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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended June 30, 2007
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
For the transition period from ____________ to ____________
Commission file number 000-50323
SERVICE 1ST BANCORP
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(Exact name of registrant as specified in its charter)
State of California 32-0061893
------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
49 W. 10th Street, Tracy, California 95376
------------------------------------------
(Address of principal executive offices)
(209) 956-7800
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(Registrant's Telephone Number, Including Area Code)
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 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 non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerate filer [ ] Non-accelerated filer [X]
Indicate by check 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 issuer's classes of
common equity as of the latest practicable date: No par value common stock -
2,388,739 shares outstanding at August 13, 2007.
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The Index to Exhibits is located at page 27.
INDEX
TO SERVICE 1ST BANCORP FORM 10-Q
FOR THE SIX MONTHS ENDED
JUNE 30, 2007
PAGE
----
Part I
Item 1 Financial Statements 3
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 11
Item 3 Quantitative and Qualitative Disclosures About Market Risk 20
Item 4 Controls and Procedures 21
Item 4T Controls and Procedures 21
Part II
Item 1 Legal Proceedings 21
Item 1A Risk Factors 21
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 22
Item 3 Defaults Upon Senior Securities 22
Item 4 Submission of Matters to a Vote of Security Holders 22
Item 5 Other Information 22
Item 6 Exhibits 22
Signatures 26
Exhibit 27
Index
4.2 Trust Preferred Security Indenture dated August 17, 2006 between Service 1st 28
Bancorp and Wells Fargo Bank, National Association
4.3 Trust Preferred Security Amended and Restated Declaration of Trust dated 91
August 17, 2006 between Service 1st Bancorp and Wells Fargo Bank, National Association
4.4 Trust Preferred Security Guarantee Agreement dated August 17, 2006 between 149
Service 1st Bancorp and Wells Fargo Bank, National Association
4.5 Trust Preferred Security Junior Subordinated Debt Security dated August 17, 2006 168
between Service 1st Bancorp and Wells Fargo Bank, National Association
4.6 Trust Preferred Security Trust Preferred Security Certificate dated August 17, 2006 174
between Service 1st Bancorp and Wells Fargo Bank, National Association
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the 182
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the 183
Sarbanes-Oxley Act of 2002
32.1 Certification of Service 1st Bancorp by its Chief Executive Officer and Chief 184
Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
06/30/07 12/31/06
------------- -------------
(Unaudited)
ASSETS
Cash and due from banks $ 5,174,082 $ 6,543,416
Federal funds sold 220,000 10,616,902
------------- -------------
Cash and cash equivalents 5,394,082 17,160,318
Certificates of deposit with other banks 2,341,750 1,500,000
Investment securities available-for-sale 72,311,970 81,157,727
Investment securities held-to-maturity 11,623,076 4,985,995
Loans, net 117,644,105 113,508,174
Bank premises and equipment, net 1,306,848 1,388,980
Cash surrender value of life insurance 3,631,474 3,566,696
Accrued interest receivable 1,444,430 1,461,602
Other assets 4,401,521 2,490,898
------------- -------------
Total assets $ 220,099,256 $ 227,220,390
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand $ 22,837,773 $ 33,848,426
Money market, NOW and savings 85,012,744 94,662,249
Time deposits under $100,000 62,806,270 48,409,724
Time deposits $100,000 and over 20,967,900 23,034,692
------------- -------------
Total deposits 191,624,687 199,955,091
Other borrowings 9,793,026 9,155,000
Accrued interest and other liabilities 1,744,117 1,143,465
------------- -------------
Total liabilities 203,161,830 210,253,556
Shareholders' equity:
Common stock 16,023,738 16,023,738
Additional paid-in-capital 313,154 207,144
Retained earnings 1,443,701 1,147,067
Accumulated other comprehensive income, net of tax (843,167) (411,115)
------------- -------------
Total shareholders' equity 16,937,426 16,966,834
------------- -------------
Total liabilities and shareholders' equity $ 220,099,256 $ 227,220,390
============= =============
The accompanying notes are an integral part of these consolidated
statements.
3
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE PERIODS ENDING
(unaudited)
For the three months ended For the six months ended
--------------------------- ---------------------------
06/30/07 06/30/06 06/30/07 06/30/06
------------ ------------ ------------ ------------
Interest income:
Interest and fees on loans $ 2,612,211 $ 2,271,226 $ 5,131,388 $ 4,164,600
Interest on investments 1,034,262 734,390 2,054,072 1,468,028
Interest on fed funds sold 9,403 5,610 66,399 24,112
Other interest income 13,839 975 31,794 7,809
------------ ------------ ------------ ------------
Total interest income 3,669,715 3,012,201 7,283,653 5,664,549
Interest expense:
Interest expense on deposits 1,750,008 1,107,460 3,513,321 2,051,577
Interest on borrowings 183,957 170,272 315,291 202,777
------------ ------------ ------------ ------------
Total interest expense 1,933,965 1,277,732 3,828,612 2,254,354
------------ ------------ ------------ ------------
Net interest income before provision for loan losses 1,735,750 1,734,469 3,455,041 3,410,195
Provision for loan losses 50,000 95,000 50,000 140,000
------------ ------------ ------------ ------------
Net interest income after provision for loan losses 1,685,750 1,639,469 3,405,041 3,270,195
Other Income:
Service charges, fees, and other income 44,121 66,052 159,516 137,477
Gain on the sale of investment securities 1,375 - (6,578) -
Gain on sale and servicing of loans 12,970 32,685 34,814 59,071
Referral fees on mortgage loans 174,970 - 211,870 -
Earnings on cash surrender value of life insurance 39,623 38,416 78,614 76,215
Consulting fees 60,000 - 60,000 -
------------ ------------ ------------ ------------
Total other income 333,059 137,153 538,236 272,763
Other Expenses:
Salaries and employee benefits 1,070,054 829,696 2,089,275 1,643,251
Occupancy expense 160,811 151,784 324,856 309,480
Equipment expense 88,406 56,823 164,075 108,165
Data processing and other professional fees 147,009 152,085 297,220 320,637
Office supplies and equipment 67,039 40,243 134,771 83,026
Loan department expense 409 20,439 20,654 124,525
Advertising and promotion 47,694 61,985 138,712 91,574
Directors fees and expenses 61,688 43,134 113,380 85,575
FDIC and state assessments 18,442 13,244 28,035 33,379
Other operating expenses 118,882 81,825 236,787 138,872
------------ ------------ ------------ ------------
Total other expenses 1,780,434 1,451,258 3,547,765 2,938,484
------------ ------------ ------------ ------------
Income before income taxes 238,375 325,364 395,512 604,474
Income tax expense 54,880 86,687 98,878 164,467
------------ ------------ ------------ ------------
Net income $ 183,495 $ 238,677 $ 296,634 $ 440,007
============ ============ ============ ============
Net income per share - basic $ 0.07 $ 0.10 $ 0.12 $ 0.18
============ ============ ============ ============
Net income per share - diluted $ 0.07 $ 0.09 $ 0.12 $ 0.17
============ ============ ============ ============
The accompanying notes are an integral part of these consolidated
statements.
4
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(unaudited)
Accumulated
Common Stock Additional Other Total
------------------------- Paid in Comprehensive Retained Comprehensive Shareholders'
Shares Amount Capital Income Earnings Income Equity
----------- ------------ ----------- -------------- ---------- ------------- -------------
Balance January 1, 2006 2,386,239 $ 15,992,913 $ - $ 299,946 $ (718,758) $ 15,574,101
Stock options exercised 2,500 30,825 30,825
Surplus from options expense 207,144 207,144
COMPREHENSIVE INCOME:
Net income $ 847,121 847,121 847,121
Unrealized losses on
securities net of taxes
of $217,194 308,699 - 308,699 308,699
Reclassification adjustment
for losses included in net
income, net of tax of $743 (1,056) - (1,056) (1,056)
-------------
Comprehensive income $ 1,154,764
=============
----------- ------------ ----------- ---------- ------------- -------------
Balance December 31, 2006 2,388,739 16,023,738 207,144 1,147,067 (411,115) 16,966,834
Surplus from options expense 106,010 106,010
COMPREHENSIVE INCOME:
Net income $ 296,634 296,634 296,634
Unrealized losses on
securities net of taxes
of $301,265 (428,191) (428,191) (428,191)
Reclassification adjustment
for losses included in net
income, net of tax of $2,717 (3,861) (3,861) (3,861)
-------------
Comprehensive income $ (135,418)
=============
----------- ------------ ----------- ---------- ------------- -------------
Balance June 30, 2007 2,388,739 $ 16,023,738 $ 313,154 $1,443,701 $ (843,167) $ 16,937,426
=========== ============ =========== ========== ============= =============
The accompanying notes are an integral part of the financial
statements.
