UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________to __________________
000-50323
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(Commission File Number)
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 Number)
49 W. 10th Street, Tracy, California 95376
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(Address of principal executive offices, Zip Code)
Registrant's telephone number, including area code: (209) 830-6995
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Title of Each Class
---------------------------
Common Stock (No Par Value)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked price of such common equity, as of
the last business day of the registrant's most recently completed second fiscal
quarter. $27,467,437.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. As of March 28, 2008, the
registrant had 2,388,739 shares of its common stock outstanding.
Documents incorporated by reference: The registrant's proxy statement for its
2008 Annual Meeting of Shareholders is incorporated herein by reference in Part
III, Items 10 through 14.
The Index to Exhibits is located at page 90.
INDEX
TO SERVICE 1ST BANCORP ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2007
Part I Page
Item 1 Business 2
Item 1A Risk Factors 13
Item 1B Unresolved Staff Comments 16
Item 2 Properties 16
Item 3 Legal Proceedings 17
Item 4 Submission of Matters to a Vote of Security Holders 17
Part II
Item 5 Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 17
Item 6 Selected Financial Data 20
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 21
Item 7A Quantitative and Qualitative Disclosures About Market Risk 42
Item 8 Financial Statements and Supplementary Data 45
Item 9 Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure 81
Item 9A Controls and Procedures 81
Item 9B Other Information 82
Part III
Item 10 Directors, Executive Officers, and Corporate Governance 83
Item 11 Executive Compensation 83
Item 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 83
Item 13 Certain Relationships and Related Transactions, and
Director Independence 83
Item 14 Principal Accounting Fees and Services 83
Part IV
Item 15 Exhibits and Financial Statement Schedules 83
Signatures 88
Exhibit Index 90
10.30 Employee Agreement dated November 16, 2007 for
Thomas A. Vander Ploeg 91
23.1 Consent of Vavrinek, Trine, Day & Co., LLP 99
31.1 Certifications of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 100
31.2 Certifications of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 101
32.1 Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 102
PART I
ITEM 1. BUSINESS
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS
Certain matters discussed or incorporated by reference in this Annual
Report on Form 10-K including, but not limited to, matters described in "Item 7
- - 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, 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 Afghanistan and Iraq and the conduct of the war on
terrorism by the United States and its allies, as well as other factors. These
factors set forth under "Item 1a-Risk Factors" in this report and 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.
GENERAL DEVELOPMENT OF BUSINESS
Service 1st Bancorp (the "Company") is a California corporation,
incorporated on January 23, 2003 to act as a holding company for Service 1st
Bank (the "Bank"). The Bank became a subsidiary of the Company effective June
26, 2003. The Bank is locally owned and operated and serves the individuals,
small and medium-sized businesses, municipalities and professionals located in
and adjacent to the cities of Stockton, Tracy, Lodi and adjacent communities in
San Joaquin County. On July 7, 2006, the Company organized Charter Services
Group, Inc., a California corporation ("Charter"), as a wholly-owned subsidiary.
Charter was formed to provide consulting services primarily related to start-up
(de novo) bank formations. Charter conducts its operations from its headquarters
office located at 1901 W. Kettleman Lane, Suite 102, Lodi, California 95242.
The Company's administrative office is located at 49 West 10th Street,
Tracy, California 95376.
The Bank conducts operations at offices located at 2800 West March
Lane, Suite 120, Stockton, California 95219, 60 West 10th Street, Tracy,
California 95376, and 1901 W. Kettleman Lane, Suite 100, Lodi, California 95242.
These offices are open from 9:00 a.m. to 5:00 p.m., Monday through Thursday and
from 9:00 a.m. to 6:00 p.m. on Friday.
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The Bank offers a full range of commercial banking services including
acceptance of demand, savings and time deposits, and the making of commercial,
real estate (including residential mortgage, construction and land development),
leases, and consumer loans. The Bank sells cashier's checks, traveler's checks
and money orders. The Bank also offers night depository, notary services,
telephone and wire transfers, and federal tax depository services. The Bank does
not offer trust or international banking services, but will arrange for such
services through a correspondent bank.
The Bank's data processing operations are provided through an outside
vendor, Fiserv Solutions, Inc., 20660 Bahama Street, Chatsworth, California
91311, which provides processing of the Bank's deposits, loans and financial
accounting.
The Bank obtains market penetration from the services referred to above
and by the personal solicitation of the Bank's officers, directors and
shareholders. The Bank's deposits are attracted primarily from individuals,
small and medium-sized businesses, municipalities and professionals in its
market area. The Bank's deposits are not received from a single depositor or
group of affiliated depositors, the loss of any one of which would have a
materially adverse effect on the business of the Bank, nor is a material portion
of the Bank's deposits concentrated within a single industry or group of related
industries.
As of December 31, 2007 the Company's total assets were $231,075,943
compared to $227,220,390 in 2006. As of December 31, 2007, the Bank had total
loans of $114,887,771 before deducting the allowance for loan losses of
$1,558,050 and deferred fees of $160,557. Of the loan total, $23,029,593 were
commercial loans, $45,002,196 were real estate loans, $29,541,045 were
construction and land development loans, $4,713,710 were agriculture loans,
$8,560,166 were leases, and $4,041,061 were consumer loans. Total deposits at
December 31, 2007 were $202,405,646. Of the deposit total, $26,697,543 were
non-interest-bearing demand deposits, $86,305,530 were interest-bearing demand,
money market and savings deposits, and $89,402,573 were interest-bearing time
deposits.
During 2007, The Company conducted no significant activities other than
holding the shares of its subsidiaries. However, it is authorized, with the
prior approval of the Board of Governors of the Federal Reserve System ("The
Board of Governors"), the Company's principal regulator, to engage in a variety
of activities which are deemed closely related to the business of banking. The
common stock of the Company is not listed on any exchange, but it is quoted on
the OTC Bulletin Board under the symbol "SCVF."
The principal source of the Company's revenues reflected as a
percentage of total revenues are: (1) interest and fees on loans 64.9%; (2)
interest on Federal Funds sold 1.6%; (3) interest on investments 28.0%; (4) gain
on sale and servicing of loans .4%; (5) referral fees on loans 1.7%; (6) service
charges and other fees 1.9%; (7) earnings on cash surrender value life insurance
1.0%; and (8) interest on certificates of deposit with other banks .5%.
Employees
The Company employed 41 people on a full-time equivalent basis as of
December 31, 2007.
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.
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SUPERVISION AND REGULATION
General
The common stock of the Company is subject to the registration
requirements of the Securities Act of 1933, as amended, and the qualification
requirements of the California Corporate Securities Law of 1968, as amended. The
Company is also subject to the periodic reporting requirements of Section 13 of
the Securities Exchange Act of 1934, as amended, which include, but are not
limited to, annual, quarterly and other current reports with the Securities and
Exchange Commission (the "SEC").
The Bank is licensed by the California Commissioner of Financial
Institutions ("Commissioner"), its deposits are insured by the Federal Deposit
Insurance Corporation ("FDIC") up to the applicable legal limits, and it has
chosen not to become a member of the Federal Reserve System. Consequently, the
Bank is subject to the supervision of, and is regularly examined by, the
Commissioner and the FDIC. The supervision and regulation includes comprehensive
reviews of all major aspects of the Bank's business and condition, including its
capital ratios, allowance for possible loan losses and other factors. However,
no inference should be drawn that such authorities have approved any such
factors. The Company and the Bank are required to file reports with the Board of
Governors, the Commissioner, and the FDIC and provide the additional information
that the Board of Governors, Commissioner, and FDIC may require.
The Company is a bank holding company within the meaning of the Bank
Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is
registered as such with, and subject to the supervision of, the Board of
Governors. The Company is required to obtain the approval of the Board of
Governors before it may acquire all or substantially all of the assets of any
bank, or ownership or control of the voting shares of any bank if, after giving
effect to such acquisition of shares, the Company would own or control more than
5% of the voting shares of such bank. The Bank Holding Company Act prohibits the
Company from acquiring any voting shares of, or interest in, all or
substantially all of the assets of, a bank located outside the State of
California unless such an acquisition is specifically authorized by the laws of
the state in which such bank is located. Any such interstate acquisition is also
subject to the California law that implemented certain provisions of prior
Federal law.
The Company, and any subsidiaries which it may acquire or organize, are
deemed to be "affiliates" within the meaning of that term as defined in the
Federal Reserve Act. This means, for example, that there are limitations (a) on
loans by the Bank to affiliates, and (b) on investments by the Bank in
affiliates' stock as collateral for loans to any borrower. The Company and its
subsidiaries are also subject to certain restrictions with respect to engaging
in the underwriting, public sale and distribution of securities.
In addition, regulations of the Board of Governors under the Federal
Reserve Act require that reserves be maintained by the Bank in conjunction with
any liability of the Company under any obligation (promissory note,
acknowledgement of advance, banker's acceptance or similar obligation) with a
weighted average maturity of less than seven (7) years to the extent that the
proceeds of such obligations are used for the purpose of supplying funds to the
Bank for use in its banking business, or to maintain the availability of such
funds.
Capital Standards
The Board of Governors and the FDIC have adopted risk-based capital
guidelines for evaluating the capital adequacy of bank holding companies and
banks. The guidelines are designed to make capital requirements sensitive to
differences in risk profiles among banking organizations, to take into account
off-balance sheet exposures and to aid in making the definition of bank capital
uniform internationally. Under the guidelines, the Company and the Bank are
required to maintain capital equal to at least 8.0% of its assets and
commitments to extend credit, weighted by risk, of which at least 4.0% must
consist primarily of common equity (including retained earnings) and the
remainder may consist of subordinated debt, cumulative preferred stock, or a
limited amount of loan loss reserves.
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Assets, commitments to extend credit, and off-balance sheet items are
categorized according to risk and certain assets considered to present less risk
than others permit maintenance of capital at less than the 8% ratio. For
example, most home mortgage loans are placed in a 50% risk category and
therefore require maintenance of capital equal to 4% of those loans, while
commercial loans are placed in a 100% risk category and therefore require
maintenance of capital equal to 8% of those loans.
Under the risk-based capital guidelines, assets reported on an
institution's balance sheet and certain off-balance sheet items are assigned to
risk categories, each of which has an assigned risk weight. Capital ratios are
calculated by dividing the institution's qualifying capital by its period-end
risk-weighted assets. The guidelines establish two categories of qualifying
capital: Tier 1 capital (defined to include common shareholders' equity and
non-cumulative perpetual preferred stock) and Tier 2 capital which includes,
among other items, limited life (and in the case of banks, cumulative) preferred
stock, mandatory convertible securities, subordinated debt and a limited amount
of reserve for credit losses. Tier 2 capital may also include up to 45% of the
pretax net unrealized gains on certain available-for-sale equity securities
having readily determinable fair values (i.e. the excess, if any, of fair market
value over the book value or historical cost of the investment security). The
federal regulatory agencies reserve the right to exclude all or a portion of the
unrealized gains upon a determination that the equity securities are not
prudently valued. Unrealized gains and losses on other types of assets, such as
bank premises and available-for-sale debt securities, are not included in Tier 2
capital, but may be taken into account in the evaluation of overall capital
adequacy and net unrealized losses on available-for-sale equity securities will
continue to be deducted from Tier 1 capital as a cushion against risk. Each
institution is required to maintain a minimum risk-based capital ratio
(including Tier 1 and Tier 2 capital) of 8%, of which at least half must be Tier
1 capital.
A leverage capital standard was adopted as a supplement to the
risk-weighted capital guidelines. Under the leverage capital standard, an
institution is required to maintain a minimum ratio of Tier 1 capital to the sum
of its quarterly average total assets and quarterly average reserve for loan
losses, less intangible assets not included in Tier 1 capital. Period-end assets
may be used in place of quarterly average total assets on a case-by-case basis.
The Board of Governors and the FDIC have also adopted a minimum leverage ratio
for bank holding companies as a supplement to the risk-weighted capital
guidelines. The leverage ratio establishes a minimum Tier 1 ratio of 3% (Tier 1
capital to total assets) for the highest rated bank holding companies or those
that have implemented the risk-based capital market risk measure. All other bank
holding companies must maintain a minimum Tier 1 leverage ratio of 4% with
higher leverage capital ratios required for bank holding companies that have
significant financial and/or operational weakness, a high risk profile, or are
undergoing or anticipating rapid growth.
At December 31, 2007, the Company and the Bank were in compliance with
the risk-weighted capital and leverage ratio guidelines.
Prompt Corrective Action
The Board of Governors and FDIC have adopted regulations implementing a
system of prompt corrective action pursuant to Section 38 of the Federal Deposit
Insurance Act and Section 131 of the FDIC Improvement Act of 1991 ("FDICIA").
The regulations establish five capital categories with the following
characteristics: (1) "Well capitalized" - consisting of institutions with a
total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital
ratio of 6% or greater and a leverage ratio of 5% or greater, and the
institution is not subject to an order, written agreement, capital directive or
prompt corrective action directive; (2) "Adequately capitalized" - consisting of
institutions with a total risk-based capital ratio of 8% or greater, a Tier 1
risk-based capital ratio of 4% or greater and a leverage ratio of 4% or greater,
and the institution does not meet the definition of a "well capitalized"
institution; (3) "Undercapitalized" - consisting of institutions with a total
risk-based capital ratio less than 8%, a Tier 1 risk-based capital ratio of less
than 4%, or a leverage ratio of less than 4%; (4) "Significantly
undercapitalized" - consisting of institutions with a total risk-based capital
ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a
leverage ratio of less than 3%; (5) "Critically undercapitalized" - consisting
of an institution with a ratio of tangible equity to total assets that is equal
to or less than 2%.
The regulations established procedures for classification of financial
institutions within the capital categories, filing and reviewing capital
restoration plans required under the regulations and procedures for issuance of
directives by the appropriate regulatory agency, among other matters. The
regulations impose restrictions upon all institutions to refrain from certain
actions which would cause an institution to be classified within any one of the
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three "undercapitalized" categories, such as declaration of dividends or other
capital distributions or payment of management fees, if following the
distribution or payment the institution would be classified within one of the
"undercapitalized" categories. In addition, institutions which are classified in
one of the three "undercapitalized" categories are subject to certain mandatory
and discretionary supervisory actions. Mandatory supervisory actions include (1)
increased monitoring and review by the appropriate federal banking agency; (2)
implementation of a capital restoration plan; (3) total asset growth
restrictions; and (4) limitations upon acquisitions, branch expansion, and new
business activities without prior approval of the appropriate federal banking
agency. Discretionary supervisory actions may include (1) requirements to
augment capital; (2) restrictions upon affiliate transactions; (3) restrictions
upon deposit gathering activities and interest rates paid; (4) replacement of
senior executive officers and directors; (5) restrictions upon activities of the
institution and its affiliates; (6) requiring divestiture or sale of the
institution; and (7) any other supervisory action that the appropriate federal
banking agency determines is necessary to further the purposes of the
regulations. Further, the federal banking agencies may not accept a capital
restoration plan without determining, among other things, that the plan is based
on realistic assumptions and is likely to succeed in restoring the depository
institution's capital. In addition, for a capital restoration plan to be
acceptable, the depository institution's parent holding company must guarantee
that the institution will comply with such capital restoration plan. The
aggregate liability of the parent holding company under the guaranty is limited
to the lesser of (i) an amount equal to 5 percent of the depository
institution's total assets at the time it became undercapitalized, and (ii) the
amount that is necessary (or would have been necessary) to bring the institution
into compliance with all capital standards applicable with respect to such
institution as of the time it fails to comply with the plan. If a depository
institution fails to submit an acceptable plan, it is treated as if it were
"significantly undercapitalized." FDICIA also restricts the solicitation and
acceptance of and interest rates payable on brokered deposits by insured
depository institutions that are not "well capitalized." An "undercapitalized"
institution is not allowed to solicit deposits by offering rates of interest
that are significantly higher than the prevailing rates of interest on insured
deposits in the particular institution's normal market areas or in the market
areas in which such deposits would otherwise be accepted.
Any financial institution which is classified as "critically
undercapitalized" must be placed in conservatorship or receivership within 90
days of such determination unless it is also determined that some other course
of action would better serve the purposes of the regulations. Critically
undercapitalized institutions are also prohibited from making (but not accruing)
any payment of principal or interest on subordinated debt without prior
regulatory approval and regulators must prohibit a critically undercapitalized
institution from taking certain other actions without prior approval, including
(1) entering into any material transaction other than in the usual course of
business, including investment expansion, acquisition, sale of assets or other
similar actions; (2) extending credit for any highly leveraged transaction; (3)
amending articles or bylaws unless required to do so to comply with any law,
regulation or order; (4) making any material change in accounting methods; (5)
engaging in certain affiliate transactions; (6) paying excessive compensation or
bonuses; and (7) paying interest on new or renewed liabilities at rates which
would increase the weighted average costs of funds beyond prevailing rates in
the institution's normal market areas.
Additional Regulations
Under the FDICIA, the federal financial institution agencies have
adopted regulations which require institutions to establish and maintain
comprehensive written real estate policies which address certain lending
considerations, including loan-to-value limits, loan administrative policies,
portfolio diversification standards, and documentation, approval and reporting
requirements. The FDICIA further generally prohibits an insured state bank from
engaging as a principal in any activity that is impermissible for a national
bank, absent FDIC determination that the activity would not pose a significant
risk to the Bank Insurance Fund, and that the bank is, and will continue to be,
within applicable capital standards.
The Federal Financial Institution Examination Counsel ("FFIEC")
utilizes the Uniform Financial Institutions Rating System ("UFIRS") commonly
referred to as "CAMELS" to classify and evaluate the soundness of financial
institutions. Bank examiners use the CAMELS measurements to evaluate capital
adequacy, asset quality, management, earnings, liquidity and sensitivity to
market risk. Effective January 1, 2005, bank holding companies such as the
Company were subject to evaluation and examination under a revised bank holding
company rating system. The so-called BOPEC rating system implemented in 1979 was
primarily focused on financial condition, consolidated capital and consolidated
earnings. The rating system reflects the change toward analysis of risk
6
management (as reflected in bank examination under the CAMELS measurements), in
addition to financial factors and the potential impact of nondepository
subsidiaries upon depository institution subsidiaries.
The federal financial institution agencies have established bases for
analysis and standards for assessing a financial institution's capital adequacy
in conjunction with the risk-based capital guidelines including analysis of
interest rate risk, concentrations of credit risk, risk posed by non-traditional
activities, and factors affecting overall safety and soundness. The safety and
soundness standards for insured financial institutions include analysis of (1)
internal controls, information systems and internal audit systems; (2) loan
documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset
growth; (6) compensation, fees and benefits; and (7) excessive compensation for
executive officers, directors or principal shareholders which could lead to
material financial loss. If an agency determines that an institution fails to
meet any standard, the agency may require the financial institution to submit to
the agency an acceptable plan to achieve compliance with the standard. If the
agency requires submission of a compliance plan and the institution fails to
timely submit an acceptable plan or to implement an accepted plan, the agency
must require the institution to correct the deficiency. The agencies may elect
to initiate enforcement action in certain cases rather than rely on an existing
plan particularly where failure to meet one or more of the standards could
threaten the safe and sound operation of the institution.
Community Reinvestment Act ("CRA") regulations evaluate banks' lending
to low and moderate income individuals and businesses across a four-point scale
from "outstanding" to "substantial noncompliance," and are a factor in
regulatory review of applications to merge, establish new branches or form bank
holding companies. In addition, any bank rated in "substantial noncompliance"
with the CRA regulations may be subject to enforcement proceedings. The Bank
currently has a rating of "satisfactory" for CRA compliance.
Limitations on Dividends
The Company's ability to pay cash dividends is subject to restrictions
set forth in the California General Corporation Law. Funds for payment of any
cash dividends by the Company would be obtained from its investments as well as
dividends and/or management fees from its subsidiaries. The payment of cash
dividends and/or management fees by the Bank is subject to restrictions set
forth in the California Financial Code, as well as restrictions established by
the FDIC. See Item 5. "Market for Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities" for more information regarding cash
dividends.
COMPETITION
Competitive Data
At June 30, 2007, based on the most recent "Data Book Summary of
Deposits in FDIC Insured Commercial and Savings Banks" report at that date, the
competing commercial and savings banks had 101 offices in the cities of Tracy,
Stockton, and Lodi, California, where the Bank has three offices. Additionally,
the Bank competes with thrifts and, to a lesser extent, credit unions, finance
companies and other financial service providers for deposit and loan customers.
Larger banks may have a competitive advantage because of higher lending limits
and major advertising and marketing campaigns. They also perform services, such
as trust services, international banking, discount brokerage and insurance
services, which the Bank is not authorized nor prepared to offer currently. The
Bank has made arrangements with its correspondent banks and with others to
provide some of these services for its customers. For borrowers requiring loans
in excess of the Bank's legal lending limits, the Bank has offered, and intends
to offer in the future, such loans on a participating basis with its
correspondent banks and with other community banks, retaining the portion of
such loans which is within its lending limits. As of December 31, 2007, the
Bank's aggregate legal lending limits to a single borrower and such borrower's
related parties were $3,369,810 on an unsecured basis and $5,616,350 on a fully
secured basis based on the Bank's regulatory capital and reserves of
$22,465,401.
The Bank's business is concentrated in its service area, which
primarily encompasses San Joaquin County. The economy of the Bank's service area
is dependent upon government, manufacturing, residential construction, tourism,
retail sales, population growth and smaller service oriented businesses.
7
Based upon the most recent "Data Book Summary of Deposits in FDIC
Insured Commercial and Savings Banks" report dated June 30, 2007, there were 123
operating commercial and savings bank offices in San Joaquin County with total
deposits of $7,467,375,000. The Bank held a total of $191,813,000 in deposits,
representing approximately 2.57% of total commercial and savings banks deposits
in San Joaquin County as of June 30, 2007. At June 30, 2006, the Bank held
approximately 2.20% of the deposits in the County.
In 1996, pursuant to Congressional mandate, the FDIC reduced bank
deposit insurance assessment rates to a range from $0 to $0.27 per $100 of
deposits, dependent upon a bank's risk. In 2005, Congress adopted the Federal
Deposit Insurance Reform Act of 2005 (the "Reform Act"), which had the effect of
merging the Bank Insurance Fund and the Savings Association Insurance Fund into
a new Deposit Insurance Fund ("DIF"). The FDIC released final regulations under
the Reform Act on November 2, 2006 that established a revised risk-based deposit
insurance assessment rate system for members of the DIF to insure, among other
matters, that there will be sufficient assessment income for repayment of DIF
obligations and to further refine the differentiation of risk profiles among
institutions as a basis for assessments. Under the new assessment rate system,
the FDIC set the assessment rates that became effective January 1, 2007 for most
institutions from $0.05 to $0.07 per $100 of insured deposits and established a
Designated Reserve Ratio ("DRR") for the DIF during 2007 of 1.25% of insured
deposits.
