SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to ________________
Commission file number 0-11337
FOOTHILL INDEPENDENT BANCORP
----------------
(Exact name of Registrant as specified in its charter)
DELAWARE 95-3815805
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
510 SOUTH GRAND AVENUE, GLENDORA, CALIFORNIA 91741
(Address of principal executive offices) (Zip Code)
(626) 963-8551 or (909) 599-9351
----------------
(Registrant's telephone number, including area code)
Not Applicable
----------------
(Former name, former address and former fiscal
year, if changed, since last year)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
5,509,179 shares of Common Stock
as of November 8, 2001
FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10Q
FOR
THE QUARTER ENDED SEPTEMBER 30, 2001
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 2001 and December 31, 2000................ 3
Condensed Consolidated Statements of Income for the three months and nine months
ended September 30, 2001 and September 30, 2000..................................... 4
Condensed Consolidated Statements of Changes in Stockholders' Equity for the
nine months ended September 30, 2001 and September 30, 2000......................... 5
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2001 and September 30, 2000........................................... 6
Notes to Condensed Consolidated Financial Statements................................... 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................. 18
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K and Exhibits.......................................... 19
SIGNATURES......................................................................................... S-1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30 December 31,
2001 2000
------------ ------------
ASSETS:
Cash and due from banks $ 31,482 $ 26,186
Federal funds sold 16,200 12,000
--------- ---------
Total Cash and Cash Equivalents 47,682 38,186
Interest-bearing deposits in other financial institutions 14,638 8,005
Investment Securities Held-To-Maturity (approximate market value: $10,433
in 2001 and $20,699 in 2000)
U.S. Treasury 349 999
U.S. Government Agencies 6,542 16,379
Municipal Agencies 1,053 1,053
Other Securities 2,311 2,311
--------- ---------
Total Investment Securities Held-To-Maturity 10,255 20,742
Investment Securities Available-For-Sale 72,787 50,074
--------- ---------
Loans, net of unearned discount and prepaid points and fees 373,992 367,310
Direct lease financing 1,240 1,164
Less reserve for possible loan and lease losses (3,961) (3,692)
--------- ---------
Total Loans & Leases, net 371,271 364,782
Bank premises and equipment 6,463 7,013
Accrued interest 2,886 3,247
Other real estate owned, net of allowance for possible losses of $-0- in 2,290 2,164
2001 and in 2000
Cash surrender value of life insurance 5,996 5,639
Prepaid expenses 867 2,785
Deferred tax asset 1,686 1,801
Federal Home Loan Bank stock, at cost 435 415
Federal Reserve Bank stock, at cost 229 229
Other assets 485 743
--------- ---------
TOTAL ASSETS $ 537,970 $ 505,825
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Demand deposits $ 165,633 $ 146,868
Savings and NOW deposits 112,647 106,618
Money market deposits 100,900 74,424
Time deposits in denominations of $100,000 or more 41,026 54,939
Other time deposits 62,810 71,192
--------- ---------
Total deposits 483,016 454,041
Accrued employee benefits 2,383 2,197
Accrued interest and other liabilities 1,830 1,324
--------- ---------
Total Liabilities 487,229 457,562
--------- ---------
Stockholders' Equity
Common stock -- authorized: 25,000,000 shares $.001 par value; issued
and outstanding: 5,508,469 shares at September 30, 2001 and 5,243,863 6 5
at December 31, 2000
Additional Paid-in Capital 42,641 37,754
Retained Earnings 7,712 10,746
Accumulated Other Comprehensive Income 382 (242)
--------- ---------
Total Stockholders' Equity 50,741 48,263
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 537,970 $ 505,825
========= =========
See Accompanying notes to financial statements.
3
FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(dollars in thousands)
Nine Months Ended Three Months Ended
September 30, September 30,
-------------------- --------------------
2001 2000 2001 2000
------- ------- ------- -------
Interest Income
Interest and fees on loans $23,841 $25,238 $ 7,818 $ 8,561
Interest on investment securities
U.S. Treasury 24 61 4 13
Obligations of other U.S. government agencies 1,693 1,925 605 675
Municipal agencies 196 237 66 76
Other securities 663 732 177 247
Interest on deposits 424 154 158 60
Interest on Federal funds sold 705 464 220 190
Lease financing income 35 63 12 17
------- ------- ------- -------
Total Interest Income 27,581 28,874 9,060 9,839
------- ------- ------- -------
Interest Expense
Interest on savings & NOW deposits 964 1,165 240 388
Interest on money market deposits 2,048 2,267 670 794
Interest on time deposits in denominations of $100,000 or more 1,866 1,930 464 718
Interest on other time deposits 2,484 2,600 687 1,014
Interest on borrowings 0 54 0 6
------- ------- ------- -------
Total Interest Expense 7,362 8,016 2,061 2,920
------- ------- ------- -------
Net Interest Income 20,219 20,858 6,999 6,919
Provision for Loan and Lease Losses 225 665 0 190
------- ------- ------- -------
Net Interest Income After Provisions for Loan and 19,994 20,193 6,999 6,729
Lease Losses
Other Income
Fees and service charges 3,828 3,293 1,252 1,153
Gain on sale SBA loans 23 27 21 21
Other 152 75 65 19
------- ------- ------- -------
Total other income 4,003 3,395 1,338 1,193
Other Expenses
Salaries and benefits 7,414 7,357 2,605 2,331
Occupancy expenses, net of revenue of $176 in 2001 and 1,860 1,661 635 547
$154 in 2000
Furniture and equipment expenses 1,156 1,153 383 376
Other expenses (Note 2) 5,485 5,537 1,847 1,898
------- ------- ------- -------
Total Other Expenses 15,915 15,708 5,470 5,152
Income Before Income Taxes 8,082 7,880 2,867 2,760
Provision for Income Taxes 2,948 2,911 1,039 1,023
------- ------- ------- -------
NET INCOME $ 5,134 $ 4,969 $ 1,828 $ 1,737
======= ======= ======= =======
Earnings per Share (Note 3)
Basic $ 0.93 $ 0.85 $ 0.33 $ 0.31
======= ======= ======= =======
Diluted $ 0.88 $ 0.82 $ 0.32 $ 0.30
======= ======= ======= =======
See accompanying notes to financial statements
4
FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(Unaudited)
(dollars in thousands)
Accumulated
Number of Additional Other
Shares Capital Paid-In Comprehensive Retained Comprehensive
Outstanding Stock Capital Income Earnings Income Total
----------- ------- ---------- ------------- ----------- ------------- ----------
BALANCE, January 1, 2000 $5,772,614 $ 6 $37,372 $11,898 $(837) $48,439
Cash dividend (853) (853)
Fractional shares of stock
dividend paid in cash --
Exercise of stock options 4,048 24 24
Common stock issued under
employee benefit and dividend
reinvestment plans 31,030 303 303
Common stock repurchased,
cancelled and retired (453,479) (5,226) (5,226)
COMPREHENSIVE INCOME
Net Income 4,969 4,969 4,969
Unrealized security holding
losses (Net of taxes $177) 397 397 397
-------
Total Comprehensive Income $ 5,366
--------- ---- ------- ======= ------- ----- -------
BALANCE, September 30, 2000 354,213 $ 6 $37,699 $10,788 $(440) $48,053
========= ==== ======= ======= ===== =======
BALANCE, January 1, 2001 5,243,863 5 37,754 10,746 (242) 48,263
7% Stock Dividend 361,421 1 4,626 (4,627)
Cash Dividend (1,633) (1,633
Exercise of stock options 38,277 -- 53 53
Common stock issued under
employee benefit and dividend
reinvestment plans 16,376 -- 208 208
Common stock repurchased,
cancelled and retired (151,468) -- -- (1,908) (1,908)
COMPREHENSIVE INCOME
Net Income 5,134 5,134 5,134
Unrealized security holding
gains (Net of taxes $113) 624 624 624
-------
Total Comprehensive Income $ 5,758
--------- ---- ------- ======= ------- ----- -------
BALANCE, September 30, 2001 5,508,469 $ 6 $42,641 $ 7,712 $ 382 $50,741
========= ==== ======= ======= ===== =======
See accompanying notes to financial statements
5
FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(Unaudited)
(dollars in thousands)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2001 2000
- ------------------------------------------------ ----------- -----------
Cash Flows From Operating Activities:
Interest and fees received $ 28,108 $ 28,810
Service fees and other income received 3,576 2,984
Financing revenue received under leases 35 63
Interest paid (7,647) (7,749)
Cash paid to suppliers and employees (12,544) (15,608)
Income taxes paid (2,081) (2,916)
----------- -----------
Net Cash Provided (Used) by Operating Activities 9,447 5,584
----------- -----------
Cash Flows From Investing Activities:
2,726,509 1,356,319
Proceeds from maturity of investment securities (AFS)
Purchase of investment securities (AFS) (2,748,708) (1,354,591)
Proceeds from maturity of investment securities (HTM) 12,805 2,140
Purchase of investment securities (HTM) (2,316) (132)
Net (increase) decrease in deposits at other financial institutions (6,633) 1,889
Net (increase) decrease in credit card and revolving credit receivables 50 (16)
Recoveries on loans previously written off 69 103
Net (increase) decrease in loans (6,760) (28,906)
Net (increase) decrease in leases (76) 1,116
Proceeds from property, plant & equipment 1,081 20
Capital expenditures (1,622) (1,526)
Stock repurchased and retired (1,908) (5,226)
----------- -----------
Net Cash Provided (Used) in Investing Activities (27,509) (28,810)
----------- -----------
Cash Flows From Financing Activities
Net increase (decrease) in demand deposits, NOW accounts,
savings accounts and money market deposits 51,225 12,718
Net increase (decrease) in certificates of deposit with
maturities of three months or less 2,020 4,319
Net increase (decrease) in certificates of deposit with maturities
of more than three months (24,315) 22,499
Net increase (decrease) in short term borrowing -- (800)
Proceeds from exercise of stock options 53 24
Proceeds from stock issued under employee benefit
and dividend reinvestment plans 208 303
Principal payment on long term debt -- (19)
Dividends paid (1,633) (853)
----------- -----------
Net Cash Provided by Financing Activities 27,558 38,191
----------- -----------
Net Increase (Decrease) in Cash and Cash Equivalents 9,496 14,965
Cash and Cash Equivalents at Beginning of Year 38,186 26,862
----------- -----------
Cash and Cash Equivalents at September 30, 2001 and 2000 $ 47,682 $ 41,827
=========== ===========
6
FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
(Unaudited)
(dollars in thousands)
2001 2000
------- -------
Net Income $ 5,134 $ 4,969
------- -------
Adjustments to Reconcile Net Income to Net Cash Provided
by Operating Activities
Depreciation and amortization 1,035 977
Provision for possible credit losses 225 665
Provision for possible OREO losses 42
(Gain)/loss on sale of equipment (70) 2
Provision for deferred taxes 115 178
Increase/(decrease) in taxes payable 752 (183)
(Increase)/decrease in other assets 240 66
(Increase)/decrease in interest receivable 361 101
Increase/(decrease) in discounts and premiums 201 (102)
Increase/(decrease) in interest payable (285) 267
(Increase)/decrease in prepaid expenses 1,918 168
Increase/(decrease) in accrued expenses and other liabilities 178 (1,153)
Increase in cash surrender value of life insurance (357) (413)
Total Adjustments 4,313 615
------- -------
Net Cash Provided (Used) by Operating Activities $ 9,447 $ 5,584
======= =======
DISCLOSURE OF ACCOUNTING POLICY
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks and Federal funds sold. Generally, Federal
funds are purchased and sold for one-day periods.
See accompanying notes to financial statements
7
FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in thousands)
September 30, 2001 and 2000
NOTE #1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments considered necessary for a fair
statement of the results for the interim periods presented have been included.
For further information, refer to the financial statements and footnotes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2000.
NOTE #2 - OTHER EXPENSES
The following is a breakdown of other expenses for the nine and three
month periods ended September 30, 2001 and 2000.
Nine Months Ended Three Months
September 30, Ended September 30,
---------------------- ----------------------
2001 2000 2001 2000
------- ------- ------- -------
Data processing $ 941 $ 799 $ 333 $ 266
Marketing expenses 797 769 273 205
Office supplies, postage and 794 797 285 288
telephone
Bank Insurance 367 360 124 121
Supervisory Assessments 95 88 32 26
Professional Expenses 1,052 1,122 326 357
Provision for OREO Loss -- -- -- --
Provision for Y2K Expense -- (285) -- --
Other Expenses 1,439 1,887 474 635
------- ------- ------- -------
Total Other Expenses $ 5,485 $ 5,537 $ 1,847 $ 1,898
======= ======= ======= =======
NOTE #3 - EARNINGS PER SHARE
The following is a reconciliation of net income and shares outstanding
to the income and number of shares used to compute earnings per share (amounts
in thousands):
Nine Months Ended Three Months Ended
September 30, September 30,
----------------------------------------- ----------------------------------------
2001 2000 2001 2000
------------------ ----------------- ------------------ ------------------
Income Shares Income Shares Income Shares Income Shares
------ ------ ------ ------- ------ ------- ------ -------
Net income as reported $ 5,134 $ 4,969 $ 1,828 $ 1,747
Shares outstanding at period end 5,610 6,176 5,500 5,711
Impact of weighting shares purchased
during period (71) (314) 3 8
----- ----- ----- -----
Used in Basic EPS 5,134 5,539 4,969 5,862 1,828 5,503 1,747 5,719
------- ------- ------- -------
Dilutive effect of outstanding stock
options 280 198 294 172
----- ----- ----- -----
Used in Dilutive EPS $ 5,134 5,819 $ 4,969 6,060 $ 1,828 5,797 $ 1,747 5,891
======= ===== ======= ===== ======= ===== ======= =====
8
NOTE #4 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair
value of financial instruments.
Investment Securities
For U.S. Government and U.S. Agency securities, fair values are based on
market prices. For other investment securities, fair value equals quoted market
price if available. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities as the basis for a
pricing matrix.
Loans
The fair value for loans with variable interest rates is the carrying
amount. The fair value of fixed rate loans is derived by calculating the
discounted value of the future cash flows expected to be received by the various
homogeneous categories of loans. All loans have been adjusted to reflect changes
in credit risk.
Deposits
The fair value of demand deposits, savings deposits, savings accounts
and NOW accounts is defined as the amounts payable on demand at September 30,
2001. The fair value of fixed maturity certificates of deposit is estimated
based on the discounted value of the future cash flows expected to be paid on
the deposits.
Notes Payable
Rates currently available to the Bank for debt with similar terms and
remaining maturities are used to estimate the fair value of existing debt.
Commitments to Extend Credit and Standby Letter of Credit
The fair value of commitments is estimated using the fees currently
charged to enter into similar agreements, taking into account the remaining
terms of the agreements and the present creditworthiness of the parties
involved. For fixed-rate loan commitments, fair value also considered the
difference between current levels of interest rates and committed rates.
The fair value of guarantees and letters of credit are based on fees
currently charged for similar agreements or on the estimated cost to terminate
them or otherwise settle the obligations with parties involved at September 30,
2001.
The estimated fair value of the Bank's financial instruments are as
follows:
September 30, 2001
--------------------------------
Carrying Amount Fair Value
--------------- ----------
(dollars in thousands)
--------------------------------
Financial Assets
Cash and cash equivalents $ 47,682 $ 47,682
Investment securities and deposits 97,680 96,218
Loans 375,328 380,884
Direct lease financing 856 1,243
Financial Liabilities
Deposits 483,016 483,736
Short term debt 0 0
Long term debt 0 0
Unrecognized Financial Instruments
Commitments to extend credit 49,033 49,033
Standby letters of credit 2,855 2,855
9
NOTE # 5 - NON-PERFORMING LOANS
The following table sets forth information regarding non-performing
loans at September 30, 2001 and December 31, 2000.
(dollars in thousands) September 30, December 31,
2001 2000
------------- ------------
Accruing Loans More Than 90 Days Past Due(1)
Aggregate Loan Amounts
Commercial, financial and agricultural $ -- $ --
Real Estate -- --
Installment loans to individuals 1 17
Aggregate Leases -- --
------ ------
Total Loans Past Due More Than 90 Days 1 17
Troubled Debt Restructurings(2) 1,933 858
Non-accrual loans(3) 2,743 2,319
------ ------
Total Non-Performing Loans $4,677 $3,194
====== ======
(1) Reflects loans for which there has been no payment of interest
and/or principal for 90 days of more. Ordinarily, loans are
placed on non-accrual status (accrual of interest is
discontinued) when the Bank has reason to believe that continued
payment of interest and principal is unlikely.
(2) Renegotiated loans are those which have been renegotiated to
provide a deferral of interest or principal.
(3) There were 6 loans on non-accrual status totaling approximately
$2,743,000 at September 30, 2001 and 6 loans totaling
approximately $2,319,000 at December 31, 2000.
Our policy is to review each loan in the loan portfolio in excess of
$500,000 in order to identify problem credits. In addition, as an integral part
of its review process of the Bank, the Federal Reserve Bank and the California
Department of Financial Institutions also classifies problem credits. There are
three classifications for problem loans: "substandard," "doubtful," and "loss."
Substandard loans have one defined weaknesses and are characterized by the
distinct possibility that the Bank will sustain some loss if the deficiencies
are not corrected. Doubtful loans have the weaknesses of substandard loans with
the additional characteristic that the weaknesses make collection or liquidation
in full, on the basis of currently existing facts, conditions, and values,
questionable. A loan classified as "loss" is considered uncollectible and of
such little value that the continuance as an asset of the institution is not
warranted. Another category designated "special mention" is maintained for loans
which do not currently expose the Bank to a significant degree of risk to
warrant classification as substandard, doubtful or loss, but do possess credit
deficiencies or potential weaknesses deserving management's close attention.
As of September 30, 2001, approximately $7,834,000 of our loans were
classified as substandard, which were comprised of approximately $5,091,000 of
performing and accruing loans and approximately $2,743,000 of non-accrual loans.
There were no loans classified as doubtful.
NOTE # 6 - RESERVE FOR LOAN AND LEASE LOSSES
The reserve for loan and lease losses is a general reserve established
to absorb potential losses inherent in the entire portfolio. The level of and
ratio of additions to the reserve are based on a periodic analysis of the loan
and lease portfolio and, at September 30, 2001, reflected an amount which we
believed was adequate to provide for known and inherent loan losses. In
evaluating the adequacy of the reserve, we give consideration to the composition
of the loan portfolio, the performance of loans in the portfolio, evaluations of
loan collateral, prior loss experience, current economic conditions and the
prospects or worth of respective borrowers or guarantors. In addition, each of
the Federal Reserve Bank and the Department of Financial Institutions, as an
integral part of its examination process, periodically reviews the Bank's
allowance for possible loan and lease losses. Its examiners may require the Bank
to recognize additions to the allowance based upon their judgement of the
information available at the time of the examination. The Bank was most recently
examined by the Department of Financial Institutions as of March 31, 2001.
10
The reserve for loan and lease losses at September 30, 2001, was
$3,961,000 or 1.06% of the total of loans and leases outstanding as of that
date. Additions to the reserve are made by means of the provision for loan
losses which is an operating expense of the Company.
The following table provides certain information with respect to the
allowance for loan losses as well as charge-off and recovery activity.
September 30, December 31,
2001 2000
------------- ------------
(Dollars in Thousands)
----------------------------------
Allowance for Loan Losses $ 3,692 $ 6,102
------- -------
Balance, Beginning of period
Charge-Offs
Commercial, financial and agricultural (22) (3,762)
Real estate -- construction -- --
Real estate -- mortgage -- --
Consumer loans (24) (30)
Lease Financing -- --
Other -- --
------- -------
Total Charge-Offs (46) (3,792)
------- -------
Recoveries
Commercial, financial and agricultural 44 134
Real estate -- construction 14 --
Real estate -- mortgage 13 170
Consumer loans 19 8
Lease Financing -- --
Other -- --
------- -------
Total Recoveries 90 312
------- -------
Net Recoveries (Charge-Offs) 44 (3,480)
Provision Charged to Operations 225 1,070
------- -------
Balance, End of period $ 3,961 $ 3,692
======= =======
Net Charge-Offs During the Period to Average
Loans Outstanding During the Period Ended (0.01%) 0.96%
======= =======
Allowance for Loan Losses to Total Loans 1.06% 1.00%
======= =======
In accordance with SFAS No. 114 (as amended by SFAS No. 118),
"Accounting by Creditors for Impairment of a Loan", loans identified as
"impaired" are measured on the present value of expected future cash flows
discounted at the loan's effective interest rate, except that as a practical
expedient, a creditor may measure impairment based on a loan's observable market
price, or the fair value of the collateral if the loan is collateral dependent.
A loan is impaired when it is probable the creditor will not be able to collect
all contractual principal and interest payments due in accordance with the terms
of the loan agreement. Loan impairment is evaluated on a loan-by-loan basis as
part of normal loan review procedures of the Bank.
11
NOTE # 7 - MARKET RISK
We utilize the results of a dynamic simulation model to quantify the
estimated exposure of net interest income to sustained interest rate changes.
The simulation model estimates the impact of changing interest rates on the
interest income from all interest earning assets and the interest expense paid
on all interest bearing liabilities reflected on the Company's balance sheet.
This sensitivity analysis is compared to policy limits which specify maximum
tolerance level for net interest income exposure over a one year horizon
assuming no balance sheet growth, given both a 100 and 300 basis point upward
and downward shift in interest rates. A parallel and pro rata shift in rates
over a 12-month period is assumed.
We do not engage in any hedging activities and does not have any
derivative securities in its portfolio.
The following reflects our net interest income sensitivity analysis as
of September 30, 2001:
(Dollars in Thousands)
ESTIMATED NET MARKET VALUE
SIMULATED INTEREST INCOME -----------------------------
RATE CHANGES SENSITIVITY ASSETS LIABILITIES
------------ --------------- ---------- -----------
+100 basis points -2.37% $ 540,227 $ 485,140
+300 basis points -7.16% $ 524,372 $ 484,049
- -100 basis points 1.00% $ 558,118 $ 486,256
- -300 basis points -9.29% $ 578,560 $ 487,153
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This Report contains "forward-looking" statements that set forth our
current expectations or beliefs regarding our future financial performance.
Forward-looking statements are subject to a number of risks and uncertainties
that could cause our actual financial performance in the future to differ,
possibly significantly, from the expectations set forth in those statements. A
discussion of those risks and uncertainties is set forth at the end of this Item
2 and readers of this Report are urged to review that discussion, which
qualifies the forward looking statements contained in this Report.
GENERAL
Our principal operating subsidiary is Foothill Independent Bank (the
"Bank"), which is a California state chartered bank and member of the Federal
Reserve System. The Bank accounts for substantially all of our consolidated
revenues and income. Accordingly, the following discussion focuses primarily on
its operations and financial condition.
RESULTS OF OPERATIONS
Overview. During the three month and nine month periods ended September
30, 2001, we generated net earnings of $1,828,000 and $5,134,000, respectively,
representing increases of $81,000 or 4.6% and $165,000 or 3%, respectively, over
net earnings generated in the three and nine month periods ended September 30,
2000. In the three months ended September 30, 2001, that increase was primarily
attributable to (i) a decrease of $859,000 in interest expense that was largely
attributable to both a decline in interest rates and in the average volume of
time deposits outstanding, which led to an $80,000 or 1.2% increase in net
interest income, and (ii) an increase in non-interest income. In the nine months
ended September 30, 2001, the increase in net income was primarily due to a
$608,000 or 17.9% increase in non-interest income, which largely offset a 3%
decline in net interest income. The decline in net interest income during the
nine months ended September 30, 2001 has been due primarily to declining market
rates of interest which have led to reductions in interest rates on our variable
rate loans that have "repriced" downward as market rates of interest have
declined. Although the declines in market rates of interest also led to
reductions in the interest rates paid on interest-bearing deposits, those
interest rate reductions could not be implemented as quickly as the declines in
interest rates on variable rate loans because reductions in interest rates paid
on time deposits cannot be implemented until those deposits mature. As a result,
since the beginning of the current fiscal year, we have been reducing the volume
of time deposits, which enabled us to achieve an increase in net interest income
in the third quarter of the year.
Net earnings for the three and nine month periods ended September 30,
2001 represent annualized returns on average assets of 1.39% and 1.34%,
respectively, as compared to 1.43% and 1.38%, respectively, for the same periods
of 2000 and annualized returns on average equity of 14.66% and 13.97%,
respectively, as compared to 14.77% and 14.16%, respectively, for the same
periods of 2000. On a fully diluted per share basis, net earnings per share
increased by 7% to $0.32 in the three months ended September 30, 2001 and by 7%
to $0.88 for the nine months ended September 30, 2001, from $0.30 in the three
months and from $0.82 in the nine months ended September 30, 2000, respectively.
Those increases were due primarily to reductions in the weighted average number
of shares outstanding that resulted from stock repurchases that we made in our
open market and private stock purchase program between October 1, 2000 and
September 30, 2001. See Note 3 to the Interim Condensed Consolidated Financial
Statements in Item 1 of this Report.
Net Interest Income. Net interest income is a principal determinant of a
bank's earnings. Net interest income represents the difference or "spread"
between the interest earned on interest-earning assets, such as loans and
investment securities, and the interest paid on interest-bearing liabilities,
principally deposits. Net interest income increased by $80,000 or 1.2% in the
three months ended September 30, 2001, as compared to the same three months of
2000, primarily as a result of reductions in interest rates and a reduction in
the average volume of time deposits, including those in denominations of
$100,000 or more ("TCDs"), outstanding. Net interest income declined by
$639,000, or 3% in the nine month period ended September 30, 2001, as compared
to the same nine
13
month period in 2000, primarily as a result of a $1,293,000, or 4.5%, decrease
in interest income that was only partially offset by a $654,000, or 8.2%,
decrease in interest expense.
RATE SENSITIVITY AND NET INTEREST MARGIN
Rate Sensitivity. Like other banks and bank holding companies, our
margins (that is, the difference between yields we are able to realize on loans
and on other interest earning assets and the interest we pay on deposits) are
affected by a number of factors, including the relative percentages or the "mix"
of:
- our assets, between loans, on the one hand, on which we are able
to charge higher rates of interest, and investment securities,
federal funds sold and funds held in interest-bearing deposits
with other financial institutions, on the other hand, on which
yields are generally lower;
- variable and fixed rate loans in our loan portfolio; and
- demand and savings deposits, on the one hand, and time deposits,
on the other hand.
As a general rule, a bank with a relatively high percentage of
fixed-rate loans will experience a decline in interest income during a period of
increasing market rates of interest, because it will be unable to "reprice" its
fixed rate loans to fully offset the increase in the rates of interest it must
offer to retain maturing time deposits and attract new deposits. Similarly, a
bank with a high percentage of time deposits generally will experience greater
increases in interest expense, and therefore, a decrease in net interest income,
during a period of increasing market rates of interest than a bank with a
greater percentage of demand and savings deposits which are less sensitive to
changes in market rates of interest. By contrast, during a period of declining
market rates of interest, a bank with a higher percentage of variable loans, as
a general rule, will experience a decline in net interest income because such
loans usually contain automatic repricing provisions that are "triggered" by
declines in market rates of interest; whereas offsetting reductions in the rates
of interest paid on time deposits cannot be implemented until they mature, at
which time a bank can seek their renewal at lower rates of interest or allow
such deposits to be withdrawn in order to reduce interest expense. However, the
impact of changes in interest rates on net interest income can be affected by
changes in the volume of loans or interest bearing deposits. In the case of the
first nine months of 2001, changes in prevailing rates of interest were the
primary cause of the decline in net interest income, rather than increases in
the volume of interest bearing deposits. By contrast, in the three months ended
September 30, 2001, we were able to achieve an $80,000 increase in our net
interest income, as compared to the three months ended September 30, 2000,
primarily as a result of a decline in the volume of our higher priced time
deposits that resulted from a decision to allow those deposits to "run off"
rather than seeking to renew them.
