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UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
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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, 2007
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 14, 2007
-------------- -------------------------------------
Common Stock 3,684,248
No Par Value
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACIFIC STATE BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) March 31, December 31,
(in thousands, except share amounts) 2007 2006
- --------------------------------------------------------------- ------------ ------------
Assets
Cash and due from banks $ 15,310 $ 18,985
Federal funds sold 47,190 31,630
------------ ------------
Total cash and cash equivalents 62,500 50,615
Investment securities - available for sale
(carrying value of $27,822 in 2006 and $23,186 in 2006) 27,769 23,107
Loans, less allowance for loan losses of $2,646 in 2007
and $2,478 in 2006 287,485 287,318
Bank premises and equipment, net 12,072 11,957
Company owned life insurance 6,139 6,079
Accrued interest receivable and other assets 8,241 7,676
------------ ------------
Total assets $ 404,206 $ 386,752
============ ============
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing $ 66,559 $ 73,197
Interest bearing 289,502 267,799
------------ ------------
Total deposits 356,061 340,996
Other borrowings 4,900 4,900
Subordinated debentures 8,764 8,764
Accrued interest payable and other liabilities 4,015 3,034
------------ ------------
Total liabilities 373,740 357,694
Commitments and contingencies
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 3,669,727 in 2007 and
3,661,477 in 2006 9,753 9,651
Retained earnings 20,781 19,455
Accumulated other comprehensive loss, net of tax (68) (47)
Total shareholders' equity 30,466 29,059
------------ ------------
Total liabilities and shareholders' equity $ 404,206 $ 386,753
============ ============
See notes to unaudited condensed consolidated financial statements
2
PACIFIC STATE BANCORP
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31,
(Unaudited) ----------------------------
(in thousands, except share amounts) 2007 2006
- --------------------------------------------------------------- ------------ ------------
Interest income:
Interest and fees on loans $ 6,842 $ 5,461
Interest on Federal funds sold 321 11
Interest on investment securities 343 320
------------ ------------
Total interest income 7,506 5,792
Interest expense:
Interest on deposits 2,917 1,485
Interest on subordinated debentures 192 164
Interest on borrowings 66 71
------------ ------------
Total interest expense 3,175 1,720
------------ ------------
Net interest income before
provision for loan losses 4,331 4,072
Provision for loan losses 165 90
------------ ------------
Net interest income after
provision for loan losses 4,166 3,982
------------ ------------
Non-interest income:
Service charges 221 208
Other fee income 456 231
Gain from sale of loans 9 160
------------ ------------
Total non-interest income 686 599
Non-interest expenses:
Salaries and employee benefits 1,482 1,349
Occupancy 286 199
Furniture and equipment 167 178
Other expenses 775 861
------------ ------------
Total non-interest expenses 2,710 2,587
------------ ------------
Income before provision for
income taxes 2,142 1,994
Provision for income taxes 816 787
------------ ------------
Net income $ 1,326 $ 1,207
============ ============
Basic earnings per share $ 0.36 $ 0.35
============ ============
Diluted earnings per share $ 0.33 $ 0.31
============ ============
Weighted average common shares outstanding 3,664,822 3,477,314
Weighted average common and common equivalent
shares outstanding 4,034,901 3,895,844
See notes to unaudited condensed consolidated financial statements
3
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Periods Ended March 31, 2007and 2006
(In thousands)
2007 2006
------------ ------------
Cash flows from operating activities:
Net income $ 1,326 $ 1,207
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 165 90
Net decrease in deferred loan origination costs 38 78
Depreciation and amortization 52 96
Gain on sale of loans, net (9) (160)
Stock-based compensation expense 50 62
Increase in Company owned life insurance, net (60) (35)
Increase in accrued interest
receivable and other assets (600) (201)
Increase in accrued interest
payable and other liabilities 981 286
------------ ------------
Net cash provided by operating Activities 1,943 1,423
------------ ------------
Cash flows from investing activities:
Purchases of available-for-sale investment securities (10,737) (3,920)
Proceeds from matured and called available-for-sale
investment securities 6,070 6,000