5
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED JUNE 30,
(unaudited)
2007 2006
------------- -------------
Operating activities:
Net income $ 296,634 $ 440,007
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses 50,000 140,000
Depreciation 118,942 80,656
Amortization and accretion on securities (36,488) 134,573
Earnings on cash surrender value life insurance, net (64,778) (66,252)
Options Expense 106,010 99,298
Gain on sale of loans (6,737) (12,733)
Loans originated for sale (63,750) -
Proceeds from loan sales 70,487 150,150
Loss on sale of securities, net 6,578 -
Decrease (Increase) in accrued interest 17,172 (97,461)
Decrease (Increase) in other assets (1,620,972) (652,265)
Increase in accrued expenses and other liabilities 600,652 (238,408)
------------- -------------
Net cash provided by (used in) operating activities (526,250) (22,435)
Investing activities:
Purchases of securities available-for-sale (5,339,062) (3,274,813)
Purchases of securities held-to-maturity (7,380,003) (500,000)
Proceeds from sales of available-for-sale securities 3,228,767 -
Proceeds from sales of held-to-maturity securities 209,042 -
Proceeds from payments, maturities and calls of available-for-sale
securities 10,158,779 3,894,905
Proceeds from payments, maturities and calls of held-to-maturity securities 639,360 54,265
Net decrease (increase) in loans (4,185,931) (26,135,106)
Certificates of deposit with other banks (841,750) 700,000
Purchases of premises and equipment (36,810) (455,592)
------------- -------------
Net cash used by investing activities (3,547,608) (25,716,341)
Financing activities:
Net decrease in demand, interest-bearing deposits and savings (14,163,446) (23,758,910)
Net increase in time deposits 5,833,042 33,309,264
Options exercised - -
Net change in borrowings 638,026 12,896,000
------------- -------------
Net cash provided by financing activities (7,692,378) 22,446,354
------------- -------------
Net increase in cash and cash equivalents (11,766,236) (3,292,422)
Cash and cash equivalents at beginning of period 17,160,318 9,024,556
------------- -------------
Cash and cash equivalents at end of period $ 5,394,082 $ 5,732,134
============= =============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 3,797,407 $ 2,290,551
Income taxes $ - $ 247,000
The accompanying notes are an integral part of the financial
statements.
6
SERVICE 1ST BANCORP AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION AND MANAGEMENT REPRESENTATION
The accompanying unaudited consolidated financial statements of Service
1st Bancorp (the "Company") have been prepared in accordance with the
instructions to Form 10-Q and, therefore, do not include information or footnote
disclosures required by generally accepted accounting principles for complete
financial statements. For further information, refer to the financial statements
and related footnotes included in the Company's annual report on Form 10-K for
the year ended December 31, 2006. In the opinion of management, the financial
statements presented herein include all adjustments (consisting of normal
recurring accruals) necessary to present fairly, in all material respects, the
financial position of the Company as of June 30, 2007 and the Company's income
statement for the three months ended June 30, 2007 and 2006, and the statement
of cash flows for the three months ended June 30, 2007 and 2006. Operating
results for interim periods are not necessarily indicative of operating results
for an entire fiscal year.
The balance sheet as of December 31, 2006, has been derived from the
audited balance sheet as of that date.
RECLASSIFICATIONS
Certain reclassifications were made to prior periods presented to
conform to the current year. These reclassifications are of a normal recurring
nature.
STOCK-BASED COMPENSATION
On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004)
(SFAS No. 123R), "Share-Based Payment," which addresses the accounting for
stock-based payment transactions in which an enterprise receives employee
services in exchange for (a) equity instruments of the enterprise or (b)
liabilities that are based on the fair value of the enterprise's equity
instruments or that may be settled by issuance of such equity instruments. In
January 2005, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 107, which provides supplemental implementation
guidance for SFAS No. 123R. SFAS No. 123R eliminates the ability to account for
stock-based compensation transactions using the intrinsic value method under
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and instead generally requires that such transactions be
accounted for using a fair-value-based method. SFAS No. 123R requires the use of
a valuation model to calculate the fair value of stock-based awards. The Company
has elected to use the Black-Scholes Model for option valuation. This model
incorporates various assumptions including volatility, expected life, and
interest rates. The expected volatility is based on the historical volatility of
the Company's common stock over the most recent period commensurate with the
estimated expected life of the Company's stock options adjusted for the impact
of unusual fluctuations not reasonably expected to recur and other relevant
factors. The expected life of an award is based on historical experience and on
the terms and conditions of the stock awards granted to employees.
The assumptions used for the six-month period ended June 30, 2007 and
2006 are as follows:
WEIGHTED AVERAGE ASSUMPTIONS FOR OPTIONS GRANTED
DURING THE PERIOD ENDED:
June 30, 2007 June 30, 2006
------------- -------------
Expected Life 72 months 72 months
Stock Volatility 75.08% 55.58%
Risk free interest rate 4.75% 4.77%
Dividend yield 0.00% 0.00%
7
SERVICE 1ST BANCORP AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - EARNINGS PER SHARE (EPS)
Basic EPS excludes dilution and is computed by dividing income
available to common shareholders' by the weighted-average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that then shared in earnings of the entity as of June 30, 2007 and 2006.
Weighted average shares outstanding used in the computation of basic earnings
per share were 2,388,739 and 2,388,739 in 2007 and 2006, respectively. Weighted
average shares outstanding used in the computation of diluted earnings per share
were 2,530,173 and 2,548,089 in 2007 and 2006, respectively.
NOTE 3 - SECURITIES
Securities are classified in two categories and accounted for as
follows: debt and equity securities that the Company has the positive intent and
ability to hold to maturity are classified as held-to-maturity and are measured
at amortized cost; and equity securities classified as available-for-sale and
are measured at fair value, with unrealized gains and losses, net of applicable
taxes reported in a separate component of stockholders' equity. Any gains or
losses on sales of investments are computed on a specific identification basis.
The tables below reflect the composition of investment securities,
amortized cost, unrealized gains and losses and estimated fair values as of June
30, 2007.
The amortized cost or fair values of investment securities available-for-sale at
June 30, 2007 were:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ------------- ------------- -------------
Available-for-Sale Securities:
Obligations of U.S. Government Agencies $ 32,455,341 $ 1,955 $ (574,883) $ 31,882,413
State and political subdivisions 18,989,867 139 (310,020) 18,679,986
Asset backed-securities 7,923,433 4,555 (184,880) 7,743,108
Mortgage backed-securities 13,879,050 7,418 (380,005) 13,506,463
Short-term mutual funds 500,000 - - 500,000
------------- ------------- ------------- -------------
$ 73,747,691 $ 14,067 $ (1,449,788) $ 72,311,970
============= ============= ============= =============
The amortized cost or fair values of investment securities held-to-maturity at
June 30, 2007 were:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ------------- ------------- -------------
Held-to-Maturity Securities:
Obligations of U.S. Government Agencies $ 3,983,667 $ 3,650 $ (259,318) $ 3,727,999
State and political subdivisions 4,564,801 13,123 (375,657) 4,202,267
Asset backed-securities 2,898,037 13,805 (12,462) 2,899,380
Mortgage backed-securities 176,571 1,223 (948) 176,846
------------- ------------- ------------- -------------
$ 11,623,076 $ 31,801 $ (648,385) $ 11,006,492
============= ============= ============= =============
Securities carried at approximately $57,366,000 were pledged to secure
deposits of public funds and borrowing arrangements.
8
SERVICE 1ST BANCORP
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES cont'd
The tables below reflect the composition of investment securities,
amortized cost, unrealized gains and losses and estimated fair values as of
December 31, 2006.
