated |
| Unrealized |
| Estimated |
| ||||||
|
| loss |
| fair value |
| loss |
| fair value |
| loss |
| fair value |
| ||||||
June 30, 2010: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
U.S. government and agency securities |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
|
States and political subdivisions |
| — |
| — |
| (7,541 | ) | 679,717 |
| (7,541 | ) | 679,717 |
| ||||||
Mortgage-backed securities |
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||
GNMA Securities |
| — |
| — |
| (9,317 | ) | 3,287,180 |
| (9,317 | ) | 3,287,180 |
| ||||||
|
| $ | — |
| $ | — |
| $ | (16,858 | ) | $ | 3,966,897 |
| $ | (16,858 | ) | $ | 3,966,897 |
|
|
| Less than twelve months |
| Over twelve months |
| Total |
| ||||||||||||
|
| Unrealized |
| Estimated |
| Unrealized |
| Estimated |
| Unrealized |
| Estimated |
| ||||||
|
| loss |
| fair value |
| loss |
| fair value |
| loss |
| fair value |
| ||||||
December 31, 2009: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
U.S. government and agency securities |
| $ | (8,531 | ) | $ | 3,995,450 |
| $ | — |
| $ | — |
| $ | (8,531 | ) | $ | 3,995,450 |
|
States and political subdivisions |
| — |
| — |
| (5,416 | ) | 290,678 |
| (5,416 | ) | 290,678 |
| ||||||
Mortgage-backed securities |
| (31,845 | ) | 3,038,225 |
| — |
| — |
| (31,845 | ) | 3,038,225 |
| ||||||
GNMA Securities |
| — |
| — |
| (866 | ) | 198,720 |
| (866 | ) | 198,720 |
| ||||||
|
| $ | (40,376 | ) | $ | 7,033,675 |
| $ | (6,282 | ) | $ | 489,398 |
| $ | (46,658 | ) | $ | 7,523,073 |
|
As of June 30, 2010, the Company had 4 investment securities where the total amortized cost was 99.6% of the total estimated fair market value. Unrealized losses on the four securities have not been recognized into income because the issuer bonds are of high credit quality (rated AAA), management does not intend to sell the securities, it is not likely that management would be required to sell the securities prior to the anticipated recovery of their market values, and the decline in fair value is considered to be largely due to changes in interest rates. The fair value is expected to recover as the bonds approach maturity.
Note 4 Loans and Related Allowance for Loan Losses:
A summary of loans as of June 30, 2010 and December 31, 2009 is as follows:
|
| (in thousands) |
| ||||
|
| 30-Jun-10 |
| 31-Dec-09 |
| ||
|
|
|
|
|
| ||
Real estate - construction |
| $ | 39,817 |
| $ | 47,458 |
|
Real estate - other |
| 114,944 |
| 111,183 |
| ||
Commercial |
| 46,727 |
| 41,744 |
| ||
Consumer |
| 1,805 |
| 1,783 |
| ||
Gross Loans |
| 203,293 |
| 202,168 |
| ||
|
|
|
|
|
| ||
Deferred loan fees |
| (736 | ) | (683 | ) | ||
Allowance for loan losses |
| (7,729 | ) | (3,386 | ) | ||
Net Loans |
| $ | 194,828 |
| $ | 198,099 |
|
The Bank’s loan portfolios consist primarily of loans to borrowers within the San Luis Obispo and northern Santa Barbara Counties, California. Although the Bank seeks to avoid concentrations of loans to a single industry or based upon a single class of collateral, real estate and real estate associated businesses are among the principal industries in the Bank’s market areas. As a result, the Bank’s loan and collateral portfolios are, to some degree, concentrated in those industries. When real estate is taken as collateral, advances are generally limited to a certain percentage of the appraised value of the collateral at the time the loan is made, depending on the type of loan, the underlying property and other factors.
The Bank’s allowance for loan losses as a percentage of total loans was 3.8% as of June 30, 2010 and 1.67% as of December 31, 2009. The primary reasons for the increase were the amount of net loan charge-offs, the increase in non-performing loans, and impairment write downs of several loans to the fair value of collateral due to the downturn in the real estate market. Management believes that the allowance for loan losses at June 30, 2010 is adequate based upon its analysis of the loan portfolio and the methodologies used for this purpose. Although management believes the allowance for loan loss is adequate, there is no assurance that during any given period the Company will not sustain charge-offs that are substantial in relation to the size of the allowance.
Concentration of Credit Risk. As of June 30, 2010, real estate served as the principal source of collateral with respect to approximately 76.1% of our loan portfolio, of which, 44.33% is considered improved commercial real estate (CRE). Within the makeup of our CRE, approximately 58.97% of our commercial term loans are granted for owner use, which is repaid from the cash flow of the owner’s business. The Bank targets commercial term loans for owners use as it supports the local business economy. The Bank believes that owner occupied properties do not carry the same risk as commercial strip centers and other income properties with higher vacancy factors that rely on third parties for repayment. Commercial properties financed by the Bank are diversified amongst type and location. The Bank has been conservative in underwriting, however this sector has been affected by the current economic climate and the Bank has experienced small losses in this category over the last 1 ½ years.
The Bank also has a concentration in land and land development loans. This category comprises 12.83% of the loan portfolio and has experienced losses during the past 1 ½ years. The Bank was prudent in underwriting these loans, however the significant declines experienced in the real estate market has impacted collateral values.
Construction loans total 6.76% of our loan portfolio. Of the total construction loans, 20.66% are for speculative purpose. The remaining 79.34% are for individual’s personal residences or for commercial properties for owner’s use. The Bank has experienced only minor losses in this category over the past 1 ½ years.
A further decline in current economic conditions or rising interest rates could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing loans and the value of real estate owned by us, as well as our financial condition and results of operations in general.
Note 5 Stock Based Compensation:
The Company has two stock option plans, which are fully described in Note K in the Bank’s Annual Report on Form 10-K. The Company recognizes the cost of employee services received in exchange for awards of stock options or other equity instruments, based on the grant-date fair value of those awards. The cost is recognized over the period which an employee is required to provide services in exchange for the award, generally the vesting period.
Note 6 Earnings (Loss) Per Share:
Basic earnings (loss) per share is based on the weighted average number of shares outstanding before any dilution from common stock equivalents. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shares in the earnings of the entity. Common stock equivalents for the six months ending June 30, 2010 have been excluded from the calculation of diluted earnings (loss) per share since their effect was anti-dilutive.
The following is a reconciliation of the net income and shares outstanding to the income and number of shares used to compute EPS:
|
| Three Months Ending |
| Six Months Ending |
| ||||||
|
| 30-Jun-10 |
| 30-Jun-10 |
| ||||||
|
| Income |
| Shares |
| Income |
| Shares |
| ||
|
| (Numerator) |
| (Denominator) |
| (Numerator) |
| (Denominator) |
| ||
Net income (loss) |
| $ | 145 |
|
|
| $ | (8,943 | ) |
|
|
Less dividends Preferred Stock |
| $ | (60 | ) |
|
| $ | (120 | ) |
|
|
Average shares outstanding |
|
|
| 2,003,131 |
|
|
| 2,001,781 |
| ||
Used in Basic EPS |
| 85 |
| 2,003,131 |
| (9,063 | ) | 2,001,781 |
| ||
Dilutive effect of outstanding |
|
|
|
|
|
|
|
|
| ||
stock options |
|
|
| 39,193 |
|
|
| 42,021 |
| ||
Used in Diluted EPS |
| $ | 85 |
| 2,042,324 |
| $ | (9,063 | ) | 2,043,802 |
|
|
| Three Months Ending |
| Six Months Ending |
| ||||||
|
| 30-Jun-09 |
| 30-Jun-09 |
| ||||||
|
| Income |
| Shares |
| Income |
| Shares |
| ||
|
| (Numerator) |
| (Denominator) |
| (Numerator) |
| (Denominator) |
| ||
Net income |
| $ | 237 |
|
|
| $ | 468 |
|
|
|
Less dividends Preferred Stock |
| $ | (60 | ) |
|
| $ | (101 | ) |
|
|
Average shares outstanding |
|
|
| 2,000,430 |
|
|
| 2,000,430 |
| ||
Used in Basic EPS |
| 177 |
| 2,000,430 |
| 367 |
| 2,000,430 |
| ||
Dilutive effect of outstanding |
|
|
|
|
|
|
|
|
| ||
stock options |
|
|
| 10,984 |
|
|
| 10,794 |
| ||
Used in Diluted EPS |
| $ | 177 |
| 2,011,414 |
| $ | 367 |
| 2,011,224 |
|
Note 7 Commitments and Contingencies:
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those commitments. Commitments to extend credit (such as the unfunded portion on lines of credit, commitments to fund new loans, and standby letters of credit) as of June 30, 2010 and December 31, 2009 amount to approximately $41,536,000 and $43,105,000 respectively. The Bank uses the same credit policies in these commitments as for all of its lending activities. As such, the credit risk involved in these transactions is essentially the same as that involved in extending
loan facilities to customers.