Proceeds from principal repayments from available-for-sale
government-guaranteed mortgage-backed securities 116 206
Proceeds from principal repayments from held-to-maturity
government-guarantee mortgage-backed securities 1 6
Purchase of FRB and FHLB stock
Net increase in loans (362) (12,261)
Purchases of premises and equipment (262) (101)
Purchase of Company owned life insurance*
------------ ------------
Net cash used in investing activities (5,174) (10,070)
------------ ------------
(Continued)
4
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Periods Ended March 31, 2007and 2006
(In thousands)
2007 2006
------------ ------------
Cash flows from financing activities:
Net increase (decrease) in demand, interest-bearing
and savings deposits $ 1,799 $ (18,305)
Net increase in time deposits 13,266 10,794
Proceeds from exercise of stock options 51 10
Net increase in short-term borrowings 14,000
------------ ------------
Net cash provided by financing Activities 15,116 6,499
------------ ------------
Increase (decrease) in cash and cash equivalents 11,885 (2,148)
Cash and cash equivalents at beginning of year 50,615 19,120
------------ ------------
Cash and cash equivalents at end of year $ 62,500 $ 16,972
============ ============
5
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 five county region that comprises Alameda, Calaveras, San Joaquin,
Stanislaus and Tuolumne counties, 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, 2007 had 86 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 nine 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, Lodi, Modesto
and Tracy and a limited service branch in Hayward, California. Pacific State
Bancorp common stock trades on the NASDAQ Global Market under the symbol of
"PSBC".
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, 2007 and December 31, 2006,
and the results of its operations for the three month period ended March 31,
2007 and 2006, and its cash flows for the three month periods ended March 31,
2007 and 2006 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 of America 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
included in the Company's 2006 Annual Report to Shareholders. The results of
operations for the three month period ended March 31, 2007 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
6
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:
March 31, December 31,
(In thousands) 2007 2006
- ------------------------------------ -------------- --------------
Commercial $ 64,846 $ 57,942
Agriculture 16,927 16,873
Real estate - commercial 133,066 127,545
Real estate - construction 64,000 75,654
Installment & other 11,290 11,742
-------------- --------------
290,129 289,756
Deferred loan fees and costs, net 2 40
Allowance for loan losses (2,646) (2,478)
-------------- --------------
Total net loans $ 287,485 $ 287,318
-------------- --------------
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 $104,424,000 and $110,937,000 and stand-by
letters of credit of $1,175,000 and $2,971,000 at March 31, 2007 and December
31, 2006, respectively. However, all such commitments will not necessarily
culminate in actual extensions of credit by the Company.
Approximately $41,898,000 of the loan commitments outstanding at March 31, 2007
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.
7
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, 2007 and December 31, 2006.
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
---------------------------
(in thousands) 03/31/07 03/31/06
- ---------------------------------- ------------ ------------
Net Income 1,326 1,207
Other Comprehensive Loss:
Change in unrealized loss on
available for sale securities (21) (19)
Reclassification adjustment - -
------------ ------------
Total Other Comprehensive Loss (21) (19)
------------ ------------
Total Comprehensive Income 1,305 1,188
============ ============
7. STOCK -BASED COMPENSATION
Stock Option Plan
At March 31, 2007, the Company has one stock-based compensation plan, the
Pacific State Bancorp 1997 Stock Option Plan (the "Plan"). 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 expire on a date 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. New shares are issued upon the exercise of options. Under the Plan,
56,954 shares of common stock remain reserved for issuance to employees and
directors through incentive and non statutory agreements.
Stock Option Compensation
There were no stock options granted in the three month periods ended March 31,
2007 and March 31, 2006. For the three month periods ended March 31, 2007 and
2006, the
8
compensation cost recognized for stock option compensation was $50,000 and
$66,000, respectively. The excess tax benefits were not significant for the
Company.
