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 September 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
------------------------------------------------------
(Exact name of registrant as specified in its charter)
State of California 32-0061893
-------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
49 W. 10th Street, Tracy, California 95376
------------------------------------------
(Address of principal executive offices)
(209) 956-7800
----------------------------------------------------
(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 [ ] Accelerated 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 November 13, 2007.
The Index to Exhibits is located at page 28.
INDEX
TO SERVICE 1ST BANCORP FORM 10-Q
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2007
Part I Page
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 21
Item 4 Controls and Procedures 22
Item 4T Controls and Procedures 22
Part II
Item 1 Legal Proceedings 22
Item 1A Risk Factors 22
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 23
Item 3 Defaults Upon Senior Securities 23
Item 4 Submission of Matters to a Vote of Security Holders 23
Item 5 Other Information 23
Item 6 Exhibits 23
Signatures 27
Exhibit 28
Index
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 29
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 30
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 31
2
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
09/30/07 12/31/06
------------- -------------
ASSETS
Cash and due from banks $ 2,815,315 $ 6,543,416
Federal funds sold 9,233,143 10,616,902
------------- -------------
Cash and cash equivalents 12,048,458 17,160,318
Certificates of deposit with other banks 1,248,006 1,500,000
Investment securities available-for-sale 77,433,658 81,157,727
Investment securities held-to-maturity 12,699,257 4,985,995
Loans, net 121,914,162 113,508,174
Bank premises and equipment, net 1,374,788 1,388,980
Cash surrender value of life insurance 3,664,263 3,566,696
Accrued interest receivable 1,726,953 1,461,602
Other assets 2,843,904 2,490,898
------------- -------------
Total assets $ 234,953,449 $ 227,220,390
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand $ 22,435,095 $ 33,848,426
Money market, NOW and savings 88,567,715 94,662,249
Time deposits under $100,000 71,771,515 48,409,724
Time deposits $100,000 and over 22,723,751 23,034,692
------------- -------------
Total deposits 205,498,076 199,955,091
Other borrowings 9,155,000 9,155,000
Accrued interest and other liabilities 2,691,491 1,143,465
------------- -------------
Total liabilities 217,344,567 210,253,556
Shareholders' equity:
Common stock 16,023,738 16,023,738
Additional paid-in-capital 321,331 207,144
Retained earnings 1,727,803 1,147,067
Accumulated other comprehensive income, net of tax (463,990) (411,115)
------------- -------------
Total shareholders' equity 17,608,882 16,966,834
------------- -------------
Total liabilities and shareholders' equity $ 234,953,449 $ 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 nine months ended
--------------------------------------------------------
09/30/07 09/30/06 09/30/07 09/30/06
--------------------------------------------------------
Interest income:
Interest and fees on loans $ 2,682,351 $ 2,538,177 $ 7,813,739 $ 6,702,777
Interest on investments 1,068,120 772,295 3,122,192 2,240,323
Interest on fed funds sold 106,514 100,308 172,913 124,420
Other interest income 22,310 3,411 54,104 11,220
--------------------------------------------------------
Total interest income 3,879,295 3,414,191 11,162,948 9,078,740
Interest expense:
Interest expense on deposits 1,973,618 1,436,635 5,486,939 3,488,212
Interest on borrowings 141,754 239,476 457,045 442,253
--------------------------------------------------------
Total interest expense 2,115,372 1,676,111 5,943,984 3,930,465
--------------------------------------------------------
Net interest income before provision for loan losses 1,763,923 1,738,080 5,218,964 5,148,275
Provision for loan losses 60,000 90,000 110,000 230,000
--------------------------------------------------------
Net interest income after provision for loan losses 1,703,923 1,648,080 5,108,964 4,918,275
Other Income:
Service charges, fees, and other income 67,361 68,503 226,877 205,980
Gain on the sale of investment securities (6,331) -- (12,909) --
Gain on sale and servicing of loans 11,163 19,601 45,977 78,672
Referral fees on mortgage loans 35,539 60,000 247,409 60,000
Earnings on cash surrender value of life insurance 40,109 38,672 118,723 114,887
Consulting fees 50,000 -- 110,000 --
--------------------------------------------------------
Total other income 197,841 186,776 736,077 459,539
Other Expenses:
Salaries and employee benefits 898,141 906,868 2,987,416 2,550,119
Occupancy expense 162,109 165,953 486,965 475,433
Equipment expense 89,003 57,187 253,078 165,352
Data processing and other professional fees 142,831 143,805 440,051 464,442
Office supplies and equipment 40,398 50,433 175,169 133,459
Loan department expense 8,204 49,214 28,858 173,739
Advertising and promotion 34,016 94,614 172,728 186,188