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ------------- ------------- -------------
Available-for-Sale Securities:
U.S. Government Agencies $ 39,415,380 $ 63,385 $ (294,940) $ 39,183,825
State and public subdivisions 19,522,737 38,074 (74,787) 19,486,024
Asset backed-securities 7,280,691 3,946 (133,943) 7,150,694
Mortgage backed-securities 15,138,808 12,460 (314,084) 14,837,184
Short-term mutual funds 500,000 - - 500,000
------------- ------------- ------------- -------------
$ 81,857,616 $ 117,865 $ (817,754) $ 81,157,727
============= ============= ============= =============
Held-to-Maturity Securities:
U.S. Government Agencies $ 2,468,485 $ - $ (17,659) $ 2,450,826
State and public subdivisions 2,313,410 119,689 (12,909) 2,420,190
Asset backed-securities 14,526 - - 14,526
Mortgage backed-securities 189,574 2,567 (57) 192,084
------------- ------------- ------------- -------------
$ 4,985,995 $ 122,256 $ (30,625) $ 5,077,626
============= ============= ============= =============
Securities carried at approximately $63,146,000 were pledged to secure
deposits of public funds and borrowing arrangements.
9
NOTE 4 - LOANS
Service 1st Bank's customers are primarily located in San Joaquin
County. At June 30, 2007, approximately 65.4% of the Bank's loans are for real
estate and construction loans and approximately 19.1% of the Bank's loans are
for general commercial users including professional, retail, and small
businesses. Consumer loans make up approximately 2.2% of the loan portfolio,
leases make up 7.4% of the loan portfolio, with agricultural loans making up the
remaining 5.9%. Generally, real estate loans are collateralized by real property
while commercial and other loans are collateralized by funds on deposit,
business or personal assets. Repayment is generally expected from the sale of
property for real estate loans and cash flows of the borrowers for other loans.
Major classifications of loans were:
6/30/2007 12/31/2006
------------- -------------
Construction and land development loans $ 32,467,271 $ 34,248,157
Real estate loans 45,583,221 43,396,795
Commercial loans 22,742,792 23,421,351
Leases 8,782,878 8,591,815
Agricultural loans 7,025,925 4,288,022
Consumer loans 2,673,588 1,225,571
------------- -------------
119,275,675 115,171,711
Deferred loan fees and costs (152,520) (234,487)
Allowance for loan losses (1,479,050) (1,429,050)
------------- -------------
Total net loans $ 117,644,105 $ 113,508,174
============= =============
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS
Certain matters discussed or incorporated by reference in this
Quarterly Report on Form 10-Q including, but not limited to, matters described
in "Item 2 - Management's Discussion and Analysis or Plan of Operation," are
"forward-looking statements" within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933,
as amended, and subject to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements may contain words
related to future projections including, but not limited to, words such as
"believe," "expect," "anticipate," "intend," "may," "will," "should," "could,"
"would," and variations of those words and similar words that are subject to
risks, uncertainties and other factors that could cause actual results to differ
materially from those projected. Factors that could cause or contribute to such
differences include, but are not limited to, the following: (1) variances in the
actual versus projected growth in assets; (2) return on assets; (3) loan and
lease losses; (4) expenses; (5) changes in the interest rate environment
including interest rates charged on loans, earned on securities investments and
paid on deposits; (6) competition effects; (7) fee and other noninterest income
earned; (8) general economic conditions nationally, regionally, and in the
operating market areas of the Company and its subsidiaries; (9) changes in the
regulatory environment; (10) changes in business conditions and inflation; (11)
changes in securities markets; (12) data processing problems; (13) a decline in
real estate values in the Company's operating market areas; (14) the effects of
earthquakes, floods, fires and other natural disasters, (15) terrorism, the
threat of terrorism or the impact of the current military conflict in Iraq and
the conduct of the war on terrorism by the United States and its allies, as well
as other factors. Other cautionary statements and information set forth in this
report should be carefully considered and understood as being applicable to all
related forward-looking statements contained in this report, when evaluating the
business prospects of the Company and its subsidiaries.
Forward-looking statements are not guarantees of performance. By their
nature, they involve risks, uncertainties and assumptions. The future results
and shareholder values may differ significantly from those expressed in these
forward-looking statements. You are cautioned not to put undue reliance on any
forward-looking statement. Any such statement speaks only as of the date of this
report, and in the case of any documents that may be incorporated by reference,
as of the date of those documents. We do not undertake any obligation to update
or release any revisions to any forward-looking statements, to report any new
information, future event or other circumstances after the date of this report
or to reflect the occurrence of unanticipated events, except as required by law.
However, your attention is directed to any further disclosures made on related
subjects in our subsequent reports filed with the Securities and Exchange
Commission on Forms 10-K, 10-Q and 8-K.
BUSINESS ORGANIZATION
Service 1st Bancorp (the "Company") is a California corporation and was
incorporated on January 23, 2004 to act as a holding company for Service 1st
Bank (the "Bank"). The Bank became a subsidiary of the Company effective June
26, 2004. As of June 30, 2007, the Company maintained its administrative office
in Tracy, San Joaquin County and the Bank operated three full-service offices in
the cities of Stockton, Tracy, and Lodi in San Joaquin County. The Bank offers a
full range of commercial banking services to individuals, small and medium-sized
businesses, municipalities and professionals in San Joaquin County and the
surrounding communities. On August 18, 2006, the Company established a new
subsidiary, Charter Services Group, Inc. ("Charter"). Charter assists new (de
novo) banks in filing applications for regulatory approval to organize and to
commence business as a commercial bank. Charter will also provide consulting
services to new banks including formulating policies and providing other ongoing
services.
The following analysis is designed to provide a more complete
understanding of the material changes and trends related to the Company's
financial condition, results of operations, cash flows, and capital resources.
This discussion should be read in conjunction with the financial statements
included in Item 1 of the Annual Report on Form 10-K for the year ended December
31, 2006.
11
CRITICAL ACCOUNTING POLICIES
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires the
Company's management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Note 1 to the financial statements describes the
significant accounting policies used in the preparation of the financial
statements. A critical accounting policy is defined as one that is both material
to the presentation of the Company's financial statements and requires
management to make difficult, subjective or complex judgments that could have a
material effect on the Company's financial condition and results of operations.
Management believes that the matters described below are critical accounting
policies.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through a provision for
loan losses charged to expenses. Loans are charged against the allowance for
loan losses when management believes that the collectibility of the principal is
unlikely. The allowance is an amount that management believes will be adequate
to absorb losses inherent in existing loans and commitments to extend credit,
based on evaluations of collectibility and prior loss experience of loans and
commitments to extend credit. The evaluations take into consideration such
factors as changes in the nature and volume of the portfolio, overall portfolio
quality, loan concentration, specific problem loans, commitments, and current
economic conditions that may affect the borrowers' ability to pay.
SUMMARY OF FINANCIAL CONDITION
The Company's total consolidated assets declined 3.1% from December 31,
2006 to June 30, 2007. As of June 30, 2007, total consolidated assets were
$220,099,256 compared to $227,220,390 as of December 31, 2006, and $191,696,466
at June 30, 2006. The decline in total assets from December 31, 2006 was
primarily due to a decline in noninterest-bearing DDA, which required a
reduction in Federal Funds sold from $10,616,902 at December 31, 2006 to
$220,000 at June 30, 2007.
Total net loans at June 30, 2007 were $117,644,106 compared to
$113,508,174 at December 31, 2006 and $108,390,821 at June 30, 2006. This
represents an increase in net loans of 3.6% from December 31, 2006.
Cash and due from banks declined from $6,543,416 at December 31, 2006
to $5,174,082 at June 30, 2007. The reduction in cash was used to fund loan
originations.
Total deposits were $191,624,687 at June 30, 2007 compared to
$199,955,091 at December 31, 2006 and $160,692,021 at June 30, 2006.
Noninterest-bearing DDA accounts decreased from $33,848,426 at December 31, 2006
to $22,837,773 at June 30, 2007. Money market, NOW, and savings accounts
decreased to $85,012,744 at June 30, 2007 from $94,662,249 at December 31, 2006.
Time deposits under $100,000 increased from $48,409,724 at December 31, 2006 to
$62,806,270 at June 30, 2007. The decline in noninterest-bearing DDA's was
primarily related to the loss of a large title company's deposit relationship.
The decline in money market, NOW, and savings accounts was primarily related to
a large client moving funds from their money market account to time deposits.
The increase in time deposits under $100,000 was primarily from the Bank's
participation in the national Certificate of Deposit Account Registry (CDARS)
program. Through this program, the Bank can offer $30,000,000 of FDIC insurance
coverage for time deposits. When the Bank places these deposits into the CDARS
network, it has the option of receiving reciprocal deposits from other banks in
the network. Reciprocal deposits from the CDARS program increased from
$42,184,035 at December 31, 2006 to $55,665,981 at June 30, 2007.