At March 31, 2007, the total compensation cost related to nonvested stock option
awards granted to employees under the Company's stock option plans but not yet
recognized was $306,000. Stock option compensation expense is recognized on a
straight-line basis over the vesting period of the option. This cost is expected
to be recognized over a weighted average remaining period of 1.25 years and will
be adjusted for subsequent changes in estimated forfeitures
Stock Option Activity
A summary of option activity under the stock option plans as of March 31, 2007
and changes during the period then ended is presented below:
Weighted
Weighted Average Aggregate
Average Remaining Intrinsic
Exercise Contractual Value
Options Shares Price Term ($000)
- --------------------------------------- ------------ ------------ ------------ ------------
Outstanding at January 1, 2007 668,499 $ 7.04 6.8 years $ 9,519
Granted - - -
Exercised (8,250) $ 6.25 - -
Cancelled - - -
------------
Outstanding at March 31, 2007 660,249 $ 7.07 6.8 years $ 9,527
============ ============ ============
Options vested or expected to vest at
March 31, 2007 423,675 $ 6.77 3.1 years $ 6,241
============ ============ ============
Exercisable at March 31, 2007 423,675 $ 6.77 3.1 years $ 6,241
============ ============ ============
The intrinsic value was derived from the market price of the Company's common
stock of $21.50 as of March 31, 2007.
8. INCOME TAXES
In July 2006, the Financial Accounting Standards Board (FASB) issued Financial
Accounting Standards Interpretation No. 48 (FIN 48), Accounting for Uncertainty
in Income Taxes--an Interpretation of FASB statement No. 109. 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 also prescribes a recognition threshold and measurement
standard for the financial statement recognition and measurement of an income
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. The Company has adopted FIN 48 as
of January 1, 2007.
The Company previously recognized income tax positions based on management's
estimate of whether it is reasonably possible that a liability has been incurred
for unrecognized income tax benefits by applying FASB Statement No. 5,
Accounting for Contingencies.
The provisions of FIN 48 have been applied to all tax positions of the Company
as of January 1, 2007. There was no cumulative effect of applying the provisions
of FIN 48 and there was no material effect on the Company's provision for income
taxes for the three months ended March 31, 2007. The Company recognizes interest
accrued related to unrecognized tax benefits and accruals for penalties in
income tax expense.
9
9. NEW ACCOUNTING PRONOUNCEMENTS
Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued Statement No. 159 (SFAS 159), The Fair Value
Option for Financial Assets and Financial Liabilities - Including an Amendment
of FASB Statement No. 115. This standard permits an entity to choose to measure
many financial instruments and certain other items at fair value at specified
election dates. The entity will report unrealized gains and losses on items for
which the fair value option has been elected in earnings at each subsequent
reporting date. The fair value option: (a) may be applied instrument by
instrument, with a few exceptions, such as investments otherwise accounted for
by the equity method; (b) is irrevocable (unless a new election date occurs);
and (c) is applied only to entire instruments and not to portions of
instruments. The provisions of SFAS 159 are effective as of the beginning of an
entity's first fiscal year that begins after November 15, 2007. Management did
not elect to early adopt SFAS 159 and has not yet completed its evaluation of
the impact that SFAS 159 will have.
Accounting for Deferred Compensation and Postretirement Benefit Aspects of
Collateral Assignment Split-Dollar Life Insurance Arrangements
In March 2007, the Emerging Issues Task Force (EITF) reached a final consensus
on Issue No. 06-10 (EITF 06-10), Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Collateral Assignment Split-Dollar Life
Insurance Arrangements. EITF 06-10 requires employers to recognize a liability
for the post-retirement benefit related to collateral assignment split-dollar
life insurance arrangements in accordance with SFAS No. 106 or APB Opinion No.
12. EITF 06-10 also requires employers to recognize and measure an asset based
on the nature and substance of the collateral assignment split-dollar life
insurance arrangement. The provisions of EITF 06-10 are effective for the
Company on January 1, 2008, with earlier application permitted, and are to be
applied as a change in accounting principle either through a cumulative-effect
adjustment to retained earnings or other components of equity or net assets in
the statement of financial position as of the beginning of the year of adoption;
or as a change in accounting principle through retrospective application to all
prior periods. The Company does not expect adoption of EITF 06-10 to have a
significant impact on its financial position, results of operations or cash
flows.
