U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003 Commission File Number: 0-15982
NATIONAL MERCANTILE BANCORP
(Exact name of small business issuer as specified in its charter)
California |
| 95-3819685 |
(State or other jurisdiction of |
| (I.R.S. Employer |
|
|
|
1840 Century Park East, Los Angeles, California 90067 | ||
(Address of principal executive offices) (Zip Code) |
Issuer’s telephone number, including area code (310) 277-2265
Indicate by check mark whether the issuer (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 ý NO o
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the issuer’s Common Stock, no par value, as of November 12, 2003 was 2,732,925.
PART I – FINANCIAL INFORMATION |
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|
|
Item 1. Financial Statements |
|
2
NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
|
| September 30, |
| December 31, |
| ||
|
| (Unaudited) |
|
|
| ||
|
| (Dollars in thousands) |
| ||||
ASSETS |
|
|
|
|
| ||
Cash and due from banks-demand |
| $ | 22,590 |
| $ | 18,876 |
|
Federal funds sold and securities purchased under agreements to resell |
| 42,000 |
| 18,700 |
| ||
Cash and cash equivalents |
| 64,590 |
| 37,576 |
| ||
Securities available-for-sale, at fair value; aggregate amortized cost of $31,250 and $25,824 at September 30, 2003 and December 31, 2002, respectively |
| 31,314 |
| 26,170 |
| ||
Securities held to maturity |
| 4,869 |
| — |
| ||
Due from banks-interest bearing |
| 2,228 |
| 325 |
| ||
FRB and other stock, at cost |
| 1,869 |
| 2,018 |
| ||
Loans receivable |
| 247,465 |
| 272,323 |
| ||
Allowance for credit losses |
| (3,588 | ) | (4,846 | ) | ||
Net loans receivable |
| 243,877 |
| 267,477 |
| ||
|
|
|
|
|
| ||
Premises and equipment, net |
| 5,552 |
| 5,836 |
| ||
Other real estate owned |
| 1,000 |
| 1,000 |
| ||
Deferred tax asset |
| 7,741 |
| 7,984 |
| ||
Goodwill |
| 2,174 |
| 2,174 |
| ||
Core deposit intangibles, net |
| 1,909 |
| 2,077 |
| ||
Accrued interest receivable and other assets |
| 3,343 |
| 2,748 |
| ||
Total assets |
| $ | 370,466 |
| $ | 355,385 |
|
|
|
|
|
|
| ||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
|
|
|
|
| ||
Deposits: |
|
|
|
|
| ||
Noninterest-bearing demand |
| $ | 127,421 |
| $ | 107,580 |
|
Interest-bearing demand |
| 28,117 |
| 30,465 |
| ||
Money market |
| 59,777 |
| 43,134 |
| ||
Savings |
| 43,423 |
| 42,182 |
| ||
Time certificates of deposit: |
|
|
|
|
| ||
$ 100,000 or more |
| 25,674 |
| 43,006 |
| ||
Under $100,000 |
| 31,013 |
| 32,358 |
| ||
Total deposits |
| 315,425 |
| 298,725 |
| ||
|
|
|
|
|
| ||
Federal funds purchased and securities sold under agreements to repurchase |
| 397 |
| 1,476 |
| ||
Other borrowings |
| 7,500 |
| 7,500 |
| ||
Junior subordinated deferrable interest debentures |
| 15,464 |
| — |
| ||
Accrued interest payable and other liabilities |
| 738 |
| 1,950 |
| ||
Total liabilities |
| 339,524 |
| 309,651 |
| ||
|
|
|
|
|
| ||
Guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures, net |
| — |
| 14,530 |
| ||
|
|
|
|
|
| ||
Shareholders’ equity: |
|
|
|
|
| ||
Preferred stock, no par value - authorized 1,000,000 shares: |
|
|
|
|
| ||
Series A non-cumulative convertible perpetual preferred stock; authorized 990,000 shares; outstanding 732,785 shares and 734,985 shares at September 30, 2003 and December 31 2002, respectively |
| 5,985 |
| 6,003 |
| ||
Series B non-cumulative convertible perpetual preferred stock; authorized 1,000 shares; outstanding 1,000 shares |
| 1,000 |
| 1,000 |
| ||
Common stock, no par value; authorized 10,000,000 shares; outstanding 2,702,529 and 2,679,544 shares at September 30, 2003 and December 31, 2002, respectively |
| 38,168 |
| 38,054 |
| ||
Accumulated deficit |
| (14,248 | ) | (14,055 | ) | ||
Accumulated other comprehensive income |
| 37 |
| 202 |
| ||
Total shareholders’ equity |
| 30,942 |
| 31,204 |
| ||
Total liabilities and shareholders’ equity |
| $ | 370,466 |
| $ | 355,385 |
|
See accompanying notes to consolidated financial statements.
3
NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
|
| For the Three Months Ended |
| For the Nine Months Ended |
| ||||||||
|
| 2003 |
| 2002 |
| 2003 |
| 2002 |
| ||||
|
| (Dollars in thousands, |
| ||||||||||
Interest income: |
|
|
|
|
|
|
|
|
| ||||
Loans, including fees |
| $ | 3,914 |
| $ | 4,363 |
| $ | 12,121 |
| $ | 13,115 |
|
Securities |
| 251 |
| 401 |
| 660 |
| 1,331 |
| ||||
Federal funds sold and securities purchased under agreements to resell |
| 92 |
| 105 |
| 268 |
| 361 |
| ||||
Interest bearing deposits |
| 5 |
| — |
| 5 |
| — |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total interest income |
| 4,262 |
| 4,869 |
| 13,054 |
| 14,807 |
| ||||
Interest expense: |
|
|
|
|
|
|
|
|
| ||||
Interest-bearing demand |
| 21 |
| 86 |
| 110 |
| 243 |
| ||||
Money market and savings |
| 181 |
| 388 |
| 736 |
| 1,087 |
| ||||
Time certificates of deposit: |
|
|
|
|
|
|
|
|
| ||||
$ 100,000 or more |
| 163 |
| 172 |
| 429 |
| 673 |
| ||||
Under $100,000 |
| 138 |
| 357 |
| 657 |
| 1,117 |
| ||||
Total interest expense on deposits |
| 503 |
| 1,003 |
| 1,932 |
| 3,120 |
| ||||
Federal funds purchased and securities sold under agreements to repurchase |
| 3 |
| 21 |
| 14 |
| 116 |
| ||||
Junior subordinated deferrable interest debentures |
| 228 |
| — |
| 228 |
| — |
| ||||
Other borrowings |
| 89 |
| 92 |
| 267 |
| 388 |
| ||||
Total interest expense |
| 823 |
| 1,116 |
| 2,441 |
| 3,624 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net interest income before provision for credit losses |
| 3,439 |
| 3,753 |
| 10,613 |
| 11,183 |
| ||||
Provision for credit losses |
| 10 |
| 1,525 |
| 1,265 |
| 1,825 |
| ||||
Net interest income after provision for credit losses |
| 3,429 |
| 2,228 |
| 9,348 |
| 9,358 |
| ||||
Other operating income: |
|
|
|
|
|
|
|
|
| ||||
Net gain on sale of securities available-for-sale |
| — |
| — |
| 100 |
| — |
| ||||
International services |
| 19 |
| 13 |
| 34 |
| 32 |
| ||||
Investment division |
| 22 |
| 20 |
| 66 |
| 62 |
| ||||
Deposit-related and other customer services |
| 356 |
| 320 |
| 977 |
| 941 |
| ||||
Gain (loss) on sale of OREO/fixed assets |
| — |
| — |
| (61 | ) | — |
| ||||
Total other operating income |
| 397 |
| 353 |
| 1,116 |
| 1,035 |
| ||||
Other operating expenses: |
|
|
|
|
|
|
|
|
| ||||
Salaries and related benefits |
| 1,792 |
| 1,730 |
| 5,462 |
| 5,135 |
| ||||
Net occupancy |
| 333 |
| 348 |
| 1,006 |
| 1,070 |
| ||||
Furniture and equipment |
| 112 |
| 101 |
| 346 |
| 315 |
| ||||
Printing and communications |
| 143 |
| 126 |
| 405 |
| 437 |
| ||||
Insurance and regulatory assessments |
| 97 |
| 89 |
| 292 |
| 267 |
| ||||
Client services |
| 129 |
| 155 |
| 449 |
| 601 |
| ||||
Computer data processing |
| 261 |
| 224 |
| 726 |
| 736 |
| ||||
Legal services |
| 122 |
| 72 |
| 382 |
| 452 |
| ||||
Other professional services |
| 206 |
| 98 |
| 613 |
| 415 |
| ||||
Amortization of core deposit intangible |
| 56 |
| — |
| 168 |
| — |
| ||||
Promotion and other expenses |
| 41 |
| 87 |
| 263 |
| 284 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total other operating expenses |
| 3,292 |
| 3,030 |
| 10,112 |
| 9,712 |
| ||||
Income before income tax provision and minority interest |
| 534 |
| (449 | ) | 352 |
| 681 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Minority interest in the Company’s income of the: |
|
|
|
|
|
|
|
|
| ||||
Guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures, net |
| — |
| 380 |
| 456 |
| 1,153 |
| ||||
Series A Preferred Stock of South Bay Bank, N.A. |
| — |
| 53 |
| — |
| 159 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Income (loss) before income tax (benefit) provision |
| 534 |
| (882 | ) | (104 | ) | (631 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Income tax (benefit) provision |
| 242 |
| (340 | ) | 26 |
| (202 | ) | ||||
Net income (loss |
| $ | 292 |
| $ | (542 | ) | $ | (130 | ) | $ | (429 | ) |
Income (loss) available to common shareholders (net income (loss) less accretion of discount of minority interest in subsidiary preferred stock of $80,000 and $231,000 for the three months and nine months ended September 30, 2002) |
| $ | 292 |
| (622 | ) | $ | (130 | ) | (660 | ) | ||
Loss per share: |
|
|
|
|
|
|
|
|
| ||||
Basic |
| $ | 0.11 |
| $ | (0.38 | ) | $ | (0.05 | ) | $ | (0.40 | ) |
Diluted |
| $ | 0.07 |
| $ | (0.38 | ) | $ | (0.05 | ) | $ | (0.40 | ) |
See accompanying notes to consolidated financial statements.
