UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For Quarter Ended March 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________to _________
Commission file number: 0-49892
PACIFIC STATE BANCORP
(Exact Name of Registrant as Specified in its Charter)
California 61-1407606
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1899 W. March Lane, Stockton, CA 95207
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code (209) 870-3200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports,) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non -accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the registrant issuer's
classes of common stock, as of the latest practicable date:
Title of Class Shares outstanding as of May 5, 2006
Common Stock 3,554,174
No Par Value
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACIFIC STATE BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEET
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(Unaudited)
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(in thousands, except share amounts) March 31 December 31
- --------------------------------------------------------------------------------------------------------------
Assets 2006 2005
- ------
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 16,972 $ 14,453
- --------------------------------------------------------------------------------------------------------------
Federal funds sold -- 4,667
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- --------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 16,972 19,120
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Investment securities - available for sale (amortized cost of $26,572 in 26,378 28,539
2006 and $28,696 in 2005)
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Loans, less allowance for loan losses of $2,441 in 2006 and $2,356 in 2005 253,809 241,556
- --------------------------------------------------------------------------------------------------------------
Premises and equipment, net 9,443 9,511
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Company owned life insurance 4,446 4,411
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Accrued interest receivable and other assets 6,596 6,474
------------ ------------
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Total assets $ 317,644 $ 309,611
============ ============
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Liabilities and Shareholders' Equity
- ------------------------------------
- --------------------------------------------------------------------------------------------------------------
Deposits:
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Non-interest bearing $ 60,234 $ 68,657
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Interest bearing 205,329 204,417
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Total deposits 265,563 273,074
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Other borrowings 18,000 4,000
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Subordinated debentures 8,764 8,764
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Accrued interest payable and other liabilities 2,686 2,400
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- --------------------------------------------------------------------------------------------------------------
Total liabilities 295,013 288,238
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- --------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Preferred stock - no par value; 2,000,000 shares authorized;
Common stock - no par value; 24,000,000 shares authorized;
shares issued and outstanding 3,524,322 in 2006 and 3,514,982 in 7,627 7,556
2005
Retained earnings 15,118 13,912
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Accumulated other comprehensive loss, net of tax (114) (95)
------------ ------------
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Total shareholders' equity 22,631 21,373
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Total liabilities and shareholders' equity $ 317,644 $ 309,611
============ ============
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See notes to unaudited condensed consolidated financial statements
2
PACIFIC STATE BANCORP
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
- ------------------------------------------------------------------ Three months ended
Unaudited March 31
- ------------------------------------------------------------------
(in thousands, except share amounts) 2006 2005
- ------------------------------------ ---- ----
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Interest income:
- ------------------------------------------------------------------------------------------------------
Interest and fees on loans $ 5,461 $ 3,647
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Interest on federal funds sold 11 58
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Interest on investment securities 320 223
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Total interest income 5,792 3,928
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Interest expense:
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Interest on deposits 1,485 935
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Interest on subordinated debentures 164 121
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Interest on borrowings 71 19
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Total interest expense 1,720 1,075
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Net interest income before
provision for loan losses 4,072 2,853
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Provision for loan losses 90 60
------------ ------------
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Net interest income after
provision for loan losses 3,982 2,793
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Non-interest income:
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Service charges 208 181
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Other fee income 231 370
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Gain on sale of loans 160 218
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Total non-interest income 599 769
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Non-interest expenses:
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Salaries and employee benefits 1,349 1,117
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Occupancy 199 197
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Furniture and equipment 178 132
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Other expenses 861 586
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Total non-interest expenses 2,587 2,032
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Income before provision for income taxes 1,994 1,530
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Provision for income taxes 787 582
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Net income $ 1,207 $ 948
============ ============
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Basic earnings per share $ 0.35 $ 0.26
============ ============
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Diluted earnings per share $ 0.31 $ 0.24
============ ============
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Weighted average common shares outstanding 3,477,314 3,452,601
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Weighted average common and common equivalent shares
outstanding 3,895,844 3,898,120
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See notes to unaudited condensed consolidated financial statements
3
PACIFIC STATE BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
For the Three Months
(Unaudited) Ended
(in thousands) March 31
------------------------------
2006 2005
------------ ------------
Cash flows from operating activities:
Net income $ 1,207 $ 948
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 90 60
Gain on sale of loans (160) (218)
Net increase in deferred loan origination fees and costs 78 51
Depreciation and amortization 96 112
Increase in Company owned life insurance, net of expenses (35) (66)
Decrease in accrued interest receivable and other assets (201) (324)
Increase in accrued interest payable and other liabilities 286 62
------------ ------------
Net cash provided by operating activities 1,361 625
------------ ------------
Cash flows from investing activities:
Net decrease in interest-bearing deposits in banks -- 1,100
Proceeds from matured and called available-for-sale investment securities 6,000 --
Purchases of available-for-sale investment securities (3,920) (1,000)
Proceeds from principal repayments from available-for-sale securities 206 200
Proceeds from principal repayments from held-to-maturity securities 6 --
Net (increase) decrease in loans (12,261) 2,825
Proceeds from sale of premises and equipment -- 17
Purchases of premises and equipment (101) (2)
------------ ------------
Net cash ( used in) provided by investing activities (10,070) 3,140
------------ ------------
Cash flows from financing activities:
Net (decrease) increase in demand, interest-bearing and savings deposits (18,305) 16,983
Net increase (decrease) in time deposits 10,794 (309)
Net Increase in borrowed funds 14,000 --
------------ ------------
Proceeds from exercise of stock options 72 15
------------ ------------
Net cash provided by financing activities 6,561 16,689
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(Decrease) increase in cash and cash equivalents (2,148) 20,454
Cash and cash equivalents at beginning of year 19,120 12,108
------------ ------------
Cash and cash equivalents at end of period $ 16,972 $ 32,562
============ ============
See notes to unaudited condensed consolidated financial statements
4
Pacific State Bancorp and Subsidiary
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. GENERAL
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 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 predominantly
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
the City of 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 31, 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 and a loan production office in Castro Valley,
California. The Bank plans to open its 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". Prior to
July 12, 2005 the Company was traded on the OTC Bulletin Board under the same
symbol.