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
10
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
The following discussion and analysis sets forth certain statistical information
relating to the Company as of March 31, 2007 and December 31, 2006 and for the
three month periods ended March 31, 2007 and 2006. 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, 2006.
CRITICAL ACCOUNTING POLICIES
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 2006 Annual Report to Shareholders on
Form 10-K.
OVERVIEW
For the three months ended March 31, 2007:
The Company's net income increased $119 thousand or 9.86% to $1,326 thousand for
the first quarter of 2007 from $1,207 thousand for the same period in 2006. The
primary contributors to the increase in net income for the first quarter of 2007
were the $259 thousand increase in net interest income and an $87 thousand
increase in non interest income over the same period in 2006. These increases
were partially offset by increases in non interest expenses of $123 thousand.
The increase in non interest expenses consisted primarily of increases in
salaries and benefits of $133 thousand, occupancy and furniture and equipment
expenses of $76 thousand offset by a decrease in other expenses of $86 thousand.
Additionally, the provision for income taxes increased $75 thousand. Basic
earnings per share increased to $0.36 for the first quarter of 2007 up 2.86%
from $0.35 for the same period in 2006. Diluted earnings per share increased to
$0.33 for the first quarter of 2007 up 6.45% from the $0.31 for the same period
in 2006.
Total assets at March 31, 2007 were $404 million, an increase of $17 million or
4.39%, from the $387 million at December 31, 2006. The growth in assets was
primarily in the Company's level of Federal funds sold and investments. Federal
funds sold and investments grew $20 million or 36.36% to $75 million at March
31, 2007 from $55 million at December 31, 2006. Loans grew slightly by $167
thousand or 0.06% to $287 million at March 31, 2007 from $287 million at
December 31, 2006. The growth in Federal funds sold and investments was funded
by the net income of $1.3 million and growth in deposits of $15 million or
4.42%.
11
The annualized return on assets ("ROA") was 1.41% for the three month period
ended March 31, 2007 compared to 1.59% for the same period in 2006. The
annualized return on equity ("ROE") was 18.25% for the three month period ended
March 31, 2007 compared to 22.67% for the same period in 2006. The decrease in
ROE is primarily attributable to an increase in shareholders equity from the net
income and the proceeds from the sale of common stock to a new member of the
Board of Directors and the exercise of options to purchase Company stock.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2007
Net interest income before provision for loan losses. Net interest income, on a
non tax equivalent basis, was $4.3 million for the three months ended March 31,
2007, an increase of $259 thousand or 6.36% from $4.1 million for the same
period in 2006. The increase in net interest income was primarily a result of
the increase in the average balances of earning assets primarily in loans and
Federal funds and supported by the overall increases in the yields earned. These
increases were partially offset by the increases in both the level of and mix in
average interest bearing liabilities, primarily increases in time deposits and
decreases in interest-bearing demand deposits, and the increase in the average
rates paid, primarily on time deposits and other borrowings.
Interest income increased $1.7 million or 29.31% to $7.5 million for the three
months ended March 31, 2007 from $5.8 million for the same period in 2006. The
increase in interest income was primarily attributed to increases in levels of
average loans and Federal funds sold and the increases in the yields earned on
those earning assets. Loan volume increased due to the overall growth of the
Company. The Company's average loan balances were $292.4 million for the three
months ended March 31, 2007, up $41.3 million or 16.44% from $251.1 million for
the same period in 2006. The Company's average loan yield was 9.49% for the
three months ended March 31, 2007, up 67 basis points from the 8.82% yield for
the same period in 2006. As a result, interest income on loans increased $1,381
thousand. The Company's average balances of investment securities decreased $955
thousand to $26.7 million for the three months ended March 31, 2007 from the
$27.6 million for the same period in 2006. The Company's average yield on
investments increased 51 basis points to 5.20% from 4.69% for the same period in
2006. As a result, interest income increased $23 thousand. The Company's average
balances of Federal funds sold increased $25.2 million to $26.1 million for the
three months ended March 31, 2007 from the $928 thousand for the same period in
2006. The Company's average yield on Federal funds sold increased 17 basis
points to 4.98% from 4.81% for the same period in 2006. As a result, interest
income increased $310 thousand. The overall yield on average earning assets
increased 42 basis points to 8.82% for the three months ended March 31, 2007,
from 8.40% for the same period in 2006.