Directors fees and expenses 47,203 52,653 160,583 138,228
FDIC and state assessments 40,747 13,638 68,782 47,017
Other operating expenses 130,702 89,032 367,489 227,904
--------------------------------------------------------
Total other expenses 1,593,354 1,623,397 5,141,119 4,561,881
--------------------------------------------------------
Income before income taxes 308,410 211,459 703,922 815,933
Income tax expense 24,308 45,824 123,186 210,291
--------------------------------------------------------
Net income $ 284,102 $ 165,635 $ 580,736 $ 605,642
========================================================
Net income per share - basic $ 0.12 $ 0.07 $ 0.24 $ 0.25
========================================================
Net income per share - diluted $ 0.12 $ 0.07 $ 0.23 $ 0.24
========================================================
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 114,187 114,187
Comprehensive income:
Net income $ 580,736 580,736 580,736
Unrealized losses on securities
net of taxes of $31,870 (45,298) (45,298) (45,298)
Reclassification adjustment for
losses included in net income,
net of tax of $5,331 (7,577) (7,577) (7,577)
-------------
Comprehensive income $ 527,861
=============
----------------------------------- ------------------------------------------
Balance September 30, 2007 2,388,739 $ 16,023,738 $ 321,331 $ 1,727,803 $ (463,990) $ 17,608,882
=================================== ==========================================
The accompanying notes are an integral part of the financial statements.
5
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30,
(unaudited)
2007 2006
------------ ------------
Operating activities:
Net income $ 580,736 $ 605,642
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses 110,000 230,000
Depreciation 185,647 128,728
Amortization and accretion on securities (76,750) 190,154
Earnings on cash surrender value life insurance, net (97,567) (98,605)
Options Expense 73,205 149,374
Gain on sale of loans (6,737) (12,733)
Loans originated for sale (63,750) (137,267)
Proceeds from loan sales 70,487 150,000
Loss on sale of securities, net 12,909 --
Increase in accrued interest (265,351) (206,831)
Increase in other assets (393,673) (249,193)
Increase (decrease) in accrued expenses and other liabilities 1,548,026 (89,859)
------------ ------------
Net cash provided by (used in) operating activities 1,677,182 659,410
Investing activities:
Purchases of securities available-for-sale (15,270,283) (12,330,690)
Purchases of securities held-to-maturity (8,380,003) (680,482)
Proceeds from sales of available-for-sale securities 4,247,543 --
Proceeds from sales of held-to-maturity securities 209,042 --
Proceeds from payments, maturities and calls of available-for-sale securities 14,617,211 6,951,080
Proceeds from payments, maturities and calls of held-to-maturity securities 679,912 33,042
Net increase in loans (8,515,988) (27,427,747)
Certificates of deposit with other banks 251,994 (1,200,000)
Purchases of premises and equipment (171,455) (812,443)
------------ ------------
Net cash used by investing activities (12,332,027) (35,467,240)
Financing activities:
Net (decrease) increase in demand, interest-bearing deposits and savings (17,507,865) 32,367,724
Net increase in time deposits 23,050,850 2,666,340
Increase in junior subordinated debts -- 5,155,000
Net increase in other borrowings -- 7,970,000
------------ ------------
Net cash provided by financing activities 5,542,985 48,159,064
------------ ------------
Net (decrease) increase in cash and cash equivalents (5,111,860) 13,351,234
Cash and cash equivalents at beginning of period 17,160,318 9,024,556
------------ ------------
Cash and cash equivalents at end of period $ 12,048,458 $ 22,375,790
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 5,781,144 $ 3,853,017
Income taxes $ -- $ 432,000
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 September 30, 2007 and the Company's
income statement for the three months ended September 30, 2007 and 2006, and the
statement of cash flows for the three months ended September 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 nine-month period ended September 30, 2007
and 2006 are as follows:
WEIGHTED AVERAGE ASSUMPTIONS FOR OPTIONS GRANTED
DURING THE PERIOD ENDED:
September 30, 2007 September 30, 2006
------------------ ------------------
Expected Life 60 months 72 months
Stock Volatility 40.97% 55.58%
Risk free interest rate 4.65% 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 September 30, 2007 and
2006. Weighted average shares outstanding used in the computation of basic
earnings per share for the three months and the nine months ended September 30,
2007 were 2,388,739 and 2,388,739 respectively. Weighted average shares
outstanding used in the computation of diluted earnings per share for the nine
months ended September 30, 2007 and 2006 were 2,509,294 and 2,574,780
respectively. Weighted average shares outstanding used in the computation of
diluted earnings per share for the three months ended September 30, 2007 and
2006 were 2,456,684 and 2,574,780 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
September 30, 2007.