2. BASIS OF PRESENTATION AND CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the unaudited condensed consolidated financial
statements contain all adjustments (consisting of only normal recurring
adjustments) necessary to present fairly the consolidated financial position of
Pacific State Bancorp (the "Company") at March 31, 2006 and December 31, 2005,
and the results of its operations for the three month periods ended March 31,
2006 and 2005, and its cash flows for the three month periods ended March 31,
2006 and 2005 in conformity with the instructions to Form 10-Q and Article 10 of
Regulation S-X of the Securities and Exchange Commission ("SEC").
Certain disclosures normally presented in the notes to the consolidated
financial statements prepared in accordance with accounting principles generally
accepted in the United States for annual financial statements have been omitted.
These interim condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 2005 Annual Report to Shareholders. The results of
operations for the three month period ended March 31, 2006 may not necessarily
be indicative of the operating results for the full year.
In preparing such financial statements, management is required to make estimates
and assumptions that affect the reported amounts of assets and liabilities as of
the date of the balance sheet and revenues and expenses for the period. Actual
results could differ significantly from those estimates. Material estimates that
are particularly susceptible to significant changes in the near term relate to
the determination of the allowance for loan and lease losses, the provision for
income taxes and the estimated fair value of investment securities.
Management has determined that all of the commercial banking products and
services offered by the Company are available in each branch of the Bank, that
all branches are located within the same economic environment and that
management does not allocate resources based on the performance of different
lending or transaction activities. Accordingly, the Company and it's subsidiary
5
operate as one business segment. No customer accounts for more than 10% of the
revenue for the Bank or the Company.
3. LOANS
Outstanding loans are summarized below:
March 31 December 31,
================================================================================
2006 2005
- --------------------------------------------------------------------------------
(In thousands)
Commercial $ 44,812 $ 43,063
Agriculture 18,825 17,582
Real estate - commercial 130,131 126,166
Real estate - construction 49,539 43,352
Installment & other 12,809 13,536
------------ ------------
256,115 243,699
Deferred loan fees and costs, net 135 213
Allowance for loan losses (2,441) (2,356)
------------ ------------
Total net loans $ 253,809 $ 241,556
------------ ------------
================================================================================
4. COMMITMENTS AND CONTINGENCIES
The Company is party to claims and legal proceedings arising in the ordinary
course of business. In the opinion of the Company's management, the ultimate
liability with respect to such proceedings will not have a materially adverse
effect on the financial condition or results of operations of the Company as a
whole.
In the normal course of business there are outstanding various commitments to
extend credit which are not reflected in the financial statements, including
loan commitments of approximately $95,265,000 and $112,066,000 and stand-by
letters of credit of $2,600,000 and $2,318,000 at March 31, 2006 and December
31, 2005, respectively. However, all such commitments will not necessarily
culminate in actual extensions of credit by the Company during 2006.
Approximately $60,334,000 of the loan commitments outstanding at March 31, 2006
are for real estate loans and are expected to fund within the next twelve
months. The remaining commitments primarily relate to revolving lines of credit
or other commercial loans, and many of these are expected to expire without
being drawn upon. Therefore, the total commitments do not necessarily represent
future cash requirements. Each potential borrower and the necessary collateral
are evaluated on an individual basis. Collateral varies, but may include real
property, bank deposits, debt or equity securities or business assets.
Stand-by letters of credit are commitments written to guarantee the performance
of a customer to a third party. These guarantees are issued primarily relating
to purchases of inventory by commercial customers and are typically short term
in nature. Credit risk is similar to that involved in extending loan commitments
to customers and accordingly, evaluation and collateral requirements similar to
those for loan commitments are used. Virtually all such commitments are
collateralized. The deferred liability related to the Company's stand-by letters
of credit was not significant at March 31, 2006 and December 31, 2005.
5. EARNINGS PER SHARE COMPUTATION
Basic earnings per share are computed by dividing net income by the weighted
average common shares outstanding for the period. Diluted earnings per share
reflect the potential dilution that could occur if outstanding stock options
were exercised. Diluted earnings per share is computed by dividing net income by
the weighted average common shares outstanding for the period plus the dilutive
effect of options.
6
6. COMPREHENSIVE INCOME
Comprehensive income is reported in addition to net income for all periods
presented. Comprehensive income is made up of net income plus other
comprehensive income or loss. Other comprehensive income or loss, net of taxes,
is comprised of the unrealized gains or losses on available-for-sale investment
securities. The following table shows comprehensive income and its components
for the periods indicated:
Three Months Ended
--------------------------
(in thousands) 03/31/06 03/31/05
---------- ----------
Net Income $ 1,207 $ 948
Other Comprehensive Loss:
Change in unrealized loss on
available for sale securities (19) (89)
Reclassification adjustment -- --
---------- ----------
Total Other Comprehensive Loss (19) (89)
Total Comprehensive Income 1,188 859
========== ==========
7. STOCK-BASED COMPENSATION
The Company had one stock-based compensation plan which is described in Note 8.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123(R), Share Based Payment ("SFAS 123(R)"), using the modified
prospective application transition method, which requires recognizing expense
for options granted prior to the adoption date equal to the fair value of the
unvested amounts over their remaining vesting period, based on the grant date
fair value estimated in accordance with the original provisions of SFAS No. 123
Accounting for Stock Based Compensation, and compensation cost for all share
based payments granted subsequent to January 1, 2006, based on the grant date
fair values estimated in accordance with the provisions of SFAS 123(R). There
were no grants made in the first quarter of 2006 or 2005. Results for prior
periods have not been restated. Prior to January 1, 2006, The Company accounted
for these plans under the recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees, and related Interpretations
("APB 25"). No stock-based compensation cost is reflected in net income prior to
January 1, 2006, 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.
