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 June 30, 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 August 10, 2006
Common Stock 3,593,008
No Par Value
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACIFIC STATE BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) June 30 December 31
(in thousands, except share amounts) 2006 2005
------------ ------------
Assets
- ------
Cash and due from banks $ 13,702 $ 14,453
Federal funds sold -- 4,667
------------ ------------
Total cash ad cash equivalents 13,702 19,120
Investment securities - available for sale
(amortized cost of $23,546 in 2006 and $28,696
in 2005) 23,329 28,539
Loans, less allowance for loan losses of $2,516 in
2006 and $2,356 in 2005
270,107 241,556
Bank premises and equipment, net 9,564 9,511
Company owned life insurance 4,499 4,411
Accrued interest receivable and other assets 6,701 6,474
------------ ------------
Total assets $ 327,902 $ 309,611
============ ============
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits:
Non-interest bearing $ 64,127 $ 68,657
Interest bearing 223,183 204,417
Total deposits 287,310 273,074
------------ ------------
Other borrowings 4,900 4,000
Subordinated debentures 8,764 8,764
Accrued interest payable and other liabilities 2,350 2,400
------------ ------------
Total liabilities 303,324 288,238
------------ ------------
Commitments and contingencies
Shareholders' equity:
Preferred stock - no par value; 2,000,000
shares authorized; none outstanding
Common stock - no par value; 24,000,000
shares authorized; issued and outstanding
3,589,458 in 2006 and 3,512,622 in 2005 8,280 7,556
Retained earnings 16,426 13,912
Accumulated other comprehensive loss,
net of tax (128) (95)
Total shareholders' equity 24,578 21,373
------------ ------------
Total liabilities and shareholders' equity $ 327,902 $ 309,611
============ ============
See notes to unaudited condensed consolidated financial statements
2
PACIFIC STATE BANCORP
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
Three months ended Six months ended
June 30 June 30
(in thousands, except share amounts) 2006 2005 2006 2005
---------- ---------- ---------- ----------
Interest income:
Interest and fees on loans $ 5,998 $ 4,234 $ 11,459 $ 7,881
Interest on federal funds sold 6 67 17 125
Interest on investment securities 317 228 637 451
---------- ---------- ---------- ----------
Total interest income 6,321 4,529 12,113 8,457
---------- ---------- ---------- ----------
Interest expense:
Interest on deposits 1,792 1,070 3,276 2,005
Interest on subordinated debentures 180 105 344 226
Interest on borrowings 150 28 221 47
---------- ---------- ---------- ----------
Total interest expense 2,122 1,203 3,841 2,278
---------- ---------- ---------- ----------
Net interest income before 4,199 3,326 8,272 6,179
provision for loan losses
Provision for loan losses 90 60 180 120
---------- ---------- ---------- ----------
Net interest income after
provision for loan losses 4,109 3,266 8,092 6,059
---------- ---------- ---------- ----------
Non-interest income:
Service charges 250 189 458 370
Other fee income 230 192 461 410
Gain from sale of loans 20 216 180 586
---------- ---------- ---------- ----------
Total non-interest income 500 597 1,099 1,366
---------- ---------- ---------- ----------
Non-interest expense:
Salaries and employee benefits 1,335 1,192 2,685 2,309
Occupancy 208 196 407 393
Furniture and equipment 183 147 361 279
Other 726 651 1,586 1,237
---------- ---------- ---------- ----------
Total non-interest expenses 2,452 2,186 5,039 4,218
---------- ---------- ---------- ----------
Income before provision for 2,157 1,677 4,152 3,207
income taxes
Provision for income taxes 850 620 1,638 1,202
---------- ---------- ---------- ----------
Net income $ 1,307 $ 1,057 $ 2,514 $ 2,005
========== ========== ========== ==========
Basic earnings per share $ 0.37 $ 0.31 $ 0.72 $ 0.58
========== ========== ========== ==========
Diluted earnings per share $ 0.34 $ 0.27 $ 0.65 $ 0.52
========== ========== ========== ==========
Weighted average common shares
Outstanding 3,510,801 3,466,017 3,493,964 3,458,115
Weighted average common and common
equivalent shares outstanding
3,900,010 3,845,993 3,894,748 3,869,135
See notes to unaudited condensed consolidated financial statements
3
PACIFIC STATE BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited) For the Six Months Ended
(in thousands) June 30, 2006 June 30, 2005
------------- -------------
Cash flows from operating activities:
Net income 2,514 2,005
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 180 120
Gain on sale of loans (180) (586)
Stock Based Compensation 124 0
Decrease in deferred loan origination costs 95 11
Depreciation and amortization 69 283
Increase in Company owned life insurance, net of
expenses (88) (83)
Increase in accrued interest receivable and other
assets 232 (793)
(Decrease) Increase in accrued interest payable and other
liabilities (50) 846
------------- -------------
Net cash provided by operating activities 2,432 1,803
------------- -------------
Cash flows from investing activities:
Net decrease in interest-bearing deposits in banks 0 1,100
Proceeds from matured and called available-for-sale
investment securities 9,026 800
Purchases of available-for-sale investment securities (4,100) (3,034)
Proceeds from principal repayments from available-for-sale
securities 360 639
Proceeds from principal repayments from held-to-maturity
securities 40 12
Net increase in loans (28,646) (12,556)
Proceeds from sale of premises and equipment 0 17
Purchases of premises and equipment (266) (131)
------------- -------------
Net cash used in investing activities (23,586) (13,153)
------------- -------------
Cash flows from financing activities:
Net (decrease) increase in demand, interest-bearing
and savings deposits (17,844) 7,101
Net increase (decrease) in time deposits 32,080 (837)
Net Increase in borrowed funds 900 0
------------- -------------
Proceeds from exercise of stock options 350 102
Proceeds from stock issuance 250 0
------------- -------------
Net cash provided by financing activities 15,736 6,366
------------- -------------
Decrease in cash and cash equivalents (5,418) (4,984)
Cash and cash equivalents at beginning of year 19,120 12,108
------------- -------------
Cash and cash equivalents at end of period 13,702 7,124
============= =============
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 after acquiring all of the outstanding shares of
Pacific State Bank . 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 interest on 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 June 30, 2006 had 81 employees,
including 33 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, in August
2006.