The amortized cost or fair values of investment securities available-for-sale at
September 30, 2007 were:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------
Available-for-Sale Securities:
Obligations of U.S. Government Agencies $ 35,223,194 $ 11,100 $ (209,590) $ 35,024,704
State and political subdivisions 19,995,004 13,483 (283,539) 19,724,948
Asset backed-securities 7,488,619 6,572 (129,812) 7,365,379
Mortgage backed-securities 14,016,982 11,503 (207,564) 13,820,921
Preferred Stock 999,761 -- -- 999,761
Short-term mutual funds 500,000 -- (2,055) 497,945
---------------------------------------------------------
$ 78,223,560 $ 42,658 $ (832,560) $ 77,433,658
=========================================================
The amortized cost or fair values of investment securities held-to-maturity at
September 30, 2007 were:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------
Held-to-Maturity Securities:
Obligations of U.S. Government Agencies $ 4,015,800 $ -- $ (170,648) $ 3,845,152
State and political subdivisions 4,616,327 119,689 (12,909) 4,723,107
Asset backed-securities 3,898,076 -- (71,273) 3,826,803
Mortgage backed-securities 169,054 2,076 (243) 170,887
---------------------------------------------------------
$ 12,699,257 $ 121,765 $ (255,073) $ 12,565,949
=========================================================
Securities carried at approximately $56,891,000 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 September 30, 2007, approximately 64.9% of the Bank's loans are for real
estate and construction loans and approximately 18.5% of the Bank's loans are
for general commercial users including professional, retail, and small
businesses. Consumer loans make up approximately 3.6% of the loan portfolio,
leases make up 7.5% of the loan portfolio, with agricultural loans making up the
remaining 5.5%. 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:
9/30/2007 12/31/2006
------------- -------------
Construction and land development loans $ 33,690,314 $ 34,248,157
Real estate loans 46,562,429 43,396,795
Commercial loans 22,902,441 23,421,351
Leases 9,210,084 8,591,815
Agricultural loans 6,787,687 4,288,022
Consumer loans 4,458,451 1,225,571
------------- -------------
123,611,406 115,171,711
Deferred loan fees and costs (158,194) (234,487)
Allowance for loan losses (1,539,050) (1,429,050)
------------- -------------
Total net loans $ 121,914,162 $ 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 of Financial Condition and Results of
Operations," 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 September 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 increased 3.4% from December 31,
2006 to September 30, 2007. As of September 30, 2007, total consolidated assets
were $234,953,449 compared to $227,220,390 as of December 31, 2006, and
$218,344,941 at September 30, 2006. The increase in total assets from December
31, 2006 was primarily due to an increase in loans.
Total net loans at September 30, 2007 were $121,914,162 compared to
$113,508,174 at December 31, 2006 and $109,730,879 at September 30, 2006. This
represents an increase in net loans of 7.4% from December 31, 2006.
Cash and due from banks declined from $6,543,416 at December 31, 2006 to
$2,815,315 at September 30, 2007. The reduction in cash was used to fund loan
originations.
Total deposits were $205,498,076 at September 30, 2007 compared to
$199,955,091 at December 31, 2006 and $186,175,731 at September 30, 2006.
