EXHIBIT 13
Dear Shareholders, Customers and Friends:
2005 was a year of special achievement for Pacific State Bancorp and its
subsidiary Pacific State Bank. Our year of milestones included the registration
of the company's common stock (PSBC) as a NASDAQ(TM) National Market System
security. Management's goals, accomplished by the registration, were to increase
visibility of our stock, increase liquidity for shareholders, and enhance
shareholder value. Prior to commencement of listing on July 25, 2005, the total
number of shares traded during 2005 were 486,445 shares with an average price of
$16.02 per share. After listing, 270,591 shares traded at an average price of
$18.98 per share.
Financially 2005 was again a banner year with record performance in earnings and
asset growth. Net Income for 2005 was $4,286,000, an increase of $1,117,000 or
35.2% over 2004. Total assets closed the year at $309,611,000, up $55,250,000 or
21.7% from the close of 2004. The company's Return on Average Equity was 22.98%
for 2005, the highest in the company's history. The company generated a Return
on Average Assets of 1.53%, also a record high. Basic Earnings per Share
increased 33.7% to $0.31 and Diluted Earnings per Share increased by 31.0% to
$0.26.
These strong increases experienced in 2005 continued the trend in the growth of
Pacific State Bancorp since the beginning of the millennium. Over the five year
period ending December 31, 2005, net income increased 324.77%, total assets
increased 172.04%, book value per share increased by 121.09%, and market price
per share grew 595.49%. PSBC can be bought or sold through most stock brokerage
firms, and a list of the company's market makers is enclosed in this Annual
Report. Pacific State Bancorp was honored for the second consecutive year as a
top performing bank stock at the California Banker's Association and the
Carpenter Investments Market Cap Awards.
Looking to the future, we expect to open our eighth branch this summer in Lodi,
California. Pacific State Bancorp has a long history of shareholder ownership
within Lodi and loyal customers that management feels will form the foundation
for financial success in our new branch. The new facility, located on the
northwest corner of Kettleman Lane (Hwy 12) and Hutchinson Street, is currently
under construction. We believe that there is opportunity for solid growth and a
strong branch in a community that is well known to our company.
As we look back on 2005, we are thankful for our strong customer support and
loyalty, as well as the commitment of our staff and management to make us the
premier independent financial institution in our five county service area. New
products such as On-Line Bill Pay and Pacific State Bank Gift Cards reflect our
continuing goal to enhance traditional banking services, and we will continue
our customer mantra of "High Tech and High Touch Service" as we look to expand
our company in 2006.
Catch the Force of the Wave!
/s/ HAROLD HAND /s/ STEVEN A. ROSSO
Chairman of the Board of Directors President & C.E.O.
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: 2005 2004 2003 2002 2001
---------- ---------- ---------- ---------- ----------
Total Interest Income $ 18,782 $ 13,509 $ 11,117 $ 9,236 $ 9,195
Net Interest Income 13,536 10,451 8,356 6,289 5,614
Provision for Loan Losses 35 504 536 286 383
Total Non-interest Income 2,481 2,525 1,978 1,636 1,259
Total Non-interest Expenses 9,100 7,429 6,498 5,846 4,935
Provision for Income Taxes 2,596 1,874 1,247 630 520
Net Income 4,286 3,169 2,053 1,163 1,036
Balance Sheets:
Total Assets $ 309,611 $ 254,361 $ 200,924 $ 180,295 $ 121,295
Total Investments 28,539 23,582 15,512 12,173 10,608
Total Loans, net 241,556 199,535 157,138 135,272 98,281
Allowance for Loan Losses (ALL) 2,356 2,214 1,653 1,306 1,172
Total Deposits 273,074 223,761 176,292 158,140 111,104
Subordinated Debentures 8,764 8,764 5,155 5,155 --
Shareholders' Equity 21,373 16,830 13,459 11,320 9,378
Performance Ratios:
Return on Average Assets 1.53% 1.37% 1.07% 0.77% 0.87%
Return on Average Equity 22.98% 21.64% 16.86% 11.27% 12.04%
Average Equity to Average Assets 6.65% 6.34% 6.36% 6.80% 7.24%
Tier 1 Risk-Based Capital 10.44% 10.10% 10.10% 9.40% 9.109
Total Risk-Based Capital 11.88% 12.60% 11.60% 11.40% 10.292
Net Interest Margin 5.41% 5.14% 4.85% 4.63% 5.15%
Average Earning Assets to Average Total Assets 89.22% 88.18% 89.85% 89.48% 90.98%
Nonperforming Assets to Total Assets -- -- -- 0.48% 0.63%
ALL to Total Loans 0.98% 1.10% 1.05% 0.97% 1.120
Nonperforming Loans to ALL -- -- -- 15.54% 41.40%
Share Data (Common Shares Outstanding) 3,512,622 3,448,042 3,377,656 3,302,748 3,038,776
Book Value Per Share $ 6.08 $ 4.88 $ 3.99 $ 3.43 $ 3.09
Basic Earnings Per Share $ 1.23 $ 0.92 $ 0.61 $ 0.36 $ 0.35
Diluted Earnings Per Share $ 1.10 $ 0.84 $ 0.59 $ 0.34 $ 0.33
2
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, 2005 and 2004 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, 2005.
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, 2005 and 2004, and the
consolidated results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 2005, in conformity with
accounting principles generally accepted in the United States of America.
/s/ Perry-Smith LLP
Sacramento, California
March 17, 2006
3
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
December 31, 2005 and 2004
(In thousands, except share amounts)
2005 2004
------------ ------------
ASSETS
Cash and due from banks $ 14,453 $ 12,108
Federal funds sold 4,667
------------ ------------
Total cash and cash equivalents 19,120 12,108
Interest-bearing deposits in banks 6,100
Investment securities (Notes 3 and 7) 28,539 17,482
Loans, less allowance for loan losses of $2,356 in
2005 and $2,214 in 2004 (Notes 4, 7, 10 and 13) 241,556 199,535
Premises and equipment, net (Note 5) 9,511 9,748
Company owned life insurance (Note 14) 4,411 4,246
Accrued interest receivable and other assets (Note 9) 6,474 5,142
------------ ------------
Total assets $ 309,611 $ 254,361
============ ============
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 68,657 $ 51,980
Interest bearing (Note 6) 204,417 171,781
------------ ------------
Total deposits 273,074 223,761
Other borrowings (Note 7) 4,000 4,000
Subordinated debentures (Note 8) 8,764 8,764
Accrued interest payable and other liabilities 2,400 1,006
------------ ------------
Total liabilities 288,238 237,531
------------ ------------
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 - 3,512,622
shares in 2005 and 3,448,042 shares in 2004 7,556 7,159
Retained earnings 13,912 9,626
Accumulated other comprehensive (loss) income, net of
taxes (Notes 3 and 15) (95) 45
------------ ------------
Total shareholders' equity 21,373 16,830
------------ ------------
Total liabilities and shareholders' equity $ 309,611 $ 254,361
============ ============
The accompanying notes are an integral
part of these consolidated financial statements.
4
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands, except per share amounts)
2005 2004 2003
------------ ------------ ------------
Interest income:
Interest and fees on loans $ 17,565 $ 12,846 $ 10,578
Interest on Federal funds sold 354 93 75
Interest on investment securities:
Taxable 712 395 262
Exempt from Federal income taxes 151 175 202
------------ ------------ ------------
Total interest income 18,782 13,509 11,117
------------ ------------ ------------
Interest expense:
Interest on deposits (Note 6) 4,610 2,564 2,393
Interest on borrowings (Note 7) 109 128 129
Interest on subordinated debentures (Note 8) 527 366 239
------------ ------------ ------------
Total interest expense 5,246 3,058 2,761
------------ ------------ ------------
Net interest income before provision for
loan losses 13,536 10,451 8,356
Provision for loan losses (Note 4) 35 504 536
------------ ------------ ------------
Net interest income after provision
for loan losses 13,501 9,947 7,820
------------ ------------ ------------
Non-interest income:
Service charges 758 1,075 694
Net gain on sale of investments (Note 3) 2
Gain on sale of loans 809 445 664
Other income 914 1,005 618
------------ ------------ ------------
Total non-interest income 2,481 2,525 1,978
------------ ------------ ------------
Non-interest expenses:
Salaries and employee benefits (Notes 4 and 14) 4,742 3,814 3,068
Occupancy (Notes 5 and 10) 782 750 669
Furniture and equipment (Notes 5 and 10) 664 468 507
Other expenses (Note 12) 2,912 2,397 2,254
------------ ------------ ------------
Total non-interest expenses 9,100 7,429 6,498
------------ ------------ ------------
Income before provision for income taxes 6,882 5,043 3,300
------------ ------------ ------------
Provision for income taxes (Note 9) 2,596 1,874 1,247
------------ ------------ ------------
Net income $ 4,286 $ 3,169 $ 2,053
============ ============ ============
Basic earnings per share (Note 11) $ 1.23 $ 0.92 $ 0.61
============ ============ ============
Diluted earnings per share (Note 11) $ 1.10 $ 0.84 $ 0.59
============ ============ ============
The accompanying notes are an integral
part of these consolidated financial statements.