Because of the nature of its activities, the Company and Bank are from time to time subject to pending and threatened legal actions, which arise out of the normal course of their business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s financial position, results of operations or liquidity.
Note 8 Fair Value Measurements:
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Current accounting guidance establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:
· Level 1 — Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date
· Level 2 — Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
· Level 3 —Significant unobservable inputs that reflect a Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:
Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1).
Collateral-Dependent Impaired Loans: The Bank does not record loans at fair value on a recurring basis. However, from time to time, fair value adjustments are recorded on these loans to reflect (1) partial write-downs, through charge-offs or specific reserve allowances, that are based on the current appraised or market-quoted value of the underlying collateral or (2) the full charge-off of the loan carrying value. In some cases, the properties for which market quotes or appraised values have been obtained are located in areas where comparable sales data is limited, outdated, or unavailable. Fair value estimates for collateral-dependent impaired loans are obtained from real estate brokers or other third-party consultants (Level 3).
Other Real Estate Owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount of fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.
The following table provides the hierarchy and fair value for each major category of assets and liabilities measured at fair value at June 30, 2010 and December 31, 2009.
|
| Fair Value Measurements as of June 30, 2010 using |
| ||||||||||
|
| Level 1 |
| Level 2 |
| Level 3 |
| Total |
| ||||
Assets and liabilities measured at fair value on a recurring basis |
|
|
|
|
|
|
|
|
| ||||
Assets: |
|
|
|
|
|
|
|
|
| ||||
Securities Available for Sale |
| $ | 38,799,899 |
| $ | — |
| $ | — |
| $ | 38,799,899 |
|
|
|
|
|
|
|
|
|
|
| ||||
Assets measured at fair value on a non-recurring basis |
|
|
|
|
|
|
|
|
| ||||
Collateral-Dependent Impaired Loans, Net of Specific Reserves |
| $ | — |
| $ | — |
| $ | 13,850,924 |
| $ | 13,850,924 |
|
Other Real Estate Owned |
| $ | — |
| $ | — |
| $ | 1,507,245 |
| $ | 1,507,245 |
|
|
| Fair Value Measurements as of December 31, 2009 using |
| ||||||||||
|
| Level 1 |
| Level 2 |
| Level 3 |
| Total |
| ||||
Assets and liabilities measured at fair value on a recurring basis |
|
|
|
|
|
|
|
|
| ||||
Assets: |
|
|
|
|
|
|
|
|
| ||||
Securities Available for Sale |
| $ | 40,989,899 |
| $ | — |
| $ | — |
| $ | 40,989,899 |
|
|
|
|
|
|
|
|
|
|
| ||||
Assets measured at fair value on a non-recurring basis |
|
|
|
|
|
|
|
|
| ||||
Collateral-Dependent Impaired Loans, Net of Specific Reserves |
| $ | — |
| $ | — |
| $ | 6,407,114 |
| $ | 6,407,114 |
|
Other Real Estate Owned |
| $ | — |
| $ | — |
| $ | 428,000 |
| $ | 428,000 |
|
Collateral-dependent impaired loans has a net carrying value of $13,850,924 which is made up of the loan balance, net of specific reserves of $0.00 at June 30, 2010 compared to $6,407,114 at December 31, 2009.
Other real estate owned has a net carrying amount of $1,507,245, which is made up of the outstanding balance of $1,507,245, net of valuation allowance of $0.00 at June 30, 2010 compared to $428,000 at December 31, 2009. In 2010, $258,987 was charged against net income.
Note 9 Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on financial instruments both on and off the balance sheet without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Additionally, tax consequences related to the realization of the unrealized gains and losses can have a potential effect on fair value estimates and have not been considered in many of the estimates.
The following methods and assumptions were used to estimate the fair value of significant financial instruments:
Financial Assets - The carrying amounts of cash, short term investments, due from customers on acceptances and bank acceptances outstanding are considered to approximate fair value. Short term investments include federal funds sold, securities purchased under agreements to resell, and interest bearing deposits with banks. The fair values of investment securities, including available for sale, are discussed in Note 3. The fair value of loans are estimated using a combination of techniques, including discounting estimated future cash flows and quoted market prices of similar instruments where available.
Financial Liabilities - The carrying amounts of deposit liabilities payable on demand, commercial paper, and other borrowed funds are considered to approximate fair value. For fixed maturity deposits, fair value is estimated by discounting estimated future cash flows using currently offered rates for deposits of similar remaining maturities. The fair value of long term debt is based on rates currently available for debt with similar terms and remaining maturities.
Off-Balance Sheet Financial Instruments - The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements. The fair values of these financial instruments are not deemed to be material.
The estimated fair value of financial instruments at June 30, 2010 and December 31, 2009 are summarized as follows:
|
| June 30, 2010 |
| December 31, 2009 |
| ||||||||
|
| Carrying |
| Market |
| Carrying |
| Market |
| ||||
|
| value |
| value |
| value |
| value |
| ||||
Financial Assets: |
|
|
|
|
|
|
|
|
| ||||
Cash and cash equivalents |
| $ | 6,772,223 |
| $ | 6,772,000 |
| $ | 6,588,396 |
| $ | 6,588,396 |
|
Fed Funds sold |
| 2,700,000 |
| 2,700,000 |
| 2,500,000 |
| 2,500,000 |
| ||||
Investment securities |
| 38,799,899 |
| 38,799,899 |
| 40,989,899 |
| 40,989,899 |
| ||||
Loans receivable, net |
| 194,827,978 |
| 187,119,000 |
| 198,098,998 |
| 195,723,998 |
| ||||
Cash surrender value of life insurance |
| 5,485,310 |
| 5,485,310 |
| 5,390,410 |
| 5,390,410 |
| ||||
Federal Reserve Bank and FHLB stock |
| 1,630,150 |
| 1,630,150 |
| 1,643,400 |
| 1,643,400 |
| ||||
Accrued interest receivable and other assets |
| 5,115,720 |
| 5,115,720 |
| 6,060,528 |
| 6,060,528 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Financial Liabilities: |
|
|
|
|
|
|
|
|
| ||||
Time deposits |
| $ | 88,851,634 |
| $ | 89,176,000 |
| $ | 89,782,887 |
| $ | 90,088,000 |
|
Other deposits |
| 154,365,442 |
| 149,924,000 |
| 148,939,637 |
| 145,844,637 |
| ||||
Other borrowings |
| — |
| — |
| — |
| — |
| ||||
Long-term debt |
| 5,821,327 |
| 5,821,327 |
| 6,154,932 |
| 6,154,932 |
| ||||
Accrued interest and other liabilities |
| 2,112,990 |
| 2,112,990 |
| 2,015,491 |
| 2,015,491 |
|
Note 10 — Stock Dividend
On March 31, 2010, the Company declared a two percent (2%) stock dividend on the Company’s common stock to the shareholders of record as of that date and payable on April 23, 2010. All per share data in the financial statements and footnotes have been adjusted to give retroactive effect of this dividend.
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following is management’s discussion and analysis of the major factors that influenced our financial performance for the three and six months ended June 30, 2010. This analysis should be read in conjunction with the Company’s 2009 Annual Report as filed on Form 10-K and with the unaudited financial statements and notes as set forth in this report. Unless the context requires otherwise, the terms “Company,” “us,” “we,” and “our” refers to Santa Lucia Bancorp on a consolidated basis.
The Federal Reserve Bank of San Francisco (FRB) recently completed its regularly scheduled examination of the bank. Based on discussions with the FRB following the examination, we presently expect to receive a formal agreement or enforcement order from the FRB requiring us to take certain steps to further strengthen the Bank, such as reducing the level of classified assets, increasing capital levels, and addressing other criticisms from the examination. We already are developing strategies and taking actions to address such issues.
FORWARD LOOKING INFORMATION
Certain statements contained in this Quarterly Report on Form 10-Q (“Report”), including, without limitation, statements containing the words “estimate,” “believes,” “anticipates,” “intends,” “may,” “expects,” “could,” and words of similar import, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements relate to, among other things, our current expectations regarding future operating results, net interest margin, strength of the local economy, and allowance for credit losses. Such forward looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: the current economic downturn and turmoil in financial markets and the response of federal and state regulators thereto; the effect of changing regional and national economic conditions; significant changes in interest rates and prepayment speeds; credit risks of lending and investment activities; changes in federal and state banking laws or regulations; competitive pressure in the banking industry; changes in governmental fiscal or monetary policies; uncertainty regarding the economic outlook resulting from the continuing war on terrorism, as well as actions taken or to be taken by the U.S. or other governments as a result of further acts or threats of terrorism; and other factors discussed in Item 1A. Risk Factors of the company’s 2009 Annual Report as filed on Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.