Effective July 12, 2005, Pacific State Bancorp common stock began
trading on the Nasdaq(TM) Global 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 June 30, 2006 and December 31, 2005,
and the results of its operations for the three and six month periods ended June
30, 2006 and 2005, and its cash flows for the six month periods ended June 30,
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.
The Company believes that the disclosures in the interim condensed consolidated
financial statements are adequate to make the information not misleading. These
interim condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
5
included in the Company's 2005 Annual Report to Shareholders. The results of
operations for the three and six month periods ended June 30, 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 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 its subsidiary
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:
June 30 December 31,
=============================================================================
2006 2005
- -----------------------------------------------------------------------------
(In thousands)
Commercial $ 48,143 $ 43,063
Agriculture 17,940 17,582
Real estate - commercial 126,861 126,166
Real estate - construction 67,217 43,352
Installment & other 12,344 13,536
------------ ------------
272,505 243,699
Deferred loan fees and costs, net
118 213
Allowance for loan losses (2,516) (2,356)
------------ ------------
Total net loans $ 270,107 $ 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 $110,019,000 and $112,066,000 and stand-by
letters of credit of $2,640,000 and $2,318,000 at June 30, 2006 and December 31,
2005, respectively. However, all such commitments will not necessarily culminate
in actual extensions of credit by the Company.
Approximately $60,604,000 of the loan commitments outstanding at June 30, 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
6
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 June 30, 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 outstanding options.
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 Six Months Ended
--------------------------- ---------------------------
(in thousands) 06/30/06 06/30//05 06/30/06 06/30//05
------------ ------------ ------------ ------------
Net Income 1,307 1,057 $ 2,514 $ 2,005
Other Comprehensive Loss:
Change in unrealized loss on
available for sale securities (14) (3) (33) (93)
Reclassification adjustment -- -- -- --
------------ ------------ ------------ ------------
Total Other Comprehensive Loss (14) (3) (33) (93)
------------ ------------ ------------ ------------
Total Comprehensive Income 1,293 1,054 2,481 1,912
============ ============ ============ ============
7. STOCK-BASED COMPENSATION
The Company has 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 six months 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
7
("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 June 30, 2006 was $62,000
and $51,000, 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 June 30, 2006 would have been $.38 and $.35, respectively,
without the adoption of SFAS 123 (R) compared to $.37 and $.34, respectively, as
reported
As a result of adopting SFAS 123(R), the Company's income before provision for
income taxes and net income for the six months ended June 30, 2006 was $124,000
and $103,000, respectively, lower than if we had continued to account for
share-based compensation under APB 25. Basic and diluted earnings per share for
the six months ended June 30, 2006 would have been $.74 and $.67, respectively,
without the adoption of SFAS 123 (R) compared to $.72 and $.65, 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.
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 and six month periods ended
June 30, 2005.
For the Three For the Six
Months Ended Months Ended
June 30 June 30
(in thousands, except share amounts) 2005 2005
------------ ------------
Net income, as reported $ 1,057 $ 2,005
Deduct: Total stock-based employee
compensation expense determined
under the fair value method for all
outstanding awards, net of related tax effects 66 132
------------ ------------
Pro forma net income, in thousands $ 991 $ 1,873
============ ============
Basic earning per share - as reported $ 0.31 $ 0.58
Basic earning per share - pro forma $ 0.29 $ 0.54
Diluted earnings per share - as reported $ 0.27 $ 0.52
Diluted earnings per share - pro forma $ 0.26 $ 0.48
8. STOCK OPTION PLAN
At June 30, 2006, the Company has one stock-based employee compensation plan,
the Pacific State Bancorp 1997 Stock Option Plan. At June 30, 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
8
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:
Six Months ended June 30, 2006
------------------------------------------------------------------
Weighted
Weighted Average Aggregate
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 -- -- --
Options exercised 60,941 5.75 792
Options canceled 30,000 7.50 165
------------ ------------
- ------------------------------------------------------------------------------------------------------------------------
Options outstanding, end of period 749,109 $ 7.73 3.9 Yrs $ 8,737
========================================================================================================================
Options vested or expected to vest at June 30, 2006 702,629 $ 6.38 3.9 Yrs $ 8,291
========================================================================================================================
Options exercisable, end of period 283,609 $ 6.47 3.9 yrs $ 3,329
========================================================================================================================
No shares vested for the three month periods ended June 30, 2006 and 2005. The
total fair value of shares vested during the six month periods ended June 30,
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 in-the-money at June 30, 2006. The intrinsic value of options
outstanding and exercisable relating to the above stock option plan was
$3,329,000 as of June 30, 2006. During the three months ended June 30, 2006 and
2005, the aggregate intrinsic value of options exercised relating to the above
stock option plan was $604,000 and $296,000, respectively. For the six months
ended June 30, 2006 and 2005, the aggregate intrinsic value of options exercised
relating to the above stock option plan was $767,000 and $687,000, respectively
There were no options granted in the six months ended June 30, 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 June 30, 2006, there was $529,000 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
1.96 years and will be adjusted for subsequent changes in estimated forfeitures.