Interest expense increased $1.5 million, or 88.24% to $3.2 million for the three
months ended March 31, 2007, from $1.7 million for the same period in 2006. The
increase is primarily attributed to both the increase in levels of the average
time deposits and other borrowings and the overall increases in the rates paid
on all interest bearing liabilities, offset by the decrease in the level of
interest-bearing demand deposits. Time deposits increased as the bank
experienced disintermediation from lower yielding transaction accounts into
higher yielding time deposits. Rates increased during the period as rates on
deposits were increased to remain competitive with other financial institutions.
The Company's average balances of time deposits were $179.1 million for the
three months ended March 31, 2007, up $81.7 million, or 83.88% from $97.4
million for the same period in 2006. The average rate paid on time deposits also
increased 160 basis points to 5.20% for the three months ended March 31, 2007
from 3.60% for the same period in 2006. As a result, interest expense on time
deposits increased $1.43 million. The Company's average balances of interest
bearing demand deposits decreased $14.2 million to $87.8 million for the three
months ended March 31, 2007 from $102.0 million for the same period in 2006. The
12
average rate paid increased 39 basis points to 2.81% from 2.42% for the same
period in 2006. As a result interest expense on interest bearing demand deposits
decreased $2 thousand. The Company's average balances of other borrowings
decreased $2.9 million to $13.8 million for the three months ended March 31,
2007 from $16.7 million for the same period in 2006 and the rates paid increased
189 basis points to 7.59% for the three months ended March 31, 2007 from 5.70%
for the same period in 2006. As a result interest expense on other borrowings
increased $23 thousand. The overall rates paid on average interest-bearing
liabilities increased 137 basis points to 4.50% for the three months ended March
31, 2007, from 3.13% for the same period in 2006.
As a result of the changes noted above, the net interest margin for the three
months ended March 31, 2007 decreased 81 basis points to 5.09%, from 5.90% for
the same period in 2006.
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:
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2007 MARCH 31, 2006
-------------------------------------- ------------------------------------
Interest Average Interest Average
Average Income or Yield or Average Income or Yield or
Balance Expense Cost Balance Expense Cost
---------- ---------- ---------- ---------- ---------- ----------
ASSETS:
Interest-earning assets:
Loans (1)(2) $ 292,410 $ 6,842 9.49% $ 251,153 $ 5,461 8.82%
Investment securities (1) 26,737 343 5.20% 27,692 320 4.69%
Federal funds sold 26,149 321 4.98% 928 11 4.81%
---------- ---------- ---------- ----------
Total average earning assets 345,296 7,506 8.82% 279,773 5,792 8.40%
Non-earning assets:
Cash and due from banks 16,107 12,277
Other assets 21,196 15,086
---------- ----------
Total average assets $ 382,599 $ 307,136
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Deposits
Interest-bearing Demand $ 87,840 608 2.81% $ 102,033 610 2.42%
Savings 5,595 14 1.01% 6,534 10 0.62%
Time Deposits 179,076 2,295 5.20% 97,369 865 3.60%
Other borrowings (3) 13,787 258 7.59% 16,724 235 5.70%
---------- ---------- ---------- ----------
Total average interest-bearing
liabilities 286,298 3,175 4.50% 222,660 1,720 3.13%
======= ==========
Noninterest-bearing liabilities:
Demand deposits 65,347 61,347
Other liabilities 1,488 1,537
---------- ----------
Total liabilities 353,133 285,544
Shareholders' equity: 29,466 21,592
---------- ----------
Total average liabilities and shareholders'
equity $ 382,599 $ 307,136
========== ==========
---------- ----------
Net interest income $ 4,331 $ 4,072
========== ==========
Yield on interest-earning assets (4) 8.85% 8.40%
Cost of funding interest-earning assets 3.74% 2.49%
------- ----------
Net interest margin (5) 5.09% 5.90%
======= ==========
(1) Not computed on a tax-equivalent basis.
(2) Loan fees included in loan interest income for the three month periods
ended March 31, 2007 and 2006 amounted to $387 thousand and $417
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 MARCH 31,
2007 OVER 2006 CHANGE IN NET INTEREST INCOME
-------------------------------------------------
NET
(In thousands) CHANGE RATE VOLUME MIX
- ------------------------------- ---------- ---------- ---------- ----------
Interest Income:
Loans and leases $ 1,381 $ 416 $ 897 $ 68
Investment securities 23 35 (11) (1)
Federal funds sold 310 0 299 11
Total interest income $ 1,714 $ 451 $ 1,185 $ 78
Interest Expense:
Interest-bearing Demand (2) 96 (85) (13)
Savings 4 6 (1) (1)
Time Deposits 1,430 383 726 321
Other borrowing 23 78 (41) (14)
---------- ---------- ---------- ----------
Total interest expense $ 1,455 $ 563 $ 598 $ 293
---------- ---------- ---------- ----------
Net interest income $ 259 $ (112) $ 587 $ (216)
========== ========== ========== ==========
(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 $165 thousand in provision for
loan losses for the three month period ended March 31, 2007 an increase of $75
thousand or 83.33% from $90 thousand for the same period in 2006. The increase
in the provision is based on management's assessment of the required level of
reserves. Management assesses 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, 2007, total
non-interest income increased $87 thousand or 14.52% to $686 thousand, up from
$599 thousand for the comparable period in 2006. The increase in non interest
income was primarily the result of increases in fee income derived from the
referral of commercial mortgage loans to third parties. The increase was offset
by a decrease in gain on sale of loans.
Other fee income increased $225 thousand as a result of increases in mortgage
referral fees due to an increase in Commercial Real Estate loan referral
activity during the first quarter of 2007 as opposed to the same period in 2006.
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
15
the gain on sale of loans decreased $151 thousand or 94.38% to $9 thousand, down
from $160 thousand for the comparable period in 2006.
Non-Interest Expenses. Non-interest expenses consist 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 March 31, 2007 was $2.7 million compared to $2.6 million for
the same period in 2006, representing an increase of $123 thousand or 4.75%.
This increase reflects increases in salaries and benefits of $133 thousand or
9.9% which are indicative of the additions to staff for the Lodi Office opened
in the 4th quarter of 2006 and of expanded branch operations in line with their
respective growth. The increase in occupancy expense is primarily attributable
to the opening of the Lodi Office. The decrease in furniture and equipment
expense, as well as the decrease in other expense is attributable to our
continued efforts to control costs .
The following table sets forth a summary of non-interest expense for the three
months periods ended March 31, 2007 and 2006:
Three Months Ended
-----------------------
March 31, March 31,
(In thousands) 2007 2006
- ------------------------------ ---------- ----------
Non-interest Expense:
Salaries & Benefits 1,482 1,349
Occupancy 286 199
Furniture and Equipment 167 178
Other Expense 775 861
---------- ----------
Total Non-Interest Expenses 2,710 2,587
========== ==========
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 three month period ended March 31, 2007 decreased slightly to 38.1% from
39.5% for the same period in 2006. The decrease was due to the increased level
of income derived from Enterprise Zone loans as well as the level of income
derived from tax exempt loans to municipalities.