Other borrowings at June 30, 2007 and December 31, 2006 were
$9,793,026. The borrowings consist of $4,000,000 from the Federal Home Loan Bank
of San Francisco, $5,155,000 of Trust Preferred Securities, and $638,026 in
overnight Federal Funds purchased.
RESULTS OF OPERATIONS
Net income for the three months ended June 30, 2007 was $183,495
compared to $238,677 for 2006. Net income for the six months ended June 30, 2007
was $296,634 compared to $440,007 for June 30, 2006.
12
Basic earnings per share for the three months ended June 30, 2007 was
$0.07 per share compared to $0.10 for the three months ended June 30, 2006.
Diluted earnings per share for the three months ended June 30, 2007 and 2006
were $0.07 and $0.09, respectively. Basic earnings per share for the six months
ended June 30, 2007 were $0.12 per share compared to $0.18 for 2006. Diluted
earnings per share for the six months ended June 30, 2007 were $0.12 compared to
$0.17 for 2006.
The decline in net income for the three months and six months ended
June 30, 2007 was primarily from increased staffing and a decline in the net
interest margin.
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income, the primary component of the net earnings of a
financial institution, refers to the difference between the interest earned on
loans and investments and the interest paid on deposits and borrowings. Please
see the tables of average balance sheet and net interest income below.
The following table sets forth average balance sheet information,
interest income and expense, average yields and rates, and net interest income
and margin for the three months ended June 30, 2007 and 2006:
June 30, 2007 June 30, 2006
------------------------------------------ ------------------------------------------
Average Average
Average Income/ Yield or Average Income/ Yield or
Balance Expense Rate Paid Balance Expense Rate Paid
------------- ------------ ---------- ------------- ------------ ----------
Interest-earning assets:
Interest-bearing deposits $ 1,067,091 $ 13,839 5.20% $ 420,093 $ 4,999 4.77%
Investments 84,791,452 1,034,262 4.89% 69,498,877 730,366 4.22%
Federal funds sold 722,318 9,403 5.22% 405,131 5,610 5.55%
Loans (1) (2) 116,915,548 2,612,211 8.96% 104,195,123 2,271,226 8.74%
------------- ------------ ------------- ------------
Total interest-earning assets 203,496,409 3,669,715 7.23% 174,519,224 3,012,201 6.92%
Allowance for possible loan losses (1,438,941) (1,218,519)
Cash and due from banks 3,319,526 3,446,733
Bank premises and equipment 1,367,060 874,776
Accrued interest receivable 1,255,897 923,815
Other assets 6,855,623 5,694,271
------------- -------------
Total assets $ 214,855,574 $ 184,240,300
============= =============
Interest-bearing liabilities:
Demand deposits $ 57,930,325 622,763 4.31% $ 67,299,123 532,034 3.17%
Savings and money market accounts 25,396,563 181,553 2.87% 11,766,345 53,516 1.82%
Time deposits 77,017,947 945,692 4.93% 47,985,957 521,910 4.36%
Other borrowings 11,530,178 183,957 6.40% 12,763,939 170,272 5.35%
------------- ------------ ------------- ------------
Total interest-bearing liabilities 171,875,013 1,933,965 4.51% 139,815,364 1,277,732 3.67%
Non-interest bearing demand deposits 23,688,288 27,222,608
Other liabilities 2,071,877 377,055
------------- -------------
Total liabilities 197,635,178 167,415,027
Shareholders' equity 17,220,396 16,825,273
------------- -------------
Total liabilities and shareholders'
equity $ 214,855,574 $ 184,240,300
============= =============
------------ ------------
Net interest income $ 1,735,750 $ 1,734,469
============ ============
Net interest margin on average interest
earning assets (3) 3.42% 3.99%
1. Average loan balances include average deferred loan fees of $250,542 and
$257,718 for the three months ended June 30, 2007 and 2006, respectively.
2. Interest on loans includes fees of $59,461 and $60,549 for the three month
periods ended June 30, 2007 and 2006, respectively.
3. Net interest margin is computed by dividing net interest income by total
average earning assets.
All average balances have been computed using daily balances.
13
The following table sets forth average balance sheet information, interest
income and expense, average yields and rates, and net interest income and margin
for the six months ended June 30, 2007 and 2006.
June 30, 2007 June 30, 2006
------------------------------------------ ------------------------------------------
Average Average
Average Income/ Yield or Average Income/ Yield or
Balance Expense Rate Paid Balance Expense Rate Paid
------------- ------------ ---------- ------------- ------------ ----------
Interest-earning assets:
Interest-bearing deposits $ 1,213,934 $ 31,794 5.28% $ 823,554 $ 18,677 4.57%
Investments 85,858,789 2,054,072 4.82% 69,337,614 1,457,160 4.24%
Federal funds sold 2,376,065 66,399 5.64% 1,061,527 24,112 4.58%
Loans (1) (2) 115,324,163 5,131,388 8.97% 96,099,130 4,164,600 8.74%
------------- ------------ ------------- ------------
Total interest-earning assets 204,772,951 7,283,653 7.17% 167,321,825 5,664,549 6.83%
Allowance for loan losses (1,434,023) (1,172,664)
Cash and due from banks 3,640,892 3,512,498
Bank premises and equipment 1,388,698 754,527
Accrued interest receivable 1,238,039 861,462
Other assets 6,749,907 5,976,867
------------- -------------
Total assets $ 216,356,464 $ 177,254,515
============= =============
Interest-bearing liabilities:
Demand deposits $ 57,620,788 1,217,904 4.26% $ 68,258,746 1,013,184 2.99%
Savings and money market accounts 27,154,165 402,194 2.99% 14,584,168 128,316 1.77%
Time deposits 77,617,673 1,893,223 4.92% 43,377,688 910,077 4.23%
Other borrowings 10,390,026 315,291 6.12% 7,654,775 202,777 5.34%
------------- ------------ ------------- ------------
Total interest-bearing liabilities 172,782,652 3,828,612 4.47% 133,875,377 2,254,354 3.40%
Non-interest bearing demand
deposits 24,471,932 26,542,275
Other liabilities 1,889,253 1,127,877
------------- -------------
Total liabilities 199,143,837 161,545,529
Shareholders' equity 17,212,627 15,708,986
------------- -------------
Total liabilities and shareholders'
equity $ 216,356,464 $ 177,254,515
============= =============
------------ ------------
Net interest income $ 3,455,041 $ 3,410,195
============ ============
Net interest margin on average interest
earning assets (3) 3.40% 4.11%
1. Average loan balances include average deferred loan fees of $195,791 and
$291,373 for the six months ending June 30, 2007 and 2006, respectively.
2. Interest on loans includes fees of $122,309 and $110,432 for the six months
ending June 30, 2007 and 2006, respectively.
3. Net interest margin is computed by dividing net interest income by total
average earning assets.
All average balances have been computed using daily balances.
14
Net interest income for the three months ended June 30, 2007 was
$1,735,750 compared to $1,734,469 for 2006. Net interest income for the six
months ended June 30, 2007 was $3,455,041 compared to $3,410,195 for 2006.
Average interest-earning assets for the three months ended June 30, 2007 were
$203,496,409 compared to $174,519,224 during the same three months of 2006. The
yield earned on average interest-earning assets during the second quarter of
2007 was 7.23% compared to 6.92% during the same quarter of 2006. The average
rate paid on interest bearing-liabilities increased from 3.67% for the second
quarter of 2006 to 4.51% during the second quarter of 2007. Average
interest-earning assets for the six months ended June 30, 2007 was $204,772,951
compared to $167,321,825 during the same six months of 2006. The yield earned on
average interest-earning assets during the six months ended June 30, 2007 was
7.17% compared to 6.83% during the same period of 2006. The average rate paid on
interest bearing liabilities increased to 4.47% for the six months ended June
30, 2007 compared to 3.40% during the same period for 2006. The increase in
rates earned on loans, investments, and paid on deposits and borrowings was a
result of the Federal Reserve Bank raising interest rates two times during the
fiscal 2006 year. Also, the competition for deposits has caused higher interest
expense to attract and maintain deposits. The Bank utilized time deposits at a
higher rate to replace a portion of the decline of noninterest-bearing DDA and
money market accounts.
ALLOWANCE AND PROVISION FOR LOAN LOSSES
The Company assesses and manages credit risk on an ongoing basis
through stringent credit review and approval policies, extensive internal
monitoring, and established formal lending policies. Additionally, the Bank
contracts with an outside source to periodically review the existing loan
portfolio.
