Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2002
-------------------------------------------------
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from_______________to_________________________________
Commission file number 0-30777
PACIFIC MERCANTILE BANCORP
---------------------------
(Exact name of Registrant as specified in its charter)
California 33-0898238
- --------------------------------------------------------------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
949 South Coast Drive, Suite 300,
Costa Mesa, California 92626
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(714) 438-2500
--------------
(Registrant's telephone number, including area code)
--------------------------------------------
(Former name, former address and former fiscal
year, if changed, since last year)
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 [_].
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
6,399,888 shares of Common Stock as of August 5, 2002
PACIFIC MERCANTILE BANCORP
QUARTERLY REPORT ON FORM 10Q
FOR
THE QUARTER ENDED JUNE 30, 2002
TABLE OF CONTENTS
Page No.
--------
Part I Financial Information
Item 1. Financial Statements ................................................................................... 3
Consolidated Statements of Financial Condition
June 30, 2002 and December 31, 2001 .................................................................... 3
Consolidated Statements of Operations
Three months and six months ended June 30, 2002 and 2001 ............................................... 4
Consolidated Statements of Comprehensive Income (Loss)
Three months and six months ended June 30, 2002 and 2001 ............................................... 5
Consolidated Statements of Cash Flows
Six months ended June 30, 2002 and 2001 ................................................................ 6
Notes to Consolidated Financial Statements ............................................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .................. 10
Forward Looking Information and Uncertainties Regarding Future Financial Performance ............................ 20
Item 3 Market Risk ............................................................................................. 21
Part II. Other Information ............................................................................................... 21
Item 4 Submission of Matters to a Vote of Security Holders ..................................................... 21
Item 6 Exhibits and Reports on Form 8-K ........................................................................ 22
Signatures ............................................................................................................... S-1
Exhibit Index ............................................................................................................ E-1
Exhibit 99.1 Certification of Chief Executive Officer ..................pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 99.2 Certification of Chief Financial Officer ..................pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
PART I. -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, December 31,
2002 2001
------------- --------------
ASSETS (unaudited)
Cash and due from banks ........................................................................... $ 19,566,000 $ 11,652,300
Federal funds sold ................................................................................ 35,850,000 23,465,000
------------ ------------
Cash and cash equivalents ................................................................ 55,416,000 35,117,300
Interest earning deposits with financial institutions ............................................. 1,686,000 1,488,000
Securities available for sale, at fair value ($9,522,400 and $11,845,900 pledged as collateral for
repurchase agreements and debtor in possession accounts at June 30, 2002, and December 31,
2001, respectively) .......................................................................... 83,723,700 13,352,600
Loans held for sale ............................................................................... 21,202,800 63,696,600
Loans (net of allowances of $1,895,800 and $1,695,500, respectively) .............................. 177,035,000 147,764,600
Accrued interest receivable ....................................................................... 1,268,700 943,500
Premises and equipment, net ....................................................................... 2,765,700 2,471,600
Other assets ...................................................................................... 2,108,900 1,599,800
------------ ------------
Total Assets ............................................................................. $345,206,800 $266,434,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing ...................................................................... $105,681,500 $ 88,832,900
Interest bearing ......................................................................... 168,100,300 122,629,000
------------ ------------
Total deposits .................................................................................... 273,781,800 211,461,900
Borrowings ........................................................................................ 23,022,600 16,273,900
Accrued interest payable .......................................................................... 256,200 181,800
Other liabilities ................................................................................. 6,399,900 1,838,300
------------ ------------
Total liabilities ................................................................................. 303,460,500 229,755,900