4
NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
|
| For the Nine Months Ended September 30, |
| ||||
|
| 2003 |
| 2002 |
| ||
|
| (Dollars in thousands) |
| ||||
Cash flows from operating activities: |
|
|
|
|
| ||
Net income (loss) |
| $ | (130 | ) | $ | (429 | ) |
Adjustments to reconcile net income to net cash used in operating activities: |
|
|
|
|
| ||
Depreciation and amortization |
| 362 |
| 350 |
| ||
Provision for credit losses |
| 1,265 |
| 1,825 |
| ||
Gain on sale of securities available for sale |
| (100 | ) | — |
| ||
Loss on sales of OREO |
| 61 |
| — |
| ||
Net amortization of premium on securities available-for-sale |
| 161 |
| 133 |
| ||
Net amortization of core deposit intangible |
| 168 |
| — |
| ||
Net amortization of premium (discount) on loans purchased |
| 204 |
| 267 |
| ||
Decrease in accrued interest receivable and other assets |
| 632 |
| 793 |
| ||
Decrease in accrued interest payable and other liabilities |
| (1,212 | ) | (1,699 | ) | ||
|
|
|
|
|
| ||
Net cash provided by operating activities |
| 1,411 |
| 1,240 |
| ||
Cash flows from investing activities: |
|
|
|
|
| ||
Purchase of securities available-for-sale |
| (36,334 | ) | (7,002 | ) | ||
Proceeds from sales of securities available-for-sale |
| 2,757 |
| — |
| ||
Proceeds from repayments and maturities of securities available-for-sale |
| 21,321 |
| 18,199 |
| ||
Proceeds from sales of OREO |
| 474 |
| — |
| ||
Loan originations and principal collections, net |
| 21,597 |
| (7,423 | ) | ||
Redemption of Federal Reserve stock and other stocks |
| 149 |
| 314 |
| ||
Purchases of premises and equipment |
| (78 | ) | (191 | ) | ||
|
|
|
|
|
| ||
Net cash provided by investing activities |
| 9,886 |
| 3,897 |
| ||
Cash flows from financing activities: |
|
|
|
|
| ||
Net increase in demand deposits, money market and savings accounts |
| 35,377 |
| 9,186 |
| ||
Net decrease in time certificates of deposit |
| (18,677 | ) | (20,939 | ) | ||
Net decrease in securities sold under agreements to repurchase and federal funds purchased |
| (1,079 | ) | (1,416 | ) | ||
Net decrease in other borrowings |
| — |
| (10,000 | ) | ||
Dividends paid on subsidiary preferred stock |
| — |
| (106 | ) | ||
Net proceeds from exercise of stock options |
| 96 |
| 56 |
| ||
|
|
|
|
|
| ||
Net cash provided by (used in) financing activities |
| 15,717 |
| (23,219 | ) | ||
Net increase in cash and cash equivalents |
| 27,014 |
| (18,082 | ) | ||
Cash and cash equivalents, January 1 |
| 37,576 |
| 52,093 |
| ||
|
|
|
|
|
| ||
Cash and cash equivalents, September 30 |
| $ | 64,590 |
| $ | 34,011 |
|
|
|
|
|
|
| ||
Supplemental disclosures of cash flow information: |
|
|
|
|
| ||
Cash paid for Interest |
| $ | 2,825 |
| $ | 3,949 |
|
Transfers to OREO from loans receivable, net |
| $ | 535 |
| $ | — |
|
See accompanying notes to consolidated financial statements.
5
NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1—BASIS OF PRESENTATION AND MANAGEMENT REPRESENTATIONS
The unaudited consolidated financial statements include the accounts of National Mercantile Bancorp (the ‘‘Company’’) and its wholly owned subsidiaries, Mercantile National Bank and South Bay Bank, N.A. The Company adopted FASB Interpretation No. 46 Consolidation of Variable Interest Entities effective July 1, 2003 and accordingly National Mercantile Capital Trust I is not included in the consolidated balance sheet at September 30, 2003 or the consolidated statement of operation for the three months then ended. The unaudited consolidated financial statements reflect all interim adjustments, which are of a normal recurring nature and which, in management’s opinion, are necessary for the fair presentation of the Company’s consolidated financial position and results of operations and cash flows for such interim periods. The results for the three and nine months ended September 30, 2003 are not necessarily indicative of the results expected for any subsequent period or for the full year ending December 31, 2003. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2002.
In December 2002 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, (“SFAS No. 148”), Accounting for Stock-Based Compensation-Transition and Disclosure. SFAS No. 148 amends Statement of Financial Accounting Standards No. 123, (“SFAS No. 123”), Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No.148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition guidance and annual disclosure provisions are effective for fiscal years ending after December 15, 2002. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The Company adopted the provisions of SFAS No. 148 effective in the first quarter of 2003.
The estimated per share weighted average fair value of options granted was $4.92 and $4.04 for the three months ended September 30, 2003 and 2002, respectively. The estimated per share weighted average fair value of options granted was $4.78 and $3.89 for the nine months ended September 30, 2003 and 2002, respectively. The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for the stock incentive plans. SFAS No. 123, Accounting for
6
Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. Accordingly, no compensation cost has been recognized for the options. Had compensation cost for the options granted been determined based on the fair value at the grant dates for awards consistent with the method of SFAS No. 123, the Company’s net income for the three months ended September 30, 2003 and 2002 and the nine months ended September 30, 2003 and 2002 would have decreased by $28,000 and $23,000, and $93,000 and $68,000 respectively. Basic and diluted earnings per share would have decreased by $0.01 for the three months ended September 30, 2003. Basic and diluted loss per share would have increased by $0.03 for the nine months ended September 30, 2003. Basic and diluted loss per share would have increased by $0.01 for the three months ended September 30, 2002 and by $0.04 for the nine months ended September 30, 2002.
The fair values of options granted during the three months ended September 30, 2003 and 2002 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used: 2003— no dividend yield, expected volatility of 59%, risk-free interest rate of 4.05%, and an expected life of 10 years; 2002— no dividend yield, expected volatility of 64%, risk-free interest rate of 3.62%, and an expected life of 10 years.
NOTE 2—EARNINGS PER SHARE
Basic earnings or loss per share is computed using the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding used in computing basic earnings per share and diluted earnings per share for the three months ended September 30, 2003 was 2,700,934 and 4,402,571, respectively. The weighted average number of common shares outstanding used in computing basic and diluted loss per share for the three months ended September 30, 2002 was 1,637,991. The weighted average number of common shares outstanding used in computing basic and diluted loss per share for the nine months ended September 30, 2003 and 2002 was 2,694,670 and 1,632,242, respectively. Common share equivalents have not been included in the loss per share computation as they are anti-dilutive.
The following table is a reconciliation of income and shares used in the computation of basic and diluted loss per share:
7
|
| Earnings |
| Weighted |
| Per share |
| ||
|
| (in thousands) |
|
|
|
|
| ||
For the three months ended September 30, 2003: |
|
|
|
|
|
|
| ||
Basic earnings per share |
| $ | 292 |
| 2,700,935 |
| $ | 0.11 |
|
|
|
|
|
|
|
|
| ||
Effect of diultive securities: |
|
|
|
|
|
|
| ||
Options |
|
|
| 72,354 |
|
|
| ||
Convertible preferred stock |
|
|
| 1,629,282 |
|
|
| ||
Diluted earnings per share |
| 292 |
| 4,402,571 |
| $ | 0.07 |
| |
|
|
|
|
|
|
|
| ||
For the three months ended September 30, 2002: |
|
|
|
|
|
|
| ||
Basic and diluted loss per share |
| $ | (622 | ) | 1,637,991 |
| $ | (0.38 | ) |
|
|
|
|
|
|
|
| ||
For the nine months ended September 30, 2003: |
|
|
|
|
|
|
| ||
Basic and diluted loss per share |
| $ | (130 | ) | 2,694,670 |
| $ | (0.05 | ) |
|
|
|
|
|
|
|
| ||
For the nine months ended September 30, 2002: |
|
|
|
|
|
|
| ||
Basic and diluted loss per share |
| $ | (660 | ) | 1,632,242 |
| $ | (0.40 | ) |
NOTE 3—CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks-demand and federal funds sold.
NOTE 4—ALLOWANCE FOR CREDIT LOSSES
Provisions for credit losses charged to operations reflect management’s judgment of the adequacy of the allowance for credit losses and are determined through periodic analysis of the loan portfolio. This analysis includes a detailed review of the classification and categorization of problem loans and loans to be charged off; an assessment of the overall quality and collectibility of the portfolio; and consideration of the loan loss experience, trends in problem loan concentrations of credit risk, as well as current and expected future economic conditions (particularly Southern California). Management performs a periodic risk and credit analysis, the results of which are reported to the Board of Directors.
8
The following table sets forth information concerning the Company’s allowance for credit losses for the periods indicated.
Analysis of Changes in Allowance for Credit Losses
|
| Three months ended |
| Nine months ended |
| ||||||||
|
| September 30, |
| September 30, |
| September 30, |
| September 30, |
| ||||
|
| (Dollars in thousands) |
| (Dollars in thousands) |
| ||||||||
|
|
|
|
|
|
|
|
|
| ||||
Balance, beginning of period |
| $ | 3,452 |
| $ | 5,374 |
| $ | 4,846 |
| $ | 6,542 |
|
Loans charged off: |
|
|
|
|
|
|
|
|
| ||||
Real estate construction and land development |
| — |
| — |
| — |
| 31 |
| ||||
Commercial loans: |
|
|
|
|
|
|
|
|
| ||||
Secured by one to four family residential properties |
| (7 | ) | — |
| 31 |
| — |
| ||||
Secured by commercial real properties |
| — |
| 44 |
| 75 |
| 44 |
| ||||
Other - secured and unsecured |
| 1 |
| 2,065 |
| 2,698 |
| 3,807 |
| ||||
Consumer installment and unsecured loans to individuals |
| 13 |
| 50 |
| 46 |
| 81 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total loans charged-off |
| 7 |
| 2,159 |
| 2,850 |
| 3,963 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Recoveries of loans previously charged off: |
|
|
|
|
|
|
|
|
| ||||
Real estate construction and land development |
| — |
| — |
| — |
| 191 |
| ||||
Commercial loans: |
|
|
|
|
|
|
|
|
| ||||
Secured by commercial real properties |
| 13 |
| — |
| 13 |
| — |
| ||||
Other - secured and unsecured |
| 114 |
| 12 |
| 247 |
| 107 |
| ||||
Consumer installment and unsecured loans to individuals |
| 6 |
| 4 |
| 67 |
| 54 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total recoveries of loans previously charged off |
| 133 |
| 16 |
| 327 |
| 352 |
| ||||
Net charge-offs |
| (126 | ) | 2,143 |
| 2,523 |
| 3,611 |
| ||||
Provision for credit losses |
| 10 |
| 1,525 |
| 1,265 |
| 1,825 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Balance, end of period |
| $ | 3,588 |
| $ | 4,756 |
| $ | 3,588 |
| $ | 4,756 |
|
Credit quality is affected by many factors beyond the control of the Company, including local and national economies, and facts may exist which are not known to the Company that adversely affect the likelihood of repayment of various loans in the loan portfolio and realization of collateral upon a default. Accordingly, no assurance can be given that the Company will not sustain loan losses materially in excess of the allowance for credit losses. In addition, the Office of the Comptroller of the Currency, as an integral part of its examination process, periodically reviews the allowance for credit losses and could require additional provisions for credit losses.