EXPLANATORY NOTE
As disclosed on Form 8-K filed August 16, 2010, the Company determined, after working closely with our banking examiners, during the course of a regular examination with the FRB, that the previously issued unaudited consolidated financial statements for the quarter ended March 31, 2010, contained in our Quarterly Report on Form 10-Q filed May 12, 2010, should be restated, primarily to reflect an additional provision to our allowance for loan losses of $7.3 million and to increase the valuation allowance for deferred tax assets by $1.1 million. Accordingly, the previously issued consolidated financial statements for such period should not be relied upon.
The increase in the provision for loan losses for the quarter ended March 31, 2010, resulting from this restatement, is the consequence of two significant factors:
· based on consultation with the FRB in connection with a recent examination, to enhance the Bank’s process for determining, documenting and recording an adequate allowance for loan losses (the “ALLL”) and to provide more directional consistency relative to underlying trends in the portfolio (e.g. trends in nonaccrual loans, trends in loan losses, trends in past due loans, and trends in classified and other problem loans), the Bank reviewed its methodology for calculating the ALLL and, working closely with the Bank’s regulators, determined that the new methodology should be adopted and reflected in the quarterly results for March 31, 2010, and
· as a result of the determination to restate the March results, in accordance with Financial Accounting Standards Board Accounting Standards Codification (“ASC”) Topic 855, “Subsequent Events,” the Bank reassessed its evaluation of potential impairment losses required by ASC Topic 310, “Receivables,” the Company evaluated current information available about problem loans, including new information about the valuation of the underlying loan collateral or information about the financial condition of borrowers, and determined that increases expected to be made to the ALLL in June should be included in this restatement of quarterly results for March 31, 2010.
Furthermore, as a result of the increase in the Company’s reported losses, we increased the valuation allowance on deferred tax assets to 100% of the related deferred tax asset because the benefit of such assets is dependent on future taxable income, which resulted in an increase in deferred tax expense of approximately $1.1 million for the quarter ended March 31, 2010.
Finally, in evaluating ASC Topic 855, “Subsequent Events”, the Company increased the amount of loans previously identified as nonaccrual loans by approximately $10.6 million as of March 31, 2010, due to the fact these loans were either placed on nonaccrual or charged off subsequent to March 31, 2010.
This Form 10-Q for the periods ending June 30, 2010, includes retroactive restatement to reflect these adjustments in the quarter ended in March. The changes noted above will be reflected in a Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2010, which we intend to file with the Securities and Exchange Commission as soon as practicable.
The results of operations for interim periods are not necessarily indicative of the results for the full year or even the next quarter. Further, the increase in the allowance for loan loss in the quarter ended March 31, 2010 and not in the quarter ended June 30, 2010 should not be read as indication that the Bank’s loan portfolio either improved or did not worsen in condition. Rather, it should be read only as a determination by management after consultation with FRB examiners and the company’s independent accountants that these changes should have been reflected in the quarter ended March 31, 2010.
EXECUTIVE OVERVIEW
General
Santa Lucia Bancorp (the “Company”) (OTC Bulletin Board SLBA) is a California corporation organized in 2006 to act as the holding company for Santa Lucia Bank (the “Bank”), a four office bank serving San Luis Obispo and northern Santa Barbara Counties.
For the six months ended June 30, 2010, the Company recorded a net loss of $8.9 million and ($4.53) per diluted common share compared to net earnings of $468 thousand and $0.18 per diluted common share for the six months of 2009. Significant factors causing the decline in 2010 results compared to 2009 include an increase in the provision for loan losses of $8.4 million associated with loan charge-offs and increased levels of nonperforming and other problem loans, see “Loan Portfolio and the Allowance for Loan Losses” for further discussion, and an increase in income tax expense of over $500 thousand primarily related to increasing the valuation allowance on deferred tax assets to 100% of the related asset at June 30, 2010.
For the quarter ended June 30, 2010, the Company reported net earnings of $145 thousand compared to net earnings of $237 thousand for the second quarter of 2009. Significant changes affecting the second quarter of 2010 compared to the same period of 2009 include a decline in net interest income of $197 thousand, associated with a decline in net interest margin, and an increase of $490 thousand in expenses associated with other real estate owned. These negative trends were partially offset by $215 thousand in investment securities gains realized in the second quarter of 2010, a reduction in the provision for credit losses of $110 thousand, reduced income tax expense of $127 thousand, and reductions in various operating expenses.
Compared to December 31, 2009, total assets declined slightly from $270 million to $265 million at June 30, 2010. Total loans net of the allowance for loan losses decreased approximately $3.2 million to $195 million at June 30, 2010, compared to $198 million at December 31, 2009, primarily attributable to an increase in the allowance for loan losses. Deposits increased $4.5 million to $243 million at June 30, 2010, compared to $239 million at December, 2009.
As a result of the losses experienced in 2010, total shareholders’ equity has declined from $23 million at December 31, 2009, to $14 million at June 30, 2010. The Bank is considered “adequately capitalized” at June 30, 2010, with total risk-based capital ratio of 9.8% compared to a “well-capitalized” ratio of 13.2% at December 31, 2009. The Bank’s leverage ratio of 6.5% continues to meet the definition of “well-capitalized” at June 30, 2010. The Bank intends to take actions to improve its total risk-based capital ratio above 10% to again meet the “well-capitalized” criteria.
Economic Conditions
The Company believes that the local economies in which it operates, Atascadero, Paso Robles, Arroyo Grande, and Santa Maria continue to decline as unemployment remains high, business cash flows continue to be weak, and the real estate market remains unstable. Residential real estate prices have continued to decline and the vacancy rates in commercial properties have increased in our markets. The state of California’s unbalanced budget continues to effect state employee’s monthly wages Recent indications show the (not seasonally adjusted) unemployment rate within California as of March 31, 2010 of 13.0% compared to December 31, 2009 of 12.1% this is up 7.44%. Competition for deposits continues to be very strong both from traditional sources as well as alternative investments such as mutual funds, money market accounts and the stock market.
The University of California Santa Barbara Economic Forecast Project reports that the local real estate markets will continue to decline through 2010 and at best California may show signs of slow growth averaging 1.0% to 2.0% in 2010 and 2011. New construction projects, even retail sites, are being developed in the San Luis Obispo County and expansion plans for the county’s prisons will certainly create jobs, especially in the construction field where they are critically needed. Weakness in the commercial real estate sector is still intensifying. The decline in the labor market has produced a rapid decline in demand for office and industrial space and many retail store closings. However, both San Luis Obispo and Santa Barbara Counties have unemployment rates well below the State and National averages.