5
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2005, 2004 and 2003
(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, 2003 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 (losses) 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
Net income 4,286 4,286
Net change in unrealized gains (losses) on
available-for-sale investment securities,
net of tax (140) (140)
Stock options exercised and related tax
benefit (Note 11) 65,760 409 409
Repurchase and retirement of
common stock (1,180) (12) (12)
---------- ---------- ---------- ---------- ----------
Balance, December 31, 2005 3,512,622 $ 7,556 $ 13,912 $ (95) $ 21,373
========== ========== ========== ========== ==========
2005 2004 2003
---------- ---------- ----------
Comprehensive income (Note 15):
Net income $ 4,286 $ 3,169 $ 2,053
---------- ---------- ----------
Other comprehensive (loss) income:
Unrealized holding (losses) gains arising during the
year, net of tax (140) (20) 66
Less: reclassification adjustment for gains included
in net income, net of tax 1
---------- ---------- ----------
Net change in unrealized gains on available-for-sale
investment securities (140) (20) 65
---------- ---------- ----------
Total comprehensive income $ 4,146 $ 3,149 $ 2,118
========== ========== ==========
The accompanying notes are an integral
part of these consolidated financial statements.
6
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands)
2005 2004 2003
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 4,286 $ 3,169 $ 2,053
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 35 504 536
Net (increase) decrease in deferred loan
origination costs (14) 85 (19)
Depreciation and amortization 600 567 628
Net realized gains on sale of investment
securities (2)
Net loss (gain) on sale of equipment 13
Increase in Company owned life insurance,
net of expenses (165) (188) (58)
(Increase) decrease in accrued interest
receivable and other assets (1,173) (198) 21
Increase (decrease) in accrued interest
payable and other liabilities 1,394 (12) 338
Provision for deferred income taxes (131) (230) (262)
---------- ---------- ----------
Net cash provided by operating
activities 4,832 3,697 3,248
---------- ---------- ----------
Cash flows from investing activities:
Net decrease (increase) in interest-bearing
deposits in banks 6,100 (2,100) (4,000)
Purchases of available-for-sale investment
securities (13,992) (14,352) (4,960)
Proceeds from matured and called available-
for-sale investment securities 1,800 7,374 4,297
Proceeds from principal repayments from
available-for-sale government-guaranteed
mortgage-backed securities 979 984 1,276
Proceeds from principal repayments from
held-to-maturity government-guaranteed
mortgage-backed securities 21 36 110
Purchase of FRB and FHLB stock (405)
Net increase in loans (42,042) (44,639) (22,036)
Proceeds from sale of other real estate 49
Proceeds from sale of premises and equipment 6
Purchases of premises and equipment (396) (1,521) (2,840)
Purchase of Company owned life insurance (4,000)
---------- ---------- ----------
Net cash used in investing activities (47,530) (54,623) (32,098)
---------- ---------- ----------
(Continued)
7
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(Continued)
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands)
2005 2004 2003
---------- ---------- ----------
Cash flows from financing activities:
Net increase in demand, interest-bearing and
savings deposits $ 26,861 $ 54,438 $ 9,711
Net increase (decrease) in time deposits 22,452 (6,969) 8,441
Proceeds from exercise of stock options 409 183 176
Share repurchase and retirement (12) (170)
Proceeds from the issuance of mandatorily
redeemable trust preferred securities 3,609
Net decrease in short-term
borrowings (1,000)
---------- ---------- ----------
Net cash provided by financing
activities 49,710 50,261 18,158
---------- ---------- ----------
Increase (decrease) in cash and cash
equivalents 7,012 (665) (10,692)
Cash and cash equivalents at beginning of year 12,108 12,773 23,465
---------- ---------- ----------
Cash and cash equivalents at end of year $ 19,120 $ 12,108 $ 12,773
========== ========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest expense $ 4,773 $ 3,083 $ 2,838
Income taxes $ 2,081 $ 1,845 $ 1,356
Non-cash investing activities:
Net change in unrealized gain on available-
for-sale investment securities $ (232) $ (26) $ 100
Non-cash financing activities:
Tax benefit from stock options exercised $ 79 $ 39 $ 16
The accompanying notes are an integral
part of these consolidated financial statements.
8
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. This corporate structure gives Bancorp and the
Bank greater flexibility in terms of operation, expansion, and
diversification.
Pacific State Bancorp's subsidiaries include the Bank, in addition to
Pacific State Statutory Trust I and Pacific State Statutory Trust II,
both of which are unconsolidated Delaware statutory business trusts
formed in June 2002 and March 2004, respectively, 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, Tracy
and one loan production office in Castro Valley. 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.
Segment Information
-------------------
Management has determined that because all of the banking products and
services offered by the Company are available in each branch of the
Bank, all branches are located within the same economic environment and
management does not allocate resources based on the performance of
different lending or transaction activities, it is appropriate to
aggregate the Bank branches and report them as a single operating
segment. No customer accounts for more than 10 percent of revenues for
the Company or the Bank.
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.
9
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
Reclassifications
-----------------
Certain reclassifications have been made to prior years' balances to
conform to classifications used in 2005.
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. The Company did not have any investments
classified as trading at December 31, 2005 or 2004. 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.
10
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Investment Securities (Continued)
---------------------
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.
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, and 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.
The Company may purchase loans or acquire loans through a business
combination for which differences exist between the contractual cash
flows and the cash flows expected to be collected due, at least in
part, to credit quality. When the Company acquires such loans, the
yield that may be accreted (accretable yield) is limited to the excess
of the Company's estimate of undiscounted cash flows expected to be
collected over the Company's initial investment in the loan. The excess
of contractual cash flows over cash flows expected to be collected may
not be recognized as an adjustment to yield, loss, or a valuation
allowance. Subsequent increases in cash flows expected to be collected
generally should be recognized prospectively through adjustment of the
loan's yield over its remaining life. Decreases in cash flows expected
to be collected should be recognized as an impairment. The Company may
not "carry over" or create a valuation allowance in the initial
accounting for loans acquired under these circumstances. At December
31, 2005, there were no such loans being accounted for under this
policy.
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.
11
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loan Sales and Servicing (Continued)
------------------------
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, 2005, 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
$48,030,000 and $42,158,000 as of December 31, 2005 and 2004
respectively.
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, 2005 and 2004.
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.
Classified loans and loans determined to be impaired 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.
12
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan Losses (Continued)
-------------------------
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, 2005 and
2004, 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, 2005 and 2004, the
Company did not have any other real estate owned.
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 $218,907 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, 2005 and 2004, 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.
13
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes (Continued)
------------
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.
Stock-Based Compensation
------------------------
At December 31, 2005, 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.
2005 2004 2003
---------- ---------- ----------
(In thousands, except per share amounts)
Net income, as reported $ 4,286 $ 3,169 $ 2,053
Deduct: Total stock-based employee com-
compensation expense determined under
the fair value based method for all awards,
net of related tax effects 264 264 95
---------- ---------- ----------
Pro forma net income $ 4,021 $ 2,905 $ 1,958
========== ========== ==========
Basic earnings per share - as reported $ 1.23 $ 0.92 $ 0.61
Basic earnings per share - pro forma $ 1.16 $ 0.85 $ 0.58
Diluted earnings per share - as reported $ 1.10 $ 0.84 $ 0.59
Diluted earnings per share - pro forma $ 1.03 $ 0.77 $ 0.57
Weighted average fair value of options
granted during the year N/A N/A $ 1.88
14
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock-Based Compensation (Continued)
------------------------
The fair value of each option is estimated on the date of grant using
an option-pricing model with the following assumptions:
2003
Expected volatility 20.34%
Risk-free interest rate 3.21%
Expected option life 5 years
Dividend yield N/A
There were no stock options granted in 2005 or
Impact of New Financial Accounting Standards
--------------------------------------------
Other-Than-Temporary Impairment of Certain Investments
In March 2004, the Financial Accounting Standards Board (FASB) and
Emerging Issues Task Force (EITF) reached consensus on several issues
being addressed in EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments. The consensus provides guidance for evaluating whether an
investment is other-than-temporarily impaired and was effective for
other-than-temporary impairment evaluations made in reporting periods
beginning after June 15, 2004. The disclosure provisions of EITF Issue
No. 03-1 continue to be effective for the Company's consolidated
financial statements for the year ended December 31, 2005.
On November 3, 2005, the FASB issued FASB Staff Position (FSP) Nos. FAS
115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments. These FSP's address the
determination as to when an investment is considered impaired, whether
that impairment is other than temporary, and the measurement of an
impairment loss. These FSP's also includes accounting considerations
subsequent to the recognition of an other-than-temporary impairment and
requires certain disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. These FSP's nullify
certain requirements of EITF Issue No. 03-1, and supersedes EITF Topic
No. D-44, Recognition of Other-Than-Temporary Impairment upon the
Planned Sale of a Security Whose Cost Exceeds Fair Value. The guidance
in these FSP's amends FASB Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities. These FSP's are effective
for reporting periods beginning after December 15, 2005. The Company
does not anticipate any material impact to its financial condition or
results of operations as a result of the adoption of this guidance.
15
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Impact of New Financial Accounting Standards (Continued)
--------------------------------------------
Share-Based Payments
In December 2004, the FASB issued Statement No. 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 may elect to adopt FAS 123 (R) using a modified prospective
method or modified retrospective method. Under the modified
retrospective method, the Company would restate previously issued
financial statements, basing the compensation expense on that
previously reported in their pro forma disclosures required by FAS 123.
The modified prospective method would require the Company to record
compensation expense for the unvested portion of previously granted
awards that remain outstanding at the date of adoption as these awards
continue to vest. FAS 123 (R) is effective for the first fiscal year
beginning after June 15, 2005. Management has elected to use the
modified prospective method and has completed its evaluation of the
effect FAS 123 (R) will have and believes that the effect of
implementation will be consistent with the pro forma disclosures noted
above.
Accounting Changes and Error Corrections
On June 7, 2005, the FASB issued Statement No. 154 (FAS 154),
Accounting Changes and Error Corrections - a replacement of Accounting
Principles Board (APB) Opinion No. 20, Accounting Changes, and SFAS No.