9
9. NEW ACCOUNTING PRONOUNCEMENTS
Accounting for Uncertainty in Income Taxes
In July 2006, the FASB issued Financial Accounting Standards Interpretation No.
48 (FIN 48), Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with FASB Statement No. 109, Accounting for
Income Taxes. FIN 48 prescribes a recognition threshold and measurement
attributable for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosures and transitions. FIN 48 is effective for fiscal
years beginning after December 15, 2006. Management has not completed its
evaluation of the impact that FIN 48 will have.
10
<pAGE>
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) Global 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 June 30, 2006 and December 31, 2005 and for the
three and six month periods ended June 30, 2006 and 2005. The discussion should
be read in conjunction with the unaudited condensed consolidated financial
statements and related notes included elsewhere in this report 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.
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).
11
Except as disclosed above, there have been no changes to the Company's critical
accounting policies from those discussed in Management's Discussion and Analysis
of Financial Condition and Results of Operations in the Company's 2005 Annual
Report to Shareholders' on Form 10-K.
OVERVIEW
For the three months ended June 30, 2006:
The Company's net income increased $250 thousand or 23.65% to $1,307 thousand
for the second quarter of 2006 from $1,057 thousand for the same period in 2005.
The primary contributor to the increase in net income for the second quarter of
2006 was the $873 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 $97 thousand and an increase in non-interest expenses of $266 thousand. The
increase in non interest expenses consisted primarily of increases in salaries
and benefits of $143 thousand, occupancy and furniture and equipment expenses of
$48 thousand and other expenses of $75 thousand. In addition the provision for
loan losses increased $30 thousand and the provision for income taxes increased
$230 thousand. Basic earnings per share increased to $0.37 for the second
quarter of 2006 up 19.35% from $0.31 for the same period in 2005. Diluted
earnings per share increased to $0.34 for the second quarter of 2006 up 25.93%
from the $0.27 for the same period in 2005.
For the six months ended June 30, 2006:
The Company's net income increased $509 thousand or 25.39% to $2,514 thousand
for the six month period ended June 30, 2006 from $2,005 thousand for the same
period in 2005. The primary contributor to the increase in net income for the
six month period ended June 30, 2006 was the $2,093 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 $267 thousand and an increase in
non-interest expenses of $821 thousand. The increase in non interest expenses
consisted primarily of increases in salaries and benefits of $376 thousand,
occupancy and furniture and equipment expenses of $96 thousand and other
expenses of $349 thousand. In addition the provision for loan losses increased
$60 thousand and the provision for income taxes increased $436 thousand. Basic
earnings per share increased to $0.72 for the six month period ended June 30,
2006 up 22.41% from $0.58 for the same period in 2005. Diluted earnings per
share increase to $0.65 for the six month period ended June 30, 2006 up 25.00%
from the $0.52 for the same period in 2005.
Total assets at June 30, 2006 were $328 million, an increase of $18 million or
5.8%, 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 and investments. Loans grew $28 million or 11.57% to $270 million at
June 30, 2006 from $242 million at December 31, 2005 while Federal funds sold
and Investment Securities decreased $10 million over the same period. The growth
in loans was also funded by the net income of $2.5 million and growth in
deposits of $14 million or 5.21%. Borrowed funds increased $0.9 million or
22.5%.
The annualized return on assets was 1.65% and 1.62% for the three and six month
periods ended June 30, 2006 compared to 1.57% and 1.50% for the same periods in
2005. The annualized return on equity was 22.60% and 22.64 % for the three and
six month periods ended June 30, 2006 compared to 23.00% and 22.58% for the same
periods in 2005.
12
RESULTS OF OPERATION FOR THE THREE MONTHS ENDED JUNE 30, 2006
Net interest income before provision for loan losses. Net interest income, on a
non tax equivalent basis, was $4.2 million for the three months ended June 30,
2006, an increase of $873 thousand or 26.25% from $3.3 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 balances supported by the
overall increases in the yields earned primarily on loans and investments. 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 and other borrowings.