Noninterest-bearing DDA accounts decreased from $33,848,426 at December 31, 2006
to $22,435,095 at September 30, 2007. Money market, NOW, and savings accounts
decreased to $88,567,715 at September 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 $71,771,515 at September 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 $50,000,000
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 $62,697,452 at
September 30, 2007.
Other borrowings at September 30, 2007 and December 31, 2006 were
$9,155,000. The borrowings consist of $4,000,000 from the Federal Home Loan Bank
of San Francisco and $5,155,000 of Trust Preferred Securities.
12
Results of Operations
Net income for the three months ended September 30, 2007 was $284,102
compared to $165,635 for 2006. The increase in net income for the three months
ended September 30, 2007 was from an increase in net interest income, a
reduction in operating expenses, and an adjustment to the Company's effective
income tax rate. Net income for the nine months ended September 30, 2007 was
$580,736 compared to $605,642 for September 30, 2006. For the nine months ended
September 30, 2007, the Company increased its net income and other income, but
this was offset by an increase in total operating expenses. The Company's
effective tax rate for 2007 was less than 2006 because the Company has more tax
exempt investments. At September 30, 2007 the Company owned $25,447,816 in tax
exempt investments compared to $15,244,077 at September 30, 2006.
Basic earnings per share for the three months ended September 30, 2007 was
$0.12 per share compared to $0.07 for the three months ended September 30, 2006.
Diluted earnings per share for the three months ended September 30, 2007 and
2006 were $0.12 and $0.07, respectively. Basic earnings per share for the nine
months ended September 30, 2007 were $0.24 per share compared to $0.25 for 2006.
Diluted earnings per share for the nine months ended September 30, 2007 were
$0.23 compared to $0.24 for 2006.
13
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 September 30, 2007 and 2006:
September 30, 2007 September 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 $ 1,719,963 $ 22,310 5.15% $ 1,041,547 $ 8,761 3.34%
Investments 83,326,661 1,068,120 5.09% 67,860,945 766,945 4.48%
Federal funds sold 8,398,552 106,514 5.03% 7,967,842 100,308 4.99%
Loans (1) (2) 121,257,221 2,682,351 8.78% 112,096,685 2,538,177 8.98%
----------------------------- ----------------------------
Total interest-earning assets 214,702,397 3,879,295 7.17% 188,967,019 3,414,191 7.17%
Allowance for possible loan losses (1,480,952) (1,300,354)
Cash and due from banks 4,934,802 3,427,031
Bank premises and equipment 1,341,416 1,300,373
Accrued interest receivable 1,330,681 970,312
Other assets 7,084,293 7,891,742
-------------- --------------
Total assets $ 227,912,637 $ 201,256,123
============== ==============
Interest-bearing liabilities:
Demand deposits $ 57,855,449 635,996 4.31% $ 59,569,752 592,819 3.95%
Savings and money market accounts 27,732,735 204,735 2.93% 20,893,768 164,562 3.12%
Time deposits 89,738,294 1,132,887 5.01% 58,924,400 679,254 4.57%
Other borrowings 9,161,936 141,754 6.14% 16,640,680 239,476 5.71%
----------------------------- ----------------------------
Total interest-bearing liabilities 184,488,414 2,115,372 4.55% 156,028,600 1,676,111 4.26%
Non-interest bearing demand deposits 24,445,991 28,966,666
Other liabilities 1,952,726 374,145
-------------- --------------
Total liabilities 210,887,131 185,369,411
Shareholders' equity 17,025,506 15,886,712
-------------- --------------
Total liabilities and shareholders'
equity $ 227,912,637 $ 201,256,123
============== ==============
------------ -----------
Net interest income $ 1,763,923 $ 1,738,080
============ ===========
Net interest margin on average interest earning assets (3) 3.26% 3.65%
1. Average loan balances include average deferred loan fees of $161,366 and
$250,542 for the three months ended September 30, 2007 and 2006,
respectively.
2. Interest on loans includes fees of $30,560 and $59,332 for the three month
periods ended September 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
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 nine months ended September 30, 2007 and 2006.
September 30, 2007 September 30, 2006
----------------------------------------- ----------------------------------------
Average Average
Yield or Yield or
Average Income/ Rate Average Income/ Rate
Balance Expense Paid Balance Expense Paid
----------------------------------------- -----------------------------------------
Interest-earning assets:
Interest-bearing deposits $ 1,384,464 $ 54,104 5.22% $ 897,017 $ 27,438 4.09%
Investments 85,005,471 3,122,192 4.91% 68,839,982 2,224,105 4.32%
Federal funds sold 4,405,621 172,913 5.25% 3,388,930 124,420 4.91%
Loans (1) (2) 117,323,582 7,813,739 8.90% 101,490,247 6,702,777 8.83%
----------------------------- -----------------------------
Total interest-earning assets 208,119,138 11,162,948 7.17% 174,616,176 9,078,740 6.95%
Allowance for loan losses (1,449,838) (1,215,695)
Cash and due from banks 4,076,935 3,483,696
Bank premises and equipment 1,372,764 938,475
Accrued interest receivable 1,269,259 898,144
Other assets 6,862,594 6,622,173
-------------- --------------
Total assets $ 220,250,852 $ 185,342,969
============== ==============
Interest-bearing liabilities:
Demand deposits $ 57,699,868 1,853,900 4.30% $ 65,330,587 1,606,003 3.29%
Savings and money market accounts 27,349,141 606,929 2.97% 16,710,480 292,878 2.34%
Time deposits 81,702,278 3,026,110 4.95% 48,616,873 1,589,331 4.37%
Other borrowings 9,976,164 457,045 6.13% 10,682,992 442,253 5.53%
----------------------------- -----------------------------
Total interest-bearing liabilities 176,727,451 5,943,984 4.50% 141,340,932 3,930,465 3.72%
Non-interest bearing demand
deposits 24,463,190 27,359,286
Other liabilities 1,910,643 873,872
-------------- --------------
Total liabilities 203,101,284 169,574,090
Shareholders' equity 17,149,568 15,768,879
-------------- --------------
Total liabilities and shareholders'
equity $ 220,250,852 $ 185,342,969
============== ==============
------------ ------------
Net interest income $ 5,218,964 $ 5,148,275
============ ============
Net interest margin on average interest earning assets (3) 3.35% 3.94%
1. Average loan balances include average deferred loan fees of $184,190 and
$277,613 for the nine months ending September 30, 2007 and 2006,
respectively.
2. Interest on loans includes fees of $152,869 and $169,764 for the nine
months ending September 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.
15
Net interest income for the three months ended September 30, 2007 was
$1,763,923 compared to $1,738,080 for 2006. Net interest income for the nine
months ended September 30, 2007 was $5,218,964 compared to $5,148,275 for 2006.
Average interest-earning assets for the three months ended September 30, 2007
were $214,702,397 compared to $188,967,019 during the same three months of 2006.
The yield earned on average interest-earning assets during the third quarter of
2007 was 7.17% compared to 7.17% during the same quarter of 2006. The average
rate paid on interest bearing-liabilities increased from 4.26% for the third
quarter of 2006 to 4.55% during the third quarter of 2007. Average
interest-earning assets for the nine months ended September 30, 2007 were
$208,119,138 compared to $174,616,176 during the same nine months of 2006. The
yield earned on average interest-earning assets during the nine months ended
September 30, 2007 was 7.17% compared to 6.95% during the same period of 2006.
The average rate paid on interest bearing liabilities increased to 4.50% for the
nine months ended September 30, 2007 compared to 3.72% 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. The Federal
Reserve lowered interest rates during September 2007. The declining interest
rates will impact interest earning assets more rapidly than interest bearing
liabilities.
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 comprised 64.9% of
total loans outstanding at September 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 September 30,
2007 was $60,000 compared to $90,000 during the same quarter of 2006. The
provision for loan losses for the nine months ended September 30, 2007 was
$110,000 compared to $230,000 during the same period of 2006. At September 30,
2007, the allowance for loan losses was $1,539,050 compared to $1,429,050 at
December 31, 2006 and $1,359,050 at September 30, 2006. The ratio of allowance
for loan losses to gross loans was 1.25% at September 30, 2007 compared to 1.24%
at December 31, 2006 and 1.22% at September 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.