3, Reporting Accounting Changes in Interim Financial Statements. Under
the provisions of FAS 154, voluntary changes in accounting principles
are applied retrospectively to prior periods' financial statements
unless it would be impractical to do so. FAS 154 supersedes APB Opinion
No. 20, which required that most voluntary changes in accounting
principles be recognized by including in the current period's net
income the cumulative effect of the change. FAS 154 also makes a
distinction between "retrospective application" of a change in
accounting principle and the "restatement" of financial statements to
reflect the correction of an error. The provisions of FAS 154 are
effective for accounting changes made in fiscal years beginning after
December 15, 2005. Management of the Company does not expect the
adoption of this standard to have a material impact on its financial
position or results of operations.
16
3. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities at
December 31, 2005 and 2004 consisted of the following:
Available-for-Sale
------------------
2005
---------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
(In thousands)
Debt securities:
U.S. Treasury securities $ 14,897 $ (45) $ 14,852
Obligations of states and
political sub-divisions 2,783 $ 86 (4) 2,865
Mortgage-backed securities 7,568 1 (195) 7,374
Corporate bonds 3,325 2 (2) 3,325
------------ ------------ ------------ ------------
$ 28,573 $ 89 $ (246) 28,416
============ ============ ============ ============
Net unrealized losses on available-for-sale investment securities
totaling $157,000 were recorded, net of $62,000 in tax benefit, as
accumulated other comprehensive loss within shareholders' equity at
December 31, 2005. There were no proceeds or gross realized gains from
the sale or call of available-for-sale investment securities for the
year ended December 31, 2005.
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 sale or call of available-for-sale investment securities for the
year ended December 31, 2004. 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.
17
3. INVESTMENT SECURITIES (Continued)
Held-to-Maturity
----------------
2005
-------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
(In thousands)
Debt securities:
Mortgage-backed securities $ 123 $ 1 $ (1) $ 123
========== ========== ========== ==========
2004
-------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
(In thousands)
Debt securities:
Mortgage-backed securities $ 145 $ 1 $ -- $ 146
========== ========== ========== ==========
There were no sales or transfers of held-to-maturity investment
securities during the years ended December 31, 2005, 2004 and 2003.
Less than 12 Months 12 Months or More Total
-------------------------- ------------------------ -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---------- ---------- ---------- ---------- ---------- ----------
(In thousands)
Debt securities:
U.S. Treasury securities $ 10,883 $ (18) $ 1,970 $ (28) $ 12,853 $ (46)
Obligations of states
and political sub-
divisions 361 (4) 361 (4)
Mortgage-backed
securities 6,489 (134) 1,224 (53) 7,713 (187)
Corporate obligations 999 (2) 999 (2)
---------- ---------- ---------- ---------- ---------- ----------
$ 18,732 $ (158) $ 3,194 $ (81) $ 21,926 $ (239)
========== ========== ========== ========== ========== ==========
At December 31, 2005, the Company held 41 investment securities of
which 16 were in a loss position for less than twelve months and 5 were
in a loss position and had been in a loss position for twelve months or
more. Management periodically evaluates each investment security for
other than temporary impairment, relying primarily on industry analyst
reports and 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.
18
3. INVESTMENT SECURITIES (Continued)
The amortized cost and estimated fair value of investment securities at
December 31, 2005 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 $ 13,272 $ 13,232
After one year through five
years 3,708 3,700
After five years through ten
years
After ten years 4,025 4,111 $ 123 $ 123
---------- ---------- ---------- ----------
21,005 21,043 123 123
Investment securities not
due at a single maturity
date:
Mortgage-backed securities 7,568 7,373
---------- ---------- ---------- ----------
$ 28,573 $ 28,416 $ 123 $ 123
========== ========== ========== ==========
Investment securities with amortized costs totaling $5,372,000 and
$4,848,000 and estimated market values totaling $5,382,000 and
$4,902,000 were pledged to secure treasury tax and loan accounts and
public deposits at December 31, 2005 and 2004, 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 AND ALLOWANCE FOR LOAN LOSSES
Outstanding loans are summarized below:
December 31,
-------------------------
2005 2004
---------- ----------
(In thousands)
Commercial $ 43,063 $ 40,562
Agricultural 17,582 15,007
Real estate - commercial mortgage 126,166 109,895
Real estate - construction 43,352 22,965
Installment 13,536 13,121
---------- ----------
243,699 201,550
Deferred loan origination costs, net 213 199
Allowance for loan losses (2,356) (2,214)
---------- ----------
$ 241,556 $ 199,535
========== ==========
19
4. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Changes in the allowance for loan losses were as follows:
Year Ended December 31,
----------------------------------------
2005 2004 2003
---------- ---------- ----------
(In thousands)
Balance, beginning of year $ 2,214 $ 1,653 $ 1,307
Provision charged to operations 35 504 536
Losses charged to allowance (17) (9) (195)
Recoveries 124 66 5
---------- ---------- ----------
Balance, end of year $ 2,356 $ 2,214 $ 1,653
========== ========== ==========
There were no loans considered impaired at December 31, 2005 and 2004.
The average recorded investment in impaired loans for the years ended
December 31, 2005, 2004 and 2003 was $0, $0 and $67,000, respectively.
The Company did not recognize any interest income on impaired loans
during 2005, 2004 and 2003.
There were no nonaccrual loans and no interest foregone on nonaccrual
loans at December 31, 2005, 2004 and 2003.
Salaries and employee benefits totaling $263,000, $208,000 and $223,000
have been deferred as loan origination costs for the years ended
December 31, 2005, 2004 and 2003, respectively.
5. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
December 31,
-------------------------
2005 2004
---------- ----------
(In thousands)
Land $ 3,307 $ 3,307
Buildings and improvements 4,806 4,790
Furniture, fixtures and equipment 4,774 4,404
Leasehold improvements 1,186 1,184
Construction in progress 12 5
---------- ----------
14,085 13,690
Less accumulated depreciation
and amortization (4,574) (3,942)
---------- ----------
$ 9,511 $ 9,748
========== ==========
Depreciation and amortization included in occupancy, furniture and
equipment expense totaled $632,000, $529,000 $495,000 for the years
ended December 31, 2005, 2004 and 2003, respectively.
20
6. INTEREST-BEARING DEPOSITS
Interest-bearing deposits consisted of the following:
December 31,
-------------------------
2005 2004
---------- ----------
(In thousands)
Savings $ 6,307 $ 7,041
Money market 89,095 78,124
NOW accounts 15,827 15,880
Time, $100,000 or more 61,180 41,001
Other time 32,008 29,735
---------- ----------
$ 204,417 $ 171,781
========== ==========
Aggregate annual maturities of time deposits are as follows (in
thousands):
Year Ending
December 31,
----------
2006 $ 91,120
2007 1,108
2008 245
2009 572
2010 143
----------
$ 93,188
==========
Interest expense recognized on interest-bearing deposits consisted of
the following:
Year Ended December 31,
----------------------------------------
2005 2004 2003
---------- ---------- ----------
(In thousands)
Savings $ 36 $ 20 $ 14
Money market 2,147 805 350
NOW accounts 237 139 53
Time, $100,000 or more 1,248 899 1,052
Other time 942 701 924
---------- ---------- ----------
$ 4,610 $ 2,564 $ 2,393
========== ========== ==========
7. OTHER BORROWINGS
The Company has unsecured short-term borrowing arrangements totaling
$7,000,000 with three of its correspondent banks. There were no
borrowings outstanding under these arrangements at December 31, 2005
and 2004.
Additionally, the Company has a borrowing arrangement with the Federal
Reserve Bank secured by investment securities with amortized costs
totaling $8,548,000 and $3,835,000 and estimated fair values totaling
$8,510,000 and $3,832,000 at December 31, 2005 and 2004, respectively.
At December 31, 2005 and 2004, the Company had no outstanding
borrowings under this arrangement.
21
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 $11,809,000 as of
December 31, 2005 based on specific percentages of the collateral
pledged. For the years ended December 31, 2005 and 2004, various
residential mortgage loans totaling approximately $8,488,000 and
$8,388,000 and investment securities totaling approximately $6,659,000
and $11,768,000, respectively, secured this borrowing arrangement. The
following table represents the Company's total other borrowings for the
periods indicated:
December 31,
-------------------------
2005 2004
---------- ----------
(In thousands)
FHLB, interest at 4.43%, matured February 13, 2006 $ 4,000 $ 4,000
========== ==========
8. SUBORDINATED DEBENTURES
The following is a summary of the subordinated debentures payable to
the Company's subsidiary grantor trusts at December 31, 2005 and 2004
(dollars in thousands):
December 31,
-------------------------
2005 2004
---------- ----------
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 (6.72% at December 31, 2005), 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% (6.48% at December 31, 2005),
and redeemable with no premium beginning March 17, 2009
and due March 17, 2034 3,609 3,609
---------- ----------
$ 8,764 $ 8,764
========== ==========
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, 2005, $7,124,000 of the trust preferred securities
qualified as Tier 1 capital and $1,376,000 qualified as Tier 2 capital.
22
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, 2005, 2004 and 2003 related to the
subordinated debentures was $527,000, $366,000 and $239,000,
respectively. The amount of deferred costs was $151,000 at December 31,
2005.