Management believes its ability to identify and assess risk and return
characteristics of the Company's loan portfolio is critical for profitability
and growth. Management strives to continue the historically low level of credit
losses by continuing its emphasis on credit quality in the loan approval
process, active credit administration, and regular monitoring. Management has
implemented a loan review and grading system that functions to continually
assess the credit risk inherent in the loan portfolio.
In extending credit and commitments to borrowers, the Bank generally
requires collateral and/or guarantees as security. The repayment of such loans
is expected to come from cash flows or from proceeds from the sale of selected
assets of the borrowers. The Bank's requirement for collateral and/or guarantees
is determined on a case-by-case basis in connection with management's evaluation
of the creditworthiness of the borrower. Collateral held varies, but may include
accounts receivable, inventory, property, plant and equipment, income-producing
properties, residences, and other real property.
Construction loans and other real estate secured loans comprise 65.4%
of total loans outstanding at June 30, 2007. Although management believes such
loans have no more than the normal risk of collectibility, a substantial decline
in the economy in general, or a decline in real estate values in the Company's
primary operating market areas in particular, could have an adverse impact on
the collectibility of such loans. In addition, such an occurrence could result
in an increase in loan losses and an increase in the provision for loan losses,
which could adversely affect the Company's future prospects, results of
operations, overall profitability, and the market price of the Company's common
stock.
The provision for loan losses for the three months ended June 30, 2007
was $50,000 compared to $95,000 during the same quarter of 2006. The provision
for loan losses for the six months ended June 30, 2007 was $50,000 compared to
$140,000 during the same period of 2006. At June 30, 2007, the allowance for
loan losses was $1,479,050 compared to $1,429,050 at December 31, 2006 and
$1,269,050 at June 30, 2006. The ratio of allowance for loan losses to gross
loans was 1.24% at June 30, 2007 compared to 1.24% at December 31, 2006 and
1.15% at June 30, 2006. The allowance for loan losses is adjusted by charges to
income and decreased by charge-offs (net of recoveries). Management's periodic
evaluation of the adequacy of the allowance is based on past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower's ability to repay, the estimated value of any
underlying collateral, and current economic conditions. Additional provisions
will be added as new loans are placed on the books in an amount necessary to
support the risks inherent in the portfolio.
The table on the next page summarizes the changes in the allowances for
loan losses arising from loans charged-off, recoveries on loans previously
charged-off, and additions to the allowance which have been charged to operating
expenses and certain ratios relating to the allowance for loan losses.
15
For the three months ended
June 30,
--------------------------------
2007 2006
-------------- --------------
OUTSTANDING LOANS:
Average for the Period $ 115,324,163 $ 96,099,130
End of the Period 119,275,675 109,951,059
ALLOWANCE FOR LOAN LOSSES:
Balance at Beginning of Year 1,429,050 1,123,494
Actual Charge-Offs:
Commercial - -
Consumer - -
Real Estate - -
-------------- --------------
Total Charge-Offs - -
-------------- --------------
Less Recoveries:
Commercial - -
Consumer - (5,556)
Real Estate - -
-------------- --------------
Total Recoveries - (5,556)
-------------- --------------
Net Loans Charged-Off (Recoveries) - (5,556)
Provision for Loan Losses 50,000 140,000
-------------- --------------
Balance at End of Period $ 1,479,050 $ 1,269,050
============== ==============
RATIOS:
Net Loans Charged-Off (Recoveries) to Average Loans 0.00% (.01)%
Allowance for Loan Losses to Total Loans 1.24% 1.15%
Net Loans Charged-Off (Recoveries) to Beginning
Allowance for Loan Losses 0.00% (.49)%
Net Loans Charged-Off (Recoveries) to Provision for Loan
Losses 0.00% (3.97)%
Allowance for Loan Losses to Nonperforming Loans 417.17% 2,957.81%
NONACCRUAL LOANS, LOANS PAST DUE 90 DAYS AND OREO
Management generally places loans on nonaccrual status when they become
90 days past due, unless the loan is well secured and in the process of
collection. Loans are charged off when, in the opinion of management, collection
appears unlikely. There were nonaccrual loans of $354,542 at June 30, 2007,
$42,905 at June 30, 2006, and $435,147 at December 31, 2006.
At June 30, 2007, there were loans totaling $354,542 that were
considered impaired or troubled debt restructurings compared to $42,905 at June
30, 2006 and $435,147 at December 31, 2006. These loans were delinquent at June
30, 2007 and placed on nonaccrual, but management currently believes that there
will be no material losses on these loans. The loans were placed on nonaccrual
to defer future income recognition until the delinquent payments have been
received. There were no loan concentrations in excess of 10% of total loans not
otherwise disclosed as a category of loans as of June 30, 2007 or December 31,
2006. Management is not aware of any potential problem loans, which were
accruing and current at June 30, 2007 or December 31, 2006, where serious doubt
exists as to the ability of the borrower to comply with the present repayment
terms. There was no other real estate owned at June 30, 2007 and December 31,
2006.
OTHER INCOME
Other income for the three months ended June 30, 2007 was $333,059
compared to $137,153 for the same period during 2006. Other income for the six
months ended June 30, 2007 was $538,236 compared to $272,763 for the same period
during 2006. The Bank offers fixed rate commercial real estate loans through a
third party lender. The Bank receives fees for the packaging of the loans
provided to the third party lender. The loans are funded by and become assets of
the third party lender. The fees on such loans for the three months ended June
30, 2007 were $174,970 and for the six months ended June 30, 2007 were $211,870.
There was no income from this activity for 2006. The Bank originates loans
through various government guarantee programs. The guaranteed portion of these
loans can be sold in the secondary market. Gains on loans sold in the secondary
market and the servicing of these loans for the three months ended June 30, 2007
were $12,970 compared to $32,685 during the same period in 2006. Gains on loans
sold in the secondary market and the servicing of these loans for the six months
ended June 30, 2007 were $34,814 compared to $59,071 during the same period in
2006.
16
OTHER EXPENSE
Salaries and employee benefits for the three months ended June 30, 2007
were $1,070,054 compared to $829,696 for the three months ended June 30, 2006.
Salaries and employee benefits for the six months ended June 30, 2007 were
$2,089,275 compared to $1,643,251 for the six months ended June 30, 2006. The
increase in salaries and employee benefits during 2007 was a result of an
increase in the number of employees from 44 at June 30, 2006 to 52 at June 30,
2007.
Occupancy and equipment expense for the three months ended June 30,
2007 was $249,217 compared to $208,607 for the same period of 2006. Occupancy
and equipment expense was $488,931 for the six months ended June 30, 2007
compared to $417,645 for the same period during 2006. The increase in expense is
related to rent for the Company's new office in Lodi, California, and annual CPI
increases in the lease expense for the branch offices.
Data processing and other professional fees expense was $147,009 for
the three months ended June 30, 2007 compared to $152,085 for the three months
ended June 30, 2006. Data processing and other professional fees for the six
months ended June 30, 2007 was $297,220 compared to $320,637 for the same period
during 2006. The primary increase in professional fees is for management
recruitment fees paid to locate new employees.
Loan department expense for the three months ended June 30, 2007 was
$409 compared to $20,439 for the same period of 2006. Loan department expense
for the six months ended June 30, 2007 was $20,654 compared to $124,525 for the
same period of 2006. The decrease in loan department expense for the six months
ended June 30, 2007 was primarily a result of a decrease in expense for loan
servicing assets. When the Company sells a government guaranteed loan it
establishes a loan servicing asset, which is the anticipated servicing over the
estimated remaining term of the loans sold. If these loans payoff early the
remaining unamortized servicing asset is written off. During the first quarter
of 2006, two large SBA loans paid off early. During the second quarter of 2007,
the Bank determined that the reserve for undisbursed loans could be reduced by
$27,000.
The increase in other operating expenses for the six months ended June
30, 2007 was primarily from an increase in fees to brokers for certificates of
deposit. The fee paid to brokers for the six months ended June 30, 2007 was
$70,006 compared to $19,943 for 2006. Losses from forgeries increased from $799
for the six months ended June 30, 2006 to $14,890 for 2007. The remainder of the
other operating expenses increased due to the growth of the Company.
CAPITAL RESOURCES
Total shareholders' equity at June 30, 2007 was $16,937,426 compared to
$16,966,834 at December 31, 2006. The primary changes in shareholders' equity
were net income for the six months ended June 30, 2007 of $296,634 and a
decrease in accumulated other comprehensive income, net of tax of $432,052.