The following table presents a summary of selected financial information for the periods ending June 30, 2010 and 2009:
SELECTED FINANCIAL INFORMATION
|
| (in thousands, except share data and ratios) |
| (in thousands, except share data and ratios) |
| ||||||||||||
|
| Unaudited |
| Unaudited |
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|
| Three Months Ended |
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|
| Six Months Ended |
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| ||||||||
|
| June 30, |
| % |
| June 30, |
| % |
| ||||||||
|
| 2010 |
| 2009 |
| Change |
| 2010 |
| 2009 |
| Change |
| ||||
Summary of Operations: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Interest Income |
| $ | 3,209 |
| $ | 3,572 |
| -10.16 | % | $ | 6,547 |
| $ | 7,035 |
| -6.94 | % |
Interest Expense |
| 628 |
| 794 |
| -20.91 | % | 1,292 |
| 1,559 |
| -17.13 | % | ||||
Net Interest Income |
| 2,581 |
| 2,778 |
| -7.09 | % | 5,255 |
| 5,476 |
| -4.04 | % | ||||
Provision for Loan Loss |
| — |
| 110 |
| -100.00 | % | 8,748 |
| 350 |
| 2399.43 | % | ||||
|
|
|
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|
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|
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|
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|
|
|
| ||||
Net Interest Income After Provision for Loan Losses |
| 2,581 |
| 2,668 |
| -3.26 | % | (3,493 | ) | 5,126 |
| -168.14 | % | ||||
Noninterest Income |
| 472 |
| 242 |
| 95.04 | % | 685 |
| 565 |
| 21.24 | % | ||||
Noninterest Expense |
| 2,908 |
| 2,546 |
| 14.22 | % | 5,328 |
| 4,977 |
| 7.05 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Income Before Income Taxes |
| 145 |
| 364 |
| -60.16 | % | (8,136 | ) | 714 |
| -1239.50 | % | ||||
Income Taxes |
| — |
| 127 |
| -100.00 | % | 807 |
| 246 |
| 228.05 | % | ||||
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|
|
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| ||||
Net Income |
| $ | 145 |
| $ | 237 |
| -38.82 | % | $ | (8,943 | ) | $ | 468 |
| -2009.57 | % |
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|
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|
| ||||
Cash Dividends Paid |
| $ | 1 |
| $ | 481 |
| -99.79 | % | $ | 1 |
| $ | 481 |
| -99.79 | % |
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|
|
| ||||
Per Common Share Data: |
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|
|
|
|
|
|
| ||||
Earnings Per Common Share - Basic |
| $ | 0.04 |
| $ | 0.09 |
| -55.56 | % | $ | (4.53 | ) | $ | 0.18 |
| -2616.67 | % |
Earnings Per Common Share - Diluted |
| $ | 0.04 |
| $ | 0.09 |
| -55.56 | % | $ | (4.53 | ) | $ | 0.18 |
| -2616.67 | % |
Dividends Per Common Share |
| $ | — |
| $ | 0.25 |
| -100.00 | % | $ | — |
| $ | 0.25 |
| -100.00 | % |
Book Value Per Common Share |
| $ | 5.00 |
| $ | 10.73 |
| -53.41 | % | $ | 5.00 |
| $ | 10.73 |
| -53.41 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Common Outstanding Shares: |
| 2,003,131 |
| 2,000,430 |
| 0.14 | % | 2,003,131 |
| 2,000,430 |
| 0.14 | % | ||||
|
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| ||||
Statement of Financial Condition Summary: |
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|
| ||||
Total Assets |
|
|
|
|
|
|
| $ | 265,164 |
| $ | 271,641 |
| -2.38 | % | ||
Total Deposits |
|
|
|
|
|
|
| 243,217 |
| 232,399 |
| 4.65 | % | ||||
Total Net Loans |
|
|
|
|
|
|
| 194,828 |
| 196,330 |
| -0.77 | % | ||||
Allowance for Loan Losses |
|
|
|
|
|
|
| 7,729 |
| 2,174 |
| 255.52 | % | ||||
Total Shareholders’ Equity |
|
|
|
|
|
|
| 14,012 |
| 25,464 |
| -44.97 | % | ||||
|
|
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|
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| ||||
Selected Ratios: |
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|
| ||||
Return on Average Assets |
| 0.21 | % | 0.36 | % | -40.63 | % | -6.56 | % | 0.36 | % | -1918.90 | % | ||||
Return on Average Equity |
| 2.90 | % | 3.67 | % | -20.96 | % | -78.93 | % | 3.64 | % | -2266.91 | % | ||||
Net interest margin |
| 4.15 | % | 4.64 | % | -10.56 | % | 4.25 | % | 4.64 | % | -8.41 | % | ||||
Average Loans as a Percentage of Average Deposits |
| 83.03 | % | 89.08 | % | -6.79 | % | 83.79 | % | 90.09 | % | -6.99 | % | ||||
Allowance for Loan Losses to Total Loans |
| 3.80 | % | 1.09 | % | 248.62 | % | 3.80 | % | 1.09 | % | 248.62 | % | ||||
Tier I Capital to Average Assets - “Bank Only” |
|
|
|
|
|
|
| 6.53 | % | 10.87 | % | -39.93 | % | ||||
Tier I Capital to Risk-Weighted Assets - “Bank Only” |
|
|
|
|
|
|
| 8.56 | % | 13.07 | % | -34.51 | % | ||||
Total Capital to Risk-Weighted Assets - “Bank Only” |
|
|
|
|
|
|
| 9.84 | % | 14.45 | % | -31.90 | % |
(1) Common outstanding shares and per share data have been adjusted for all periods to give retroactive adjustment to the stock dividends declared.
The following sections set forth a discussion of the significant operating changes, business trends, financial condition, earnings, capital position and liquidity that occurred, in the three months and six months ended June 30, 2010 compared with the three and six months ended June 30, 2009.
RESULTS OF OPERATIONS
Net Earnings (Loss)
As indicated above in “Executive Overview”, net earnings for the six month period ending June 30, 2010, were impacted significantly as a result of substantial increases in the provision for loan losses which resulted in a net loss for the six months ended June 30, 2010, of $8.9 million compared to net earnings of $468 thousand for the same period of 2009. Year to date results through June 2010 also reflect the affects of increasing the valuation allowance on deferred tax assets. See “Loan Portfolio and Allowance for Loan Losses” for further discussion of the increased provision for loan losses. The following discussion highlights other areas included in the results of operations in comparison with prior periods.
Net Interest Income and Net Interest Margin
Net interest income is the Company’s largest source of operating income and is derived from interest and fees received on interest earning assets, less interest expense incurred on interest bearing liabilities. The most significant impact on the Company’s net interest income between periods is derived from the interaction of changes in the volume of and rates earned or paid on interest earning assets and interest bearing liabilities. The volume of loans, investment securities and other interest earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the spread, produces changes in the net interest income between periods.
Net interest margin is a ratio used to measure net interest income and is the result of dividing net interest income by average earning assets. The Company’s net interest margin tends to expand in a rising interest rate environment and decline in a falling interest rate environment. The majority of earning assets are tied to market rates, such as the prime rate, and therefore rates on our earning assets generally reprice along with a movement in market rates while interest bearing liabilities, mainly deposits, typically reprice more slowly and usually incorporate only a portion of the movement in market rates. This asset sensitivity causes the Bank’s yields on assets to typically reprice faster than its cost of funds which causes improvements in the net interest margin to materialize more slowly in a declining rate environment.
The following tables present for the periods indicated, condensed average balance sheet information for the Company, together with interest income and yields earned on average interest earnings assets, as well as interest expense and rates paid on average interest bearing liabilities.
AVERAGE BALANCE SHEET INFORMATION
|
| For the six months ended June 30, |
| ||||||||||||||
|
| 2010 |
| 2009 |
| ||||||||||||
|
| Average |
|
|
| Yield/ |
| Average |
|
|
| Yield/ |
| ||||
|
| Balance |
| Interest |
| Rate |
| Balance |
| Interest |
| Rate |
| ||||
|
| (dollars in thousands) |
| ||||||||||||||
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Loans |
| $ | 202,427 |
| $ | 5,924 |
| 5.85 | % | $ | 196,834 |
| $ | 6,252 |
| 6.35 | % |
Investment securities |
| 39,803 |
| 620 |
| 3.12 | % | 36,127 |
| 782 |
| 4.33 | % | ||||
Federal funds sold |
| 5,158 |
| 3 |
| 0.12 | % | 2,894 |
| 1 |
| 0.07 | % | ||||
Interest-earning deposits with other institutions |
| 31 |
| — |
| — |
| — |
| — |
| — |
| ||||
Total average interest-earning assets |
| 247,419 |
| 6,547 |
| 5.29 | % | 235,855 |
| 7,035 |
| 5.97 | % | ||||
Other assets |
| 28,743 |
|
|
|
|
| 25,709 |
|
|
|
|
| ||||
Less allowance for loan losses |
| (3,699 | ) |
|
|
|
| (2,218 | ) |
|
|
|
| ||||
Total average assets |
| $ | 272,463 |
|
|
|
|
| $ | 259,346 |
|
|
|
|
| ||
|
|
|
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|
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|
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|
| ||||
Liabilities and Shareholders’ Equity: |
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|
|
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|