The new assessment rate system consolidates the nine categories of the
prior assessment system into four categories (Risk Categories I, II, III and IV)
and three Supervisory Groups (A, B and C) based upon an institution's capital
levels and supervisory ratings. Risk Category I includes all well capitalized
institutions with the highest supervisory ratings. Risk Category II includes
adequately capitalized institutions that are assigned to Supervisory Groups A
and B. Risk Category III includes all undercapitalized institutions that are
assigned to Supervisory Groups A and B and institutions assigned to Supervisory
Group C that are not undercapitalized, but have a low supervisory rating. Risk
Category IV includes all undercapitalized institutions that are assigned to
Supervisory Group C.
Based upon the current risk-based assessment rate schedule, Service 1st
Bank's current capital ratios and levels of deposits, Service 1st Bank does not
anticipate a significant increase in operating expenses due to the assessment
rate applicable to it during 2008 compared to 2007.
General Competitive Factors
In order to compete with the major financial institutions in their
primary service areas, the Bank uses to the fullest extent possible the
flexibility which is accorded by its community bank status. This includes an
emphasis on specialized services, local promotional activity, and personal
contacts by its respective officers, directors and employees. The Bank also
seeks to provide special services and programs for individuals in its primary
service area who are employed in the agricultural, professional and business
fields, such as loans for equipment, furniture, tools of the trade or expansion
of practices or businesses. In the event there are customers whose loan demands
exceed their respective lending limits, the Bank seeks to arrange for such loans
on a participation basis with other financial institutions. The Bank also
assists those customers requiring services not offered by the Bank to obtain
such services from correspondent banks.
Commercial banks compete with savings and loan associations, credit
unions, other financial institutions and other entities for funds. For instance,
yields on corporate and government debt securities and other commercial paper
affect the ability of commercial banks to attract and hold deposits. Commercial
banks also compete for loans with savings and loan associations, credit unions,
consumer finance companies, mortgage companies and other lending institutions.
Banking is a business that depends on interest rate differentials. In
general, the difference between the interest rate paid by a bank to obtain their
deposits and other borrowings and the interest rate received by a bank on loans
extended to customers and on securities held in a bank's portfolio comprise the
major portion of a bank's earnings.
The interest rate differentials of a bank, and therefore its earnings,
are affected not only by general economic conditions, both domestic and foreign,
but also by the monetary and fiscal policies of the United States as set by
statutes and as implemented by federal agencies, particularly the Federal
Reserve Board. The Federal Reserve Board can and does implement national
8
monetary policy, such as seeking to curb inflation and combat recession, by its
open market operations in United States government securities, adjustments in
the amount of interest free reserves that banks and other financial institutions
are required to maintain, and adjustments to the discount rates applicable to
borrowing by banks from the Federal Reserve Board. These activities influence
the growth of bank loans, investments and deposits and also affect interest
rates charged on loans and paid on deposits. The nature and timing of any future
changes in monetary policies and their impact on the Company and the Bank is not
predictable.
Impact of Legislative and Regulatory Proposals
Since 1996, California law implementing certain provisions of prior
federal law has (1) permitted interstate merger transactions; (2) prohibited
interstate branching through the acquisition of a branch business unit located
in California without acquisition of the whole business unit of the California
bank; and (3) prohibited interstate branching through de novo establishment of
California branch offices. Initial entry into California by an out-of-state
institution must be accomplished by acquisition of or merger with an existing
whole bank which has been in existence for at least five years.
The federal financial institution agencies, especially the Office of
the Comptroller of the Currency ("OCC") and the Board of Governors, have taken
steps to increase the types of activities in which national banks and bank
holding companies can engage, and to make it easier to engage in such
activities. The OCC has issued regulations permitting national banks to engage
in a wider range of activities through subsidiaries. "Eligible institutions"
(those national banks that are well capitalized, have a high overall rating and
a satisfactory CRA rating, and are not subject to an enforcement order) may
engage in activities related to banking through operating subsidiaries subject
to an expedited application process. In addition, a national bank may apply to
the OCC to engage in an activity through a subsidiary in which the Bank itself
may not engage.
In 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was signed into
law. The GLB Act eliminates most of the remaining depression-era "firewalls"
between banks, securities firms and insurance companies which was established by
The Banking Act of 1933, also known as the Glass-Steagall Act
("Glass-Steagall"). Glass-Steagall sought to insulate banks as depository
institutions from the perceived risks of securities dealing and underwriting,
and related activities. The GLB Act repealed Section 20 of Glass-Steagall which
prohibited banks from affiliating with securities firms. Bank holding companies
that can qualify as "financial holding companies" can now acquire securities
firms or create them as subsidiaries, and securities firms can now acquire banks
or start banking activities through a financial holding company. The GLB Act
includes provisions which permit national banks to conduct financial activities
through a subsidiary that are permissible for a national bank to engage in
directly, as well as certain activities authorized by statute, or that are
financial in nature or incidental to financial activities to the same extent as
permitted to a "financial holding company" or its affiliates. This
liberalization of United States banking and financial services regulation
applies both to domestic institutions and foreign institutions conducting
business in the United States. Consequently, the common ownership of banks,
securities firms and insurance firms is now possible, as is the conduct of
commercial banking, merchant banking, investment management, securities
underwriting and insurance within a single financial institution using a
"financial holding company" structure authorized by the GLB Act.
Prior to the GLB Act, significant restrictions existed on the
affiliation of banks with securities firms and on the direct conduct by banks of
securities dealing and underwriting and related securities activities. Banks
were also (with minor exceptions) prohibited from engaging in insurance
activities or affiliating with insurers. The GLB Act removed these restrictions
and substantially eliminated the prohibitions under the Bank Holding Company Act
on affiliations between banks and insurance companies. Bank holding companies
which qualify as financial holding companies can now insure, guarantee, or
indemnify against loss, harm, damage, illness, disability, or death; issue
annuities; and act as a principal, agent, or broker regarding such insurance
services.
In order for a commercial bank to affiliate with a securities firm or
an insurance company pursuant to the GLB Act, its bank holding company must
qualify as a financial holding company. A bank holding company will qualify if
(1) its banking subsidiaries are "well capitalized" and "well managed" and (2)
it files with the Board of Governors a certification to such effect and a
declaration that it elects to become a financial holding company. The amendment
of the Bank Holding Company Act now permits financial holding companies to
engage in activities, and acquire companies engaged in activities, that are
9
financial in nature or incidental to such financial activities. Financial
holding companies are also permitted to engage in activities that are
complementary to financial activities if the Board of Governors determines that
the activity does not pose a substantial risk to the safety or soundness of
depository institutions or the financial system in general. These standards
expand upon the list of activities "closely related to banking" which have to
date, defined the permissible activities of bank holding companies under the
Bank Holding Company Act.
One further effect of the GLB Act is to require that federal financial
institution and securities regulatory agencies prescribe regulations to
implement the policy that financial institutions must respect the privacy of
their customers and protect the security and confidentiality of customers'
non-public personal information. These regulations require, in general, that
financial institutions (1) may not disclose non-public personal information of
customers to non-affiliated third parties without notice to their customers, who
must have the opportunity to direct that such information not be disclosed; (2)
may not disclose customer account numbers except to consumer reporting agencies;
and (3) must give prior disclosure of their privacy policies before establishing
new customer relationships.
Neither the Company nor the Bank have determined whether or when they
may seek to acquire and exercise powers or activities under the GLB Act, and the
extent to which competition will change among financial institutions affected by
the GLB Act has not yet become clear.
On October 26, 2001, President Bush signed the USA Patriot Act (the
"Patriot Act"), which includes provisions pertaining to domestic security,
surveillance procedures, border protection, and terrorism laws to be
administered by the Secretary of the Treasury. Title III of the Patriot Act
entitled, "International Money Laundering Abatement and Anti-Terrorist Financing
Act of 2001" includes amendments to the Bank Secrecy Act which expand the
responsibilities of financial institutions in regard to anti-money laundering
activities with particular emphasis upon international money laundering and
terrorism financing activities through designated correspondent and private
banking accounts.
Effective December 25, 2001, Section 313(a) of the Patriot Act
prohibits any insured financial institution such as Service 1st Bank, from
providing correspondent accounts to foreign banks which do not have a physical
presence in any country (designated as "shell banks"), subject to certain
exceptions for regulated affiliates of foreign banks. Section 313(a) also
requires financial institutions to take reasonable steps to ensure that foreign
bank correspondent accounts are not being used to indirectly provide banking
services to foreign shell banks, and Section 319(b) requires financial
institutions to maintain records of the owners and agent for service of process
of any such foreign banks with whom correspondent accounts have been
established.
Effective July 23, 2002, Section 312 of the Patriot Act created a
requirement for special due diligence for correspondent accounts and private
banking accounts. Under Section 312, each financial institution that
establishes, maintains, administers, or manages a private banking account or a
correspondent account in the United States for a non-United States person,
including a foreign individual visiting the United States, or a representative
of a non-United States person shall establish appropriate, specific, and, where
necessary, enhanced, due diligence policies, procedures, and controls that are
reasonably designed to detect and record instances of money laundering through
those accounts.
The Patriot Act contains various provisions in addition to Sections
313(a) and 312 that affect the operations of financial institutions by
encouraging cooperation among financial institutions, regulatory authorities and
law enforcement authorities with respect to individuals, entities and
organizations engaged in, or reasonably suspected of engaging in, terrorist acts
or money laundering activities. The Company and Service 1st Bank are not
currently aware of any account relationships between Service 1st Bank and any
foreign bank or other person or entity as described above under Sections 313(a)
or 312 of the Patriot Act.
Certain surveillance provisions of the Patriot Act were scheduled to
expire on December 31, 2005, and actions to restrict the use of the Patriot Act
surveillance provisions were filed by the ACLU and other organizations. On March
9, 2006, after temporary extensions of the Patriot Act, President Bush signed
the "USA Patriot Improvement and Reauthorization Act of 2005" and the "USA
Patriot Act Additional Reauthorizing Amendments Act of 2006," which reauthorized
all expiring provisions of the Patriot Act by making permanent 14 of the 16
provisions and imposed a four-year expiration date on December 31, 2009 on the
other two provisions related to "roving surveillance" and production of business
records.
10
The effects which the Patriot Act and any additional legislation
enacted by Congress may have upon financial institutions is uncertain; however,
such legislation could increase compliance costs and thereby potentially may
have an adverse effect upon the Company's results of operations.
On July 30, 2002, President George W. Bush signed into law the
Sarbanes-Oxley Act of 2002 (the "Act") which responds to recent issues in
corporate governance and accountability. Among other matters, key provisions of
the Act and rules promulgated by the SEC pursuant to the Act include the
following:
o Expanded oversight of the accounting profession by creating a
new independent public company oversight board to be monitored
by the SEC.
o Revised rules on auditor independence to restrict the nature
of non-audit services provided to audit clients and to require
such services to be pre-approved by the audit committee.
o Improved corporate responsibility through mandatory listing
standards relating to audit committees, certifications of
periodic reports by the CEO and CFO and making issuer
interference with an audit a crime.
o Enhanced financial disclosures, including periodic reviews for
largest issuers and real time disclosure of material company
information.
o Enhanced criminal penalties for a broad array of white collar
crimes and increases in the statute of limitations for
securities fraud lawsuits.
o Disclosure of whether a company has adopted a code of ethics
that applies to the company's principal executive officer,
principal financial officer, principal accounting officer or
controller, or persons performing similar functions, and
disclosure of any amendments or waivers to such code of
ethics.
o Disclosure of whether a company's audit committee of its board
of directors has a member of the audit committee who qualifies
as an "audit committee financial expert."
o A prohibition on insider trading during pension plan black-out
periods.
o Disclosure of off-balance sheet transactions.
o A prohibition on personal loans to directors and officers.
o Conditions on the use of non-GAAP (generally accepted
accounting principles) financial measures.
o Standards on professional conduct for attorneys requiring
attorneys having an attorney-client relationship with a
company, among other matters, to report "up the ladder" to the
audit committee, another board committee or the entire board
of directors certain material violations.
o Expedited filing requirements for Form 4 reports of changes in
beneficial ownership of securities reducing the filing
deadline to within 2 business days of the date a transaction
triggers an obligation to report.
o Accelerated filing requirements for Forms 10-K and 10-Q by
public companies which qualify as "accelerated filers" to a
phased-in reduction of the filing deadline for Form 10-K
reports and Form 10-Q reports.
o Disclosure concerning website access to reports on Forms 10-K,
10-Q and 8-K, and any amendments to those reports, by
"accelerated filers" as soon as reasonably practicable after
such reports and material are filed with or furnished to the
Securities and Exchange Commission.
o Rules requiring national securities exchanges and national
securities associations to prohibit the listing of any
security whose issuer does not meet audit committee standards
established pursuant to the Act.
The Company's securities are not currently listed on the Nasdaq Stock
Market and trading activity is reported on the OTC Bulletin Board. Consequently,
the Company is not currently required to comply with Nasdaq listing standards in
addition to the rules promulgated by the SEC pursuant to the Act. However, if
the Company lists its common stock for trading on the Nasdaq Stock Market in the
future, the Company would be required to comply with the Nasdaq listing rules in
effect at that time, which may include additional standards related to (i)
director independence, (ii) executive session meetings of the board, (iii)
requirements for audit, nominating and compensation committee charters,
membership qualifications and procedures, (iv) shareholder approval of equity
compensation arrangements, and (v) code of conduct requirements that comply with
the code of ethics under the Act.
11
The effect of the Act upon the Company is uncertain; however, the
Company has incurred and it is anticipated that it will continue to incur
increased costs to comply with the Act and the rules and regulations promulgated
pursuant to the Act by the SEC, Nasdaq and other regulatory agencies having
jurisdiction over the Company or the issuance and listing of its securities. The
Company does not currently anticipate, however, that compliance with the Act and
such rules and regulations will have a material adverse effect upon its
financial position or results of its operations or its cash flows.
Effective January 1, 2003, the California Corporate Disclosure Act (the
"CCD Act") required publicly traded corporations incorporated or qualified to do
business in California to disclose information about their past history,
auditors, directors and officers. Effective September 28, 2004, the CCD Act, as
currently in effect and codified at California Corporations Code Section 1502.1,
requires the Company to file with the California Secretary of State and disclose
within 150 days after the end of its fiscal year certain information including
the following:
o The name of the a company's independent auditor and a
description of services, if any, performed for a company
during the previous two fiscal years and the period from the
end of the most recent fiscal year to the date of filing;
o The annual compensation paid to each director and the five
most highly compensated non-director executive officers
(including the CEO) during the most recent fiscal year,
including all plan and non-plan compensation for all services
rendered to a company as specified in Item 402 of Regulation
S-K such as grants, awards or issuance of stock, stock options
and similar equity-based compensation;
o A description of any loans made to a director at a
"preferential" loan rate during the company's two most recent
fiscal years, including the amount and terms of the loans;
o Whether any bankruptcy was filed by a company or any of its
directors or executive officers within the previous 10 years;
o Whether any director or executive officer of a company has
been convicted of fraud during the previous 10 years; and
o A description of any material pending legal proceedings other
than ordinary routine litigation as specified in Item 103 of
Regulation S-K and a description of such litigation where the
company was found legally liable by a final judgment or order.
The Company does not currently anticipate that compliance with the CCD
Act will have a material adverse effect upon its financial position or results
of its operations or its cash flows.
The Check Clearing for the 21st Century Act (commonly referred to as
"Check 21") was signed into law in 2003 and became effective on October 28,
2004. The law facilitates check truncation by creating a new negotiable
instrument called a "substitute check" which permits banks to truncate original
checks, to process check information electronically and to deliver "substitute
checks" to banks that want to continue receiving paper checks. Check 21 is
intended to reduce the dependence of the check payment system on physical
transportation networks (which can be disrupted by terrorist attacks of the type
which occurred on September 11, 2001) and to streamline the collection and
return process. The law does not require banks to accept checks in electronic
form nor does it require banks to use the new authority granted by the Act to
create "substitute checks." The Company does not currently anticipate that
compliance with the Act will have a material effect upon its financial position
or results of its operations or its cash flows.
The Board of Governors, the FDIC, the other federal financial
institution regulatory agencies, and the Federal Trade Commission issued a joint
press release on October 31, 2007 and final rules and guidelines effective
January 1, 2008, subject to mandatory compliance as of November 1, 2008,
implementing sections 114 and 315 of the Fair and Accurate Credit Transactions
Act of 2003 to require financial institutions and other creditors to develop and
implement a written identity theft prevention program. The program must include
reasonable policies and procedures for detecting, preventing, and mitigating
identity theft in connection with certain new and existing covered accounts.
Covered accounts are defined as (i) an account primarily for personal, family,
or household purposes (i.e., consumer accounts), or (ii) any other account for
which there is a reasonably foreseeable risk to customers or the safety and
soundness of the financial institution or creditor from identity theft. The
program must be appropriate to the size and complexity of the financial
institution or creditor and the nature and scope of its activities and should be
designed to:
12
o identify relevant patterns, practices, and specific forms of
activity that are "red flags" of possible identity theft and
incorporate those red flags into the program;
o detect the occurrence of red flags incorporated into the
program;
o respond appropriately to any red flags that are detected to
prevent and mitigate identity theft; and
o ensure that the program is updated periodically to reflect
changes in risks to customers or to the safety and soundness
of the financial institution or creditor from identity theft.
The regulations include guidelines that each financial institution must
consider and, to the extent appropriate, include in its program and steps that
must be taken to administer the program including (i) obtaining approval of the
program by the board of directors or a committee of the board, (ii) ensuring
oversight of the development, implementation and administration of the program,
(iii) training staff, and (iv) overseeing service provider arrangements. The
guidelines contemplate that existing fraud prevention procedures may be
incorporated into the program.
Certain legislative and regulatory proposals that could affect the
Company, the Bank and the banking business in general are periodically
introduced before the United States Congress, the California State Legislature
and Federal and state government agencies. It is not known to what extent, if
any, legislative proposals will be enacted and what effect such legislation
would have on the structure, regulation and competitive relationships of
financial institutions. In addition to legislative changes, the various Federal
and state financial institution regulatory agencies frequently propose rules and
regulations to implement and enforce already existing legislation. It cannot be
predicted whether or in what form any such rules or regulations will be enacted
or the effect that such regulations may have on the Company and the Bank. It is
likely, however, that such legislation and regulation could subject the Company
and the Bank to increased regulation, disclosure and reporting requirements,
competition, and costs of doing business.
Item 1A. Risk Factors.
The Company and its subsidiary, Service 1st Bank, conduct business in
an environment that includes certain risks described below which could have a
material adverse effect on the Company's business, results of operations,
financial condition, future prospects and stock price. You are also referred to
the matters described under the heading "Cautionary Statements Regarding
Forward-Looking Statements," in Part I, Item 1 and Part II, Item 7 of this
report on Form 10-K for additional information regarding factors that may affect
the Company's business.
o Service 1st Bancorp's business is subject to interest rate
risk and variations in interest rates may negatively affect
its financial performance.
Changes in the interest rate environment may reduce the Company's net
interest income. It is expected that the Company will continue to realize income
from the differential or "spread" between the interest earned on loans,
securities and other interest-earning assets, and interest paid on deposits,
borrowings and other interest-bearing liabilities. Net interest spreads are
affected by the difference between the maturities and repricing characteristics
of interest-earning assets and interest-bearing liabilities. In addition, loan
volume and yields are affected by market interest rates on loans, and rising
interest rates generally are associated with a lower volume of loan
originations. We cannot assure you that we can minimize the Company's interest
rate risk. In addition, an increase in the general level of interest rates may
adversely affect the ability of certain borrowers to pay the interest on and
principal of their obligations. Accordingly, changes in levels of market
interest rates could materially and adversely affect the Company's net interest
spread, asset quality, loan origination volume and overall profitability.
o Governmental monetary policies affect the Company's business
and are beyond the control of the Company.
The business of banking is affected significantly by the fiscal and
monetary policies of the federal government and its agencies. Such policies are
beyond the control of the Company. The Company is particularly affected by the
policies established by the Board of Governors in relation to the supply of
money and credit in the United States. The instruments of monetary policy
available to the Board of Governors can be used in varying degrees and
13
combinations to directly affect the availability of bank loans and deposits, as
well as the interest rates charged on loans and paid on deposits, and this can
and does have a material effect on the Company's business, results of operations
and financial condition.
o Service 1st Bancorp's subsidiary, Service 1st Bank, faces
strong competition from banks, financial service companies and
other companies that offer banking services, which can hurt
Service 1st Bancorp's business.
The Company's subsidiary, Service 1st Bank, conducts banking operations
principally in Northern California. Increased competition in Service 1st Bank's
market may result in reduced loans and deposits. Ultimately, it may not be able
to compete successfully against current and future competitors. Many competitors
offer the banking services that are offered by Service 1st Bank in its service
area. These competitors include national and super-regional banks, finance
companies, investment banking and brokerage firms, credit unions,
government-assisted farm credit programs, other community banks and
technology-oriented financial institutions offering online services. In
particular, Service 1st Bank's competitors include several major financial
companies whose greater resources may afford them a marketplace advantage by
enabling them to maintain numerous banking locations and mount extensive
promotional and advertising campaigns. Additionally, banks and other financial
institutions with larger capitalization and financial intermediaries not subject
to bank regulatory restrictions have larger lending limits and are thereby able
to serve the credit needs of larger customers. Areas of competition include
interest rates for loans and deposits, efforts to obtain deposits, and range and
quality of products and services provided, including new technology-driven
products and services. Technological innovation continues to contribute to
greater competition in domestic and international financial services markets as
technological advances, such as Internet-based banking services that cross
traditional geographic bounds, enable more companies to provide financial
services. If Service 1st Bank is unable to attract and retain banking customers,
it may be unable to continue its loan growth and level of deposits, which may
adversely affect its and the Company's results of operations, financial
condition and future prospects.
o Worsening economic conditions in Northern California could
adversely affect the Company's business.
The Company conducts business operations principally in Northern
California. As a result, the Company's financial condition, results of
operations and cash flows are subject to changes in the economic conditions in
Northern California. The Company's business results are dependent in large part
upon the business activity, population, income levels, deposits and real estate
activity in Northern California, and adverse economic conditions could have
adverse effects upon the Company. The State of California is currently
experiencing significant budgetary and fiscal difficulties. The Company can
provide no assurance that conditions in the California economy will not
deteriorate or that such deterioration will not adversely affect the Company. A
deterioration in economic conditions locally, regionally or nationally,
including the economic impact of terrorist activities within and outside
California could result in an economic downturn in Northern California and
trigger the following consequences, any of which could adversely affect the
Company's business:
o loan delinquencies and defaults may increase;
o problem assets and foreclosures may increase;
o demand for the Company's products and services may decline;
o low cost or non-interest bearing deposits may decrease; and
o collateral for loans may decline in value, in turn reducing
customers' borrowing power, and reducing the value of assets
and collateral as sources of repayment of existing loans.
o The Company has a concentration risk in real estate related
loans.
At December 31, 2007, approximately 64.9% of the Company's loan and
lease portfolio consisted of real estate related loans. The majority of the
Company's real property collateral is located in its operating markets in
Northern California. A substantial decline in real estate values in the
Company's primary market areas could occur as a result of worsening economic
conditions, or other events including natural disasters such as earthquakes,
fires, and floods. Such a decline in values could have an adverse impact on the
Company by limiting repayment of defaulted loans through sale of the real estate
collateral and by likely increasing the number of defaulted loans to the extent
that the financial condition of its borrowers is adversely affected by such a
14
decline in values. At December 31, 2007, residential construction loans,
including land acquisition and development, totaled $17 million or 14.84% of the
Company's total loan portfolio. This was comprised of 1.47% owner-occupied and
13.37% speculative construction and land loans. Construction, land acquisition
and development lending involve additional risks because funds are advanced on
the security of the project, which is of uncertain value prior to its
completion. Because of the uncertainties inherent in estimating construction
costs, as well as the market value of the completed project and the effects of
governmental regulation on real property, it is relatively difficult to evaluate
accurately the total funds required to complete a project and the related
loan-to-value ratio. As a result, speculative construction loans often involve
the disbursement of substantial funds with repayment dependent, in part, on the
completion of the project and the ability of the borrower to sell the property,
rather than the ability of the borrower or the guarantor to repay the principal
and interest. If our appraisal of the value of the completed project proves to
be overstated, we may have inadequate security for the repayment of the loan
upon completion of construction of the project. If we are forced to foreclose on
a project prior to or at completion due to a default, there can be no assurance
that we will be able to recover all of the unpaid balance of, and accrued
interest on, the loan, a well as related foreclosure and holding costs. In
addition, we may be required to fund additional amounts to complete the project
and may have to hold the property for an unspecified period of time. The adverse
effects of the foregoing matters upon the Company's real estate portfolio could
necessitate a material increase in the provision for loan and lease losses which
could adversely affect the Company's results of operations, financial condition,
and future prospects.
o Service 1st Bancorp is subject to extensive regulation, which
could adversely affect its business.
The Company's operations are subject to extensive regulation by state
and local governmental authorities and are subject to various laws and judicial
and administrative decisions imposing requirements and restrictions on part or
all of its operations. The Company believes that it is in substantial compliance
in all material respects with laws, rules and regulations applicable to the
conduct of its business. Because the Company's business is highly regulated, the
laws, rules and regulations applicable to it are subject to regular modification
and change. There can be no assurance that these laws, rules and regulations, or
any other laws, rules or regulations, will not be adopted in the future, which
could make compliance much more difficult or expensive, restrict the Company's
ability to originate, broker or sell loans, further limit or restrict the amount
of commissions, interest or other charges earned on loans originated or sold by
the Company, or otherwise adversely affect the Company's results of operations,
financial condition, or future prospects.
o Service 1st Bancorp's allowance for loan and lease losses may
not be adequate to cover actual losses.
Like all financial institutions, Service 1st Bancorp's subsidiary,
Service 1st Bank, maintains an allowance for loan and lease losses to provide
for loan defaults and non-performance, but its allowance for loan and lease
losses may not be adequate to cover actual loan and lease losses. In addition,
future provisions for loan and lease losses could materially and adversely
affect Service 1st Bank's and therefore the Company's operating results. Service
1st Bank's allowance for loan and lease losses is based on prior experience, as
well as an evaluation of the risks in the current portfolio. The amount of
future losses is susceptible to changes in economic, operating and other
conditions, including changes in interest rates that may be beyond Service 1st
Bank's control, and these losses may exceed current estimates. Federal
regulatory agencies, as an integral part of their examination process, review
Service 1st Bank's loans and leases and allowance for loan and lease losses.
Although we believe that Service 1st Bank's allowance for loan and lease losses
is adequate to cover current losses, we cannot assure you that it will not
further increase the allowance for loan and lease losses or that regulators will
not require it to increase this allowance. Either of these occurrences could
materially and adversely affect the Company's earnings.
o Service 1st Bancorp's and Service 1st Bank's operations are
dependent upon key personnel.
The future prospects of the Company will be highly dependent on its
directors, executive officers and other key personnel. The success of the
Company will, to some extent, depend on the continued service of its directors
and continued employment of the executive officers, in addition to the Company's
ability to attract and retain experienced banking professionals to serve the
Company and the Bank in other key positions. The unexpected loss of the services
of any of these individuals could have a detrimental effect on the Company and
Service 1st Bank.
15
o Technology implementation problems or computer system failures
could adversely affect Service 1st Bancorp and Service 1st
Bank.
The Company's future prospects will be highly dependent on the ability
of Service 1st Bank to implement changes in technology that affect the delivery
of banking services such as the increased demand for computer access to bank
accounts and the availability to perform banking transactions electronically.
The Bank's ability to compete will depend upon it ability to continue to adapt
technology on a timely and cost-effective basis to meet such demands. In
addition, the business and operations of the Company and the Bank will be
susceptible to adverse effects from computer failures, communication and energy
disruption, and the activities of unethical individuals with the technological
ability to cause disruptions or failures of the Bank's data processing system.
o Information security breach or other technology difficulties
could adversely affect Service 1st Bancorp and Service 1st
Bank.
The Company and the Bank cannot be certain that implementation of
safeguards will eliminate the risk of vulnerability to technological
difficulties or failures or ensure the absence of a breach of information
security. The Bank will rely on the services of various vendors who provide data
processing and communication services to the banking industry. Nonetheless, if
information security is compromised or other technology difficulties or failures
occur, information may be lost or misappropriated, services and operations may
be interrupted and the Company and Bank could be exposed to claims from its
customers as a result. The occurrence of any of these events could adversely
affect the Company's results of operations, financial condition, prospects, and
stock price.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The Company's administrative office consists of approximately 1,800
square feet on the ground floor of a one story building located in downtown
Tracy and is leased from May 1, 2005 through April 30, 2010. There are no
options to renew this lease. The current monthly lease rate is $3,004 subject to
a 4% adjustment on each anniversary of the commencement of the lease.
The Bank conducts operations at offices located at 2800 West March
Lane, Suite 120, Stockton, California 95219, 60 West 10th Street, Tracy,
California 95376, and 1901 W. Kettleman Lane, Suite 100, Lodi, California 95242.
The Bank's Stockton office consists of approximately 4,715 square feet
on the ground floor of an office building located adjacent to Interstate Highway
5 and is leased from October 1, 2002 to September 30, 2009. There are two
five-year options to extend the lease term. The current monthly lease rate is
$10,938, subject to a 3% annual adjustment. The monthly rate during the extended
term will be the fair market rental value of the premises at the commencement of
the extended term.
The Bank's Tracy office consists of approximately 7,500 square feet of
space on the ground floor and second floor of a two-story building located in
downtown Tracy. The original lease from February 15, 2000 to February 28, 2007,
with two five-year options has been extended by the exercise of the first
five-year option to extend the lease term to February 28, 2012. The current
monthly lease rate is $9,000, subject to increase as specified in the lease
option exercise letter dated September 12, 2006.
The Bank's Lodi office consists of approximately 9,580 square feet on
the first floor of a two story office building and is leased from January 1,
2006 through December 31, 2015. There are two five year options to extend the
lease. The monthly rental is $21,027, subject to a 3% annual adjustment. The
monthly rate during the extended term will be adjusted at the commencement of
each extension to the fair market rental value for comparable buildings in San
Joaquin County at the time of such extension. The Bank subleased 2,170 square
feet to a third party at $4,779.40 per month. The Bank has also subleased 910
square feet to the Company's subsidiary, Charter Services Group, Inc. at a
monthly rental of $2,010.
16
Charter conducts is operations at an office located at 1901 W.
Kettleman Lane, Suite 102, Lodi, California 95242. The office consists of
approximately 910 square feet. The lease agreement is on a month-to-month basis
with the Bank.
Management believes that the facilities are appropriate and adequate
for the operation of the business as it is currently structured. The foregoing
lease descriptions are qualified in their entirety by reference to the lease
agreements listed in Item 15 as exhibits to this Annual Report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
The Bank is not a party to any pending legal or administrative
proceedings other than ordinary routine litigation incidental to the Bank's
business involving the Bank or any of its property, and no such proceedings are
known to be contemplated.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 2007.
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
There is limited trading in and no established public trading market
for the Company's common stock. The Company's common stock is not listed on any
exchange and is not quoted by The Nasdaq Stock Market. The Company's common
stock is quoted on the OTC Bulletin Board under the symbol "SVCF." The
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not represent actual transactions. Total shares and prices
per share have been adjusted retroactively to reflect a three-for-two stock
split payable on September 29, 2005. As of March 28, 2008, there were 2,388,739
shares of the Company's common stock outstanding. The Company's common stock was
registered under Section 12(g) of the Securities Exchange Act of 1934, by the
filing of the Company's registration statement on Form 8-A with the SEC on June
26, 2003. Pershing LLC and Wells Fargo Van Kasper have facilitated trades in the
Company's common stock. The high and low bid quotations for the Company's common
stock for each full quarterly period of the Company's operations for the last
two years is listed in the chart shown below.
Calendar Year High Low
------------- ----------- -----------
2007
First Quarter $ 20.42 $ 18.00
Second Quarter $ 18.00 $ 14.00
Third Quarter $ 14.75 $ 10.75
Fourth Quarter $ 13.15 $ 7.00
2006
First Quarter $ 23.00 $ 15.25
Second Quarter $ 18.00 $ 17.00
Third Quarter $ 27.00 $ 17.65
Fourth Quarter $ 22.00 $ 19.25
The high and low bid quotations for the Company's common stock were
$6.75 and $7.00 as of March 28, 2008.
17
Holders
At March 28, 2008, there were approximately 833 shareholders of the
Company's common stock. There are no other classes of equity shares of the
Company outstanding.
Dividends
The Company's shareholders are entitled to receive dividends when and
as declared by its Board of Directors, out of funds legally available therefore,
subject to the restrictions set forth in the California General Corporation Law
(the "Corporation Law"). The Corporation Law provides that a corporation may
make a distribution to its shareholders if the corporation's retained earnings
equal at least the amount of the proposed distribution. The Corporation Law
further provides that, in the event that sufficient retained earnings are not
available for the proposed distribution, a corporation may nevertheless make a
distribution to its shareholders if it meets two conditions, which generally
stated are as follows: (1) the corporation's assets equal at least 1-1/4 times
its liabilities; and (2) the corporation's current assets equal at least its
current liabilities or, if the average of the corporation's earnings before
taxes on income and before interest expenses for the two preceding fiscal years
was less than the average of the corporation's interest expenses for such fiscal
years, then the corporation's current assets must equal at least 1-1/4 times its
current liabilities. Funds for payment of any cash dividends by the Company
would be obtained from its investments as well as dividends and/or management
fees from the Bank.
The payment of cash dividends by the Bank is subject to restrictions
set forth in the California Financial Code (the "Financial Code") which may
include obtaining the consent of the California Commissioner of Financial
Institutions (the "Commissioner") under certain circumstances described below.
The Financial Code provides that a bank may not make a cash
distribution to its shareholders in excess of the lesser of (a) the bank's
retained earnings; or (b) the bank's net income for its last three fiscal years,
less the amount of any distributions made by the bank or by any majority-owned
subsidiary of the bank to the shareholders of the bank during such period.
However, a bank may, with the approval of the Commissioner, make a distribution
to its shareholders in an amount not exceeding the greater of (a) its retained
earnings; (b) its net income for its last fiscal year; or (c) its net income for
its current fiscal year. In the event that the Commissioner determines that the
shareholders' equity of a bank is inadequate or that the making of a
distribution by the bank would be unsafe or unsound, the Commissioner may order
the bank to refrain from making a proposed distribution.
The FDIC may also restrict the payment of dividends if such payment
would be deemed unsafe or unsound or if after the payment of such dividends, a
bank would be included in one of the "undercapitalized" categories for capital
adequacy purposes pursuant to the Federal Deposit Insurance Corporation
Improvement Act of 1991. Additionally, while the Board of Governors has no
general restriction with respect to the payment of cash dividends by an
adequately capitalized bank to its parent holding company, the Board of
Governors might, under certain circumstances, place restrictions on the ability
of a particular bank to pay dividends based upon peer group averages and the
performance and maturity of the particular bank, or object to management fees on
the basis that such fees cannot be supported by the value of the services
rendered or are not the result of an arm's length transaction.
To date, the Company has not paid a cash dividend and presently does
not intend to pay cash dividends in the foreseeable future. The Company declared
a five percent stock dividend in February 2004 payable in April 2004. Payment of
dividends in the future will be determined by the Board of Directors after
consideration of various factors including the profitability and capital
adequacy of the Company and the Bank.
Stock Repurchases
The Company did not repurchase shares of its common stock during the
fourth quarter of the year ended December 31, 2007, and has not repurchased
shares of its common stock at any time since its incorporation.
18
PERFORMANCE GRAPH
The following graph compares the performance of Service 1st Bancorp's
common shares to the Nasdaq Stock Market Total Return Index and the Nasdaq Bank
Stock Index during the last five years. The graph shows the value of $100
invested in Service 1st Bancorp common stock and both indices on December 31,
2002 and the change in the value of Service 1st Bancorp's common shares compared
to the indices as of the end of each year. The graph assumes the reinvestment of
all dividends. Historical stock price performance is not necessarily indicative
of future stock price performance.
SERVICE 1ST BANCORP
[GRAPHIC CHART OMITTED]
Year Ending
--------------------------------------------------------------------------------
Index 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07
- ---------------------------------------------------------------------------------------------------------
Service 1st Bancorp 100 152.44 162.67 267.71 303.15 124.41
NASDAQ Composite 100 150.01 162.90 165.13 180.85 198.59
NASDAQ Bank 100 129.93 144.21 137.97 153.16 119.36
19
ITEM 6. SELECTED FINANCIAL DATA
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 December 31, 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. The Company also has a wholly-owned
subsidiary, Charter Services Group, Inc., which provides consulting services to
start-up (de novo) banks.
The following analysis is designed to enhance the reader's
understanding of the Company's financial condition and the results of its
operations as reported in the Financial Statements included in this Annual
Report. Reference should be made to the financial statements and notes thereto
for additional detailed information. All per share data has been retroactively
restated to reflect stock dividends and stock splits.
SELECTED FINANCIAL DATA
2007 2006 2005
------------- ------------- -------------
Interest Income $ 14,906,522 $ 12,723,496 $ 8,479,233
Interest Expense 8,000,166 5,772,931 2,853,899
------------- ------------- -------------
Net interest Income 6,906,356 6,950,565 5,625,334
Provision for loan loss 935,000 300,000 165,000
------------- ------------- -------------
Net Interest Income After Provision for Loan Losses 5,971,356 6,650,565 5,460,334
Non-interest Income 888,995 806,295 686,843
Non-interest Expense 6,879,522 6,310,574 4,579,562
------------- ------------- -------------
Income (loss) before Provision for Taxes (19,171) 1,146,286 1,567,615
Tax Expense (Credit) (356,194) 299,165 144,996
------------- ------------- -------------
Net Income $ 337,023 $ 847,121 $ 1,422,619
============= ============= =============
Net Income Per Share - Basic $ .14 $ .35 $ .60
Net Income Per Share - Diluted $ .14 $ .33 $ .56
Return on Average Assets .15% .44% .90%
Return on Average Equity 1.95% 5.37% 9.42%
Average Equity to Average Assets 7.69% 8.16% 9.53%
Average Loans to Average Deposits 60.18% 62.75% 52.21%
Total Assets as of December 31, $ 231,075,943 $ 227,220,390 $ 169,329,270
Total Deposits as of December 31, $ 202,405,646 $ 199,955,091 $ 151,141,667
Net Interest Margin 3.25% 3.82% 3.88%
20
ITEM 7. 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 Annual
Report on Form 10-K including, but not limited to, matters described in "Item 7
- - 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, 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 Afghanistan and Iraq and the conduct of the war on
terrorism by the United States and its allies, as well as other factors. These
factors set forth under "Item 1a-Risk Factors" in this report and 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.
21
EARNINGS OVERVIEW
For the year ended December 31, 2007, the Company reported net income
of $337,023 or $0.14 basic and $0.14 diluted earnings per share, compared with
the net of income of $847,121 or $0.35 basic and $0.33 diluted earnings per
share for the year ended December 31, 2006 and $1,422,619 or $0.60 basic and
$0.56 diluted earnings per share for the year ended December 31, 2005. The
decline in net income for 2007 resulted primarily from an increase in the
allowance for loan loss and an increase in salary expense.
The decline in net income from 2005 to 2006 resulted primarily from an
increase in salary expense, occupancy expense, advertising, and promotional
expense. The increase in salary expense from 2005 to 2006 included $121,810 for
stock-based compensation. There was no stock-based compensation expense for
2005.
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income refers to the difference between the interest paid
on deposits and borrowings, and the interest earned on loans and investments. It
is the primary component of the net earnings of a financial institution. The
primary factors to consider in analyzing the net interest income are the
composition and volume of earning assets and interest bearing liabilities, the
amount of noninterest bearing liabilities and nonaccrual loans, and changes in
market interest rates. Beginning in July 2004 and continuing through June 2006,
actions by the Federal Reserve Board to raise interest rates resulted in the
prime rate being raised from 4.00% to 8.25%. Beginning on September 18, 2007 the
Federal Reserve changed its policy and started dropping interest rates. The
prime rate declined from 8.25% on September 18, 2007 to 7.25% on December 11,
2007. Historically, the largest source of income for banks is that which is
created by net interest income. Even though the Federal Reserve began to reduce
rates in September 2007, the competition for deposits caused interest rates on
interest-bearing liabilities to increase from 3.91% for 2006 to 4.43% for 2007.
The yield on interest-earning assets increased from 6.98% during 2006 to 7.02%
during 2007.
Net interest income before provision for loan losses for 2007 was
$6,906,356 compared to $6,950,565 in 2006. The average rate earned on interest
earning assets increased from 6.98% in 2006 to 7.02% in 2007. Interest income in
2007 was $14,906,522 or $2,183,026 greater than the $12,723,496 in 2006. The
growth in average interest bearing liabilities was $32,691,144. Interest expense
for 2007 was $8,000,166 or $2,227,235 greater than the $5,772,931 in 2006.
Net interest income before provision for loan losses for 2006 was
$6,950,565 representing an increase of $1,325,231 or 23.56% from $5,625,334 in
2005. The increase in net interest income for 2006 was primarily attributable to
an increase of $37,194,858 in average interest-earning assets from 2005 to 2006.
The average rate earned on interest earning assets increased from 5.85% in 2005
to 6.98% in 2006. Interest income in 2006 was $12,723,496 or $4,244,263 greater
than the $8,479,233 in 2005. The growth in average interest bearing liabilities
was $33,517,489. Interest expense for 2006 was $5,772,931 or $2,919,032 greater
than the $2,853,899 in 2005.
22
The following tables set forth average balance sheet information,
interest income and expense, average yields and rates, and net interest income
and margin for the years ended December 31, 2007, 2006 and 2005.
December 31, 2007 December 31, 2006
------------------------------------------- ------------------------------------------
Average Average
Average Income/ Yield or Average Income/ Yield or
Balance (4) Expense Rate Paid Balance (4) Expense Rate Paid
------------------------------------------- ------------------------------------------
Interest-earning assets:
Interest-bearing deposits $ 1,438,011 $ 71,627 4.98% $ 1,469,855 $ 81,322 5.53%
Investment securities, taxable 64,535,592 3,414,206 5.29% 56,510,601 2,609,668 4.62%
Investment securities, non-taxable 23,561,350 975,926 4.14% 15,279,119 549,852 3.60%
Federal funds sold 4,972,951 250,587 5.04% 4,863,038 247,675 5.09%
Loans (1) (2) 117,744,381 10,194,176 8.66% 104,063,315 9,234,979 8.87%
------------- ------------- ------------- -------------
Total interest-earning assets 212,252,285 14,906,522 7.02% 182,185,928 12,723,496 6.98%
------------- -------------
Allowance for loan losses (1,479,968) (1,260,870)
Cash and due from banks 4,229,357 3,692,527
Bank premises and equipment 1,367,153 1,051,835
Accrued interest receivable 1,316,236 956,572
Other assets 6,718,547 6,844,281
------------- -------------
Total assets $ 224,403,610 $ 193,470,273
============= =============
Interest-bearing liabilities:
Demand deposits $ 57,736,501 2,446,946 4.24% $ 63,060,814 2,199,856 3.49%
Savings & money market accounts 28,722,251 845,277 2.94% 21,266,677 588,396 2.77%
Time deposits 84,239,592 4,110,771 4.88% 52,683,301 2,374,854 4.51%
Other borrowings 9,769,185 597,172 6.11% 10,765,593 609,825 5.66%
------------- ------------- ------------- -------------
Total interest-bearing liabilities 180,467,529 8,000,166 4.43% 147,776,385 5,772,931 3.91%
------------- -------------
Non-interest bearing demand deposits 24,940,284 28,776,610
Other liabilities 1,729,218 1,148,399
------------- -------------
Total liabilities 207,137,031 177,701,394
Shareholders' equity 17,266,579 15,768,879
------------- -------------
Total liabilities and shareholders'
equity $ 224,403,610 $ 193,470,273
============= =============
Net interest income $ 6,906,356 $ 6,950,565
============= =============
Net interest margin on average
interest earning assets (3) 3.25% 3.82%
1. Average loan balances include average deferred loan fees of $178,983 and
$261,631 for the years ending December 31, 2007 and 2006, respectively.
2. Interest on loans includes fees of $190,955 and $248,683 for the years
ending December 31, 2007 and 2006, respectively.
3. Net interest margin is computed by dividing net interest income by total
average earning assets.
4. All average balances have been computed using daily balances.
23
December 31, 2005
--------------------------------------------
Average
Average Income/ Yield or
Balance (4) Expense Rate Paid
--------------------------------------------
Interest-earning assets:
Interest-bearing deposits $ 2,624,303 $ 73,952 2.82%
Investment securities, taxable 58,180,384 2,271,855 3.90%
Investment securities, non-taxable 3,982,007 149,133 3.75%
Federal funds sold 6,225,953 188,098 3.02%
Loans (1) (2) 73,978,423 5,796,195 7.83%
------------- -------------
Total interest-earning assets 144,991,070 8,479,233 5.85%
-------------
Allowance for loan losses (1,070,293)
Cash and due from banks 8,283,607
Bank premises and equipment 631,980
Accrued interest receivable 641,492
Other assets 4,929,952
-------------
Total assets $ 158,407,808
=============
Interest-bearing liabilities:
Demand deposits $ 68,382,714 1,519,486 2.22%
Savings & money market accounts 15,745,131 200,799 1.28%
Time deposits 29,852,230 1,122,522 3.76%
Other borrowings 278,821 11,092 3.98%
------------- -------------
Total interest-bearing liabilities 114,258,896 2,853,899 2.50%
-------------
Non-interest bearing demand deposits 27,703,879
Other liabilities 1,341,828
-------------
Total liabilities 143, 304,603
Shareholders' equity 15,103,205
-------------
equity $ 158,407,808
=============
Net interest income $ 5,625,334
=============
Net interest margin on average
interest earning assets (3) 3.88%
1. Average loan balances include average deferred loan fees of $277,103 for
the year ended December 31, 2005.
2. Interest on loans includes fees of $193,744 for the year ended December 31,
2005.
3. Net interest margin is computed by dividing net interest income by total
average earning assets.
4. All average balances have been computed using daily balances.
24
Rate/Volume Analysis
2007 over 2006 2006 over 2005
Increase (decrease) due to change in: Increase (decrease) due to change in:
----------------------------------------- -----------------------------------------
Volume (1)(3) Rate (2)(3) Total Volume (1)(3) Rate (2)(3) Total
----------------------------------------- -----------------------------------------
Increase (Decrease) in:
Interest income:
Interest-bearing deposits
in banks $ (1,737) $ (7,958) $ (9,695) $ (42,365) $ 49,735 $ 7,370
Investment securities,
taxable 397,920 406,618 804,538 616,636 (9,486) 607,150
Investment securities,
non-taxable 505,226 140,341 645,567 (67,119) 404,933 337,814
Taxable equivalent
adjustment (171,777) (47,716) (219,493) (209,657) 3,225 (206,432)
Federal funds sold 5,454 (2,542) 2,912 (48,010) 107,587 59,577
Loans 1,185,096 (225,899) 959,197 2,589,473 849,311 3,438,784
----------- ----------- ----------- ----------- ----------- -----------
Total 1,920,182 262,844 2,183,026 2,838,958 1,405,305 4,244,263
Interest Expense:
Demand, interest-bearing (196,802) 443,892 247,090 (126,404) 806,775 680,371
Savings 218,051 38,830 256,881 89,884 297,712 387,596
Time 1,526,870 209,047 1,735,917 993,881 258,451 1,252,332
Borrowings (59,081) 46,428 (12,653) 592,070 6,663 598,733
----------- ----------- ----------- ----------- ----------- -----------
Total 1,489,038 738,197 2,227,235 1,549,431 1,369,601 2,919,032
----------- ----------- ----------- ----------- ----------- -----------
Increase (Decrease) in
Net interest income $ 431,144 $ (475,353) $ (44,209) $ 1,289,527 $ 35,704 $ 1,325,231
=========== =========== =========== =========== =========== ===========
1. Average balances of all categories in each period were included in the
volume computations.
2. Average yields and rates in each period were used in rate computations.
3. Any change attributable to changes in both volume and rate which cannot be
segregated has been allocated based on the absolute value of each.
25
OTHER INCOME
Total other income was $888,995 for 2007, $806,295 for 2006, and
$686,843 for 2005. During 2007, service charges and fees increased from $275,863
in 2006 to $304,281 in 2007. During 2006, service charges and fees decreased
from $323,980 in 2005 to $275,863 in 2006. The increase in service charges,
fees, and other income for 2007 was primarily from consulting fees from the
Company's subsidiary, Charter Services Group, Inc. ("Charter") of $110,000.
There were no fees earned from Charter in 2006 and 2005. During 2002, the Bank
established a Small Business Administration ("SBA") Department. The Government
guarantees a portion of each SBA loan. The guaranteed portion of each SBA loan
can be sold in the secondary market and the Bank receives a premium on these
sales and servicing revenue. Gains on sales and servicing of the guaranteed
portion of SBA loans during 2007 were $56,655 compared to $102,845 in 2006 and
$187,902 in 2005. The decline in gains on SBA loan sales was due to the loss of
the Bank's SBA loan officer and the Company does not anticipate any growth in
this category until a new officer fills that position. The Bank offers loans on
single family homes and commercial mortgage loans through third party lenders.
The Bank receives fees for packaging loans for third party lenders. These loans
are then funded by and become assets of the third party lenders. The fees
received on such loans were $265,409 for 2007 compared to $275,661 in 2006 and
$45,285 for 2005. There was no comparable income from loan packaging of
commercial mortgage loans during 2005.
The Company purchased key-man life insurance policies on several of its
officers. The proceeds received from these policies will fund retirement
benefits for executive officers of the Company and the Bank. The earnings on the
cash surrender value of life insurance were $159,837 during 2007 compared to
$153,725 during 2006 and $123,485 during 2005.
Gains/losses on the sale of investment securities consisted of a loss
of $7,187 for the year ended December 31, 2007, a loss of $1,799 for the year
ended December 31, 2006, and a gain of $6,191 for the year ended December 31,
2005.
The major components of other expenses for the years ended December 31,
2007, 2006, and 2005 are listed in the table below.
2007 2006 2005
---------- ---------- ----------
Other expenses:
Salaries & employee benefits $3,935,912 $3,564,721 $2,701,793
Occupancy expense 649,247 641,177 329,017
Equipment expense 345,107 237,866 185,313
Data Processing and other professional services 603,000 625,216 504,024
Office supplies and equipment 222,450 178,813 155,880
Loan department expense 53,552 191,203 105,734
Advertising and promotion 225,162 270,766 139,902
Directors fees and expenses 210,360 196,230 93,852
FDIC & State assessments 141,350 61,876 82,956
Other operating expenses 493,382 342,706 281,091
---------- ---------- ----------
Total other expenses $6,879,522 $6,310,574 $4,579,562
========== ========== ==========
Other expenses as a percentage of average assets 3.06% 3.26% 2.89%
Salaries and Employee Benefits
Salaries and employee benefits expense for 2007 was $3,935,912, an
increase of $371,191 from $3,564,721 in 2006. The primary increase in salaries
and employee benefits was from additional staff required to service the
anticipated growth in the Company. The total salary and employee benefits
expense for the Lodi branch office in 2006 was approximately $350,000. Salaries
and employee benefits expense for 2005 was $2,701,793. The increase from 2005 to
2006 was due to the opening of a new branch office in Lodi and the establishment
of a new subsidiary, Charter Services Group, Inc. There were no comparable
26
expenses in 2005 for Charter or the Lodi branch. Prior to 2006, the Company was
not required to expense stock-based compensation on its statement of income.
During 2007 and 2006, the Company recognized $75,322 and $121,810, respectively,
for stock-based compensation expense on incentive stock options that had been
granted to certain employees.
Occupancy Expense
Occupancy expense was $649,247 in 2007, $641,177 in 2006 and $329,017
in 2005. The increase in expense from 2005 to 2006 was primarily related to the
expense for the new Lodi branch office. The occupancy expense for the Lodi
branch office was $258,957 for 2006. There was no occupancy expense for Lodi in
2005.
Equipment Expense
Equipment expense in 2007 was $345,107 compared to $237,866 in 2006 and
$185,313 in 2005. The increase in equipment expense was primarily related to an
increase in depreciation expense which increased from $147,981 in 2006 to
$202,724 in 2007. The increased depreciation expense was incurred to replace
obsolescent equipment. The amortization of maintenance contracts associated with
the new equipment caused total maintenance expense to increase from $62,254 in
2006 to $112,177 in 2007.
Data Processing and Other Professional Services
Data processing and other professional services for 2007 were $603,000
compared to $625,216 in 2006 and $504,024 in 2005. The increase in expense from
2005 to 2006 was primarily related to services provided by consultants. During
2006, the Company incurred costs to assist it with the preparation of a disaster
recovery procedures manual. The Company also paid approximately $50,000 to a
recruitment agency to find new employees.
Office Supplies and Equipment
Office supplies and equipment expenses were $222,450 in 2007 compared
to $178,813 in 2006 and $155,880 for 2005. The increase in expense was related
to the anticipated expansion of the Bank and the printing costs associated with
the change in the Bank's logo.
Loan Department Expense
Loan department expense for 2007 was $53,552 compared to $191,203 for
2006 and $105,734 for 2005. The provision for the reserve for loan losses on
undisbursed loans was $(22,000) for 2007 compared to $12,000 for 2006 and
$10,000 for 2005. During 2007, it was determined that the Company's reserves for
undisbursed loans could be reduced by $22,000. There have been no losses on
undisbursed loans in prior years. The Bank has sold the guaranteed portion on
certain loans to other third parties but continues to service these loans. The
loan servicing expense was $50,794 in 2007 compared to $160,373 in 2006 and
$68,436 in 2005. The increase in loan servicing expense for 2006 is related to
the early payoff of loans that the Company was servicing. When the Company sells
loans but retains the servicing, the Company amortizes the loan servicing fees
over the estimated life of the loan. If the loan pays off early, the remaining
unamortized servicing asset is expensed. During 2006, several loans paid off
early.
Advertising and Promotion Expense
Advertising and promotion expense in 2007 was $225,162 compared to
$270,766 in 2006 and $139,902 in 2005. The increases in expense for 2007 and
2006 compared to 2005 was related to promoting the growth of the Bank.
Directors Fees and Expenses
The Company does not pay director fees to employee directors. Director
fees and expenses for 2007 were $210,360 compared to $196,230 in 2006 and
$93,852 in 2005. The primary increase in director expense from 2005 to 2006 was
from $77,640 associated with stock-based compensation expense for options
granted to directors. Prior to 2006, the Company was not required to reflect a
27
cost related to stock options granted to directors on its income statement.
Beginning in 2006, the Company was required to reflect this cost on its income
statement in accordance with SFAS No. 123R.
FDIC and State Assessments
FDIC and California Department of Financial Institutions assessments
were $141,350 in 2007 compared to $61,876 in 2006 and $82,956 in 2005. During
2007, the FDIC imposed a large increase in rates that all banks were required to
pay to the FDIC.
Other Operating Expense
Other operating expenses in 2007 were $493,382 compared to $342,706 in
2006 and $281,091 in 2005. The increase is related to the growth of the Company.
The Bank belongs to the Certificate of Deposit Account Registry Service(R)
(CDARS) network. The Bank can provide its customers with $50,000,000 in FDIC
insurance coverage on certificates of deposit accounts. Through the CDARS
network, the Bank places its customers with other banks throughout the country
and receives reciprocal deposits from other bank's customers. The Bank pays a
fee for placing these reciprocal deposits through the CDARS network. The CDARS
expense for 2007 was $159,170 compared to $58,525 in 2006 and $48,001 in 2005.
The average balance of CDARS deposits during 2007 was $54,448,389 compared to
$19,948,093 in 2006.
Provision for Income Taxes
The Company has a large portfolio of municipal investment securities.
These securities are substantially tax free for federal income tax purposes. As
a result of the benefits associated with these securities, the Company has a tax
benefit of $356,194 for 2007 compared to the tax expense of $299,165 in 2006 and
$144,996 in 2005.
Provision and Allowance for Loan Losses
The allowance for loan losses is established through a provision for
loan losses charged to expense. 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.
The allowance for loan losses is maintained at a level that is
considered adequate to provide for the loan losses inherent in the Company's
loans. The provision for loan losses was $935,000 in 2007, $300,000 in 2006 and
$165,000 in 2005. During 2007, the Company charged off $806,000 of a $2,420,000
real estate loan located in Clements, California reducing the loan balance to
$1,614,000. After the loan was written down, The Company increased its provision
for loan loss to maintain an adequate reserve for other possible loan losses.
28
Summary of Loan Loss Experience
The following table summarizes the changes in the allowance 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 Year Ended December 31,
------------------------------------------------
2007 2006 2005
------------- ------------- -------------
Outstanding Loans:
Average for the Year $ 117,744,381 $ 104,063,315 $ 73,978,423
End of the Year $ 114,887,771 $ 115,171,711 $ 83,964,728
Allowance For Loan Losses:
Balance at Beginning of Year $ 1,429,050 $ 1,123,494 $ 963,000
Actual Charge-Offs:
Commercial -- -- 4,506
Consumer -- -- --
Real Estate 806,000 -- --
------------- ------------- -------------
Total Charge-Offs 806,000 -- 4,506
Less Recoveries:
Commercial -- -- --
Consumer 5,556 --
Real Estate -- -- --
------------- ------------- -------------
Total Recoveries -- 5,556 --
------------- ------------- -------------
Net Loans Charged-Off (Recovered) 806,000 (5,556) 4,506
Provision for Loan Losses 935,000 300,000 165,000
------------- ------------- -------------
Balance at End of Year $ 1,558,050 $ 1,429,050 $ 1,123,494
============= ============= =============
Ratios:
Net Loans Charged-Off (Recovered) to Average Loans .68% (.01%) .01%
Allowance for Loan Losses to Total Loans 1.36% 1.24% 1.34%
Net Loans Charged-Off (Recovered) to Beginning
Allowance for Loan Losses 56.40% (.49%) .47%
Net Loans Charged-Off (Recovered) to Provision
for Loan Losses 86.20% (1.85%) 2.73%
Allowance for Loan Losses to Nonperforming Loans 77.67% 328.41% 363.29%
Management believes that the allowance for loan losses is adequate.
Quarterly detailed reviews are performed to identify the risks inherent in the
loan portfolio, assess the overall quality of the loan portfolio and to
determine the adequacy of the allowance for loan losses and the related
provision for loan losses to be charged to expense. These systematic reviews
follow the methodology set forth by the Interagency Policy Statements on the
Allowance for Loan and Lease Losses dated December 13, 2006, the update of
Accounting for Loan and Lease Losses dated March, 2004, and the Interagency
Policy Statements on Allowance for Loan and Lease Losses Methodologies for Banks
and Savings Institutions dated July 6, 2001.
The following table summarizes the allocation of the allowance for loan
losses by loan type for the years indicated and the percent of loans in each
category to total loans (dollar amounts in thousands):
2007 2006 2005
- --------------------------------- ------------------- ------------------- -------------------
Loan category Amount Percent Amount Percent Amount Percent
- --------------------------------- -------- -------- -------- -------- -------- --------
Construction and land development $ 530 34.01% $ 310 29.74% $ 459 40.88%
Real estate 446 28.63% 445 37.68% 312 27.78%
Commercial 300 19.26% 438 20.34% 315 28.05%
Agriculture 35 2.25% 35 3.72% 10 .89%
Consumer 160 10.27% 108 1.06% 27 2.40%
Leases 87 5.58% 93 7.46% -- --
-------- -------- -------- -------- -------- --------
Total gross loans $ 1,558 100.00% $ 1,429 100.00% $ 1,123 100.00%
======== ======== ======== ======== ======== ========
29
The Company's current policy is to cease accruing interest when a loan
becomes 90 days past due as to principal or interest, when the full timely
collection of interest or principal becomes uncertain or when a portion of the
principal balance has been charged off, unless the loan is well secured and in
the process of collection. When a loan is placed on nonaccrual status, the
accrued and uncollected interest receivable is reversed and the loan is
accounted for on the cash or cost recovery method thereafter, until qualifying
for return to accrual status. Generally, a loan may be returned to accrual
status when all delinquent interest and principal become current in accordance
with the terms of the loan agreement or when the loan is both well secured and
in the process of collection.
NONPERFORMING ASSETS
The following table provides information with respect to the components
of our nonperforming assets at the dates indicated (dollars in thousands):
December 31,
-------------------------------------
2007 2006 2005
---------- ---------- ----------
Loans 90 Days Past Due and Still Accruing $ -- $ -- $ 255
Nonaccrual Loans 2,006 435 54
---------- ---------- ----------
Total Nonperforming Loans 2,006 435 309
Other Real Estate Owned -- -- --
---------- ---------- ----------
Total Nonperforming Assets $ 2,006 $ 435 $ 309
========== ========== ==========
Non performing Loans as a Percentage of Total Loans 1.75% .38% .37%
Allowance for Loan Loss as a Percentage of
Nonperforming Loans 77.67% 328.41% 363.29%
Nonperforming Assets as a Percentage of Total Assets .87% .19% .18%
Nonaccrual loans are generally past due 90 days or are loans as to
which the principal may not be collectible. Loans past due 90 days will continue
to accrue interest only when the loan is both well secured and in the process of
collection.
There were $2,006,029 in nonperforming loans held by the Bank at
December 31, 2007. One of the loans in the amount of $352,542 is guaranteed by
the Small Business Administration for $264,407. The Bank does not currently
anticipate that there will be any significant losses associated with these
nonperforming loans. The Bank subsequently foreclosed on a real estate loan of
$1,614,000 during the first quarter of 2008.
BALANCE SHEET ANALYSIS
Total assets of the Company at December 31, 2007 were $231,075,943
compared to $227,220,390 in 2006 and $169,329,270 in 2005, representing an
increase of 1.70% and 34.2%, respectively. The growth of the Company in 2007
slowed as a result of a worsening economy and a slow down in new real estate
construction. The growth in 2006 over 2005 was primarily from the opening of a
new branch in Lodi.
Investment Securities
Other earning assets are comprised of Federal Funds sold (funds loaned
on a short-term basis to other banks), investment securities, mutual funds,
commercial paper, and short-term interest bearing deposits at other financial
institutions. These assets are maintained for short-term liquidity needs of the
Company, collateralization of public deposits, and diversification of the
earning asset mix.
Investment securities increased to $95,995,684 at December 31, 2007
compared to $86,143,722 at December 31, 2006 and to $68,809,971 at December 31,
2005. This represents an increase of $9,851,962 or 11.4% for 2007 as compared to
2006. The increase in investments is available for liquidity and pledging
purposes.
30
The tables below reflect the composition of investment securities,
amortized cost, unrealized gains and losses and estimated fair values as of
December 31, 2007.
Gross Gross Estimated
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yields
------------ ------------ ------------ ----------------------------
Available-for-Sale Securities:
U.S. Government Agencies $ 35,211,652 $ 83,394 $ (53,615) $ 35,241,431 5.20%
State and Political Subdivisions 23,520,119 24,390 (249,204) 23,295,305 4.15%
Asset-Backed Securities 7,173,180 1,274 (77,244) 7,097,210 5.15%
Mortgage-Backed Securities 14,368,973 47,170 (128,003) 14,288,140 4.66%
Agency Preferred Stock 2,530,000 -- (13,767) 2,516,233 7.40%
Short-Term Mutual Funds 500,000 -- (4,111) 495,889 5.21%
------------ ------------ ------------ ------------
$ 83,303,924 $ 156,228 $ (525,944) $ 82,934,208 4.91%
============ ============ ============ ============
Held-to-Maturity Securities:
U.S. Government Agencies $ 3,875,767 $ 353 $ (96,834) $ 3,779,286 6.51%
State and Political Subdivisions 5,123,990 18,549 (383,769) 4,758,770 4.46%
Corporate 3,898,115 14,070 (83,352) 3,828,833 10.46%
Mortgage-Backed Securities 163,604 3,202 (6) 166,800 6.02%
------------ ------------ ------------ ------------
$ 13,061,476 $ 36,174 $ (563,961) $ 12,533,689 6.99%
============ ============ ============ ============
The following table sets forth the total gross unrealized losses and
estimated fair values of investment securities with continuous losses less than
twelve months, those with continuous losses for twelve months or more, and total
losses as of December 31, 2007 (dollar amounts in thousands).
Less than Twelve Months Twelve Months or More Total
--------------------------- ---------------------------- ----------------------------
Gross Estimated Gross Estimated Gross Estimated
Unrealized Fair Unrealized Fair Unrealized Fair
Losses Value Losses Value Losses Value
------------ ------------ ------------ ------------ ------------ ------------
US Government Agencies $ (78) $ 7,863 $ (73) $ 9,462 $ (151) $ 17,325
State and Political Subdivisions (475) 14,975 (158) 6,025 (633) 21,000
Preferred Stock (14) 486 -- -- (14) 486
Asset-Backed Securities (11) 2,798 (66) 4,662 (77) 7,460
Mortgage-Backed Securities (4) 972 (124) 8,466 (128) 9,438
Short-Term Mutual Funds (4) 496 -- -- (4) 496
Corporate (83) 2,185 -- -- (83) 2,185
------------ ------------ ------------ ------------ ------------ ------------
$ (669) $ 29,775 $ (421) $ 28,615 $ (1,090) $ 58,390
============ ============ ============ ============ ============ ============
31
As of December 31, 2007, the Company had 278 investment securities with
an estimated fair value decline of .93% from the Company's amortized cost.
Management evaluates investment securities for other than temporary impairment
taking into consideration the extent and length of time the fair value has been
less than cost, the financial condition of the issuer, and whether the Company
has the intent and ability to retain the investment for a period of time
sufficient to allow for any anticipated recovery in fair value. As of December
31, 2007, no declines in fair value are deemed to be other than temporary.
The scheduled maturities of securities available-for-sale and
held-to-maturity as of December 31, 2007 are shown below. Actual maturities may
differ from contractual maturities because borrowers have the right to call or
prepay obligations with or without call or prepayment penalties.
Available-for-Sale Held-to-Maturity
--------------------------------------- --------------------------------------
Weighted Weighted
Amortized Fair Average Amortized Fair Average
Cost Value Yields (1) Cost Value Yields (1)
----------- ----------- ---------- ----------- ----------- ----------
Due in one year or less $ 3,967,362 $ 3,946,364 3.79% $ -- $ -- N/A
After one year to five years 7,715,875 7,699,821 4.91% -- -- N/A
After five years to ten years 15,697,581 15,730,936 5.36% 1,000,000 1,013,710 8.75%
After ten years 38,524,133 38,256,825 5.76% 11,897,872 11,353,179 7.72%
Mortgage-backed securities 14,368,973 14,288,140 4.66% 163,604 166,800 6.01%
Preferred stock 2,530,000 2,516,233 7.40% -- -- N/A
Short-term mutual fund 500,000 495,889 5.21% -- -- N/A
----------- ----------- ----------- -----------
$83,303,924 $82,934,208 5.37% $13,061,476 $12,533,689 7.78%
=========== =========== =========== ===========
(1) Weighted average yields for municipal securities have been adjusted to
reflect their tax equivalent yields.
Listed below are the amortized cost and fair value of the securities
owned by the Company, which exceed ten percent of shareholders' equity.
Amortized
Cost Fair Value
----------- -----------
Federal National Mortgage Association $22,979,620 $23,000,325
Federal Home Loan Mortgage Corporation $15,161,337 $15,018,342
Federal Home Loan Bank $14,347,803 $14,326,203
Government National Mortgage Association $ 2,161,237 $ 2,157,485
32
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 Average
Cost Gains Losses Value Yields
------------ ------------ ------------ --------------------------
Available-for-Sale Securities:
U.S. Government Agencies $ 39,415,380 $ 63,385 $ (294,940) $ 39,183,825 4.97%
State and Political Subdivisions 19,522,737 38,074 (74,787) 19,486,024 3.92%
Asset-Backed Securities 7,280,691 3,946 (133,943) 7,150,694 4.90%
Mortgage-Backed Securities 15,138,808 12,460 (314,084) 14,837,184 4.41%
Short-Term Mutual Funds 500,000 -- -- 500,000 5.38%
------------ ------------ ------------ ------------
$ 81,857,616 $ 117,865 $ (817,754) $ 81,157,727 4.61%
============ ============ ============ ============
Held-to-Maturity Securities:
U.S. Government Agencies $ 2,468,485 $ -- $ (17,659) $ 2,450,826 6.44%
State and Political Subdivisions 2,313,410 119,689 (12,909) 2,420,190 4.58%
Asset-Backed Securities 14,526 -- -- 14,526 6.30%
Mortgage-Backed Securities 189,574 2,567 (57) 192,084 5.79%
------------ ------------ ------------ ------------
$ 4,985,995 $ 122,256 $ (30,625) $ 5,077,626 5.55%
============ ============ ============ ============
The following sets forth the total gross unrealized losses and
estimated fair values of investment securities with continuous losses less than
twelve months, those with continuous losses for twelve months or more, and total
losses as of December 31, 2006 (dollar amounts in thousands).
Less than Twelve Months Twelve Months or More Total
--------------------------- --------------------------- ---------------------------
Gross Estimated Gross Estimated Gross Estimated
Unrealized Fair Unrealized Fair Unrealized Fair
Losses Value Losses Value Losses Value
------------ ------------ ------------ ------------ ------------ ------------
US Government Agencies $ (32) $ 8,951 $ (281) $ 19,219 $ (313) $ 28,170
State and Political
Subdivisions (46) 6,518 (40) 5,635 (86) 12,153
Asset-Backed Securities (1) 451 (133) 6,497 (134) 6,665
Mortgage-Backed Securities (1) 168 (314) 12,580 (315) 13,031
------------ ------------ ------------ ------------ ------------ ------------
$ (80) $ 16,088 $ (768) $ 43,931 $ (848) $ 60,019
============ ============ ============ ============ ============ ============
As of December 31, 2007, the Company had 278 investment securities with
an estimated fair value decline of .93% from the Company's amortized cost.
Management evaluates investment securities for other than temporary impairment
taking into consideration the extent and length of time the fair value has been
less than cost, the financial condition of the issuer, and whether the Company
has the intent and ability to retain the investment for a period of time
sufficient to allow for any anticipated recovery in fair value. As of December
31, 2007, no declines in value are deemed to be other than temporary.
33
Loans
A significant portion of the Company's assets consists of the loan
portfolio. Gross loans were $114,887,771 in 2007, $115,171,711 in 2006 and
$83,964,728 at December 31, 2005. Approximately 74.6% of the gross loans at
December 31, 2007 are adjustable rate loans. Nearly all of the adjustable rate
loans are tied to the prime rate. To mitigate the negative effect on earnings
from declining interest rates, the Bank included interest rate floors on some of
its loans. Once the interest rate on a loan reaches the interest rate floor, the
interest rate cannot decline further. The interest rate floors helped to protect
net income from declining interest rates, but also creates a lag in the
repricing of certain loans as interest rates rise.
The table below summarizes the composition of the loan portfolio as of
December 31, 2007, 2006, and 2005.
2007 2006 2005
Loan category Amount Percent Amount Percent Amount Percent
- --------------------------------- ------------- --------- ------------- --------- ------------- ---------
Construction and land development $ 29,541,045 25.71% $ 34,248,157 29.74% $ 27,787,719 33.09%
Real estate 45,004,402 39.18% 43,396,795 37.68% 33,672,659 40.11%
Commercial 23,027,387 20.04% 23,421,351 20.34% 18,109,304 21.57%
Leases 8,560,166 7.45% 8,591,815 7.46% -- --
Agriculture 4,713,710 4.10% 4,288,022 3.72% 1,964,690 2.34%
Consumer 4,041,061 3.52% 1,225,571 1.06% 2,430,356 2.89%
------------- --------- ------------- --------- ------------- ---------
Total gross loans 114,887,771 100.00% 115,171,711 100.00% 83,964,728 100.00%
Deferred loan fees and discounts (160,557) (234,487) (308,102)
Reserve for possible loan losses (1,558,050) (1,429,050) (1,123,494)
------------- ------------- -------------
Total net loans $ 113,169,164 $ 113,508,174 $ 82,533,132
============= ============= =============
The table below summarizes the approximate maturities and sensitivity
to changes in interest rates for the loans at December 31, 2007.
After One Year
Due Within But Within After
Loan category One Year Five Years Five Years Total
- --------------------------------- ------------ ------------ ------------ ------------
Construction and land development $ 25,936,817 $ 2,903,107 $ 701,122 $ 29,541,046
Real estate 12,487,825 22,117,178 10,397,192 45,002,195
Commercial 13,232,822 6,494,042 3,302,729 23,029,593
Leases -- 2,588,166 5,972,000 8,560,166
Agriculture 3,634,656 976,287 102,767 4,713,710
Consumer 3,705,141 310,033 25,887 4,041,061
------------ ------------ ------------ ------------
Total gross loans $ 58,997,261 $ 35,388,813 $ 20,501,697 $114,887,771
============ ============ ============ ============
Interest rate provision
- -----------------------
Predetermined rates $ 6,013,534 $ 13,947,663 $ 9,175,017 $ 29,136,214
Floating or adjustable rates 52,983,727 21,441,150 11,326,680 85,751,557
------------ ------------ ------------ ------------
$ 58,997,261 $ 35,388,813 $ 20,501,697 $114,887,771
============ ============ ============ ============
34
Risk Elements
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 Company
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 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 Company 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 Company'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, personal property, plant and
equipment, income-producing properties, residences and other real property.
California's economy has not been as robust as in prior years.
Construction loans and other real estate secured loans comprise approximately
64.9% of total loans outstanding, which management believes represents a
concentration in the loan portfolio. 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.
Management believes that its lending policies and underwriting
standards will tend to minimize losses in an economic downturn; however, there
is no assurance that losses will not occur under such circumstances. The
Company's loan policies and underwriting standards include, but are not limited
to, the following: (1) maintaining a thorough understanding of the Company's
service area and limiting investments outside this area; (2) maintaining a
thorough understanding of borrowers' knowledge and capacity in their field of
expertise; (3) basing real estate construction loan approval not only on the
prospects for sale of the project, but also within the original projected time
period; and (4) maintaining conforming and prudent loan to value and loan to
cost ratios based on independent outside appraisals and ongoing inspection and
analysis by the Company's construction lending officers. In addition, the
Company strives to diversify the risk inherent in the construction portfolio by
avoiding concentrations to individual borrowers and on any one category of
loans.
Subprime loans generally refer to adjustable rate residential mortgages
made to higher-risk borrowers with lower credit and/or income histories. Such
subprime loans coupled with declines in housing prices have led to an increase
in default rates resulting in many instances of increased foreclosure rates as
the adjustable interest rates reset to higher levels. The Company does not
originate and does not have any "subprime" loans or investments on its books at
December 31, 2007; however, the effects of subprime loan defaults, foreclosures
and declining housing prices has contributed to the worsening economic
conditions affecting the real estate markets generally in areas where the
Company conducts its business. The continuing effect of such circumstances may
adversely affect the value of the Company's loan portfolio requiring further
reserves against loss and thereby adversely affect the Company's results of
operations, financial condition, prospects and stock price.
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. Total nonaccrual loans and loans more than 90 days past due at
December 31, 2007 were $2,006,029, $435,147 at December 31, 2006 and $309,256 at
December 31, 2005. The increase from 2006 to 2007 was primarily from one real
estate loan secured by a tract of 15 developed lots.
35
At December 31, 2007, there were loans totaling $2,006,029 that were
considered impaired. There were no loans that were considered troubled debt
restructurings. Management is not aware of any potential problem loans, which
were accruing and current at December 31, 2007, 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 December 31, 2007, 2006 and
2005.
Off-Balance Sheet Arrangements and Contractual Obligations
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 and 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 uses the
same credit policies in making commitments and letters of credit as it does for
loans included on the consolidated balance sheet.
The following financial instruments represent off-balance-sheet credit
risk (dollars in thousands):
December 31,
------------------------------------------
2007 2006 2005
------------ ------------ ------------
Commitments to extend credit:
Revolving lines of credit secured by 1-4 family
residences $ 4,653 $ 4,580 $ 4,442
Commercial real estate, construction and land
development commitments secured by real estate 8,984 17,321 16,475
Other commitments:
Commercial loans 15,489 9,587 7,943
Agricultural loans 4,591 3,774 1,939
Unsecured consumer lines of credit 2,775 4,103 2,501
------------ ------------ ------------
Total $ 36,492 $ 39,365 $ 33,300
============ ============ ============
Letters of Credit $ 1,547 $ 1,242 $ 1,596
============ ============ ============
As of December 31, 2007, commitments to extend credit and 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. Real estate commitments
are generally secured by property with a loan-to-value ratio of 65% to 80%. In
addition, the majority of the Company's commitments have variable interest
rates.
Certain financial institutions have elected to use special purpose
vehicles ("SPV") to dispose of problem assets. The SPV is typically a subsidiary
company with an asset and liability structure and legal status that makes its
obligations secure even if the parent corporation goes bankrupt. Under certain
circumstances, these financial institutions may exclude the problem assets from
their reported impaired and non-performing assets. The Company does not use
those vehicles or any other structures to dispose of problem assets.
36
Contractual Obligations
The Company leases certain facilities at which it conducts its
operations. Future minimum lease commitments under non-cancelable operating
leases as of December 31, 2007 are listed in the table below.
2008 470,247
2009 450,422
2010 332,797
2011 339,595
2012 300,536
Thereafter 888,563
------------
Total $ 2,782,160
============
Deposits
Deposits represent the Company's principal source of funds for loans
and investments. Deposits are primarily generated from local businesses,
government agencies and individuals. Total deposits were $202,405,646 at
December 31, 2007 compared to $199,955,091 at December 31, 2006 and $151,141,667
at December 31, 2005. This represents an increase of $245,055 or 1.2% at
December 31, 2007. Average non-interest bearing demand deposits increased from
$28,776,610 at December 31, 2006 to $24,940,284 at December 31, 2007. Total
average balances of money market accounts at December 31, 2007 were $25,568,491
compared to $17,871,116 at December 31, 2006 and $12,316,407 at December 31,
2005. Average balances of certificates of deposit increased from $52,683,301 at
December 31, 2006 to $84,239,592 at December 31, 2007.
The table below reflects the composition of the deposits including
average balance and the average rate paid for the years ended December 31, 2007,
2006 and 2005.
Composition of Deposits
2007 2006 2005
-------------------------- -------------------------- --------------------------
Deposits Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------------ ---------- ------------ ---------- ------------ ----------
Non-interest bearing demand $ 24,940,284 0.00% $ 28,776,610 0.00% $ 27,703,879 0.00%
Interest bearing demand 57,736,501 4.24% 63,060,814 3.49% 68,382,714 2.22%
Money market deposit accounts 25,568,491 3.20% 17,871,116 3.15% 12,316,407 1.47%
Savings accounts 3,153,760 .86% 3,395,561 .74% 3,428,724 0.57%
Certificates of deposit 84,239,592 4.88% 52,683,301 4.51% 29,852,230 3.76%
------------ ------------ ------------
$195,638,625 3.78% $165,787,402 3.12% $141,683,954 2.01%
============ ============ ============
37
The maturities of time certificates of deposit of $100,000 or more at
December 31, 2007 are summarized as follows:
December 31,
2007
---------------
Three months or less $ 10,915,891
Over three months through six months 2,452,275
Over six months through twelve months 3,167,410
Over one year through three years 536,981
Over three years 2,548,331
---------------
Total $ 19,620,888
===============
38
CAPITAL RESOURCES
The Company's total shareholders' equity was $17,648,014 at December
31, 2007 compared to $16,966,834 at December 31, 2006 and $15,574,101 as of
December 31, 2005. The increase in shareholders' equity was primarily from the
current year's net income of $337,023 and a reduction in the accumulated other
comprehensive income net of tax of $195,149, and an increase in additional paid
in capital of $149,008.
The Company's capital resources include shareholders' equity plus
junior subordinated debt securities (trust preferred securities) and the
allowance for loan losses for regulatory purposes, subject to limitations. See
Note 7 of the financial statements in Item 8 for information regarding junior
subordinated debt securities.
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. See the discussion of capital standards
and prompt corrective action at pages 4 through 6 for more information regarding
capital resources.
39
The table below reflects the capital and leverage ratios of the Company
and the Bank as of December 31, 2007, 2006 and 2005.
Actual For capital adequacy To be well-capitalized under
purposes prompt corrective action
provisions
------------------------- ------------------------- -------------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ---------- ------------ ---------- ------------ ----------
As of December 31, 2007:
Company:
Total capital (to risk weighted assets) $ 24,574 14.7% $ 13,334 8.0% N/A N/A
Tier 1 capital (to risk weighted assets) $ 23,016 13.8% $ 6,667 4.0% N/A N/A
Tier 1 capital (to average assets) $ 23,016 9.8% $ 9,422 4.0% N/A N/A
Bank:
Total capital (to risk weighted assets) $ 22,423 13.5% $ 13,334 8.0% $ 16,668 10.0%
Tier 1 capital (to risk weighted assets) $ 20,825 12.5% $ 6,667 4.0% $ 10,001 6.0%
Tier 1 capital (to average assets) $ 20,825 8.9% $ 9,375 4.0% $ 11,719 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 1 capital (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 1 capital (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%
As of December 31, 2005:
Company:
Total capital (to risk weighted assets) $ 17,404 15.1% $ 9,224 8.0% N/A N/A
Tier 1 capital (to risk weighted assets) $ 16,281 14.1% $ 4,612 4.0% N/A N/A
Tier 1 capital (to average assets) $ 16,281 9.8% $ 6,683 4.0% N/A N/A
Bank:
Total capital (to risk weighted assets) $ 16,304 14.1% $ 9,224 8.0% $ 11,530 10.0%
Tier 1 capital (to risk weighted assets) $ 15,181 13.2% $ 4,612 4.0% $ 6,918 6.0%
Tier 1 capital (to average assets) $ 15,181 9.1% $ 6,644 4.0% $ 8,304 5.0%
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 customers. 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.
Commitments to fund loans and letters of credit at December 31, 2007 were
approximately $38,038,672. Such loans relate primarily to real estate
construction loans and revolving lines of credit and other commercial loans.
The Company's sources of liquidity consist of its available-for-sale
securities, cash and due from banks, overnight funds sold, mutual funds, and
short-term borrowing lines. At December 31, 2007, the net ratio of available
liquidity not pledged for collateral and other purposes to deposits and other
short-term borrowings was 17.7% in 2007 compared to 17.1 % in 2006 and 31.4 % in
2005. The ratio of gross loans to deposits, another key liquidity ratio, was
56.8% at year-end 2007 compared to 57.6% at year-end 2006 and 54.0% at year-end
2005.
The Bank has unused borrowing lines from correspondent banks totaling
$41,310,000 and an additional available borrowing line with the Federal Home
Loan Bank of San Francisco totaling $16,332,796.
40
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 indirectly through its effect on market
rates of interest, and thus the ability of the Company 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 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 of the Company.
The effects of inflation were not material to the Company's results of
operations during the years ended December 31, 2007, 2006 and 2005.
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
Bank'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.
Stock-Based Compensation
The Company previously accounted for its stock-based compensation under
the recognition and measurement principles of Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. Because the Company's 2000 Stock Option Plan provides for the
issuance of options at a price of no less than the fair market value at the date
of the grant, no compensation expense was recognized in the financial statements
unless the options were modified after the grant date.
In December 2004, the Financial Accounting Standards Board issued
Statement Number 123 (revised 2004) ("FAS 123 (R)"), Share-Based Payments. FAS
123 (R) requires all entities to recognize compensation expense in an amount
equal to the fair value of share-based payments such as stock options granted to
employees. The Company adopted FAS 123 (R) on a modified prospective method,
beginning on January 1, 2006. Under this method, the Company is required to
record compensation expense (as previous awards continue to vest) for the
unvested portion of previously granted awards that remain outstanding at the
date of adoption. As a result of adopting Statement 123 (R) on January 1, 2006,
the Company's income before benefit for income taxes and net income for the year
ended December 31, 2007 was $149,009 and $118,797 lower, respectively, than if
it had continued to account for share-based compensation under APB Opinion No.
25. Diluted earnings per share and basic earnings per share for the year ended
December 31, 2007 would have increased $0.05 had the Company continued to
account for share-based compensation under APB Opinion No. 25. The Company's
income before provision for income taxes and net income for the year ended
December 31, 2006, was $199,260 and $167,277 lower, respectively, than if it had
continued to account for share-based compensation under APB Opinion No. 25.
Diluted earnings per share and basic earnings per share for the year ended
December 31, 2006 would have increased $0.04 and $0.03, respectively, had the
Company continued to account for share-based compensation under APB Opinion No.
25.
41
The fair value of each option is estimated on the date of grant and
amortized over the service period using an option pricing model. Critical
assumptions that affect the estimated fair value of each option include expected
stock price volatility, dividend yields, option life and the risk-free interest
rate.
Financial Assets and Liabilities
The Company has adopted SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." The Statement
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. Under this Statement, after
a transfer of financial assets, an entity recognizes the financial and servicing
assets it controls and liabilities it has incurred, derecognizes financial
assets when control has been surrendered, and derecognizes liabilities when
extinguished.
To calculate the gain (loss) on sale of loans, the Company's investment
in the loan is allocated among the retained portion of the loan, the servicing
retained, the interest-only strip and the sold portion of the loan, based on the
relative fair market value of each portion. The gain (loss) on the sold portion
of the loan is recognized at the time of sale based on the difference between
the sale proceeds and the allocated investment. As a result of the relative fair
value allocation, the carrying value of the retained portion is discounted, with
the discount accreted to interest income over the life of the loan. That portion
of the excess servicing fees that represent contractually specified servicing
fees (contractual servicing) are reflected as a servicing asset which is
amortized over an estimated life using a method approximating the level yield
method. In the event future prepayments exceed management's estimates and future
expected cash flows are inadequate to cover the unamortized servicing asset,
additional amortization would be recognized. The portion of excess servicing
fees in excess of the contractual servicing fees is reflected as interest-only
strips receivable, which are classified as interest-only strips receivable
available for sale and are carried at fair value.
Income Taxes
The Company recognizes deferred tax assets and liabilities based on
differences between the financial reporting and tax bases of assets and
liabilities using the enacted tax rates and laws that are expected to be in
effect when the differences are expected to be recognized. The Company provides
a valuation allowance for deferred tax assets when it does not consider
recognition of such assets to be more likely than not.
OTHER MATTERS
Effects of Terrorism
The terrorist actions on September 11, 2001 and thereafter and the
military conflicts in Afghanistan, Iraq and elsewhere 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 Company,
increasing nonperforming loans and the amounts reserved for loan and lease
losses, and causing a decline in the Company's stock price.
ITEM 7A. 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 Results of
Operations - Liquidity for a discussion of our liquidity risk. Our interest rate
risk and equity market price risk are described below.
42
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
--------------------------
December 31, December 31,
Change in interest rates 2007 2006
- ---------------------------- ------------ -----------
100 basis point rise -23.4% -15.6%
100 basis point decline 6.68% 5.2%
The economic value of portfolio equity sensitivity from December 31,
2006 to December 31, 2007 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.
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
--------------------------
December 31, December 31,
Change in interest rates 2007 2006
- ---------------------------- ------------ -----------
100 basis point rise 2.15% 4.32%
100 basis point decline .55% 1.12%
43
Net interest income sensitivity from December 31, 2006 to December 31,
2007 evolved from a slightly asset-sensitive position to a relatively neutral
position.
Equity Market Price Risk
The actively traded equity stocks owned at December 31,2007 were
comprised of $2,530,000 of preferred stock in Federal Home Loan Bank and Federal
National Mortgage Association. The market value of these preferred stocks was
$2,516,233 at December 31, 2007. The only other stocks owned are 9,586 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.
44
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Independent Registered Public Accounting Firm 46
Consolidated Balance Sheets 47
Consolidated Statements of Income 48
Consolidated Statement of Shareholders' Equity 49
Consolidated Statements of Cash Flows 50
Notes to Financial Statements 51
Schedules have been omitted since the required information is not
present in amounts sufficient to require submission of the schedule or because
the information required is included in the Financial Statements or notes
thereto.
45
[GRAPHIC OMITTED] Vavrinek, Trine, Day & Co., LLP
vtd Certified Public Accountants & Consultants
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Service 1st Bancorp
We have audited the accompanying consolidated balance sheets of Service 1st
Bancorp and Subsidiaries as of December 31, 2007 and 2006, and the related
consolidated statements of income, shareholders' equity, and cash flows for the
each of the years in the three year period ended December 31, 2007. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. Our audits included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company's
internal control over financial reporting. Accordingly, we express no such
opinion. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Service 1st Bancorp
and Subsidiaries as of December 31, 2007 and 2006, and the results of its
operations and cash flows for each of the years in the three year period ended
December 31, 2007 in conformity with accounting principles generally accepted in
the United States of America.
/s/ Vavrinek, Trine, Day & Co., LLP
Pleasanton, California
March 28, 2008
46
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2007 and 2006
ASSETS
2007 2006
------------- -------------
Cash and due from banks $ 6,636,751 $ 6,543,416
Federal funds sold 4,652,900 10,616,902
------------- -------------
Cash and cash equivalents 11,289,651 17,160,318
Certificates of deposit with other banks 486,488 1,500,000
Investment securities available for sale 82,934,208 81,157,727
Investment securities held to maturity 13,061,476 4,985,995
Loans, net 113,169,164 113,508,174
Bank premises and equipment, net 1,308,720 1,388,980
Cash surrender value of life insurance 3,698,239 3,566,696
Accrued interest receivable 1,505,244 1,461,602
Other assets 3,622,753 2,490,898
------------- -------------
$ 231,075,943 $ 227,220,390
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand $ 26,697,543 $ 33,848,426
Money market, NOW and savings 86,305,530 94,662,249
Time deposits under $100,000 69,781,685 48,409,724
Time deposits $100,000 and over 19,620,888 23,034,692
------------- -------------
Total deposits 202,405,646 199,955,091
Junior subordinated debt securities 5,155,000 5,155,000
Other borrowings 4,000,000 4,000,000
Accrued interest and other liabilities 1,867,283 1,143,465
------------- -------------
Total liabilities 213,427,929 210,253,556
Commitments and contingencies - Notes 5 and 9 -- --
Shareholders' equity:
Preferred stock, no par value, 10,000,000 shares
authorized, none issued or outstanding -- --
Common stock, no par value, 30,000,000 shares
authorized; issued and outstanding, 2,388,739 shares
at December 31, 2007 and issued and outstanding,
2,386,239 shares at December 31, 2006 16,023,738 16,023,738
Additional paid in capital 356,152 207,144
Retained earnings 1,484,090 1,147,067
Accumulated other comprehensive income, net of tax (215,966) (411,115)
------------- -------------
Total shareholders' equity 17,648,014 16,966,834
------------- -------------
$ 231,075,943 $ 227,220,390
============= =============
The accompanying notes are an integral part of these consolidated statements.
47
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31, 2007, 2006 and 2005
2007 2006 2005
------------ ------------ ------------
Interest income:
Interest and fees on loans $ 10,194,176 $ 9,234,979 $ 5,796,195
Interest on investment securities 4,390,132 3,159,520 2,420,988
Interest on federal funds sold 250,587 247,675 188,098
Other interest income 71,627 81,322 73,952
------------ ------------ ------------
14,906,522 12,723,496 8,479,233
Interest expense:
Interest expense on deposits 7,402,994 5,163,106 2,842,807
Other interest expense 597,172 609,825 11,092
------------ ------------ ------------
8,000,166 5,772,931 2,853,899
------------ ------------ ------------
Net interest income 6,906,356 6,950,565 5,625,334
Provision for loan losses 935,000 300,000 165,000
------------ ------------ ------------
Net interest income after provision for loan losses 5,971,356 6,650,565 5,460,334
Other income:
Service charges, fees and other income 304,281 275,863 323,980
(Loss) Gain on the sale of investment securities (7,187) (1,799) 6,191
Gain on sale and servicing of loans 56,655 102,845 187,902
Referral fees on mortgage loans 265,409 275,661 45,285
Earnings on cash surrender value life insurance 159,837 153,725 123,485
Consulting fees 110,000 -- --
------------ ------------ ------------
888,995 806,295 686,843
Other expenses:
Salaries and employee benefits 3,935,912 3,564,721 2,701,793
Occupancy expense 649,247 641,177 329,017
Equipment expense 345,107 237,866 185,313
Data processing and other professional services 603,000 625,216 504,024
Office supplies and equipment 222,450 178,813 155,880
Loan department expense 53,552 191,203 105,734
Advertising and promotion 225,162 270,766 139,902
Directors fees and expenses 210,360 196,230 93,852
FDIC and state assessments 141,350 61,876 82,956
Other operating expenses 493,382 342,706 281,091
------------ ------------ ------------
6,879,522 6,310,574 4,579,562
------------ ------------ ------------
Net income before income taxes (19,171) 1,146,286 1,567,615
Income taxes (benefit) (356,194) 299,165 144,996
------------ ------------ ------------
Net income $ 337,023 $ 847,121 $ 1,422,619
============ ============ ============
Net income per share - basic $ 0.14 $ 0.35 $ 0.60
============ ============ ============
Net income per share - diluted $ 0.14 $ 0.33 $ 0.56
============ ============ ============
The accompanying notes are an integral part of these consolidated statements.
48
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the years ended December 31, 2007, 2006 and 2005
Accumulated
Common Stock Additional Retained Other Total
------------------------- Paid In Comprehensive Earnings Comprehensive Shareholders'
Shares Amount Capital Income (Deficit) Income Equity
------------------------------------------------------------------- ---------- ------------
----------- ----------- ---------- ---------- ---------- ------------
Balance at January 1, 2005 1,541,664 15,425,042 -- (1,117,844) (205,527) 14,101,671
Common stock sold, net of costs
of $11,086 49,273 567,871 567,871
Three for two stock split
including cash
for fractional shares 795,302 (4,829) (4,829)
Comprehensive Income:
Net income $ 1,422,619 1,422,619 1,422,619
Unrealized losses on securities
net of taxes of $357,867 (509,594) (509,594) (509,594)
Reclassification adjustment for
gains included in net income,
net of tax of $2,554 (3,637) (3,637) (3,637)
------------
Comprehensive Income $ 909,388
============
----------- ----------- ---------- ---------- ---------- ------------
Balance at December 31, 2005 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 gains on securities
net of taxes of $217,194 308,699 308,699 308,699
Reclassification adjustment for
gains
included in net income,
net of tax of $743 (1,056) (1,056) (1,056)
------------
Comprehensive Income $ 1,154,764
============
----------- ----------- ---------- ---------- ---------- ------------
Balance at December 31, 2006 2,388,739 $16,023,738 $ 207,144 $1,147,067 $ (411,115) $ 16,966,834
Surplus from options expense 149,008 149,008
Comprehensive Income:
Net income $ 337,023 337,023 337,023
Unrealized gains on securities
net of taxes of $135,135 199,368 199,368 199,368
Reclassification adjustment for
gains included in net income,
net of tax of $2,968 (4,219) (4,219) (4,219)
------------
Comprehensive Income $ 532,172
============
----------- ----------- ---------- ---------- ---------- ------------
Balance at December 31, 2007 2,388,739 $16,023,738 $ 356,152 $1,484,090 $ (215,966) $ 17,648,014
=========== =========== ========== ========== ========== ============
The accompanying notes are an integral part of these consolidated statements.
49
SERVICE 1ST BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2007, 2006 and 2005
2007 2006 2005
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 337,023 $ 847,121 $ 1,422,619
Adjustments to reconcile net income to net cash
Provided by operating activities:
Provision for loan losses 935,000 300,000 165,000
Depreciation and amortization 276,749 206,950 168,002
Deferred income tax expense (credit) 168,000 (70,000) (212,000)
Loss (Gain) on sale of securities 7,187 1,799 (6,191)
Options expense 149,008 199,450 --
Gain on sale of loans (6,737) (20,023) (67,226)
Loans originated for sale (63,750) (221,621) (887,997)
Proceeds from loans sales 70,487 241,644 955,223
Amortization and accretion on securities (98,305) 221,191 310,400
Earnings on cash surrender value life insurance, net (131,543) (130,546) (104,842)
(Increase) decrease in accrued interest (43,642) (503,601) (418,476)
Decrease/(Increase) in other assets (1,434,379) 246,091 (680,512)
(Decrease)/Increase in accrued interest
and other liabilities 723,818 (432,343) 621,119
------------ ------------ ------------
888,916 886,112 1,265,119
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of securities available for sale (35,915,181) (30,332,660) (34,617,974)
Proceeds from sales of securities available for sale 6,743,578 3,497,638 1,396,477
Proceeds from maturities and calls of securities available for sale 27,508,532 13,328,771 15,919,158
Purchases of securities held to maturity (8,835,032) (3,615,234) (619,838)
Proceeds from maturities and calls of securities held to maturity 857,891 107,688 250,286
Proceeds from sale of securities held to maturity 209,041 -- --
Increase in loans (595,990) (31,275,042) (14,375,784)
Purchase of certificates of deposit at other banks 1,013,512 (506,280) (648,720)
Purchase of bank owned life insurance -- -- (1,000,000)
Purchases of premises and equipment (196,489) (924,480) (212,660)
------------ ------------ ------------
Net cash used by investing activities (9,210,138) (49,719,599) (33,909,055)
Cash flows from financing activities:
Net increase in demand, interest-bearing deposits, and savings (15,507,602) 52,061,138 16,302,368
Net increase in time deposits 17,958,157 (3,247,714) 12,730,717
Cash paid for fractional shares -- -- (4,829)
Proceeds from sale of common stock, net of costs -- -- 567,871
Stock options exercised -- 30,825 --
Increase in junior subordinated debt -- 5,155,000 --
Net increase in other borrowings -- 2,970,000 1,030,000
------------ ------------ ------------
Net cash from financing activities 2,450,555 56,929,249 30,626,127
Net increase (decrease) in cash and cash equivalents (5,870,667) 8,135,762 (2,017,809)
Cash and cash equivalents at beginning of year 17,160,318 9,024,556 11,042,365
------------ ------------ ------------
Cash and cash equivalents at end of year $ 11,289,651 $ 17,160,318 $ 9,024,556
============ ============ ============
Supplemental disclosures of cash flow information:
Interest $ 8,012,547 $ 5,633,334 $ 2,735,722
Income taxes $ 30,000 $ 534,281 $ 325,000
The accompanying notes are an integral part of these consolidated statements.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2007, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the
preparation of the accompanying financial statements follows:
Principles of Consolidation
- ---------------------------
The financial statements include the accounts of Service 1st Bancorp
and its subsidiaries, Service 1st Bank ("the Bank") and Charter Services Group,
Inc. ("Charter"), collectively referred to herein as the "Company". All
significant intercompany transactions have been eliminated.
Nature of operations
- --------------------
The Company has been organized as a single operating segment and
operates full-service branch offices in Stockton, Tracy, and Lodi, California.
The Company's primary source of revenue is providing loans to customers, who are
predominately small and middle-market businesses and individuals.
Use of estimates
- ----------------
In preparing financial statements in conformity with accounting
principles generally accepted in the United States of America, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents
- -------------------------
For purposes of the statement of cash flows, the Company considers
cash, due from banks, certificates of deposit with maturities of three months or
less and federal funds sold to be cash equivalents.
Securities available for sale
- -----------------------------
Available-for-sale securities consist of bonds, notes, short-term
mutual funds, commercial paper and debentures not classified as trading
securities or held-to-maturity securities. These securities are carried at
estimated fair value with unrealized holding gains and losses, net of tax,
reported as a separate component of stockholders' equity, accumulated other
comprehensive income, until realized. Gains and losses on the sale of
available-for-sale securities are determined using the specific identification
method. The amortization of premiums and accretion of discounts are recognized
as adjustments to interest income over the period to maturity.
Investment Securities
- ---------------------
Bonds, notes, and debentures for which the Company has the positive
intent and ability to hold to maturity are reported at cost, adjusted for
premiums and discounts that are recognized in interest income using the interest
method over the period to maturity. Declines in the fair value of individual
held-to-maturity and available-for-sale securities below their cost that are
other-than-temporary result in write-downs of the individual securities to their
fair value. The related write-downs are included in earnings as realized losses.
In estimating other-than-temporary impairment losses, management considers the
length of time and the extent to which the fair value has been less than cost,
the financial condition and near-term prospects of the issuer, and the intent
and ability of the Bank to retain its investment in the issuer for a period of
time sufficient to allow for any anticipated recovery in fair value.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Loans
- -----
Loans receivable that management has the intent and ability to hold for
the foreseeable future or until maturity or payoff are reported at their
outstanding unpaid principal balances reduced by any charge-offs or specific
valuation accounts and net of any deferred fees or costs on originated loans, or
unamortized premiums or discounts on purchased loans.
Loan origination fees and certain direct origination costs are
capitalized and recognized as an adjustment of the yield of the related loan.
Deferred loan origination fee income and direct loan origination costs are
amortized to interest income over the life of the loan using the interest
method. Interest on loans is accrued to income daily based upon the outstanding
principal balances.
Loans for which the accrual of interest has been discontinued are
designated as nonaccrual loans. Accrual of interest on such loans is
discontinued when there exists a reasonable doubt as to the full and timely
collection of either principal or interest or when principal or interest is past
due 90 days, based on the contractual terms of the loan. Income on such loans is
then only recognized to the extent that cash is received and where the future
collection of principal is probable. Accrual of interest is resumed only when
principal and interest are brought fully current and when such loans are
considered to be collectible as to both principal and interest.
For impairment recognized in accordance with Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS")
No. 114, "Accounting by Creditors for Impairment of a Loan", as amended by SFAS
No. 118, the entire change in the present value of expected cash flows is
reported as either provision for credit losses in the same manner in which
impairment initially was recognized, or as a reduction in the amount of
provision for credit losses that otherwise would be reported.
Loans Held for Sale
- -------------------
Mortgage loans and SBA loans originated and intended for sale in the
secondary market are carried at the lower of cost or estimated market value in
the aggregate. Net unrealized losses are recognized through a valuation
allowance by charges to income.
The only loans originated by the Company for sale in the secondary
market are government guaranteed loans such as SBA loans. The Bank retains the
unguaranteed portion of the loan on its books and intends to hold that portion
of the loan to maturity. Historically, the Bank sold most of the guaranteed
portion of the SBA loans in the secondary market thereby receiving premiums and
service fees. The Bank does have SBA loans wherein the guaranteed portion,
totaling $382,816 has not been sold. It is the Bank's intention to retain the
guaranteed portion of these loans; however, they could be sold at a later date.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
The Company has adopted SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities". The Statement
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. Under this Statement, after
a transfer of financial assets, an entity recognizes the financial and servicing
assets it controls and liabilities it has incurred, derecognizes financial
assets when control has been surrendered, and derecognizes liabilities when
extinguished.
To calculate the gain (loss) on sale of loans, the Company's investment
in the loan is allocated among the retained portion of the loan, the servicing
retained, the interest-only strip and the sold portion of the loan, based on the
relative fair market value of each portion. The gain (loss) on the sold portion
of the loan is recognized at the time of sale based on the difference between
the sale proceeds and the allocated investment.
Servicing Rights - Servicing rights are recognized separately when they
are acquired through sale of loans. For sales of SBA loans prior to January 1,
2007, a portion of the cost of the loan was allocated to the servicing right
based on relative fair values. The Company adopted SFAS No. 156, Accounting for
Servicing of Financial Assets, on January 1, 2007, for sales of SBA loans
beginning in 2007. Servicing rights are initially recorded at fair value with
the income statement effect recorded in gain on sale of loans. Fair value is
based on a valuation model that calculates the present value of estimated future
cash flows from the servicing assets. The valuation model uses assumptions that
market participants would use in estimating cash flows from servicing assets,
such as the cost to service, discount rates and prepayment speeds. The Company
compares the valuation model inputs and results to published industry data in
order to validate the model results and assumptions. All classes of servicing
assets are subsequently measured using the amortization method which requires
servicing rights to be amortized into non-interest income in proportion to, and
over the period of, the estimated future net servicing income of the underlying
loans.
Servicing assets are evaluated for impairment based upon the fair value
of the rights as compared to the carrying amount. Impairment is determined by
stratifying rights into groupings based on predominant risk characteristics,
such as interest rate, loan type and investor type. For purposes of measuring
impairment, the Company has identified each servicing asset with the underlying
loan being serviced. A valuation allowance is recorded where the fair value is
below the carrying amount of the asset. If the Company later determines that all
or a portion of the impairment no longer exists for a particular grouping, a
reduction of the allowance may be recorded as an increase to income. The fair
values of servicing rights are subject to significant fluctuations as a result
of changes in estimated and actual prepayment speeds and changes in the discount
rates.
Servicing fee income which is reported on the income statement as
servicing income is recorded for fees earned for servicing loans. The fees are
based on a contractual percentage of the outstanding principal and recorded as
income when earned. The amortization of servicing rights and changes in the
valuation allowance are netted against loan servicing income.
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 in
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.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Premises and equipment
- ----------------------
Premises and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization are provided for in amounts
sufficient to relate the cost of depreciable assets to operations over their
estimated service lives using the straight-line basis. The estimated lives used
in determining depreciation are:
Equipment 3 - 5 years
Furniture and fixtures 5 - 7 years
Leasehold improvements 5 - 15 years
Leasehold improvements are amortized over the lesser of the useful life
of the asset or the term of the lease. The straight-line method of depreciation
is followed for all assets for financial reporting purposes, but accelerated
methods are used for tax purposes. Deferred income taxes have been provided for
the resulting temporary differences.
Advertising Costs
- -----------------
The Company expenses the costs of advertising in the year incurred.
Income taxes
- ------------
The Company recognizes deferred tax assets and liabilities based on
differences between the financial reporting and tax bases of assets and
liabilities using the enacted tax rates and laws that are expected to be in
effect when the differences are expected to be covered. The Company provides a
valuation allowance for deferred tax assets for which it does not consider
realization of such assets to be more likely than not.
On January 1, 2007, the Bank adopted Financial Accounting Standards
Board ("FASB") Interpretation No. 48, Accounting for Uncertainty in Income Taxes
("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition
threshold and measurement standard for the financial statement recognition and
measurement of an income tax position taken or expected to be taken in a tax
return. In addition, FIN 48 provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.
The provisions of FIN 48 have been applied to all tax positions of the
Bank as of January 1, 2007. Only tax positions that met the more-likely-than-not
recognition threshold on January 1, 2007 were recognized or continue to be
recognized upon adoption. The Bank previously recognized income tax positions
based on management's estimate of whether it was reasonably possible that a
liability has been incurred for unrecognized income tax benefits by applying
FASB Statement No. 5, Accounting for Contingencies. The adoption of FIN 48 did
not have a material impact on the Bank's financial position, results of
operations or cash flows. The adoption of FIN 48 made no impact on the balance
of retained earnings as of January 1, 2007.
Interest expense associated with unrecognized tax benefits is
classified as income tax expense in the statement of income. Penalties
associated with unrecognized tax benefits are classified as income tax expense
in the statement of income.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Earnings per share (EPS)
- ------------------------
Basic EPS excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if options 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 the earnings of the entity.
Weighted average shares outstanding used in the computation of basic
earning per share were 2,388,739, 2,386,739 and 2,381,219 in 2007, 2006 and
2005, respectively. Weighted average shares outstanding used in the computation
of diluted earning per share were 2,486,050, 2,568,990 and 2,531,586 in 2007,
2006 and 2005, respectively.
Comprehensive income
- --------------------
Statement of Financial Accounting Standards ("SFAS") No. 130,
"Reporting Comprehensive Income," requires the disclosure of comprehensive
income and its components. Included in accumulated other comprehensive income at
December 31, 2007 is unrealized loss on investment securities available for sale
of $369,716, less taxes of $153,750. Included in accumulated other comprehensive
income at December 31, 2006 is unrealized loss on investment securities
available for sale of $699,889, less taxes of $288,774. Included in accumulated
other comprehensive income at December 31, 2005 is unrealized loss on investment
securities available for sale of $1,223,626, less taxes of $504,868.
Financial instruments
- ---------------------
In the ordinary course of business, the Company has entered into
off-balance sheet financial instruments consisting of commitments to extend
credit, commercial letters of credit, and standby letters of credit as described
in Note 9. Such financial instruments are recorded in the financial statements
when they are funded or related fees are incurred or received.
Fair values of financial instruments
- ------------------------------------
SFAS No. 107 specifies the disclosure of the estimated fair value of
financial instruments. The Company's estimated fair value amounts have been
determined by the Company using available market information and appropriate
valuation methodologies.
However, considerable judgment is required to develop the estimates of
fair value. Accordingly, the estimates are not necessarily indicative of the
amounts the Company could have realized in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair value amounts.
Although management is not aware of any factors that would
significantly affect the estimated fair value amounts, such amounts have not
been comprehensively revalued for purposes of these financial statements since
the balance sheet date and, therefore, current estimates of fair value may
differ significantly from the amounts presented in the accompanying Notes.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Reclassifications
- -----------------
Certain reclassifications were made to prior years' presentations to
conform to the current year. These reclassifications are of a normal recurring
nature.
Stock-based compensation
- ------------------------
Effective January 1, 2006, the Company adopted the provisions of SFAS
No. 123R Share Based Payment (SFAS No. 123R) under the modified prospective
method. Accordingly, compensation expense for stock options is measured at the
grant-date fair value and amortized over the requisite service period of the
award. The impact of adopting SFAS No. 123R is discussed in Note 12.
Prior to the adoption of SFAS No. 123R, the Bank measured compensation
expense for its employee stock-based compensation plans using the intrinsic
value method prescribed by APB Opinion No. 25. The Bank applied the disclosure
provisions of SFAS No. 123 as amended by SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure as if the fair-value-based
method had been applied in measuring compensation expense. Under APB Opinion No.
25, when the exercise price of the Company's employee stock options was equal to
the market price of the underlying stock on the date of the grant, no
compensation expense was recognized.
The following table illustrates the effect on net income after taxes
and net income per common share as if the Bank had applied the fair value
recognition provisions of SFAS No. 123 to stock-based compensation during the
year ended December 31, 2005.
2005
------------
Net Income:
As Reported $ 1,422,619
Stock-Based Compensation using the Intrinsic Value Method --
Stock-Based Compensation that would have been reported
using the Fair Value Method of SFAS 123 (119,000)
------------
Pro Forma $ 1,303,619
============
Net income per share - basic
As reported $ .60
Pro forma $ .55
Net income per share - diluted
As reported $ .56
Pro forma $ .52
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
The fair value of each option was estimated on the date of the grant
using an option-pricing model with the following assumptions:
2007 2006 2005
----------------------------------------
Expected volatility 52.34% 55.58% 45.52%
Expected dividends None None None
Expected term 4 years 7 years 7 years
Risk-free rate 4.68% 4.77% 4.21%
Recently issued accounting pronouncements
- -----------------------------------------
In May 2005, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 154, "Accounting Changes
and Error Corrections" (SFAS No. 154). SFAS No. 154 provides guidance on the
accounting for and reporting of accounting changes and error corrections. It
establishes, unless impracticable, retrospective application as the required
method for reporting a change in accounting principle in the absence of explicit
transition requirements specific to the newly adopted accounting principle. SFAS
No. 154 is effective for accounting changes and corrections of errors made in
fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154,
effective January 1, 2006, did not have a material impact on our financial
position or operating results.
In February 2006, the Financial Accounting standards Board (FASB)
released Statement of Financial Accounting Standard (SFAS) No. 155, "Accounting
for Certain Hybrid Financial Instruments" (SFAS No. 155). SFAS No. 155 is an
amendment of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," and SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities." SFAS No. 155 establishes,
among other items, the accounting for certain derivative instruments embedded
within other types of financial instruments; and eliminates a restriction on the
passive derivative instruments that a qualifying special-purpose entity may
hold. Effective for the Company for January 1, 2007, SFAS No. 155 did not have
any impact on our financial position, results of operations or cash flows.
In March 2006, the FASB released SFAS No. 156, "Accounting for
Servicing of Financial Assets," an amendment of SFAS Statement No. 140, (SFAS
No. 156). SFAS No. 156 amends SFAS No. 140 to require that all separately
recognized servicing assets and liabilities in accordance with SFAS No. 140 be
initially measured at fair value, if practicable. Furthermore, this standard
permits, but does not require fair value measurement for separately recognized
servicing assets and liabilities in subsequent reporting periods. SFAS No. 156
is also effective for the Company beginning January 1, 2007; however, the
standard did not have any impact on the Company's financial position, results of
operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurement" a standard that provides enhanced guidance for using fair value to
measure assets and liabilities. The standard also responds to investors'
requests for expanded information about the extent to which companies' measure
assets and liabilities at fair value, the information used to measure fair
value, and the effect of fair value measurements on earnings. The standard
applies whenever other standards require (or permit) assets or liabilities to be
measured at fair value. Under the standard, fair value refers to the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the market in which the reporting
entity transacts. The standard clarifies that fair value should be based on the
assumptions market participants would use when pricing the asset or liability.
In support of this principle, the standard establishes a fair value hierarchy
that prioritizes the information used to develop those assumptions. The fair
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
value hierarchy gives the highest priority to quoted prices in active markets
and the lowest priority to unobservable data, for example, the reporting
entity's own data. Under the standard, fair value measurements would be
separately disclosed by level within the fair value hierarchy. We will adopt
SFAS No. 157 on January 1, 2008, and we do not expect the adoption of SFAS No.
157 to have a material impact on our financial condition or operating results.
In September 2006, the FASB issued SFAS No. 158 "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans," which will require
employers to fully recognize the obligations associated with single-employer
defined benefit pension, retiree healthcare and other postretirement plans in
their financial statements. The standard will make it easier for investors,
employees, retirees and others to understand and assess an employer's financial
position and its ability to fulfill the obligations under its benefit plans.
Specifically, SFAS No. 158 requires an employer to (a) recognize in its balance
sheet an asset for a plan's over funded status or a liability for a plan's under
funded status; (b) measure a plan's assets and its obligations that determine
its funded status as of the end of the employer's fiscal year (with limited
exceptions); and (c) recognize changes in the funded status of a defined benefit
postretirement plan in the year in which the changes occur. Those changes will
be reported in comprehensive income of a business entity. The adoption of SFAS
No. 158 did not have a material impact on our financial condition or operating
results. The requirement to recognize the funded status of a benefit plan and
the disclosure requirements are effective as of December 31, 2006.
In February 2007, the FASB issued SFAS No. 159 "The Fair Value Option
for Financial Assets and Financial Liabilities", which provides companies with
an option to report selected financial assets and liabilities at fair value.
This statement requires companies to display on the face of the balance sheet
the fair value of those assets and liabilities for which they have chosen to use
fair value. This standard also requires companies to provide additional
information that will help investors and other users of financial statements to
easily understand the effect on earnings of a company's choice to use fair
value. SFAS No. 159 also establishes presentation and disclosure requirements
designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities. This
statement is effective as of our fiscal year beginning January 1, 2008. We are
currently evaluating the potential impact this statement will have on our
statements of financial condition and operating results.
NOTE 2 - CASH AND DUE FROM BANKS
Cash and due from banks includes balances with the Federal Reserve and
other correspondent banks. The Company is required to maintain specified
reserves by the Federal Reserve Bank. The average reserve requirements are based
on a percentage of the Company's deposit liabilities. In addition, the Federal
Reserve requires the Company to maintain a certain minimum balance at all times.
The Company maintains amounts due from banks, which exceed federally
insured limits. The Company has not experienced any losses in such accounts.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 3 - SECURITIES
The amortized cost and estimated fair values of securities as of
December 31, 2007 are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
Available-for-Sale Securities:
U.S. Government Agencies $ 35,211,652 $ 83,394 $ (53,615) $ 35,241,431
State and political subdivisions 23,520,119 24,390 (249,204) 23,295,305
Asset backed-securities 7,173,180 1,274 (77,244) 7,097,210
Mortgage backed-securities 14,368,973 47,170 (128,003) 14,288,140
Agency preferred stock 2,530,000 -- (13,767) 2,516,233
Short-term mutual funds 500,000 -- (4,111) 495,889
------------ ------------ ------------ ------------
$ 83,303,924 $ 156,228 $ (525,944) $ 82,934,208
============ ============ ============ ============
Held-to-Maturity Securities:
U.S. Government Agencies $ 3,875,767 $ 353 $ (96,834) $ 3,779,286
State and political subdivisions 5,123,990 18,549 (383,769) 4,758,770
Asset backed-securities 3,898,115 14,070 (83,352) 3,828,833
Mortgage backed-securities 163,604 3,202 (6) 166,800
------------ ------------ ------------ ------------
$ 13,061,476 $ 36,174 $ (563,961) $ 12,533,689
============ ============ ============ ============
59
The following sets forth the total gross unrealized losses and
estimated fair values of investment securities with continuous losses less than
twelve months, those with continuous losses for twelve months or more and total
losses (dollar amounts in thousands):
Less than Twelve Months Twelve Months or More Total
---------------------------- ---------------------------- ----------------------------
Gross Estimated Gross Estimated Gross Estimated
Unrealized Fair Unrealized Fair Unrealized Fair
Losses Value Losses Value Losses Value
------------ ------------ ------------ ------------ ------------ ------------
US Government Agencies $ (78) $ 7,863 $ (73) $ 9,462 $ (151) $ 17,325
State and Political Subdivisions (475) 14,975 (158) 6,025 (633) 21,000
Preferred stock (14) 486 -- -- (14) 486
Asset-Backed Securities (11) 2,798 (66) 4,662 (77) 7,460
Mortgage-Backed Securities (4) 972 (124) 8,466 (128) 9,438
Short-term mutual funds (4) 496 -- -- (4) 496
Corporate (83) 2,185 -- -- (83) 2,185
------------ ------------ ------------ ------------ ------------ ------------
$ (669) $ 29,775 $ (421) $ 28,615 $ (1,090) $ 58,390
============ ============ ============ ============ ============ ============
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 3 - SECURITIES - CONTINUED
As of December 31, 2007, the Company had 278 investment securities
where estimated fair value had declined .93% from the Company's amortized cost.
Management evaluates investment securities for other-than-temporary impairment
taking into consideration the extent and length of time the fair value has been
less than cost, the financial condition of the issuer and whether the Company
has the intent and ability to retain the investment for a period of time
sufficient to allow for any anticipated recovery in fair value. As of December
31, 2007, no declines in value are deemed to be other-than-temporary.
The scheduled maturities of securities as of December 31, 2007 are
shown below. Actual maturities may differ from contractual maturities because
borrowers have the right to call or prepay obligations with or without call or
prepayment penalties.
Available-for-Sale Held-to-Maturity
--------------------------------------- ---------------------------------------
Weighted Weighted
Amortized Fair Average Amortized Fair Average
Cost Value Yields (1) Cost Value Yields (1)
----------- ----------- ----------- ----------- ----------- ----------
Due in one year or less $ 3,967,362 $ 3,946,364 3.79% $ -- $ -- N/A
After one year to five years 7,715,875 7,699,821 4.91% -- -- N/A
After five years to ten years 15,697,581 15,730,936 5.36% 1,000,000 1,013,710 8.75%
After ten years 38,524,133 38,256,825 5.76% 11,897,872 11,353,179 7.72%
Mortgage-backed securities 14,368,973 14,288,140 4.66% 163,604 166,800 5.61%
Preferred stock 2,530,000 2,516,233 7.40% -- -- N/A
Short-term mutual fund 500,000 495,889 5.21% -- -- N/A
----------- ----------- ----------- -----------
$83,303,924 $82,934,208 5.37% $13,061,476 $12,533,689 7.78%
=========== =========== =========== ===========
(1) Weighted average yields for municipal securities have been adjusted to
reflect their tax equivalent yields.
Proceeds from the sale of available-for-sale securities were
$6,743,578, $3,497,638, and $1,396,477 for the years ended December 31, 2007,
2006, and 2005, respectively. Gross losses of $7,187 were realized on sales of
securities during 2007, a loss of $1,799 in 2006 and a gain of $6,191 in 2005.
Securities carried at approximately $42,672,000 and $63,146,000 at
December 31, 2007 and 2006, respectively, were pledged to secure deposits of
public funds and borrowing arrangements
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 3 - SECURITIES - CONTINUED
The amortized cost and estimated fair values of securities as of
December 31, 2006 are as follows:
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 political 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 political 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
============ ============ ============ ============
Proceeds from the sale of available-for-sale securities were $3,497,638
for 2006. Gross losses of $1,799 were realized on sales of securities during
2006.
The following sets forth the total gross unrealized losses and
estimated fair values of investment securities with continuous losses less than
twelve months, those with continuous losses for twelve months or more and total
losses (dollar amounts in thousands):
Less than Twelve Months Twelve Months or More Total
---------------------------- ---------------------------- ----------------------------
Gross Estimated Gross Estimated Gross Estimated
Unrealized Fair Unrealized Fair Unrealized Fair
Losses Value Losses Value Losses Value
------------ ------------ ------------ ------------ ------------ ------------
US Government Agencies $ (32) $ 8,951 $ (281) $ 19,219 $ (313) $ 28,170
State and Political
Subdivisions (46) 6,518 (40) 5,635 (86) 12,153
Asset-Backed Securities (1) 451 (133) 6,497 (134) 6,665
Mortgage-Backed Securities (1) 168 (314) 12,580 (315) 13,031
------------ ------------ ------------ ------------ ------------ ------------
$ (80) $ 16,088 $ (768) $ 43,931 $ (848) $ 60,019
============ ============ ============ ============ ============ ============
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 3 - SECURITIES - CONTINUED
The Company evaluates investment securities for other-than-temporary
impairment taking into consideration the extent and length of time the fair
value has been less than cost, the financial condition of the issuer and whether
the Company has the intent and ability to retain the investment for a period of
time sufficient to allow for any anticipated recovery in fair value. As of
December 31, 2006, no declines are deemed to be other than temporary.
NOTE 4 - LOANS
The Company's customers are primarily located in San Joaquin County. At
December 31, 2007, approximately 64.9% of the Company's loans are for real
estate and construction and approximately 20.0% of the Company's loans are for
general commercial uses including professional, retail and small businesses.
Consumer loans make up approximately 3.5% of the loan portfolio, leases make up
7.5%, and agriculture loans making up the remaining 4.1%. Generally, real estate
loans are collateralized by real property while commercial and other loans are
collateralized by funds on deposit, business or personal assets.
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 4 - LOANS - CONTINUED
Loans at December 31, 2007 and 2006 consisted of the following:
2007 2006
------------- -------------
Construction and land development loans $ 29,541,045 $ 34,248,157
Real estate loans 45,002,196 43,396,795
Commercial loans 23,029,593 23,421,351
Leases 8,560,166 8,591,815
Agricultural loans 4,713,710 4,288,022
Consumer loans 4,041,061 1,225,571
------------- -------------
114,887,771 115,171,711
Deferred loan fees and costs, net (160,557) (234,487)
Allowance for loan losses (1,558,050) (1,429,050)
------------- -------------
$ 113,169,164 $ 113,508,174
============= =============
A summary of activity in the allowance for loan losses for the years
ended December 31, 2007, 2006 and 2005 are as follows:
2007 2006 2005
------------- ------------- -------------
Balance, beginning of year $ 1,429,050 $ 1,123,494 $ 963,000
Provision for loan losses 935,000 300,000 165,000
------------- ------------- -------------
2,364,050 1,423,494 1,128,000
Less net (charge-offs) recoveries (806,000) (5,556) 4,506
------------- ------------- -------------
Balance, end of year $ 1,558,050 $ 1,429,050 $ 1,123,494
============= ============= =============
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 4 - LOANS - CONTINUED
The following is a summary of the investment in impaired loans, the
related allowance for loan losses, and income recognized thereon and information
pertaining to loans on nonaccrual and certain past due loans as of December 31:
2007 2006 2005
---------- ---------- ----------
Recorded Investment in Impaired Loans $2,006,029 $ 435,147 $ 309,256
Related Allowance for Loan Losses $ 74,635 $ 90,720 $ 92,305
Average Recorded Investment in Impaired Loans $1,059,140 $ 210,246 $ 129,591
Interest Income Recognized for Cash Payments $ 12,425 $ -- --
Total Loan on Nonaccrual $2,006,029 $ 435,147 $ 54,020
Total Loans Past Due 90 Days or More and Still Accruing $ -- $ -- $ 255,237
Loans totaling approximately $51,145,000 have been pledged as
collateral for Federal Home Loan Bank borrowing line.
The Bank also originated mortgage and SBA loans and under its Section
7a program and has sold the guaranteed portions of most of the loans to
institutional investors. Funding for the Section 7a program depends on annual
appropriations by the U.S. Congress.
At December 31, 2007, 2006, and 2005 the Bank was servicing
approximately $10,155,328, $13,731,908, and $12,593,000 respectively, in loans
previously sold. A summary of the changes in the related servicing assets and
interest-only strips receivable are as follows:
Servicing Assets
------------------------------------
2007 2006 2005
---------- ---------- ----------
Balance at beginning of year $ 57,544 $ 121,258 $ 137,960
Increase from loan sales 1,242 3,996 15,677
Amortization charged to income (30,847) (67,710) (32,379)
Change in valuation allowance -- -- --
---------- ---------- ----------
Balance at end of year $ 27,939 $ 57,544 $ 121,258
========== ========== ==========
Interest-Only Strips
Receivable
------------------------------------
2007 2006 2005
---------- ---------- ----------
Balance at beginning of year $ 51,757 $ 144,206 $ 180,262
Increase from loan sales 201 214 --
Amortization charged to income (19,948) (92,663) (36,056)
Writedowns -- -- --
---------- ---------- ----------
Balance at end of year $ 32,010 $ 51,757 $ 144,206
========== ========== ==========
The estimated fair value of the servicing assets approximated the
carrying amount at December 31, 2007, 2006, and 2005. Fair value is estimated by
discounting estimated future cash flows from the servicing assets using discount
rates that approximate current market rates over the expected lives of the loans
being serviced.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 4 - LOANS - CONTINUED
Management has estimated the expected life of these loans to be
approximately 25% to 30% of the remaining life at the time of sale. For purposes
of measuring impairment, the Bank has identified each servicing asset with the
underlying loan being serviced. A valuation allowance is recorded where the fair
value is below the carrying amount of the asset. At December 31, 2007 and 2006,
the Bank had no valuation allowances.
The Bank may also receive a portion of subsequent interest collections
on loans sold that exceed the contractual servicing fee. In that case the Bank
records an interest-only strip based on the relative fair market value of it and
the other components of the loan. At December 31, 2007 and 2006, the Bank had
interest-only strips of $32,010 and $51,757, respectively, which approximates
fair value. Fair value is estimated by discounting estimated future cash flows
from the interest-only strips using assumptions similar to those used in valuing
servicing assets.
NOTE 5 - PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as
follows:
2007 2006
------------ ------------
Leasehold improvements $ 1,057,723 $ 1,079,996
Furniture, fixtures and equipment 1,527,350 1,308,959
------------ ------------
2,585,073 2,388,955
Less accumulated depreciation and amortization (1,276,353) (999,974)
------------ ------------
$ 1,308,720 $ 1,388,980
============ ============
Depreciation and amortization expense on premises and equipment was
$276,749, $206,950 and $168,002 for the years ended December 31, 2007, 2006, and
2005, respectively.
The Company leases its premises under noncancelable operating leases
with initial terms expiring in 2012, 2009, 2015, and 2010. Certain of these
contain renewal options with escalation clauses that provide for increased lease
payments. The Company recognized rent expense, including common area costs and
equipment rentals, of $464,201, 504,235, and $248,693 in 2007, 2006 and 2005,
respectively.
The future minimum commitments under these operating leases are as
follows:
2008 470,247
2009 450,422
2010 332,797
2011 339,595
2012 300,536
Thereafter 888,563
------------
Total $ 2,782,160
============
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 6 - TIME DEPOSITS
Time deposits issued and their remaining maturities as of December 31,
2007 are as follows:
2008 $ 85,098,115
2009 920,088
2010 508,192
2011 61,648
2012 2,814,530
------------
Total $ 89,402,573
============
NOTE 7 - JUNIOR SUBORDINATED DEBT SECURITIES AND OTHER BORROWINGS
On August 17, 2006, Service 1st Bancorp (the "Company") completed a
private placement to an institutional investor of approximately $5 million of
trust preferred securities, through a newly formed Delaware trust affiliate,
Service 1st Capital Trust I (the "Trust"). The trust preferred securities mature
on October 7, 2036, are redeemable at the Company's option beginning after five
years, and require quarterly distributions by the Trust to the holder of the
trust preferred securities at a variable interest rate which will adjust
quarterly to equal the three month LIBOR plus 1.60%.
The proceeds from the sale of the trust preferred securities were used
by the Trust to purchase from the Company approximately $5,155,000 in aggregate
principal amount of the Company's junior subordinated notes (the "Notes"). The
Notes will bear interest at the same variable interest rate during the same
quarterly periods as the trust preferred securities. The net proceeds to the
Company from the sale of the Notes to the Trust will be used by the Company
primarily to fund the growth of its bank subsidiary, Service 1st Bank, and for
general corporate purposes.
The Notes were issued pursuant to a Junior Subordinated Indenture (the
"Indenture"), dated August 17, 2006, by and between the Company and Wells Fargo
National Bank, National Association, as trustee. Like the trust preferred
securities, the interest rate on the Notes will adjust quarterly to equal the
three month LIBOR plus 1.60%. The interest payments by the Company will be used
to pay the quarterly distributions payable by the Trust to the holder of the
trust preferred securities. However, so long as no event of default, as
described below, has occurred under the Notes, the Company may defer interest
payments on the Notes (in which case the Trust will be entitled to defer
distributions otherwise due on the trust preferred securities) for up to 20
consecutive quarters.
The Notes are subordinated to the prior payment of any other
indebtedness of the Company that by its terms is not similarly subordinated and
will be recorded as a long-term liability on the Company's balance sheet. For
regulatory purposes, the Notes will be treated as Tier 1 or Tier 2 capital under
applicable regulations of the Federal Reserve Board, the Company's primary
federal regulatory agency.
The Notes mature on October 7, 2036, but may be redeemed at the
Company's option on any January 7, April 7, July 7, or October 7 on or after
October 7, 2011 or at any time within 90 days following the occurrence of
certain events, such as: (i) a change in the regulatory capital treatment of the
Notes (ii) in the event the Trust is deemed an investment company or (iii) upon
the occurrence of certain adverse tax events. In each such case, the Company may
redeem the Notes for their aggregate principal amount, plus any accrued but
unpaid interest.
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 7 - JUNIOR SUBORDINATED DEBT SECURITIES AND OTHER BORROWINGS - CONTINUED
The Notes may be declared immediately due and payable at the election
of the trustee or holders of 25% of the aggregate principal amount of
outstanding Notes in the event that the Company defaults in the payment of any
interest following the nonpayment of any such interest for 20 or more
consecutive quarterly periods. Also, the entire principal amount of the Notes
and any premium and interest accrued becomes immediately due and payable without
further action if (1) a court enters a decree or order for relief in respect of
the Company in any involuntary case under any bankruptcy or similar law; (2) the
Company commences a voluntary case under any bankruptcy or similar law, consents
to the entry of an order for relief in an involuntary case under any such law or
consents to the appointment of or taking possession by a receiver, liquidator or
trustee of the Company or substantially all of its property; (3) the Company
makes any general assignment for the benefit of creditors or fails generally to
pay its debits as they become due; or (4) the Trust liquidates or winds up,
other that as contemplated in the Indenture. Further, if the Company is no
longer subject to the supervision and regulation of the Federal Reserve, the
trustee or the holders of 15% of the aggregate principal amount of the
outstanding Notes may declare the Notes immediately due and payable if (x) the
Company defaults in the payment of any interest in such default continues
unremedied for a period of thirty (30) days, except in the case of an election
by the Company to defer payments of interest for up to 20 consecutive quarters
(which deferral will not constitute a default and will not subject the Notes to
acceleration); (y) the Company defaults in the payment of the principal amount
of the Notes when due; or (z) the Company defaults in the performance of or
breaches certain covenants in the Indenture, which default or breach which is
not cured within 30 days after there has been given notice of such default or
breach.
The Company also has entered into a Guarantee Agreement pursuant to
which it has agreed to guarantee the payment by the Trust of distributions on
the trust preferred securities, and the payment of principal of the trust
preferred securities when due, either at maturity or on redemption, but only if
and to the extent that the Trust fails to pay distributions on or principal of
the trust preferred securities after having received interest payments or
principal payments on the Notes from the Company for the purpose of paying those
distributions or the principal amount of the trust preferred securities.
The Company has unsecured borrowing lines available with correspondent
banks totaling $36,300,000 and secured borrowing lines totaling $5,000,000.
Management uses these borrowing lines for short-term funding needs and usually
repays the lines within a week. The interest rate charged on these lines is
approximately the prevailing federal funds rate plus 20 to 100 basis points. In
addition to the borrowing lines with the correspondent banks, the Company also
has a secured borrowing line with the Federal Home Loan Bank of San Francisco
("the FHLB"). As of December 31, 2006, the Company had no outstanding borrowings
from any of its correspondent banks, but did have a loan of $4,000,000
outstanding from the FHLB. This borrowing will mature on May 7, 2008 and has a
fixed rate of interest at 5.21%. The Company had additional credit available
with the FHLB of $16,332,796 at December 31, 2007. As of December 31, 2005, the
Company had outstanding borrowings from correspondent banks of $1,030,000. There
were no borrowings from correspondent banks at December 31, 2007 or 2006.
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 8 - INCOME TAXES
Income taxes included in the consolidated statements of income consist
of the following:
2007 2006 2005
---------- ---------- ----------
Current:
Federal $ (524,194) $ 223,288 $ 337,964
State -- 145,877 19,032
---------- ---------- ----------
(524,194) 369,165 356,996
Deferred 168,000 (70,000) (212,000)
---------- ---------- ----------
$ (356,194) $ 299,165 $ 144,996
========== ========== ==========
A comparison of the federal statutory income tax rates to the Company's
effective income tax rates follow:
2007 2006 2005
------------------------ ------------------------ ------------------------
Amount Rate Amount Rate Amount Rate
---------- ---------- ---------- ---------- ---------- ----------
Statutory federal tax $ (7,000) (34.0%) $ 390,000 34.0% $ 533,000 34.0%
State franchise tax, net of federal benefit -- -- 82,000 7.0% 93,000 6.0%
Reduction in valuation allowance -- -- -- -- (414,000) (27.0%)
Nontaxable income (386,000) (2,035.0%) (232,000) (21.0%) (82,000) (5.0%)
Other items, net 36,806 194.0% 59,165 6.0% 14,996 1.0%
---------- ---------- ---------- ---------- ---------- ----------
Actual tax expense (credit) $ (356,194) (1,875.0%) $ 299,165 26.0% $ 144,996 9.0%
========== ========== ========== ========== ========== ==========
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 8 - INCOME TAXES - CONTINUED
Deferred income taxes reflect the effect of temporary differences
between the tax basis of assets and liabilities and the reported amounts of
those assets and liabilities for financial reporting purposes. Deferred income
taxes also reflect the value of net operating losses and an offsetting valuation
allowance. The Company's deferred tax assets, liabilities and corresponding
valuation allowance consist of the following:
2007 2006 2005
----------- ----------- -----------
Deferred tax assets:
Allowance for loan losses $ 567,000 $ 550,000 $ 448,000
Net operating loss carryforward 249,000 -- --
Unrealized loss on investment securities 154,000 289,000 505,000
Deferred compensation 375,000 302,000 191,000
Other items 188,000 155,000 9,000
----------- ----------- -----------
1,533,000 1,296,000 1,153,000
Deferred tax liabilities:
Deferred tax leases (770,000) (272,000) --
Deferred loan costs (129,000) (96,000) (102,000)
Other items (63,000) (54,000) (69,000)
----------- ----------- -----------
(962,000) (422,000) (171,000)
Total deferred income tax asset 571,000 874,000 982,000
Valuation allowance -- -- --
----------- ----------- -----------
Net deferred income tax assets $ 571,000 $ 874,000 $ 982,000
=========== =========== ===========
Income tax returns for the years ended December 31, 2006, 2005 and 2004
are open to audit by the federal authorities and income tax returns for the
years ended December 31, 2006, 2005, 2004 and 2003 are open to audit by
California authorities. Unrecognized tax benefits are not expected to
significantly increase or decrease within the next twelve months.
NOTE 9 - FINANCIAL INSTRUMENTS
The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit in
the form of loans. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet. The contract amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 9 - FINANCIAL INSTRUMENTS - CONTINUED
The Company's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitment to extend credit is
represented by the contractual amount of those instruments. The Company uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance-sheet instruments.
Financial instruments at December 31, whose contract amounts represent
credit risk are as follows:
2007 2006 2005
----------- ----------- -----------
Undisbursed loan commitments $36,491,788 $39,365,000 $33,301,000
Standby letters of credit 1,546,884 1,242,000 1,596,000
----------- ----------- -----------
$38,038,672 $40,607,000 $34,897,000
=========== =========== ===========
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation. Collateral held varies but may include accounts
receivable, inventory, property, plant and equipment, and income-producing
commercial properties.
NOTE 10 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company has granted loans to
certain officers and directors and the companies with which they are associated.
In the Company's opinion, all loan commitments to such parties are made on
substantially the same terms including interest rates and collateral, as those
prevailing at the time of comparable transactions with other persons. The
following is a summary of the activity in these loans commitments:
2007 2006 2005
----------- ----------- -----------
Balance at the beginning of the year $ 5,212,000 $ 3,530,000 $ 1,971,000
New loans and renewals 4,370,375 4,167,000 2,708,000
Repayments and renewals (2,331,407) (2,485,000) (1,149,000)
----------- ----------- -----------
Balance at the end of the year $ 7,250,843 $ 5,212,000 $ 3,530,000
=========== =========== ===========
Also in the ordinary course of business, certain officers and directors
of the Company have deposits with the Bank. In the Bank's opinion, all deposit
relationships with such parties are made on substantially the same terms
including interest rates and maturities, as those prevailing at the time of
comparable transactions with other persons. The balance of these deposits at
December 31, 2007, 2006 and 2005 was approximately $4,789,000, $5,051,000 and
$1,198,000, respectively.
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 11 - COMPANY SAVINGS PLAN
In October 2001, the Company elected to establish a deferred
compensation plan for those employees employed as of this date or for all
employees who have completed at least 1,000 hours of service during a twelve
consecutive month period. The employees may defer a portion of their
compensation subject to certain limits based on federal tax laws. The Company
may elect to make matching contributions to the plan. Matching contributions
vest to the employee equally over a five-year period. For the year ended
December 2007, the Company made a contribution of $85,200. For the year ended
December 2006, the Company made a contribution of $34,417. For the year ended
December 2005, the Company made a contribution of $20,254.
NOTE 12 - STOCK OPTION PLAN
On January 1, 2006, the Company adopted the provisions of SFAS No. 123R
"Share Based Payment" (SFAS No. 123R) requiring the measurement and recognition
of all share-based compensation under the fair value method. Prior to January 1,
2006, the Company accounted for share-based awards under APB No. 25. The Company
adopted SFAS No. 123R using the modified prospective transition method,
therefore, prior period results are not restated and do not reflect the
recognition of share-based compensation.
Under the modified prospective transition method, share-based
compensation expense is recorded for all awards granted after the adoption date
and for the unvested portion of previously granted awards outstanding on the
adoption date. Compensation cost related to the unvested portion of previously
granted awards is based on the grant-date fair value estimated in accordance
with the original provisions of SFAS No. 123. Compensation cost for awards
granted after the adoption date is based on the grant-date fair value estimated
in accordance with the provisions of SFAS No. 123R. Total compensation costs
recorded during the year ended December 31, 2007, amounted to $75,322 for
employees and $73,687 for directors. The effect of implementing SFAS No. 123R
reduced net income in 2007 by $118,797 or $.05 per share basic and $.05 per
share fully diluted and reduced net income in 2006 by $167,277 or $.07 per share
basic and $.06 per share fully diluted.
During 1999, the Company's Board of Directors approved a fixed stock
option plan under which incentive and non-qualified stock options may be granted
to key, full-time salaried officers, employees and directors of the Company. The
shares of stock initially subject to options authorized to be granted under the
Plan consist of 252,000 shares of the authorized and unissued common stock of
the Company. All options are granted at an exercise price equal to the fair
market value of the shares on the date of grant and have an exercise period of
not longer than ten years from the date of grant. The Plan was ratified by the
shareholders at the Company's annual meeting in May 2001. These options vest
equally over a three-year period. All of the unissued options in this plan were
canceled with the adoption of the 2004 stock option plan.
During 2004, the Company's Board of Directors approved a fixed stock
option plan under which incentive and non-qualified stock options may be granted
to key, full-time salaried officers, employees and directors of the Company. The
shares of stock initially subject to options authorized to be granted under the
Plan consist of 253,500 shares of the authorized and unissued common stock of
the Company. All options are granted at an exercise price equal to the fair
market value of the shares on the date of grant and have an exercise period of
not longer than ten years from the date of grant. The Plan was ratified by the
shareholders at the Company's annual meeting in May 2004. These options vest
equally over a three-year period.
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 12 - STOCK OPTION PLAN - CONTINUED
The fair value of each option award is estimated on the date of grant
using the Black Scholes option pricing model. Expected volatility is based on
historical volatility of the common stock. The Company uses historical data to
estimate option exercise and forfeiture rates within the valuation model. The
expected life of the options granted is derived from the award's vesting period
and the award recipient's exercise history, if applicable, and represents the
period of time that the options are expected to be outstanding. The risk-free
rate for periods within the expected life of the option is based on the 7-year
U.S. Treasury note rate at the time of the grant. The assumptions used for
determining the fair value of the options granted during the year ended December
31, 2007, 2006, and 2005 are as follows:
2007 2006 2005
-----------------------------------------------
Expected volatility 52.34% 55.58% 45.52%
Expected dividends None None None
Expected term 4 years 7 years 7 years
Risk-free rate 4.68% 4.77% 4.21%
A summary of option activity of the Company's fixed stock option plan
is presented below.
Weighted Aggregate
Weighted average intrinsic
average remaining value of
exercise contractual term outstanding
Shares price in years options
------------- ------------- ------------- -------------
Outstanding, January 1, 2007 419,113 $ 9.20
Exercised -- $ --
Forfeited (42,875) $ 12.79
Granted 30,000 $ 16.13
-------------
Outstanding, December 31, 2007 406,238 $ 9.41 4.60 $ (818,721)
=============
Exercisable, December 31, 2007 328,738 $ 8.31 4.16 $ (300,887)
=============
Weighted Weighted
Average Average
Exercise Number Remaining Exercise
Price Outstanding Life Price
------------- ------------- ------------- -------------
$ 6.03 23,625 3.23 $ 6.03
$ 6.35 183,488 2.19 $ 6.35
$ 9.30 34,125 6.82 $ 9.30
$ 12.33 125,000 7.46 $ 12.33
$ 13.00 15,000 9.72 $ 13.00
$ 15.50 5,000 8.05 $ 15.50
$ 18.67 5,000 7.80 $ 18.67
$ 19.25 15,000 9.05 $ 19.25
-------------
406,238 4.60 $ 9.41
=============
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 12 - STOCK OPTION PLAN - CONTINUED
The weighted-average grant-date fair value of options granted during
the year ended December 31, 2007 was $2.73. There were no options exercised in
2007. The total intrinsic value of options exercised during the year ended
December 31, 2006, was $18,675.
Cash received from options exercised under the Plan for the years ended
December 31, 2006, was $30,825. The actual tax benefit realized for the tax
deductions from options exercised was $7,694.
As of December 31, 2007, there was $122,348 of total unrecognized
compensation cost related to nonvested share-based compensation arrangements
granted under the Plan. That cost is expected to be recognized over a
weighted-average period of 1.35 years.
NOTE 13 - DEFERRED COMPENSATION AGREEMENTS
During 2004 and 2005, the Company entered into deferred compensation
agreements with certain executive officers. Under these agreements, the Company
is obligated to provide, upon retirement, annual benefit for the officers
ranging from $40,000 to $133,000 for 15 years. The estimated present value of
future benefits to be paid is being accrued over the period from the effective
date of the agreements until the expected retirement dates of the participants.
The expense incurred and amount accrued for this plan for the years ended
December 31, 2007, 2006 and 2005 totaled $153,244, $229,505, and $217,554,
respectively. The Company is a beneficiary of the life insurance policies that
have been purchased as a method of financing the benefits under the agreements.
NOTE 14 - RESTRICTION ON RETAINED EARNINGS
With certain exceptions, a California corporation may pay a dividend to
its shareholders in an amount equal to the lesser of total retained earnings or
the sum of the prior three years net income after subtracting dividends paid, if
any.
NOTE 15 - REGULATORY MATTERS
The Company (on a consolidated basis) and the Bank are subject to
various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain
mandatory - and possibly additional discretionary - actions by regulators that,
if undertaken, could have a direct material effect on the Company's and the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company and the Bank must
meet specific capital guidelines that involve quantitative measures of the
Company's and Bank's assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts and ratios
(set forth in the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined).
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 15 - REGULATORY MATTERS - CONTINUED
The Bank's primary federal regulator is the Federal Deposit Insurance
Corporation (FDIC). As of December 31, 2007, the most recent notification from
the FDIC categorized the Bank as well capitalized under the regulatory framework
for prompt corrective action. There are no events or conditions since
notification that management believes have changed the Bank's category. To be
categorized as well capitalized the Bank must maintain minimum total risk-based,
Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following
table. The Company's and the Bank's actual capital amounts and ratios are
presented in the following table (dollar amounts are in thousands).
To be
Actual For capital adequacy well-capitalized under
purposes prompt corrective
action provisions
----------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ---------- ---------- --------- ---------- ----------
As of December 31, 2007:
Company:
Total capital (to risk weighted assets) $ 24,574 14.7% $ 13,334 8.0% N/A N/A
Tier 1 capital (to risk weighted assets) $ 23,016 13.8% $ 6,667 4.0% N/A N/A
Tier 1 capital (to average assets) $ 23,016 9.8% $ 9,422 4.0% N/A N/A
Bank:
Total capital (to risk weighted assets) $ 22,423 13.5% $ 13,334 8.0% $ 16,668 10.0%
Tier 1 capital (to risk weighted assets) $ 20,825 12.5% $ 6,667 4.0% $ 10,001 6.0%
Tier 1 capital (to average assets) $ 20,825 8.9% $ 9,375 4.0% $ 11,719 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 1 capital (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 1 capital (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%
As of December 31, 2005:
Company:
Total capital (to risk weighted assets) $ 17,404 15.1% $ 9,224 8.0% N/A N/A
Tier 1 capital (to risk weighted assets) $ 16,281 14.1% $ 4,612 4.0% N/A N/A
Tier 1 capital (to average assets) $ 16,281 9.8% $ 6,683 4.0% N/A N/A
Bank:
Total capital (to risk weighted assets) $ 16,304 14.1% $ 9,224 8.0% $ 11,530 10.0%
Tier 1 capital (to risk weighted assets) $ 15,181 13.2% $ 4,612 4.0% $ 6,918 6.0%
Tier 1 capital (to average assets) $ 15,181 9.1% $ 6,644 4.0% $ 8,304 5.0%
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the amount at which the
asset or obligation could be exchanged in a current transaction between willing
parties, other than in a forced or liquidation sale. Fair value estimates are
made at a specific point in time based on relevant market information and
information about the financial instrument. These estimates do not reflect any
premium or discount that could result from offering for sale at one time the
entire holdings of a particular financial instrument. Because no market value
exists for a significant portion of the financial instruments, fair value
estimates are based on judgments regarding future expected loss experience,
current economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in nature,
involve uncertainties and matters of judgment and, therefore, cannot be
determined with precision. Changes in assumptions could significantly affect the
estimates.
Fair value estimates are based on financial instruments both on and off
the balance sheet without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments. Additionally, tax consequences related to the realization
of the unrealized gains and losses can have a potential effect on fair value
estimates and have not been considered in many of the estimates.
The following methods and assumptions were used to estimate the fair
value of significant financial instruments:
Financial Assets
- ----------------
The carrying amounts of cash, short-term investments, due from
customers on acceptances, and Bank acceptances outstanding are considered to
approximate fair value. Short-term investments include federal funds sold,
securities purchased under agreements to resell, commercial paper and interest
bearing deposits with Banks. The fair values of investment securities, including
available-for-sale, are generally based on quoted market prices. The fair value
of loans are estimated using a combination of techniques, including discounting
estimated future cash flows and quoted market prices of similar instruments
where available.
Financial Liabilities
- ---------------------
The carrying amounts of deposit liabilities payable on demand,
commercial paper, and other borrowed funds are considered to approximate fair
value. For fixed maturity deposits, fair value is estimated by discounting
estimated future cash flows using currently offered rates for deposits of
similar remaining maturities. The fair value of long-term debt is based on rates
currently available to the Company for debt with similar terms and remaining
maturities.
Off-Balance Sheet Financial Instruments
- ---------------------------------------
The fair value of commitments to extend credit and standby letters of
credit is estimated using the fees currently charged to enter into similar
agreements. The fair value of these financial instruments is not material.
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED
The estimated fair value of financial instruments is summarized as
follows: (dollar amounts in thousands)
December 31,
---------------------------------------------------------------------------
2007 2006 2005
----------------------- ----------------------- -----------------------
Carrying Fair Carrying Fair Carrying Fair
Value Value Value Value Value Value
---------- ---------- ---------- ---------- ---------- ----------
Financial Assets:
Cash and due from banks $ 6,637 $ 6,637 $ 6,543 $ 6,543 $ 9,025 $ 9,025
Federal funds sold 4,653 4,653 10,617 10,617 -- --
Certificates of deposit 486,488 486,488 1,500 1,500 994 994
Investment securities 96,365 95,468 86,144 86,235 68,810 68,832
Loans, net 113,169 112,116 113,508 113,473 82,533 82,115
Cash surrender value of life
insurance 3,698 3,698 3,567 3,567 3,436 3,436
Accrued interest receivable 1,505 1,505 1,462 1,462 958 958
Financial Liabilities:
Deposits 202,406 200,522 199,955 199,895 151,142 154,165
Other borrowings 9,155 9,143 9,155 9,145 1,030 1,030
Accrued interest and other liabilities 1,867 1,867 1,143 1,143 1,584 1,584
Undisbursed loan commitments and
letters of credit 38,039 38,039 40,607 40,607 34,897 34,897
NOTE 17 - FORMATION OF SERVICE 1ST BANCORP
On June 26, 2003, Service 1st Bancorp acquired Service 1st Bank by
issuing 1,155,105 shares of common stock in exchange for the surrender of all
outstanding shares of the Bank's common stock. There was no cash involved in
this transaction. The acquisition was accounted for like a pooling of interests
and the consolidated financial statements contained herein have been restated to
give full effect to this transaction.
Service 1st Bancorp has no significant business activity other than its
investment in Service 1st Bank and Charter Services Group, Inc. Accordingly, no
separate financial information on the Company is provided.
NOTE 18 - STOCK SPLIT
On September 15, 2005, the Company declared a three-for-two stock split
stock dividend to shareholders of record on September 29, 2005. The split was
paid on October 18, 2005. Each shareholder entitled to the split received a
stock certificate equal to 50% of the shares held by the shareholder rounded
down to the nearest whole share with fractional shares paid in cash.
All of the per share data in the financial statements were
retroactively adjusted to reflect this three-for-two stock split.
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 19 - PARENT ONLY CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEET
December 31, 2007 and 2006
2007 2006
------------ ------------
ASSETS
Cash and due from banks $ 219,058 $ 64,007
Investment in subsidiaries 20,329,560 19,512,746
Other assets 2,350,756 2,624,248
------------ ------------
Total assets $ 22,899,374 $ 22,201,001
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Junior subordinated debt securities $ 5,155,000 $ 5,155,000
Other liabilities 96,360 79,167
------------ ------------
Total liabilities 5,251,360 5,234,167
Shareholders' equity:
Common stock 16,023,738 16,023,738
Additional paid in capital 356,152 207,144
Retained earnings 1,484,090 1,147,067
Accumulated other comprehensive income, net of taxes (215,966) (411,115)
------------ ------------
Total shareholders' equity 17,648,014 16,966,834
------------ ------------
Total liabilities and shareholders' equity $ 22,899,374 $ 22,201,001
============ ============
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 19 - PARENT ONLY CONDENSED FINANCIAL STATEMENTS - CONTINUED
CONDENSED STATEMENT OF INCOME
December 31, 2007, 2006 and 2005
2007 2006 2005
----------- ----------- -----------
Income:
Investment and interest income $ 64,938 $ 44,887 $ 35,523
----------- ----------- -----------
Total income 64,938 44,887 35,523
Expenses:
Salaries and employee benefits 386,637 698,148 391,926
Occupancy expenses 59,121 43,402 23,702
Director fees and expenses 73,185 79,320 --
Data processing and other professional expenses 40,615 77,095 40,742
Interest expenses 352,678 129,593 --
Other operating expenses 85,032 78,432 68,147
----------- ----------- -----------
Total expenses 997,268 1,105,990 524,517
Loss before equity in undistributed income of
subsidiaries (932,330) (1,061,103) (488,994)
Equity in undistributed income of subsidiaries 905,088 1,520,501 1,683,627
----------- ----------- -----------
Income (loss) before income taxes (27,242) 459,398 1,194,633
Income tax benefit 364,265 387,723 227,986
----------- ----------- -----------
Net income $ 337,023 $ 847,121 $ 1,422,619
=========== =========== ===========
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2007, 2006 and 2005
NOTE 19 - PARENT ONLY CONDENSED FINANCIAL STATEMENTS - CONTINUED
CONSOLIDATED STATEMENT OF CASH FLOWS
December 31, 2007, 2006 and 2005
2007 2006 2005
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 337,023 $ 847,121 $ 1,422,619
Adjustments to reconcile net income to net cash provided by
operating activities:
Undistributed earnings of subsidiaries (905,088) (1,520,501) (1,683,627)
Depreciation 15,982 14,172 --
Stock option compensation expense 82,345 199,450 --
(Increase) decrease in other assets (392,840) (514,546) (245,051)
Increase (decrease) in other liabilities 17,193 57,159 14,556
----------- ----------- -----------
Net cash provided by operating activities (845,385) (917,145) (491,503)
----------- ----------- -----------
Cash flows from investing activities:
(Increase) decrease in short-term investments 1,201,000 (1,100,000) 300,000
Increase in investment in subsidiaries (200,000) (3,200,000) (250,000)
Purchase of equipment (564) (46,850) (33,624)
----------- ----------- -----------
Net cash used in investing activities 1,000,436 (4,346,850) 16,376
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from sale of common stock, net of costs -- -- 567,871
Exercise of stock options, including tax benefit -- 30,825 --
Increase in junior subordinated debt -- 5,155,000 --
----------- ----------- -----------
Net cash used in financing activities -- 5,185,825 567,871
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 155,051 (78,170) 92,744
Cash and cash equivalents at beginning of year $ 64,007 $ 142,177 $ 49,433
----------- ----------- -----------
Cash and cash equivalents at end of year $ 219,058 $ 64,007 $ 142,177
=========== =========== ===========
80
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
An evaluation of the Company's disclosure controls and procedures (as
defined in the Securities Exchange Act of 1934 ("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 period covered
by this annual report on Form 10-K. The Company's Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures as 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 Securities and
Exchange Commission's rules and forms.
Changes in Internal Controls
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 December 31, 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.
Management's Report on Internal Controls
Management is responsible for establishing and maintaining adequate
internal control over financial reporting for the Company (as defined in Rule
13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended).
The Company's management, including the Chief Executive Officer and Chief
Financial Officer, has assessed the effectiveness of the Company's internal
control over financial reporting as of December 31, 2007. In making this
assessment, management used the criteria applicable to the Company as set forth
by the Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control--Integrated Framework. Based upon such assessment and criteria,
management believes that, as of December 31, 2007, the Company's internal
control over financial reporting was effective.
This Annual Report does not include an attestation report of our
independent registered public accounting firm regarding internal control over
financial reporting. The Company is not currently required to engage and has not
engaged its independent registered public accounting firm to provide an
attestation report regarding the Company's internal controls over financial
reporting pursuant to temporary rules of the Securities and Exchange Commission
that permit us to provide only the above-described report by management.
/s/ JOHN O. BROOKS /s/ROBERT E. BLOCH
----------------------- -----------------------
John O. Brooks Robert E. Bloch
Chief Executive Officer Chief Financial Officer
81
ITEM 9B. OTHER INFORMATION
None
82
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information required by Item 10 of Form 10-K is incorporated by
reference to the information contained in the Company's Proxy Statement for the
2008 Annual Meeting of Shareholders which will be filed pursuant to Regulation
14A.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by
reference to the information contained in the Company's Proxy Statement for the
2008 Annual Meeting of Shareholders which will be filed pursuant to Regulation
14A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 of Form 10-K is incorporated by
reference to the information contained in the Company's Proxy Statement for the
2008 Annual Meeting of Shareholders which will be filed pursuant to Regulation
14A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information required by Item 13 of Form 10-K is incorporated by
reference to the information contained in the Company's Proxy Statement for the
2008 Annual Meeting of Shareholders which will be filed pursuant to Regulation
14A.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 of Form 10-K is incorporated by
reference to the information contained in the Company's Proxy Statement for the
2008 Annual Meeting of Shareholders which will be filed pursuant to Regulation
14A.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements. Listed and included in Part II, Item 8.
--------------------
(2) Financial Statement Schedules
-----------------------------
Not applicable.
(3) 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.
83
(3.2) Bylaws, as amended 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 March 31, 2005.
(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.
(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.
84
(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.
(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 March 31, 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.
85
(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.
(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) Private placement to an institutional investor of
approximately $5 million of trust preferred
securities, incorporated by reference from
Registrant's Form 8-K, filed with the Securities and
Exchange Commission on August 23, 2006.
(10.29) 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 for the year ended December 31, 2006,
filed with the Securities and Exchange Commission on
March 14, 2007.
(10.30)* Thomas A. Vander Ploeg Employment Agreement dated
November 16, 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.
(23.1) Consent of Vavrinek, Tine, Day & Co., LLP
(31.1) Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
86
(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.
87
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: March 28, 2008 By: /s/ John O. Brooks
------------------------------------
John O. Brooks
Chief Executive Officer
(Principal Executive Officer)
Date: March 28, 2008 By: /s/ Robert E. Bloch
------------------------------------
Robert E. Bloch
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934
this report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated.
Signature Title Date
- --------------------------- ------------------- ------------------
/s/ John O. Brooks Chairman March 28, 2008
- ---------------------------
John O. Brooks
/s/ Eugene C. Gini Director March 28, 2008
- ---------------------------
Eugene C. Gini
/s/ Bryan R. Hyzdu Director March 28, 2008
- ---------------------------
Bryan R. Hyzdu
/s/ Susan Lenz Director March 28, 2008
- ---------------------------
Susan Lenz
/s/ Robert D. Lawrence Director March 28, 2008
- ---------------------------
Robert D. Lawrence
/s/ Frances C. Mizuno Director March 28, 2008
- ---------------------------
Frances C. Mizuno
/s/ Richard R. Paulsen Director March 28, 2008
- ---------------------------
Richard R. Paulsen
88
/s/ Toni Marie Raymus Director March 28, 2008
- ---------------------------
Toni Marie Raymus
/s/ Michael K. Repetto Director March 28, 2008
- ---------------------------
Michael K. Repetto
/s/ Anthony F. Souza Director March 28, 2008
- ---------------------------
Anthony F. Souza
/s/ Donald L. Walters Director March 28, 2008
- ---------------------------
Donald L. Walters
/s/ Dean Andal Director March 28, 2008
- ---------------------------
Dean Andal
89
EXHIBIT INDEX
Exhibit Sequential
Number Description Page Number
- ------ --------------------------------------------------------- -----------
10.30 Thomas A. Vander Ploeg Employment Agreement dated
November 16, 2007 91
23.1 Consent of Vavrinek, Trine, Day & Co., LLP 99
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 100
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 101
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 102
90