9
NOTE 5—GOODWILL AND OTHER INTANGIBLE ASSETS
As of September 30, 2003 and December 31, 2002, the Company had goodwill of $2.2 million, and net core deposit intangibles of $1.9 million and $2.1 million, respectively, from its acquisition of the South Bay Bank in December 2001. The gross carrying amount of core deposit intangibles was $2.3 million at September 30, 2003 and December 31, 2002, and accumulated amortization was $397,000 and $223,000, respectively, at such dates. The core deposit intangibles are estimated to have a life of 10 years and 4 months. Amortization for intangibles for 2003 and each of the next four years is estimated to be $223,000 per year. In accordance with SFAS No. 142 goodwill is not amortized. The Company has no other indefinite-lived intangible assets.
NOTE 6—INCOME TAXES
Income tax provision of $242,000 and benefit of $340,000 were recorded for the three months ended September 30, 2003 and 2002, respectively. Income tax provision of $26,000 and benefit of $202,000 were recorded for the nine months ended September 30, 2003 and 2002, respectively. The difference between the statutory tax rate and the effective tax rate for the three and nine months ended September 30, 2003 is due to the amortization of the core deposit intangible not being deductible for tax purposes.
At September 30, 2003, the Company had: (i) federal net operating loss carry forwards (“NOLS”) of approximately $17.4 million, which begin to expire in the year 2009; (ii) California NOLS of $559,000 which will expire in 2005; (iii) a federal alternative minimum tax “AMT” credit of $298,000; and (iv) a California AMT of $16,000. The California NOLS were scheduled to expire in 2002; the state legislature suspended NOLS utilization and extended the related carryforward expiration. The AMT credits carry forward indefinitely.
NOTE 7—BENEFICIAL CONVERSION RIGHTS OF SUBSIDIARY PREFERRED STOCK
In connection with its acquisition of South Bay Bank, the Company recorded $1.8 million additional paid in capital, with a corresponding discount to the minority interest in the South Bay Series A Preferred stock, which remained outstanding following the acquisition, related to the beneficial conversion rights of such preferred stock. The discount was being amortized against retained earnings over the period from the acquisition date through the earliest possible conversion date of the preferred stock (June 30, 2005) using the effective yield method. For the three months and nine months ended September 30, 2002 the amount of the discount amortized against retained earnings was $80,000 and $231,000, respectively. The amortization of the
10
discount was netted against net income to determine income available to common shareholders for earnings per share in the 2002 period. The South Bay Series A Preferred stock was fully redeemed in December 2002.
NOTE 8—COMPREHENSIVE INCOME
Comprehensive income is comprised of net income and all changes to shareholders’ equity, except those changes resulting from investments by shareholders and distributions to shareholders. Total comprehensive income is as follows
|
| For the three months ended |
| For the nine months ended |
| ||||||||
|
| 2003 |
| 2002 |
| 2003 |
| 2002 |
| ||||
Net income (loss) |
| $ | 292 |
| $ | (542 | ) | $ | (130 | ) | $ | (429 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Other comprehensive income, before tax, and unrealized losses on securities: |
|
|
|
|
|
|
|
|
| ||||
Unrealized gain (loss) on securities available for sale |
| (62 | ) | 62 |
| (282 | ) | 354 |
| ||||
Other comprehensive income (loss), before tax |
| (62 | ) | 62 |
| (282 | ) | 354 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Income tax benefit (expense) related to items of other comprehensive income |
| 26 |
| (25 | ) | 117 |
| (145 | ) | ||||
Other comprehensive loss |
| (36 | ) | 37 |
| (165 | ) | 209 |
| ||||
Total comprehensive income |
| $ | 256 |
| $ | (505 | ) | $ | (295 | ) | $ | (220 | ) |
NOTE 9—JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES
In 2001, the Company, through National Mercantile Capital Trust I (the “Trust”), issued 15,000 of 10.25% fixed-rate preferred securities due July 25, 2031 (the “Trust Preferred Securities”), with a liquidation amount of $1,000 per Trust Preferred Security and an aggregate liquidation amount of $15.0 million. The Trust Preferred Securities represent undivided beneficial interests in the assets of the Trust and are unconditionally guaranteed by the Company with respect to distributions and payments upon liquidation, redemption and otherwise pursuant to the terms of a guarantee agreement.
The primary assets of the Trust are $15.5 million aggregate principal amount of the Company’s 10.25% fixed-rate junior subordinated deferrable interest debentures due July 25, 2031, (the “Junior Subordinated Debentures”) that pay interest each January 25 and July 25. The interest is deferrable, at the Company’s option, for a period up to ten consecutive semi-annual
11
payments, but in any event not beyond June 25, 2031. The debentures are redeemable, in whole or in part, at the Company’s option on or after five years from issuance at declining premiums to maturity.
The Company adopted FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46) as of July 1, 2003 resulting in the deconsolidation of the Trust. Accordingly, the Junior Subordinated Debentures have been classified in liabilities at September 30, 2003 and the related interest was classified as interest expense for the three months then ended. For periods prior to the adoption of FIN 46, the Trust Preferred Securities, net of the issuance cost, were recorded as a minority interest and the related interest was recorded as a minority interest in the Company’s income.
NOTE 10—DERIVATIVE FINANCIAL INSTRUMENTS
In January 2003, the Company entered into a interest rate swap agreement pursuant to which it exchanged a fixed rate payment obligation of 10.25% on a notional principal amount of $15.0 million for a floating rate interest based on the six-month London InterBank Offered Rate plus 458 basis points for a 29-year period ending July 25, 2031. The interest rate swap agreement results in the Company paying or receiving the difference between the fixed and floating rates at specified intervals calculated based on the notional amounts. The differential paid or received on the interest rate swap is recognized as an adjustment to interest expense. At July 25, 2003, the most recent rate reset date, the Company was paying an interest rate of 5.70% under the terms of the swap which will reduce its interest expense $642,000 for the twelve months ended December 31, 2003. The counter party to the swap has the option to call the swap under a declining premium schedule beginning July 2006.
The interest rate swap reduces the adverse impact of the 10.25% fixed-rate Junior Subordinated Debentures in a declining interest rate environment. The Company does not utilize derivatives for speculative purposes. Under Statement of Financial Accounting Standards No. 133 this swap transaction is designated as a fair value hedge. Accordingly, the ineffective portion of the change in the fair value of the swap transaction is recorded each period in current income. The terms of the swap are symmetrical with the terms of the Junior Subordinated Debentures, including the payment deferral terms, and considered highly effective in offsetting changes in fair value of the Junior Subordinated Debentures. Accordingly, a $545,000 decrease in the fair value of the swap was recorded in income for the three-month period ended September 30, 2003 and an $88,000 decrease in the fair value of the swap was recorded in income for the nine-month period ended September 30, 2003 with an offsetting charge to earnings to reflect a similar decrease in the fair value of the Junior Subordinated Debentures.No ineffectiveness was recorded to current earnings related to the interest rate swap.
The terms of the swap require the Company to provide collateral of $1.0 million plus the value of the swap contract in minimum increments of $250,000 when the value is positive for the counterparty.
12
NOTE 11— CONVERSION OF PREFERRED STOCK
In the nine months ended September 30, 2003, 2,200 shares of Series A non-cumulative convertible perpetual preferred stock were converted to 4,400 shares of common stock.
NOTE 12—RECLASSIFICATIONS
Certain prior year data have been reclassified to conform to current year presentation.
NOTE 13—ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued FIN 46. FIN 46 changes the consolidation requirements by requiring a variable interest entity to be consolidated by a company if that company is subject to the majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. In addition, FIN No. 46 requires disclosures about variable interest entities that a company is not required to consolidate but in which it has a significant variable interest.The consolidation requirements of FIN No. 46 apply to variable interest entities created after January 31, 2003 and apply to existing variable interest entities no later than the first fiscal year or interim period beginning after June 15, 2003.
The Company adopted FIN 46 effective July 1, 2003 and accordingly reclassified the Junior Subordinated Debentures as other liabilities and the related interest as other interest expense.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires than an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity.
The Company adopted SFAS 150 effective July 1, 2003, which had no effect on the Company’s financial statements.
13
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
National Mercantile Bancorp (“National Mercantile” on a parent-only basis, and the ‘‘Company’’ on a consolidated basis) is the holding company for two subsidiary banks, Mercantile National Bank (“Mercantile”) and South Bay Bank, N.A. (“South Bay”) (collectively, “the Banks”). National Mercantile’s principal assets are the capital stock of Mercantile and South Bay.
In July 2001, National Mercantile formed National Mercantile Capital Trust (the “Trust”) as a Delaware statutory business trust formed for the exclusive purpose of issuing and selling trust preferred securities (the “Trust Preferred Securities”). The trust issued those securities and utilized the proceeds to purchase from the National Mercantile junior subordinated deferrable interest debentures (the “Junior Subordinated Debentures”). Through June 30, 2003, the Company’s financial statements reflected the Trust as a consolidated subsidiary, with the effect that the Trust Preferred Securities of the Trust were reflected on the balance sheet as mezzanine equity and payments on the Trust Preferred Securities were set forth as expenses classified as minority interest in the Company’s income of the guaranteed preferred beneficial interest in the Junior Subordinated Debentures.
The Company implemented FIN 46 effective July 1, 2003 with the effect that since that date the Trust has not been a consolidated subsidiary of the Company for financial reporting purposes. As a result: (i) the Company’s balance sheets as of dates on or after July 1, 2003 no longer reflect the Trust Preferred Securities as mezzanine equity but instead reflect the Junior Subordinated Debentures as liabilities, and (ii) the Company’s statements of operations incorporating periods on or after July 1, 2003, reflect from July 1, 2003 forward interest payments on the Junior Subordinated Debentures as interest expense and do not reflect payments on the Trust Preferred Securities as expenses classified as minority interest in the Company’s income of the guaranteed preferred beneficial interest in the Company’s junior subordinated interest. As discusses below, this has a significant effect on comparisons of net interest income between periods including and not including periods on and after July 1, 2003.
RESULTS OF OPERATIONS
The Company recorded net income of $292,000, or $0.11 basic earnings per share and $0.07 diluted earning per share, for the three months ended September 30, 2003 compared to a net loss of $542,000, or $0.38 basic and diluted loss per share, for the same period of 2002.The increase in net income for the 2003 period was primarily due to a $1.5 million decrease in provision for credit losses. This was partially offset by a $262,000 increase in total other operating expenses and a $582,000
14
increase in income tax provisions. Net interest income before provision for credit losses for the three months ended September 30, 2003 reflects a $314,000 decline from the same period in 2002.
The Company recorded a loss for the nine months ended September 30, 2003 of $130,000, or $0.05 basic and diluted loss per share, compared to a net loss of $660,000 for the same period of 2002. On a per share basis, the results for the nine months ended September 30, 2002 was $0.40 basic and diluted loss per share. The decrease in net loss was primarily due to a $560,000 decrease in the provision for credit losses, a $159,000 decrease in the minority interest in the Company’s income of the preferred stock of South Bay and a $100,000 net gain on sale of securities available-for-sale. This was partially offset by a $400,000 increase in other operating expenses and a $228,000 increase in the provision for income taxes.Net interest income for the nine months ended September 30, 2003 was $10.6 million compared to $11.2 million in 2002.