Interest income increased $1.8 million or 39.57% to $6.3 million for the three
months ended June 30, 2006 from $4.5 million for the same period in 2005. The
increase in interest income was primarily attributed to volume increases in loan
balances and an increase in yield, particularly in loans and investments. Loan
volume increased due the bank's increased loan demand. The yield on loans
increased as the Federal Open Market Committee increased the prime lending twice
during the three month period ended June 30, 2006. The increase in rate totaled
50 basis points for the period. The Company's average loan balances were $265.3
million for the three months ended June 30, 2006, up $56.8 million or 27.2% from
$208.5 million for the same period in 2005. The Company's average loan yield was
9.06% for the three months ended June 30, 2006, up 92 basis points from the
8.14% yield for the same period in 2005. Although the Company's average balances
of investment securities decreased $1.6 million to $27.0 million for the three
months ended June 30, 2006 from the $28.6 million for the same period in 2005,
interest income increased $143 thousand as a result of the increase in the
average yield on investment securities of 222 basis points to 4.66% from 2.44%
for the same period in 2005. As a result of the increases in the level of
average loans and the yields earned, the overall yield on average earning assets
increased 143 basis points to 8.64% for the three months ended June 30, 2006,
from 7.21% for the same period in 2005.
Interest expense increased $919 thousand, or 76.39% to $2.1 million for the
three months ended June 30, 2006, from $1.2 million for the same period in 2005.
The increase is primarily attributed to both the increase in levels of the
average time deposits and other borrowings and in the overall increases in the
rates paid on all interest bearing liabilities. Time deposits increased as the
bank experienced disintermediation from lower yielding transaction accounts into
higher yielding time deposits. Rates increase during the period as rates on
deposits were increased to remain completive with other financial institutions.
The Company's average balances of time deposits were $116.1 million for the
three months ended June 30, 2006, up $43.2 million, or 59.3% from $72.9 million
for the same period in 2005. The average rate paid on time deposits also
increased 160 basis points to 4.16% for the three months ended June 30, 2006
from 2.56% for the same period in 2005. As a result interest expense on time
deposits increased $738 thousand. The Company's average balances of other
borrowings increased $6.7 million to $19.6 million for the three months ended
June 30, 2006 from $12.8 million for the same period in 2005 and the rates paid
increased 261 basis points to 6.76% for the three month ended June 30, 2006 from
4.15% for the same period in 2005. As a result interest expense on other
borrowings increased $197 thousand. The Company's average balances of interest
bearing demand deposits decreased $15.6 million to $89.4 million for the three
months ended June 30, 2006 from $105.0 million for the same period in 2005. The
average rate paid increased 30 basis points to 2.57% from 2.27% for the same
period in 2005. As a result interest expense on interest bearing demand deposits
decreased $22 thousand.
As a result of the changes noted above, the net interest margin for the three
months ended June 30, 2006 increased 44 basis points or 8.30% to 5.74%, from
5.30% for the same period in 2005.
13
The following table presents for the three month periods indicated the
distribution of consolidated average assets, liabilities and shareholders'
equity. It also presents the amounts of interest income from the interest
earning assets and the resultant yields expressed in both dollars and rate
percentages. Average balances are based on daily averages. Nonaccrual loans are
included in the calculation of average loans while nonaccrued interest thereon
is excluded from the computation of yields earned:
----------------------------------------------------------------------------
($ in `000s) For the Three Months Ended For the Three Months Ended
June 30, 2006 June 30, 2005
----------------------------------------------------------------------------
Interest Average Interest Average
Average Income Yield or Average Income Yield or
Balance or Expense Cost Balance or Expense Cost
----------------------------------------------------------------------------
Assets:
- ------
Interest-earning assets:
Loans (1) (2) $ 265,333 $ 5,998 9.06% $ 208,585 $ 4,234 8.14%
Investment securities (2) 27,095 317 4.66% 28,628 174 2.44%
Federal funds sold 861 6 2.80% 9,571 67 2.81%
Interest bearing deposits in banks -- -- --% 5,000 54 4.33%
----------------------- -----------------------
Total average earning assets 293,289 6,321 8.64% 251,784 4,529 7.21%
Non-earning assets:
Cash and due from banks 13,498 14,184
Other assets 11,215 4,849
---------- ----------
Total average assets $ 318,002 $ 270,817
========== ==========
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
Deposits
Interest-bearing demand $ 89,412 573 2.57% $ 105,049 595 2.27%
Savings 6,298 15 0.96% 6,935 9 0.52%
Time deposits 116,062 1,204 4.16% 72,901 466 2.56%
Other borrowings (3) 19,592 330 6.76% 12,869 133 4.15%
----------------------- -----------------------
Total average interest-bearing liabilities 231,364 2,122 3.68% 197,754 1,203 2.44%
========== ==========
Non-interest bearing liabilities:
Demand deposits 62,558 54,721
Other liabilities 881 170
---------- ----------
Total liabilities 294,803 252,645
Shareholders' equity: 23,199 18,172
---------- ----------
Total average liabilities and shareholders' equity $ 318,002 $ 270,817
========== ==========
---------- ----------
Net interest income $ 4,199 $ 3,326
========== ==========
Yield on interest-earning assets (4) 8.64% 7.21%
Cost of funding interest-earning assets 2.90% 1.92%
---------- ----------
Net interest margin (5) 5.74% 5.30%
========== ==========
- -----------------------------------------------------------------------------------------------------------------------------------
(1) Not computed on a tax-equivalent basis.