------------ ------------
Commitments and contingencies (See Note 2) ........................................................ -- --
Trust preferred securities (See Note 3) ........................................................... 5,000,000 --
Shareholders' Equity:
Preferred stock, no par value, 2,000,000 shares authorized; none issued ........................... -- --
Common stock, no par value, 10,000,000 shares authorized, 6,393,888 and
6,344,828 shares issued and outstanding at June 30, 2002 and December 31, 2001,
respectively ................................................................................. 37,838,300 37,607,900
Accumulated deficit ............................................................................... (1,084,000) (1,041,100)
Accumulated other comprehensive income (loss) ..................................................... (8,000) 111,300
------------ ------------
Total Shareholders' Equity ............................................................... 36,746,300 36,678,100
------------ ------------
Total Liabilities and Shareholders' Equity ................................................... $345,206,800 $266,434,000
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
3
Part I. Item 1. (continued)
PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Interest income:
Loans, including fees $ 2,883,100 $ 2,323,000 $ 5,804,100 $ 4,494,000
Federal funds sold 338,600 372,200 595,000 967,900
Securities available for sale 301,800 115,300 465,500 257,900
Interest earning deposits with financial institutions 14,200 14,600 27,200 32,700
----------- ----------- ----------- -----------
Total interest income 3,537,700 2,825,100 6,891,800 5,752,500
Interest expense:
Deposits 1,006,000 848,500 1,932,800 1,827,300
Borrowings 72,200 35,100 123,800 72,100
----------- ----------- ----------- -----------
Total interest expense 1,078,200 883,600 2,056,600 1,899,400
Net interest income 2,459,500 1,941,500 4,835,200 3,853,100
Provision for loan losses 155,000 100,000 205,000 200,000
----------- ----------- ----------- -----------
Net interest income after provision for loan losses 2,304,500 1,841,500 4,630,200 3,653,100
Noninterest income 1,070,100 770,500 2,105,500 1,264,000
Noninterest expense 3,636,800 2,191,800 6,806,300 4,027,600
----------- ----------- ----------- -----------
(Loss) income before income taxes (262,200) 420,200 (70,600) 889,500
Income tax (benefit) expense (99,700) -- (27,700) --
----------- ----------- ----------- -----------
Net (loss) income $ (162,500) $ 420,200 $ (42,900) $ 889,500
=========== =========== =========== ===========
(Loss) income per share:
Basic $ (0.03) $ 0.07 $ (0.01) $ 0.14
=========== =========== =========== ===========
Fully diluted $ (0.03) $ 0.07 $ (0.01) $ 0.14
=========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
4
Part I. Item 1. (continued)
PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2002 2001 2002 2001
--------- -------- --------- --------
Net (loss) income $(162,500) $420,200 $ (42,900) $889,500
Other comprehensive (loss) gain, net of tax:
Change in unrealized (loss) gain on securities
available for sale, net of tax effect (67,200) (10,600) (119,300) 6,000
--------- -------- --------- --------
Total comprehensive (loss) income $(229,700) $409,600 $(162,200) $895,500
========= ======== ========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
5
Part I. Item 1. (continued)
PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30,
------------------------------
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (42,900) $ 889,500
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization 453,100 256,300
Provision for loan losses 205,000 200,000
Net amortization (accretion) of premiums (discounts) on securities 47,700 (106,500)
Net gains on sales of loans held for sale (704,000) (375,600)
Mark to market loans held for sale (74,800) 14,600
Proceeds from sales of loans held for sale 252,598,000 135,494,500
Originations and purchases of loans held for sale (209,325,400) (150,268,700)
Net change in accrued interest receivable (325,200) 11,100
Net change in other assets (831,200) (363,100)
Net change in accrued interest payable 74,400 5,200
Net change in other liabilities 4,561,600 174,600
------------- -------------
Net cash provided by (used in) operating activities 46,636,300 (14,068,100)
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in interest earning deposits with financial
Institutions (198,000) (298,000)
Proceeds from maturities of and principal payments received for securities
available for sale 655,100 14,700,000
Purchase of securities available for sale (70,871,100) (10,984,600)
Net increase in loans (29,475,400) (15,367,500)
Purchase of premises and equipment (747,200) (549,100)
------------- -------------
Net cash used in investing activities (100,636,600) (12,499,200)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 62,319,900 23,208,800
Proceeds from exercise of stock options 230,400 --
Proceeds from investment in trust preferred securities 5,000,000 --
Net increase in borrowings 6,748,700 3,025,300
------------- -------------
Net cash provided by financing activities 74,299,000 26,234,100
------------- -------------
Increase (decrease) in cash and cash equivalents 20,298,700 (333,200)
Cash and cash equivalents, beginning of period 35,117,300 47,588,300
------------- -------------
Cash and cash equivalents, end of period $ 55,416,000 $ 47,255,100
============= =============
SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
Cash paid for interest on deposits and borrowings $ 1,981,800 $ 1,894,200
Cash paid for income taxes $ 144,000 $ 27,800
The accompanying notes are an integral part of these consolidated financial
statements.
6
Part I. Item 1. (continued)
PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
1. Nature of Business and Significant Accounting Policies
Organization
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q and, therefore,
do not include all footnotes as would be necessary for a fair presentation of
financial position, results of operations, changes in cash flows and
comprehensive income (loss) in conformity with generally accepted accounting
principles. However, these interim financial statements reflect all adjustments
(consisting of normal recurring adjustments and accruals) which, in the opinion
of the management, are necessary for a fair presentation of the results for the
interim periods presented. These unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles on a basis consistent with prior periods, and should be read in
conjunction with the Company's audited financial statements as of and for the
year ended December 31, 2001 and the notes thereto included in the Company's
Annual Report on Form 10-K filed with the Securities and Exchange Commission
under the Securities Exchange Act of 1934.
The financial position at June 30, 2002, and the results of operations for
the three and six month periods ended June 30, 2002 are not necessarily
indicative of the results of operations that may be expected for any other
interim period or for the full year ending December 31, 2002.
The consolidated financial statements include the accounts of Pacific
Mercantile Bancorp and its wholly owned subsidiaries Pacific Mercantile Bank,
PMB Securities Corporation, and Pacific Mercantile Capital Trust I (which
together shall be referred to as the "Company"). The Company is a bank holding
company, which was incorporated on January 7, 2000 in the State of California.
Pacific Mercantile Bank (the "Bank") is a banking corporation which was formed
on May 29, 1998, incorporated November 18, 1998 in the State of California and
commenced operations on March 1, 1999. The Bank is chartered by the California
Department of Financial Institutions (the "DFI") and is a member of the Federal
Reserve Bank of San Francisco ("FRB"). In addition, the Bank's customers'
deposit accounts are insured by the Federal Deposit Insurance Corporation
("FDIC") up to the maximum amount allowed by Federal Regulations.
Pacific Mercantile Bancorp was organized to acquire all of the outstanding
shares of the Bank and, on June 12, 2000, it consummated that acquisition by
means of a merger as a result of which the Bank became a wholly-owned subsidiary
of the Company and the Bank's shareholders became the Company's shareholders,
owning the same number and percentage of the Company's shares as they had owned
in the Bank (the "Reorganization"). Prior to the Reorganization, the Company had
only nominal assets and had not conducted any business.
In June 2002, Pacific Mercantile Capital Trust I, a Delaware trust, was
organized to facilitate the sale of $5,000,000 of trust preferred securities to
an institutional investor in a private placement.
In June 2002, PMB Securities Corp., a wholly owned subsidiary of the
Company, commenced operations. PMB Securities Corp. is a securities
broker-dealer engaged in the retail securities brokerage business that is
registered with the Securities and Exchange Commission and is a member firm of
the National Association of Securities Dealers, Inc.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets, liabilities, and
contingencies 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.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)
Loans
At June 30, 2002, the Company had $81,000 in nonaccrual loans and had
$90,000 in loans delinquent 90 days or more with principal that were still
accruing interest. There were no impaired or restructured loans as of June 30,
2002.
(Loss) Income Per Share
Basic (loss) income per share for each of the periods presented was
computed by dividing the net (loss) income by the weighted average number of
shares of common stock outstanding during each such period. The weighted average
number of shares used in the basic (loss) income per share computations for the
six months ended June 30, 2002 and 2001 were 6,356,022 and 6,332,020,
respectively. The weighted average numbers of shares used in the basic (loss)
income per share computations for the three month periods ended June 30, 2002
and 2001 were 6,361,255 and 6,332,020, respectively. The weighted average
numbers of shares used in the fully diluted income per share computations for
the three and six months ended June 30, 2001 were 6,475,695 and 6,481,003,
respectively. The Company's common stock equivalents are anti-dilutive for both
the three months and the six months ended June 2002 and are therefore not
included in the loss per share calculations in those periods.
Comprehensive Income
Components of comprehensive income include non-ownership related revenues,
expenses, gains, and losses that under generally accepted accounting principles
are included in equity but excluded from net income.
Hedged Items
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
For Derivative Instruments and Hedging Activities", as amended and interpreted
("SFAS No. 133") was effective for the Company as of January 1, 2001. SFAS No.
133 requires all derivative instruments to be recognized on the balance sheet at
fair value. Gains or losses resulting from changes in the values of derivatives
are accounted for depending on the purpose of the derivative and whether it
qualifies for hedge accounting. If certain conditions are met, hedge accounting
may be applied and the derivative instrument may be specifically designated as a
fair value, cash flow or foreign currency hedge. In the absence of meeting these
conditions, the derivatives are designated as non-designated derivative
instruments with gains or losses recorded to current earnings.
Effective January 1, 2001, the Company adopted the provisions of SFAS 133
by recognizing all derivative instruments on the balance sheet at fair value. At
January 1, 2001, the adoption of SFAS No. 133 did not have a material impact on
the financial statements. All derivative instruments entered into by the Bank
prior to February 19, 2002 were non-designated derivative instruments. On
February 19, 2002, the Bank's Board of Directors approved the "Mortgage Banking
Risk Management Policy". This policy specifically implements the Bank's policy
to designate interest rate lock commitments with investors as hedge instruments
to hedge the mortgage loans upon funding. At June 30, 2002, approximately $21.2
million of loans held for sale were hedged.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)
2. Commitments and Contingencies
In order to meet the financing needs of its customers in the normal course
of business, the Company is party to financial instruments with off-balance
sheet risk, which consist of commitments to extend credit and standby letters of
credit. These instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the consolidated
financial statements. At June 30, 2002, we were committed to fund certain loans
amounting to approximately $119,590,800. We use the same credit policies in
making commitments and conditional obligations as we do for on-balance sheet
instruments. Commitments generally have fixed expiration dates; however, since
many of the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash requirements.
We evaluate each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company upon an extension of
credit, is based on management's credit evaluation of the customer. Collateral
held varies, but may include accounts receivable, inventory, property, plant and
equipment, residential real estate and income-producing commercial properties.
We are subject to legal actions normally associated with financial
institutions. At June 30, 2002, we did not have any pending legal actions that
would be material to the consolidated financial condition or results of
operations of the Company.
3. Trust Preferred Securities
In June 2002, the Company's newly formed wholly owned subsidiary, Pacific
Mercantile Capital Trust I, a Delaware trust, sold $5,000,000 of trust preferred
securities to an institutional investor in a private placement. These securities
mature in 30 years, are redeemable at the Company's option beginning after 5
years, and require quarterly distributions, initially at a rate of 5.65%, which
will reset quarterly at the three month LIBOR rate plus 3.75%. The trust
preferred securities are subordinated to other borrowings that may be obtained
by the Company in the future. The securities also qualify as tier one capital
for regulatory purposes.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Forward-Looking Information
The following discussion contains information regarding operating trends
and expectations regarding our future performance (which is referred to as
"forward-looking information"). That information is subject to the uncertainties
and risks described below in the Section of this Report entitled "Forward
Looking Information and Uncertainties Regarding Future Financial Performance"
and readers of this Report are urged to read that Section in its entirety.
Background
Substantially all of our operations are conducted by the Bank, which
accounts for substantially all of our revenues and expenses. This information
should be read in conjunction with the Company's quarterly unaudited
consolidated financial statements, and the notes thereto, contained earlier in
this Report.
The principal determinant of a bank's income is net interest income, which
is the difference between the interest that a bank earns on loans, investments
and other interest earning assets, and its interest expense, which consists
primarily of the interest it must pay to attract and retain deposits and the
interest that it pays on its other interest bearing liabilities. A bank's
interest income and interest expense are, in turn, affected by a number of
factors, some of which are outside of its control, including the monetary
policies of the Federal Reserve Board and national and local economic
conditions, which affect interest rates and also the demand for loans and the
ability of borrowers to meet their loan payment obligations.
Recent Operating Results
During 2001 the Federal Reserve Board adopted and implemented a monetary
policy that was designed to reduce market rates of interest in an effort to
stimulate the U.S. economy, which was heading into recession. That policy has
continued into 2002, as the hoped for economic recovery has been slow to
develop. As a result of that policy, during the six months ended June 30, 2001
the prime rate of interest charged by most banks declined from 9.50% to a low of
6.75%; and by January 1, 2002 the prime rate of interest had declined further,
to 4.75% where it has remained throughout the six months ended June 30, 2002. As
a result, our net interest margin for the three and six month periods ended June
30, 2002 was 3.40% and 3.53%, respectively, as compared to 4.56% and 4.67%,
respectively, during the same three and six month periods of 2001.
Despite those declines in our net interest margin, we generated net
interest income of $2,459,500 and $4,835,200, respectively, in the three and six
month periods ended June 30, 2002, which represented increases of $518,000 or
26.7% and $982,100 or 25.5%, respectively, over the net interest income
generated in the same periods of 2001. Additionally, noninterest income,
consisting largely of revenue from our mortgage loan operations, increased by
$299,600, or 38.9%, in the quarter ended June 30, 2002 as compared to the same
quarter of 2001 and by $841,500 or 66.6%, for the six months ended June 30, 2002
as compared to the same period in 2001.
However, these increases in revenues were more than offset by growth
related increases in noninterest expense of $1,445,000 for the quarter ended
June 30, 2002 as compared to the same quarter in 2001. This increase in
noninterest expense was primarily due to the opening of the Bank's sixth
full-service financial center in La Jolla, and a Loan Production Office in North
Orange County in the second quarter of 2002, coupled with start-up costs of
approximately $82,000 associated with the launch of a new securities brokerage
subsidiary, PMB Securities Corp., which commenced business operations in June,
2002. As a result, for the quarter ended June 30, 2002, the Company incurred a
net loss of $162,500, or $0.03 per share, as compared to net income of $420,200,
or $0.07 per share, for the same quarter of 2001. Noninterest expense for the
six months ended June 30, 2002, increased $2,778,700 as compared to the same
period in 2001. This increase was due to the aforementioned growth-related
expenses and also to the opening of two new financial centers in Costa Mesa, and
Beverly Hills, California that occurred in the second and third quarters of
2001. As a result, for the six months ended June 30, 2002, the Company incurred
a net loss of $42,900, or $0.01 per share, as compared to net income of
$889,500, or $0.14 per share, for the same period of 2001.
10
Set forth below are key financial performance ratios for the periods indicated:
Three months ended Six months ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Return on average assets /(1)/............................. (0.21)% 0.94% (0.03)% 1.02%
Return on average shareholders' equity /(1)/............... (1.78)% 4.74% (0.24)% 5.05%
Net interest margin /(2)/.................................. 3.40% 4.56% 3.53 % 4.67%
Basic and fully diluted income(loss) per share/(3)/....... $ (0.03) $0.07 $ (0.01) $0.14
Weighted average shares outstanding - basic................ 6,361,255 6,332,020 6,356,022 6,332,020
Weighted average shares outstanding - diluted/(3)/......... 6,361,255 6,475,695 6,356,022 6,481,003
- -----------
/(1)/ Annualized.
/(2)/ Net interest income expressed as a percentage of total average interest
earning assets.
/(3)/ Basic weighted average shares outstanding is used for both basic and fully
diluted loss per share in 2002 since both the three and six months ended
results reflect a net loss.
RESULTS OF OPERATIONS
Net Interest Income
We generated net interest income of $2,459,500 and $4,835,200,
respectively, in the three and six months ended June 30, 2002 as compared to
$1,941,500 and $3,853,100, respectively, for the corresponding periods of 2001.