|
| ||||
Interest Bearing liabilities: |
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|
| ||||
Deposits |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Interest-bearing demand - NOW |
| $ | 13,936 |
| $ | 21 |
| 0.30 | % | $ | 13,492 |
| $ | 25 |
| 0.37 | % |
Money Market |
| 42,375 |
| 333 |
| 1.57 | % | 29,541 |
| 276 |
| 1.87 | % | ||||
Savings |
| 27,573 |
| 34 |
| 0.25 | % | 26,760 |
| 33 |
| 0.25 | % | ||||
Time certificates of deposit |
| 91,135 |
| 837 |
| 1.84 | % | 77,818 |
| 1,042 |
| 2.68 | % | ||||
Total average interest-bearing deposits |
| 175,019 |
| 1,225 |
| 1.40 | % | 147,611 |
| 1,376 |
| 1.86 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Short-term borrowings |
| — |
| — |
| 0.00 | % | 6,149 |
| 74 |
| 2.41 | % | ||||
Long-term debt |
| 6,090 |
| 67 |
| 2.20 | % | 6,724 |
| 109 |
| 3.24 | % | ||||
Total interest-bearing liabilities |
| 181,109 |
| 1,292 |
| 1.43 | % | 160,484 |
| 1,559 |
| 1.94 | % | ||||
|
|
|
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|
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|
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|
|
|
|
| ||||
Demand deposits |
| 66,562 |
|
|
|
|
| 70,874 |
|
|
|
|
| ||||
Other liabilities |
| 2,131 |
|
|
|
|
| 2,291 |
|
|
|
|
| ||||
Shareholders’ equity |
| 22,661 |
|
|
|
|
| 25,697 |
|
|
|
|
| ||||
Total average liabilities and shareholders’ equity |
| $ | 272,463 |
|
|
|
|
| $ | 259,346 |
|
|
|
|
| ||
Net interest income |
|
|
| $ | 5,255 |
|
|
|
|
| $ | 5,476 |
|
|
| ||
Net interest margin |
|
|
|
|
| 4.25 | % |
|
|
|
| 4.64 | % |
AVERAGE BALANCE SHEET INFORMATION
|
| For the three months ended June 30, |
| ||||||||||||||
|
| 2010 |
| 2009 |
| ||||||||||||
|
| Average |
|
|
| Yield/ |
| Average |
|
|
| Yield/ |
| ||||
|
| Balance |
| Interest |
| Rate |
| Balance |
| Interest |
| Rate |
| ||||
|
| (dollars in thousands) |
| ||||||||||||||
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Loans |
| $ | 202,478 |
| $ | 2,901 |
| 5.73 | % | $ | 199,655 |
| $ | 3,202 |
| 6.42 | % |
Investment securities |
| 40,166 |
| 306 |
| 3.05 | % | 35,218 |
| 369 |
| 4.19 | % | ||||
Federal funds sold |
| 6,083 |
| 2 |
| 0.13 | % | 4,802 |
| 1 |
| 0.08 | % | ||||
Interest-earning deposits with other institutions |
| 61 |
| — |
| — |
| — |
| — |
| — |
| ||||
Total average interest-earning assets |
| 248,788 |
| 3,209 |
| 5.16 | % | 239,675 |
| 3,572 |
| 5.96 | % | ||||
Other assets |
| 27,112 |
|
|
|
|
| 26,395 |
|
|
|
|
| ||||
Less allowance for loan losses |
| (3,919 | ) |
|
|
|
| (2,155 | ) |
|
|
|
| ||||
Total average assets |
| $ | 271,981 |
|
|
|
|
| $ | 263,915 |
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| ||
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Liabilities and Shareholders’ Equity: |
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| ||||
Interest Bearing liabilities: |
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|
|
| ||||
Deposits |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Interest-bearing demand - NOW |
| $ | 13,777 |
| $ | 10 |
| 0.29 | % | $ | 13,843 |
| $ | 15 |
| 0.43 | % |
Money Market |
| 44,389 |
| 170 |
| 1.53 | % | 30,916 |
| 144 |
| 1.86 | % | ||||
Savings |
| 27,867 |
| 17 |
| 0.24 | % | 27,213 |
| 17 |
| 0.25 | % | ||||
Time certificates of deposits |
| 90,510 |
| 398 |
| 1.76 | % | 82,112 |
| 530 |
| 2.58 | % | ||||
Total average interest-bearing deposits |
| 176,543 |
| 595 |
| 1.35 | % | 154,084 |
| 706 |
| 1.83 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Short-term borrowings |
| — |
| — |
| 0.00 | % | 5,019 |
| 36 |
| 2.87 | % | ||||
Long-term debt |
| 5,975 |
| 33 |
| 2.21 | % | 6,642 |
| 52 |
| 3.13 | % | ||||
Total interest-bearing liabilities |
| 182,518 |
| 628 |
| 1.38 | % | 165,745 |
| 794 |
| 1.92 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Demand deposits |
| 67,318 |
|
|
|
|
| 70,053 |
|
|
|
|
| ||||
Other liabilities |
| 2,168 |
|
|
|
|
| 2,310 |
|
|
|
|
| ||||
Shareholders’ equity |
| 19,977 |
|
|
|
|
| 25,807 |
|
|
|
|
| ||||
Total average liabilities and shareholders’ equity |
| $ | 271,981 |
|
|
|
|
| $ | 263,915 |
|
|
|
|
| ||
Net interest income |
|
|
| $ | 2,581 |
|
|
|
|
| $ | 2,778 |
|
|
| ||
Net interest margin |
|
|
|
|
| 4.15 | % |
|
|
|
| 4.64 | % |
As reflected above, the Company experienced decreases in net interest income of approximately 4% and 7% for the six month and three month periods ended June 30, 2010, compared to the same periods of the previous year. This decrease in net interest income during both periods can be attributed to a decline in net interest margin which declined from 4.64% in 2009 to 4.25% in 2010 for the six month period ending in June, an 8.4% decrease, and declined from 4.64% in 2009 to 4.15% in 2010 for the quarters ending in June, a 10.6% decline. This decline in the net interest margin was partially offset by growth in the volume of average earning assets, which increased $11.6 million or 4.9% for the six
months of 2010 compared to 2009 and increased $9.1 million or 3.8% for the second quarter of 2010 compared to 2009.
The decline in the net interest margin in 2010 compared to 2009 is partially a result of yields on earning assets declining more than costs of liabilities and partially the result of the mix of assets and liabilities. Yields on loans declined from 6.35% for the six months of 2009 to 5.85% for the six months of 2010, which is largely attributable to the increase in nonaccrual loans compared to the prior period. Yields on the investment securities portfolio declined from 4.33% to 3.12% for the six months of 2009 compared to 2010 primarily as a result of lower reinvestment rates as the investment portfolio securities mature in a lower rate environment. In addition to the decline in loan and investment yields compared to the prior period, the mix of earning assets shifted slightly from higher yielding loan assets to lower yielding investment and other assets, as reflected in the following table comparing average balances for the six months ending in June of each year:
|
| (dollars in thousands) |
| ||||||||
|
|
|
| Percent of |
|
|
| Percent of |
| ||
|
| June |
| Earning |
| June |
| Earning |
| ||
|
| 2010 |
| Assets |
| 2009 |
| Assets |
| ||
Federal Funds Sold |
| $ | 5,158 |
| 2.08 | % | $ | 2,894 |
| 1.23 | % |
Interest-earning deposits with other institutions |
| 31 |
| 0.01 | % | — |
| 0.00 | % | ||
Gross Loans |
| 202,427 |
| 81.82 | % | 196,834 |
| 83.46 | % | ||
Investments |
| 39,803 |
| 16.09 | % | 36,127 |
| 15.32 | % | ||
Total Average Earning Assets |
| $ | 247,419 |
| 100.00 | % | $ | 235,855 |
| 100.00 | % |
The cost of interest-bearing deposits decreased by 46 basis points from June of 2009 to June of 2010. However, net interest margin was also affected by the mix of deposits as noninterest bearing demand deposits declined in 2010 and the relatively more costly money market and time deposits increased in 2010. The following table compares the average balances of deposits for the six months ending in June of each year and reflects the 6.08% decline in noninterest bearing demand deposits offset by the increase in interest bearing deposits, primarily money market accounts, and time deposits.
|
| (dollars in thousands) |
|
|
| |||||||
|
| June |
| June |
| Dollar |
| Percent |
| |||
|
| 2010 |
| 2009 |
| Variance |
| Variance |
| |||
Noninterest bearing deposits |
| $ | 66,562 |
| $ | 70,874 |
| $ | (4,312 | ) | -6.08 | % |
Interest bearing deposits |
| 83,884 |
| 69,793 |
| 14,091 |
| 20.19 | % | |||
Interest bearing time |
| 91,135 |
| 77,818 |
| 13,317 |
| 17.11 | % | |||
Total Deposits |
| $ | 241,581 |
| $ | 218,485 |
| $ | 23,096 |
| 10.57 | % |
Interest rate sensitivity is closely monitored and managed; however, management anticipates continued volatility in the Company’s net interest margin due to changes in earning asset mix, the level of non-earning assets, including nonaccrual loans and OREO, changes in cost of funds, and changes in the level and direction of interest rates as determined by rate policies of the Federal Reserve Board.
Noninterest Income
Noninterest income for the three months ended June 30, 2010 was $472,000 compared to $242,000 for the same period in 2009, an increase of $230,000. Noninterest income for the six months ended June 30, 2010 was $685,000 compared to $565,000 for the same period in 2009, an increase of $120,000. This increase in noninterest income was primarily attributable to increased gains on the sale of investment securities, which increased by $215,000 for the three month period and $123,000 for the six month period of 2010 compared to the same periods of 2009. During the second quarter of 2010, the Company sold $2.8 million of mortgage-backed securities which resulted in the recorded gain. Sales of investment securities are the result of management conclusions to take advantage of market opportunities or implementing strategies to increase the level of liquid assets. Sales of investment securities in future periods, if any, could result in either gains or losses.