(2) Loan fees included in loan interest income for the three month periods
ended June 30, 2006 and 2005 amounted to $480 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
14
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 June 30,
2006 over 2005 change in net interest income
---------------------------------------------------------
Net
Change Rate Volume Mix
------------ ------------ ------------ ------------
(In thousands)
Interest Income:
Loans and leases $ 1,764 $ 478 $ 1,152 $ 134
Investment securities 143 159 (9) (7)
Federal funds sold (61) (0) (63) 2
Interest Bearing Deposits in Banks (54) (54) (54) 54
------------ ------------ ------------ ------------
Total interest income $ 1,792 $ 583 $ 1,026 $ 183
Interest Expense:
Interest-bearing Demand (22) 77 (89) (10)
Savings 6 8 (1) (1)
Time Deposits 738 290 276 172
Other borrowing 197 84 69 44
------------ ------------ ------------ ------------
Total interest expense $ 919 $ 459 $ 255 $ 205
------------ ------------ ------------ ------------
Net interest income $ 873 $ 124 $ 773 $ (24)
============ ============ ============ ============
(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 June 30, 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 June 30, 2006, total
non-interest income decreased $97 thousand or 16.25% to $500 thousand, down from
$597 thousand for the comparable period in 2005. The decrease in non interest
income was primarily the result of a decrease in gain on sale of loans partially
offset by an increase in service charges and other fee income.
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 from the gain on sale of loans decreased $196 thousand or 99.80%
to $20 thousand, down from $216 thousand for the comparable period in 2005.
Service charge fee income increased $61 thousand or 32.3% to $250 thousand, from
$189 thousand for the comparable period in 2005. The increase is primarily the
result of the growth in the number of deposit accounts from the same period in
2005.
15
Other fee income increased $38 thousand as a result of increases in mortgage
referral fees due to an increase in activity during the second quarter of 2006
as opposed to the same period in 2005.
Non-Interest Expense. 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
three months ended June 30, 2006 was $2.5 million compared to $2.2 million for
the same period in 2005, representing an increase of $266 thousand or 12.2%.
Increases in salaries and benefits of $143 thousand or 12.0% 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 June 30, 2006, there was $529,000 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 1.96 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.
The following table sets forth a summary of non-interest expense for the three
months ended June 30, 2006 and 2005:
Three Months Ended
June 30, June 30,
(In thousands) 2006 2005
------------ ------------
Non-interest Expense:
Salaries & Benefits 1,335 1,192
Occupancy 208 196
Furniture and Equipment 183 147
Other Expense 726 651
------------ ------------
Total Non-Interest Expenses 2,452 2,186
============ ============
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 Company's Effective Tax Rate
for the six month period ended June 30, 2006 increased to 39.4% from 37.0% for
the same period in June. The increase was due to decreases in the level of
investments in tax free municipal bonds. Additionally, income derived Enterprise
Zone loan income represents a smaller percentage of the loan portfolio than in
prior periods.
The following table reflects the Company's tax provision and the related
effective tax rate for the three months ended June 30, 2006 and 2005.
Three Months Ended
June 30, June 30,
(In thousands) 2006 2005
------------ ------------
Tax Provision $ 850 $ 620
Effective Tax Rate 39.4% 37.0%
16
RESULTS OF OPERATION FOR THE SIX MONTHS ENDED JUNE 30, 2006
Net interest income before provision for loan losses. Net interest income, on a
non tax equivalent basis, was $8.3 million for the six months ended June 30,
2006, an increase of $2.09 million or 33.87% from $6.2 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
investments. 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 and other borrowings.
Interest income increased $3.7 million or 43.23% to $12.1 million for the six
months ended June 30, 2006 from $8.4 million for the same period in 2005. The
increase in interest income was primarily attributed to volume increases in loan
and investment balances and increases in yields on all interest earning assets.
Loan volume increased due the bank's increased loan demand. The yield on loans
increased as the Federal Open Market Committee increased the prime lending four
times during the six period ended June 30, 2006. The increase in rate totaled
100 basis points for the period. The Company's average loan balances were $257.0
million for the six months ended June 30, 2006, up $50.9 million or 24.7% from
$206.2 million for the same period in 2005. The Company's average loan yield was
8.99% for the six months ended June 30, 2006, up 128 basis points from the 7.71%
yield for the same period in 2005. The Company's average investment balances
were $27.4 million for the six months ended June 30, 2006, up $8.9 million, or
47.5%, from $18.6 million for the same period in 2005. The Company's average
investment yield was 4.69% for the six months ended June 30, 2006, up 72 basis
points from the 3.97% yield for the same period in 2005. Although the Company's
average balances of Federal funds sold decreased $9.2 million to $845 thousand
for the six months ended June 30, 2006 from the $10.0 million for the same
period in 2005 and interest income decreased $108 thousand, the average yield on
Federal funds sold increased 154 basis points to 4.06% compared to 2.52% for the
same period in 2005. As a result of the change in mix of the Company's earning
assets and the yields earned, the overall yield on average earning assets
increased 146 basis points to 8.56% for the six months ended June 30, 2006, from
7.10% for the same period in 2005.
Interest expense increased $1.56 million, or 68.6% to $3.8 million for the six
months ended June 30, 2006, from $2.3 million for the same period in 2005. The
increase is primarily attributed to both the increase in the levels of average
time deposits and other borrowings and in the overall increases in the rates
paid on all interest bearing liabilities. Time deposits increased as the bank
experienced disintermediation from lower yielding transaction accounts into
higher yielding time deposits. Rates increase during the period as rates on
deposits were increased to remain completive with other financial institutions.