These increases in net interest income were largely attributable to increases in
interest income of $712,600 and $1,139,300, respectively, in the three and six
months ended June 30, 2002, which more than offset increases in our interest
expense of $194,600 and $157,200, respectively, in those same periods. The
increases in interest income were primarily attributable to increases of
approximately $52,028,800 and $64,566,200 in our average loans outstanding for
the three and six months ended June 30, 2002, respectively, which more than
offset the effect of declining interest rates on loans and other interest
earning assets due to declining market rates of interest that resulted from the
Federal Reserve Board's monetary policy and a general slowness in the economy.
The increases in interest expense for the three and the six months ended
June 30, 2002 were due primarily to increases in the volume of our interest
bearing deposits, which more than offset the effect on interest expense of
declining market rates of interest. Average interest bearing deposits
outstanding during the three and six month periods ended June 30, 2002 increased
by approximately $72,300,100 and $65,381,600, respectively, as compared to the
corresponding periods of 2001. In addition, other borrowings increased by
$7,575,100 and $7,411,600, respectively, during the three and six months ended
June 30, 2002, as compared to the same periods in 2001.
Our ratio of net interest income to average earning assets ("net interest
margin") for the three and six month periods ended June 30, 2002 declined to
3.40% and 3.53%, respectively, from 4.56% and 4.67% in the same respective
periods of 2001. These declines were primarily attributable to decreases in the
average prime lending rate that occurred subsequent to June 30, 2001 along with
percentage increases of 7% and 3% in federal funds sold to average earning
assets for the three and six month periods ended June 30, 2002, as compared to
the corresponding periods in 2001.
As described below in the Subsection entitled "Asset/Liability Management,"
our balance sheet was shown to be in a negative gap position at June 30, 2002.
This implies that our earnings would decrease in the short-term if interest
rates were to rise and would increase in the short-term if interest rates were
to fall.
Provision for Loan Losses
Like virtually all banks and other financial institutions, we follow the
practice of maintaining a reserve or allowance (the "Allowance") for possible
losses on loans and leases that occur from time to time as an incidental part of
the banking business. When it is determined that the payment in full of a loan
has become unlikely, the
11
carrying value of the loan is reduced to its realizable value. This reduction,
which is referred to as a loan "charge-off" is charged against the Allowance.
The amount of the Allowance is increased periodically to replenish the Allowance
after it has been reduced due to loan charge-offs and to reflect changes in (i)
the volume of outstanding loans, and (ii) the risk of potential losses due to a
deterioration in the condition of borrowers or in the value of property securing
non-performing loans or changes in economic conditions. See "Financial
Condition-Allowance for Loan Losses" below in this Section of this Report.
Increases in the Allowance are made through a charge, recorded as an expense in
the statement of income, referred to as the "provision for loan losses."
Recoveries of loans previously charged-off are added back to and, therefore,
have the effect of increasing, the Allowance.
During the quarter ended June 30, 2002, we made a provision for loan losses
of $155,000 as compared to $100,000 for the quarter ended June 30, 2001, in
response to the growth in the volume of our outstanding loans. There were no
charge offs of loans during the quarter ended June 30, 2002. For the six months
ended June 30, 2002 there was a $4,700 loan charge off. At June 30, 2002, the
Allowance for Loan Losses represented 1.1% of our gross loans excluding loans
held for sale. See "Financial Condition - Allowance for Loan Losses" below.
Although we employ economic models that are based on bank regulatory
guidelines and industry standards to evaluate and determine the sufficiency of
the Allowance and, thereby, the amount of the provisions required to be made for
potential loan losses, those determinations involve judgments or forecasts about
future economic conditions and other events that are subject to a number of
uncertainties, some of which are outside of our ability to control. See the
discussion below under the caption "Forward Looking Information and
Uncertainties Regarding Future Performance." In the event of unexpected
subsequent events or changes in circumstances, it could become necessary in the
future to incur additional charges in order to increase the Allowance, which
would have the effect of reducing our income or even causing us to incur losses.