As a result of adopting SFAS 123(R), the Company's income before provision for
income taxes and net income for the three months ended March 31, 2006 was
$2,056,000 and $1,269,000, respectively, lower than if we had continued to
account for share-based compensation under APB 25. Basic and diluted earnings
per share for the quarter ended March 31, 2006 would have been $.36 and $.32,
respectively, without the adoption of SFAS 123 (R) compared to $.35 and $.31,
respectively, as reported.
SFAS 123(R) requires the cash flows resulting from the tax benefits resulting
from tax deductions in excess of the compensation cost recognized for those
options (excess tax benefits) to be classified as a cash flow from financing in
the statement of cash flows. These excess tax benefits were not significant for
the Company.
7
The following table illustrates the pro forma effect on net income and earnings
per share if the fair value recognition provisions of SFAS 123 had been applied
to the Company's stock option plans for the quarter ended March 31, 2005.
For the Quarter Ended
March 31, 2005
- --------------------------------------------------------------------------------
(In thousands, except per
share amounts)
Net earnings as reported $ 948
Add: Share-based compensation cost, net of related tax
effects, included in net income as reported --
----------
Deduct: Total stock-based compensation expense determined
under the fair value based method for all awards, net
of related tax effects 66
----------
Pro forma net income $ 882
==========
Basic earnings per share - as reported $ 0.26
Basic earnings per share - pro forma $ 0.26
Diluted earnings per share - as reported $ 0.24
Diluted earnings per share - pro forma $ 0.23
8. STOCK OPTION PLAN
At March 31, 2006, the Company has one stock-based employee compensation plan,
the Pacific State Bancorp 1997 Stock Option Plan. At March 31, 2006, 28,304
shares of common stock remain reserved under the 1997 plan for issuance to
employees and directors through incentive and nonstatutory agreements. The plan
requires 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. The Company issues new shares of common stock upon
the exercise of stock options.
A summary of the activity of the plan is as follows:
Three Months ended March 31, 2006
------------------------------------------------------------
Weighted Weighted Aggregate
Average Average Remaining Intrinsic
Exercise Contractual Value
Shares Price Term (000's)
- ------------------------------------------------------------------------------------------------------------
Options outstanding, beginning of period 840,050 $ 6.96 4.3 Yrs $ 9,694
Options granted -0-
Options exercised 11,700 5.09 149
Options canceled -0-
---------
- ------------------------------------------------------------------------------------------------------------
Options outstanding, end of period 828,350 6.99 4.1 Yrs 8,954
============================================================================================================
Options vested or expected to vest at 756,013 6.38 4.1 Yrs 8,634
March 31, 2006
============================================================================================================
Options exercisable, end of period 374,550 $ 6.47 4.1 yrs $ 4,242
============================================================================================================
The total fair value of shares vested during the quarter ended March 31, 2006
and 2005 was $155,000 and $135,000, respectively. The aggregate intrinsic value
is calculated as the difference between the exercise price of the underlying
awards and the quoted price of the Company's common stock for options that were
8
in-the-money at March 31, 2006. The intrinsic value of options outstanding and
exercisable relating to the above stock option plan was $4,242,000 as of March
31, 2006. During the three months ended March 31, 2006 and 2005, the aggregate
intrinsic value of options exercised relating to the above stock option plan was
$149,000 and $71,000, respectively.
There were no options granted in the quarters ended March 31, 2006 and 2005. The
Company bases the fair value of the options previously granted on the date of
grant using a Black-Scholes option pricing model that uses assumptions based on
expected option life and the level of estimated forfeitures, expected stock
volatility, risk free interest rate, and dividend yield. The Company uses
historical data to estimate expected option life. Stock volatility is based on
the historical volatility of the Company's stock. The risk-free rate is based on
the U. S. Treasury yield curve for the periods within the contractual life of
the options in effect at the time of grant.
As required by SFAS 123(R), management made an estimate of expected forfeitures
and is recognizing compensation costs only for those equity awards expected to
vest. Management has estimated the forfeiture rate to be approximately 3% for
the remaining non-vested options.
As of March 31, 2006, there was $593,000 of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under the
Plans. The cost is expected to be realized over a weighted average period of
2.21 years and will be adjusted for subsequent changes in estimated forfeitures.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Certain matters discussed in this Quarterly Report are forward-looking
statements that are subject to risks and uncertainties that could cause actual
results to differ materially from those projected in the forward-looking
statements. Such risks and uncertainties include, among others (1) significant
increases in competitive pressures in the financial services industry; (2)
changes in the interest rate environment resulting in reduced margins; (3)
general economic conditions, either nationally or regionally, may be less
favorable than expected, resulting in among other things, a deterioration in
credit quality; (4) changes in the regulatory environment; (5) loss of key
personnel; (6) fluctuations in the real estate market; (7) changes in business
conditions and inflation; (8) operational risks including data processing
systems failures and fraud; and (9) changes in the securities market. Therefore
the information set forth herein should be carefully considered when evaluating
the business prospects of the Company.