The Company's average balances of time deposits were $106.8 million for the six
months ended June 30, 2006, up $34.2 million, or 47.1% from $72.6 million for
the same period in 2005. The average rate paid on time deposits also increased
155 basis points to 3.91% for the six months ended June 30, 2006 from 2.36% for
the same period in 2005. As a result interest expense on time deposits increased
$1,219 thousand. The Company's average balances of other borrowings increased
$5.4 million to $18.2 million for the six months ended June 30, 2006 from $12.8
million for the same period in 2005 and the rates paid increased 197 basis
points to 6.27% from 4.30% for the same period in 2005. As a result interest
expense on other borrowings increased $292 thousand. The Company's average
balances of interest bearing demand deposits decreased $7.37 million to $95.7
million for the six months ended June 30, 2006 from $103.0 million for the same
period in 2005. The average rate paid increased 26 basis points to 2.49% from
2.23% for the same period in 2005. As a result interest expense on interest
bearing demand deposits increased $45 thousand.
17
As a result of the changes noted above, the net interest margin for the six
months ended June 30, 2006 increased 66 basis points or 12.7% to 5.85%, from
5.19% for the same period in 2005.
18
The following table presents for the six month periods indicated the
distribution of consolidated average assets, liabilities and shareholders'
equity. It also presents the amounts of interest income from the interest
earning assets and the resultant yields expressed in both dollars and rate
percentages. Average balances are based on daily averages. Nonaccrual loans are
included in the calculation of average loans while nonaccrued interest thereon
is excluded from the computation of yields earned:
---------------------------------------------------------------------------
($ in `000s) For the Six Months Ended For the Six Ended
June 30, 2006 June 30, 2005
---------------------------------------------------------------------------
Interest Average Interest Average
Average Income Yield or Average Income Yield or
Balance or Expense Cost Balance or Expense Cost
---------------------------------------------------------------------------
Assets:
- ------
Interest-earning assets:
Loans(1) (2) $ 257,036 $ 11,459 8.99% $ 206,150 $ 7,881 7.71%
Investment securities (2) 27,408 637 4.69% 18,587 366 3.97%
Federal funds sold 845 17 4.06% 10,011 125 2.52%
Interest bearing deposits in banks -- -- --% 5,450 85 3.15%
----------------------- -----------------------
Total average earning assets 285,289 12,113 8.56% 240,198 8,457 7.10%
Non-earning assets:
Cash and due from banks 12,896 13,930
Other assets 14,431 14,462
---------- ----------
Total average assets $ 312,616 $ 268,590
========== ==========
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
Deposits
Interest-bearing demand $ 95,679 1,182 2.49% $ 103,045 1,137 2.23%
Savings 6,415 25 0.79% 7,109 18 0.51%
Time deposits 106,785 2,069 3.91% 72,590 850 2.36%
Other borrowings (3) 18,169 565 6.27% 12,814 273 4.30%
----------------------- -----------------------
Total average interest-bearing liabilities 227,048 3,841 3.41% 195,558 2,278 2.35%
========== ==========
Non-interest bearing liabilities:
Demand deposits 61,686 54,965
Other liabilities 1,486 1,222
---------- ----------
Total liabilities 290,220 251,745
Shareholders' equity: 22,396 16,845
---------- ----------
Total average liabilities and shareholders' equity $ 312,616 $ 268,590
========== ==========
---------- ----------
Net interest income $ 8,272 $ 6,179
========== ==========
Yield on interest-earning assets (4) 8.56% 7.10%
Cost of funding interest-earning assets 2.72% 1.91%
---------- ----------
Net interest margin (5) 5.85% 5.19%
========== ==========
- -----------------------------------------------------------------------------------------------------------------------------------
(1) Not computed on a tax-equivalent basis.
(2) Loan fees included in loan interest income for the six month periods ended
June 30, 2006 and 2005 amounted to $897 thousand and $537 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
19
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:
Six Months ended June 30, 2006
2006 over 2005 change in net interest income
Net
Change Rate Volume Mix
------------ ------------ ------------ ------------
(In thousands)
Interest Income:
Loans and leases $ 3,578 $ 1,309 $ 1,945 $ 324
Investment securities 271 66 174 31
Federal funds sold (108) 76 (114) (70)
Interest Bearing Deposits in Banks (85) (85) (85) 85
------------ ------------ ------------ ------------
Total interest income $ 3,656 $ 1,366 $ 1,920 $ 370
Interest Expense:
Interest-bearing Demand 45 136 (81) (10)
Savings 7 10 (2) (1)
Time Deposits 1,219 556 400 263
Other borrowing 292 125 114 53
------------ ------------ ------------ ------------
Total interest expense $ 1,563 $ 827 $ 431 $ 305
------------ ------------ ------------ ------------
Net interest income $ 2,093 $ 539 $ 1,489 $ 65
============ ============ ============ ============
(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 $180 thousand in provision for
loan losses for the six month period ended June 30, 2006, up $60 thousand or
50.0%, from the $120 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 six months ended June 30, 2006, total
non-interest income decreased $267 thousand or 19.5% to $1.10 million, down from
$1.37 million for the comparable period in 2005. The decrease in non interest
income was primarily the result of a decrease in gains on sales of loans
partially offset by increases in other fee income and service charges.
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 $406 thousand or 69.3% to
$180 thousand, down from $586 thousand for the comparable period in 2005.
The increase in service charges of $88 thousand or 23.8% to $458 thousand from
$370 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.