The following table reflects the Company's tax provision and the related
effective tax rate for the three months periods ended March 31, 2007 and 2006:
Three Months Ended
------------------------
March 31, March 31,
(In thousands) 2007 2006
- ------------------------------ ---------- ----------
Tax Provision $ 816 $ 787
Effective Tax Rate 38.1% 39.5%
16
FINANCIAL CONDITION
Total assets at March 31, 2007 were $404 million, an increase of $17 million or
4.39%, from the $387 million at December 31, 2006. The growth in assets was
primarily in the Company's level of Federal funds sold and investments. Federal
funds sold and investments grew $20 million or 36.36% to $75 million at March
31, 2007 from $55 million at December 31, 2006. Loans grew slightly by $167
thousand or 0.06% to $287 million at March 31, 2007 from $287 million at
December 31, 2006. The growth in Federal funds sold and investments was funded
by the net income of $1.3 million and growth in deposits of $15 million or
4.42%.
The change in deposits was comprised of a decrease in non-interest bearing
deposits of $6.6 million or 9.10% to $66.6 million at March 31, 2007 from $73.2
million at December 31, 2006; this decrease was offset by increases in interest
bearing deposits of $21.7 million or 8.10% to $289.5 million at March 31, 2007
from $267.8 million at December 31, 2006. The change in the mix of deposit is
the result of disintermediation in which depositors seek higher yields on
deposits by placing the deposits in higher yield term accounts.
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:
March 31, December 31,
(In thousands) 2007 2006
- --------------------------------- ------------ ------------
Commercial $ 64,846 $ 57,942
Agriculture 16,927 16,873
Real estate - commercial 133,066 127,545
Real estate - construction 64,000 75,654
Installment & other 11,290 11,742
------------ ------------
290,129 289,756
Deferred loan fees and costs, net 2 40
Allowance for loan losses (2,646) (2,478)
------------ ------------
Total net loans $ 287,485 $ 287,318
------------ ------------
The Company continues to manage the mix in its loan portfolio consistently with
its identity as a community bank serving Northern California and the Central
Valley. Net portfolio loans have increased slightly by $167 thousand or 0.06%,
to $287.5 million at March 31, 2007 from $287.3 million at December 31, 2006.
Commercial loans increased $6.9 million or 11.9% to $64.8 million from $57.9
million at December 31, 2006. Agricultural loans increased slightly by $53
thousand or 0.31%. Real estate - commercial loans increased by $5.6 million or
4.4% to $133.1 million from $127.5 million at December 31, 2006. Real estate -
construction loans decreased $11.6 million or 15.4% to $64.0 million from
17
$75.6 million at December 31, 2006. Installment and other loans decreased $451
thousand or 3.8% to $11.3 million from $11.7 million at December 31, 2006. The
portfolio mix remained consistent with the prior year, with commercial and
agricultural loans now representing 22.35% of total loans compared to 22.57% in
the prior year, real estate construction loans now representing 22.06% compared
to 22.27% in the prior year, commercial real estate loans now representing
45.87% compared to 46.33% in the prior year, and installment loans now
representing 3.89% compared to 3.93% in the prior year.
Nonperforming loans. There were no nonperforming loans at March 31, 2007 and
December 31, 2006.
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
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.
18
Management believes the assigned risk grades and our methods for managing risk
are satisfactory.
The provision for loan losses increased to $165,000 for the three months ended
March 31, 2007 compared to $90,000 for the same period in 2006. 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
March 31,
------------------------
(In thousands) 2007 2006
- ---------------------------------- ---------- ----------
Beginning Balance: $ 2,478 $ 2,357
Provision for loan losses 165 90
Charge-offs:
Commercial - -
Real Estate - -
Other 0 5
---------- ----------
Total Charge-offs 0 5
---------- ----------
Recoveries:
Commercial - -
Other 3 -
---------- ----------
Total Recoveries - -
---------- ----------
Ending Balance $ 2,646 $ 2,442
========== ==========
ALL to total loans 0.91% 0.95%
Net Charge-offs to average
loans-annualized 0.00% 0.00%
Investment securities. Investment securities increased $4.6 million to $27.7
million at March 31, 2007, from $23.1 million at December 31, 2006. Federal
funds sold increased $15.6 million to $47.2 million at March 31, 2007, from
$31.6 million at December 31, 2006.