Noninterest Expense
Total noninterest expense for the three months ended June 30, 2010 was $2,908,000, which reflects an increase of $362,000 or 14.2% over the like period in 2009. For the six months ended June 30, 2010, total noninterest expense increased $351,000 or 7.1% over the same period of 2009. The increase in noninterest expense is largely attributable to the increase in other real estate owned (“OREO”) expenses, which increased by $490,000 and $493,000 for the three and six months periods of 2010 compared to 2009, respectively, and is attributable to costs associated with OREO, such as property taxes, appraisals and recording fees.
Other fluctuations in noninterest expense of note include a reduction in regulatory assessment expense of $64,000 for the three month period ending June, 2010, compared to the second quarter of 2009. This is primarily a result of a one time special assessment of $120,000 from the FDIC in quarter ended June, 2009, which was partially offset by the generally higher levels of FDIC assessment rates in 2010 compared to 2009. These higher assessment rates explain why regulatory assessment expense for the six month period of 2010 is comparable to the same period of 2009, despite the fact the special assessment is included in the six month period of 2009. We anticipate FDIC insurance premiums following completion of the regulatory examination to increase for the balance of the year.
Income Taxes
As a result of the increase in the Bank’s reported losses, we have increased the valuation allowance on deferred tax assets to 100% of the related deferred tax asset because the benefit of such assets is dependent on future taxable income. As discussed in the “EXPLANATORY NOTE” above, the effect of this increase to the valuation allowance was retroactively restated to the quarter ended March 31, 2010. As a result, income tax expense for the six month period ending June 30, 2010, was $807,000 despite the pre-tax losses reported. As the Company implements plans to return to profitability, future operating earnings, if any, would benefit from significant net operating loss carryforwards.
FINANCIAL CONDITION
Compared to December 31, 2009, total assets declined slightly from $270 million to $265 million at June 30, 2010. The following discussion provides further analysis of the Company’s financial condition at June 30, 2010, compared to prior periods.
Loan Portfolio and the Allowance for Loan Losses
Total loans, net of the allowance for loan losses, decreased approximately $3.3 million to $194.8 million at June 30, 2010, compared to $198.1 million at December 31, 2009, which is primarily attributable to the increase in the allowance for loan losses, which increased by $5.0 million from December 31, 2009, to $7.7 million at June 30, 2010. Gross loans increased by $1.8 million to $203.0 million at June 30, 2010; an increase of $5.0 million in commercial loans was partially offset by a $3.9 million decrease in construction and real estate loans.
The Bank made an $8,748,000 provision to its allowance for loan losses during the six month period ending June 30, 2010. As discussed in the “EXPLANATORY NOTE” above, the effect of this increase to the allowance for loan losses was retroactively restated to the quarter ended March 31, 2010. The Bank evaluates the allowance for possible loan losses based upon an individual analysis of specific categories of loans, specific categories of classified loans and individual classified assets. As of June 30, 2010, the ALLL was 3.80% of total loans, compared to 1.67% at December 31, 2009 and 1.09% at June 30, 2009.
The significant increase in the allowance for loan losses compared to prior periods is a result of the Bank’s efforts to improve and enhance its methodology for estimating the level of the ALLL. More specifically, based on consultation with the FRB in connection with a recent examination, in order to enhance the Bank’s process for determining, documenting and recording an adequate allowance for loan losses (the “ALLL”) and to provide more directional consistency relative to underlying trends in the portfolio (e.g. trends in nonaccrual loans, trends in loan losses, trends in past due loans, and trends in classified and other problem loans), the Bank reviewed its methodology for calculating the appropriate level of the ALLL and, working closely with the Bank’s regulators, determined that the revised methodology, which reflects significant increases to the level of the ALLL should be adopted. As noted above, we determined that these changes should be reflected in the quarterly results for the quarter ended March 31, 2010, and
therefore, in accordance with Financial Accounting Standards Board Accounting Standards Codification (“ASC”) Topic 855, “Subsequent Events,” the Bank reassessed its evaluation of potential impairment losses required by ASC Topic 310, “Receivables,” including current information available about problem loans, and determined that increases expected to be made to the ALLL in June should be included in this restatement of quarterly results for March 31, 2010. Thus, the entire increase to the ALLL for the six months ended June 30, 2010, has been included in the quarterly results for the quarter ended March 31, 2010. The results of operations for interim periods are not necessarily indicative of the results for the full year. Further the timing of the increase to the provision for loan loss should not be interpreted to mean that the Bank’s asset quality improved or did not worsen in the second quarter June 30, 2010.
The following table shows the changes in the allowance for loan losses during the periods indicated.
|
| (in thousands, except share data and ratios) Unaudited |
| ||||||||||
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| June 30, |
| June 30, |
| ||||||||
|
| 2010 |
| 2009 |
| 2010 |
| 2009 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Allowance,beginning of period |
| $ | 11,226 |
| $ | 2,132 |
| $ | 3,386 |
| $ | 2,310 |
|
Provision for loan loss |
| — |
| 110 |
| 8,748 |
| 350 |
| ||||
Recoveries on Loans Charges Off |
| 1 |
| 1 |
| 53 |
| 1 |
| ||||
Loans Charged Off |
| 3,498 |
| 69 |
| 4,458 |
| 487 |
| ||||
Allowance, End of Period |
| $ | 7,729 |
| $ | 2,174 |
| $ | 7,729 |
| $ | 2,174 |
|
|
|
|
|
|
|
|
|
|
| ||||
Ratios: |
|
|
|
|
|
|
|
|
| ||||
Net loan charge-offs (recoveries) to average loans |
| 1.73 | % | 0.03 | % | 2.18 | % | 0.25 | % | ||||
|
|
|
|
|
|
|
|
|
| ||||
Allowance for loan losses to end of year loans |
| 3.80 | % | 1.09 | % | 3.80 | % | 1.09 | % | ||||
|
|
|
|
|
|
|
|
|
| ||||
Net loan charge-offs (recoveries) to allowance for loan losses |
| 45.25 | % | 3.13 | % | 56.99 | % | 22.36 | % | ||||
|
|
|
|
|
|
|
|
|
| ||||
Net loan charge-offs (recoveries) to provision charged to operating expense |
| 0.00 | % | 61.82 | % | 50.35 | % | 138.86 | % |
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 provision for loan losses is determined based on management’s assessment of several qualitative factors: changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry groups; the level of classified and nonperforming loans and the results of regulatory examinations. Consideration is also given to the possible effects of changes in lending policies and procedures; the experience and depth of lending management and staff; concentrations, and changes in underlying collateral values. For loans not considered to be impaired, management uses historical loss experience coupled with the previously mentioned qualitative factors to determined estimated reserves.
Impaired loans are analyzed on a loan by loan basis due to the unique characteristics of each loan. Loan are considered impaired if, based on current information and events, it is probable that we will be unable to collect the scheduled payments 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 contractual interest rate set in the loan agreement. Collateral-dependent loans are measured for impairment based on the fair value of the collateral. A loan is considered collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. The fair value of the underlying collateral is generally determined by utilizing an appraisal of the collateral discounted for estimated costs to sell.
In general, collateral values have declined as real estate values have fallen in our markets throughout the periods covered by this Report and several borrowers, including some with long borrowing histories and relationships with the Bank have experienced difficulty in meeting contractual payments obligations. This has resulted in write downs of some of the collateral securing some of the Bank’s loans as well as the restructuring of some loans. Others have become non-performing and the Bank is pursuing various legal remedies including foreclosure. On a comparative basis, nonperforming loans and other nonperforming assets (OREO) are detailed in the following table:
|
| June |
| December |
| June |
| |||
|
| 2010 |
| 2009 |
| 2009 |
| |||
Nonaccrual Loans |
| $ | 16,321 |
| $ | 6,407 |
| $ | 441 |
|
Accruing loans over 90 days past due |
| — |
| — |
| — |
| |||
Total nonperforming loans: |
| 16,321 |
| 6,407 |
| 441 |
| |||
|
|
|
|
|
|
|
| |||
OREO |
| 1,507 |
| 428 |
| 464 |
| |||
Total nonperforming assets |
| 17,828 |
| 6,835 |
| 905 |
| |||
|
|
|
|
|
|
|
| |||
Nonperforming assets as a percentage of total gross loans |
| 8.77 | % | 3.38 | % | 0.45 | % | |||
|
|
|
|
|
|
|
| |||
Nonperforming assets as a percentage of total assets |
| 6.72 | % | 2.53 | % | 0.33 | % | |||
|
|
|
|
|
|
|
| |||
Allowance for loan losses to nonperforming assets |
| 43.35 | % | 49.54 | % | 240.22 | % | |||
Nonaccrual Loans
The Bank had total nonaccrual loans of $16,321,000 as of June 30, 2010, comprised of 39 loans with 18 borrowing relationships, compared to eight nonaccrual loans at December 31, 2009 totaling $6,407,000 and one nonaccrual loan totaling $441,000 at June 30, 2009. The increase in non-performing loans as of June 30, 2010 was a result of the current economic downturn, a continued reduction in real estate collateral values along with a recent regulatory examination. For loans that were considered to be impaired, which totaled $13,859,924 at June 30, 2010 the Bank determined the fair value of the real estate collateral and charged off the portions of such loans considered uncollectible based on these analyses.