When the Company uses in this Quarterly Report the words "anticipate",
"estimate", "expect", "project", "intend, "commit", "believe" and similar
expressions, the Company intends to identify forward-looking statements. Such
statements are not guarantees of performance and are subject to certain risks,
uncertainties and assumptions, including those described in this Quarterly
Report. Should one or more of the uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those anticipated, estimated, expected, projected, intended, committed or
believed. The future results and stockholder values of the Company may differ
materially from those expressed in these forward-looking statements. Many
factors that will determine these results and values are beyond the Company's
ability to control or predict. For those statements, the Company claims the
protection of the safe harbor for forward-looking statements contained in the
Private Securities Litigation Reform Act of 1995.
INTRODUCTION
Effective July 12, 2005, trading of Pacific State Bancorp common stock began on
the Nasdaq(TM) National Market under the symbol of "PSBC". Prior to July 12,
2005 the Company was traded on the OTC Bulletin Board under the same symbol.
The following discussion and analysis sets forth certain statistical information
relating to the company as of March 31, 2006 and December 31, 2005 and the three
month periods ended March 31, 2006 and 2005. The discussion should be read in
conjunction with condensed consolidated financial statements and related notes
included elsewhere in this 10-Q and the consolidated financial statements and
notes thereto included in Pacific State Bancorp's Annual Report filed on form
10-K for the year ended December 31, 2005.
9
CRITICAL ACCOUNTING POLICIES
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (R), Share Based Payment ("SFAS 123(R)") using the modified
prospective transition method. Prior to adoption of this statement, the Company
accounted for its share-based employee compensation plans under the recognition
and measurement provisions of APB Opinion No. 25, Accounting for Stock-Based
Compensation. See Notes 7 and 8 to the Condensed Consolidated Financial
Statements for additional information related to implementation of SFAS 123(R).
Except as disclosed above, there have been no changes to the Company's critical
accounting policies from those discussed in Note 2 to the Consolidated Financial
Statements included in the Company's 2005 Annual Report to Shareholders' on Form
10-K filed with the Commission, which is incorporated here by reference.
OVERVIEW
The Company's net income increased $259 thousand or 27.3% to $1,207 thousand for
the first quarter of 2006 from $948 thousand for the same period in 2005. The
primary contributor to the increase in net income for the first quarter of 2006
was the $1,219 thousand increase in net interest income over the same period in
2005. This increase was partially offset by a decrease in non-interest income of
$170 thousand and an increase in non-interest expenses of $555 thousand. The
increase in non interest expenses consisted primarily of increases in salaries
and benefits of $232 thousand, occupancy and furniture and equipment expenses of
$48 thousand and other expenses of $275 thousand and an increase in the
provision for income taxes of $205 thousand. Basic earnings per share were $0.35
for the first quarter of 2006 up 34.6% from $0.26 for the same period in 2005.
Diluted earnings per share were $0.31 for the first quarter of 2006 up 29.2%
from the $0.24 for the same period in 2005.
Total assets at March 3, 2006 were $318 million, an increase of $8 million or
2.6%, from the $310 million at December 31, 2005. The growth in assets was
primarily in the Company's loans offset by decreases in the level of Federal
funds sold. Loans grew $12 million or 5.1% to $254 million at March 31, 2006
from $242 million at December 31, 2005 while Federal funds sold decreased $5
million over the same period. The growth in assets was funded by the net income
of $1.2 million and $14 million or 350% growth in borrowed funds offset by
decreases in deposits of $7.0 million. The decrease in deposits consisted of $8
million or 12.3% in non-interest bearing deposits offset by $1 million or 0.4%
growth in interest bearing deposits. The annualized return on assets was 1.59%
for the three months ended March 31, 2006 compared to 1.42% for the same period
in 2005. The annualized return on equity was 22.68% for the three months ended
March 31, 2006 compared to 22.11% for the same period in 2005.
RESULTS OF OPERATION FOR THE THREE MONTHS ENDED MARCH 31, 2006
Net interest income before provision for loan losses. Net interest income, on a
non tax equivalent basis, was $4.1 million for the three months ended March 31,
2006, an increase of $1,219 thousand or 42.7% from $2.9 million for the same
period in 2005. The increase in net interest income was primarily attributed to
the volume increase in the Company's average loan and investment balances
supported by the overall increases in the yields earned primarily on loans and
Federal funds sold. These increases were partially offset by the increases in
both the level of average interest bearing liabilities and the increase in the
average rates paid, primarily on time deposits.
Interest income increased $1.9 million or 47.5% to $5.8 million for the three
months ended March 31, 2006 from $3.9 million for the same period in 2005. The
increase in interest income was primarily attributed to volume increases in
investment and loan balances and an increase in yield, particularly in loans and
federal funds sold. The Company's average loan balances were $251.2 million for
the three months ended March 31, 2006, up $48.0 million or 23.6% from $203.2
million for the same period in 2005. The Company's average loan yield was 8.82%
for the three months ended March 31, 2006, up 154 basis points from the 7.28%
yield for the same period in 2005. Although the Company's average balances of
Federal funds sold decreased $9.5 million to $1.0 million for the three months
ended March 31, 2006 from the $10.5 million for the same period in 2005 and
interest income decreased $47 thousand, the average yield on Federal funds sold
increased 256 basis points to 4.81% compared to 2.25% for the same period in
2005. The Company's average investment balances were $27.7 million for the three
months ended March 31, 2006, up $9.5 million, or 52.2%, from $18.1 million for
the same period in 2005. The Company's average investment yield was 4.69% for
the three months ended March 31, 2006, up 34 basis points from the 4.35% yield
for the same period in 2005. As a result of the change in mix of the Company's
10
earning assets and the yields earned, the overall yield on average earning
assets increased 170 basis points to 8.40% for the three months ended March 31,
2006, from 6.70% for the same period in 2005.
Interest expense increased $645 thousand, or 60.0% to $1.7 million for the three
months ended March 31, 2006, from $1.1 million for the same period in 2005. The
increase is primarily attributed to both the increase in time deposit and other
borrowing volumes and in the overall increases in the rates paid on interest
bearing liabilities. The Company's average balances of Time Deposits were $97.4
million for the three months ended March 31, 2006, up $25.1 million, or 34.7%
from $72.3 million for the same period in 2005. Additionally the average rate
paid on Time Deposits increased 144 basis points to 3.60% for the three months
ended March 31, 2006 from 2.16% for the same period in 2005. The Company's
average balances of interest bearing demand deposits increased 1.0 million to
$102.0 million for the three months ended March 31, 2006 from $101.0 million for
the same period in 2005 while interest expense increased $68 thousand as a
result of the increase in rates paid of 24 basis points. Average rates paid
increased to 2.42% from 2.18% for the same period in 2005. The Company's average
balances of other borrowings increased 4.0 million to $16.7 million for the
three months ended March 31, 2006 from $12.8 million for the same period in 2005
while interest expense increased $95 thousand as a result of the increase in
volume and in rates paid of 125 basis points. Average rates paid increased to
5.70% from 4.45% for the same period in 2005.
As a result of the changes noted above, the net interest margin for the three
months ended March 31, 2006 increased 104 basis points or 21.4% to 5.90%, from
4.86% for the same period in 2005.
11
The following table presents for the three month periods indicated the
distribution of consolidated average assets, liabilities and shareholders'
equity. It also presents the amounts of interest income from the interest
earning assets and the resultant yields expressed in both dollars and rate
percentages. Average balances are based on daily averages. Nonaccrual loans are
included in the calculation of average loans while nonaccrued interest thereon
is excluded from the computation of yields earned:
Yield Analysis
For the Three Months Ended For the Three Months Ended
Ended March 31, 2006 Ended March 31, 2005
------------------------------------ ------------------------------------
Interest Average Interest Average
Average Income or Yield or Average Income or Yield or
Assets: Balance Expense Cost Balance Expense Cost
- ------- ---------- ---------- ---------- ---------- ---------- ----------
Interest-earning assets:
Loans 251,153 5,461 8.82% 203,198 3,647 7.28%
Investment securities 27,692 320 4.69% 18,191 195 4.35%
Federal funds sold 928 11 4.81% 10,460 58 2.25%
Interest bearing deposits in banks -- -- --% 6,088 28 1.87%
----------------------- -----------------------
Total average earning assets 279,773 5,792 8.40% 237,937 3,928 6.70%
Non-earning assets:
Cash and due from banks 12,277 13,450
Other assets 15,086 18,839
---------- ----------
Total average assets 307,136 270,226
========== ==========
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
Deposits
Interest-bearing demand 102,033 610 2.42% 101,019 542 2.18%
Savings 6,534 10 0.62% 7,286 9 0.50%
Time deposits 97,369 865 3.60% 72,264 384 2.16%
Other borrowings 16,724 235 5.70% 12,764 140 4.45%
----------------------- -----------------------
Total average interest-bearing
liabilities 222,660 1,720 3.13% 193,333 1,075 2.26%
========== ==========
Noninterest-bearing liabilities:
Demand deposits 61,347 55,229
Other liabilities 1,537 4,284
---------- ----------
Total liabilities 285,550 252,846
Shareholders' equity: 21,592 17,380
---------- ----------
Total average liabilities and shareholders' equity 307,136 270,226
========== ==========
---------- ----------
Net interest income 4,072 2,853
========== ==========
Yield on interest-earning assets 8.40% 6.70%
Cost of funding interest-earning assets 2.50% 1.83%
---------- ----------
Net interest margin 5.90% 4.86%
========== ==========
(1) Not computed on a tax-equivalent basis.
(2) Loan fees included in loan interest income for the three month periods
ended March 31, 2006 and 2005 amounted to $417 thousand and $177
thousand, respectively.
(3) For the purpose of this schedule the interest expense related to the
Company's junior subordinated debentures is included in other
borrowings.
(4) Total interest expense divided by the average balance of total earning
assets.
(5) Net interest income divided by the average balance of total earning
assets
12
The following table sets forth changes in interest income and interest expense,
for the three month periods indicated and the change attributable to variance in
volume, rates and the combination of volume and rates on the relative changes of
volume and rates:
Three Months ended March 31,
2006 over 2005 change in net interest income
----------------------------------------------------------
Net
Change Rate Volume Mix
---------- ---------- ---------- ----------
(In thousands)
Interest Income:
Loans $ 1,814 $ 771 $ 861 $ 182
Investment securities 125 15 102 8
Federal funds sold (47) 66 (53) (60)
Interest bearing deposits in banks (28) (28) (28) 28
---------- ---------- ---------- ----------
Total interest income $ 1,864 $ 824 $ 882 $ 158
Interest Expense:
Interest-bearing demand 68 62 5 1
Savings 1 2 (1) (0)
Time deposits 481 258 133 90
Other borrowings 95 39 43 12
Total interest expense $ 645 $ 361 $ 181 $ 102
---------- ---------- ---------- ----------
Net interest income $ 1,219 $ 463 $ 700 $ 56
========== ========== ========== ==========
(1) The volume change in net interest income represents the change in
average balance multiplied by the previous year's rate.
(2) The rate change in net interest income represents the change in rate
multiplied 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.
Provision for loan losses. The Company recorded $90 thousand in provision for
loan losses for the three month period ended March 31, 2006, up $30 thousand or
50.0%, from the $60 thousand provision for the same period in 2005. Management
assesses its loan quality monthly to maintain an adequate allowance for loan
losses. Based on the information currently available, management believes that
the allowance for loan losses is adequate to absorb probable losses in the
portfolio. However, no assurance can be given that the Company may not sustain
charge-offs which are in excess of the allowance in any given period. The
Company's loan portfolio composition and non-performing assets are further
discussed under the "Financial Condition" section below.
Non-Interest Income. During the three months ended March 31, 2006, total
non-interest income decreased $170 thousand or 22.1% to $599 thousand, down from
$769 thousand for the comparable period in 2005. The decrease in non interest
income was primarily the result of decreases in other fee income and a decrease
in gains on sales of loans partially offset by an increase in service charges.
The decrease in other fee income is primarily the result of a decrease in
mortgage referral fees due to a decrease in activity during the first quarter of
2006 as opposed to the same period in 2005. Other fee income decreased $139
thousand or 37.6% to $231 thousand, from $370 thousand for the comparable period
in 2005.
The decrease in gain on sale of loan income is due to the timing of the sale of
the loans as well as the decrease in the number and dollar amount of loans sold.
Income derived for the gain on sale of loans decreased $58 thousand or 26.6% to
$160 thousand, down from $218 thousand for the comparable period in 2005.
The increase in service charges of $27 thousand or 14.9% to $208 thousand from
$181 thousand for the comparable period in 2005 is primarily the result of the
growth in the number of deposit accounts from the same period in 2005.
Non-Interest Expenses. Non-interest expense consists of salaries and related
employee benefits, occupancy, furniture and equipment expenses, professional
fees, appraisal fees, directors' fees, postage, stationary and supplies
expenses, telephone expenses, data processing expenses, advertising and
promotion expense and other operating expenses. Non-interest expense for the
13
three months ended March 31, 2006 was $2.6 million compared to $2.0 million for
the same period in 2005, representing an increase of $555 thousand or 27.3%.
Increases in salaries and benefits of $232 thousand or 20.8% are indicative of
the additions to staff to expand branch operations in line with their respective
growth. and the recognition of stock based compensation expenses of $62,000 as a
result of adopting SFAS No. 123(R). As of March 31, 2006, there was $593,000 of
total unrecognized compensation cost related to non-vested share-based
compensation arrangements granted under the Company's stock option plan. The
related compensation expense is expected to be realized over a weighted average
period of 2.21 years. The increase in furniture and equipment expense is
attributable to the depreciation on new computer equipment purchased to stay
current with technology. The increase in other expense relates to the increased
expenses associated with the growth of the company as well as increased legal
expense associated with the settlement of a litigation matter.
The following table sets forth a summary of non-interest expense for the three
months ended March 31, 2006 and 2005:
Three Months Ended
-------------------------
March 31, March 31,
(In thousands) 2006 2005
---------- ----------
Non-interest Expense:
Salaries & Benefits 1,349 1,117
Occupancy 199 197
Furniture and Equipment 178 132
Other Expense 861 586
---------- ----------
Total Non-Interest Expenses 2,587 2,032
========== ==========
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 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 three months ended March 31, 2006 and 2005.
Three Months Ended
---------------------------
March 31, March 31,
(In thousands) 2006 2005
---------- ----------
Tax Provision $ 787 $ 582
Effective Tax Rate 39.5% 38.0%
FINANCIAL CONDITION
Total assets at March 31, 2006 were $318 million, an increase of $8 million or
2.6%, from the $310 million at December 31, 2005. The growth in assets was
primarily in the Company's loans and cash and due from banks, offset by
decreases in Federal funds sold and investment securities. Loans grew $12
million or 5.1% to $254 million at March 31, 2006 from $242 million at December
31, 2005 while cash and due from banks increased $2 million over the same
period. There were no Federal funds sold at March 31, 2006 representing a
decrease $5 million from December 31, 2005. Over the same period investments
decreased $2 million or 7.6% to $26 million from $28 million. The growth in
assets was funded by the $14 million or 350% growth in borrowed funds offset by
a decrease in total deposits of $7.5 million or 2.8% to $266 million at March
31, 2006 from $273 million at December 31, 2005. The change in deposits was
comprised of a decrease in non-interest bearing deposits of $8.4 million or
12.3% to $60 million at March 31, 2006 from $69 million at December 31, 2005,
this decrease was partially offset by increases in interest bearing deposits of
$1 million or .04% to $205 million at March 31, 2006 from $204 million at
December 31, 2005.
Loan portfolio composition. The Company concentrates its lending activities
primarily within Calaveras, San Joaquin, Stanislaus, Tuolumne and Alameda
Counties.
14
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:
March 31 December 31,
================================================================================
2006 2005
- --------------------------------------------------------------------------------
(In thousands)
Commercial $ 44,812 $ 43,063
Agriculture 18,825 17,582
Real estate - commercial 130,131 126,166
Real estate - construction 49,539 43,352
Installment & other 12,809 13,536
------------ ------------
256,115 243,699
Deferred loan fees and costs 135 213
Allowance for loan losses (2,441) (2,356)
------------ ------------
Total net loans $ 253,809 $ 241,556
------------ ------------
================================================================================
The Company continues to manage the mix in its loan portfolio consistent with
its identity as a community bank serving Northern California and the Central
Valley. Net portfolio loans have increased $12.3 million or 5.1%, to $253.8
million at March 31, 2006 from $241.5 million at December 31, 2005. Commercial
loans increased slightly by $1.7 million or 4.1% to $44.8 million from $43.1
million at December 31, 2005. Agricultural Loans increased $1.2 million or 7.1%
to $18.8 million from $17.6 million at December 31, 2005. The largest increase
was in real estate - commercial and construction loans. Real estate commercial
mortgage loans increased by $4.0 million or 3.1% to $130.1 million from $126.2
million at December 31, 2005. Real estate construction loans increased $6.2
million or 14.3% to $49.5 from $43.4 million at December 31, 2005. Installment
and other loans decreased $727 thousand or 5.4% to $12.8 million from $13.5
million at December 31, 2005. The portfolio mix continues to reflect the
increase in real estate loans as compared with the mix of a year ago, with
commercial and agricultural loans representing approximately 24.9% of total
loans, real estate construction loans representing 19.3%, commercial real estate
loans representing 50.8%, and installment loans representing 5% at March 31,
2006.
Nonperforming loans. There were no nonperforming loans at March 31, 2006 and
December 31, 2005.
Analysis of allowance for loan losses. In determining the amount of the
Company's Allowance for Loan Losses ("ALL"), management assesses the
diversification of the portfolio. Each credit is assigned a credit risk rating
factor, and this factor, multiplied by the dollars associated with the credit
risk rating, is used to calculate one component of the ALL. In addition,
management estimates the probable loss on individual credits that are receiving
increased management attention due to actual or perceived increases in credit
risk.
The Company makes provisions to the ALL on a regular basis through charges to
operations that are reflected in the Company's statements of income as a
provision for loan losses. When a loan is deemed uncollectible, it is charged
against the allowance. Any recoveries of previously charged-off loans are
credited back to the allowance. There is no precise method of predicting
specific losses or amounts that ultimately may be charged-off on particular
categories of the loan portfolio. Similarly, the adequacy of the ALL and the
level of the related provision for possible loan losses is determined on a
judgment basis by management based on consideration of a number of factors
including (i) economic conditions, (ii) borrowers' financial condition, (iii)
loan impairment, (iv) evaluation of industry trends, (v) industry and other
concentrations, (vi) loans which are contractually current as to payment terms
15
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 loan losses in future periods.
The adequacy of the ALL is calculated upon three components. First is the credit
risk rating of the loan portfolio, including all outstanding loans and leases.
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 effect 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 provision for loan losses increased to $90,000 for the three months ended
March 31, 2006 compared to $60,000 for the same period in 2005. The increase in
the amount of the provision is a direct result of the Company's analysis of the
loan portfolio and the loan loss history of the Company. Management does not
believe that there were any adverse trends indicated by the detail of the
aggregate charge-offs for any of the periods discussed.
The following table summarizes the activity in the ALL for the periods
indicated.
Three Months Ended
(In thousands) March 31,
================================================================================
2006 2005
- --------------------------------------------------------------------------------
Beginning Balance: $ 2,357 $ 2,213
Provision for loan losses 90 60
Charge-offs:
Commercial -- --
Real Estate -- --
Other 5 --
---------- ----------
Total Charge-offs 5 0
---------- ----------
Recoveries:
Commercial -- 3
Other -- --
---------- ----------
Total Recoveries -- 3
---------- ----------
Ending Balance $ 2,442 $ 2,276
========== ==========
ALL to total loans 0.95% 1.14%
Net Charge-offs to average loans-
annualized 0.00% 0.00%
================================================================================
Investment securities and interest-bearing deposits in banks. Combined
investment securities, and interest-bearing deposits in other banks decreased
$2.2 million to $26.4 million at March 31, 2006, from $28.5 million at December
31, 2005.
16
The Company's investment in U.S. Treasury securities increased to 52.4% of the
investment portfolio at March 31, 2006 compared to 52.0% at December 31, 2005.
Obligations of U.S. Agencies increased to 27.9% of the investment portfolio at
March 31, 2006 compared to 26.3% at December 31, 2005. The Company's investment
in corporate bonds decreased to 7.6% of the investment portfolio at March 31,
2006 compared to 11.7% at December 31, 2005. Tax-exempt municipal obligations
bonds increased to 12.1% of the investment portfolio at March 31, 2006 compared
to 10.0% at December 31, 2005. Fed Funds sold decreased $4.7 million, or 100% as
a result of the increase in loans.
Deposits. Total deposits were $265.6 million as of March 31, 2006 a decrease of
$7.5 million or 2.8% from the December 31, 2005 balance of $273.1 million. The
Company continues to manage the mix of its deposits consistent with its identity
as a community bank serving the financial needs of its customers. Non-interest
bearing demand deposit and interest bearing checking deposits decreased slightly
to 30.1% of total deposits from 30.9% at December 31, 2005. Money market and
savings accounts decreased to 30.8% of total deposits from 34.9% at December 31,
2005. Time deposits increased to 39.2% of total deposits from 34.1% at December
31, 2005
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 the qualifying
portion of subordinated debentures) and "Tier 2" capital (defined as principally
comprising Tier 1 capital and the remaining qualifying portion of subordinated
debentures and the qualifying portion of the ALL).
The minimum ratio of total risk-based capital to risk-adjusted assets, including
certain off-balance sheet items, is 8%. At least one-half (4%) of the total
risk-based capital is to be comprised of Tier 1 capital; the balance may consist
of debt securities and a limited portion of the ALL.
As of March 31, 2006 the most recent notification by the Federal Deposit
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 Bank's category. Management believes that the Company met all of its
capital adequacy requirements.