9. INCOME TAXES
The provision for income taxes for the years ended December 31, 2005,
2004 and 2003 consisted of the following:
Federal State Total
---------- ---------- ----------
(In thousands)
2005
----
Current $ 2,040 $ 687 $ 2,727
Deferred (108) (23) (131)
---------- ---------- ----------
Provision for income taxes $ 1,932 $ 664 $ 2,596
========== ========== ==========
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
========== ========== ==========
Deferred tax assets (liabilities) consisted of the following:
December 31,
-------------------------
2005 2004
---------- ----------
(In thousands)
Deferred tax assets:
Allowance for loan losses $ 841 $ 872
Future benefit of state tax deduction 234 215
Organization costs 19 21
Deposit purchase premium 46 36
Mark-to-market adjustment 10 11
Deferred compensation 237 150
Litigation reserve 82
Unrealized losses on available-for-sale
investment securities 62
---------- ----------
Total deferred tax assets 1,531 1,305
========== ==========
23
9. INCOME TAXES (Continued)
December 31,
-------------------------
2005 2004
---------- ----------
(In thousands)
Deferred tax liabilities:
Future federal liability of state deferred
tax asset $ (88)
Bank premises and equipment $ (86) (29)
Goodwill (33) (7)
Unrealized gain on available-for-sale
investment securities (30)
Prepaid expense (44)
Other accruals (7)
---------- ----------
Total deferred tax liabilities (163) (161)
---------- ----------
Net deferred tax assets $ 1,368 $ 1,144
========== ==========
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, 2005, 2004 and 2003 consisted of the
following:
2005 2004 2003
---------- ---------- ----------
Federal income tax, at statutory rate 34.0% 34.0% 34.0%
State franchise tax, net of Federal tax effect 6.3% 7.2% 6.0%
Tax exempt investment security income, net (0.8)% (1.1)% (1.9)%
Company owned life insurance, net (0.9)% (1.5)%
Other (0.8)% 1.0% (0.3)%
---------- ---------- ----------
Effective tax rate 37.8% 39.6% 37.8%
========== ========== ==========
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.
24
10. COMMITMENTS AND CONTINGENCIES (Continued)
Leases (Continued)
------
Future minimum lease payments are as follows (in thousands):
Year Ending
December 31,
------------
2006 $ 364
2007 463
2008 474
2009 486
2010 283
2011 and thereafter 1,758
------------
$ 3,828
============
Rental expense included in occupancy, furniture and equipment expense
totaled $276,000, $236,000 and $267,000 for the years ended December
31, 2005, 2004 and 2003, 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 $2,619,000 and $1,364,000 as
of December 31, 2005 and 2004, respectively.
Correspondent Banking Agreements
--------------------------------
The Company maintains funds on deposit with other federally insured
financial institutions under correspondent banking agreements.
Uninsured deposits totaled $12,483,000 at December 31, 2005.
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,
-------------------------
2005 2004
---------- ----------
(In thousands)
Commitments to extend credit $ 112,066 $ 41,868
Standby letters of credit $ 2,318 $ 498
25
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, 2005 and 2004. The
Company recognizes these fees as revenue over the term of the
commitment or when the commitment is used.
At December 31, 2005, commercial loan commitments represent
approximately 36% of total commitments and are generally secured by
various assets of the borrower. Real estate loan commitments represent
approximately 60% 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 4% 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. At December 31, 2005,
approximately 18% of the Company's loans are for general commercial
uses, including professional, retail and small business, and 7% are for
agricultural uses. Additionally, 18% of the Company's loans are for the
construction of residential and commercial real estate and 52% 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 6% 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.
26
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. In addition, the Company's ability to pay
dividends is subject to certain covenants contained in the indentures
related to the trust preferred securities issued by the Trusts.
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,
2005, Bank retained earnings of $9,508,000 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,
----------------------------------------
2005 2004 2003
---------- ---------- ----------
(In thousands, except share and
per share amounts)
Basic Earnings Per Share
------------------------
Numerator:
Net income $ 4,286 $ 3,169 $ 2,053
Denominator:
Weighted average shares outstanding 3,473,511 3,432,023 3,362,076
---------- ---------- ----------
Basic earnings per share $ 1.23 $ 0.92 $ 0.61
========== ========== ==========
27
11. SHAREHOLDERS' EQUITY (Continued)
Earnings Per Share (Continued)
------------------
Year Ended December 31,
----------------------------------------
2005 2004 2003
---------- ---------- ----------
(In thousands, except share and
per share amounts)
Diluted Earnings Per Share
--------------------------
Numerator:
Net income $ 4,286 $ 3,169 $ 2,053
Denominator:
Weighted average shares outstanding 3,473,511 3,432,023 3,362,076
Effect of dilutive stock options 433,493 341,150 119,694
---------- ---------- ----------
Weighted average shares of common
stock and common stock equivalents 3,907,004 3,773,173 3,481,770
---------- ---------- ----------
Diluted earnings per share $ 1.10 $ 0.84 $ 0.59
========== ========== ==========
All of the stock options outstanding were included in the computation
of diluted earnings per share for the years ended December 31, 2005,
2004 and 2003 as none of the stock options were antidilutive.
Stock Options
-------------
At December 31, 2005, 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,
2005, 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.
28
11. SHAREHOLDERS' EQUITY (Continued)
Stock Options (Continued)
-------------
A summary of the activity within the plans adjusted to give effect to
stock splits follows:
2005 2004 2003
---------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ------------ ------------ ------------ ------------ ------------
Incentive Agreements
- --------------------
Options outstanding,
beginning of year 528,810 $ 6.23 587,696 $ 5.90 340,120 $ 2.52
Options granted -- 387,500 $ 7.50
Options exercised (45,560) $ 3.93 (58,886) $ 2.96 (95,724) $ 1.61
Options canceled (23,000) $ 5.19 -- (44,200) $ 3.15
------------ ------------ ------------
Options outstanding,
end of year 460,250 $ 6.52 528,810 $ 6.23 587,696 $ 5.90
============ ============ ============
Options exercisable,
end of year 223,330 $ 5.84 174,648 $ 4.78 114,036 $ 2.34
============ ============ ============
Nonstatutory Agreements
- -----------------------
Options outstanding,
beginning of year 400,000 $ 7.50 411,500 $ 7.31 29,076 $ 1.14
Options granted -- 400,000 $ 7.50
Options exercised (20,200) $ 7.50 (11,500) $ 1.00 (17,576) $ 1.25
------------ ------------ ------------
Options outstanding,
end of year 379,800 $ 7.50 400,000 $ 7.50 411,500 $ 7.31
============ ============ ============
end of year 151,920 $ 7.50 80,000 $ 7.50 11,500 $ 1.00
============ ============ ============
29
11. SHAREHOLDERS' EQUITY (Continued)
Stock Options (Continued)
-------------
A summary of options outstanding at December 31, 2005 follows:
Number of Weighted Number of
Options Average Options
Outstanding Remaining Exercisable
December 31, Contractual December 31,
Range of Exercise Prices 2005 Life 2005
------------------------ ------------- ------------- -------------
Incentive
---------
$ 2.13 10,000 1.0 years 10,000
$ 2.22 10,000 1.5 years 10,000
$ 2.19 4,000 2.7 years 4,000
$ 1.27 1,000 2.3 years 1,000
$ 2.20 14,600 4.0 years 14,600
$ 2.59 7,600 4.6 years 7,600
$ 3.75 45,900 6.0 years 27,540
$ 3.73 8,650 6.2 years 5,190
$ 7.50 358,500 7.8 years 143,400
------------- -------------
460,250 223,330
============= =============
Nonstatutory
------------
$ 7.50 379,800 7.8 years 151,920
============= =============
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, 2005 and 2004.
30
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, 2005 that management believes have changed the
Bank's category.
To Be Well Capitalized
For Capital Under Prompt Corrective
Adequacy Purposes Action Provisions
Actual ---------------------- ----------------------
--------------------- Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
---------- --------- ---------- --------- ---------- ---------
(Dollars in thousands)
December 31, 2005
-----------------
Company:
Total capital (to risk-
weighted assets) $ 31,650 11.9% $ 21,268 8.0% N/A N/A
Tier 1 capital (to risk-
weighted assets) $ 27,654 10.4% $ 10,634 4.0% N/A N/A
Tier 1 capital (to average
assets) $ 27,654 9.2% $ 12,067 4.0% N/A N/A
Bank:
Total capital (to risk-
weighted assets) $ 29,933 11.5% $ 20,865 8.0% $ 26,082 10.0%
Tier 1 capital (to risk-
weighted assets) $ 27,577 10.6% $ 10,433 4.0% $ 15,649 6.0%
Tier 1 capital (to average
assets) $ 27,577 9.1% $ 12,067 4.0% $ 15,083 5.0%
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%
12. OTHER EXPENSES
Other expenses consisted of the following:
Year Ended December 31,
------------------------------------
2005 2004 2003
---------- -------- ----------
(In thousands)
Professional fees $ 397 $ 316 $ 480
Appraisal fees 255 253 32
Directors fees 259 190 177
Postage, stationery and supplies 196 159 212
Telephone 190 152 157
Data processing 243 102 19
Advertising and promotion 127 74 98
Other operating expenses 1,245 1,151 1,079
---------- -------- ----------
$ 2,912 $ 2,397 $ 2,254
========== ======== =========
31
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, 2005 $ 2,982
Disbursements 652
Amounts repaid (1,745)
----------
Balance, December 31, 2005 $ 1,889
==========
Undisbursed commitments to related
parties, December 31, 2005 $ 2,541
==========
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 $30,000, $45,000 and
$41,000 for the years ended December 31, 2005, 2004 and 2003,
respectively.
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
based on a 7% discount rate. The expense recognized under these plans
for the years ended December 31, 2005 and 2004 totaled $242,000 and
$334,000, respectively. Accrued compensation payable under the plans
totaled $576,000 and $334,000 at December 31, 2005 and 2004,
respectively.
In connection with these plans, the Company purchased single premium
life insurance policies with cash surrender values totaling $4,411,000
at December 31, 2005. Income earned on these policies, net of expenses,
totaled $(61,380), $188,000 and $58,000 for the years ended December
31, 2005, 2004 and 2003, respectively. Income earned on these policies
is not subject to Federal or state income tax under certain
circumstances.