Net Interest Margin. We attempt to reduce our exposure to market risks
associated with interest rate fluctuations and, thereby, at least to maintain
and, if possible, to increase, our net interest margin or spread by seeking (i)
to attract and maintain a significant volume of demand and savings deposits that
are not as sensitive to interest rate fluctuations as are TCDs and other time
deposits, and (ii) to match opportunities to "reprice" earning assets,
particularly loans, in response to changes in market rates of interest which
require or cause repricing of deposits. Last year we initiated new loan programs
to increase loan volume and, at the same time, we increased the volume of TCDs
and other time deposits, by offering higher rates of interest on such deposits,
primarily to fund the increase in loan volume. We were somewhat able to mitigate
the effect on our net interest margin of the increase in TCDs and other time
deposits by also continuing to actively seek and obtain additional demand and
savings deposits. During the current fiscal year, we decided to allow higher
priced time deposits to "run off" at they matured, rather than to seek their
renewal. By the third quarter of the current year a significant portion of our
TCDs and, to a lesser extent, our other time deposits, had run off. As a result,
for the quarter ended September 30, 2001, the average volume of demand, savings
and money market deposits had increased to 78%, while time deposits, including
TCDs, declined to 22%, of average total deposits, from 74% and 26%,
respectively, for the same quarter of 2000. We currently expect that, as a
percentage of total deposits, time deposits will remain at about the same levels
during the balance of the current fiscal year.
Our net interest margin (i.e., tax-adjusted net interest income stated
as a percentage of average interest-earning assets) decreased in the quarter and
nine months ended September 30, 2001 to 5.93% and 5.86%, respectively, from
6.31% and 6.47%, respectively, for the same periods of 2000. These decreases
were primarily due to declining market rates of interest, which reduced our
yields on loans and other variable rate earning assets.
14
While we were able to offset some of the decline in interest income by allowing
TCDs and time deposits to "run off" at their maturity dates, due to the maturity
of the remaining TCDs and time deposits we were not able to implement reductions
in interest expense as rapidly as the reductions that occurred in interest
income from our variable rate interest earning assets. However, we believe that
our net interest margin continues to exceed the average net interest margin for
California-based, publicly traded banks and bank holding companies with assets
ranging from $250-to-$750 million (the "Peer Group Banks").
The ability to maintain our net interest margin is not entirely within
our control because the interest rates we are able to charge on loans and the
interest rates we must offer to maintain and attract deposits are affected by
national monetary policies established and implemented by the Federal Reserve
Board and by competitive conditions in our service areas. In addition, the
effect on a bank's net interest margin of changes in market rates of interest
will depend on the types and maturities of its deposits and earning assets. For
example, a change in interest rates paid on deposits in response to changes in
market rates of interest can be implemented more quickly in the case of savings
deposits and money market accounts than with respect to time deposits as to
which a change in interest rates generally cannot be implemented until such
deposits mature. In addition, a change in rates of interest paid on deposits can
and often does lead consumers to move their deposits from one type of deposit to
another or to shift funds from deposits to non-bank investments or from such
investments to bank deposit accounts or instruments, which also will affect a
bank's net interest margin. So far during 2001, the Federal Reserve Board has
been attempting to decrease market rates of interest as a means of stimulating
the economy. As a result, we expect that interest on loans will continue to
decrease during the remainder of 2001, which could result in further reductions
in our net interest margin during that period. However, we also expect that the
cost of deposits will decrease, which should lessen the overall effect that such
decreases in interest income will have on our net interest margins.
Provision for Loan Losses. We follow the practice of maintaining a
reserve for possible losses on loans that occur from time to time as an
incidental part of the banking business. Charge-offs (essentially reductions in
the carrying values) of non-performing loans due to possible losses on their
ultimate recovery are applied against this reserve (the "Loan Loss Reserve").
That Reserve is adjusted periodically to reflect changes in (i) the volume of
outstanding loans, (ii) the risk of potential losses due to a deterioration in
the condition of borrowers or in the value of property securing non-performing
loans or changes in economic conditions, and (iii) reductions in the amount of
the Reserve due to loan charge-offs that occur from time to time. Additions to
the Loan Loss Reserve are made through a charge against income referred to as
the "provision for loan losses." We did not make any provisions for potential
loan losses in the three-month period ended September 30, 2001, as compared to
$190,000 during the same period of 2000. During the nine-month period ended
September 30, 2001 we made a provision of $225,000, as compared to $665,000
during the same nine-month period of 2000. At September 30, 2001, the Loan Loss
Reserve was approximately $3,961,000 or 1.06% of total loans outstanding,
compared to approximately $3,901,000 or 1.05% of total loans outstanding at
September 30, 2000. Recoveries of previously "charged off" loans exceeded loan
charge-offs by $44,000 in the first nine months of 2001. By comparison, in the
same nine months of 2000, net charge-offs aggregated $2,866,000. See Note 6 to
our Condensed Consolidated Financial Statements contained in Part I of this
Report for further information with respect to an analysis of our loan and lease
loss experience for the nine months ended September 30, 2001 and the fiscal year
ended December 31, 2000.
Other Income. Other income increased by $145,000, or 12.2%, and
$608,000, or 17.9%, in the quarter and nine-month periods ended September 30,
2001, compared to the same periods of 2000, due primarily to increases in
transaction fees and service charges collected on deposits and other banking
transactions. Also contributing to the increase in other income for the nine
months ended September 30, 2001 was a one-time $72,000 gain on the sale of a
parcel of real property in the first quarter of 2001 that the Bank had been
using as a parking lot, but which it no longer needed.
Other Expense. Other expense (also known as "non-interest expense"),
consists primarily of (i) salaries and other employee expenses, (ii) occupancy
and furniture and equipment expenses, and (iii) other operating and
miscellaneous expenses that include insurance premiums, marketing expenses, data
processing costs, and professional expenses.
15
In order to attract a higher volume of non-interest bearing demand and
lower cost savings and money market deposits as a means of maintaining the
Bank's net interest margin, it has been our policy to provide a much higher
level of personal service to our customers than the level of services that is
provided by many of our competitors. As a result, our net interest margin has
usually exceeded the average net interest margin of the Peer Group Banks and
more than offset the adverse effects that the higher costs of providing such
services would otherwise have had on our profitability.
Non-interest expense increased approximately $318,000, or 6.2%, and
$207,000, or 1.3%, in the quarter and nine-month periods ended September 30,
2001, compared to same periods of 2000, primarily due to additional salaries,
occupancy, and other expenses resulting from the opening of our 12th branch
office in late December of 2000. Our efficiency ratio (that is, basically, the
ratio of non-interest expense to the sum of our net interest income and other
income, as adjusted to eliminate non-recurring expenses and income) increased to
66.0% and 66.2%, respectively, for the three and nine-month periods ended
September 30, 2001 from 60.87% and 63.83%, respectively, for the same periods of
2000. The increase in our efficiency ratio was primarily due to the decline in
net interest income during the quarter and nine-months ended September 30, 2001,
and to a lesser extent, the increased expenses associated with the opening of
our new banking office.
Income Taxes. Income taxes increased by approximately $16,000, or 1.6%,
and $37,000, or 1.3%, during the quarter and nine-month periods ended September
30, 2001 compared to the same periods of 2000, primarily as a result of
increases in taxable income.
FINANCIAL CONDITION
Our total assets increased during the nine months ended September 30,
2001 by $32,145,000 or 6.4%, when compared to total assets at December 31, 2000.
Average total assets at September 30, 2001 of $511,598,000 were $25,945,000, or
5.3%, higher than average total assets at December 31, 2000. At September 30,
2001, the volume of demand and savings deposits at the Bank was $51,270,000, or
15.6%, higher than at December 31, 2000, while the volume of time deposits,
including TCDs, was $22,295,000, or 17.7%, lower than at December 31, 2000,
reflecting our decision, made at the beginning of the current fiscal year, to
allow TCDs to "run off" rather than attempt to retain them.
Liquidity Management. Liquidity management policies attempt to achieve a
matching of sources and uses of funds in order to enable us to fund our
customers' requirements for loans and for deposit withdrawals. In conformity
with those policies, we maintain a number of short-term sources of funds to meet
periodic increases in loan demand and deposit withdrawals and maturities. At
September 30, 2001, the principal sources of liquidity consisted of $31,482,000
of cash and demand balances due from other banks; $16,200,000 in Federal funds
sold; and $12,000,000 in an overnight repurchase agreement, which, together,
totaled $59,682,000, as compared to $38,186,000 at December 31, 2000. Other
sources of liquidity include $61,451,000 in securities available-for-sale, of
which approximately $2,926,000 mature within one year; and $14,638,000 in
interest bearing deposits at other financial institutions, which mature in 6
months or less. We also have established facilities enabling us to borrow up to
$13,000,000 of Federal funds from other banks and we have an unused $22,068,000
line of credit with the Federal Home Loan Bank. We also have approval from the
Federal Reserve Bank of San Francisco to establish an account that will also
allow us to borrow at its discount window should the need arise. Additionally,
substantially all of our installment loans and leases, the amount of which
aggregated $5,587,000 at September 30, 2001, require regular installment
payments from customers, providing us with a steady flow of cash funds.
Accordingly, we believe that we have adequate cash and cash equivalent resources
to meet any increases in demand for loans-and leases and any increase in deposit
withdrawals that might occur in the foreseeable future.
Capital Resources. Between late 1998 and September 30, 2001, we
purchased a total of 976,588 shares of our common stock, in open market and
private transactions, for an aggregate price of approximately $11,970,000. In
addition, in September of 1999 our Board of Directors adopted a cash dividend
policy which provides for the Company to pay quarterly cash dividends, currently
$.10 per share. We declared our eighth consecutive quarterly cash dividend,
pursuant to that policy, in July 2001 which was paid on August 24, 2001 to
shareholders of record as of August 3, 2001.
16
It has been and continues to be the objective of our Board of Directors
to retain earnings that are needed to meet capital requirements under applicable
government regulations and to support our growth. As a result, the Board may
change the amount or frequency of cash dividends to the extent that it deems
necessary or appropriate to achieve these objectives. For example the retention
of earnings in previous years enabled us to fund the opening of four new banking
offices and extend the Bank's market areas, all of which have contributed to our
increased profitability and the maintenance of our capital adequacy ratios well
above regulatory requirements.