Return on average assets during the third quarter and first nine months of 2003 was 0.31% and a minus 0.05%, respectively, compared to minus 0.60% and a minus 0.16% during the third quarter and first nine months of 2002, respectively. Return on average equity during the third quarter and first nine months of 2003 was 3.72% and a minus 0.55%, respectively, compared to a minus 8.46% and a minus 2.25% during the third quarter and first nine months of 2002, respectively.
NET INTEREST INCOME
Net interest income before the provision for credit losses decreased $314,000 from the third quarter of 2002 to the third quarter of 2003 due primarily to the inclusion of $228,000 of expense on the Junior Subordinated Debentures (which comparable expense was not classified as interest expense in prior periods). This decrease was also due to the decrease in net interest margin (net yield on earning assets) from 3.98% for the third quarter of 2002 to 3.59% in the third quarter of 2003. This 60 basis point decrease in net interest margin was due primarily to: (i) lower yielding assets comprising a higher portion of the interest-earning asset portfolio, as the Company invested funds from new deposits and other sources in federal funds and repurchase agreements pending deployment into loans or securities; and (ii) a 196 basis point decrease in the weighted average yield on securities available-for-sale due to significantly lower yields on newly acquired securities. The decrease in net interest income occurred notwithstanding an increase in net interest earning assets (interest earning assets less interest bearing liabilities) from $108.7 million in the third quarter of 2002 to $115.1 million in the third quarter of 2003, which occurred despite the inclusion of $15.4 million of Junior Subordinated Debentures as interest-bearing liabilities in the 2003 quarter. This was due primarily to a $22.1 million increase in average non-interest bearing demand deposits reflecting the impact of the Company’s continued emphasis on business banking and the generation of lower cost transactional deposits particularly at South Bay, which historically had emphasized time certificates of deposit.
15
Net interest income before provision for credit losses decreased $570,000 from the nine months ended September 30, 2003 to the nine months ended September 30, 2003. Factors effecting this decline were the inclusion of $228,000 of expense on the Junior Subordinated Debentures in the 2003 nine months (which comparable expense was not classified as interest expense in the 2002 nine month) and a decrease in the net interest spread from 3.92% to 3.79%. The decrease in net interest income occurred notwithstanding an increase in net interest earning assets from $106.1 million in the 2002 nine months to $120.3 million in the 2003 nine months, which occurred despite the inclusion of average balance of $5.2 million of Junior Subordinated Debentures as interest-bearing liabilities in the 2003 nine months. This was due primarily to a $3.5 million increase in average interest earning assets and a $10.7 million reduction in interest bearing liabilities, as the Company continued to replace higher cost time certificates of deposit (the average balances of which were reduced by $21.4 million) with non-interest bearing demand deposits.
The weighted average yields earned on interest earning assets and rates paid on interest bearing liabilities generally declined from the 2002 periods to the 2003 periods as a result of decreases in market interest rates as a result of the Federal Reserve’s reduction in the federal funds rate in response to the slow economy.
The net yield on earning assets was 4.11% for the three months ended September 30, 2003 compared to 4.71% for the same period in 2002 due to a change in mix of interest earning assets to lower yielding asset types and the overall decline in yields. Partially mitigating the decline in net yield on earning assets was an overall decline in deposit rates, a change in deposit mix to lower costing deposits, and an increase in noninterest-bearing demand deposits.
The net yield on interest-earning assets decreased from 4.67% to 4.38% due to an overall decline in yields on interest earning assets, partially offset by overall declines in deposit rates, a change in deposit mix to lower costing deposits, and an increase in noninterest bearing demand deposits.
Average loans receivable decreased $3.8 million or 1.4% for the three months ended September 30, 2003 compared to the same period in 2002 primarily due to the repayment of construction loans in the 2003 period. Due to the nature of construction loans, the outstanding balance of newly originated loans increases gradually during the life of the loan and repays in a lump sum. The weighted average yield on loans receivable declined 60 basis points to 6.03% for the third quarter 2003. The lower yields on loans receivable are due to the sustained decline in interest rates over the past two years affecting the yields on adjustable rate loans tied to rate indices as well as the yields on newly originated fixed rate loans and existing fixed rate loans upon renewal at maturity.
16
Securities available-for-sale and securities held-to-maturity increased slightly to $30.7 million average for the three months ended September 30, 2003 compared to $30.6 million average for the period ended September 30, 2002.The weighted average yield on securities available-for-sale was 3.26% and 5.20% for the three months ended September 30, 2003 and 2002, respectively, representing a 194 basis point decline. The decline in yield was due to purchases of securities in the declining rate environment during 2002 and to a lesser extent, adjustable rate securities in the portfolio. The weighted average yield on securities held-for-maturity was 3.34% for the three months ended September 30, 2003. There were no securities held-for-maturity during the three months ended September 30, 2002. Federal funds sold averaged $43.2 million and yielded 0.84% during the third quarter of 2003 compared to an average of $24.5 million yielding 1.70% for the same period in 2002.
Average loans receivable increased $5.1 million for the nine months ended September 30, 2003 compared to the same period in 2002. The weighted average yield on loans receivable declined 65 basis points to 6.13% for the nine months ended September 30, 2003. The lower yields on loans receivable are due to the sustained decline in interest rates over the past two years affecting the yields on adjustable rate loans tied to rate indices as well as the yields on newly originated fixed rate loans and existing fixed rate loans upon renewal at maturity. Securities available for sale decreased $7.1 million or 21.9% for the nine months ended September 30, 2003 compared to the same period in 2002, in order to fund higher yielding loans, reduce higher cost funding sources and to reduce the exposure to a decline in market value in the event that market rates begin to rise. The weighted average yield on securities available for sale was 3.37% and 5.50% for the nine months ended September 30, 2003 and 2002, respectively, representing a 213 basis point decline for the nine months ended September 30, 2003. The decline in yield was due to purchases of securities in the declining rate environment during 2002 and to a lesser extent, adjustable rate securities in the portfolio. The weighted average yield on securities held-for-maturity was 3.30% for the nine months ended September 30, 2003.Federal funds sold averaged $33.0 million and yielded 1.09% during the nine months ended September 30, 2003 compared to an average of $28.6 million yielding 1.69% for the same period in 2002.
Average total deposits increased $16.4 million or 5.4% to $317.6 million during the third quarter of 2003 compared to $301.2 million during the third quarter of 2002. Federal funds purchased and securities sold under agreements to repurchase averaged $606,000 and $1.8 million for the three months ended September 30, 2003 and 2002, respectively. Average total other borrowings decreased slightly from $7.6 million the quarter ended September 30, 2002, to $7.5 million during the quarter ended September 30, 2003. Other borrowings included advances from the Federal Home Loan Bank. Junior subordinated debentures were reclassified as interest-bearing liabilities upon adoption of SFAS 150 and FIN 46 as previously discussed. The average was $15.5 million for the three months September 30, 2003.
17
Average total deposits increased $8.9 million or 3.0% to $307.9 million during the nine months ended September 30, 2003 compared to $299.0 million during the nine months ended September 30, 2002. Federal funds purchased and securities sold under agreements to repurchase averaged $686,000 and $2.6 million for the nine months ended September 30, 2003 and 2002, respectively. Average total other borrowings decreased $5.1 million or 40.4% to $7.5 million during the nine months ended September 30, 2003 compared to $12.6 million during the nine months ended September 30, 2002 reflecting a planned reduction in these relatively high cost funds provided for by a reduction in securities available for sale. Junior subordinated debentures were reclassified as interest-bearing liabilities upon adoption of SFAS 150 and FIN 46 as previously discussed. The average was $5.2 million for the nine months September 30, 2003. This was not reported as an interest-bearing liability for the period ending September 30, 2002.
The weighted average cost of interest bearing liabilities declined 62 basis points to 1.51% during the third quarter of 2003 from 2.13% the during the third quarter of 2002. This change was a result of a decrease in the weighted average cost of interest bearing deposits to 1.04% during the third quarter of 2003 compared to 2.01% during the third quarter of 2002. The decline in the weighted average cost of deposits was due to a lower volume of higher-costing time certificates of deposit as well as lower rates on deposits. The change in the composition of deposits reflects management’s emphasis on business banking at South Bay, which resulted in lower cost transaction deposit accounts.
The weighted average cost of interest bearing liabilities declined 66 basis points to 1.60% during the nine months ended September 30, 2003 from 2.26% the during the nine months ended September 30, 2002. This change was a result of a decrease in the weighted average cost of interest bearing deposits to 1.36% during the nine months ended September 30, 2003 compared to 2.10% during the nine months ended September 30, 2002. The decline in the weighted average cost of deposits was due to a lower volume of higher-costing time certificates of deposit as well as lower rates on deposits. The change in the composition of deposits reflects management’s emphasis on business banking at South Bay, which resulted in lower cost transaction deposit accounts.
The weighted average cost of other borrowings was 4.71% during the third quarter of 2003 compared to 4.78% during the third quarter of 2002.
The weighted average cost of other borrowings was 4.76% during the nine months ended September 30, 2003 compared to 4.12% during the nine months ended September 30, 2002. The increase was due to the maturity of lower costing borrowings.
Average noninterest-bearing demand deposits increased $22.1 million or 21.5% during the third quarter 2003 to $125.4 million from $103.2 million due to management’s emphasis on growth in business banking.
18
Average noninterest-bearing demand deposits increased $17.7 million or 17.7% during the nine months ended September 30, 2003 to $117.8 million from $100.1 million due to an increase in business transaction accounts.
The following table presents the components of net interest income for the three months ended September 30, 2003 and 2002.