The Bank has been working closely with our regulators and has completed a review of the loan portfolio. Due to current market and economic conditions several relationships were placed on non-accrual. The non-accrual loans have been analyzed under FAS 114 with appropriate reserves established or in the case of collateral dependent loans, loans were written down to fair market value.
The non-accrual loans are comprised of the following: 10 loans secured by 1-4 family residential properties totaling $2,220,000; 3 loans covering 2 commercial properties for owner’s use totaling $1,826,000; 8 commercial loans for 6 relationships totaling $2,786,000 of which 1 loan is the guaranteed portion of a loan where the entity has been requested to honor the guarantee in the amount of $656,000; and finally there are 6 loans for land and land development totaling $9,488,000. It is important to note that all loans are current with their payments to the Bank as of June 30, 2010.
OREO
Total Other Real Estate Owned (“OREO”) increased from one property with a carrying value of $428,000 on December 31, 2009 to three properties with a carrying value of $1.5 million at June 30, 2010. The first property is a single family residence, the second property is land and the third is commercial office space in which the company is currently receiving rent. All three properties are actively being marketed for sale at this time.
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 provision for loan losses is determined based on management’s assessment of several qualitative factors: changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry groups; the level of classified and nonperforming loans and the results of regulatory examinations. Consideration is also given to the possible effects of changes in lending policies and procedures; the experience and depth of lending management and staff; concentrations, and changes in underlying collateral values. For loans not considered to be impaired, management uses historical loss experience coupled with the previously mentioned qualitative factors to determined estimated reserves.
Impaired loans are analyzed on a loan by loan basis due to the unique characteristics of each loan. Loan are considered impaired if, based on current information and events, it is probable that we will be unable to collect the scheduled payments 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 contractual interest rate set in the loan agreement. Collateral-dependent loans are measured for impairment based on the fair value of the collateral. A loan is considered collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. The fair value of the underlying collateral is generally determined by utilizing an appraisal of the collateral discounted for estimated costs to sell.
The adequacy of the allowance is determinable only on an approximate basis, since estimates as to the magnitude and timing of loan losses are not predictable because of the impact of external events. Based on the most recent regulatory examination and the analysis performed by the Bank both believe that the allowance for loan loss at June 30, 2010 is adequate.
Other Borrowings
On June 30, 2010 the Company had no borrowings with Federal Home Loan Bank or its correspondent banks.
Trust Preferred Securities
On April 28, 2006, the Company issued $5,155,000 in Trust Preferred securities. The issue was priced at 1.48% over the quarterly adjustable 3-month LIBOR. The issue was written for a term of 30-years, with an option to redeem in whole or part at par anytime after the fifth year. The Company contributed $3,000,000 to the Bank and retained $2,000,000 at the Company level in which $1,000,000 was used to repurchase the Company’s stock. The Company incurred $46,000 in interest expense during the six month period ending June 30, 2010. As of June 30, 2010 the trust preferred securities interest rate was 2.01%.
Based on the financial condition of the Company, including its deficit retained earnings, various statutes and regulations may limit the ability of the Company to continue to make payments on its trust preferred securities. The terms of our trust preferred securities allow the company to defer payments for up to 20 consecutive quarters without being in default. However, during any such deferral we would be prohibited from paying dividends on our common and preferred stock. The deferral of payments on our trust preferred securities and related limitations may adversely affect our business operations, financial condition, results of operations and prospects.
Subordinated Debt
During the Third Quarter of 2003, the Bank completed a private placement of subordinated debentures (“notes”) to augment its Tier II capital. The total principal amount of the notes issued was $2,000,000. The notes were sold pursuant to an applicable exemption from registration under the Securities Act of 1933 to certain accredited investors, including some of the Bank’s directors and senior officers.
The notes have a floating rate of interest, which is reset quarterly, equal to the prime rate published in the western edition of the Wall Street Journal plus 1.50%. The initial rate for the notes was 5.50%. The rate as of June 30, 2010, was 4.75%. Quarterly principal payments of $166,678 began in the third quarter of 2008 and continue over the next three years until the notes mature in June 2011. As of June 30, 2010 the outstanding balance was $666,327.
Capital
Total shareholders’ equity at June 30, 2010 totaled $14,012,000 compared to $23,030,000 at December 31, 2009, for a decrease of $9.0 million or 39%. This decrease is due primarily to the net loss for the period of $8.9 million, as well as the effects from the payment of the preferred stock dividend. The preferred stock dividend is paid directly from capital, not from expenses; therefore, preferred stock dividends reduce capital directly and reduce EPS on common stock.
As part of the United States Treasury’s Capital Purchase Program, the Company entered into a Letter Agreement on December 19, 2008 with the United States Department of Treasury, pursuant to which the Company issued and sold 4,000 shares of the Company’s Preferred Stock and a warrant to purchase 38,869 shares of the Company’s Common Stock for an aggregate purchase price of $4,000,000 in cash. The Preferred Stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. It is the Company’s intention to repay the capital within the five year time frame although no assurance can be given that we will be able to do so. The warrant has a 10-year term and is immediately exercisable upon its issuance, with an exercise price equal to $15.446 (adjusted for the 2.0% stock dividend declared in September 2009 and March 2010) per share of the Common Stock.
The primary source of our funds from which the Company services its debt and pays its obligations and dividends is the receipt of dividends from the Bank. Based on the financial condition of the Company and the Bank, various statutes and regulations may limit the ability of the Company to pay dividends on its preferred stock or other equity securities and may limit the availability of dividends to the Company from the Bank. These limitations may adversely affect our business operations, financial condition, results of operations and prospects. If the Company fails to pay dividends on Series A Senior Preferred Stock for a total of six quarters, whether or not consecutive, the U.S. Treasury will have the right to elect two members of the Company’s Board of Directors, voting together with any other holders of preferred shares ranking pari passu with the Series A Senior Preferred Stock. These directors would serve on the Company’s Board of Directors until such time as the Company has paid in full all dividends not previously paid, at which time these directors’ terms of office would immediately terminate.
Regulatory capital adequacy requirements state that the Bank must maintain minimum ratios to be categorized as “well capitalized” or “adequately capitalized.” The Company is not subject to similar regulatory capital requirements because its consolidated assets do not exceed $500 million, the minimum asset size criteria for bank holding companies subject to those requirements. The Bank’s actual capital ratios and the required ratios for a “well capitalized” and “adequately capitalized” bank are as follows:
|
| “Adequately |
| “Well Capitalized” Minimum Ratio |
| June 2010 |
| December 2009 |
|
Tier I Capital to Average Assets - “Bank Only” |
| 4.0 | % | 5.0 | % | 6.5 | % | 9.7 | % |
Tier I Capital to Risk-Weighted Assets - “Bank Only” |
| 4.0 | % | 6.0 | % | 8.6 | % | 11.9 | % |
Total Capital to Risk-Weighted Assets - “Bank Only” |
| 8.0 | % | 10.0 | % | 9.8 | % | 13.2 | % |
As June 30, 2010, the Bank is considered “adequately capitalized”, because of one ratio. The other two remain in excess of “well capitalized.” The Bank is considering alternatives to enhance its capital ratios to the “well capitalized” level, including strategies to reduce total assets initiatives to improve core operating earnings, and strategies to raise capital.
Liquidity
Liquidity management involves our ability to meet cash flow requirements arising from fluctuations in deposit levels and demands of daily operations, which include funding of securities purchases, providing for customers’ credit needs and ongoing repayment of borrowings. Our liquidity is actively managed on a daily basis and reviewed periodically by our ALCO Committee and Board of Directors. This process is intended to ensure the maintenance of sufficient funds to meet our needs, including adequate cash flow for off-balance sheet instruments.