32
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, 2005, 2004 and 2003, the Company held securities
classified as available-for-sale which had net unrealized gains or
losses as follows:
2005 2004 2003
---------- ---------- ----------
(In thousands)
Other comprehensive (loss) income:
Unrealized holding (losses) gains $ (233) $ (26) $ 102
Tax benefit (expense) on unrealized
holding gains 93 6 (36)
---------- ---------- ----------
Net unrealized holding (losses) gains (140) (20) 66
---------- ---------- ----------
Less: reclassification adjustment for gains
included in net income -- -- 2
Tax benefit on reclassification adjustment -- -- (1)
---------- ---------- ----------
Net reclassification adjustment -- -- 1
---------- ---------- ----------
Total other comprehensive (loss) income $ (140) $ (20) $ 65
========== ========== ==========
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, 2005 and 2004:
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.
33
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. The carrying amount of
accrued interest payable approximates its fair value.
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.
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, 2005 December 31, 2004
------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ---------- ---------- ----------
(In thousands)
Financial assets:
Cash and due from banks $ 14,453 $ 14,453 $ 12,108 $ 12,108
Federal funds sold 4,667 4,667
Interest-bearing deposits
in banks 6,100 6,100
Investment securities 28,539 28,539 17,482 17,482
Loans, net 241,556 239,629 199,535 199,574
Company owned life
insurance 4,411 4,411 4,246 4,246
Accrued interest receivable 1,890 1,890 1,249 1,249
Other investments 1,229 1,229 1,000 1,000
Financial liabilities:
Deposits $ 273,074 $ 272,362 $ 223,761 $ 227,400
Other borrowings 4,000 4,000 4,000 4,050
Subordinated debentures 8,764 8,764 8,764 8,764
Accrued interest payable 810 810 337 337
Off-balance-sheet financial
instruments (notional amount):
Commitments to extend credit $ 112,066 $ 112,066 $ 41,868 $ 41,868
Standby letters of credit 2,318 2,318 498 498
34
17. PARENT ONLY CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEET
December 31, 2005 and 2004
(In thousands)
2005 2004
---------- ----------
ASSETS
Cash and cash equivalents $ 2 $ 7
Investment in bank subsidiary 28,420 24,370
Investment in Pacific State Statutory Trust I and II 264 264
Investment in other securities 204 204
Other assets 1,267 769
---------- ----------
Total assets $ 30,157 $ 25,614
========== ==========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Liabilities:
Subordinated debentures $ 8,764 $ 8,764
Other liabilities 20 20
---------- ----------
Total liabilities 8,784 8,784
---------- ----------
Shareholders' equity:
Common stock 7,556 7,159
Retained earnings 13,912 9,626
Accumulated other comprehensive (loss) income, net of taxes (95) 45
---------- ----------
Total shareholders' equity 21,373 16,830
---------- ----------
Total liabilities and shareholders' equity $ 30,157 $ 25,614
========== ==========
35
17. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF INCOME
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands)
2005 2004 2003
---------- ---------- ----------
Income:
Dividends declared by bank subsidiary $ 550 $ 395 $ 350
Interest on investment securities 5 5 4
Earnings from investment in Pacific
State Statutory Trust I 7 8
---------- ---------- ----------
Total income 562 400 362
Expenses:
Interest on subordinated debentures 527 366 239
Salaries and employee benefits 70 70 68
Professional 76 60 61
Other expenses 99 92 64
---------- ---------- ----------
Total expenses 772 588 432
---------- ---------- ----------
Loss before equity in undistributed income
of subsidiary (210) (188) (70)
Equity in undistributed income of subsidiary 4,190 3,135 1,950
---------- ---------- ----------
Income before income tax benefit 3,980 2,947 1,880
Income tax benefit (306) (222) (173)
---------- ---------- ----------
Net income $ 4,286 $ 3,169 $ 2,053
========== ========== ==========
36
17. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF CASH FLOWS
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands)
2005 2004 2003
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 4,286 $ 3,169 $ 2,053
Adjustments to reconcile net income to net
cash used in operating activities:
Undistributed net income of subsidiary (4,190) (3,135) (1,950)
Increase in other assets (498) (224) (184)
(Decrease) increase in other liabilities (1) 18
---------- ---------- ----------
Net cash used in operating activities (402) (191) (63)
Cash flows from investing activities:
Investment in bank subsidiary (3,500)
Investment in Pacific State Statutory
Trust II (109)
---------- ---------- ----------
Investment in other securities
Net cash used in investing activities (3,609)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of junior
subordinated debentures 3,609
Proceeds from exercise of stock options 409 183 176
Repurchase of common stock (12) (170)
---------- ---------- ----------
Net cash provided by financing
activities 397 3,792 6
Decrease in cash and cash equivalents (5) (8) (57)
Cash and cash equivalents at beginning
of year 7 15 72
---------- ---------- ----------
Cash and cash equivalents at end of year $ 2 $ 7 $ 15
========== ========== ==========
Non-cash investing activities:
Net change in unrealized gain on
available-for-sale investment securities $ (232) $ (26) $ 100
Non-cash financing activities:
Tax benefit from stock options exercised $ 79 $ 39 $ 16
37
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 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.
38
GENERAL DESCRIPTION OF BUSINESS
Pacific State Bancorp is a holding company with one bank subsidiary, Pacific
State Bank, (the "Bank"), and two unconsolidated subsidiary grantor trusts,
Pacific State Statutory Trusts I and II. Pacific State Bancorp commenced
operations on June 24, 2002 when it acquired all the 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 formed November 2, 1987.
The Bank is a member of the Federal Reserve System. The Bank's primary source of
revenue is providing loans to customers who are small to middle-market
businesses and middle-income individuals. Pacific State Statutory 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 conducts 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, 2006 had 82 employees, including 36
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 Administrative Office located at 1899 W.
March Lane, in Stockton, California; additional branches are located in downtown
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. The bank plans to open it's 8th branch in Lodi,
California, mid-year 2006.
Effective July 12, 2005, Pacific State Bancorp common stock began
trading on the Nasdaq(TM) National Market under the symbol of "PSBC". Previously
the Company' common stock was traded on the OTC Bulletin Board under the same
symbol.
Business Plan
-------------
The focus of the Company's business plan is to attract "Business
Relationship" small, medium and large 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 full 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, manufacturing, agricultural 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
39
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 included with this report.
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, agriculture 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, First Tennessee Bank in Memphis, Tennessee, Bank of
the West in Walnut Creek, California, U. S. Bank, Minneapolis, Minnesota, 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,
FSA, 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.
40
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 has applied Accounting Principles Board ("APB") opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations to
account for its stock option plan awards. Commencing January 1, 2006, the
Company was required to adopt Statement of Financial Accounting Standard
("SFAS") No. 123(R), "Share Based Payment"; see information under the header
"Share Based Payments" in Note 2 to the consolidated financial statements
included with this report. Other estimates that we use are related to the
expected useful lives of our depreciable assets and in determining whether any
impairment exists related to our investments and intangible and other long-lived
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. If different estimates that the company reasonably could have
used for the accounting estimate in the current period were made, or if changes
in the accounting estimate that are reasonably likely to occur from period to
period occurred, they could 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
The company applies APB No. 25, to account for its stock option awards
plans. As a result, 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
41
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 under APB
No. 25 for the stock options granted under the company's plan.
Results of Operation
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Net income for the year ended December 31, 2005, was $4,286,000
representing an increase of $1,117,000 or 35.24% over net income of $3,169,000
for the year ended December 31, 2004. The primary contributing factor to the
increase in net income was an increase in net interest income of $3,085,000 as a
result of an increase in both the volume of average earning assets, offset by
the increase in average interest bearing liabilities, and an increase in the net
interest margin. This was offset by an increase in non interest expense of
$1,681,000 and a slight decrease in non interest income of $44,000. The increase
in non interest expenses was primarily due to an increase in salaries and
employee benefits of $928,000 and in other expenses of $515,000.
Return on average assets (ROA) improved to 1.53% and return on average
common equity (ROE) improved to 22.98% in 2005 compared with 1.37% and 21.65%,
respectively, in 2004. Diluted earnings per share for 2005 and 2004 were $1.10
and $0.84, respectively, an increase of 30.95%. The increase in earnings per
share is primarily due to the increase in net income of 35.24%.
The Company's average total assets increased to $280.3 million in 2005
or 21.45% over $230.8 million in 2004. In 2005 average earning assets increased
to $250.1 million or 22.90% over $203.5 million in 2004. Average interest
bearing liabilities increased to $201.6 million or 20.79% over $166.9 million in
2004.
The Company's total assets increased to $309.6 million as of December
31, 2005 or 21.70% over $254.4 million at December 31, 2004. Total loans
increased to $243.9 million from $201.7 million in 2004, an increase of $42.2
million or 20.92%. Total Deposits grew to $273.0 million, or 21.98%, compared to
$223.8 million in 2004. The increases on the balance sheet are attributable to
the growth of the bank.
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.
42
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.
43
The Company's total assets increased to $254.4 million or 26.63% 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.
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 $3.1 million or 29.81% to $13.5 million
in 2005 from $10.4 million in 2004 and $2.1 million or 25.1% in 2004 from $8.3
million in 2003. The average balance of total earning assets for 2005, increased
$46.6 million or 22.90% to $250.1 million from $203.5 million. Average loan
balances outstanding during 2005 increased $35.3 million or 19.58%, while
average balances of investments, federal funds sold and interest bearing
deposits in banks increased by $11.3 million or 49.12%. The average yields on
loans in 2005 increased by 103 basis points. The average yield on investments,
federal funds sold and interest bearing deposits increased 67 basis points in
2005 compared to 2004. The increase in yields is directly attributable to
increases in the prime rate during 2005. During 2005, the prime rate increased
eleven times from 5.25% to 7.25%. As a result, the overall yield on average
earning assets during 2005 increased 87 basis points to 7.51% from 6.64% for
2004.