19
Average Balance Sheet and
Analysis of Net Interest Income
|
| Three months ended |
| ||||||||||||||
|
| September 30, 2003 |
| September 30, 2002 |
| ||||||||||||
|
| Average |
| Weighted |
| Average |
| Average |
| Interest |
| Weighted |
| ||||
|
| (Dollars in thousands) |
| ||||||||||||||
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Federal funds sold and securities purchased under agreements to resell |
| $ | 43,228 |
| 92 |
| 0.84 | % | $ | 24,454 |
| $ | 105 |
| 1.70 | % | |
Interest-bearing deposits with other financial institutions |
| 363 |
| 5 |
| 5.39 | % | — |
| — |
| — |
| ||||
Securities available-for-sale |
| 28,341 |
| 231 |
| 3.26 | % | 30,621 |
| 401 |
| 5.20 | % | ||||
Securities held-to-maturity |
| 2,395 |
| 20 |
| 3.34 | % | — |
| — |
| — |
| ||||
Loans receivable (1) (2) |
| 257,328 |
| 3,914 |
| 6.03 | % | 261,109 |
| 4,363 |
| 6.63 | % | ||||
Total interest earning assets |
| 331,655 |
| 4,262 |
| 5.10 | % | 316,184 |
| 4,869 |
| 6.11 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Noninterest earning assets: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Cash and due from banks - demand |
| 22,764 |
|
|
|
|
| 20,051 |
|
|
|
|
| ||||
Other assets |
| 22,032 |
|
|
|
|
| 23,827 |
|
|
|
|
| ||||
Allowance for credit losses and net unrealized gain on sales of securities available-for-sale |
| (3,480 | ) |
|
|
|
| (5,927 | ) |
|
|
|
| ||||
Total assets |
| $ | 372,971 |
|
|
|
|
| $ | 354,135 |
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Liabilities and shareholders’ equity: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Interest-bearing deposits: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Demand |
| $ | 29,781 |
| 21 |
| 0.28 | % | $ | 27,970 |
| $ | 86 |
| 1.22 | % | |
Money market and savings |
| 102,838 |
| 181 |
| 0.70 | % | 91,443 |
| 388 |
| 1.68 | % | ||||
Time certificates of deposit: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
$100,000 or more |
| 27,504 |
| 163 |
| 2.35 | % | 41,801 |
| 172 |
| 1.63 | % | ||||
Under $100,000 |
| 32,158 |
| 138 |
| 1.70 | % | 36,808 |
| 357 |
| 3.85 | % | ||||
Total time certificates of deposit |
| 59,662 |
| 301 |
| 2.00 | % | 78,609 |
| 529 |
| 2.67 | % | ||||
Total interest-bearing deposits |
| 192,281 |
| 503 |
| 1.04 | % | 198,022 |
| 1,003 |
| 2.01 | % | ||||
Other borrowings |
| 7,500 |
| 89 |
| 4.71 | % | 7,638 |
| 92 |
| 4.78 | % | ||||
Junior subordinated debentures |
| 15,464 |
| 228 |
| 5.85 | % | — |
| — |
| — |
| ||||
Federal funds purchased and securities sold under agreements to repurchase |
| 606 |
| 3 |
| 1.96 | % | 1,782 |
| 21 |
| 4.68 | % | ||||
Total interest-bearing liabilities |
| 215,851 |
| 823 |
| 1.51 | % | 207,442 |
| 1,116 |
| 2.13 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Noninterest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Noninterest bearing demand deposits |
| 125,363 |
|
|
|
|
| 103,220 |
|
|
|
|
| ||||
Other liabilities |
| 620 |
|
|
|
|
| 2,994 |
|
|
|
|
| ||||
Guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures, net |
| — |
|
|
|
|
| 14,524 |
|
|
|
|
| ||||
Minority interest of the preferred stock of subsidiary |
| — |
|
|
|
|
| 869 |
|
|
|
|
| ||||
Shareholders’ equity |
| 31,137 |
|
|
|
|
| 25,086 |
|
|
|
|
| ||||
Total liabilities and shareholders’ equity |
| $ | 372,971 |
|
|
|
|
| $ | 354,135 |
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net interest income (spread) |
|
|
| $ | 3,439 |
| 3.59 | % |
|
| $ | 3,753 |
| 3.98 | % | ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net yield on earning assets (2) |
|
|
|
|
| 4.11 | % |
|
|
|
| 4.71 | % | ||||
(1) The average balance of nonperforming loans has been included in loans receivable.
(2) Yields and amounts earned on loans receivable include loan fees of $239,000 and $116,000 for the three months ended September 30, 2003 and 2002, respectively.
20
The following table presents the components of net interest income for the nine months ended September 30, 2003 and 2002.
21
|
| Nine months ended |
| ||||||||||||||
|
| September 30, 2003 |
| September 30, 2002 |
| ||||||||||||
|
| Average |
| Interest |
| Weighted |
| Average |
| Interest |
| Weighted |
| ||||
|
| (Dollars in thousands) |
| ||||||||||||||
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Federal funds sold and securities purchased under agreements to resell |
| $ | 32,974 |
| 268 |
| 1.09 | % | $ | 28,588 |
| $ | 361 |
| 1.69 | % | |
Interest-bearing deposits with other financial institutions |
| 338 |
| 5 |
| 1.95 | % | — |
| — |
| — |
| ||||
Securities available-for-sale |
| 25,296 |
| 640 |
| 3.37 | % | 32,383 |
| 1,331 |
| 5.50 | % | ||||
Securities held-to-maturity |
| 807 |
| 20 |
| 3.30 | % | — |
| — |
| — |
| ||||
Loans receivable (1) (2) |
| 264,345 |
| 12,121 |
| 6.13 | % | 259,211 |
| 13,115 |
| 6.78 | % | ||||
Total interest earning assets |
| 323,760 |
| 13,054 |
| 5.39 | % | 320,182 |
| 14,807 |
| 6.18 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Noninterest earning assets: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Cash and due from banks - demand |
| 21,884 |
|
|
|
|
| 20,251 |
|
|
|
|
| ||||
Other assets |
| 21,574 |
|
|
|
|
| 24,035 |
|
|
|
|
| ||||
Allowance for credit losses and net unrealized gain on sales of securities available-for-sale |
| (4,161 | ) |
|
|
|
| (5,925 | ) |
|
|
|
| ||||
Total assets |
| $ | 363,057 |
|
|
|
|
| $ | 358,543 |
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Liabilities and shareholders’ equity: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Interest-bearing deposits: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Demand |
| $ | 28,349 |
| 110 |
| 0.52 | % | $ | 27,762 |
| $ | 243 |
| 1.17 | % | |
Money market and savings |
| 97,077 |
| 736 |
| 1.01 | % | 85,037 |
| 1,087 |
| 1.71 | % | ||||
Time certificates of deposit: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
$ 100,000 or more |
| 30,172 |
| 429 |
| 1.90 | % | 46,545 |
| 673 |
| 1.93 | % | ||||
Under $100,000 |
| 34,526 |
| 657 |
| 2.54 | % | 39,586 |
| 1,117 |
| 3.77 | % | ||||
Total time certificates of deposit |
| 64,698 |
| 1,086 |
| 2.24 | % | 86,131 |
| 1,790 |
| 2.78 | % | ||||
Total interest-bearing deposits |
| 190,124 |
| 1,932 |
| 1.36 | % | 198,930 |
| 3,120 |
| 2.10 | % | ||||
Other borrowings |
| 7,500 |
| 267 |
| 4.76 | % | 12,592 |
| 388 |
| 4.12 | % | ||||
Junior subordinated debentures |
| 5,155 |
| 228 |
| 5.91 | % | — |
| — |
| — |
| ||||
Federal funds purchased and securities sold under agreements to repurchase |
| 686 |
| 14 |
| 2.73 | % | 2,562 |
| 116 |
| 6.05 | % | ||||
Total interest-bearing liabilities |
| 203,465 |
| 2,441 |
| 1.60 | % | 214,084 |
| 3,624 |
| 2.26 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Noninterest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Noninterest bearing demand deposits |
| 117,791 |
|
|
|
|
| 100,078 |
|
|
|
|
| ||||
Other liabilities |
| 743 |
|
|
|
|
| 3,666 |
|
|
|
|
| ||||
Guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures, net |
| 9,689 |
|
|
|
|
| 14,520 |
|
|
|
|
| ||||
Minority interest of the preferred stock of subsidiary |
| — |
|
|
|
|
| 791 |
|
|
|
|
| ||||
Shareholders’ equity |
| 31,369 |
|
|
|
|
| 25,404 |
|
|
|
|
| ||||
Total liabilities and shareholders’ equity |
| $ | 363,057 |
|
|
|
|
| $ | 358,543 |
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net interest income (spread) |
|
|
| $ | 10,613 |
| 3.79 | % |
|
| $ | 11,183 |
| 3.92 | % | ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net yield on earning assets (2) |
|
|
|
|
| 4.38 | % |
|
|
|
| 4.67 | % | ||||
(1) The average balance of nonperforming loans has been included in loans receivable.
(2) Yields and amounts earned on loans receivable include loan fees of $656,000 and $395,000 for the nine months ended September 30, 2003 and 2002, respectively.
22
The following table sets forth, for the periods indicated, the changes in interest earned and interest paid resulting from changes in volume and changes in rates. Average balances in all categories in each reported period were used in the volume computations. Average yields and rates in each reported period were used in rate computations.
Increase (Decrease) in Interest Income/Expense Due to Change in
Average Volume and Average Rate (1)
|
| Nine months ended September 30, |
| |||||||
|
|
|
| Net |
| |||||
Increase (decrease) due to: | ||||||||||
Volume |
| Rate | ||||||||
|
|
|
|
|
|
|
| |||
Interest Income: |
|
|
|
|
|
|
| |||
Federal funds sold and securities purchased under agreement to resell |
| $ | 55 |
| $ | (148 | ) | $ | (93 | ) |
Interest-bearing deposits with other financial institutions |
| 5 |
| — |
| 5 |
| |||
Securities available-for-sale |
| (293 | ) | (398 | ) | (691 | ) | |||
Securities held-to-maturity |
| 20 |
| — |
| 20 |
| |||
Loans receivable (2) |
| 260 |
| (1,254 | ) | (994 | ) | |||
|
|
|
|
|
|
|
| |||
Total interest-earning assets |
| 47 |
| (1,800 | ) | (1,753 | ) | |||
|
|
|
|
|
|
|
| |||
Interest Expense: |
|
|
|
|
|
|
| |||
Interest-bearing deposits: |
|
|
|
|
|
|
| |||
Demand |
| $ | 5 |
| $ | (138 | ) | $ | (133 | ) |
Money market and savings |
| 154 |
| (505 | ) | (351 | ) | |||
Time certificates of deposit: |
|
|
|
|
|
|
| |||
$100,000 or more |
| (237 | ) | (7 | ) | (244 | ) | |||
Under $100,000 |
| (143 | ) | (317 | ) | (460 | ) | |||
|
|
|
|
|
|
|
| |||
Total time certificates of deposit |
| (380 | ) | (324 | ) | (704 | ) | |||
Total interest-bearing deposits |
| (221 | ) | (967 | ) | (1,188 | ) | |||
Other borrowings |
| (157 | ) | 36 |
| (121 | ) | |||
Junior subordinated debentures |
| 228 |
| — |
| 228 |
| |||
Federal funds purchased and securities sold under agreements to repurchase |
| (85 | ) | (17 | ) | (102 | ) | |||
Total interest-bearing liabilities |
| (235 | ) | (948 | ) | (1,183 | ) | |||
|
|
|
|
|
|
|
| |||
Net interest income |
| $ | 282 |
| $ | (852 | ) | $ | (570 | ) |
(1) The change in interest income or interest expense that is attributable to both changes in average balance and average rate has been allocated to the changes due to (i) average balance and (ii) average rate in proportion to the relationship of the absolute amounts of changes in each.
(2) Table does not include interest income that would have been earned on nonaccrual loans.
23
PROVISION FOR CREDIT LOSSES
Provisions for credit losses were $10,000 and $1.3 million, for the three months and nine months ended September 30, 2003, respectively, compared to $1.5 million and $1.8 million for the three months and nine months ended September 30, 2002, respectively. The decrease in provisions for credit losses during the third quarter 2003 was due to the decrease in loans outstanding for the period and the current adequacy of the allowance for credit losses based upon our analysis. See Note 4 of Notes to Consolidated Financial Statements.