The Company and the Bank are subject to regulations issued by the Board
of Governors of the Federal Reserve System and the FDIC, which require
maintenance of a certain level of capital. Under the regulations, capital
requirements are based upon the composition of an institution's asset base and
the risk factors assigned to those assets. The guidelines characterize an
institution's capital as being "Tier 1" capital (defined to be principally
shareholders' equity less intangible assets) and "Tier 2" capital (defined to be
principally the allowance for loan losses, limited to one and one-fourth percent
of gross risk weighted assets). The guidelines require the Company and the Bank
to maintain a risk-based capital target ratio of 8%, one-half or more of which
should be in the form of Tier 1 capital.
17
The following table shows the Company's and the Bank's actual capital
amounts and ratios at June 30, 2007 and December 31, 2006, as well as the
minimum capital ratios for capital adequacy under the regulatory framework
(dollar amounts are in thousands).
To be well-capitalized
For capital adequacy under prompt corrective
Actual purposes action provisions
----------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ---------- ---------- ---------- ---------- ----------
As of June 30, 2007:
Company:
Total capital (to risk weighted assets) $ 24,411 15.2% $ 12,749 8.0% N/A N/A
Tier 1 capital (to risk weighted assets) $ 17,777 11.1% $ 6,374 4.0% N/A N/A
Tier 1 capital (to average assets) $ 17,777 4.2% $ 17,061 4.0% N/A N/A
Bank:
Total capital (to risk weighted assets) $ 21,982 13.8% $ 12,749 8.0% $ 15,936 10.0%
Tier 1 capital (to risk weighted assets) $ 20,468 12.8% $ 6,374 4.0% $ 9,562 6.0%
Tier 1 capital (to average assets) $ 20,468 9.7% $ 8,482 4.0% $ 10,603 5.0%
As of December 31, 2006:
Company:
Total capital (to risk weighted assets) $ 23,956 15.3% $ 12,510 8.0% N/A N/A
Tier 1capital (to risk weighted assets) $ 22,527 14.4% $ 6,255 4.0% N/A N/A
Tier 1 capital (to average assets) $ 22,527 10.4% $ 8,673 4.0% N/A N/A
Bank:
Total capital (to risk weighted assets) $ 21,519 13.8% $ 12,510 8.0% $ 15,637 10.0%
Tier 1capital (to risk weighted assets) $ 20,028 12.8% $ 6,255 4.0% $ 9,382 6.0%
Tier 1 capital (to average assets) $ 20,028 9.3% $ 8,593 4.0% $ 10,741 5.0%
The Bank met the "well capitalized" capital ratio measures at both June
30, 2007 and December 31, 2006.
LIQUIDITY
Liquidity management refers to the Company's ability to provide funds
on an ongoing basis to meet fluctuations in deposit levels as well as the credit
needs and requirements of its clients. Both assets and liabilities contribute to
the Company's liquidity position. Federal funds lines, short-term investments
and securities, and loan repayments contribute to liquidity, along with deposit
increases, while loan funding and deposit withdrawals decrease liquidity. The
Company assesses the likelihood of projected funding requirements by reviewing
historical funding patterns, current and forecasted economic conditions and
individual client funding needs. Commitments to fund loans and outstanding
letters of credit at June 30, 2007 and December 31, 2006 were approximately
$34,902,000 and $40,607,000, respectively. Such loan commitments relate
primarily to revolving lines of credit and other commercial loans and to real
estate construction loans. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
The Company's sources of liquidity consist of cash and due from
correspondent banks, overnight funds sold to correspondent banks, unpledged
marketable investments and loans held for sale and/or pledged for secured
borrowings. At June 30, 2007, consolidated liquid assets totaled $28,787,000 or
13.1% of total assets compared to $47,002,000 or 20.7% of total assets on
December 31, 2006. In addition to liquid assets, the Company maintains
short-term lines of credit in the amount of $35,300,000 with correspondent
banks. At June 30, 2007, the Company had $34,662,000 available under these
credit lines. Additionally, Service 1st Bank is a member of the FHLB. At June
30, 2007, Service 1st Bank could have arranged for up to $17,964,500 in secured
borrowings from the FHLB. These borrowings are secured by pledged mortgage
loans. At June 30, 2007, the Company had advances, borrowings and commitments
(including letters of credit) outstanding of $4,000,000, leaving $13,964,500
available under these FHLB secured borrowing arrangements. Service 1st Bank also
has informal agreements with various other banks to sell participations in
loans, if necessary. The Company serves primarily a business and professional
customer base and, as such, its deposit base is susceptible to economic
fluctuations. Accordingly, management strives to maintain a balanced position of
liquid assets and borrowing capacity to volatile and cyclical deposits.
18
Liquidity is also affected by portfolio maturities and the effect of
interest rate fluctuations on the marketability of both assets and liabilities.
The Company can sell any of its unpledged securities held in the
available-for-sale category to meet liquidity needs. These securities are also
available to pledge as collateral for borrowings if the need should arise.
Service 1st Bank has established a master repurchase agreement with a
correspondent bank to enable such transactions. Service 1st Bank can also pledge
securities to borrow from the FRB and the FHLB. The principal cash requirements
of the Company are for expenses incurred in the support of administration and
operations.
INFLATION
The impact of inflation on a financial institution differs
significantly from that exerted on manufacturing or other commercial concerns,
primarily because its assets and liabilities are largely monetary. In general,
inflation primarily affects the Company and the Bank indirectly through its
effect on market rates of interest, and thus the ability of the Bank to attract
loan customers. Inflation affects the growth of total assets by increasing the
level of loan demand, and potentially adversely affects the Company's and the
Bank's capital adequacy because loan growth in inflationary periods can increase
at rates higher than the rate that capital grows through retention of earnings,
which the Company may generate in the future. In addition to its effects on
interest rates, inflation directly affects the Company by increasing operating
expenses. The effects of inflation were not material to the Company's results of
operations during the periods ending June 30, 2007 and 2006.
OFF-BALANCE SHEET ITEMS
The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business in order to meet the financing needs of
its customers and to reduce its exposure to fluctuations in interest rates.
These financial instruments consist of commitments to extend credit and letters
of credit. These instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized on the balance sheet.
The Company's exposure to credit loss in the event of nonperformance by
the other party for commitments to extend credit and letters of credit is
represented by the contractual amount of those instruments. The Company applies
the same credit policies to commitments and letters of credit as it does for
loans included on the consolidated balance sheet. As of June 30, 2007 and
December 31, 2006, commitments to extend credit and standby letters of credit
were the only financial instruments with off-balance sheet risk. The Company has
not entered into any contracts for financial derivative instruments such as
futures, swaps, options or similar instruments. Loan commitments and standby
letters of credit were $34,902,000 and $40,607,000 at June 30, 2007 and December
31, 2006, respectively. As a percentage of gross loans and leases these
off-balance sheet items represent 29.3% and 35.3%, respectively.
The Company has certain ongoing commitments under operating leases. The minimum
commitment under these operating leases for 2007 is $508,500.
EFFECTS OF TERRORISM
The terrorist actions on September 11, 2001 and thereafter and the
conflict with Iraq have had significant adverse effects upon the United States
economy. Whether the terrorist activities in the future and the actions of the
United States and its allies in combating terrorism on a worldwide basis will
adversely impact the Company and the extent of such impact is uncertain. Such
economic deterioration could adversely affect the Company's future results of
operations by, among other matters, reducing the demand for loans and other
products and services offered by the Bank, increasing nonperforming loans and
the amounts reserved for loan losses, and causing a decline in the Company's
stock price.
19
WEBSITE ACCESS
Information regarding the Company, the Bank, and Charter may be
obtained from the Company's website at www.service1stbank.com. Copies of the
Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and Section 16 reports by Company insiders, including
exhibits and amendments thereto, are available free of charge on the Company's
website as soon as they are published by the Securities and Exchange Commission
through a link to the Edgar reporting system maintained by the Securities and
Exchange Commission. To access Company filings, select "Go to Service 1st
Bancorp" at the bottom of the Company website page, then select "Click here to
view Service 1st Bancorp SEC Filings", followed by selecting "Continue to view
SEC Filings" to view or download copies of reports including Form 10-K, 10-Q or
8-K, or select "Click here to view Section 16 Reports," followed by selecting
"Continue to view Section 16 Reports," to view or download reports on Forms 3, 4
or 5 of insider transactions in Company securities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The types of market risk exposures generally faced in the banking
industry include interest rate risk, liquidity risk, equity price risk, foreign
currency risk, and commodity price risk. Due to the nature of our operations,
foreign currency and commodity price risk are not significant to us. See
"Management's Discussion and Analysis of Financial Condition and Operations -
Liquidity" for a discussion of our liquidity risk. Our interest rate risk and
equity market price risk are described below.