Our primary sources of liquidity are derived from financing activities that include the acceptance of customer deposits, federal fund purchase lines and a Federal Home Loan Bank advance line. The Bank currently has two credit lines with FHLB totaling $67.6 million. The Bank’s current Liquidity policy is to maintain a liquidity ratio of not less than 20.0% based on regulatory formula. As of June 30, 2010 the Bank had a liquidity ratio of 20.1%.
Interest Rate Sensitivity
The Bank closely follows the maturities and repricing opportunities of both assets and liabilities to reduce gaps in interest spreads. An analysis is performed quarterly to determine the various interest sensitivity gaps, the economic value of equity and earnings at risk. The reports indicate that the Bank is asset sensitive, meaning that when interest rates change, assets (loans) will reprice faster than short-term liabilities (deposits). Therefore, higher interest rates improve short-term profits and lower rates decrease short-term profits.
The asset liability reports as of June 30, 2010 indicate that the Bank has an actual dollar risk exposure of $4,000 if interest rates fall 100 basis points. This represents a 0.0% risk to interest income. The Equity to Asset ratio is 11.90% at zero basis points and 12.60% at an assumed 100 basis points decline in interest rates.
Interest Income and Expense Under Rate Shock
|
| -200bp |
| -100bp |
| 0bp |
| +100bp |
| +200bp |
| |||||
Net Interest Income |
|
|
|
|
|
|
|
|
|
|
| |||||
Earnings at Risk |
| $ | -118 |
| $ | 4 |
| $ | 0 |
| $ | -181 |
| $ | -207 |
|
Percent of Risk |
| -1.1 | % | 0.0 | % | 0.0 | % | 1.7 | % | 1.9 | % | |||||
Assumptions are inherently uncertain and, consequently, the model cannot precisely measure net interest income or precisely predict the impact of changes in interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and management strategy.
Off-Balance Sheet Arrangements
The Company, in the ordinary course of business, routinely enters into contracts for services. These contracts may require payment for services to be provided in the future and may also contain penalty clauses for the early termination of the contracts. The Company is also party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Additionally, in connection with the issuance of trust preferred securities, the Company has committed to irrevocably and unconditionally guarantee the following payments or distributions with respect to the preferred securities to the holders thereof to the extent that the trust has not made such payments or distributions and has the funds, therefore: (i) accrued and unpaid distributions; (ii) the redemption price; and (iii) upon a dissolution or termination of the trust, the lesser of the liquidation amount and all accrued and unpaid distributions and the amount of assets of the trust remaining available for distribution. Management does not believe that these off-balance sheet arrangements have a material effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, but there can be no assurance that such arrangements will not have a future effect.
Critical Accounting Policies
This discussion should be read in conjunction with the unaudited consolidated financial statements of the Company, including the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations and audited financial statements, including the note’s thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing in the Bank’s Form 10-K for the year ended December 31, 2009.
Our accounting policies are integral to understanding the results reported. Our most complex accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies involving significant management valuation judgments.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of certain revenues and expenses during the reporting period. Actual results could differ from those estimates.
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 provision for loan losses is determined based on management’s assessment of several factors: reviews and evaluation of specific 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, the level of classified and nonperforming loans and the results of regulatory examinations.
Loans are considered impaired if, based on current information and events, it is probable that we 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.
Available-for-Sale Securities
The fair value of most securities classified as available-for-sale are based on quoted market prices. If quoted market prices are not available, fair values are extrapolated from the quoted prices of similar instruments.
Deferred Compensation Liabilities
Management estimates the life expectancy of the participants and the accrual methods used to accrue compensation expense. If individuals or their beneficiaries outlive their assumed expectancies the amounts accrued for the payment of their benefits will be inadequate and additional charges to income will be required.
ITEM 3 — Quantitative and Qualitive Disclosures about Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices, interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. Management uses various asset/liability strategies to manage the re-pricing characteristics of the Company’s earning assets and funding liabilities to ensure that exposure to interest rate fluctuations is within its guidelines of acceptable risk-taking. Hedging strategies, including the terms and pricing of loans and deposits, and managing the deployment of the Company’s securities are used to reduce mismatches in interest rate re-pricing opportunities of portfolio assets and their funding sources.
Interest rate risk is addressed by our Asset Liability Management Committee (“ALCO”) which is comprised of senior management officers of the bank. The ALCO monitors interest rate risk by analyzing the potential impact on the net equity value and net interest income from potential changes in interest rates, and considers the impact of alternative strategies or changes in balance sheet structure. The ALCO manages the Company’s balance sheet in part to maintain, within acceptable ranges, the potential impact on net equity value and net interest income despite fluctuations in market interest rates.
Exposure to interest rate risk is reviewed on at least a quarterly basis by the ALCO and the Board of Directors. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the change in net portfolio value in the event of hypothetical changes in interest rates. If potential changes to net equity value and net interest income resulting from hypothetical interest rate changes are not within the limits established by the Board of Directors, management may adjust the asset and liability mix to bring interest rate risk within approved limits.
ITEM 4T — Controls and Procedures
As of the end of the period covered by this report, management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures with respect to the information generated for use in this Quarterly Report. Based upon, and as of the date of that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the disclosures controls and procedures were effective to provide reasonable assurances that information required to be disclosed in the reports the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
There was no change in the Company’s internal controls over financial reporting during the quarter ended June 30, 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
In designing and evaluating disclosure controls and procedures, the Company’s management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurances of achieving the desired control objectives and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
The Company is involved in various legal proceedings occurring in the ordinary course of business which, in aggregate, are believed by management to be immaterial to the financial condition and results of operations of the Company.
We Are Subject to Various Regulatory Requirements and Expect to Be Subject to Future Regulatory Restrictions and Enforcement Actions
In light of the current challenging operating environment, along with our elevated level of non-performing assets, delinquencies, and adversely classified assets, we are subject to increased regulatory scrutiny, and expect to become subject to potential enforcement actions. Such enforcement actions could place limitations on our business and adversely affect our ability to implement our business plans, including our growth strategy. Even though the Bank is adequately capitalized, the regulatory agencies have the authority to place certain restrictions on our operations for example, if the regulatory agencies were to impose such a restriction, we would likely have limitations on our lending activities. The regulatory agencies also have the power to limit the rates paid by the Bank to attract retail deposits in its local markets. We also may be required to reduce our levels of non-performing assets within specified time frames. These time frames might not necessarily result in maximizing the price that might otherwise be received for the underlying properties. In addition, if such restrictions were also imposed upon other institutions that operate in the Bank’s markets, multiple institutions disposing of properties at the same time could further diminish the potential proceeds received from the sale of these properties. If any of these or other additional restrictions are placed on us, it may limit the opportunities and strategies we may deploy to improve our operations.
In this regard, the FRB recently completed its regularly scheduled examination of the Bank. Based on discussions with the FRB following the examination, we presently expect to receive a formal agreement or enforcement order from the FRB requiring us to take certain steps to further strengthen the Bank, such as reducing the level of classified assets, increasing capital levels, and addressing other criticisms from the examination. We already are developing strategies and taking actions to address such issues.
Our Level of Classified Assets Expose Us to Increased Lending Risk. Further, if Our Allowance for Loan Losses is Insufficient to Absorb Losses in Our Loan Portfolio, Our Earnings Could Decrease
At June 30, 2010, loans that we have categorized as doubtful, substandard or special mention totaled $39.0 million, representing 19.3% of total loans. If these loans do not perform according to their terms and the collateral is insufficient to pay any remaining loan balance, we may experience loan losses, which could have a material effect on our operating results. Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. At June 30, 2010, our allowance for loan losses totaled $7.7 million, which represented 3.8%% of total loans and 43.4% of non-performing loans. We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and their probability of making payment, as well as the value of real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, significant factors we consider include loss experience in particular segments of the portfolio, trends and absolute levels of classified loans, trends and absolute levels in delinquent loans, trends in risk ratings, trends in industry charge-offs by particular segments and changes in existing general economic and business conditions affecting our lending areas and the national economy. If our assumptions are incorrect, our allowance for loan losses may be insufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance. Material additions to our allowance could materially decrease our net income. Our regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.
ITEM 2. Unregistered Sale of Equity Securities and Use of Proceeds.
None.
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Not applicable.
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SANTA LUCIA BANCORP
Date: | August 30, 2010 | |
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|
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| /s/ John C. Hansen |
|
| John C. Hansen | |
| President and Chief Executive Officer | |
| (Principal Executive Officer and Principal Financial Officer) |
Exhibit |
| Sequential |
Number |
| Description |
|
|
|
31.1 |
| Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
|
|
32.1 |
| Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |