Exhibit 13
Dear Shareholders, Customers and Friends;
Pacific State Bancorp and Pacific State Bank achieved some noteworthy milestones
in 2004. Pacific State Bank was able to announce record annual earnings of
$3,159,843 and Pacific State Bancorp grew assets over the $250,000,000 mark. The
strong asset growth occurred primarily in the bank's loan portfolio. As well in
2004, Pacific State Bank expanded its presence into the Bay Area with the
opening of a Loan Production Center in Castro Valley located in Alameda County.
Our reception by the business community has been so positive management is
looking for a permanent branch location.
In 2004 Pacific State Bancorp distributed a 2 for 1 stock split of its
outstanding shares of common stock effective September 30, 2004and our market
capitalization closed the year strongly at over $70,000,000.
With all of the growth Pacific State Bank is experiencing, it is natural that
the delivery of information and financial services would be more demanding. In
response, the bank has upgraded its technology to include full imaging services.
This allows for real time exchange of information and instant images of checks
and statements available on our website at www.pacificstatebank.com. As well,
on-line deposit and loan applications are now available on our website.
In April of 2004, Pacific State Bancorp received the prestigious Carpenter &
Company Market Capitalization Champion 2003 Award for Financial Institutions in
the $100,000,000 to $250,000,000 asset class recognizing the Company's stock
appreciation of 292%. In addition, the bank's personnel continue to be
recognized both locally and nationally. In April, Laura Bunch was recognized by
Women for Agriculture as the recipient of the annual "Women in Ag Lending
Recognition" for her continued commitment to agricultural lending. Mrs. Bunch
was also recognized by United States Congressman Richard Pombo of the 11th
Congressional District and California State Senator Chuck Poochigian for her
contributions to California Agriculture and was extended commendations for the
vital investment made to the prosperity of this community.
2004 was an excellent year in which the company achieved great financial
milestones. Going forward management believes that 2005 will provide more
opportunities for success.
We thank you for your support and encourage all of you to open a new account and
apply for a loan with your community bank.
/s/ HAROLD HAND M.D. /s/ STEVEN A. ROSSO
- ---------------------------------- ------------------------------------
Harold Hand, M.D. Steven A. Rosso
Chairman of the Board of Directors President & C.E.O.
17
BUSINESS OF THE COMPANY
Certain statements discussed or incorporated by reference in this Annual
Report including, but not limited to, information concerning possible or assumed
future results of operations of the Company set forth matters in the
Management's Discussion and Analysis of Financial Condition and Results of
Operation, are forward-looking statements within the meaning of the Securities
Exchange Act of 1934 (the "Exchange Act"). Forward-looking statements include
statements in which words such as "expect," "anticipate," "intend," "plan,"
"believe," "estimate," "consider" or variants or similar expressions are used.
The Company's actual future results and shareholder values may differ materially
from those anticipated and expressed in these forward-looking statements, which
are based on management's beliefs and assumptions and on information currently
available to management, and are subject to risks and uncertainties that could
cause actual results to differ materially from those projected. Such risks and
uncertainties include, among others, (1) competitive pressures in the banking
industry; (2) changes in the interest rate environment; (3) general economic
conditions, either nationally or regionally; (4) changes in the regulatory
environment; (5) changes in business conditions and inflation; and (6) changes
in securities markets. Many of these factors are beyond the Company's ability to
control or predict. Investors are cautioned not to put undue reliance on any
forward-looking statements. In addition, the Company does not have any intention
or obligation to update forward-looking statements contained in this Annual
Report, even if new information, future events or other circumstances have made
them incorrect or misleading. Except as specifically noted herein all references
to the "Company" refer to Pacific State Bancorp, a California corporation
18
SELECTED FINANCIAL DATA
The information set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's audited consolidated financial statements and
notes thereto, included elsewhere in this report.
(dollars in thousands, except per share data) Year Ended December 31,
-----------------------
Statements of Income: 2004 2003 2002 2001 2000
Total Interest Income $13,509 $11,117 $9,236 $9,195 $9,720
Net Interest Income 10,451 8,356 6,289 5,614 5,735
Provision for Loan Losses 504 536 286 383 300
Total Non-interest Income 2,525 1,978 1,636 1,259 748
Total Non-interest Expenses 7,429 6,498 5,846 4,935 4,620
Provision for Income Taxes 1,874 1,247 630 520 555
Net Income 3,169 2,053 1,163 1,036 1,009
Balance Sheets:
Total Assets 254,361 200,924 180,295 121,295 113,809
Total Investments 23,582 15,512 12,173 10,608 16,684
Total Loans 199,535 157,138 135,272 98,281 83,644
Allowance for Loan Losses (ALL) 2,214 1,653 1,306 1,172 1,001
Total Deposits 223,761 176,292 158,140 111,104 104,747
Subordinated Debentures 8,764 5,155 5,155 --- ---
Shareholders' Equity 16,830 13,459 11,320 9,378 8,047
Performance Ratios:
Return on Average Assets 1.37% 1.07% 0.77% 0.87% 0.92%
Return on Average Equity 21.65% 16.86% 11.27% 12.04% 13.93%
Average Equity to Average Assets 6.34% 6.36% 6.80% 7.24% 6.57%
Tier 1 Risk-Based Capital 10.10% 10.10% 9.40% 9.085% 9.06%
Total Risk-Based Capital 12.60% 11.60% 11.40% 10.22% 10.20%
Net Interest Margin 5.14% 4.85% 4.63% 5.15% 5.66%
Average Earning Assets to Average Total Assets 88.18% 89.85% 89.48% 90.98% 90.80%
Nonperforming Assets to Total Assets -- -- 0.48% 0.63% 0.79%
ALL to Total Loans 1.10% 1.05% .97% 1.20% 1.20%
Nonperforming Loans to ALL -- -- 15.24% 41.40% 74.33%
Share Data (Common Shares Outstanding) 3,448,042 3,377,656 3,302,748 3,038,776 2,925,196
Book Value Per Share $4.88 $3.99 $3.43 $3.09 $2.75
Basic Earnings Per Share $0.92 $0.61 $0.36 $0.35 $0.36
Diluted Earnings Per Share $0.84 $0.59 $0.34 $0.33 $0.34
19
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
The Shareholders and
Board of Directors
Pacific State Bancorp
We have audited the accompanying consolidated balance sheet of Pacific
State Bancorp and subsidiary as of December 31, 2004 and 2003 and the related
consolidated statements of income, changes in shareholders' equity and cash
flows for each of the years in the three-year period ended December 31, 2004.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Pacific State Bancorp and subsidiary as of December 31, 2004 and 2003, and the
consolidated results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 2004, in conformity with
accounting principles generally accepted in the United States of America.
March 10, 2005
20
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
December 31, 2004 and 2003
(In thousands, except share amounts)
2004 2003
---------- ----------
ASSETS
Cash and due from banks $ 12,108 $ 5,317
Federal funds sold 7,456
---------- ----------
Total cash and cash equivalents 12,108 12,773
Interest-bearing deposits in banks 6,100 4,000
Investment securities (Notes 3 and 7) 17,482 11,512
Loans, less allowance for loan losses of $2,214 in
2004 and $1,653 in 2003 (Notes 4, 7, 10 and 13) 199,535 155,485
Premises and equipment, net (Note 5) 9,748 8,756
Company owned life insurance (Note 14) 4,246 4,058
Accrued interest receivable and other assets (Note 9) 5,142 4,340
---------- ----------
Total assets $ 254,361 $ 200,924
========== ==========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 51,980 $ 40,400
Interest bearing (Note 6) 171,781 135,892
---------- ----------
Total deposits 223,761 176,292
Other borrowings (Note 7) 4,000 5,000
Subordinated debentures (Note 8) 8,764 5,155
Accrued interest payable and other liabilities 1,006 1,018
---------- ----------
Total liabilities 237,531 187,465
---------- ----------
Commitments and contingencies (Note 10)
Shareholders' equity (Note 11):
Preferred stock - no par value; 2,000,000 shares
authorized; none issued and outstanding -- --
Common stock - no par value; 24,000,000 shares
authorized; issued and outstanding - 3,448,042
shares in 2004 and 3,377,656 shares in 2003 7,159 6,937
Retained earnings 9,626 6,457
Accumulated other comprehensive income, net of taxes
(Notes 3 and 15) 45 65
---------- ----------
Total shareholders' equity 16,830 13,459
---------- ----------
Total liabilities and shareholders' equity $ 254,361 $ 200,924
========== ==========
The accompanying notes are an integral
part of these consolidated financial statements.
21
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
For the Years Ended December 31, 2004, 2003 and 2002
(In thousands, except per share amounts)
2004 2003 2002
---------- ---------- ----------
Interest income:
Interest and fees on loans $ 12,846 $ 10,578 $ 8,508
Interest on Federal funds sold 93 75 64
Interest on investment securities:
Taxable 395 262 426
Exempt from Federal income taxes 175 202 238
---------- ---------- ----------
Total interest income 13,509 11,117 9,236
---------- ---------- ----------
Interest expense:
Interest on deposits (Note 6) 2,564 2,393 2,796
Interest on borrowings (Note 7) 128 129 10
Interest on subordinated debentures (Note 8) 366 239 141
---------- ---------- ----------
Total interest expense 3,058 2,761 2,947
---------- ---------- ----------
Net interest income before provision for
loan losses 10,451 8,356 6,289
Provision for loan losses (Note 4) 504 536 286
---------- ---------- ----------
Net interest income after provision
for loan losses 9,947 7,820 6,003
---------- ---------- ----------
Non-interest income:
Service charges 1,075 694 532
Net gain on sale of investments (Note 3) 2 29
Gain on sale of loans 445 664 584
Other income 1,005 618 491
---------- ---------- ----------
Total non-interest income 2,525 1,978 1,636
---------- ---------- ----------
Non-interest expenses:
Salaries and employee benefits (Notes 4 and 14) 3,814 3,068 2,601
Occupancy (Notes 5 and 10) 750 669 543
Furniture and equipment (Notes 5 and 10) 468 507 567
Other expenses (Note 12) 2,397 2,254 2,135
---------- ---------- ----------
Total non-interest expenses 7,429 6,498 5,846
---------- ---------- ----------
Income before provision for income taxes 5,043 3,300 1,793
Provision for income taxes (Note 9) 1,874 1,247 630
---------- ---------- ----------
Net income $ 3,169 $ 2,053 $ 1,163
========== ========== ==========
Basic earnings per share (Note 11) $ 0.92 $ 0.61 $ 0.36
========== ========== ==========
Diluted earnings per share (Note 11) $ 0.84 $ 0.59 $ 0.34
========== ========== ==========
The accompanying notes are an integral
part of these consolidated financial statements.
22
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2004, 2003 and 2002
(In thousands, except share and per share amounts)
Accumulated
Other
Compre-
Common Stock hensive Total
-------------------------- Retained (Loss) Income Shareholders'
Shares Amount Earnings (Net of Taxes) Equity
----------- ----------- ----------- ----------- -----------
Balance, January 1, 2002 3,038,776 $ 6,192 $ 3,241 $ (55) $ 9,378
Net income 1,163 1,163
Net change in unrealized losses on
available-for-sale investment securities,
net of tax 55 55
Stock options exercised and related tax
benefit (Note 11) 115,972 242 242
Issuance of common stock 148,000 481 481
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2002 3,302,748 6,915 4,404 11,319
Net income 2,053 2,053
Net change in unrealized gains on
available-for-sale investment securities,
net of tax 65 65
Stock options exercised and related tax
benefit (Note 11) 113,300 192 192
Repurchase and retirement of common
stock (38,392) (170) (170)
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2003 3,377,656 6,937 6,457 65 13,459
Net income 3,169 3,169
Net change in unrealized gains on
available-for-sale investment securities,
net of tax (20) (20)
Stock options exercised and related tax
benefit (Note 11) 70,386 222 222
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2004 3,448,042 $ 7,159 $ 9,626 $ 45 $ 16,830
=========== =========== =========== =========== ===========
2004 2003 2002
----------- ----------- -----------
Comprehensive income (Note 15):
Net income $ 3,169 $ 2,053 $ 1,163
----------- ----------- -----------
Other comprehensive income:
Unrealized holding (losses) gains arising
during the year, net of tax (20) 66 74
Less: reclassification adjustment for
gains included in net income, net of tax 1 19
----------- ----------- -----------
Net change in unrealized gains on
available-for-sale investment
securities (20) 65 55
----------- ----------- -----------
Total comprehensive income $ 3,149 $ 2,118 $ 1,218
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
23
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Years Ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 3,169 $ 2,053 $ 1,163
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 504 536 286
Net increase (decrease) in deferred loan
origination fees and costs 85 (19) 52
Depreciation and amortization 567 628 738
Net realized gains on sale of investment
securities (2) (29)
Net loss (gain) on sale of equipment 13 (3)
Increase in Company owned life insurance,
net of expenses (188) (58)
(Increase) decrease in accrued interest
receivable and other assets (198) 21 (481)
(Decrease) increase in accrued interest
payable and other liabilities (12) 338 (156)
Provision for deferred income taxes (230) (262) (191)
---------- ---------- ----------
Net cash provided by operating
activities 3,697 3,248 1,379
---------- ---------- ----------
Cash flows from investing activities:
Net increase in interest-bearing deposits
in banks (2,100) (4,000)
Purchases of available-for-sale investment
securities (14,352) (4,960) (20,343)
Proceeds from matured and called available-
for-sale investment securities 7,374 4,297 16,111
Proceeds from sale of available-for-sale
investment securities 1,978
Proceeds from principal repayments from
available-for-sale government-guaranteed
mortgage-backed securities 984 1,276 544
Proceeds from principal repayments from
held-to-maturity government-guaranteed
mortgage-backed securities 36 110 61
Purchase of FRB and FHLB stock (405) (414)
Net increase in loans (44,639) (22,036) (29,201)
Proceeds from sale of other real estate 49 141
Proceeds from sale of premises and equipment 6 17
Purchases of premises and equipment (1,521) (2,840) (2,295)
Net cash received in branch acquisition 13,722
Purchase of Company owned life insurance (4,000)
---------- ---------- ----------
Net cash used in investing activities (54,623) (32,098) (19,679)
---------- ---------- ----------
(Continued)
24
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(Continued)
For the Years Ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---------- ---------- ----------
Cash flows from financing activities:
Net increase in demand, interest-bearing and
savings deposits $ 54,438 $ 9,711 $ 13,037
Net (decrease) increase in time deposits (6,969) 8,441 11,578
Proceeds from exercise of stock options 183 176 170
Share repurchase and retirement (170)
Proceeds from the issuance of mandatorily
redeemable trust preferred securities 3,609 5,155
Net (decrease) increase in short-term
borrowings (1,000) 1,000
Proceeds from issuance of long-term debt 4,000
---------- ---------- ----------
Net cash provided by financing
activities 50,261 18,158 34,940
---------- ---------- ----------
(Decrease) increase in cash and cash
equivalents (665) (10,692) 16,640
Cash and cash equivalents at beginning of year 12,773 23,465 6,825
---------- ---------- ----------
Cash and cash equivalents at end of year $ 12,108 $ 12,773 $ 23,465
========== ========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest expense $ 3,083 $ 2,838 $ 3,278
Income taxes $ 1,845 $ 1,356 $ 512
Non-cash investing activities:
Real estate acquired through foreclosure $ 30
Net change in unrealized gain on available-
for-sale investment securities $ (26) $ 100 $ 87
Common stock issued in connection with
branch acquisition $ 481
Non-cash financing activities:
Tax benefit from stock options exercised $ 39 $ 16 $ 72
The accompanying notes are an integral
part of these consolidated financial statements.
25
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
On June 24, 2002, Pacific State Bancorp ("Bancorp") commenced operations as
a bank holding company by acquiring all of the outstanding shares of
Pacific State Bank ("Bank") in a one bank holding company reorganization.
The new corporate structure gives Bancorp and the Bank greater flexibility
in terms of operation, expansion, and diversification. The reorganization
was approved by the Bank's shareholders on May 9, 2002, and all required
regulatory approvals or non-disapprovals with respect to the reorganization
were obtained.
Pacific State Bancorp's subsidiaries include the Bank, Pacific State
Statutory Trust I, an unconsolidated Delaware statutory business trust
which was formed in June 2002, and Pacific State Statutory Trust II, an
unconsolidated Delaware statutory business trust which was formed in March
2004, for the exclusive purpose of issuing and selling trust preferred
securities and holding subordinated debentures issued by Bancorp. The
proceeds from the issuance of subordinated debentures in 2004 and 2002 were
utilized by Bancorp to provide capital to the Bank and for general
corporate purposes.
The Bank commenced operations in 1987 and is a California state-chartered
member bank of the Federal Reserve System. The Bank operates seven branches
in California, including two branches in Stockton and branches in Modesto,
Groveland, Arnold, Angels Camp and Tracy. The Bank's primary source of
revenue is providing loans to customers who are predominately small and
middle-market businesses and individuals.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Pacific State Bancorp and its
subsidiary (collectively, the "Company") conform with accounting principles
generally accepted in the United States and prevailing practice within the
banking industry. The more significant of these policies applied in the
preparation of the accompanying consolidated financial statements are
discussed below.
Principles of Consolidation
---------------------------
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiary, Pacific State Bank.
Significant intercompany transactions and balances have been eliminated in
consolidation. For financial reporting purposes, the Company's investment
in Pacific State Statutory Trusts I and II ("Trusts") are accounted for
under the equity method and are included in accrued interest receivable and
other assets in the consolidated balance sheet. The subordinated debentures
issued and guaranteed by the Company and held by the Trusts are included as
subordinated debentures in the consolidated balance sheet.
Stock Splits
------------
On both September 16, 2004 and September 18, 2003, the Company's Board of
Directors approved a two-for-one stock split to shareholders of record at
the close of business on September 30, 2004 and 2003, respectively,
effective on the same date. All shares outstanding, stock option and per
share data in the consolidated financial statements have been retroactively
restated to give effect to the stock splits.
Use of Estimates
----------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
these estimates.
26
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Reclassifications
-----------------
Certain reclassifications have been made to prior years' balances to
conform to classifications used in 2004.
Cash and Cash Equivalents
-------------------------
For the purpose of the statement of cash flows, cash, due from banks and
Federal funds sold are considered to be cash equivalents. Generally,
Federal funds are sold for one-day periods.
Investment Securities
---------------------
Investments are classified into the following categories:
o Available-for-sale securities, reported at fair value, with
unrealized gains and losses excluded from earnings and reported,
net of taxes, as accumulated other comprehensive income (loss)
within shareholders' equity.
o Held-to-maturity securities, which management has the positive
intent and ability to hold to maturity, reported at amortized
cost, adjusted for the accretion of discounts and amortization of
premiums.
Management determines the appropriate classification of its investments at
the time of purchase and may only change the classification in certain
limited circumstances. All transfers between categories are accounted for
at fair value.
Gains or losses on the sale of investment securities are computed on the
specific identification method. Interest earned on investment securities is
reported in interest income, net of applicable adjustments for accretion of
discounts and amortization of premiums.
Investment securities are evaluated for impairment on at least a quarterly
basis and more frequently when economic or market conditions warrant such
an evaluation to determine whether a decline in their value is other than
temporary. Management utilizes criteria such as the magnitude and duration
of the decline and the intent and ability of the Company to retain its
investment in the securities for a period of time sufficient to allow for
an anticipated recovery in fair value, in addition to the reasons
underlying the decline, to determine whether the loss in value is other
than temporary. The term "other than temporary" is not intended to indicate
that the decline is permanent, but indicates that the prospects for a
near-term recovery of value is not necessarily favorable, or that there is
a lack of evidence to support a realizable value equal to or greater than
the carrying value of the investment. Once a decline in value is determined
to be other than temporary, the value of the security is reduced and a
corresponding charge to earnings is recognized.
As a member of the Federal Reserve System, the Federal Home Loan Bank
System and the Farmer Mac Home Administration System, the Bank is required
to maintain an investment in restricted capital stock of each system. These
investments are carried at cost and are redeemable at par and are included
in accrued interest receivable and other assets in the consolidated balance
sheet.
27
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans
-----
Loans are stated at principal balances outstanding. Interest is accrued
daily based upon outstanding loan balances. However, when, in the opinion
of management, loans are considered to be impaired and the future
collectibility of interest and principal is in serious doubt, loans are
placed on nonaccrual status and the accrual of interest income is
suspended. Any interest accrued but unpaid is charged against income.
Payments received are applied to reduce principal to the extent necessary
to ensure collection. Subsequent payments on these loans, or payments
received on nonaccrual loans for which the ultimate collectibility of
principal is not in doubt, are applied first to earned but unpaid interest
and then to principal.
An impaired loan is measured based on the present value of expected future
cash flows discounted at the loan's effective interest rate or, as a
practical matter, at the loan's observable market price or the fair value
of collateral if the loan is collateral dependent. A loan is considered
impaired when, based on current information and events, it is probable that
the Company will be unable to collect all amounts due (including both
principal and interest) in accordance with the contractual terms of the
loan agreement. Interest income on impaired loans, if appropriate, is
recognized on a cash basis.
Loan origination fees, commitment fees, direct loan origination costs and
purchase premiums and discounts on loans are deferred and recognized as an
adjustment of yield, to be amortized to interest income over the
contractual term of the loan. The unamortized balance of deferred fees and
costs is reported as a component of net loans.
Loan Sales and Servicing
------------------------
The Company accounts for the transfer and servicing of financial assets
based on the financial and servicing assets it controls and liabilities it
has incurred, derecognizes financial assets when control has been
surrendered and derecognizes liabilities when extinguished.
Government Guaranteed Loans
Included in the loan portfolio are loans which are 75% to 90% guaranteed by
the Small Business Administration (SBA), Farmer Mac and USDA Business and
Industry. The guaranteed portion of these loans may be sold to a third
party, with the Company retaining the unguaranteed portion. The Company
generally receives a premium in excess of the adjusted carrying value of
the loan at the time of sale. The Company may be required to refund a
portion of the sales premium if the borrower defaults or prepays within
ninety days of the settlement date. At December 31, 2004, there were no
premiums subject to these recourse provisions.
The Company's investment in the loan is allocated between the retained
portion of the loan, the servicing asset (liability) and the sold portion
of the loan based on their relative fair values on the date the loan is
sold. The gain on the sold portion of the loan is recognized as income at
the time of sale. The carrying value of the retained portion of the loan is
discounted based on the estimated value of a comparable non-guaranteed
loan. The servicing asset (liability) is recognized and amortized over the
estimated life of the related loan. Significant future prepayments of these
loans will result in the recognition of additional amortization of related
servicing assets (liabilities).
The Company serviced government-guaranteed loans for others totaling
$42,158,000 and $40,003,000 as of December 31, 2004 and 2003 respectively.
28
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loan Sales and Servicing (Continued)
------------------------------------
Servicing Rights
Servicing rights acquired through 1) a purchase or 2) the origination of
loans which are sold with servicing rights retained are recognized as
separate assets or liabilities. Servicing assets or liabilities are
recorded at the difference between the contractual servicing fees and
adequate compensation for performing the servicing, and are subsequently
amortized in proportion to and over the period of the related net servicing
income or expense. Servicing assets are periodically evaluated for
impairment. Servicing rights were not significant at December 31, 2004 and
2003.
Allowance for Loan Losses
-------------------------
The allowance for loan losses is maintained to provide for losses related
to impaired loans and other losses that can be expected to occur in the
normal course of business. The determination of the allowance is based on
estimates made by management, to include consideration of the character of
the loan portfolio, specifically identified problem loans, potential losses
inherent in the portfolio taken as a whole and economic conditions in the
Company's service area.
Loans determined to be impaired or classified are individually evaluated by
management for specific risk of loss. In addition, reserve factors are
assigned to currently performing loans based on management's assessment of
the following for each identified loan type: (1) inherent credit risk, (2)
historical losses and, (3) where the Company has not experienced losses,
the loss experience of peer banks. These estimates are particularly
susceptible to changes in the economic environment and market conditions.
The Bank's Loan Committee reviews the adequacy of the allowance for loan
losses at least quarterly, to include consideration of the relative risks
in the portfolio and current economic conditions and other factors. The
allowance is adjusted based on that review if, in the judgment of the Loan
Committee and management, changes are warranted.
This allowance is established through a provision for loan losses which is
charged to expense. Additions to the allowance are expected to maintain the
adequacy of the total allowance after net charge-offs and loan growth. The
allowance for loan losses at December 31, 2004 and 2003, respectively,
reflects management's estimate of probable losses in the portfolio.
Other Real Estate
-----------------
Other real estate includes real estate acquired in full or partial
settlement of loan obligations. When property is acquired, any excess of
the Company's recorded investment in the loan balance and accrued interest
income over the estimated fair market value of the property, net of
estimated selling costs, is charged against the allowance for loan losses.
A valuation allowance for losses on other real estate is maintained to
provide for temporary declines in value. The allowance is established
through a provision for losses on other real estate which is included in
other expenses. Subsequent gains or losses on sales or writedowns resulting
from permanent impairments are recorded in other income or expenses as
incurred. At December 31, 2004 and 2003, the Company did not have any other
real estate owned.
29
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Premises and Equipment
----------------------
Premises and equipment are carried at cost. Depreciation is determined
using the straight-line method over the estimated useful lives of the
related assets. The useful lives of premises are estimated to be twenty to
twenty-seven years. The useful lives of furniture, fixtures and equipment
are estimated to be two to seven years. Leasehold improvements are
amortized over the life of the asset or the life of the related lease,
whichever is shorter. When assets are sold or otherwise disposed of, the
cost and related accumulated depreciation and amortization are removed from
the accounts, and any resulting gain or loss is recognized in income for
the period. The cost of maintenance and repairs is charged to expense as
incurred.
The Company evaluates premises and equipment for financial impairment as
events or changes in circumstances indicate that the carrying amount of
such assets may not be fully recoverable.
Goodwill and Intangible Assets
------------------------------
As a result of the Company's 2002 acquisition of the Stockton branch of
California Bank & Trust, the Company recognized a core deposit intangible
asset of $448,000 and goodwill of $718,000. The valuation of the core
deposit intangible was based on the estimated fair value of deposits
acquired and is amortized on a straight-line basis over a period of ten
years. The current balance of the core deposit intangible of $283,000 is
included in accrued interest receivable and other assets in the
consolidated balance sheet. Goodwill is not amortized, but is measured
along with the core deposit intangible for impairment. At December 31, 2004
and 2003, no impairment of the core deposit intangible or goodwill has been
recognized in the Company's consolidated financial statements.
Income Taxes
------------
The Company files its income taxes on a consolidated basis with its
subsidiary. The allocation of income tax expense (benefit) represents each
entity's proportionate share of the consolidated provision for income
taxes.
Deferred tax assets and liabilities are recognized for the tax consequences
of temporary differences between the reported amounts of assets and
liabilities and their tax basis. Deferred tax assets and liabilities are
adjusted for the effects of changes in tax laws and rates on the date of
enactment. On the consolidated balance sheet, net deferred tax assets are
included in accrued interest receivable and other assets.
Earnings Per Share
------------------
Basic earnings per share (EPS), which excludes dilution, is computed by
dividing income available to common shareholders by the weighted-average
number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock, such as stock options, result in the issuance of common
stock which shares in the earnings of the Company. All data with respect to
computing earnings per share is retroactively adjusted to reflect stock
splits and dividends and the treasury stock method is applied to determine
the dilutive effect of stock options in computing diluted EPS.
30
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock-Based Compensation
------------------------
At December 31, 2004, the Company has two stock-based employee compensation
plans, the Pacific State Bancorp 1997 Stock Option Plan and the Pacific
State Bancorp 1987 Stock Option Plan (the "Plans"), which are described
more fully in Note 11. The Company accounts for these plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting
for Stock Issued to Employees, and related Interpretations. No stock-based
employee compensation cost is reflected in net income, as all options
granted under these plans had an exercise price equal to the market value
of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if the Company
had applied the fair value recognition provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
Pro forma adjustments to the Company's consolidated net earnings and
earnings per share are disclosed during the years in which the options
become vested.
2004 2003 2002
------------ ------------ ------------
(In thousands, except per share amounts)
Net income, as reported $ 3,169 $ 2,053 $ 1,163
Deduct: Total stock-based employee com-
pensation expense determined under
the fair value based method for all awards,
net of related tax effects 264 95 30
------------ ------------ ------------
Pro forma net income $ 2,905 $ 1,958 $ 1,133
============ ============ ============
Basic earnings per share - as reported $ 0.92 $ 0.61 $ 0.36
Basic earnings per share - pro forma $ 0.85 $ 0.58 $ 0.35
Diluted earnings per share - as reported $ 0.84 $ 0.59 $ 0.34
Diluted earnings per share - pro forma $ 0.77 $ 0.57 $ 0.34
Weighted average fair value of options
granted during the year N/A $ 1.88 $ 0.92
The fair value of each option is estimated on the date of grant using an
option-pricing model with the following assumptions:
2003 2002
--------------- ----------------
Expected volatility 20.34% 12.45% to 12.80%
Risk-free interest rate 3.21% 4.87% to 5.39%
Expected option life 5 years 5 years
Dividend yield N/A N/A
There were no stock options granted in 2004.
31
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Impact of New Financial Accounting Standards
--------------------------------------------
Other-Than-Temporary Impairment of Certain Investments
In June 2004, the Financial Accounting Standards Board (FASB) ratified
Emerging Issues Task Force (EITF) Issue 03-1, The Meaning of
Other-than-Temporary Impairment and Its Application to Certain Investments
(EITF 03-1). EITF 03-1 includes additional guidance for evaluating and
recording impairment losses on debt and equity investments, as well as
disclosure requirements for investments that are deemed to be temporarily
impaired. The proposed guidance indicates that an investor must have the
intent and ability to hold an investment until a forecasted recovery of the
fair value up to or beyond the cost of the investment in order to determine
that any impairment is temporary. In September 2004, the FASB delayed the
effective date of the recognition and measurement guidance of EITF 03-1,
pending further deliberations. The disclosures for investments that are
deemed temporarily impaired are included in Note 3 to the consolidated
financial statements. Once the FASB has reached a final decision on the
measurement and recognition provisions, the Company will evaluate the
impact of the adoption of EITF 03-1.
Share-Based Payments
In December 2004 the FASB issued Statement Number 123 (revised 2004) (FAS
123 (R)), Share-Based Payments. FAS 123 (R) requires all entities to
recognize compensation expense in an amount equal to the fair value of
share-based payments such as stock options granted to employees. The
Company is required to apply FAS 123 (R) on a modified prospective method.
Under this method, the Company is required to record compensation expense
(as previous awards continue to vest) for the unvested portion of
previously granted awards that remain outstanding at the date of adoption.
In addition, the Company may elect to adopt FAS 123 (R) by restating
previously issued financial statements, basing the expense on that
previously reported in their pro forma disclosures required by FAS 123. FAS
123 (R) is effective for the first reporting period beginning after
December 31, 2005. Management has not completed its evaluation of the
effect that FAS 123 (R) will have, but believes that the effect will be
consistent with its previous pro forma disclosures.
Accounting for Certain Loans or Debt Securities Acquired in a Transfer
In December 2003, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of
Position 03-03, Accounting for Certain Loans or Debt Securities Acquired in
a Transfer (SOP). This SOP addresses accounting for differences between
contractual cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities (loans) acquired
in a transfer if those differences are attributable, at least in part, to
credit quality. It also includes such loans acquired in purchase business
combinations. This SOP does not apply to loans originated by the entity.
This SOP limits the yield that may be accreted and requires that the excess
of contractual cash flows over cash flows expected to be collected not be
recognized as an adjustment of yield, loss accrual, or valuation allowance.
This SOP prohibits "carrying over" or creation of valuation allowances in
the initial accounting for loans acquired in a transfer that are within its
scope. The prohibition of the valuation allowance carryover applies to the
purchase of an individual loan, a pool of loans, a group of loans, and
loans acquired in a purchase business combination.
This SOP is effective for loans acquired in fiscal years beginning after
December 15, 2004. In management's opinion, the adoption of this
pronouncement will not have a material impact on the Company's financial
position or results of operations.
32
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities at
December 31, 2004 and 2003 consisted of the following:
Available-for-Sale:
-------------------
2004
-----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
(In thousands)
Debt securities:
U.S. Treasury securities $ 5,970 $ (14) $ 5,956
Obligations of states and
political sub-divisions 3,057 $ 96 3,153
Mortgage-backed securities 7,933 13 (24) 7,922
Corporate bonds 302 4 306
------------ ------------ ------------ ------------
$ 17,262 $ 113 $ (38) 17,337
============ ============ ============ ============
Net unrealized gains on available-for-sale investment securities totaling
$75,000 were recorded, net of $30,000 in tax expense, as accumulated other
comprehensive income within shareholders' equity at December 31, 2004.
There were no proceeds or gross realized gains from the call of
available-for-sale investment securities for the year ended December 31,
2004.
2003
-----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
(In thousands)
Debt securities:
U.S. Treasury securities $ 2,517 $ 2 $ 2,519
U.S. Government agencies 500 8 508
Obligations of states and
political sub-divisions 5,295 61 $ (64) 5,292
Mortgage-backed securities 1,697 68 (5) 1,760
Corporate bonds 1,221 31 1,252
------------ ------------ ------------ ------------
$ 11,230 $ 170 $ (69) $ 11,331
============ ============ ============ ============
Net unrealized gains on available-for-sale investment securities totaling
$101,000 were recorded, net of $36,000 in tax liabilities, as accumulated
other comprehensive income within shareholders' equity at December 31,
2003. Proceeds and gross realized gains from the call of available-for-sale
investment securities for the year ended December 31, 2003 totaled $996,000
and $2,000, respectively. Proceeds, gross realized gains and gross realized
losses from the sale of available-for-sale investment securities for the
year ended December 31, 2002 totaled $1,978,000, $32,000 and $(3,000),
respectively.
33
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. INVESTMENT SECURITIES (Continued)
Held-to-Maturity:
-----------------
2004
-----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
(In thousands)
Debt securities:
Mortgage-backed securities $ 145 $ 1 $ -- $ 146
============ ============ ============ ============
2003
-----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
(In thousands)
Debt securities:
Mortgage-backed securities $ 181 $ -- $ (10) $ 171
============ ============ ============ ============
There were no sales or transfers of held-to-maturity investment securities
during the years ended December 31, 2004, 2003 and 2002.
At December 31, 2004, the Company held 36 investment securities of which 10
were in a loss position for less than twelve months as follows:
Less than 12 Months
-------------------------
Fair Unrealized
Value Losses
---------- ----------
(In thousands)
Debt securities:
U.S. Treasury securities $ 5,956 $ (14)
Mortgage-backed securities 1,647 (24)
---------- ----------
$ 7,603 $ (38)
========== ==========
No investment securities held at December 31, 2004 had been in a loss
position for greater than twelve months. Management periodically evaluates
each investment security for other than temporary impairment, relying
primarily on industry analyst reports, observation of market conditions and
interest rate fluctuations. Management believes it will be able to collect
all amounts due according to the contractual terms of the underlying
investment securities and that the noted decline in fair value is
considered temporary and due only to interest rate fluctuations.
34
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. INVESTMENT SECURITIES (Continued)
Held-to-Maturity: (Continued)
The amortized cost and estimated fair value of investment securities at
December 31, 2004 by contractual maturity are shown below. Expected
maturities will differ from contractual maturities because the issuers of
the securities may have the right to call or prepay obligations with or
without call or prepayment penalties.
Available-for-Sale Held-to-Maturity
----------------------- ------------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- ---------- ---------- ----------
(In thousands)
Within one year $ 5,275 $ 5,269
After one year through five
years 1,881 1,895
After ten years 2,173 2,251 $ 145 $ 146
---------- ---------- ---------- ----------
9,329 9,415 145 146
Investment securities not
due at a single maturity
date:
Mortgage-backed securities 7,933 7,922
---------- ---------- ---------- ----------
$ 17,262 $ 17,337 $ 145 $ 146
========== ========== ========== ==========
Investment securities with amortized costs totaling $4,848,000 and
$3,994,000 and estimated market values totaling $4,902,000 and $3,958,000
were pledged to secure treasury tax and loan accounts and public deposits
at December 31, 2004 and 2003, respectively. Certain other investment
securities are pledged to secure borrowings with the Federal Reserve Bank
and the Federal Home Loan Bank (see Note 7).
4. LOANS
Outstanding loans are summarized below:
December 31,
--------------------------
2004 2003
----------- -----------
(In thousands)
Commercial $ 40,562 $ 46,783
Agricultural 15,007 10,855
Real estate - commercial mortgage 109,895 60,174
Real estate - construction 22,965 28,219
Installment 13,121 10,823
----------- -----------
201,550 156,854
Deferred loan origination costs, net 199 284
Allowance for loan losses (2,214) (1,653)
----------- -----------
$ 199,535 $ 155,485
=========== ===========
35
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4. LOANS (Continued)
Changes in the allowance for loan losses were as follows:
Year Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
(In thousands)
Balance, beginning of year $ 1,653 $ 1,307 $ 1,172
Provision charged to operations 504 536 286
Losses charged to allowance (9) (195) (199)
Recoveries 66 5 48
---------- ---------- ----------
Balance, end of year $ 2,214 $ 1,653 $ 1,307
========== ========== ==========
There were no loans considered impaired at December 31, 2004 and 2003. The
average recorded investment in impaired loans for the year ended December
31, 2004, 2003 and 2002 was $0, $67,000 and $293,000, respectively. The
Company did not recognize any interest income on impaired loans during
2004, 2003 and 2002.
There were no nonaccrual loans and no interest foregone on nonaccrual loans
at December 31, 2004 and 2003. Interest foregone on nonaccrual loans
totaled approximately $72,000 for the year ended December 31, 2002.
Salaries and employee benefits totaling $208,000, $223,000 and $555,000,
have been deferred as loan origination costs for the years ended December
31, 2004, 2003 and 2002, respectively.
5. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
December 31,
------------------------
2004 2003
---------- ----------
(In thousands)
Land $ 3,307 $ 3,009
Buildings and improvements 4,790 3,669
Furniture, fixtures and equipment 4,404 3,660
Leasehold improvements 1,184 1,184
Construction in progress 5 647
---------- ----------
13,690 12,169
Less accumulated depreciation
and amortization (3,942) (3,413)
---------- ----------
$ 9,748 $ 8,756
========== ==========
Depreciation and amortization included in occupancy, furniture and
equipment expense totaled $529,000, $495,000 and $471,000 for the years
ended December 31, 2004, 2003 and 2002, respectively.
36
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
6. INTEREST-BEARING DEPOSITS
Interest-bearing deposits consisted of the following:
December 31,
-----------------------
2004 2003
---------- ----------
(In thousands)
Savings $ 7,041 $ 5,702
Money market 78,124 36,288
NOW accounts 15,880 15,998
Time, $100,000 or more 41,001 44,793
Other time 29,735 33,111
---------- ----------
$ 171,781 $ 135,892
========== ==========
Aggregate annual maturities of time deposits are as follows (in thousands):
Year Ending
December 31,
2005 $ 59,803
2006 9,338
2007 445
2008 103
2009 1,047
----------
$ 70,736
==========
Interest expense recognized on interest-bearing deposits consisted of the
following:
Year Ended December 31,
------------------------------------
2004 2003 2002
---------- ---------- ----------
(In thousands)
Savings $ 20 $ 14 $ 14
Money market 805 350 653
NOW accounts 139 53 45
Time, $100,000 or more 899 1,052 991
Other time 701 924 1,093
---------- ---------- ----------
$ 2,564 $ 2,393 $ 2,796
========== ========== ==========
7. OTHER BORROWINGS
The Company has unsecured short-term borrowing arrangements totaling
$5,000,000 with two of its correspondent banks. There were no borrowings
outstanding under these arrangements at December 31, 2004 and 2003.
Additionally, the Company has a borrowing arrangement with the Federal
Reserve Bank secured by investment securities with amortized costs totaling
$3,835,000 and $2,197,000 and estimated fair values totaling $3,832,000 and
$2,267,000 at December 31, 2004 and 2003, respectively. At December 31,
2004 and 2003, the Company had no outstanding borrowings under this
arrangement.
37
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
7. OTHER BORROWINGS (Continued)
The Company has a borrowing arrangement with the Federal Home Loan Bank of
San Francisco (FHLB) which allow the Company to borrow on either a
short-term or long-term basis up to approximately $5,091,000 as of December
31, 2004 based on specific percentages of the collateral pledged. For the
years ended December 31, 2004 and 2003, various residential mortgage loans
totaling approximately $8,388,000 and $7,401,000 and investment securities
totaling approximately $11,768,000 and $4,000,000, respectively, secured
this borrowing arrangement. The following table represents the Company's
total other borrowings for the periods indicated:
December 31,
-----------------------
2004 2003
---------- ----------
(In thousands)
FHLB short-term borrowings, interest at 1.47%,
matured December 9, 2004 $ 1,000
FHLB long-term borrowings, interest at 2.29%,
matures December 9, 2005 $ 4,000 4,000
---------- ----------
Total other borrowings $ 4,000 $ 5,000
========== ==========
8. SUBORDINATED DEBENTURES
The following is a summary of the notes payable to the Company's subsidiary
grantor trusts at December 31, 2004 and 2003 (dollars in thousands):
December 31,
-----------------------
2004 2003
---------- ----------
Subordinated debentures due to Pacific
State Statutory Trust I with interest
payable semi-annually based on 6-month
LIBOR plus 3.45% to a maximum of 11.95%
prior to June 26, 2007 (5.39% at December
31, 2004), and redeemable under certain
conditions with a premium prior to
June 26, 2007 and with no premium
beginning June 26, 2007 and due June 26,
2031 $ 5,155 $ 5,155
Subordinated debentures due to Pacific State
Statutory Trust II with interest payable
quarterly based on 3-month LIBOR plus 2.79%
(4.39% at December 31, 2004), and redeemable
with no premium beginning March 17, 2009
and due March 17, 2034 3,609
---------- ----------
$ 8,764 $ 5,155
========== ==========
Under applicable regulatory guidance, the amount of trust preferred
securities that is eligible as Tier 1 capital is limited to twenty-five
percent of the Company's Tier 1 capital on a pro forma basis. At December
31, 2004, $5,535,000 of the trust preferred securities qualified as Tier 1
capital and $3,229,000 qualified as Tier 2 capital.
38
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8. SUBORDINATED DEBENTURES (Continued)
The Company has guaranteed, on a subordinated basis, distributions and
other payments due on the trust preferred securities issued by the
subsidiary grantor trusts. Interest expense recognized by the Company for
the years ended December 31, 2004, 2003 and 2002 related to the
subordinated debentures was $366,000, $239,000 and $141,000, respectively.
The amount of deferred costs was $151,000 at December 31, 2004.
9. INCOME TAXES
The provision for income taxes for the years ended December 31, 2004, 2003
and 2002 consisted of the following:
Federal State Total
---------- ---------- ----------
(In thousands)
2004
----
Current $ 1,534 $ 570 $ 2,104
Deferred (157) (73) (230)
---------- ---------- ----------
Provision for income taxes $ 1,377 $ 497 $ 1,874
========== ========== ==========
2003
----
Current $ 1,159 $ 350 $ 1,509
Deferred (211) (51) (262)
---------- ---------- ----------
Provision for income taxes $ 948 $ 299 $ 1,247
========== ========== ==========
2002
----
Current $ 698 $ 123 $ 821
Deferred (175) (16) (191)
---------- ---------- ----------
Provision for Income taxes $ 523 $ 107 $ 630
========== ========== ==========
Deferred tax assets (liabilities) consisted of the following:
December 31,
------------------------
2004 2003
---------- ----------
(In thousands)
Deferred tax assets:
Allowance for loan losses $ 872 $ 652
Premises and equipment 129
Future benefit of State tax deduction 215 122
Organization costs 21 21
Deposit purchase premium 36 72
Mark-to-market adjustment 11 45
Deferred compensation 150
---------- ----------
Total deferred tax assets 1,305 1,041
---------- ----------
39
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. INCOME TAXES (Continued)
Deferred tax liabilities:
Future federal liability of state
deferred tax asset $ (88) $ (63)
Bank premises and equipment (29)
Goodwill (7) (34)
Unrealized gain on available-for-
sale investment securities (30) (36)
Other accruals (7)
---------- ----------
Total deferred tax liabilities (161) (133)
---------- ----------
Net deferred tax assets $ 1,144 $ 908
========== ==========
The Company believes that it is more likely than not that it will realize
the above deferred tax assets in future periods; therefore, no valuation
allowance has been provided against its deferred tax assets.
The provision for income taxes differs from amounts computed by applying
the statutory Federal income tax rates to operating income before income
taxes. The significant items comprising these differences for the years
ended December 31, 2004, 2003 and 2002 consisted of the following:
2004 2003 2002
---------- ---------- ----------
Federal income tax, at statutory rate 34.0% 34.0% 34.0%
State franchise tax, net of Federal tax effect 7.2% 6.0% 5.4%
Tax exempt investment security income, net (1.1)% (1.9)% (4.1)%
Company owned life insurance, net (1.5)%
Other 1.0% (0.3)% (0.2)%
---------- ---------- ----------
Effective tax rate 39.6% 37.8% 35.1%
========== ========== ==========
10. COMMITMENTS AND CONTINGENCIES
Leases
------
The Company leases branch offices and certain equipment under
non-cancelable operating leases. The leases expire on various dates through
2009 and have various renewal options ranging from five to ten years.
40
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. COMMITMENTS AND CONTINGENCIES (Continued)
Leases (Continued)
------
Future minimum lease payments are as follows (in thousands):
Year Ending
December 31,
------------
2005 $ 246
2006 241
2007 243
2008 246
2009 81
-----------
$ 1,057
===========
Rental expense included in occupancy, furniture and equipment expense
totaled $236,000, $267,000 and $273,000 for the years ended December 31,
2004, 2003 and 2002, respectively.
Federal Reserve Requirements
----------------------------
Banks are required to maintain a combination of reserves with the Federal
Reserve Bank and vault cash equal to a percentage of their reservable
deposits. The reserve balances held with the Federal Reserve Bank or in the
form of vault cash totaled $1,364,000 and $1,160,000 as of December 31,
2004 and 2003, respectively.
Correspondent Banking Agreements
--------------------------------
The Company maintains funds on deposit with other federally insured
financial institutions under correspondent banking agreements. Uninsured
deposits totaled $9,142,000 at December 31, 2004.
Financial Instruments With Off-Balance-Sheet Risk
-------------------------------------------------
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business in order to meet the financing needs of
its customers and to reduce its own exposure to fluctuations in interest
rates. These financial instruments consist of commitments to extend credit
and standby letters of credit. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized on the balance sheet.
The Company's exposure to credit loss in the event of nonperformance by the
other party for commitments to extend credit and standby letters of credit
is represented by the contractual amount of those instruments. The Company
uses the same credit policies in making commitments and standby letters of
credit as it does for loans included on the balance sheet.
The following financial instruments represent off-balance-sheet credit
risk:
December 31,
-----------------------
2004 2003
---------- ----------
(In thousands)
Commitments to extend credit $ 41,868 $ 42,536
Standby letters of credit $ 498 $ 837
41
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. COMMITMENTS AND CONTINGENCIES (Continued)
Financial Instruments With Off-Balance-Sheet Risk (Continued)
-------------------------------------------------
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since some of the commitments are
expected to expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The Company
evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation of the
borrower. Collateral held varies, but may include accounts receivable,
inventory, equipment, income-producing commercial properties and
residential real estate.
Standby letters of credit are conditional commitments issued by the Company
to guarantee the performance or financial obligation of a customer to a
third party. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loans to customers. The
fair value of the liability related to these standby letters of credit,
which represents the fees received for issuing the guarantees, was not
significant at December 31, 2004 and 2003. The Company recognizes these
fees as revenue over the term of the commitment or when the commitment is
used.
At December 31, 2004, commercial loan commitments represent approximately
48% of total commitments and are generally secured by various assets of the
borrower. Real estate loan commitments represent approximately 44% of total
commitments and are generally secured by property with a loan-to-value
ratio not to exceed 75% to 80%. Consumer loan commitments represent the
remaining 8% of total commitments and are generally unsecured. In addition,
the majority of the Company's commitments have variable interest rates.
Concentrations of Credit Risk
-----------------------------
The Company's customers are primarily located in San Joaquin, Stanislaus,
Calaveras and Tuolumne Counties. Approximately 20% of the Company's loans
are for general commercial uses, including professional, retail and small
business, and 7% are for agricultural uses. Additionally, 11% of the
Company's loans are for the construction of residential and commercial real
estate and 55% are loans which are collateralized by mortgages on
residential and commercial real estate. Generally, real estate loans are
secured by real property while commercial and other loans are secured by
funds on deposit and business or personal assets. The remaining 7% of the
Company's loans are consumer installment loans. Repayment is generally
expected from the proceeds of property sales and permanent financing for
real estate construction loans and borrower cash flows for other loans.
Contingencies
-------------
The Company is subject to legal proceedings and claims which arise in the
ordinary course of business. In the opinion of management, the amount of
ultimate liability with respect to such actions will not materially affect
the consolidated financial position or consolidated results of operations
of the Company.
42
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11. SHAREHOLDERS' EQUITY
Dividends
---------
The Company's ability to pay cash dividends is dependent on dividends paid
to it by the Bank and limited by California corporation law. Under
California law, the holders of common stock of the Company are entitled to
receive dividends when and as declared by the Board of Directors, out of
funds legally available, subject to certain restrictions. The California
general corporation law prohibits the Company from paying dividends on its
common stock unless: (i) its retained earnings, immediately prior to the
dividend payment, equals or exceeds the amount of the dividend or (ii)
immediately after giving effect to the dividend, the sum of the Company's
assets (exclusive of goodwill and deferred charges) would be at least equal
to 125% of its liabilities (not including deferred taxes, deferred income
and other deferred liabilities) and the current assets of the Company would
be at least equal to its current liabilities, or, if the average of its
earnings before taxes on income and before interest expense for the two
preceding fiscal years was less than the average of its interest expense
for the two preceding fiscal years, at least equal to 125% of its current
liabilities.
Upon declaration by the Board of Directors of the Company, all shareholders
of record will be entitled to receive dividends. A significant source of
cash for the Company is dividends from the Bank. The California Financial
Code restricts the total dividend payment of any bank in any calendar year
to the lesser of (1) the bank's retained earnings or (2) the bank's net
income for its last three fiscal years, less distributions made to
shareholders during the same three-year period. As a member of the Federal
Reserve System, the Bank is also subject to similar restrictions imposed by
Federal law. At December 31, 2004, Bank retained earnings of $6,281,000
were free of such restrictions and available for dividend payments to
Bancorp.
Earnings Per Share
------------------
A reconciliation of the numerators and denominators of the basic and
diluted earnings per share computations is as follows:
Year Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
(In thousands, except share and
per share amounts)
Basic Earnings Per Share
Numerator:
Net income $ 3,169 $ 2,053 $ 1,163
Denominator:
Weighted average shares outstanding 3,432,023 3,362,076 3,226,184
------------ ------------ ------------
Basic earnings per share $ 0.92 $ 0.61 $ 0.36
============ ============ ============
Diluted Earnings Per Share
Numerator:
Net income $ 3,169 $ 2,053 $ 1,163
Denominator:
Weighted average shares outstanding 3,432,023 3,362,076 3,226,184
Effect of dilutive stock options 341,150 119,694 165,288
------------ ------------ ------------
3,773,173 3,481,770 3,391,472
------------ ------------ ------------
Diluted earnings per share $ 0.84 $ 0.59 $ 0.34
============ ============ ============
43
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11. SHAREHOLDERS' EQUITY (Continued)
Earnings Per Share (Continued)
------------------
All of the stock options outstanding were included in the computation of
diluted earnings per share for the years ended December 31, 2004, 2003 and
2002 as none of the stock options were antidilutive.
Stock Options
-------------
At December 31, 2004, the Company has two stock-based employee compensation
plans, the Pacific State Bancorp 1987 Stock Option Plan and the Pacific
State Bancorp 1997 Stock Option Plan. At December 31, 2004, 1,904 shares of
common stock remain reserved under the 1997 plan for issuance to employees
and directors through incentive and nonstatutory agreements. Outstanding
options under the 1987 Plan are exercisable until their expiration;
however, no new options will be granted under that plan. The plans require
that the option price may not be less than the fair market value of the
stock at the date the option is granted, and that the stock must be paid in
full at the time the option is exercised. The options under the plans
expire on dates determined by the Board of Directors, but not later than
ten years from the date of grant. The vesting period is determined by the
Board of Directors and is generally over five years.
A summary of the activity within the plans adjusted to give effect to stock
splits follows:
2004 2003 2002
-------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- ----------- ----------- ----------- ----------- -----------
Incentive Agreements
Options outstanding,
beginning of year 587,696 $ 5.90 340,120 $ 2.52 272,120 $ 1.88
Options granted - 387,500 $ 7.50 118,000 $ 3.75
Options exercised (58,886) $ 2.96 (95,724) $ 1.61 (46,000) $ 1.80
Options canceled - (44,200) $ 3.15 (4,000) $ 3.75
----------- ----------- -----------
Options outstanding,
end of year 528,810 $ 6.23 587,696 $ 5.90 340,120 $ 2.52
=========== =========== ===========
Options exercisable,
end of year 174,648 $ 4.78 114,036 $ 2.34 175,680 $ 1.76
=========== =========== ===========
Nonstatutory Agreements
Options outstanding,
beginning of year 411,500 $ 7.31 29,076 $ 1.14 99,048 $ 1.22
Options granted - 400,000 $ 7.50
Options exercised (11,500) $ 1.00 (17,576) $ 1.25 (69,972) $ 1.25
----------- ----------- -----------
Options outstanding,
end of year 400,000 $ 7.50 411,500 $ 7.31 29,076 $ 1.14
=========== =========== ===========
Options exercisable,
end of year 80,000 $ 7.50 11,500 $ 1.00 23,180 $ 1.13
=========== =========== ===========
44
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11. SHAREHOLDERS' EQUITY (Continued)
Stock Options (Continued)
-------------
A summary of options outstanding at December 31, 2004 follows:
Number of Weighted Number of
Options Average Options
Outstanding Remaining Exercisable
December 31, Contractual December 31,
Range of Exercise Prices 2004 Life 2004
------------------------ ------------ ------------ -----------
Incentive
---------
$ 2.13 14,000 2.0 years 14,000
$ 2.22 23,400 2.5 years 23,400
$ 1.27 1,000 3.3 years 1,000
$ 2.19 4,000 3.7 years 4,000
$ 2.20 22,400 5.0 years 17,920
$ 2.59 12,560 5.6 years 10,048
$ 3.75 59,950 7.0 years 23,980
$ 3.73 10,000 7.2 years 4,000
$ 7.50 381,500 8.8 years 76,300
------------ -----------
528,810 174,648
============ ===========
Nonstatutory
------------
$ 7.50 400,000 8.8 years 80,000
============ ===========
Regulatory Capital
------------------
The Company and the Bank are subject to certain regulatory capital
requirements administered by the Board of Governors of the Federal Reserve
System and the Federal Deposit Insurance Corporation (FDIC). Failure to
meet these minimum capital requirements can initiate certain mandatory, and
possibly additional discretionary, actions by regulators that, if
undertaken, could have a direct material effect on the Company's
consolidated financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of their
assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's and the Bank's capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of
total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to
average assets as set forth on the following table. Each of these
components is defined in the regulations. Management believes that the
Company and the Bank met all their capital adequacy requirements as of
December 31, 2004 and 2003.
45
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11. SHAREHOLDERS' EQUITY (Continued)
Regulatory Capital (Continued)
------------------
In addition, the most recent notification from the FDIC categorized the
Bank as well capitalized under the regulatory framework for prompt
correction action. To be considered well capitalized, the Bank must
maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage
ratios as set forth below. There are no conditions or events since December
31, 2004 that management believes have changed the Bank's category.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------- ------------------- -------------------
Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
December 31, 2004
-----------------
Company:
Total capital (to risk-
weighted assets) $ 26,704 12.6% $ 16,875 8.0% N/A N/A
Tier 1 capital (to risk-
weighted assets) $ 21,262 10.1% $ 8,437 4.0% N/A N/A
Tier 1 capital (to average
assets) $ 21,262 8.3% $ 10,245 4.0% N/A N/A
Bank:
Total capital (to risk-
weighted assets) $ 25,655 12.2% $ 16,809 8.0% $ 21,012 10.0%
Tier 1 capital (to risk-
weighted assets) $ 23,315 11.1% $ 8,405 4.0% $ 12,607 6.0%
Tier 1 capital (to average
assets) $ 23,315 9.1% $ 10,242 4.0% $ 12,802 5.0%
December 31, 2003
-----------------
Company:
Total capital (to risk-
weighted assets) $ 19,125 11.6% $ 13,239 8.0% N/A N/A
Tier 1 capital (to risk-
weighted assets) $ 16,782 10.1% $ 6,619 4.0% N/A N/A
Tier 1 capital (to average
assets) $ 16,782 8.3% $ 8,129 4.0% N/A N/A
Bank:
Total capital (to risk-
weighted assets) $ 18,273 11.1% $ 13,179 8.0% $ 16,474 10.0%
Tier 1 capital (to risk-
weighted assets) $ 16,620 10.1% $ 6,589 4.0% $ 9,884 6.0%
Tier 1 capital (to average
assets) $ 16,620 8.2% $ 8,129 4.0% $ 10,161 5.0%
46
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12. OTHER EXPENSES
Other expenses consisted of the following:
Year Ended December 31,
------------------------------------
2004 2003 2002
---------- ---------- ----------
(In thousands)
Professional fees $ 316 $ 480 $ 484
Appraisal fees 253 32 70
Directors fees 190 177 126
Postage, stationery and supplies 159 212 186
Telephone 152 157 151
Data processing 102 19 5
Advertising and promotion 74 98 120
Other operating expenses 1,151 1,079 993
---------- ---------- ----------
$ 2,397 $ 2,254 $ 2,135
========== ========== ==========
13. LOANS TO RELATED PARTIES
During the normal course of business, the Company enters into loans with
related parties, including executive officers and directors. These loans
are made with substantially the same terms, including rates and collateral,
as loans to unrelated parties. The following is a summary of the aggregate
activity involving related party borrowers (in thousands):
Balance, January 1, 2004 $ 2,885
Disbursements 2,475
Amounts repaid (2,378)
----------
Balance, December 31, 2004 $ 2,982
==========
Undisbursed commitments to related
parties, December 31, 2004 $ 1,491
==========
14. EMPLOYEE BENEFIT PLANS
The 401(k) Savings Plan established by the Bank in 1990 was converted into
a Company plan in 1992. Under the provisions of the plan, the Company
matches one-half of the employees' contributions up to a maximum of three
percent of an employee's annual salary. All employees who are at least 21
years of age and have completed one year of service are eligible under the
plan. The Company's contributions vest at a rate of 20% after one year of
service and an additional 20% for each year thereafter. Contributions to
the plan totaled $45,000, $41,000 and $42,000 for the years ended December
31, 2004, 2003 and 2002, respectively.
47
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
14. EMPLOYEE BENEFIT PLANS (Continued)
Salary Continuation and Retirement Plans
----------------------------------------
The Board of Directors approved salary continuation and retirement plans
for six key executives in 2003. Under these plans, the executives will
receive monthly payments for twenty years after retirement. These benefits
are substantially equivalent to those available under split-dollar life
insurance policies purchased by the Company on the lives of the executives.
In addition, the estimated present value of these future benefits is
accrued over the period from the effective dates of the plans until the
participants' expected retirement dates. The expense and related accrued
liability recognized under these plans for the year ended December 31, 2004
is $334,000.
In connection with these plans, the Company purchased single premium life
insurance policies with cash surrender values totaling $4,246,000 at
December 31, 2004. Income earned on these policies, net of expenses,
totaled $188,000 and $58,000 for the years ended December 31, 2004 and
2003, respectively. Income earned on these policies is not subject to
Federal or state income tax under certain circumstances.
15. COMPREHENSIVE INCOME
Comprehensive income is a more inclusive financial reporting methodology
that includes disclosure of other comprehensive income that historically
has not been recognized in the calculation of net income. The Company's
only source of other comprehensive income (loss) is unrealized gains and
losses on the Company's available-for-sale investment securities. Total
comprehensive income and the components of accumulated other comprehensive
income (loss) are presented in the consolidated statement of changes in
shareholders' equity.
At December 31, 2004, 2003 and 2002, the Company held securities classified
as available-for-sale which had net unrealized gains or losses as follows:
2004 2003 2002
---------- ---------- ----------
(In thousands)
Other comprehensive income:
Unrealized holding (losses) gains $ (26) $ 102 $ 115
Tax benefit (expense) on unrealized
holding gains 6 (36) (41)
---------- ---------- ----------
Net unrealized holding (losses) gains (20) 66 74
---------- ---------- ----------
Less: reclassification adjustment for gains
included in net income - 2 29
Tax benefit on reclassification adjustment - (1) (10)
---------- ---------- ----------
Net reclassification adjustment - 1 19
---------- ---------- ----------
Total other comprehensive income $ (20) $ 65 $ 55
========== ========== ==========
48
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Disclosures include estimated fair values for financial instruments for
which it is practicable to estimate fair value. These estimates are made at
a specific point in time based on relevant market data and information
about the financial instruments. These estimates do not reflect any premium
or discount that could result from offering the Company's entire holdings
of a particular financial instrument for sale at one time, nor do they
attempt to estimate the value of anticipated future business related to the
instruments. In addition, the tax ramifications related to the realization
of unrealized gains and losses can have a significant effect on fair value
estimates and have not been considered in any of these estimates.
Because no market exists for a significant portion of the Company's
financial instruments, fair value estimates are based on judgments
regarding current economic conditions, risk characteristics of various
financial instruments and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions could
significantly affect the fair values presented.
The following methods and assumptions were used by management to estimate
the fair value of the Company's financial instruments at December 31, 2004
and 2003:
Cash and cash equivalents: For cash and cash equivalents, the carrying
amount is estimated to be fair value.
Interest-bearing deposits in banks: The fair values of interest-bearing
deposits in banks are estimated using discounted cash flow analysis, using
interest rates available at the reporting date for similar deposits.
Investment securities: For investment securities, fair values are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are estimated using quoted market prices for similar
securities and indications of value provided by brokers.
Loans: For variable-rate loans that reprice frequently with no significant
change in credit risk, fair values are based on carrying values. The fair
values for the remaining loans are estimated using discounted cash flow
analyses, using interest rates being offered at each reporting date for
loans with similar terms to borrowers of comparable creditworthiness
adjusted for the allowance for loan losses. The carrying amount of accrued
interest receivable approximates its fair value.
Company owned life insurance: The fair values of life insurance policies
are based on current cash surrender values at each reporting date provided
by the insurers.
Other investments: Other investments include Federal Reserve Bank Stock,
Federal Home Loan Bank Stock and Farmer Mac Home Administrative Stock. The
carrying value of other investments approximate fair value. These
investments are carried at cost and are redeemable at par with certain
restrictions.
Deposits: The fair values for demand deposits are, by definition, equal to
the amount payable on demand at the reporting date represented by their
carrying amount. Fair values for fixed-rate certificates of deposit are
estimated using a discounted cash flow analysis using interest rates
offered at each reporting date by the Company for certificates with similar
remaining maturities.
Other borrowings: The carrying amount of short-term borrowings and interest
payable approximates their fair value. The fair value of long-term debt is
estimated using a discounted cash flow analysis using interest rates
currently available to the Company for similar debt instruments.
49
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Subordinated debentures: The fair value of subordinated debentures was
determined based on the current market value for like-kind instruments of
similar rates and terms.
Commitments to extend credit: Off-balance-sheet commitments to extend
credit are primarily for variable rate loans. For these commitments, there
is no difference between the committed amounts and their fair values.
Commitments to fund fixed rate loans and standby letters of credit are at
rates which approximate fair value at each reporting date.
December 31, 2004 December 31, 2003
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ---------- ---------- ----------
(In thousands)
Financial assets:
Cash and due from banks $ 12,108 $ 12,108 $ 5,317 $ 5,317
Federal funds sold 7,456 7,456
Interest-bearing deposits
in banks 6,100 6,100 4,000 4,000
Investment securities 17,482 17,482 11,512 11,501
Loans, net 199,535 199,574 155,485 155,811
Company owned life
insurance 4,246 4,246 4,058 4,058
Accrued interest receivable 1,249 1,249 1,068 1,068
Other investments 1,000 1,000 595 595
Financial liabilities:
Deposits $ 223,761 $ 227,400 $ 176,292 $ 176,628
Other borrowings 4,000 4,050 5,000 5,003
Subordinated debentures 8,764 8,764 5,155 5,155
Accrued interest payable 337 337 362 362
Off-balance-sheet financial
instruments (notional amount):
Commitments to extend credit $ 41,868 $ 41,868 $ 42,536 $ 42,536
Standby letters of credit 498 498 837 837
50
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
17. PARENT ONLY CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEET
December 31, 2004 and 2003
(In thousands)
2004 2003
---------- ----------
ASSETS
Cash and cash equivalents $ 7 $ 15
Investment in bank subsidiary 24,370 17,762
Investment in Pacific State Statutory
Trust I and II 264 155
Investment in other securities 204 204
Other assets 769 498
---------- ----------
Total assets $ 25,614 $ 18,634
========== ==========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Liabilities:
Subordinated debentures $ 8,764 $ 5,155
Other liabilities 20 21
---------- ----------
Total liabilities 8,784 5,176
---------- ----------
Shareholders' equity:
Common stock 7,159 6,937
Retained earnings 9,626 6,457
Accumulated other comprehensive income,
net of taxes 45 65
---------- ----------
Total shareholders' equity 16,830 13,459
---------- ----------
Total liabilities and shareholders'
equity $ 25,614 $ 18,635
========== ==========
The Company commenced operation on June 24, 2002. As a result, comparative
financial information for each of the years in the three-year period ended
December 31, 2004 is not available. The information below is presented as
if the reorganization had taken place on January 1, 2002.
51
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
17. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF INCOME
For the Years Ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---------- ---------- ----------
Income:
Dividends declared by bank subsidiary $ 395 $ 350 $ 123
Interest on investment securities 5 4 2
Earnings from investment in Pacific
State Statutory Trust I 8 4
---------- ---------- ----------
Total income 400 362 129
---------- ---------- ----------
Expenses:
Interest on subordinated debentures 366 239 141
Salaries and employee benefits 70 68 43
Professional 60 61 77
Other expenses 92 64 7
---------- ---------- ----------
Total expenses 588 432 268
---------- ---------- ----------
Loss before equity in undistributed
income of subsidiary (188) (70) (139)
Equity in undistributed income of subsidiary 3,135 1,950 1,212
---------- ---------- ----------
Income before income tax benefit 2,947 1,880 1,073
Income tax benefit (222) (173) (90)
---------- ---------- ----------
Net income $ 3,169 $ 2,053 $ 1,163
========== ========== ==========
52
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
18. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF CASH FLOWS
For the Years Ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 3,169 $ 2,053 $ 1,163
Adjustments to reconcile net income to net
cash used in operating activities:
Undistributed net income of subsidiary (3,135) (1,950) (1,212)
Increase in other assets (224) (184) (299)
(Decrease) increase in other liabilities (1) 18 2
---------- ---------- ----------
Net cash used in operating activities (191) (63) (346)
---------- ---------- ----------
Cash flows from investing activities:
Investment in bank subsidiary (3,500) (4,543)
Investment in Pacific State Statutory
Trust I (159)
Investment in Pacific State Statutory
Trust II (109)
Investment in other securities (205)
---------- ---------- ----------
Net cash used in investing activities (3,609) (4,907)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of junior
subordinated debentures 3,609 5,155
Proceeds from exercise of stock options 183 176 170
Repurchase of common stock (170)
---------- ---------- ----------
Net cash provided by financing
activities 3,792 6 5,325
---------- ---------- ----------
(Decrease) increase in cash and cash
equivalents (8) (57) 72
Cash and cash equivalents at beginning
of year 15 72
---------- ---------- ----------
Cash and cash equivalents at end of year $ 7 $ 15 $ 72
========== ========== ==========
Non-cash investing activities:
Net change in unrealized (loss) gain on
available-for-sale investment securities $ (26) $ 100 $ 87
Non-cash financing activities:
Tax benefit from stock options exercised $ 39
53
GENERAL DESCRIPTION OF BUSINESS
Pacific State Bancorp is a holding company with one bank subsidiary, Pacific
State Bank, (the "Bank"), and two unconsolidated subsidiary guarantor trusts,
Pacific State Statutory Trusts I and II. Pacific State Bancorp commenced
operations on June 24, 2002 when it acquired all the then issued and outstanding
shares of Pacific State Bank under a plan of reorganization approved by the
Bank's shareholders on May 9, 2002. The Bank is a California state chartered
bank. The Bank is a member of the Federal Reserve System. The Bank's primary
source of revenue is providing loans to customers who are predominately small to
middle-market businesses and middle-income individuals. Pacific State Statuatory
Trusts I and II are unconsolidated, wholly owned statutory business trusts
formed in June 2002 and March 2004, respectively for the exclusive purpose of
issuing and selling trust preferred securities.
The Bank has engaged since November 2, 1987 in a general commercial banking
business, primarily in Stockton and San Joaquin County, and offers commercial
banking services to residents and employers of businesses in the Bank's service
area, including professional firms and small to medium sized retail and
wholesale businesses and manufacturers. The Company as of March 15, 2005 had 65
employees, including 28 officers. The Bank does not engage in any non-bank lines
of business. The business of the Bank is not to any significant degree seasonal
in nature. The Bank has no operations outside California and has no material
amount of loans or deposits concentrated among any one or few persons, groups or
industries. The Bank operates seven branches with its main office located at 6
So. El Dorado Street, in Stockton, California; additional branches are located
elsewhere in Stockton and in the communities of Angels Camp, Arnold, Groveland,
Modesto and Tracy, California. In 2004, the company opened a loan production
office in Castro Valley, California.
Business Plan
-------------
The focus of the Company's business plan is to attract "middle market"
accounts, but not to the exclusion of any other business which the Company can
reasonably and profitably attract. In order to provide a level of service to
attract such customers, the Company has structured its specific services and
charges on a basis which management believes to be profitable, taking into
consideration other aspects of the account relationship. The Company offers a
range of banking services to its customers intended to attract the following
specific types of accounts: relatively large consumer accounts; professional
group and association accounts, including the accounts of groups or firms of
physicians, dentists, attorneys and accountants; and accounts of small to
medium-sized businesses engaged in retail, wholesale, light industrial and
service activities.
Trust Subsidiaries
------------------
The Company during 2002 and 2004 established two subsidiary grantor trusts.
Pacific State Statutory Trusts I and II (the "Trusts"), for the sole purpose of
issuing capital securities ("Capital Securities") pursuant to declarations of
trust (the "Declarations"). The proceeds from the sale of the Capital Securities
were loaned to the Company as subordinated debentures (the "Debentures") issued
to the Trusts pursuant to indentures (the "Indentures"). Interest payments on
the Debentures will flow through the Trusts to the Pooling Vehicles, which are
the holders of the Capital Securities and similar securities issued by other
financial institutions. Payments of distributions by the Trusts to the Pooling
Vehicle are guaranteed by the Company. See note 8 to the Company's consolidated
financial statements.
54
Proceeds from the issuance of the 2002 subordinated debentures were used to
provide the Bank with an additional $4.5 million in capital in order to support
the continued growth of the Bank. The remaining $500,000 was placed in the
Company for general corporate purposes. Proceeds from the issuance of the 2004
subordinated debentures were used to provide the Bank with an additional $3.5
million in capital in order to support the continued growth of the Bank.
Product Lines and Services
--------------------------
The Bank currently offers the following general banking services at all of
its branches: commercial, construction and real estate loans and personal credit
lines, interest on checking, U.S. Savings bond services, domestic and foreign
drafts, banking by appointment, automatic transfer of funds between savings and
checking accounts, business courier services, checking and savings accounts for
personal and business purposes, domestic letters of credit, a depository for
MasterCard and Visa drafts, federal depository services, cash management
assistance, wire and telephone transfers, Individual Retirement Accounts, time
certificates of deposit, courier service for non-cash deposits, Visa and
MasterCard, revolving lines of credit to consumers secured by deeds of trust on
private residences, unsecured overdraft protection credit lines attached to
checking accounts, ATM cards and MasterMoney debit cards via the Star, Cirrus,
Plus, MasterCard and Visa networks.
The Bank is not authorized to offer trust services. The Federal Reserve
Bank of San Francisco is the Company's primary correspondent relationship. The
Bank currently also has correspondent relationships with City National Bank in
Beverly Hills, California, Bank of America in San Francisco, California, First
Tennessee Bank in Memphis, Tennessee, Compass Bank in Birmingham, Alabama, Wells
Fargo Bank, San Francisco, California and Pacific Coast Bankers Bank, San
Francisco, California.
The Bank recognizes that, in order to be competitive, it must attract a
certain number of consumer accounts. Individual Retirement Accounts, Visa and
MasterCard, revolving lines of credit to consumers secured by deeds of trust on
private residences, and unsecured overdraft protection credit lines attached to
checking accounts currently offered by the Bank are designed to appeal
particularly to consumers. Moreover, participation in a large-scale ATM network
assists the Company in competing for consumer accounts.
The Bank is an approved Small Business Administration and 504 lender,
FarmerMac I and II, USDA Business and Industry, USDA Part-time Farmer Program,
FHA and VA lender and California Capital lender. The Bank is a national leader
in the underwriting of U.S. Department of Agriculture business and industry
loans, as well as a Preferred Lender for this program.
55
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Critical Accounting Policies
General
Pacific State Bancorp's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America (GAAP). The financial information contained within our consolidated
financial statements is, to a significant extent, financial information that is
based on measures of the financial effects of transactions and events that have
already occurred. A variety of factors could affect the ultimate value that is
obtained either when earning income, recognizing an expense, recovering an asset
or relieving a liability. We use historical loss factors as one factor in
determining the inherent loss that may be present in our loan portfolio. Actual
losses could differ significantly from the historical factors that we use. The
Company applies Accounting Principles Board ("APB") No. 25, "Accounting for
Stock Issued to Employees" and related interpretations to account for its stock
option plan awards. Other estimates that we use are related to the expected
useful lives of our depreciable assets. In addition, GAAP itself may change from
one previously acceptable method to another method. Although the economics of
our transactions would be the same, the timing of events that would impact our
transactions could change.
A critical accounting estimate is one that requires a company to make
assumptions about matters that are highly uncertain at the time the accounting
estimate is made and that different estimates that the company reasonably could
have used for the accounting estimate in the current period, or changes in the
accounting estimate that are reasonably likely to occur from period to period,
would have a material impact on the presentation of the company's financial
condition, changes in financial condition or results of operations.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basic principles
of accounting. (1) Statement of Financial Accountings Standards (SFAS) No. 5
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and estimable and (2) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses on impaired
loans be accrued and measured based on the differences between the value of
collateral, present value of future cash flows or values that are observable in
the secondary market and the loan balance.
Stock Based Compensation
Under APB No. 25, compensation cost for stock options is measured as the
excess, if any, of the fair market value of the Company's stock at the date of
the grant over the amount required to be paid to the Company by the optionee
upon exercising the option. Because the Company's stock option plan provides for
the issuance of options at a price of no less than the fair market value at the
date of the grant, no compensation cost is required to be recognized for the
stock option plan on the date of grant.
56
Results of Operation
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Net income for the year ended December 31, 2004, was $3,169,000
representing an increase of $1,116,000 or 54.36%, over net income of $2,053,000
for the year ended December 31, 2003. A contributing factor to the increase in
net income was an increase in net interest income of $2,095,000 and a slight
increase in non interest income of $547,000. The increase in non interest income
was due to an increase in service charges of $381,000 and an increase in other
fee income of $387,000. These increases were off set by a decrease of $219,000
in loan sales during 2004.
Return on average assets (ROA) was 1.37% and return on average common
equity (ROE) was 21.65% in 2004 compared with 1.07% and 16.86% respectively in
2003. Diluted earnings per share for 2004 and 2003 were $0.84 and $0.59,
respectively, an increase of 42.37%. The increase in earnings per share is
primarily due to the increase in net income of 54.36%.
The Company's average total assets increased to $230.8 million in 2004 or
20.50% over $191.5 million in 2003. In 2004 average earning assets increased to
$203.5 million or 18.26% over $172.0 million in 2003. Average interest bearing
liabilities increased to $166.9 million or 17.15% over $142.5 million in 2003.
The Company's total assets increased to $254.3 million or 26.58% over
$200.9 million in 2003. Total loans increased to $201.7 million over $157.1
million in 2003, an increase of $44.6 million or 28.39%. Total Deposits in 2004
grew to $223.8 million, or 26.93%, compared to $176.3 million at December 31,
2003. The increases on the balance sheet are attributable to the growth of the
bank.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Net income for the year ended December 31, 2003, was $2,053,000
representing an increase of $890,000, or 76.5%, over net income of $1,163,000
for the year ended December 31, 2002. A contributing factor to the increase in
net income was an increase in net interest income of $2,067,000 and a slight
increase in non interest income of $342,000, due to an increase in the sale of
loans.
Return on average assets (ROA) was 1.07% and return on average common
equity (ROE) was 16.86% in 2003 compared with .77% and 11.27% respectively in
2002. Diluted earnings per share for 2003 and 2002 were $.59 and $0.34,
respectively, an increase of 73.5%. The increase in earnings per share is due to
the increase in net income of 76.5%.
The Company's average total assets in 2003 increased to $191.5 million or
26.2% over $151.7 million in 2002. Average earning assets increased to $172.0
million or 26.7% over $135.8 million in 2003. Average interest bearing
liabilities increased to $142.5 million or 24.9% over $114.0 million in 2003.
The Company's total assets increased to $200.9 million or 11.4% over $180.3
million in 2003. Total loans increased to $157.1 million over $135.3 million in
2002, an increase of $21.9 million or 16.2%. Total Deposits in 2003 grew to
$176.3 million, or 11.5%, compared to $158.1 million at December 31, 2002. The
increases on the balance sheet are attributable to the growth of the bank.
57
Net Interest Income
The primary source of income for the Company is derived from net interest
income. Net interest income represents the excess of interest and fees earned on
interest-earning assets (loans, securities and federal funds sold) over the
interest paid on deposits and borrowed funds. Net interest margin is net
interest income expressed as a percentage of average earning assets.
Net interest income increased $2.1 million or 25.1% to $10.5 million in
2004 from $8.4 million in 2003 and $2.1 million or 32.9% in 2003 from $6.3
million in 2002. The average balance of total earning assets during 2004,
increased $31.4 million or 18.3% to $203.5 million from $172.1 million. Average
loan balances outstanding during 2004 increased $29.09 million or 19.16%, while
average balances of investments and federal funds sold and interest bearing
deposits in banks increased by $2.4 million or 11.6%. The average yields on
loans and investment securities in 2004 both increased by 13 basis points. The
average yield on Fed Funds sold increased 29 basis points in 2004 compared to
2003. The increase in yields is directly attributable to increases in the prime
rate during 2004. During the second half of 2004, the prime rate increased five
times from 4.00% to 5.25%. As a result, the overall yield on average earning
assets during 2004 increased 18 basis points to 6.64% from 6.46% for 2003.
Total interest expense increased $0.3 million or 10.1% to $3.1 million in
2004, from $2.8 million for 2003, compared to a decrease of $0.2 million or 6.3%
from $2.9 million for 2002. In 2004 Interest expense increased primarily because
average balances of interest-bearing liabilities increasing $24.4 million or
17.2% to $166.9 million from $142.5 million for the year ended December 31,
2003. This increase was mitigated by a slight decrease in the rates paid on
interest bearing liabilities of 11 basis points. In 2003 the average balances of
interest-bearing liabilities increased $28.4 million or 24.9% to $142.5 million
from $114.0 million for the year ended December 31, 2002 but the decrease in
interest expense as a result of declining rates more than offset the growth in
deposits.
Average certificates of deposit increased $10.0 million or 13.2% to $85.5
million in 2004 from $75.5 million in 2003. The average rate paid on
certificates of deposit during 2004 decreased 74 basis points, while the average
rate paid on all interest bearing deposits and borrowings decreased 11 basis
points to 1.83% from 1.94% for 2003.
The Company's net interest margin (net interest income divided by average
earning assets) was 5.14% in 2004, 4.85% in 2003 and 4.63% in 2002. The increase
in volume of earning assets and increase in yield on earning assets, coupled
with stable funding sources and a slight decline in rates paid resulted in an
increase of $2.1 million (25.1%) in net interest income for the year ended
December 31, 2004 compared to 2003. For 2003, For the year ended December 31,
2003 compared to 2002, the combined effect of the increase in volume of earning
assets and decrease in yield on earning assets, coupled with stable funding
sources resulted in an increase of $2.1 million (32.9%) in net interest income.
for the year ended December 31, 2003 compared to 2002. The increase in yields on
earning assets is directly attributable to increases in the prime rate during
2004. In 2004, the prime rate increased five times from 4.00% to 5.25%.
The following table sets forth the Company's daily average balance sheet,
related interest income or expense and yield or rate paid for the periods
indicated. The yield on tax-exempt securities has not been adjusted to a
tax-equivalent yield basis. Average balances are based on daily averages.
58
Average Balances, Interest Income/Expense and Yields/Rates Paid
(Dollars in thousands)
Years Ended December 31,
2004 2003 2002
---------------------------------- -------------------------------- -------------------------------
Average Interest Average Average Interest Average Average Interest Average
Balance Income / Yield/ Balance Income / Yield/ Balance Income / Yield/
Expense Rate Expense Rate Expense Rate
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Assets
Loans[1] $180,559 $12,846 7.11% $151,529 $10,578 6.98% $115,742 $8,508 7.35%
Investment Securities 15,068 535 3.55% 13,570 464 3.42% 15,838 664 4.19%
Federal Funds Sold 6,775 93 1.37% 6,952 75 1.08% 4,183 64 1.53%
Interest-bearing
Deposits in Banks 1,066 35 3.28%
Total Average Earning
Assets $203,468 $13,509 6.64% $172,051 $11,117 6.46% $135,763 $9,236 6.80%
--------- --------- --------- ---------
Cash & Due From Banks $11,579 $9,129 $9,286
Bank Premises and
Equipment 9,599 7,689 5,136
Other Assets 8,066 4,101 2,803
Less: Allowance for
loan loss (1,961) (1,476) (1,264)
--------- --------- ---------
Total Average Assets $230,751 $191,494 $151,724
========= ========= =========
Liabilities and
Shareholders Equity
Interest Bearing
Liabilities:
Interest-bearing
Demand $61,801 $945 1.53% $51,370 $403 0.78% $50,190 $698 1.39%
Savings 6,606 20 0.30% 5,473 14 0.26% 5,084 14 0.28%
Time Deposits
B/O <100k &
>100K 85,548 1,600 1.87% 75,549 1,976 2.61% 55,849 2,084 3.73%
Other Borrowings 12,958 494 3.81% 10,080 368 3.65% 2,914 151 5.18
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total Average Interest
Bearing Liabilities 166,913 $3,058 1.83% 142,472 $2,761 1.94% 114,037 $2,947 2.58%
--------- --------- ---------
Non-interest Bearing
Demand 47,969 36,436 26,381
Other Liabilities 1,233 408 985
Shareholder Equity 14,636 12,178 10,321
--------- --------- ---------
Total Average Liabilities
and Shareholders Equity $230,751 $191,494 $151,724
========= ========= =========
Net Interest Income and
Net Interest Margin $10,451 5.14% $8,356 4.85% $6,289 4.63%
========= ========= =========
1. Interest income and yields on loans includes fee income of $1,112,000,
$546,000 and $121,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. Nonaccrual loans of zero, zero and $199,000 for the years
ended December 31, 2004, 2003 and 2002 are included in the average balance
calculations above.
59
The Company's average total assets increased to $230.8 million in 2004 from
$191.5 million in 2003 and $151.7 million in 2002, representing a 20.5% increase
in 2004 over 2003 and a 26.2% increase in 2003 over 2002. Average loans
increased to $180.1 million in 2004 from $151.5 million in 2003 and $115.7
million in 2002 representing a 19.2% and 30.9% increase respectively. The
Company's average total interest bearing liabilities increased to $166.9 million
in 2004 from $142.5 million in 2003 and $114.0 million in 2002, representing a
17.1% and 25.0% increase respectively. The Company's average non-interest
bearing demand deposits increased to $48.0 million in 2004 from $36.4 million in
2003 and $26.4 million in 2002, representing a 31.6% and 38.1% increase
respectively. The growth came from the Bank's current market share. The
following table sets forth changes in interest income and expense for each major
category of earning assets and interest-bearing liabilities, and the amount of
change attributable to volume and rate changes for the periods indicated.
Changes attributable to both rate and volume have been allocated to volume
changes. The yield on tax-exempt securities has not been adjusted to a
tax-equivalent yield basis.
The following table sets forth, for the years indicated, a summary of the
changes in interest earned and interest paid resulting from changes in asset and
liability volumes and changes in rates.
Analysis of Changes in Net Interest Income
------------------------------------------
Years ended December 31,
(Dollars in thousands) 2004 over 2003 2003 over 2002
- ----------------------------------------------------------------------------------------------------------------
Average Average Average Average
Volume Rate Mix Volume Rate Mix
(1) (2) (3) Total (1) (2) (3) Total
Increase (Decrease)
In Interest Income:
- -------------------
Loans $2,027 $203 $38 $2,268 $2,631 $(428) $(133) $2,070
Investment securities 51 18 2 71 (95) (122) 7 (200)
Federal Funds sold (2) 20 18 42 (19) (12) 11
Interest-bearing Deposits
in Banks 35 35 35
Total Increase (Decrease) $2,076 $241 $75 $2,392 $2,578 $(569) $(128) $1,881
-------- -------- -------- -------- -------- -------- -------- --------
Increase (Decrease)
In Interest Expense:
Interest-bearing Demand $82 $382 $78 $542 $16 $(304) $(7) $(295)
Savings 3 3 6 1 (1) 0
Time Deposits 262 (564) (75) (377) 735 (623) (220) (108)
Other Borrowings 105 16 5 126 372 (45) (110) 217
Total Increase (Decrease) $452 $(163) $8 $297 $1,124 $(973) $(337) $(186)
-------- -------- -------- -------- -------- -------- -------- --------
Net Increase (Decrease) $ 1625 $404 $67 $2,095 $1,454 $404 $209 $2,067
======== ======== ======== ======== ======== ======== ======== ========
1. The volume change in net interest income represents the change in average
balance divided by the previous year's rate.
2. The rate change in net interest income represents the change in rate
divided by the previous year's average balance.
3. The mix change in net interest income represents the change in average
balance multiplied by the change in rate.
60
Non-interest Income
-------------------
The Company's non-interest income consists primarily of service charges on
deposit accounts, gain on sale of loans and ATM and other service fees. For the
year ended December 31, 2004, non-interest income represented 15.75% of the
Company's revenues versus 15.10% in 2003, and 15.05% in 2002.
Total non-interest income increased to $2.5 million in 2004 over $2.0
million in 2003 and $1.6 million in 2002, representing an increase of 27.7% and
21.0% respectively. The increase in 2004 is directly attributable to the 54.9%
increase in service charge income as a result of the implementation of new
overdraft protection product and an increase of 62.6% in other income which
includes a 220% increase in Bank Owned Life Insurance income as well as fees
collected from brokering mortgage loans offset by a decrease in gain on sale of
loans of 32.9%.
The following table sets forth a summary of non-interest income for the
periods indicated.
Years Ended December 31,
(Dollars in thousands)
- ----------------------------------------------------------------------------
2004 2003 2002
Non-interest Income:
Service Charges $1,075 $694 $532
Rental Income from Other Real Estate 9 15 21
Gain on Sale of Guaranteed Loans 445 664 584
Gain on Sale of Investment Securities -0- 2 29
Other Income 996 603 470
------ ------ ------
Total Non-interest Income $2,525 $1,978 $1,636
====== ====== ======
- ----------------------------------------------------------------------------
Non-interest Expense
--------------------
Non-interest expense consists of salaries and related employee benefits,
occupancy and equipment expenses, professional fees, appraisal fees, directors'
fees, postage, stationary and supplies expenses, telephone expenses, data
processing expenses, advertising and promotion expense and other operating
expenses. Non-interest expense for 2004 was $7.4 million compared to $6.5
million for 2003 and $5.8 million in 2002, representing an increase of $931,000
or 14.33% for 2004, and $652,000 or 11.15% for 2003. Increases in salaries and
benefits are indicative of the additions to staff to expand branch operations in
line with their respective growth for the year and the expense related to the
salary continuation plan approved in late December 2003. The increase in
occupancy and equipment expense is attributable to the general upgrade of
technology systems. During 2004, Data Processing expense increased $83,000 due
to the outsourcing on the Company's item processing system. The outsourcing of
the system allowed the Bank to offer additional service to its deposit customers
without purchasing additional equipment. Appraisal fees also increased during
2004 as the company assumed the expense of the appraisal prior to collecting
from the borrower. These increases were offset by a decrease in Professional
Fees. Professional Fees in prior years were primarily legal fees associated with
the collection of bad debt.
The following table sets forth a summary of non-interest expense for the periods
indicated.
61
Years Ended, December 31,
(Dollars in thousands)
- --------------------------------------------------------------------
2004 2003 2002
- --------------------------------------------------------------------
Non-interest Expense:
Salaries & Benefits $3,814 $3,068 $2,601
Occupancy & Equipment 1,218 1,176 1,110
Professional fees 316 480 484
Appraisal fees 253 32 70
Directors fees 190 177 126
Postage, stationary and supplies 159 212 186
Telephone 152 157 151
Data Processing 102 19 5
Advertising and promotion 74 98 120
Other operating expenses 1,151 1,079 993
-------- -------- --------
Total Non-Interest Expenses $7,429 $6,498 $5,846
======== ======== ========
- --------------------------------------------------------------------
Provision for Income Taxes
--------------------------
The Company's provision for income taxes includes both federal income and
state franchise taxes and reflects the application of federal and state
statutory rates to the Company's net income before taxes. The principal
difference between statutory tax rates and the Company's effective tax rate is
the benefit derived from investing in tax-exempt securities and company owned
life insurance. Increases and decreases in the provision for taxes primarily
reflect changes in the Company's net income before tax.
The following table reflects the Company's tax provision and the related
effective tax rate for the periods indicated.
Years Ended December 31,
(Dollars in thousands)
- --------------------------------------------------------------------
2004 2003 2002
- --------------------------------------------------------------------
Tax Provision $1,874 $ 1,247 $ 630
Effective Tax Rate 39.6% 37.8% 35.1%
- --------------------------------------------------------------------
Investment Securities
The Company classifies its investment securities as "held-to-maturity" or
"available-for-sale" at the time of investment purchase. Generally, all
securities are purchased with the intent and ability to hold them for long-term
investment, and the Company has both the ability and intent to hold
"held-to-maturity" investments to maturity. The Company does not engage in
trading activities.
Investment securities held-to-maturity are carried at cost adjusted for the
accretion of discounts and amortization of premiums. Securities
available-for-sale may be sold to implement the Company's asset/liability
management strategies and in response to changes in interest rates, prepayment
rates and similar factors. Securities available-for-sale are recorded at fair
value and unrealized gains or losses, net of income taxes, are reported as
accumulated other comprehensive income or loss, in a separate component of
shareholder's equity. Gain or loss on sale of investment securities is based on
the specific identification method.
62
Investment securities held-to-maturity at December 31, 2004, consisted of
mortgage-backed securities totaling $145,000 with a remaining contractual
maturity of 11 to 18 years and a weighted-average yield to maturity of 6.55%.
The following table summarizes the contractual maturities of the Company's
investment securities at their carrying value and their weighted-average yields
at December 31, 2004. The yield on tax-exempt securities has not been adjusted
to a tax-equivalent yield basis.
(Dollars in thousands)
Within One Year One to Five Years Five to Ten Years Over Ten Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
Available-for-sale securities:
US Gov't & Agencies 4,061 1.45% 1,895 2.73% 5,956 2.09%
Municipal Obligations 902 3.92% 2,251 4.81% 3,153 3.72%
Corporate and Other Bonds 306 5.99% 306 5.99%
Mortgage- backed securities 534 5.86% 1,830 4.07% 5,558 4.48% 7,922 4.21%
Total available-for-sale securities 5,269 2.01% 2,429 3.40% 1,830 4.07% 7,809 4.40% 17,337 3.38%
===== ===== ===== ===== ===== ===== ===== ===== ====== =====
Held-to-maturity Securities
Mortgage-backed securities $145 6.55% $145 6.55%
==== ===== ==== =====
The following table summarizes the carrying value of the Company's investment
securities held on the dates indicated.
Years Ended December 31,
(Dollars in thousands)
- --------------------------------------------------------------------------
2004 2003 2002
- --------------------------------------------------------------------------
Available-for-sale Securities - at
fair value:
U.S. Government & Agencies $5,956 $3,027 $2,521
Municipal Obligations $3,153 5,292 6,036
Corporate and Other Bonds $306 1,252 1,263
Mortgage- backed securities 7,922 1,760 2,061
========= ========= =========
Total available-for-sale $17,337 $11,331 $11,881
========= ========= =========
Held-to-maturity Securities - at
amortized cost:
Mortgage-backed Securities $145 $181 $292
--------- --------- ---------
- --------------------------------------------------------------------------
As of December 31, 2004, the aggregate book value of the Company's
investment in securities of a single issuer did not exceed 10% of the company's
shareholders' equity.
63
Loans and Asset Quality
-----------------------
The Company concentrates its lending activities primarily within Alameda,
Calaveras, San Joaquin, Stanislaus and Tuolumne Counties.
The Company manages its credit risk through diversification of its loan
portfolio and the application of underwriting policies and procedures and credit
monitoring practices. Although the Company has a diversified loan portfolio, a
significant portion of its borrowers' ability to repay the loans is dependent
upon the professional services and residential real estate development industry
sectors. Generally, the loans are secured by real estate or other assets and are
expected to be repaid from cash flows of the borrower or proceeds from the sale
of collateral.
The following table sets forth the amounts of loans outstanding by category
as of the dates indicated:
- --------------------------------------------------------------------------------------------------
(Dollars in thousands) As of December 31,
- --------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
Commercial and Agricultural $55,569 $57,638 $40,226 $34,079 $34,128
Real estate-construction 22,965 28,219 33,887 23,561 16,875
Real estate-commercial mortgage 109,895 60,174 53,160 36,831 29,703
Installment 13,121 10,823 7,734 3,493 2,729
Deferred Loan Fees and Costs 199 284 265 317 209
Allowance for Loan Losses (2,214) (1,653) (1,306) (1,172) (1,001)
---------- ---------- ---------- ---------- ----------
Total Net Loans $199,535 $155,485 $133,966 $97,109 $82,643
========== ========== ========== ========== ==========
- --------------------------------------------------------------------------------------------------
Net loans have increased $44.0 million or 28.3%, to $199.5 million at
December 31, 2004 over $155.4 million at December 31, 2003. Comparing 2004 to
2003 commercial and agricultural loans have decreased $2.1 million or 3.6%, real
estate construction projects have decreased $5.3 million or 18.6%, real estate
commercial loans have increased by $49.7 million or 82.6% and installment loans
have increased by $2.3 million or 21.2% over 2003. The portfolio mix has changed
in 2004 as compared with the mix of the previous year with commercial and
agricultural loans decreased to 27.8% compared to 37.1% in 2003, of total loans,
real estate construction loans decreased to 11.5% compared to 18.1% in 2003,
commercial and residential real estate loans increasing to 55.1%, compared to
38.7% and Installment loans decreased to 6.6% compared to 7.0% in 2003. The
shift in the mix reflects the changes in lending needs within the Company's
bank's service area.
The following table sets forth the maturity distribution of the Company's
commercial and agricultural loans and construction loans outstanding as of
December 31, 2004, which, based on remaining scheduled repayments of principal,
were due within the periods indicated.
(Dollars in thousands)
- ----------------------------------------------------------------------------------------------------
After One
Within One through After
Year Five Years Five Years Total
- ----------------------------------------------------------------------------------------------------
Commercial and agricultural
loans $29,222 $18,815 $7,532 $55,569
Construction Loans 17,054 5,911 -- 22,965
------- ------- ------ -------
Total $46,276 $24,726 $7,532 $78,534
======= ======= ====== =======
Loans due after one year with:
Fixed Rates $2,087 $2,428 $4,515
Variable Rates $22,639 $5,104 $27,743
------- ------ -------
- ----------------------------------------------------------------------------------------------------
64
The Company's practice is to place a loan on nonaccrual status when one of
the following events occurs:(i) Any installment of principal or interest is 90
days or more past due (unless in management's opinion the loan is well-secured
and in the process of collection), (ii) management determines the ultimate
collection of principal or interest to be unlikely or iii) the terms of the loan
have been renegotiated due to a serious weakening of the borrower's financial
condition. Nonperforming loans are loans that are on nonaccrual, are 90 days
past due and still accruing or have been restructured.
The following table sets forth a summary of the Company's nonperforming loans
and other assets as of the dates indicated:
(Dollars in Thousands) As of December 31,
- --------------------------------------------------------------------------------
2004 2003 2002 2001 2000
Nonaccrual loans $ -0- $ -0- $199 $585 $744
90 days past due and still
accruing interest -0- -0- -0- -0- -0-
Other Real Estate Owned -0- -0- 49 182 151
- --------------------------------------------------------------------------------
The Company did not have any nonaccrual loans at December 31, 2004 or 2003.
At December 31, 2004, the Company has not identified any potential problem loans
that would result in these loans being included as nonperforming loans at a
future date.
Allowance for Loan Losses (ALL)
In determining the amount of the Company's Allowance for Loan Losses
("ALL"), management assesses the diversification of the portfolio. Each credit
is assigned a credit risk rating factor, and this factor, multiplied by the
dollars associated with the credit risk rating, is used to calculate one
component of the ALL. In addition, management estimates the probable loss on
individual credits that are receiving increased management attention due to
actual or perceived increases in credit risk. Management reviews the credit risk
report with the Director Loan Committee on a weekly basis as well as with the
full Board monthly.
The Company makes provisions to the ALL on a regular basis through charges
to operations that are reflected in the Company's statements of income as a
provision for loan losses. When a loan is deemed uncollectible, it is charged
against the allowance. Any recoveries of previously charged-off loans are
credited back to the allowance. There is no precise method of predicting
specific losses or amounts that ultimately may be charged-off on particular
categories of the loan portfolio. Similarly, the adequacy of the ALL and the
level of the related provision for possible loan losses is determined on a
judgment basis by management based on consideration of a number of factors
including (i) economic conditions, (ii) borrowers' financial condition, (iii)
loan impairment, (iv) evaluation of industry trends, (v) industry and other
concentrations, (vi) loans which are contractually current as to payment terms
but demonstrate a higher degree of risk as identified by management, (vii)
continuing evaluation of the performing loan portfolio, (viii) monthly review
and evaluation of problem loans identified as having a loss potential, (ix)
monthly review by the Board of Directors, (x) off balance sheet risks and (xi)
assessments by regulators and other third parties. Management and the Board of
Directors evaluate the allowance and determine its desired level considering
objective and subjective measures, such as knowledge of the borrowers'
businesses, valuation of collateral, the determination of impaired loans and
exposure to potential losses.
While management uses available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in economic
conditions and other qualitative factors. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's ALL. Such agencies may require the Company to provide additions to
the allowance based on their judgment of information available to them at the
65
time of their examination. There is uncertainty concerning future economic
trends. Accordingly it is not possible to predict the effect future economic
trends may have on the level of the provision for possible loan losses in future
periods.
The Company's principal lines of lending are (i) commercial and
agricultural, (ii) real estate construction and (iii) commercial and residential
real estate. The primary sources of repayment of the Company's commercial loans
are the borrowers' conversion of short-term assets to cash and operating cash
flow. The net assets of the borrower or guarantor are usually identified as a
secondary source of repayment. The principal factors affecting the Company's
risk of loss from commercial lending include each borrower's ability to manage
its business affairs and cash flows, local and general economic conditions and
real estate values in the Company's service area. The Company manages its
commercial loan portfolio by monitoring its borrowers' payment performance and
their respective financial condition and makes periodic adjustments, if
necessary, to the risk grade assigned to each loan in the portfolio. The
Company's evaluations of its borrowers are facilitated by management's knowledge
of local market conditions and periodic reviews by a consultant of the Company's
credit administration policies.
The principal source of repayment of the Company's real estate construction
loans is the sale of the underlying collateral or the availability of permanent
financing from the Company or other lending source. The principal risks
associated with real estate construction lending include project cost overruns
and deterioration of real estate values as a result of various factors,
including competitive pressures and economic downturns. The Company manages its
credit risk associated with real estate construction lending by establishing
loan-to-value ratios and loan-to-cost ratios on projects on an as-completed
basis, inspecting project status in advance of controlled disbursements and
matching maturities with expected completion dates. Generally, the Company
requires a loan-to-value ratio of not more than 80% on single family residential
construction loans.
The principal source of repayment of the Company's real estate mortgage
loans is the borrowers' operating cash flow. Similar to commercial loans, the
principal factors affecting the Company's risk of loss in real estate mortgage
lending include each borrower's ability to manage its business affairs and cash
flows, local and general economic conditions and real estate values in the
Company's service area. The Company manages its credit risk associated with real
estate mortgage lending primarily by establishing maximum loan-to-value ratios
and using strategies to match the borrower's cash flow to loan repayment terms.
The Company's specific underwriting standards and methods for each of its
principal lines of lending include industry-accepted analysis and modeling and
certain proprietary techniques. The Company's underwriting criteria are designed
to comply with applicable regulatory guidelines, including required
loan-to-value ratios. The Company's credit administration policies contain
mandatory lien position and debt service coverage requirements, and the Company
generally requires a guarantee from 20% or more owners of its corporate
borrowers.
The ALL should not be interpreted as an indication that charge-offs in
future periods will occur in the stated amounts or proportions.
The adequacy of the ALL is calculated upon three components. First is the
credit risk rating of the loan portfolio, including all outstanding loans. Every
extension of credit has been assigned a risk rating based upon a comprehensive
definition intended to measure the inherent risk of lending money. Each rating
has an assigned risk factor expressed as a reserve percentage. Central to this
assigned risk factor is the historical loss record of the Company. Secondly,
established specific reserves are available for individual loans currently on
management's watch and high-grade loan lists. These are the estimated potential
losses associated with specific borrowers based upon the collateral and event(s)
causing the risk ratings. The third component is unallocated. This reserve is
for qualitative factors that may affect the portfolio as a whole, such as those
factors described above. Management believes the assigned risk grades and our
methods for managing risk are satisfactory.
66
The following table summarizes the Company's loan loss experience as well as
provisions and charges to the allowance for loan losses and certain ratios for
the periods indicated.
(Dollars in thousands) Years Ended December 31,
- --------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
- --------------------------------------------------------------------------------------------------
Beginning Balance: $1,653 $1,307 $1,172 $1,001 $796
Provision for loan losses 504 536 286 383 300
Charge-offs:
Commercial (9) (90) (171) (226) (70)
Real Estate (-) (-) (-)
Other (-) (105) (28) (2) (26)
--------- --------- --------- --------- ---------
Total Charge-offs (9) (195) (199) (228) (96)
--------- --------- --------- --------- ---------
Recoveries:
Commercial 66 1 -- 16
Other 4 48 -- 1
Total Recoveries 66 5 48 16 1
--------- --------- --------- --------- ---------
Ending Balance 2,214 $1,653 $1,307 $1,172 $1,001
========= ========= ========= ========= =========
ALL to total loans 1.10% 1.05% .97% 1.20% 1.20%
Net charge-offs (recoveries)
to average loans (.03)% .12% .13% .23% .12%
- --------------------------------------------------------------------------------------------------
The provision for loan losses was $504,000 for 2004 compared to $536,000
for 2003 and $286,000 in 2002. The decrease in the amount of the provision in
2004 compared to 2003 is a ct result of the analysis of the loan portfolio and
the loan loss history of the Company. Net charge-offs (recoveries) were
$(57,000).or .003% of average loans for 2004 compared to $190,000 or .12% of
average loans for 2003 and $151,000 or .13% of average loans for 2002.
Management does not believe that there were any trends indicated by the detail
of the aggregate charge-offs for any of the periods discussed.
The following table summarizes the allocation of the allowance for loan
losses (ALL) by loan type and the allocation as a percent of loans outstanding
in each loan category at the dates indicated.
(Dollars in thousands)
- ---------------------------------------------------------------------------------------------
2004 2003
- ---------------------------------------------------------------------------------------------
Allowance Percent of ALL Allowance Percent of ALL
in each category in each category
to total loans to total loans
Commercial and Agricultural $880 1.58% $736 1.27%
Real estate - construction 115 0.50% 141 0.50%
Real estate - commercial 422 0.38% 229 0.38%
Installment 308 2.35% 242 2.24%
Unallocated 489 305
Total $2,214 1.10% $1,653 1.05%
- ---------------------------------------------------------------------------------------------
67
Deposits
--------
The Company primarily obtains deposits from local businesses and
professionals as well as through certificates of deposits, savings and checking
accounts.
The following table sets forth the remaining maturities of certificates of
deposit at December 31, 2004 Deposit Maturity Schedule
(Dollars in thousands)
- --------------------------------------------------------------------------
Under $100,000 Over $100,000
- --------------------------------------------------------------------------
Three Months or less $8,363 $11,485
Over three through six months 8,350 9,905
Over six through twelve months 8,395 13,305
Over twelve months 4,627 6,306
------- -------
Total $29,735 $41,001
======= =======
- --------------------------------------------------------------------------
Liquidity and Market Risk
-------------------------
The purpose of liquidity management is to ensure efficient and economical
funding of the Company's assets consistent with the needs of the Company's
depositors and, to a lesser extent, shareholders. This process is managed not by
formally monitoring the cash flows from operations, investing and financing
activities as described in the Company's statement of cash flows, but through an
understanding principally of depositor and borrower needs. As loan demand
increases, the Company can use asset liquidity from maturing investments along
with deposit growth to fund the new loans.
With respect to assets, liquidity is provided by cash and money market
investments such as interest-bearing time deposits, federal-funds sold,
available-for-sale investment securities, and principal and interest payments on
loans. With respect to liabilities, liquidity is provided by core deposits,
shareholders' equity and the ability of the Company to borrow funds and to
generate deposits.
Because estimates of the liquidity needs of the Company may vary from
actual needs, the Company maintains a substantial amount of liquid assets to
absorb short-term increases in loans or reductions in deposits. As loan demand
decreases or loans are paid off, investment assets can absorb these excess funds
or deposit rates can be decreased to run off excess liquidity. Therefore, there
is some correlation between financing activities associated with deposits and
investing activities associated with lending. The Company's liquid assets (cash
and due from banks, federal funds sold, interest bearing deposits in banks and
available-for-sale investment securities) totaled $35.6 million or 14.0% of
total assets at December 31, 2004, $28.1 million or 14.0% of total assets at
December 31, 2003 and $35.6 million or 20.0% of total assets at December 31,
2002. The Company expects that its primary source of liquidity will be earnings
of the Company, acquisition of core deposits, and wholesale borrowing
arrangements.
Market Risk
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates and process such as interest rates, commodity
prices and equity prices. As a financial institution, the Company's market risk
arises primarily form interest rate risk exposure. Fluctuation in interest rates
will ultimately impact both the level of income and expense recorded on a large
portion of the Company's assets and liabilities, and the market value of all
interest earnings assets and interest bearing liabilities, other than those that
possess a short term to maturity. Based upon the nature of it's operations, the
Company is not subject to foreign currency exchange or commodity pricing.
However, the Company's commercial real estate loan portfolio, concentrated
primarily in Northern California, is subject to risks associated with the local
economies.
68
The fundamental objective of the Company's management of its assets and
liabilities is to maximize the economic value of the Company while maintaining
adequate liquidity and managing exposure to interest rate risk deemed by
management to be acceptable. Management believes an acceptable degree of
exposure to interest rate risk results from management of assets and liabilities
through using floating rate loans and deposits, maturities, pricing and mix to
attempt to neutralize the potential impact of changes in market interest rates.
The Company's profitability is dependent to a large extent upon it's net
interest income which is the difference between its interest income on interest
earning assets, such as loans and securities, and interest expense on interest
bearing liabilities, such as deposits trust preferred securities and other
borrowings. The Company, like other financial institutions, is subject to
interest rate risk to the degree that its interest earning assets reprice
differently than its interest bearing liabilities. The Company manages its mix
of assets and liabilities with the goal of limiting exposure to interest rate
risk, ensuring adequate liquidity, and coordinating its sources and uses of
funds.
The Company seeks to control its interest rate risk exposure in a manner
that will allow for adequate levels earnings and capital over a range of
possible interest rate environments. The Company has adopted formal policies and
practices to monitor and manage interest rate exposure. As part of this effort,
the Company measures interest rate risk utilizing both an internal asset
liability measurement system as well as employing independent third party
reviews to confirm the reasonableness of the assumptions used to measure and
report the Company's interest rate risk, enabling management to make any
adjustments necessary.
Interest rate risk is managed by the Company's Asset Liability Committee
("ALCO"), which includes members of senior management and several members of the
Board of Directors. The ALCO monitors interest rate risk by analyzing the
potential impact on interest income from potential changes in interest rates and
considers the impact of alternative strategies or changes in balance sheet
structure. The ALCO manages the Company's balance sheet in part to maintain the
potential impact on net interest income within acceptable ranges despite changes
in interest rates. The Company's exposure to interest rate risk is reviewed on
at least a quarterly basis by the ALCO.
Net Interest Income Simulation.
In order to measure interest rate risk at December 31, 2004, the Company
used a simulation model to project changes in net interest income that result
from forecasted changes in interest rates. This analysis which is performed
quarterly by management, calculates the difference between net interest income
forecasted using a rising and falling interest rate scenario and net interest
income forecast using a base market derived from the current interest rates. The
income simulation model includes various assumptions regarding the re-pricing
relationships for each of the Company's products. Many of the Company's assets
are floating rate loans, which are assumed to reprice immediately and to the
same extent as the change in market rates according to their contracted index.
The Company's non-term deposit products reprice more slowly, usually changing
less than the change in market rates and at the discretion of the Company.
The analysis indicates the impact of changes in net interest income for the
given set of rate changes and assumptions. It assumes that the balance sheet
grows modestly, but that its structure will remain similar to the structure at
year-end. It does not account for all factors that impact this analysis,
including the potential impact of loan prepayments, deposit drifts or other
balance sheet movements including changes by management to mitigate the impact
of interest rate changes or secondary impacts such as changes to the Company's
credit risk profile as interest rates change. Changes that vary significantly
from the assumptions may have significant effects on the Company's net interest
income.
69
The following table reflects the company's projected net interest income
sensitivity analysis based on year-end data:
December 31, 2004
----------------------------------------
Change in Rates Adjusted Net Interest
Income Percent change
(in thousands) from base
----------------------------------------
Up 300 basis points $15,208 8.68%
Up 200 basis points 14,792 5.70%
Up 100 basis points 14,373 2.71%
Base Scenario 13,994 0.00%
Down 100 basis points (13,474) -3.72%
Down 200 basis points (12,991) -7.17%
Down 300 basis points (12,507) -10.63%
Contractual Obligations
The following table summarizes the contractual obligations of the Company
as of December 31, 2004:
Less than More than
Total one year 1-3 years 3-5 years 5 years
--------- --------- --------- --------- ---------
Subordinated Debentures, floating rate
of 5.39% payable June 26, 2031 $5,155 $5,155
Subordinated Debentures, floating rate
of 4.39% payable March 17, 2034 $3,609 $3,609
FHLB Loan fixed rate of 2.29%, payable
on December 9, 2005 $4,000 4,000
Operating lease obligations $1,057 246 484 327
Salary continuation plan $344 $344
--------- --------- --------- --------- ---------
Total $14,165 $4,246 $484 $327 $9,108
========= ========= ========= ========= =========
In addition to those obligations listed above, in the normal course of
business, the Company will make cash distributions for, among other items, the
payment of interest on interest bearing deposit accounts and debt obligations,
payments for quarterly tax estimates and contributions to certain employee
benefit plans.
Capital Resources
-----------------
Capital adequacy is a measure of the amount of capital needed to sustain
asset growth and act as a cushion for losses. Capital protects depositors and
the deposit insurance fund from potential losses and is a source of funds for
the investments the Company needs to remain competitive. Historically, capital
has been generated principally from the retention of earnings.
70
Overall capital adequacy is monitored on a day-to-day basis by the
Company's management and reported to the Company's Board of Directors on a
quarterly basis. The Bank's regulators measure capital adequacy by using a
risk-based capital framework and by monitoring compliance with minimum leverage
ratio guidelines. Under the risk-based capital standard, assets reported on the
Company's balance sheet and certain off-balance sheet items are assigned to risk
categories, each of which is assigned a risk weight.
This standard characterizes an institution's capital as being "Tier 1"
capital (defined as principally comprising shareholders' equity and qualifying
subordinated debentures ) and "Tier 2" capital (defined as principally
comprising the qualifying portion of subordinated debt and the qualifying
portion of the ALL), the total amount not to exceed 100% of Tier 1 capital.
The minimum ratio of total risk-based capital to risk-adjusted assets,
including certain off-balance sheet items, is 8%.
At December 31, 2004, 2003 and 2002 the company's capital met all minimum
regulatory requirements.
As of December 31, 2004, the most recent notification by the Federal
Depository Insurance Corporation (FDIC) categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To be categorized
as well capitalized the Bank must meet the minimum ratios as set forth below.
There are no conditions or events since that notification that management
believes have changed the institution's category.
The Company's and the Bank's risk-based capital ratios are presented below.
Pacific State Bancorp December 31, December 31,
2004 2003
------------ ------------
Total Risk-Based Capital 12.6% 11.6%
Tier 1 Capital to Risk-Based Assets 10.1% 10.1%
Tier 1 Capital to Average Assets 8.3% 8.3%
(Leverage ratio)
Pacific State Bank To Be Well Capitalized
December 31, December 31, Under Prompt Corrective
2004 2003 Action
------------ ------------ -----------------------
Total Risk-Based Capital 12.2% 11.1% > 10.00%
Tier 1 Capital to Risk-Based Assets 11.1% 10.1% > 6.00%
Tier 1 Capital to Average Assets 9.1% 8.2% > 5.00%
(Leverage ratio)
Impact of Inflation
Inflation affects the Company's financial position as well as its operating
results. It is management's opinion that the effects of inflation on the
financial statements have not been material.
71
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table presents the summary unaudited results for the stated eight
quarters:
(Dollars in thousands,
except per share) 2004 2003
---- ----
Net Income Per
Common Share: 4th 3rd 2nd 1st 4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
Diluted $0.21 $0.24 $0.21 $0.18 $0.18 $0.15 $0.14 $0.12
Basic $0.24 $0.26 $0.23 $0.19 $0.15 $0.16 $0.14 $0.14
Interest income $4,002 $3,371 $3,180 $2,956 $2,948 $2,908 $2,713 $2,548
Net interest income 3,037 2,568 2,478 2,368 2,315 2,235 2,011 1,795
Provision for loan losses
138 138 138 90 138 138 138 122
Total non-interest income
536 818 700 471 634 414 394 536
Total non-interest expense
2,110 1,840 1,774 1,705 1,744 1,648 1,527 1,579
Income before taxes 1,326 1,407 1,266 1,044 1,065 864 741 630
Net Income 841 894 776 658 641 530 476 406
72
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
---------------------------------------------------------------------
There is only a limited trading market for the Company's Common stock,
which is not listed on any exchange. Hoefer & Arnett (San Francisco) is the
Company's primary market maker. Trading information is available via the
internet on the Bulletin Board (www.otcbb.com), under the symbol PSBC.OB.
The following table, which summarizes trading activity during the Company's
last two fiscal years, is based on information provided by Yahoo.com Historical
Quotes. The quotations reflect the price that would be received by the seller
without retail mark-up, mark-down or commissions and may not have represented
actual transactions.
Sales Price
Quarter Ended: High Low Volume
-------------- ---- --- ------
March 31, 2004 $10.500 $10.050 346,874
June 30, 2004 $11.350 $10.700 263,344
September 30, 2004 $12.500 $12.500 136,414
December 31, 2004 $20.500 $20.000 115,998
March 31, 2003 $4.375 $4.000 36,300
June 30, 2003 $5.750 $4.275 16,100
September 30, 2003 $6.500 $5.000 38,800
December 31, 2003 $8.125 $6.125 149,886
As of March 15, 2005, there were approximately 330 holders of record of the
common stock of the Company.
Dividends
- ---------
The Company's primary source of cash is dividends from the Bank. The Bank's
ability to pay dividends is subject to certain regulatory requirements. The
California Financial Code restricts the total dividend payment of any bank in
any calendar year to the lesser of (1) the bank's retained earnings or (2) the
bank's net income for its last three fiscal years, less distributions made to
shareholders' during the same three-year period. As of December 31, 2004, the
Bank had $6,281,000 in retained earnings available for dividends to
shareholders.
The power of the board of directors of an insured depository institution to
declare a cash dividend or other distribution with respect to capital is subject
to statutory and regulatory restrictions which limit the amount available for
such distribution depending upon the earnings, financial condition and cash
needs of the institution, as well as general business conditions.
73
Company and Bank Officers
- -------------------------
Steven A. Rosso Glenn Scott
President & Chief Executive Vice President & MIS
Officer Director
Gary A. Stewart Alan Lozito
Executive Vice President & Chief Vice President Commercial
Credit Officer Loan Officer - Castro Valley
LPO
JoAnne Roberts
Senior Vice President & Chief Eric Nelson
Financial Officer Vice President Commercial
Loan Officer - Castro Valley
Bank Officers LPO
- -------------
Douglas van den Enden
Laura Maffei Vice President & Commercial
Senior Vice President & Manager- Loan Officer
Tracy
Sylvia Hanania
Linda Ogata Vice President & Senior
Senior Vice President & Manager- Operations Officer - Stockton
March Lane Main
Rick Simas Shelly Urbanek
Senior Vice President & Regional Assistant Vice President-
Manager -Stanislaus & Tuolumne Training Officer
Counties
Jamie Vroege
Ron Aschwanden Lending Services Officer -
Senior Vice President & Regional March Lane
Manager - Calaveras County
Lori Menchaca
Venus Colombini Operations Officer - Arnold
Vice President & Manager-
Groveland Michelle Hendrix
Operations Officer - Groveland
Janita Cavanaugh
Vice President & Controller Carol Barnett
Operations Officer - Angels Camp
Patrick MacDonald
Vice President & Manager - Larry Hernandez
Stockton Main Operations Officer - Tracy
Paul Bergson Rosibel Rivera
Vice President Commercial Operations Officer - Modesto
Loan Officer Stockton Main
Cassandra Turner
Allen Hafizi Operations Officer - Stockton
Vice President & Note Main
Department Manager
74
Board Of Directors
- ------------------
Harold Hand, M.D.
Chairman of the Board
Owner, Stockton, Eye Surgery
Steven A. Rosso
President & Chief Executive Officer
Pacific State Bancorp & Pacific State Bank
Michael L. Dalton, C.P.A.
Partner, Dalton & Lagorio, C.P.A.
Maxwell M. Freeman
Freeman, D'Auito, Pierce & Gurev
A Professional Law Corporation
Patricia A. Hatton, M.D.
Gynecologist
Gary A. Stewart
Executive Vice President & Chief Credit Officer
Pacific State Bancorp & Pacific State Bank
Steven J. Kikuchi
Landscape Architect
Kathleen M. Verner
Vice President
Verner Construction
Yoshikazu Mataga,
Owner, Mataga Buick Pontiac & GMC
Mataga Cadillac
Tracy Pontiac Cadillac & GMC
Phillip B. Wallace
Chairman
Western Empire Management Company
75
CORPORATE DIRECTORY
-------------------
Stock Market Makers Legal Counsel
- ------------------- -------------
First Security Van Casper Shapiro Buchman Provine
San Francisco, CA Patton LLP
Stephen L. Eddy John Carr
800-652-1747 ext. 727 1333 N. California Blvd., Suite 350
Walnut Creek, CA 94596
Hoefer & Amett
Dave Bonacorso Certified Public Accountants
353 Sacramento Street ----------------------------
San Francisco, CA 94 111 Perry-Smith LLP
800-346-5544 ex. 223 400 Capitol Mall, Suite 1200
dave.b@hoeferarnett.com Sacramento, CA 95814
www.hoeferarnett.com
Transfer Agent
Monroe Securities --------------
800-766-5560 Mellon Investor Services LLC
85 Challenger Rd
Wedbush Morgan Securities Ridgefield, Park, NJ 07660
Joey Warmenhoven
1300 S.W. Fifth Avenue Corporate Office
Suite 2000 ----------------
Portland, OR 97201 1889 West March Lane
503/471-1898 Stockton, CA 95207
www.wedbush.com
Customer Service
Shareholder Relations ----------------
- --------------------- 877-841-0110
A copy of Pacific State Banks
Form 10-k or other Annual report TeleWave Banking
filed with the Federal Reserve ----------------
Board. Requests for Form 10-k or 877-487-2265
Other shareholder information
should be directed to: Web Address
JoAnne Roberts -----------
Vice President/Chief Financial Officer www.pacificstatebank.com
Pacific State Bank
P.O.Box 1649 Trading Symbol
Stockton, CA 95201-1649 --------------
PSBC
Member F.D.IC.
76