INTEREST RATE RISK
The Company manages its interest rate risk within an overall asset and
liability management framework that includes attention to credit risk, liquidity
risk, and capital structure. A principal objective of asset/liability management
is to manage the sensitivity of net interest income to changing interest rates.
Asset and liability management activity is governed by a policy reviewed and
approved annually by the Board of Directors. The Board of Directors has
delegated the administration of this policy to the Funds Management Committee, a
committee of the Board of Directors, which is comprised of senior executive
management, and four independent directors. Two common measures used to monitor
interest rate risk are economic value interest rate sensitivity and forecasted
net interest income rate sensitivity.
Economic Value Interest Rate Sensitivity
Interest rate sensitivity is computed by estimating percentage changes
in the economic value of our equity over a range of potential yield curve
shocks. Economic value sensitivity is defined as the economic value of our
assets less the economic value of our liabilities plus or minus the economic
value of off-balance sheet items. The economic value of each asset, liability
and off-balance sheet item is its discounted present value of expected cash
flows. Discount rates are based on implied forward market rates of interest,
adjusted for assumed shock scenario interest rate changes. The following table
shows our projected percentage change in economic value sensitivity for parallel
yield curve shocks as of the dates indicated relative to the value if wholesale
market rates follow implied forward rates.
Projected change in economic
value
----------------------------
June 30, December 31,
Change in interest rates 2007 2006
- ----------------------------------------------- ------------ ------------
100 basis point rise -18.4% -15.6%
100 basis point decline 9.98% 5.2%
The economic value of portfolio equity sensitivity from December 31,
2005 to December 31, 2006 has shifted due to changes in wholesale rates, a
change in the composition of customer loans, leases, investments, and deposits,
and shortened wholesale borrowing maturities.
Forecasted Net Interest Income Interest Rate Sensitivity
The impact of interest rate changes on the next 12 months' net interest
income is measured using income simulation. The various products in our balance
sheet are modeled to simulate their income (and cash flow) behavior in relation
to interest rate movements. Income for the next 12 months is calculated using
the implied forward curve and for immediate and sustained yield curve shocks.
20
The income simulation model includes various assumptions about the
repricing behavior for each product and new business volumes and pricing
behaviors. Many of our assets are floating rate loans, which would subsequently
reprice in response to changes in market interest rates with the repricing being
the same extent as the change in the underlying contracted index. Our Liquid
Gold account deposit products are assumed to reprice gradually in response to
wholesale rate changes. The following table shows our projected percentage
change in 12 month net interest income as a consequence of parallel yield curve
shocks from the implied forward curve:
Projected change in net
interest income
----------------------------
June 30, December 31,
Change in interest rates 2007 2006
- ----------------------------------------------- ------------ ------------
100 basis point rise 0.74% 4.32%
100 basis point decline 0.47% 1.12%
Net interest income sensitivity from December 31, 2005 to December 31,
2006 evolved from a slightly asset-sensitive position to a relatively neutral
position.
EQUITY MARKET PRICE RISK
We are not exposed to equity market risk through our investments in
stocks. The only stocks owned are 9,346 shares of FHLB of San Francisco and 400
shares of Pacific Coast Bankers' Bank. These stocks are not actively traded on
any exchange, but their market value exceeds their cost.
ITEM 4. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures
An evaluation of the Company's disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) was carried out under the
supervision and with the participation of the Company's Chief Executive Officer,
Chief Financial Officer and other members of the Company's senior management as
of the end of the Company's fiscal quarter ended June 30, 2007. The Company's
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures as currently in effect are effective in
ensuring that the information required to be disclosed by the Company in the
reports it files or submits under the Exchange Act is (i) accumulated and
communicated to the Company's management (including the Chief Executive Officer
and Chief Financial Officer) to allow timely decisions regarding required
disclosure, and (ii) recorded, processed, summarized and reported within the
time periods specified in the Commission's rules and forms.
(b) Internal Control Over Financial Reporting
An evaluation of any changes in the Company's internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)),
that occurred during the Company's fiscal quarter ended June 30, 2007, was
carried out under the supervision and with the participation of the Company's
Chief Executive Officer, Chief Financial Officer and other members of the
Company's senior management. The Company's Chief Executive Officer and Chief
Financial Officer concluded that no change identified in connection with such
evaluation has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
ITEM 4T. CONTROLS AND PROCEDURES
Not Applicable
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 1A. RISK FACTORS
None
21
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual shareholder's meeting was held on May 31, 2007. The
incumbent directors were elected as Directors for the year 2007 and
until their successors are elected and qualified as follows:
For Against
------------ ---------
Dean Andal 1,506,148 42,728
John O. Brooks 1,510,095 38,791
Eugene C. Gini 1,509,702 39,184
Bryan R. Hyzdu 1,510,095 38,791
Robert D. Lawrence, M.D. 1,510,095 38,791
Frances C. Mizuno 1,510,095 38,791
Richard R. Paulsen 1,508,095 40,791
Toni Marie Raymus 1,510,095 38,791
Michael K. Repetto 1,510,095 38,791
Anthony F. Souza 1,510,095 38,791
Albert Van Veldhuizen 1,510,095 38,791
Donald L. Walters 1,508,095 40,611
Votes cast to ratify the selection of Vavrinek, Trine, Day & Co., LLP
as independent public accountants for the 2007 fiscal year as follows:
For Against Abstain
------------- ------------ ------------
1,541,409 393 7,084
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(2.1) Plan of Reorganization and Merger Agreement (included in
Annex A) incorporated by reference from the Registrant's
Form S-4EF, Registration No. 333-104244, filed with the
Securities and Exchange Commission on April 1, 2003.
(3.1) Articles of Incorporation, as amended, incorporated by
reference from the Registrant's Form 10-QSB for the quarter
ended September 30, 2005, filed with the Securities and
Exchange Commission on November 10, 2005.
(3.2) Bylaws, as amended, incorporated by reference from the
Registrant's Form 8-K, filed with the Securities and
Exchange Commission on July 23, 2007.
(4.1) Specimen form of certificate for Service 1st Bancorp common
stock incorporated by reference from Registrant's Form
10-QSB for the quarterly period ended September 30, 2003,
filed with the Securities and Exchange Commission on
November 14, 2003.
(4.2) Trust Preferred Security Indenture dated August 17, 2006
between Service 1st Bancorp and Wells Fargo Bank, National
Association.
22
(4.3) Trust Preferred Security Amended and Restated Declaration
of Trust dated August 17, 2006 between Service 1st Capital
Trust I and Wells Fargo Bank, National Association.
(4.4) Trust Preferred Security Guarantee Agreement dated August
17, 2006 between Service 1st Bancorp and Wells Fargo Bank,
National Association.
(4.5) Trust Preferred Security Junior Subordinated Debt Security
dated August 17, 2006 between Service 1st Bancorp and Wells
Fargo Bank, National Association.
(4.6) Trust Preferred Security Trust Preferred Security
Certificate dated August 17, 2006 between Service 1st
Capital Trust I and Wells Fargo Bank, National Association.
(10.1) Lease agreement dated May 3, 2002, related to 2800 West
March Lane, Suite 120, Stockton, CA 95219 incorporated by
reference from the Registrant's Form S-4EF, Registration
No. 333-104244, filed with the Securities and Exchange
Commission on April 1, 2003.
(10.2) Lease agreement dated April 13, 1999 and amendment thereto
dated June 17, 1999, related to 60 West 10th Street, Tracy,
CA 95376, incorporated by reference from the Registrant's
Form S-4EF, Registration No. 333-104244, filed with the
Securities and Exchange Commission on April 1, 2003.
(10.3)* 1999 Service 1st Bancorp Stock Option Plan, Amendment No. 1
thereto, and related forms of Incentive and Nonstatutory
Stock Option Agreements entered into with executive
officers and directors, incorporated by reference from the
Registrant's Form S-8, Registration No. 333-107346, filed
with the Securities and Exchange Commission on July 25,
2003.