We continue to evaluate and explore opportunities to expand our market
into areas such as eastern Los Angeles County, western San Bernardino County,
north Orange County and northern Riverside County, all of which are contiguous
to our existing markets. We believe that the mergers and consolidations of
independent banks that have occurred have created opportunities for us to
increase our market share in those areas. We have taken advantage of those
opportunities within our existing market areas and have established a
substantial number of new customer relationships and increased the volume of our
demand, savings and money market deposit balances obtained largely from
customers of the merged banks who we disaffected by the quality of services they
were receiving. We also opened a branch banking office in the city of Temecula,
California, in December of 2000, which is our 12th banking office, and we
believe that there are still additional expansion and growth opportunities that
we will seek to take advantage of in 2001 and 2002.
At September 30, 2001, the Bank's Tier 1 leverage ratio and Tier 1
risk-based capital ratio were 9.50% and 11.97%, respectively, which were in
excess of minimum bank regulatory requirements and categorize the bank as "Well
Capitalized". Our consolidated Tier 1 risk-based capital ratio was 12.02%. The
risk-based capital ratio is determined by weighting our assets in accordance
with certain risk factors and, the higher the risk profile of the assets, the
greater is the amount of capital that is required to maintain an adequate
risk-based capital ratio, which generally is at least 8%. The Tier 1 capital and
Tier 1 risk-based capital ratios of the Bank compare favorably with those of the
Peer Group Banks.
FORWARD LOOKING INFORMATION AND UNCERTAINTIES REGARDING FUTURE PERFORMANCE
This Report, including this Section, entitled "Management's Discussion
and Analysis of Financial Condition and Results of Operations," contains
statements regarding our expectations or beliefs about our future financial
performance (including statements concerning business trends) that are
"forward-looking statements" as defined in the Private Securities Litigation
Reform Act of 1995. Our actual financial results in future periods may differ,
possibly materially, from those forecast in this Report due to a number of risks
and uncertainties. Those risks and uncertainties include, but are not limited
to, the following:
INCREASED COMPETITION. Increased competition from other financial
institutions, mutual funds and securities brokerage and investment banking firms
that offer competitive loan and investment products could require us to reduce
interest rates and loan fees to attract new loans or to increase interest rates
that we offer on time deposits, either or both of which could, in turn, reduce
our interest income and net interest margins.
POSSIBLE ADVERSE CHANGES IN ECONOMIC CONDITIONS. Adverse changes in
economic conditions, either national or local, could (i) reduce loan demand
which could, in turn, reduce interest income and net interest margins; (ii)
adversely affect the financial capability of borrowers to meet their loan
obligations which, in turn, could result in increases in loan losses and require
increases in reserves for possible loan losses, thereby adversely affecting
earnings; and (iii) lead to reductions in real property values that, due to our
reliance on real property to secure many of our loans, could make it more
difficult for us to prevent losses from being incurred on non-performing loans
through the sale of such real properties.
POSSIBLE ADVERSE CHANGES IN NATIONAL ECONOMIC CONDITIONS AND CHANGES IN
FEDERAL RESERVE BOARD MONETARY POLICIES. Changes in national economic
conditions, such as increases in inflation or declines in economic output often
prompt changes in Federal Reserve Board monetary policies that could increase
the cost of funds to us or reduce yields on interest earning assets and,
thereby, reduce net interest margins. As discussed above in this Report, so far
in 2001 the Federal Reserve Board has been lowering market rates of interest to
stimulate the national economy. Those reductions have caused a decline in our
net interest margins and could continue to do so in the future.
17
CHANGES IN REGULATORY POLICIES. Changes in federal and state bank
regulatory policies, such as increases in capital requirements or in loan loss
reserves, or changes in required asset/liability ratios, could adversely affect
earnings by reducing yields on earning assets or increasing operating costs.
EFFECTS OF GROWTH. It is our intention to take advantage of
opportunities to increase our business, either through acquisitions of other
banks, the establishment of new banking offices or the offering of new products
or services to our customers. If we do acquire any other banks or open any
additional banking offices or begin offering new products or services, we are
likely to incur additional operating costs that may adversely affect our income,
at least on a short term basis.
Due to these and other possible uncertainties and risks, readers are
cautioned not to place undue reliance on the forward-looking statements, which
speak only as of the date of this Quarterly Report. The Company undertakes no
obligation to update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss to future earnings, to fair values of
assets or to future cash flows that may result from changes in the price or
value of a financial instrument. The value of a financial instrument may change
as a result of changes in interest rate and other market conditions. Market risk
is attributed to all market risk sensitive financial instruments, including loan
and investment securities, deposits and borrowings. We do not engage in trading
activities or participate in foreign currency transactions for our own account.
Accordingly, our exposure to market risk is primarily a function of our asset
and liability management activities and of changes in market rates of interest
that can cause or require increases in the rates we pay on deposits that may
take effect more rapidly or may be greater than the increases in the interest
rates we are able to charge on loans and the yields that we can realize on our
investments. The extent of that market risk, depends on a number of variables,
including the sensitivity to changes in market interest rates and the maturities
of our interest earning assets and our deposits. See "Rate Sensitivity" above.
We use a dynamic simulation model to forecast the anticipated impact of
changes in market interest rates on our net interest income. That model is used
to assist management in evaluating, and in determining and adjusting strategies
designed to reduce, our exposure to these market risks, which may include, for
example, changing the mix of earning assets or interest-bearing deposits. See
Note 8 to our Condensed Consolidated Financial Statements contained in Part I of
this Report for further information with respect to that dynamic simulation
model that, based on certain assumptions, attempts to quantify the impact that
simulated upward and downward interest rate changes would have on our net
interest income.
18
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None.
(b) Reports on Form 8-K:
None
19
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.
Date: November 12, 2001 FOOTHILL INDEPENDENT BANCORP
By: /s/ CAROL ANN GRAF
-------------------------------------
Carol Ann Graf,
Senior Vice President,
Chief Financial Officer
and Secretary
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