16
The following table 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.
For the nine months ended September 30,
2007 2006
------------------ ------------------
Outstanding Loans:
Average for the Period $ 117,323,582 $ 101,490,247
End of the Period 123,611,406 111,303,338
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 110,000 230,000
------------------ ------------------
Balance at End of Period $ 1,539,050 $ 1,359,050
================== ==================
Ratios:
Net Loans Charged-Off (Recoveries) to Average Loans 0.00% (.01)%
Allowance for Loan Losses to Total Loans 1.25% 1.22%
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% (2.42)%
Allowance for Loan Losses to Nonperforming Loans 52.66% 308.15%
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 $2,922,861 at September 30, 2007,
$441,037 at September 30, 2006, and $435,147 at December 31, 2006.
At September 30, 2007, there were loans totaling $2,922,861 that were
considered impaired or troubled debt restructurings compared to $441,037 at
September 30, 2006 and $435,147 at December 31, 2006. These loans were
delinquent at September 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 September 30, 2007 or December 31, 2006. Management is not aware of any
potential problem loans, which were accruing and current at September 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 September 30, 2007 and December 31, 2006.
17
Other Income
Other income for the three months ended September 30, 2007 was $197,841
compared to $186,776 for the same period during 2006. Other income for the nine
months ended September 30, 2007 was $736,077 compared to $459,539 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 September 30, 2007 were $35,539 compared to $60,000 for the same quarter
in 2006. The fees on such loans for the nine months ended September 30, 2007
were $247,409 compared to $60,000 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 September 30, 2007 were
$11,163 compared to $19,601 during the same period in 2006. Gains on loans sold
in the secondary market and the servicing of these loans for the nine months
ended September 30, 2007 were $45,977 compared to $78,672 during the same period
in 2006. The gains on the guaranteed portion of loans sold for the nine months
ended September 30, 2007 were $6,737 compared to a gain of $12,733 in 2006.
Other Expense
Salaries and employee benefits for the three months ended September 30,
2007 were $898,141 compared to $906,868 for the three months ended September 30,
2006. During the third quarter of 2007, the Company was able to reverse $44,203
of expense related to stock-based compensation. This reversal was for the
portion of the risk-based compensation that had been accrued on options that
were not vested prior to the employees' separation of employment with the
Company. Salaries and employee benefits for the nine months ended September 30,
2007 were $2,987,416 compared to $2,550,119 for the nine months ended September
30, 2006. The overall increase in salaries and employee benefits for the nine
months ended September 30, 2007 was due to an initial increase in the number of
employees. In the third quarter of 2007, the number of employees declined by 8
through attrition and layoffs.
Occupancy and equipment expense for the three months ended September 30,
2007 was $251,112 compared to $223,140 for the same period of 2006. Occupancy
and equipment expense was $740,043 for the nine months ended September 30, 2007
compared to $640,785 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 $142,831 for the
three months ended September 30, 2007 compared to $143,805 for the three months
ended September 30, 2006. Data processing and other professional fees for the
nine months ended September 30, 2007 was $440,051 compared to $464,442 for the
same period during 2006.
Loan department expense for the three months ended September 30, 2007 was
$8,204 compared to $49,214 for the same period of 2006. Loan department expense
for the nine months ended September 30, 2007 was $28,858 compared to $173,739
for the same period of 2006. The decrease in loan department expense for the
nine months ended September 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 third
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 three months and nine
months ended September 30, 2007 was primarily from an increase in fees
associated with CDARS deposits. The fee associated with CDARS deposits for the
nine months ended September 30, 2007 was $112,041 compared to $35,930 for 2006.
Fees related to CDARS deposits were $42,035 for the three months ended September
30, 2007 compared to $15,987 for the third quarter of 2006. The remainder of the
other operating expenses increased due to the growth of the Company.
Capital Resources
Total shareholders' equity at September 30, 2007 was $17,608,882 compared
to $16,966,834 at December 31, 2006. The primary changes in shareholders' equity
were net income for the nine months ended September 30, 2007 of $580,736, an
increase in additional paid in capital of $114,187 related to stock-based
compensation, and a decrease in accumulated other comprehensive income, (net of
tax of $52,875).