OTHER OPERATING INCOME
Other operating income increased to $397,000 during the third quarter of 2003 from $353,000 during the third quarter of 2002 primarily due to an increase in deposit-related and other customer service income.
Other operating income increased to $1.1 million during the nine months ended September 30, 2003 from $1.0 million during the nine months ended September 30, 2002 due to net gains on sales of securities of $100,000 for the 2003 period compared to no gains for the 2002 period and an $36,000 increase in deposit-related and other customer service income, offset by a loss on sale of other real estate owned in 2003 for $61,000.
Net gains on sales of securities are generated primarily in declining interest rate environments. Accordingly, gains or losses from sales of securities may fluctuate significantly from period to period, and the results in any period are not necessarily indicative of the results, which may be obtained in future periods.
OTHER OPERATING EXPENSES
Other operating expense increased to $3.3 million for the three months ended September 30, 2003 compared to $3.0 million for the same period in 2002. Variances within operating expenses were reflected as follows; (i) salaries and related benefits expense increased $62,000, or 3.6%; (ii) client services expense decreased $26,000 or 16.8%; (iii) computer data processing expense increased $37,000 or 16.5%; (iv) legal serivces expense increased $50,000, or 69.4%; (v) other professional services expense increased $108,000 or 110.2%; (vi) amortization of core deposit intangible expense increased $56,000; and (vii) promotion and other expenses decreased $46,000 or 52.9%.
Other operating expense increased by $400,000 to $10.1 million during the nine months ended September 30, 2003 compared to $9.7 million during nine months ended September 30, 2002. This increase was reflected as follows; (i) salaries and related benefits expense increased $327,000, or 6.4%; (ii) net occupancy expense decreased $64,000 or 6.0%; (iii) client
24
services expense decreased $152,000, or 25.3%; (iv) legal services expense decreased $70,000, or 15.5%; and (v) amortization of core deposits expenses increased $168,000.
The increase in salary and related expense in the third quarter of 2003 is due to greater temporary help expense and an increase in incentive bonus accrual. The temporary help expense is expected to decrease in later quarters, however, it will be largely offset by salary expense. The decline in client services is primarily related to the decrease in services by the escrow customers. Although legal expenses increased in the third quarter of 2003 as compared to the third quarter of 2002, legal expenses for the nine months ending September 30, 2003 are 15.5% lower than the same period of 2002 primarily due to lower fees relating to credit collection. Other professional expense increased for the three months ended September 30, 2003 to $206,000 from $98,000 during the third quarter of 2002. This increase is due to a sales training program, and an increase in audit fee and consulting fees.
MINORITY INTEREST IN THE COMPANY’S INCOME
The minority interest in the Company’s income of the guaranteed beneficial interest in the Company’s Junior Subordinated Debentures $380,000 for the three months ended September 30, 2002. As a result of the reclassification pursuant to FIN 46 effective July 1, 2003, no such minority interest expense was recorded for three months ended September 30, 2003. The minority interest in the Company’s income of the guaranteed beneficial interest in the Junior Subordinated Debenture was $456,000 and $1,153,000 for the nine months ended September 30, 2003 and 2002, respectively. This reduction reflected, in part, the reclassification.
This reduction also reflected the effect of an interest rate swap agreement that the Company entered into in January 2003 in which it exchanged a fixed rate payment obligation of 10.25% on a notional principal amount of $15.0 million for a floating interest rate based on the six-month London InterBank Offered Rate plus 458 basis points for a 29-year period ending July 25, 2031. The weighted average cost of the Trust Preferred Securities/Junior Subordinated Debentures was 5.83% and 10.25% for the nine months ended September 30, 2003 and 2002, respectively. On July 25, 2003 the interest rate reset to 5.70% per annum.
This swap transaction is designated as a fair value hedge. Accordingly, a $545,000 decrease in the fair value of the swap was recorded in income for the three-month period ended September 30, 2003. The terms of the swap are symmetrical with the terms of the Junior Subordinated Debentures, including the payment deferral terms, and considered highly effective in offsetting changes in fair value of the Junior Subordinated Debentures. Accordingly, an offsetting charge to earnings was
25
recorded for the three months ended September 30, 2003 to reflect the increase in the fair value of the Junior Subordinated Debentures. See Note 10 of Notes to Consolidated Financial Statements.
BALANCE SHEET ANALYSIS
INVESTMENT SECURITIES
The following comparative period-end table sets forth certain information concerning the estimated fair values and unrealized gains and losses of securities available-for-sale and securities held-to-maturity.
26
Estimated Fair Values of and Unrealized
Gains and Losses on Securities
|
| September 30, 2003 |
| ||||||||||
|
| Total |
| Gross |
| Gross |
| Estimated |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Available-for-Sale: |
|
|
|
|
|
|
|
|
| ||||
U.S. Treasury securities |
| $ | 3,096 |
| $ | — |
| $ | — |
| $ | 3,096 |
|
GNMA-issued/guaranteed mortgage pass through certificates |
| 454 |
| 13 |
| — |
| 467 |
| ||||
Other U.S. Government and federal agency securities |
| 7,256 |
| 46 |
| — |
| 7,302 |
| ||||
FHLMC/FNMA-issued mortgage pass through certificates |
| 6,315 |
| 197 |
| — |
| 6,512 |
| ||||
CMO’s and REMIC’s issued by U.S. government-sponsored agencies |
| 703 |
| — |
| 18 |
| 685 |
| ||||
Mutual funds |
| 10,000 |
| — |
| 36 |
| 9,964 |
| ||||
Privately issued corporate bonds, CMO and REMIC securities |
| 3,426 |
| 7 |
| 145 |
| 3,288 |
| ||||
|
| $ | 31,250 |
| $ | 263 |
| $ | 199 |
| $ | 31,314 |
|
|
|
|
|
|
|
|
|
|
| ||||
FRB and other equity stocks |
| $ | 1,869 |
| — |
| — |
| $ | 1,869 |
|
|
| September 30, 2003 |
| ||||||||||
|
| Total |
| Gross |
| Gross |
| Estimated |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Held-to-Maturity: |
|
|
|
|
|
|
|
|
| ||||
U.S. Treasury securities |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
|
GNMA-issued/guaranteed mortgage pass through certificates |
| — |
| — |
| — |
| — |
| ||||
Other U.S. Government and federal agency securities |
| — |
| — |
| — |
| — |
| ||||
FHLMC/FNMA-issued mortgage pass through certificates |
| 4,869 |
| 23 |
| — |
| 4,892 |
| ||||
CMO’s and REMIC’s issued by U.S. government-sponsored agencies |
| — |
| — |
| — |
| — |
| ||||
Mutual funds |
| — |
| — |
| — |
| — |
| ||||
Privately issued corporate bonds, CMO and REMIC securities |
| — |
| — |
| — |
| — |
| ||||
|
| $ | 4,869 |
| $ | 23 |
| $ | — |
| $ | 4,892 |
|
|
| December 31, 2002 |
| ||||||||||
|
| Total |
| Gross |
| Gross |
| Estimated |
| ||||
|
| (Dollars in thousands) |
| ||||||||||
Available-for-Sale: |
|
|
|
|
|
|
|
|
| ||||
U.S. Treasury securities |
| $ | 998 |
| $ | — |
| $ | 1 |
| $ | 997 |
|
GNMA-issued/guaranteed mortgage pass through certificates |
| 2,409 |
| 73 |
| — |
| 2,482 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
FHLMC/FNMA-issued mortgage pass through certificates |
| 12,370 |
| 506 |
| — |
| 12,876 |
| ||||
CMO’s and REMIC’s issued by U.S. government-sponsored agencies |
| 4,544 |
| 44 |
| — |
| 4,588 |
| ||||
Privately issued corporate bonds, CMO and REMIC securities |
| 5,503 |
| 12 |
| 288 |
| 5,227 |
| ||||
|
| $ | 25,824 |
| $ | 635 |
| $ | 289 |
| $ | 26,170 |
|
|
|
|
|
|
|
|
|
|
| ||||
FRB and other equity stocks |
| $ | 2,018 |
| — |
| — |
| $ | 2,018 |
|
27
As of September 30, 2003 the Company did not hold securities of any issuer, other than U.S. government agencies and corporations, the aggregate book value of which exceeded 10% of the Company’s shareholders’ equity. The Company had no securities classified as held-to-maturity at December 31, 2002.
LOAN PORTFOLIO
The following comparative period-end table sets forth certain information concerning the composition of the loan portfolio.
Loan Portfolio Composition
|
| September 30, |
| December 31, |
| ||||||
|
| Amount |
| Percent |
| Amount |
| Percent |
| ||
|
| (Dollars in thousands) |
| ||||||||
Commercial loans: |
|
|
|
|
|
|
|
|
| ||
Secured by one to four family residential properties |
| $ | 6,540 |
| 3 | % | $ | 10,797 |
| 4 | % |
Secured by multifamily residential properties |
| 10,912 |
| 4 | % | 12,596 |
| 5 | % | ||
Secured by commercial real properties |
| 121,364 |
| 49 | % | 119,872 |
| 44 | % | ||
Other - secured and unsecured |
| 78,151 |
| 32 | % | 86,015 |
| 32 | % | ||
Real estate construction and land development |
| 28,506 |
| 12 | % | 37,934 |
| 14 | % | ||
Consumer installment, home equity and unsecured loans to individuals |
| 2,594 |
| 1 | % | 5,566 |
| 1 | % | ||
Total loans outstanding |
| 248,067 |
| 100 | % | 272,780 |
| 100 | % | ||
|
|
|
|
|
|
|
|
|
| ||
Deferred net loan origination fees and purchased loan discount |
| (602 | ) |
|
| (457 | ) |
|
| ||
Loans receivable, net |
| $ | 247,465 |
|
|
| $ | 272,323 |
|
|
|
Total loans outstanding decreased by $24.7 million to $248.1 million at September 30, 2003 compared to $272.8 million at December 31, 2002 as loan payoffs exceeded loan originations. While all loan categories reflects declines except for commercial real estate loans, the payoffs were primarily in the construction loans. Due to the nature of construction loans, the outstanding balance of newly originated loan increases gradually during the life of the loan and repays in a lump sum.
28
NONPERFORMING ASSETS
The following comparative period-end table sets forth certain information concerning nonperforming assets.
Nonperforming Assets
|
| September 30, |
| December 31 |
| ||
|
| (Dollars in thousands) |
| ||||
Nonaccrual loans |
| $ | 442 |
| $ | 5,787 |
|
Troubled debt restructurings |
| — |
| — |
| ||
Loans contractually past due ninety or more days with respect to either principal or interest and still accruing interest |
| 51 |
| 209 |
| ||
Nonperforming loans |
| 493 |
| 5,996 |
| ||
Other real estate owned |
| 1,000 |
| 1,000 |
| ||
Other nonperforming assets |
| — |
| — |
| ||
Total nonperforming assets |
| $ | 1,493 |
| $ | 6,996 |
|
|
|
|
|
|
| ||
Allowance for credit losses as a percent of nonaccrual loans |
| 811.8 | % | 83.7 | % | ||
Allowance for credit losses as a percent of nonperforming loans |
| 727.8 | % | 80.8 | % | ||
Total nonperforming assets as a percent of loans receivable |
| 0.6 | % | 2.6 | % | ||
Total nonperforming assets as a percent of total shareholders’ equity |
| 4.8 | % | 22.4 | % |
Nonaccrual loans decreased $5.3 million at September 30, 2003 to $442,000 from $5.8 million at December 31, 2002 due primarily to collection of nonaccrual loans and loan charge offs. There was $51,000 loans past due 90 days or more and still accruing interest at September 30, 2003 compared to $209,000 at December 31, 2002. As a result, the amount of nonperforming assets at September 30, 2003 decreased 78.7% to $1.5 million from $7.0 million at December 31, 2002.
ALLOWANCE FOR CREDIT LOSSES
Provisions for credit losses charged to operations reflect management’s judgment of the adequacy of the allowance for credit losses and are determined through periodic analysis of the loan portfolio. This analysis includes a detailed review of the classification and categorization of problem loans and loans to be charged off; an assessment of the overall quality and collectibility of the portfolio; and consideration of the loan loss experience, trends in problem loan concentrations of credit risk, as well as current and expected future economic conditions (particularly Southern California). Management, in conjunction
29
with an outside advisory firm, performs a periodic risk and credit analysis, the results of which are reported to the Board of Directors.
Loans charged off during the third quarter and first nine months of 2003 were $7,000 and $2.9 million, respectively, compared to $2.2 million and $4.0 million during the third quarter and first nine months of 2002, respectively. Recoveries of loans previously charged off were $133,000 and $327,000 during the third quarter and first nine months of 2003 compared to $16,000 and $352,000 during the third quarter and first nine months of 2002, respectively. See Note 4 of Notes to Consolidated Financial Statements.
Credit quality is affected by many factors beyond the control of the Company, including local and national economies, and facts may exist which are not known to the Company that adversely affect the likelihood of repayment of various loans in the loan portfolio and realization of collateral upon a default. Accordingly, no assurance can be given that the Company will not sustain loan losses materially in excess of the allowance for credit losses. In addition, the Office of the Comptroller of the Currency (“OCC”), as an integral part of its examination process, periodically reviews the allowance for credit losses and could require additional provisions for credit losses.
TOTAL DEPOSITS
Total deposits were $315.4 million and $298.7 million at September 30, 2003 and December 31, 2002, respectively. Noninterest-bearing demand deposits and money market deposits were $127.4 million and $59.8 million, respectively, at September 30, 2003 compared to $107.6 million and $43.1 million, respectively, at December 31, 2002. The increase in these accounts is attributable to an emphasis on growing business banking, particularly at South Bay, which generates transaction deposit accounts. Interest-bearing demand deposits, which are largely limited to individuals, decreased to $28.1 million at September 30, 2003 from $30.5 million at December 31, 2002. Savings deposits increased to $43.4 million at September 30, 2003 compared to $42.2 million at December 31, 2002 reflecting the relative higher yields being paid on this deposit type. Time certificates of deposit (“TCDs”) decreased significantly to $56.7 million at September 30, 2003 from $75.4 million at December 31, 2002. This decrease is due to an emphasis on growing lower cost transaction accounts. Additionally, TCDs $100,000 and over decreased due to the termination of a $15.0 million public funds deposit partially offset by $5.0 million of brokered TCDs in January 2003. Brokered TCDs at September 30, 2003 were $5.0 million. There were no brokered TCDs at December 31, 2002.
30
FEDERAL FUNDS SOLD AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Federal funds sold and securities sold under agreements to repurchase at September 30, 2003 were $397,000 compared to $1.5 million at year-end 2002. The decline is due to the planned runoff of the higher costing liabilities at South Bay.
OTHER BORROWINGS
Other borrowings were $7.5 million at September 30, 2003 and December 31, 2002 representing advances from the Federal Home Loan Bank.
JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES
Junior Subordinated Debentures were $15.5 million at September 30, 2003, reflecting the reclassification of trust preferred securities formerly reflected as minority interest. See Note 9 in Notes to Consolidated Financial Statements.
SHAREHOLDERS’ EQUITY
Shareholders’ equity declined from $31.2 at December 31, 2002 to $30.9 million at September 30, 2003 due to the net loss for the nine months ended September 30, 2003 and the declines in market value of securities available-for-sale.
CAPITAL ADEQUACY REQUIREMENTS
At September 30, 2003 the Company and the Banks were in compliance with all applicable regulatory capital requirements and the Banks were “well capitalized” under the Prompt Corrective Action rules of the OCC. The following table sets forth the regulatory capital standards for well-capitalized institutions, and the capital ratios for the Company and the Banks as of September 30, 2003 and December 31, 2002.
31
Regulatory Capital Information
of the National MercantileBancorp and Banks
|
| Minimum |
| Well |
| September 30, |
| December 31, |
|
National Mercantile Bancorp: |
|
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|
|
|
|
|
|
|
Tier 1 leverage |
| 4.00 | % | N/A |
| 8.50 | % | 8.60 | % |
Tier 1 risk-based capital |
| 4.00 | % | N/A |
| 10.89 | % | 10.57 | % |
Total risk-based capital |
| 8.00 | % | N/A |
| 13.69 | % | 13.31 | % |
|
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Mercantile National Bank: |
|
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|
|
|
Tier 1 leverage |
| 4.00 | % | 5.00 | % | 7.38 | % | 7.20 | % |
Tier 1 risk-based capital |
| 4.00 | % | 6.00 | % | 9.99 | % | 9.89 | % |
Total risk-based capital |
| 8.00 | % | 10.00 | % | 11.25 | % | 11.15 | % |
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South Bay Bank, NA: |
|
|
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|
|
|
|
|
|
Tier 1 leverage |
| 4.00 | % | 5.00 | % | 9.57 | % | 9.38 | % |
Tier 1 risk-based capital |
| 4.00 | % | 6.00 | % | 12.15 | % | 10.90 | % |
Total risk-based capital |
| 8.00 | % | 10.00 | % | 13.39 | % | 12.15 | % |
LIQUIDITY
The Company manages its liquidity through a combination of core deposits, federal funds purchased, repurchase agreements, collateralized borrowing lines, and a portfolio of securities available for sale. Liquidity is also provided by maturing investment securities and loans.
The Company’s cash and due from banks was $22.6 million on September 30, 2003 compared to $18.9 million on December 31, 2002. Federal funds sold were $42.0 million and $18.7 million for September 30, 2003 and December 31, 2002, respectively. Mercantile had $5.0 million and South Bay had $12.0 million in Federal funds lines with correspondent banks as of September 30, 2003.
National Mercantile is a legal entity separate and distinct from the Banks, and therefore it must provide for its own liquidity. National Mercantile’s principal sources of funds are proceeds from the sales of securities and dividends or capital distributions from the Banks. In addition to its own operating expenses, National Mercantile is responsible for the payment of the interest on the outstanding Junior Subordinated Debentures. The semi-annual interest payments on the Junior Subordinated Debentures, under the terms of the indenture, are deferrable at the Company’s option, for a period up to ten consecutive semi-annual payments, but in any event not beyond June 25, 2031.
National Mercantile’s cash and due from banks was $711,000 on September 30, 2003 compared to $120,000 at December 31, 2002.
32
The payment of dividends by National Mercantile is limited by the terms of the Trust Preferred Securities indenture. National Mercantile may not declare or pay any dividends or other distributions on its common stock or preferred stock if it is in default under the terms of the indenture or if it has elected to defer payments of interest on the Trust Preferred Securities.
ASSET LIABILITY MANAGEMENT
The following table shows that the Company’s cumulative one-year interest rate sensitivity gap indicated an asset sensitive position of $63.8 million at September 30, 2003, a change from an asset sensitive position of $41.2 million at December 31, 2002. This change resulted primarily from an increase in assets repricing in less than three months, consisting of federal funds sold, securities and due from banks – interest bearing partially offset by a decrease in adjustable loans receivable and securities available for sale. Rate-sensitive liabilities increased only $947,000, consisting of an increase in demand, money market and savings and other borrowings, offset by a decrease in time certificates of deposit.
The Company’s asset sensitive position during a period of slowly declining interest rates is not expected to have a significant negative impact on net interest income since rates paid on the Company’s large base of interest bearing demand, savings and money market deposit accounts historically have not changed proportionately with changes in interest rates. However, since the Company is in an asset sensitive position, in a period of rapidly declining rates, such as the environment that was experienced during 2001 and 2002, the rapid decline will have a negative effect on the Company’s net interest income as changes in the rates of interest bearing deposits historically have not changed in similar magnitude to changes in market interest rates. Additionally, in relatively low and declining interest rate environments, the interest rates paid on funding liabilities may begin to reach floors preventing further downward adjustments while rates on earning assets continue to adjust downward.
33
Rate-Sensitive Assets and Liabilities
|
| September 30, 2003 |
| |||||||||||||
|
| Less |
| After three |
| After one |
| After |
| Total |
| |||||
|
| (Dollars in thousands) |
| |||||||||||||
Rate-Sensitive Assets: |
|
|
|
|
|
|
|
|
|
|
| |||||
Federal funds sold and securities purchased under agreements to resell |
| $ | 42,000 |
| $ | — |
| $ | — |
| $ | — |
| $ | 42,000 |
|
Securities at amortized cost |
| 15,924 |
| 615 |
| 5,056 |
| 14,524 |
| 36,119 |
| |||||
Due from banks - interest bearing |
| 1,500 |
| 728 |
| — |
| — |
| 2,228 |
| |||||
FRB and other stock, at cost |
| — |
| — |
| — |
| 1,869 |
| 1,869 |
| |||||
Loans receivable (1) |
| 183,393 |
| 6,546 |
| 41,129 |
| 15,955 |
| 247,023 |
| |||||
Total rate-sensitive assets |
| 242,817 |
| 7,889 |
| 46,185 |
| 32,348 |
| 329,239 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Rate-Sensitive Liabilities: (2) |
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|
|
|
|
| |||||
Interest bearing deposits: |
|
|
|
|
|
|
|
|
|
|
| |||||
Demand, money market and savings |
| 131,317 |
| — |
| — |
| — |
| 131,317 |
| |||||
Time certificates of deposit |
| 24,950 |
| 24,787 |
| 6,571 |
| 379 |
| 56,687 |
| |||||
Other borrowings |
| — |
| 5,897 |
| 2,000 |
| — |
| 7,897 |
| |||||
Total rate-sensitive liabilities |
| 156,267 |
| 30,684 |
| 8,571 |
| 379 |
| 195,901 |
| |||||
Interest rate-sensitivity gap |
| 86,550 |
| (22,795 | ) | 37,614 |
| 31,969 |
| 133,338 |
| |||||
Cumulative interest rate-sensitivity gap |
| $ | 86,550 |
| $ | 63,755 |
| $ | 101,369 |
| $ | 133,338 |
|
|
| |
Cumulative ratio of rate sensitive assets to rate-sensitive liabilities |
| 155 | % | 134 | % | 152 | % | 168 | % |
|
| |||||
(1) Loans receivable excludes nonaccrual loans.