17
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------- ------------------------- -------------------------
Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
Company
As of March 31, 2006:
Total capital
(to risk weighted assets) $ 33,033 11.98% $ 22,058 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 29,293 10.62% $ 11,029 4.00% N/A N/A
Tier I capital
(to average assets) $ 29,293 9.57% $ 12,149 4.00% N/A N/A
Bank
As of March 31, 2006:
Total capital
(to risk weighted assets) $ 31,179 11.39% $ 21,894 8.00% $ 27,368 10.00%
Tier I capital
(to risk weighted assets) $ 28,738 10.50% $ 10,947 4.00% $ 16,421 6.00%
Tier I capital
(to average assets) $ 28,738 9.38% $ 12,249 4.00% $ 15,311 5.00%
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------- ------------------------- -------------------------
Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
Company
As of December 31, 2005:
Total capital
(to risk weighted assets) $ 31,650 11.90% $ 21,268 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 27,654 10.40% $ 10,634 4.00% N/A N/A
Tier I capital
(to average assets) $ 27,654 9.20% $ 12,067 4.00% N/A N/A
Bank
As of December 31, 2005:
Total capital
(to risk weighted assets) $ 29,933 11.50% $ 20,865 8.00% $ 26,082 10.00%
Tier I capital
(to risk weighted assets) $ 27,577 10.60% $ 10,433 4.00% $ 15,649 6.00%
Tier I capital
(to average assets) $ 27,577 9.10% $ 12,067 4.00% $ 15,083 5.00%
*The leverage ratio consists of Tier I capital divided by quarterly average
assets. The minimum leverage ratio is 3 percent for banking organizations that
do not anticipate significant growth and that have well-diversified risk,
excellent asset quality and in general, are considered top-rated banks. For all
other institutions the minimum rate is 4%. The Company's and the Bank's
risk-based capital ratios are presented below.
LIQUIDITY
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
18
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 and available-for-sale investment
securities) totaled $43.4 million or 13.6% of total assets at March 31, 2006
compared to $47.7 million or 15.4% of total assets at December 31, 2005. The
Company expects that its primary source of liquidity will be earnings of the
Company, acquisition of core deposits, and wholesale borrowing arrangements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates 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 fluctuations in 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
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 than its
interest bearing liabilities. The Company manages its mix of assets and
liabilities with the goal of limiting exposure to interest rate risk, ensuring
adequate liquidity, and coordinating its sources and uses of funds.
The Company seeks to control its interest rate risk exposure in a manner that
will allow for adequate levels 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 risk exposure. As part of this
effort, the Company measures interest rate risk utilizing both an internal asset
liability measurement system as well as employing independent third party
reviews to confirm the reasonableness of the assumptions used to measure and
report the Company's interest rate risk, enabling management to make any
adjustments necessary.
Interest rate risk is managed by the Company's Asset Liability Committee
("ALCO"), which includes members of senior management and several members of the
Board of Directors. The ALCO monitors interest rate risk by analyzing the
potential impact on interest income from potential changes in interest rates and
considers the impact of alternative strategies or changes in balance sheet
structure. The ALCO manages the Company's balance sheet in part to maintain the
potential impact on net interest income within acceptable ranges despite changes
in interest rates. The Company's exposure to interest rate risk is reviewed on
at least a quarterly basis by the ALCO.
19
In management's opinion there has not been a material change in the Company's
market risk or interest rate risk profile for the three months ended March 31,
2006 compared to December 31, 2005 as discussed under the caption "Liquidity and
Market Risk" and "Net Interest Income Simulation" in the Company's 2005 Annual
Report to Shareholders filed as an exhibit with the Company's 2005 Annual Report
on Form 10-K, which is incorporated here by reference..
ITEM 4. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer, based on
their evaluation as of the end of the period covered by this report of the
Company's disclosure controls and procedures (as defined in Exchange Act Rule
13a--15(e)), have concluded that the Company's disclosure controls and
procedures are designed to ensure that information required to be disclosed by
the Company in its periodic SEC filings is recorded, processed and reported
within the time periods specified in the SEC's rules and forms. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated and unconsolidated subsidiaries) required to be included in the
Company's periodic SEC filings. There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures, including
cost limitations, judgments used in decision making, assumptions regarding the
likelihood of future events, soundness of internal controls, fraud, the
possibility of human error and the circumvention or overriding of the controls
and procedures. Accordingly, even effective disclosure controls and procedures
can provide only reasonable, and not absolute, assurance of achieving their
control objectives.
There were no significant changes in the Company's internal controls or in other
factors during the period covered by this report that have materially affected
or could significantly affect internal controls over financial reporting.
Part II - Other Information
ITEM 1 LEGAL PROCEEDINGS
None to report.
ITEM 1A RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2005, which could
materially affect our business, financial condition or future results. The
Company is not aware of any material changes to the risks described in our
Annual Report.
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
None to report.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None to report.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None to report
ITEM 5 OTHER INFORMATION
None to report.
20
ITEM 6. EXHIBITS
31.1 Certification of Chief Executive Officer (section 302 of the Sarbanes-
Oxley Act).
31.2 Certification of Chief Financial Officer (section 302 of the Sarbanes-
Oxley Act).
32.1 Certification of Chief Executive Officer pursuant to section 906 of
the Sarbanes-Oxley Act.
32.2 Certification of Chief Financial Officer pursuant to section 906 of
the Sarbanes-Oxley Act
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Pacific State Bancorp
Date: May 15, 2006 By: /s/ STEVEN A. ROSSO
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Steven A. Rosso
President and Chief Executive Officer
Pacific State Bancorp
Date: May 15, 2006 By: /s/ JOANNE ROBERTS
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JoAnne Roberts
Senior Vice President and Chief
Financial Officer
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EXHIBITS
31.1 Certification of Chief Executive Officer (section 302 of the Sarbanes-
Oxley Act).
31.2 Certification of Chief Financial Officer (section 302 of the Sarbanes-
Oxley Act).
32.1 Certification of Chief Executive Officer pursuant to section 906 of
the Sarbanes-Oxley Act.
32.2 Certification of Chief Financial Officer pursuant to section 906 of
the Sarbanes-Oxley Act
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