20
The increase in other fee income is primarily the result of an increase in
mortgage referral fees due to increases in activity during the first six months
of 2006 as compared to the same period in 2005. Other fee income increased $51
thousand or 12.4% to $461 thousand, from $410 thousand for the comparable period
in 2005.
Non-Interest Expense. 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 six
months ended June 30, 2006 was $5.0 million compared to $4.2 million for the
same period in 2005, representing an increase of $821 thousand or 19.5%.
Increases in salaries and benefits of $376 thousand or 16.3% 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 $124 thousand
as a result of adopting SFAS No. 123(R). As of June 30, 2006, there was $529,000
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 1.96 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 six
months ended June 30, 2006 and 2005:
Six Months Ended
June 30, June 30,
(In thousands) 2006 2005
------------ ------------
Non-interest Expense:
Salaries & Benefits $ 2,685 $ 2,309
Occupancy 407 393
Furniture and Equipment 361 279
Other Expense 1,586 1,237
------------ ------------
Total Non-Interest Expenses $ 5,039 $ 4,218
============ ============
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 Company's Effective Tax Rate
for the six month period ended June 30, 2006 increased to 39.5% from 37.5% for
the same period in June. The increase was due to decreases in the level of
investments in tax free municipal bonds. Additionally, income derived Enterprise
Zone loan income represents a smaller percentage of the loan portfolio than in
prior periods.
21
The following table reflects the Company's tax provision and the related
effective tax rate for the six months ended June 30, 2006 and 2005.
Six Months Ended
June 30, June 30,
(In thousands) 2006 2005
------------ ------------
Tax Provision $ 1,638 $ 1,202
Effective Tax Rate 39.5% 37.5%
FINANCIAL CONDITION
Total assets at June 30, 2006 were $328 million, an increase of $18 million or
5.8%, from the $310 million at December 31, 2005. The growth in assets was
primarily in the Company's loans offset by decreases in Federal funds sold and
investment securities. Loans grew $28.6 million or 11.8% to $270 million at June
30, 2006 from $242 million at December 31, 2005. There were no Federal funds
sold at June 30, 2006 representing a decrease of $5 million from December 31,
2005. Over the same period investments decreased $5.2 million or 18.2% to $23
million from $28 million. The growth in assets was primarily funded by the net
income of $2.5 million and growth in deposits of $14 million or 5.21%. Borrowed
funds increased $900 thousand or 22.5%.
The change in deposits was comprised of a decrease in non-interest bearing
deposits of $4.5 million or 7.2% to $64 million at June 30, 2006 from $69
million at December 31, 2005; this decrease was offset by increases in interest
bearing deposits of $18 million or 8.8% to $223 million at June 30, 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.
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:
June 30 December 31,
- ----------------------------------------------------------------------------
2006 2005
- ----------------------------------------------------------------------------
(In thousands)
Commercial $ 48,143 $ 43,063
Agriculture 17,940 17,582
Real estate - commercial 126,861 126,166
Real estate - construction 67,217 43,352
Installment & other 12,344 13,536
------------ ------------
272,505 243,699
Deferred loan fees and costs 118 213
Allowance for loan losses (2,516) (2,356)
------------ ------------
Total net loans $ 270,107 $ 241,556
============ ============
22
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 $28.6 million or 11.8%, to $270.1
million at June 30, 2006 from $241.5 million at December 31, 2005. Commercial
loans increased $5.6 million or 13.2% to $48.1 million from $43.1 million at
December 31, 2005. Agricultural loans increased slightly by $358 thousand or
2.0% to $17.9 million from $17.6 million at December 31, 2005. Real estate -
commercial loans increased slightly by $695 thousand or 1.0% to $126.9 million
from $126.2 million at December 31, 2005. The largest increase was in real
estate - construction loans which increased $23.9 million or 55.1% to $67.2
million from $43.4 million at December 31, 2005. The increase in construction
loans during the six month period ended June 30, 2006 was due to delayed draws
on construction loans as building was delayed due the longer than normal winter
season. Installment and other loans decreased $910 thousand or 6.9% to $12.3
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 now representing 24.3% of total
loans compared to 27.8% in the prior year, real estate construction loans now
representing 24.7% compared to 14.9% in the prior year, commercial real estate
loans now representing 46.6% compared to 51.9% in the prior year, and
installment loans now representing 4.4% compared to 6.3% in the prior year,
Nonperforming loans. There were no nonperforming loans at June 30, 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 operations as a
provision for loan losses. When a loan is deemed uncollectible, it is charged
against the allowance. Any recoveries of previously charged-off loans are
credited back to the allowance. There is no precise method of predicting
specific losses or amounts that ultimately may be charged-off on particular
categories of the loan portfolio. Similarly, the adequacy of the ALL and the
level of the related provision for possible loan losses is determined on a
judgment basis by management based on consideration of a number of factors
including (i) economic conditions, (ii) borrowers' financial condition, (iii)
loan impairment, (iv) evaluation of industry trends, (v) industry and other
concentrations, (vi) loans which are contractually current as to payment terms
but demonstrate a higher degree of risk as identified by management, (vii)
continuing evaluation of the performing loan portfolio, (viii) monthly review
and evaluation of problem loans identified as having a loss potential, (ix)
monthly review by the Board of Directors, (x) off balance sheet risks and (xi)
assessments by regulators and other third parties. Management and the Board of
Directors evaluate the allowance and determine its desired level considering
objective and subjective measures, such as knowledge of the borrowers'
businesses, valuation of collateral, the determination of impaired loans and
exposure to potential losses.