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.
18
The following table shows the Company's and the Bank's actual capital
amounts and ratios at September 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 under
For capital adequacy prompt corrective
Actual purposes action provisions
------------------------- ------------------------- -------------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ----------- ----------- ----------- ----------- -----------
As of September 30, 2007:
Company:
Total capital (to risk weighted assets) $ 24,763 14.2% $ 13,876 8.0% N/A N/A
Tier 1 capital (to risk weighted assets) $ 18.069 10.4% $ 6,938 4.0% N/A N/A
Tier 1 capital (to average assets) $ 18,069 7.9% $ 9,117 4.0% N/A N/A
Bank:
Total capital (to risk weighted assets) $ 22,408 12.9% $ 13,876 8.0% $ 17,345 10.0%
Tier 1 capital (to risk weighted assets) $ 20,869 12.0% $ 6,938 4.0% $ 10,407 6.0%
Tier 1 capital (to average assets) $ 20,869 9.3% $ 9,000 4.0% $ 11,250 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
September 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 September 30, 2007 and December 31, 2006 were approximately
$35,012,000 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 September 30, 2007, consolidated liquid assets totaled
$35,462,656 or 15.1% 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 September 30, 2007, the Company had $35,300,000 available under these
credit lines. Additionally, Service 1st Bank is a member of the FHLB. At
September 30, 2007, Service 1st Bank could have arranged for up to $18,768,500
in secured borrowings from the FHLB. These borrowings are secured by pledged
mortgage loans. At September 30, 2007, the Company had advances, borrowings and
commitments (including letters of credit) outstanding of $4,000,000, leaving
$14,768,500 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.
19
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 September 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 September 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 $35,012,000 and $40,607,000 at September 30, 2007 and
December 31, 2006, respectively. As a percentage of gross loans and leases these
off-balance sheet items represent 28.3% 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.
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.
20
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
-----------------------------
September 30, December 31,
Change in interest rates 2007 2006
- --------------------------------- ------------- -------------
100 basis point rise -18.3% -15.6%
100 basis point decline 10.2% 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.
21
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
----------------------------------
September 30, December 31,
Change in interest rates 2007 2006
- --------------------------------- ---------------- ---------------
100 basis point rise 0.62% 4.32%
100 basis point decline 0.23% 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 September 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 September 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
22
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
None
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, incorporated by reference from the Registrant's
Form 10-Q for the quarterly period ended June 30, 2007, filed
with the Securities and Exchange Commission on August 13,
2007.
(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, incorporated by
reference from the Registrant's Form 10-Q for the quarterly
period ended June 30, 2007, filed with the Securities and
Exchange Commission on August 13, 2007.
(4.4) Trust Preferred Security Guarantee Agreement dated August 17,
2006 between Service 1st Bancorp and Wells Fargo Bank,
National Association, incorporated by reference from the
Registrant's Form 10-Q for the quarterly period ended June
30, 2007, filed with the Securities and Exchange Commission
on August 13, 2007.
(4.5) Trust Preferred Security Junior Subordinated Debt Security
dated August 17, 2006 between Service 1st Bancorp and Wells
Fargo Bank, National Association, incorporated by reference
from the Registrant's Form 10-Q for the quarterly period
ended June 30, 2007, filed with the Securities and Exchange
Commission on August 13, 2007.
(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, incorporated by
reference from the Registrant's Form 10-Q for the quarterly
period ended June 30, 2007, filed with the Securities and
Exchange Commission on August 13, 2007.
23
(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.
(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.
24
(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 quarterly period 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 quarterly period 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.
(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.
25
(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.
26
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: November 13, 2007 By: /s/ JOHN O. BROOKS
----------------------------------
John O. Brooks
Chief Executive Officer
(Principal Executive Officer)
Date: November 13, 2007 By: /s/ ROBERT E. BLOCH
----------------------------------
Robert E. Bloch
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
27
EXHIBIT INDEX
Exhibit Sequential
Number Description Page Number
- ----------- ------------------------------------------------------------------ ----------------
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002. 29
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002. 30
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. 31
28