The Company's investment in U.S. Treasury securities increased to 53.4% of the
investment portfolio at March 31, 2007 compared to 47.2% at December 31, 2006.
Obligations of U.S. Agencies decreased to 27.2% of the investment portfolio at
March 31, 2007 compared to 29.2% at December 31, 2006. The Company's investment
in corporate bonds decreased to 9.1% of the investment portfolio at March 31,
2007 compared to 10.9% at December 31, 2006. Tax-exempt municipal obligation
bonds decreased to 10.3% of the investment portfolio at March 31, 2007 compared
to 12.7% at December 31, 2006. Fed Funds sold increased $15.6 million, or 49.2%.
The overall increase was primarily the result of the increase in deposits being
placed in Federal funds sold and the increase in U. S. Treasury securities used
to pledge as collateral for public deposits.
Deposits. Total deposits were $356.1 million as of March 31, 2007 an increase of
$15.1 million or 4.42% from the December 31, 2006 balance of $341.0 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 deposits and interest bearing checking deposits decreased to
24.15% of total deposits down from 27.0% at December 31, 2006. Money market and
savings accounts increased to 23.3% of total deposits from 21.9% at December 31,
2006. Time deposits increased to 51.4% of total deposits from 51.1% at
December 31, 2006
19
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, 2007 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.
20
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 March 31, 2007:
Total capital
(to risk weighted assets) $ 41,041 12.63% $ 26,002 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 37,316 11.48% $ 13,001 4.00% N/A N/A
Tier I capital
(to average assets) $ 37,316 9.78% $ 15,270 4.00% N/A N/A
BANK
As of March 31, 2007:
Total capital
(to risk weighted assets) $ 38,837 11.95% $ 25,969 8.00% $ 32,461 10.00%
Tier I capital
(to risk weighted assets) $ 35,976 11.08% $ 12,984 4.00% $ 19,477 6.00%
Tier I capital
(to average assets) $ 35,956 9.42% $ 15,269 4.00% $ 19,087 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, 2006:
Total capital
(to risk weighted assets) $ 39,427 11.83% $ 26.654 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $ 35,499 10.65% $ 13,327 4.00% N/A N/A
Tier I capital
(to average assets) $ 35,499 10.17% $ 13,961 4.00% N/A N/A
BANK
As of December 31, 2006:
Total capital
(to risk weighted assets) $ 37,141 11.2% $ 27,922 8.00% $ 33,317 10.00%
Tier I capital
(to risk weighted assets) $ 34,141 10.3% $ 13,327 4.00% $ 19,990 6.00%
Tier I capital
(to average assets) $ 34,141 9.7% $ 13,961 4.00% $ 17,541 5.00%
21
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, borrowers 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 $90.2 million or 22.3% of total assets at March 31, 2007
compared to $73.6 million or 19.0% of total assets at December 31, 2006. 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
22
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 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 three months ended March 31,
2007 compared to December 31, 2006 as discussed under the caption "Liquidity and
Market Risk" and "Net Interest Income Simulation" in the Company's 2006 Annual
Report to Shareholders filed as an exhibit with the Company's 2006 Annual Report
on Form 10-K, which is incorporated here by reference.
The following table reflects the company's projected net interest income
sensitivity analysis based on year-end data:
March 31, 2007
---------------------------------
Adjusted Net Percent change
Change in Rates Interest Income from base
- ------------------------- --------------- --------------
(in thousands)
Up 200 basis points $ 19,634 5.02%
Up 150 basis points 19,409 3.82%
Up 100 basis points 19,176 2.57%
Base Scenario 18,695 0.00%
Down 100 basis points (18,494) -1.08%
Down 150 basis points (18,388) -1.64%
Down 200 basis points (18,277) -2.24%
23
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 control over financial reporting.
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, 2006, 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 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
24
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, 2007 By: /s/ Steven A. Rosso
-------------------------------------
Steven A. Rosso
President and Chief Executive Officer
Pacific State Bancorp
Date: May 15, 2007 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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