(2) Deposits which are subject to immediate withdrawal are presented as repricing within three months or less.
The distribution of other time deposits is based on scheduled maturities.
34
|
| December 31, 2002 |
| |||||||||||||
|
| Less |
| After three |
| After one |
| After |
| Total |
| |||||
|
| (Dollars in thousands) |
| |||||||||||||
Rate-Sensitive Assets: |
|
|
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|
|
|
| |||||
Federal funds sold and securities purchased under agreements to resell |
| $ | 18,700 |
| $ | — |
| $ | — |
| $ | — |
| $ | 18,700 |
|
Securities available-for-sale, at amortized cost |
| — |
| 998 |
| 1,857 |
| 22,969 |
| 25,824 |
| |||||
Due from banks - time |
| — |
| 325 |
| — |
| — |
| 325 |
| |||||
FRB and other stock, at cost |
| — |
| — |
| — |
| 2,018 |
| 2,018 |
| |||||
Loans receivable (1) |
| 196,286 |
| 10,907 |
| 40,375 |
| 19,425 |
| 266,993 |
| |||||
Total rate-sensitive assets |
| 214,986 |
| 12,230 |
| 42,232 |
| 44,412 |
| 313,860 |
| |||||
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| |||||
Rate-Sensitive Liabilities: (2) |
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| |||||
Interest bearing deposits: |
|
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|
|
| |||||
Demand, money market and savings |
| 115,781 |
| — |
| — |
| — |
| 115,781 |
| |||||
Time certificates of deposit |
| 36,882 |
| 31,865 |
| 6,617 |
| — |
| 75,364 |
| |||||
Other borrowings |
| — |
| 1,476 |
| 7,500 |
| — |
| 8,976 |
| |||||
Total rate-sensitive liabilities |
| 152,663 |
| 33,341 |
| 14,117 |
| — |
| 200,121 |
| |||||
Interest rate-sensitivity gap |
| 62,323 |
| (21,111 | ) | 28,115 |
| 44,412 |
| 113,739 |
| |||||
Cumulative interest rate-sensitivity gap |
| $ | 62,323 |
| $ | 41,212 |
| $ | 69,327 |
| $ | 113,739 |
|
|
| |
Cumulative ratio of rate sensitive assets to rate-sensitive liabilities |
| 141 | % | 122 | % | 135 | % | 157 | % |
|
| |||||
(1) Loans receivable excludes nonaccrual loans.
(2) Deposits which are subject to immediate withdrawal are presented as repricing within three months or less.
The distribution of other time deposits is based on scheduled maturities.
In October 2002, Mercantile executed an informal non-binding memorandum of understanding (“MOU”), with the OCC relating to its interest rate risk management. The MOU provided for Mercantile to take certain actions that the OCC believed would strengthen Mercantile’s interest rate risk management process, including the review of its interest rate risk limits and interest rate risk modeling assumptions and the retention of an independent consultant to conduct a review of Mercantile’s interest rate risk measurement processes. Mercantile completed the actions provided in the MOU and was informed by the OCC that the MOU has been terminated.
35
FACTORS WHICH MAY AFFECT FUTURE OPERATING RESULTS
Our results of operations and financial condition are affected by many factors, including the following.
We face risk from changes in interest rates.
The success of our business depends, to a large extent, on our net interest income. Changes in market interest rates can affect our net interest income by affecting the spread between our interest-earning assets and interest-bearing liabilities. This may be due to the different maturities of our interest-earning assets and interest-bearing liabilities, as well as an increase in the general level of interest rates. Changes in market interest rates also affect, among other things:
• Our ability to originate loans;
• The ability of our borrowers to make payments on their loans;
• The value of our interest-earning assets and our ability to realize gains from the sale of these assets;
• The average life of our interest-earning assets;
• Our ability to generate deposits instead of other available funding alternatives; and
• Our ability to access the wholesale funding market.
Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control.
We face risk from possible declines in the quality of our assets.
Our financial condition depends significantly on the quality of our assets. While we have developed and implemented underwriting policies and procedures to guide us in the making of loans, compliance with these policies and procedures in making loans does not guarantee repayment of the loans. If the level of our non-performing assets rises, our results of operations and financial condition will be affected. A borrower’s ability to pay its loan in accordance with its terms can be adversely affected by a number of factors, such as a decrease in the borrower’s revenues and cash flows due to adverse changes in economic conditions or a decline in the demand for the borrower’s products and/or services.
Our allowances for credit losses may be inadequate.
We establish allowances for credit losses against each segment of our loan portfolio. At September 30, 2003, our allowance for credit losses equaled 1.5% of loans receivable and 727.8% of nonperforming loans. Although we believed that we had established adequate allowances for credit losses as of September 30, 2003, the credit quality of our assets is affected by many factors beyond our control, including local and national economic conditions, and the possible existence of facts
36
which are not known to us which adversely affect the likelihood of repayment of various loans in our loan portfolio and realization of the collateral upon a default. Accordingly, we can give no assurance that we will not sustain loan losses materially in excess of the allowance for credit losses. In addition, the Office of the Comptroller of the Currency, as an integral part of its examination process, periodically reviews our allowance for credit losses and could require additional provisions for credit losses. Material future additions to the allowance for credit losses may also be necessary due to increases in the size and changes in the composition of our loan portfolio. Increases in our provisions for credit losses would adversely affect our results of operations.
Economic conditions may worsen.
Our business is strongly influenced by economic conditions in our market area (principally, the Greater Los Angeles metropolitan area) as well as regional and national economic conditions and in our niche markets, including the entertainment industry in Southern California. During the past several years economic conditions in these areas have been generally unfavorable. Should the economic condition in these areas continue to be unfavorable, the financial condition of our borrowers could weaken, which could lead to higher levels of loan defaults or a decline in the value of collateral for our loans. In addition, an unfavorable economy could reduce the demand for our loans and other products and services.
Because a significant amount of the loans we make are to borrowers in California, our operations could suffer as a result of local recession or natural disasters in California.
At September 30, 2003, a large majority of our loans outstanding were collateralized by real properties located in California. Because of this concentration in California, our financial position and results of operations have been and are expected to continue to be influenced by general trends in the California economy and its real estate market. Real estate market declines may adversely affect the values of the properties collateralizing loans. If the principal balances of our loans, together with any primary financing on the mortgaged properties, equal or exceed the value of the mortgaged properties, we could incur higher losses on sales of properties collateralizing foreclosed loans. In addition, California historically has been vulnerable to certain natural disaster risks, such as earthquakes and erosion-caused mudslides, which are not typically covered by the standard hazard insurance policies maintained by borrowers. Uninsured disasters may adversely impact our ability to recover losses on properties affected by such disasters and adversely impact our results of operations.
Our business is very competitive.
There is intense competition in Southern California and elsewhere in the United States for banking customers. We experience competition for deposits from many sources, including credit unions, insurance companies and money market and
37
other mutual funds, as well as other commercial banks and savings institutions. We compete for loans and deposits primarily with other commercial banks, mortgage companies, commercial finance companies and savings institutions. In recent years out-of-state financial institutions have entered the California market, which has also increased competition. Many of our competitors have greater financial strength, marketing capability and name recognition than we do, and operate on a statewide or nationwide basis. In addition, recent developments in technology and mass marketing have permitted larger companies to market loans more aggressively to our small business customers. Such advantages may give our competitors opportunities to realize greater efficiencies and economies of scale than we can. We can provide no assurance that we will be able to compete effectively against our competition.
Our business is heavily regulated.
Both National Mercantile as a bank holding company, and Mercantile and South Bay, as national banks, are subject to significant governmental supervision and regulation, which is intended primarily for the protection of depositors. Statutes and regulations affecting us may be changed at any time, and the interpretation of these statutes and regulations by examining authorities also may change. We cannot assure you that future changes in applicable statutes and regulations or in their interpretation will not adversely affect our business.
We test goodwill annually and must record any impairment as a charge to earnings.
Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS No. 142”), among other provisions, prescribes that goodwill and intangible assets that have indefinite useful lives will not be amortized but rather tested annually, or more frequently upon the occurrence of certain events, for impairment. SFAS No. 142 provides specific guidance for the testing of goodwill for impairment, which may require re-measurement of the fair value of the reporting unit. Impairment losses are to be reported as a charge to current period earnings.
We recorded goodwill of $2.2 million in connection with the South Bay acquisition in December 2001. During the fourth quarter of 2002, we completed the required impairment tests of goodwill. The tests determined that our goodwill was not considered impaired. No assurance can be given that our goodwill will not become impaired in the future.
We determine annually whether our deferred tax asset will be realized and must establish a valuation allowance if necessary to reduce it to its realizable value.
In conjunction with the acquisition of South Bay, we reversed our valuation allowance of $6.9 million on the deferred tax asset with the related benefit reducing goodwill. On a periodic basis, at least annually, we perform an analysis to determine if
38
it is more likely than not that some or all of the gross deferred tax asset will not be realized. Factors used in the analysis that are reflective of the future realization of a deferred tax asset are:
• A relatively consistent strong earnings history;
• Future earnings are assured;
• Expected adequate future taxable income arising from the reversal of temporary differences to realize the tax asset;
An evaluation allowance may be established to reduce the deferred tax asset to its realizable value. The determination of whether a valuation allowance is necessary involves considering the positive and negative factors related to whether the deferred tax asset is more likely than not to be realized. Any adjustment required to the valuation allowance is coupled with a related entry to income tax expense. A charge to earnings will be made in the event that we determine that a valuation allowance to the deferred tax asset is necessary.
ITEM 3. CONTROLS AND PROCEDURES
The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer believe that the Company’s disclosure controls and procedures reasonable ensure that information required to be disclosed by the Company in this quarterly report has been made known to them in a timely manner.
There was no change in the Company’s internal control over financial reporting during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonabley likely to materially affect, the Company’s internal control over financial reporting.
39
PART II—OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
None.
Item 2. CHANGES IN SECURITIES
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. |
| ||
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| ||
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| 31.1 Certification of Scott A. Montgomery on disclosure controls. | |
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| 31.2 Certification of David R. Brown on disclosure controls. | |
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| 32.1 Certification of Scott A. Montgomery pursuant to section 906 of the Sarbanes-Oxley Act of 2002 | |
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| 32.2 Certification of David R. Brown pursuant to section 906 of the Sarbanes-Oxley Act of 2002 | |
| |||
(b) Reports on Form 8-K. | |||
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| |
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| Form 8-K, reporting the Company’s press release regarding second quarter 2003 operating results was filed August 6, 2003. | |
40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
| National Mercantile Bancorp |
| |||
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| (Registrant) | ||||
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| |||
DATE: | November 14, 2003 |
| /s/ Scott A. Montgomery |
| ||
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| Scott A. Montgomery | ||||
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| Chief Executive Officer | ||||
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| |||
DATE: | November 14, 2003 |
| /s/ David R. Brown |
| ||
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| David R. Brown | ||||
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| Principal Financial and Principal Accounting | ||||
41