Total interest expense increased $2.2 million or 70.97% to $5.3
million in 2005, from $3.1 million for 2004 and $0.3 million or 10.71% over $2.8
million for 2003. In 2005 the average balance of interest-bearing liabilities
increased $34.7 million or 20.79% to $201.6 million from $166.9 million for the
year ended December 31, 2004. Additionally, the average rate paid on
interest-bearing liabilities increased 77 basis points to 2.60% from 1.83% in
2004. In 2004 interest expense increased primarily due to the increase in
average balances of interest-bearing liabilities of $24.4 million or 17.2% to
$166.9 million from $142.5 million for the year ended December 31, 2004. This
increase was mitigated by a slight decrease in the rates paid on interest
bearing liabilities.
Average interest-bearing demand deposits increased $43.1 million or
69.74% to $104.9 million in 2005 from $61.8 million in 2004. The average rate
paid on these deposits during 2005 increased 64 basis points. Average
certificates of deposit decreased $7.9 million or 9.24% to $77.6 million in 2005
from $85.5 million in 2004. The average rate paid on certificates of deposit
during 2005 increased 95 basis points. As a result of the overall changes in the
mix of interest-bearing deposits, the average rate paid on all interest bearing
deposits and borrowings increased 77 basis points to 2.60% from 1.83% for 2004.
The Company's net interest margin (net interest income divided by
average earning assets) was 5.41% in 2005, up from 5.14% in 2004 and 4.85% in
2003. The increases in both the volume of and yields on earning assets, coupled
with stable funding sources and change in mix of and rates paid on
interest-bearing liabilities resulted in an increase of $3.1 million or 29.81%
in net interest income for the year ended December 31, 2005 compared to 2004.
For the year ended December 31, 2004 compared to 2003, the combined effect of
the increase in volume of and 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 over 2003.
44
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.
Average Balances, Interest Income/Expense and Yields/Rates Paid
(Dollars in thousands)
Years Ended December 31,
2005 2004 2003
=================================================================================================================================
Average Interest Average Average Interest Average Average Interest Average
Balance Income / Yield/Rate Balance Income / Yield/Rate Balance Income / Yield/Rate
Expense Expense Expense
Assets
Loans(1) $ 215,907 $ 17,565 8.14% $ 180,559 $ 12,846 7.11% $ 151,529 $ 10,578 6.98%
- ---------
Investment
Securities 19,694 707 3.59% 15,068 535 3.55% 13,570 464 3.42%
Federal Funds
Sold 11,169 354 3.17% 6,775 93 1.37% 6,952 75 1.08%
Interest-bearing
Deposits in Banks 3,299 156 4.73% 1,066 35 3.28% -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Total Average
Earning Assets $ 250,069 $ 18,782 7.51% $ 203,766 $ 13,509 6.64% $ 172,051 $ 11,117 6.46%
---------- ---------- ---------- ---------- ---------- ---------- ----------
Cash & Due From
Banks $ 14,474 $ 11,579 $ 9,129
Bank Premises and
Equipment 9,581 9,599 7,689
Other Assets 8,511 8,066 4,101
Less: Allowance for
loan loss (2,346) (1,961) (1,476)
---------- ---------- ----------
Total Average
Assets $ 280,289 $ 230,751 $ 191,494
========== ========== ==========
Liabilities and
Shareholders
Equity
Interest Bearing
Liabilities:
Interest-bearing
Demand $ 104,922 $ 2,384 2.27% $ 61,801 $ 944 1.53% $ 51,370 $ 403 0.78%
Savings 6,307 36 0.57% 6,606 20 0.30% 5,473 14 0.26%
Time Deposits 77,567 2,190 2.82% 85,548 1,600 1.87% 75,549 1,976 2.61%
Other Borrowings 12,845 636 4.95% 12,958 494 3.81% 10,080 368 3.65%
---------- ---------- ---------- ---------- ---------- ----------
Total Average
Interest Bearing
Liabilities $ 201,641 $ 5,246 2.60% $ 166,913 $ 3,058 1.83% $ 142,472 $ 2,761 1.94%
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Non-interest
Bearing Demand 59,009 47,969 36,436
Other Liabilities 986 1,233 408
Shareholder Equity 18,653 14,636 12,178
---------- ---------- ----------
Total Average
Liabilities and
Shareholders Equity $ 280,289 $ 230,751 $ 191,494
========== ========== ==========
Net Interest Income
and Net Interest
Margin $ 13,536 5.41% $ 10,451 5.14% $ 8,356 4.85%
========== ========== ==========
(1) Interest income and yields on loans includes fee income of $1,680,000,
$1,112,000 and $546,000 for the years ended December 31, 2005, 2004 and
2003, respectively. The Company did not have any non accrual loans for
the years ended December 31, 2005, 2004 and 2003.
45
The Company's average total assets increased to $280.3 million in 2005
from $230.8 million in 2004 and $191.5 million in 2003, representing a 21.4%
increase in 2005 over 2004 and a 20.5% increase in 2004 over 2003. Average loans
increased to $215.9 million in 2005 from $180.6 million in 2004 and $151.5
million in 2003 representing a 19.5% and 19.2% increase respectively. The
Company's average total interest bearing liabilities increased to $201.6 million
in 2005 from $166.9 million in 2004 and $142.5 million in 2003, representing a
20.8% and 17.1% increase respectively. The Company's average non-interest
bearing demand deposits increased to $59.0 million in 2005 from $48.0 million in
2004 and $36.4 million in 2003, representing a 22.9% and 31.9% 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.
Analysis of Changes in Net Interest Income and Expense
------------------------------------------------------
Years ended December 31,
(Dollars in thousands) 2005 over 2004 2004 over 2003
==================================================================================================================================
Average Average Mix (3) Average Average Mix (3)
Volume Rate Total Volume Rate Total
(1) (2) (1) (2)
Increase (Decrease)
In Interest Income:
- ------------------
Loans $ 2,515 $ 1,843 $ 361 $ 4,719 $ 2,027 $ 203 $ 38 $ 2,268
Investment securities 164 6 2 172 51 18 2 71
Federal Funds sold 60 122 79 261 (2) 20 18
Interest-bearing Deposits
in Banks 73 15 32 121 35 -- 35 35
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total Increase (Decrease) $ 2,813 $ 1,986 $ 474 $ 5,273 $ 2,076 $ 241 $ 75 $ 2,392
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Increase (Decrease)
In Interest Expense:
Interest-bearing Demand $ 659 $ 459 $ 322 $ 1,440 $ 82 $ 382 $ 77 $ 541
Savings (1) 18 (1) 16 3 3 6
Time Deposits (149) 815 (76) 590 262 (564) (74) (376)
Other Borrowings (4) 148 (2) 142 105 16 5 126
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total Increase (Decrease) $ 505 $ 1,440 $ 243 $ 2,188 $ 452 $ (163) $ 8 $ 297
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net Increase (Decrease) $ 2,308 $ 547 $ 231 $ 3,085 $ 1,624 $ 404 $ 67 $ 2,095
========== ========== ========== ========== ========== ========== ========== ==========
==================================================================================================================================
(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.
46
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, 2005, non-interest income represented 11.67% of the
Company's revenues versus 15.75% in 2004, and 15.10% in 2003.
Total non-interest income decreased slightly to $2.48 million in 2005
from $2.53 million in 2004 and $2.0 million in 2003, representing a decrease of
2.0% and an increase of 27.7% respectively. Service charge income decreased $317
thousand in 2005 or 29.5% to $758 thousand, down from $1.07 million for the
comparable period in 2004. The decrease in service charge income is the result
of (1) the higher earnings rate used to offset fees paid on accounts charged
through account analysis and (2) a decrease in the volume of account overdrafts.
The decrease in service charges was offset by an increase in gain on sales of
loans of $364 thousand or 81.8%. The increase in the gain on sale of loans is
due to the timing of the sale of the loans as well as the increase in the number
and dollar amount of loans sold. The increase in 2004 over 2003 is a result of
the 54.9% increase in service charge income from the implementation of new
overdraft protection product and an increase of 62.6% in other income. Other
income includes a 220% increase in Bank Owned Life Insurance income as well as
fees collected from brokering mortgage loans. This was 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)
===============================================================================================
2005 2004 2003
Non-interest Income:
Service Charges $ 758 $ 1,075 $ 694
Rental Income from Other Real Estate 10 9 15
Gain on Sale of Loans 809 445 664
Gain on Sale of Investment Securities -0- -0- 2
Other Income 904 996 603
---------- ---------- ----------
Total Non-interest Income $ 2,481 $ 2,525 $ 1,978
========== ========== ==========
===============================================================================================
Non-interest Expense
--------------------
Non-interest expense consists of salaries and related employee
benefits, occupancy and equipment expenses, professional fees, appraisal fees,
directors' fees, postage, stationery and supplies expenses, telephone expenses,
data processing expenses, advertising and promotion expense and other operating
expenses. Non-interest expense for 2005 was $9.10 million compared to $7.43
million for 2004 and $6.50 million in 2003, representing an increase of $1.67
million or 22.48% for 2005, and $.93 million or 14.31% for 2004. Increases in
salaries and benefits are indicative of the continuing additions to staff to
expand branch operations in line with their respective growth for both years.
The increase in occupancy and equipment expense is attributable to the general
47
upgrade of technology systems in both 2004 and 2005. Data Processing expense
increased $141,000 due to a full year of expense related to the 2004 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. Other expense increased during 2005 and 2004 due to
increased insurance expense associated with the growth of the company.
The following table sets forth a summary of non-interest expense for the
periods indicated.
Years Ended, December 31,
(Dollars in thousands)
==========================================================================================
2005 2004 2003
- ------------------------------------------------------------------------------------------
Non-interest Expense:
Salaries & Benefits $ 4,742 $ 3,814 $ 3,068
Occupancy & Equipment 1,446 1,218 1,176
Professional fees 397 316 480
Appraisal fees 255 253 32
Directors fees 259 190 177
Postage, stationery and supplies 196 159 212
Telephone 190 152 157
Data Processing 243 102 19
Advertising and promotion 127 74 98
Other operating expenses 1,245 1,151 1,079
---------- ---------- ----------
Total Non-Interest Expenses $ 9,100 $ 7,429 $ 6,498
========== ========== ==========
==========================================================================================
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.
(Dollars in thousands) Years Ended December 31,
================================================================================
2005 2004 2003
- --------------------------------------------------------------------------------
Tax Provision $ 2,596 $ 1,874 $ 1,247
Effective Tax Rate 37.8% 39.6% 37.8%
================================================================================
48
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.
Investment securities held-to-maturity at December 31, 2005, consisted
of mortgage-backed securities totaling $123,000 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, 2005. The yield on tax-exempt securities
has not been adjusted to a tax-equivalent yield basis.
(Dollars in thousands)
Within One One to Five Five to Ten
Year Years Years Over Ten Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
Available-for-sale
securities:
US Gov't & Agencies $ 11,869 3.57% $ 2,983 4.32% $ 14,852 3.72%
Municipal Obligations 364 3.25% 407 3.62% $ 2,094 4.38% 2,865 4.21%
Corporate and Other Bonds 999 4.25% 309 5.21% 2,017 4.34% 3,325 4.40%
Mortgage- backed
securities -- -- 2,152 3.66% $ 975 3.42% 4,247 4.77% 7,374 4.27%
-------- -------- -------- -------- --------
Total available-for-sale
securities 13,232 3.17% 5,851 3.87% 975 3.42% 8,358 4.69% 28,416 3.77%
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Held-to-maturity
Securities
Mortgage-backed
securities $ 123 6.55% $ 123 6.55%
======== ======== ======== ========
49
The following table summarizes the carrying value of the Company's investment
securities held on the dates indicated.
(Dollars in thousands) Years Ended December 31
====================================================================================
2005 2004 2003
------------------------------------------------------------------------------------
Available-for-sale Securities - at fair
value:
U.S. Government & Agencies $ 14,852 $ 5,956 $ 3,027
Municipal Obligations 2,865 3,153 5,292
Corporate and Other Bonds 3,325 306 1,252
Mortgage- backed securities 7,374 7,922 1,760
---------- ---------- ----------
Total available-for-sale $ 28,416 $ 17,337 $ 11,331
========== ========== ==========
Held-to-maturity Securities - at
amortized cost:
Mortgage-backed Securities $ 123 $ 145 $ 181
---------- ---------- ----------
====================================================================================
As of December 31, 2005, 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.
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,
--------------------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
---------- ---------- ---------- ---------- ----------
Commercial and Agricultural $ 60,645 $ 55,569 $ 57,638 $ 40,226 $ 34,079
Real estate-construction 43,352 22,965 28,219 33,887 23,561
Real estate-commercial mortgage 126,166 109,895 60,174 53,160 36,831
Installment 13,536 13,121 10,823 7,734 3,493
Deferred Loan Fees and Costs 213 199 284 265 317
Allowance for Loan Losses (2,356) (2,214) (1,653) (1,306) (1,172)
---------- ---------- ---------- ---------- ----------
Total Net Loans $ 241,556 $ 199,535 $ 155,485 $ 133,966 $ 97,109
========== ========== ========== ========== ==========
==============================================================================================================
50
Net loans have increased $42.0 million or 21.1%, to $241.5 million at
December 31, 2005 from $199.5 million at December 31, 2004. Comparing 2005 to
2004 commercial and agricultural loans have increased $5.1 million or 8.9%, real
estate construction projects have increased $20.4 million or 80.9%, real estate
commercial loans have increased by $16.3 million or 14.8% and installment loans
have increased by $415 thousand or 3.2% over 2004. The portfolio mix has changed
in 2005 as compared with the mix of the previous year with commercial and
agricultural loans decreasing to 25.1% of total loans compared to 27.8% in 2004,
of total loans, real estate construction loans increasing to 17.9% compared to
11.5% in 2004, real estate - commercial mortgage loans decreasing to 52.2%,
compared to 55.1% and installment loans decreasing to 5.6% compared to 6.6% in
2004. The shift in the mix reflects the changes in lending needs within the
Company's service area. The overall change in the mix of the loan portfolio did
not significantly impact the overall risk profile in the our loan portfolio.
The following table sets forth the maturity distribution of the
Company's commercial and agricultural loans and construction loans outstanding
as of December 31, 2005, which, based on remaining scheduled repayments of
principal, were due within the periods indicated.
(Dollars in thousands)
================================================================================================================
Within One After One through After Five Years Total
Year Five Years
- ----------------------------------------------------------------------------------------------------------------
Commercial and agricultural
loans $ 37,918 $ 15,324 $ 7,403 $ 60,645
Construction Loans 42,515 483 354 43,352
------------ ------------ ------------ ------------
Total $ 80,433 $ 15,807 $ 7,757 $ 103,997
============ ============ ============ ============
Loans due after one year
with:
Fixed Rates $ 6,947 $ 626 $ 7,573
Variable Rates $ 8,860 $ 7,131 $ 15,991
================================================================================================================
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,
=================================================================================================
2005 2004 2003 2002 2001
-------------------------------------------------------------------------------------------------
Nonaccrual loans $ -- $ -- $ -- $ 199 $ 585
90 days past due and still accruing
interest -- -- -- -- --
Other Real Estate Owned -- -- -- 49 182
=================================================================================================
51
The Company did not have any nonaccrual loans at December 31, 2005 or
2004. At December 31, 2005, the Company has not identified any potential problem
loans that would result in those 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 probable loss characteristics of the loan portfolio
including the concentrations, nature and 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.
52
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.
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 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 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.
53
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 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,
===============================================================================================================
2005 2004 2003 2002 2001
---------------------------------------------------------------------------------------------------------------
Beginning Balance: $ 2,214 $ 1,653 $ 1,307 $ 1,172 $ 1,001
Provision for loan losses 35 504 536 286 383
Charge-offs:
Commercial (--) (9) (90) (171) (226)
Real Estate (--) (--) (--) (--)
Other (17) (--) (105) (28) (2)
---------- ---------- ---------- ---------- ----------
Total Charge-offs (17) (9) (195) (199) (228)
---------- ---------- ---------- ---------- ----------
Recoveries:
Commercial 124 66 1 -- 16
Other -- -- 4 48 --
---------- ---------- ---------- ---------- ----------
Total Recoveries 124 66 5 48 16
---------- ---------- ---------- ---------- ----------
Ending Balance 2,356 2,214 $ 1,653 $ 1,307 $ 1,172
========== ========== ========== ========== ==========
ALL to total loans 0.98% 1.10% 1.05% .97% 1.20%
Net charge-offs (recoveries) to
average loans (.01)% (.03)% .12% .13% .23%
===============================================================================================================
54
The provision for loan losses was $35,000 for 2005 compared to
$504,000 for 2004 and $536,000 in 2003. The decrease in the amount of the
provision in 2005 compared to 2004 is a direct result of the analysis of the
loan portfolio and the loan loss history of the Company. Additionally, the
Company received a large recovery in 2005 on one loan of $120,000 in the fourth
quarter of 2005. As a result of management's assessment of the overall required
level of allowance and the impact of this recovery on the allowance, the Company
reduced the provision in the fourth quarter by $175,000 resulting in the total
provision for the year of $35,000. Net charge-offs (recoveries) were $(107,000)
or .05% of average loans for 2005 compared to $(57,000) or .03% of average loans
for 2004 and $190,000 or .12% of average loans for 2003. 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 ALL by loan type
and the allocation as a percent of loans outstanding in each loan category at
the dates indicated.
(Dollars in thousands)
===============================================================================================================
2005 2004
---------------------------------------------------------------------------------------------------------------
Allowance Percent of ALL in Allowance Percent of ALL in
each category to each category to
total loans total loans
Commercial and Agricultural $ 994 1.64% $ 880 1.58%
Real estate - construction 196 0.45% 115 0.50%
Real estate - commercial 501 0.39% 422 0.38%
Installment 300 2.26% 308 2.35%
Unallocated 365 489
---------- ----------
Total $ 2,356 0.98% $ 2,214 1.10%
========== ==========
===============================================================================================================
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, 2005
Deposit Maturity Schedule
(Dollars in thousands)
=====================================================================================
Under $100,000 Over $100,000
-------------------------------------------------------------------------------------
Three Months or less $ 10,029 $ 13,471
Over three through six months 11,959 27,167
Over six through twelve months 8,772 19,722
Over twelve months 1,248 820
------------ ------------
Total $ 32,008 $ 61,180
============ ============
=====================================================================================
55
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 $37.5 million or 15.4% of
total assets at December 31, 2005, $35.6 million or 14.0% of total assets at
December 31, 2004 and $28.1 million or 14.0% of total assets at December 31,
2003. 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 processes such as interest rates, commodity
prices and equity prices. As a financial institution, the Company's market risk
arises primarily from 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 its 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.
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
56
attempt to neutralize the potential impact of changes in market interest rates.
The Company's profitability is dependent to a large extent upon its 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 from 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 of 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 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, 2005, 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 forecasted 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.