While management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions and other qualitative factors. In addition, various regulatory
23
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 $180,000 for the six months ended
June 30, 2006 compared to $120,000 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 Six Months Ended
(In thousands) June 30, June 30,
- --------------------------------------------------------------------------------------------------
2006 2005 2006 2005
- --------------------------------------------------------------------------------------------------
Beginning Balance: $ 2,442 $ 2,276 $ 2,356 $ 2,214
Provision for loan losses 90 60 180 120
Charge-offs:
Commercial 16 4 15 5
Real Estate -- -- -- --
Other -- -- 5 --
---------- ---------- ---------- ----------
Total Charge-offs 16 4 20 5
---------- ---------- ---------- ----------
Recoveries:
Commercial -- -- 0 3
Other -- -- -- --
---------- ---------- ---------- ----------
Total Recoveries -- -- 0 3
---------- ---------- ---------- ----------
Ending Balance $ 2,516 $ 2,332 $ 2,516 $ 2,332
========== ========== ========== ==========
ALL to total loans 0.93% 1.09% 0.93% 1.09%
Net Charge-offs to average loans-annualized 0.00% 0.00% 0.00% 0.00%
- --------------------------------------------------------------------------------------------------
Investment securities. Investment securities decreased $5.2 million to $23.3
million at June 30, 2006, from $28.5 million at December 31, 2005.
The Company's investment in U.S. Treasury securities decreased to 47.0% of the
investment portfolio at June 30, 2006 compared to 52.0% at December 31, 2005.
Obligations of U.S. Agencies increased to 30.4% of the investment portfolio at
June 30, 2006 compared to 26.3% at December 31, 2005. The Company's investment
in corporate bonds decreased to 8.6% of the investment portfolio at June 30,
24
2006 compared to 11.7% at December 31, 2005. Tax-exempt municipal obligation
bonds increased to 14.0% of the investment portfolio at June 30, 2006 compared
to 10.0% at December 31, 2005. Fed Funds sold decreased $4.7 million, or 100%.
The overall decrease was the result of the proceeds from maturities of
securities and the cash position being used as a funding source for the
increased demand in loans.
Deposits. Total deposits were $287.3 million as of June 30, 2006 an increase of
$14.2 million or 5.2% 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 to 29.2%
of total deposits from 30.9% at December 31, 2005. Money market and savings
accounts decreased to 27.2% of total deposits from 34.9% at December 31, 2005.
Time deposits increased to 43.6% 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 June 30, 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.
25
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
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------------- ----------------------- ------------------------
Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
---------- ---------- ---------- ---------- ---------- ----------
Company
As of June 30, 2006:
Total capital
(to risk weighted assets) $ 35,081 11.89% $ 23,595 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 31,912 10.82% $ 11,798 4.00% N/A N/A
Tier I capital
(to average assets) $ 31,912 10.06% $ 12,684 4.00% N/A N/A
Bank
As of June 30, 2006:
Total capital
(to risk weighted assets) $ 32,777 11.17% $ 23,467 8.00% $ 29,156 10.00%
Tier I capital
(to risk weighted assets) $ 30,261 10.32% $ 11,734 4.00% $ 17,493 6.00%
Tier I capital
(to average assets) $ 30,261 9.54% $ 12,685 4.00% $ 15,856 5.00%
To Be Well
Capitalized Under
For Capital 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%
26
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
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 $37.0 million or 11.3% of total assets at June 30, 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 earning
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.
27
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.
In management's opinion there has not been a material change in the Company's
market risk or interest rate risk profile for the six months ended June 30, 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.
28
Part II - Other Information
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 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Bank held its annual shareholders meeting ("Meeting") on May 11, 2006 at the
Bank's office at 6 So El Dorado St., Stockton, CA. 94501.
According to the certified list of stockholders which was presented at the
Meeting, there were 3,524,282 shares of Common Stock of the Company outstanding
and entitled to vote at the Meeting. There were present at the Meeting, in
person or by proxy, the holders of 2,435,569 shares of Common Stock of the
Company, representing 69.11 % of the total votes eligible to be cast,
constituting a majority and more than a quorum of the outstanding shares
entitled to vote.
The Shareholders approved the following:
PROPOSAL 1 - Election of Directors
FOR WITHHELD
Michael L. Dalton 2,434,129 1,440
Maxwell M. Freeman 2,434,129 1,440
Harold Hand 2,434,129 1,440
Patricia Ann Hatton 2,434,129 1,440
Steven J. Kikuchi 2,434,129 1,440
Yosh Mataga 2,434,129 1,440
Steven A. Rosso 2,430,129 5,440
Gary A. Stewart 2,434,120 1,440
Kathleen Verner 2,433,929 1,640
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
29
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: August 14, 2006 By: /s/ STEVEN A. ROSSO
-------------------------------------
Steven A. Rosso
President and Chief Executive Officer
Pacific State Bancorp
Date: August 14, 2006 By: /s/ JOANNE ROBERTS
-------------------------------------
JoAnne Roberts
Senior Vice President and Chief
Financial Officer
30
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
31