(10.4) Agreement dated July 27, 1999 with BancData Solutions, Inc.
for service bureau and data processing services,
incorporated by reference from the Registrant's Form S-4EF,
Registration No. 333-104244, filed with the Securities and
Exchange Commission on April 1, 2003.
(10.5) Agreement with Financial Marketing Services dated February
1, 2000, incorporated by reference from the Registrant's
Form S-4EF, Registration No. 333-104244, filed with the
Securities and Exchange Commission on April 1, 2003.
(10.6)* Service 1st Bank 401(k) Profit Sharing Plan and Trust
Summary Plan Description, dated January 1, 2000,
incorporated by reference from the Registrant's Form S-4EF,
Registration No. 333-104244, filed with the Securities and
Exchange Commission on April 1, 2003.
(10.7)* John O. Brooks Salary Continuation Agreement dated
September 10, 2003, incorporated by reference from the
Registrant's Form 10-KSB for the year ended December 31,
2003, filed with the Securities and Exchange Commission on
March 30, 2004.
(10.8)* Bryan R. Hyzdu Salary Continuation Agreement dated
September 10, 2003, incorporated by reference from the
Registrant's Form 10-KSB for the year ended December 31,
2003, filed with the Securities and Exchange Commission on
March 30, 2004.
(10.9)* Robert E. Bloch Salary Continuation Agreement dated
September 10, 2003, incorporated by reference from the
Registrant's Form 10-KSB for the year ended December 31,
2003, filed with the Securities and Exchange Commission on
March 30, 2004.
(10.10)* Patrick Carman Salary Continuation Agreement dated
September 10, 2003, incorporated by reference from the
Registrant's Form 10-KSB for the year ended December 31,
2003, filed with the Securities and Exchange Commission on
March 30, 2004.
23
(10.11)* 2004 Stock Option Plan and Forms of Incentive and
Nonstatutory Stock Option Agreements, incorporated by
reference from the Registrant's Form S-8, Registration No.
333-116818, filed with the Securities and Exchange
Commission on June 24, 2004.
(10.12)* John O. Brooks Employment Agreement dated July 15, 2004,
incorporated by reference from the Registrant's Form
10-QSB, for the quarterly period ended September 30, 2004,
filed with the Securities and Exchange Commission on
November 15, 2004.
(10.13)* Bryan R. Hyzdu Employment Agreement dated July 15, 2004,
incorporated by reference from the Registrant's Form
10-QSB, for the quarterly period ended September 30, 2004,
filed with the Securities and Exchange Commission on
November 15, 2004.
(10.14)* Robert E. Bloch Employment Agreement dated July 15, 2004,
incorporated by reference from the Registrant's Form
10-QSB, for the quarterly period ended September 30, 2004,
filed with the Securities and Exchange Commission on
November 15, 2004.
(10.15)* Patrick Carman Employment Agreement dated July 15, 2004,
incorporated by reference from the Registrant's form
10-QSB, for the quarterly period ended September 30, 2004,
filed with the Securities and Exchange Commission on
November 15, 2004.
(10.16)* Shannon Reinard Employment Agreement dated July 15, 2004,
incorporated by reference from the Registrant's Form
10-QSB, for the quarterly period ended September 30, 2004,
filed with the Securities and Exchange Commission on
November 15, 2004.
(10.17) Fiserv Solutions, Inc. Agreement dated October 7, 2004, for
service bureau, data processing, and item processing,
incorporated by reference from the Registrant's Form 10-KSB
for the year ended December 31, 2004, filed with the
Securities and Exchange Commission on June 30, 2005.
(10.18) Lease agreement dated May 1, 2005, related to 49 W. 10th
Street, Tracy, CA 95378 incorporated by reference from the
Registrant's Form 10-QSB for the quarter ended September
30, 2005, filed with the Securities and Exchange Commission
on November 10, 2005.
(10.19) Lease agreement dated October 3, 2005, related to 1901 W.
Kettleman Lane, Building A, Suite 1A and 1B, Lodi, CA
95242, incorporated by reference from the Registrant's Form
10-QSB for the quarter ended September 30, 2005, filed with
the Securities and Exchange Commission on November 10,
2005.
(10.20)* Shannon Reinard Salary Continuation Agreement dated August
8, 2005, incorporated by reference from Registrant's Form
10-KSB for the year ended December 31, 2005, filed with the
Securities and Exchange Commission on March 30, 2006.
(10.21)* Bryan R. Hyzdu First Amendment dated August 8, 2005 to
Salary Continuation Agreement dated September 10, 2003,
incorporated by reference from Registrant's Form 10-KSB for
the year ended December 31, 2005, filed with the Securities
and Exchange Commission on March 30, 2006.
(10.22)* Bryan R. Hyzdu Second Amendment dated August 8, 2005 to
Salary Continuation Agreement dated September 10, 2003,
incorporated by reference from Registrant's Form 10-KSB for
the year ended December 31, 2005, filed with the Securities
and Exchange Commission on March 30, 2006.
(10.23)* Patrick Carman First Amendment dated August 8, 2005 to
Salary Continuation Agreement dated September 10, 2003,
incorporated by reference from Registrant's Form 10-KSB for
the year ended December 31, 2005, filed with the Securities
and Exchange Commission on March 30, 2006.
24
(10.24)* Patrick Carman Second Amendment dated August 8, 2005 to
Salary Continuation Agreement dated September 10, 2003,
incorporated by reference from Registrant's Form 10-KSB for
the year ended December 31, 2005, filed with the Securities
and Exchange Commission on March 30, 2006.
(10.25)* Robert E. Bloch First Amendment dated August 8, 2005 to
Salary Continuation Agreement dated September 10, 2003,
incorporated by reference from Registrant's Form 10-KSB for
the year ended December 31, 2005, filed with the Securities
and Exchange Commission on March 30, 2006.
(10.26)* Robert E. Bloch Second Amendment dated August 8, 2005 to
Salary Continuation Agreement dated September 10, 2003,
incorporated by reference from Registrant's Form 10-KSB for
the year ended December 31, 2005, filed with the Securities
and Exchange Commission on March 30, 2006.
(10.27)* Director Emeritus Program approved by Board of Directors
effective June 30, 2006, incorporated by reference from
Registrant's Form 8-K, filed with the Securities and
Exchange Commission on July 7, 2006.
(10.28) Lease option exercise letter dated September 12, 2006,
related to 60 West 10th Street, Tracy, CA 95376,
incorporated by reference from Registrant's Form 10-K,
filed with the Securities and Exchange Commission on April
2, 2007.
(14.1) Code of Ethics, incorporated by reference from the
Registrant's Form 10-K for the year ended December 31,
2003, filed with the Securities and Exchange Commission on
March 30, 2004.
(21.1) Registrant's only subsidiaries are Service 1st Bank and
Charter Services Group, Inc.
(31.1) Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
(31.2) Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
(32.1) Certification of Service 1st Bancorp by its Chief Executive
Officer and Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
*Denotes management compensatory plans or arrangements.
25
SIGNATURES
Pursuant to the requirements of Section 13 or 15d) 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.
SERVICE 1ST BANCORP
Date: August 13, 2007 By: /s/ JOHN O. BROOKS
------------------------------
John O. Brooks
Chief Executive Officer
(Principal Executive Officer)
Date: August 13, 2007 By: /s/ ROBERT E. BLOCH
------------------------------
Robert E. Bloch
Executive Vice President and
Chief financial Officer
(Principal Financial and
Accounting Officer)
26
EXHIBIT INDEX
Exhibit Sequential
Number Description Page Number
- --------- ------------------------------------------------------------------ -------------
4.2 Trust Preferred Security Indenture dated August 17, 2006 between 28
Service 1st Bancorp and Wells Fargo Bank, National Association
4.3 Trust Preferred Security Amended and Restated Declaration of 91
Trust dated August 17, 2006 between Service 1st Bancorp and Wells
Fargo Bank, National Association
4.4 Trust Preferred Security Guarantee Agreement dated August 17, 149
2006 between Service 1st Bancorp and Wells Fargo Bank, National
Association
4.5 Trust Preferred Security Junior Subordinated Debt Security dated 168
August 17, 2006 between Service 1st Bancorp and Wells Fargo Bank,
National Association
4.6 Trust Preferred Security Trust Preferred Security Certificate 174
dated August 17, 2006 between Service 1st Bancorp and Wells Fargo
Bank, National Association
31.1 Certification of Chief Executive Officer pursuant to Section 302 182
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 183
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Service 1st Bancorp by its Chief Executive 184
Officer and Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
27