57
The following table reflects the company's projected net interest
income sensitivity analysis based on year-end data:
December 31, 2005
-------------------------------------------------------
Change in Adjusted Net Interest
Rates Income Percent change from
(in thousands) base
-------------------------------------------------------
Up 200 basis
points $ 15,651 9.05%
Up 150 basis
points 15,328 6.80%
Up 100 basis
points 15,003 4.54%
Base Scenario 14,352 0.00%
Down 100
basis points (13,714) -4.45%
Down 150
basis points (13,396) -6.66%
Down 200
basis points (13,077) -8.88%
Contractual Obligations
The following table summarizes the contractual obligations of the
Company as of December 31, 2005:
Less than More than
(in thousands) Total one year 1-3 years 3-5 years 5 years
---------- ---------- ---------- ---------- ----------
Subordinated Debentures, floating rate
of 6.72% payable June 26, 2031 $ 5,155 $ 5,155
Subordinated Debentures, floating rate
of 6.48% payable March 17, 2034 3,609 3,609
FHLB Loan fixed rate of 4.43%, payable
on February 13, 2006 4,000 $ 4,000
Operating lease obligations 3,828 364 937 1,061 $ 1,466
Salary continuation plan (1) 576 $ 576
---------- ----------
Total $ 17,168 $ 4,364 $ 937 $ 1,061 $ 10,806
========== ========== ========== ========== ==========
(1) Salary continuation plan obligations represents amount accrued as of
December 31, 2005 under the terms of the plan.
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.
58
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.
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, 2005 and 2004 the company's capital met all minimum
regulatory requirements.
As of December 31, 2005, 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,
------------ ------------
2005 2004
---- ----
Total Risk-Based Capital 11.9% 12.6%
Tier 1 Capital to Risk-Based Assets 10.4% 10.1%
Tier 1 Capital to Average Assets 9.2% 8.3%
(Leverage ratio)
Pacific State Bank December 31, December 31, To Be Well Capitalized Under
------------- ------------ ----------------------------
2005 2004 Prompt Corrective Action
---- ---- ------------------------
Total Risk-Based Capital 11.5% 12.2% > 10.00%
Tier 1 Capital to Risk-Based Assets 10.6% 11.1% > 6.00%
Tier 1 Capital to Average Assets 9.1% 9.1% > 5.00%
(Leverage ratio)
59
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.
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table presents the summary unaudited results for the
stated eight quarters:
(Dollars in thousands, except per share amounts)
2005 2004
---- ----
Net Income Per 4th 3rd 2nd 1st 4th 3rd 2nd 1st
Common Share: Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
--------- --------- --------- --------- --------- --------- --------- ---------
Diluted $ 0.28 $ 0.31 $ 0.27 $ 0.24 $ 0.21 $ 0.24 $ 0.21 $ 0.18
Basic $ 0.31 $ 0.35 $ 0.31 $ 0.27 $ 0.24 $ 0.26 $ 0.23 $ 0.19
Interest income $ 5,208 $ 5,117 $ 4,529 $ 3,928 $ 4,002 $ 3,371 $ 3,180 $ 2,956
Net interest income 3,605 3,752 3,326 2,853 3,037 2,568 2,478 2,368
Provision for loan
losses (175) 90 60 60 138 138 138 90
Total non-interest
income 538 577 597 769 536 818 700 471
Total non-interest
expense 2,521 2,361 2,186 2,032 2,110 1,840 1,774 1,705
Income before taxes 1,797 1,878 1,677 1,530 1,326 1,407 1,266 1,044
Net Income 1,083 1,198 1,057 948 841 894 776 658
60
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
---------------------------------------------------------------------
The Company's common stock is listed for trading on the Nasdaq(TM)
National Market under the symbol PSBC. Prior to July 12, 2005, trading
information regarding the common stock was available via the OTC Bulletin Board.
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. The numbers listed in this table have been adjusted for the
September 30, 2004 stock split.
Sales Price
-----------
Quarter Ended: High Low Volume
-------------- ---- --- ------
March 31, 2005 $ 20.50 $ 15.500 195,429
June 30, 2005 $ 15.50 $ 14.00 224,430
September 30, 2005 $ 20.75 $ 14.00 125,902
December 31, 2005 $ 20.10 $ 17.05 211,271
March 31, 2004 $ 10.50 $ 10.05 346,874
June 30, 2004 $ 11.35 $ 10.70 263,344
September 30, 2004 $ 12.50 $ 12.50 136,414
December 31, 2004 $ 20.50 $ 20.00 115,998
As of March 15, 2006, there were approximately 306 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, 2005, the
Bank had $9,508,000 in retained earnings available for dividends to
shareholders. In addition, the Company's ability to pay dividends is subject to
certain covenants contained in the indentures related to the trust preferred
securities issued by the Trusts.
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.
61
- -------------------------------------------------------------------------------------------------------
Board Of Directors Company and Bank Officers
- ------------------ -------------------------
Steven A. Rosso
Harold Hand, M.D. President & Chief Executive Officer
Chairman of the Board
Owner, Stockton, Eye Surgery Gary A. Stewart
Executive Vice President & Chief Credit Officer
Steven A. Rosso
President & Chief Executive Officer JoAnne Roberts
Pacific State Bancorp & Pacific State Bank Senior Vice President & Chief Financial
Officer
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
- -------------------------------------------------------------------------------------------------------
62
- -------------------------------------------------------------------------------------------------------
Bank Officers
- -------------
Laura Bunch Sylvia Hanania
Senior Vice President & Regional Vice President & Senior Operations Officer
Manager- Tracy/Castro Valley Stockton Main
Linda Ogata Shelly Urbanek
Senior Vice President & Manager-March Assistant Vice President- Lending Services
Lane Officer-Tracy
Rick Simas Jamie Vroege
Senior Vice President & Regional Manager Assistant Vice President-Lending Services
Manager-Stanislaus & Tuolumne Officer - March Lane
Counties
Patrick Coon
Ron Aschwanden Assistant Vice President- Business
Senior Vice President & Regional Development Officer
Manager -
Calaveras County Maureen Enright
Assistant Vice President-Loan Support
Venus Colombini Specialist
Vice President & Manager-Groveland
Stefani Rosso
Janita Cavanaugh Loan Officer-Credit Administration
Vice President & Controller
Ron Rivera
Patrick MacDonald Assistant Controller
Vice President & Manager - Stockton
Main Laurence Held
Business Development Officer
Paul Bergson
Vice President Commercial Loan Officer Touch Keo (Deborah)
Stockton Main Business Development Officer
Allen Hafizi Jean Turpin
Vice President & Note Department Consumer Loan Officer-Angels Camp
Manager
Alan Morris
Fred Bernhardt Operations Officer - March Lane
Vice President
Commercial Loan Officer- Main Lori Menchaca
Operations Officer - Arnold
Glenn Scott
Vice President & MIS Director Michelle Hendrix
Operations Officer - Groveland
Alan Lozito
Vice President Commercial Carol Barnett
Loan Officer - Castro Valley LPO Operations Officer - Angels Camp
- -------------------------------------------------------------------------------------------------------
63
- -------------------------------------------------------------------------------------------------------
Eric Nelson Larry Hernandez
Vice President Commercial Operations Officer - Tracy
Loan Officer - Castro Valley LPO
Rosibel Rivera
Douglas van den Enden Operations Officer - Modesto
Vice President & Commercial Loan
Officer Carrie Wright
Operations Officer - Stockton Main
- -------------------------------------------------------------------------------------------------------
64
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 & Arnett
Dave Bonacorso Independent Registered Public
353 Sacramento Street -----------------------------
San Francisco , CA 94 111 Accounting Firm
800-346-5544 ex. 223 Perry-Smith LLP
dave.b@hoeferarnett.com 400 Capitol Mall, Suite 1200
Sacramento , CA 95814
Howe Barnes Investments, Inc.
Michael S. Hedrei Transfer Agent
222 South Riverside Plaza, 7th Floor --------------
Chicago, IL 60606-5808 Mellon Investor Services LLC
800-800-4693 85 Challenger Rd
mhedrei@howebarnes.com Ridgefield, Park, NJ 07660
Keefe, Bruyette & Woods Corporate Office
Robert Sprotte -------------
787 Seventh Ave, 4th Floor 1899 West March Lane
New York, NY 10019 Stockton , CA 95207
212-887-8960
rsprotte@kbw.com Customer Service
----------------
Monroe Securities 877-841-0110
Russel J. Feltes
343 W. Erie Street, Suite 410
Chicago, IL 60610 TeleWave Banking
800-766-5560 ----------------
rfeltes@monroesecurities.net 877-487-2265
Web Address
Seidler & Company www.pacificstatebank.com
Troy Norlander
P.O. Box 1688 Trading Symbol
42605 Moonridge Road --------------
Big Bear lake, CA 92315 PSBC
800-288-2811
tnorlander@seidlercos.com Shareholder Relations
---------------------
Wedbush Morgan Securities The Company has adopted a Code of Ethics
Joey Warmenhoven as defined in Item 406 of Regulation S-K
1300 S.W. Fifth Avenue that applies to its principal executive
Suite 2000 and financial officers and the persons
Portland , OR 97201 performing similar functions. In
503/471-1898 addition, the Company files an Annual
www.wedbush.com Report on Form 10-K with the Securities
and Exchange Commission and Annual Report
on Form FR Y-6 with the Federal Reserve
Board. Copies of the Code of Ethics, and
latest Annual Report on Form 10-K and
Form FR Y-6 are available upon request.
Requests for such information should be
directed to:
JoAnne Roberts
Senior Vice President/Chief Financial
Officer
Pacific State Bank
P.O.Box 1649
Stockton , CA 95201-1649
Member FDIC
[GRAPHIC OMITTED]
Equal Housing Lender
65