Noninterest Income
Noninterest income consists primarily of mortgage banking income (which
includes loan origination and processing fees and yield spread premiums) and net
gains on sales of loans held for sale, which are generated by our mortgage loan
division. That division originates conforming and non-conforming, agency
quality, residential first and home equity mortgage loans. As indicated in the
table below, noninterest income increased by $299,600, or 39%, and by $841,500,
or 66.6%, respectively in the three and six months ended June 30, 2002, as
compared to the same respective periods of 2001. Those increases were primarily
attributable to substantial increases in mortgage loan originations as a result
of significant increases in the volume of mortgage loan refinancings prompted by
declining market rates of interest.
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------
Mortgage banking ................................... $ 444,400 $377,500 $1,053,300 $ 562,800
Net gains on sales of loans held for sale .......... 469,000 204,600 704,000 375,600
Automated clearing house and wire transfer income.. 99,000 24,600 195,200 35,200
Service charges and fees ........................... 35,800 58,900 88,000 112,600
Merchant income .................................... 5,600 71,400 12,200 124,500
Other .............................................. 16,300 33,500 52,800 53,300
- ---------------------------------------------------------------------------------------------------------
Total noninterest income ........................... $1,070,100 $770,500 $2,105,500 $1,264,000
=========================================================================================================
Noninterest Expense
Total noninterest expense for the three and six month periods ended June
30, 2002, were $3,636,800 and $6,806,300, respectively, as compared to
$2,191,800 and $4,027,600 for the corresponding periods of 2001. As indicated in
the table below, salaries and employee benefits constitute the largest
components of noninterest expense. The increase in noninterest expense in the
second quarter of 2002 was primarily attributable to increased staffing,
occupancy and equipment costs incurred in connection with the opening by the
Bank of a new financial center in La Jolla, California and a new loan production
office, and the commencement of operations of a new securities brokerage
subsidiary of the Company. The increase in noninterest expense for the six
months ended June
12
30, 2002 as compared to the same period for 2001, was primarily attributable to
the growth mentioned above, as well as the opening of two new financial centers
in Costa Mesa and Beverly Hills, California and the establishment of Company
headquarters offices in Costa Mesa, which took place in the second and third
quarters of 2001. Other professional expenses increased as a result of the legal
costs incurred in connection with credit card refund claims in our merchant
processing area.
The following table sets forth the principal components of noninterest
expense and the amount thereof, incurred in the three and six month periods
ended June 30, 2002 and 2001.
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Salaries and employee benefits $1,791,200 $1,119,400 $3,417,200 $2,064,100
Occupancy 389,900 193,600 786,200 358,300
Depreciation 238,500 135,700 453,100 256,300
Equipment 61,400 42,100 109,000 64,700
Data processing 94,800 75,100 180,700 145,300
Professional fees 229,600 99,900 385,400 197,300
Other loan related 60,900 132,300 185,000 163,200
Stationery and supplies 106,200 46,200 177,100 90,200
Courier 69,000 51,700 139,500 90,600
Customer fees paid 95,300 39,700 145,700 84,600
Telephone 61,900 29,100 104,800 50,300
Organizational costs PMB Securities,
Corporation 70,700 -- 70,700 --
Mileage and parking 29,600 7,800 51,700 13,900
Insurance 26,700 21,200 51,300 39,600
Professional dues and memberships 23,500 11,200 45,600 22,900
Advertising, promotion, and development 59,200 41,800 85,200 110,100
Correspondent bank service charges 49,000 36,500 90,400 68,200
Other operating expense /(1)/ 179,400 108,500 327,700 208,000
---------- ---------- ---------- ----------
Total noninterest expense $3,636,800 $2,191,800 $6,806,300 $4,027,600
========== ========== ========== ==========
- --------------
/(1)/ Other operating expense primarily consists of donations, postage, and
travel expense.
Due largely to the growth-related expenses described above, noninterest
expense as a percentage of the sum of net interest income and noninterest income
(the "efficiency ratio") was 103.0% for the quarter ended June 30, 2002 compared
to 80.8% for the corresponding period of 2001 and to 98.1% for the six months
ended June 30, 2002 from 78.7% for the same six month period in 2001.
ASSET/LIABILITY MANAGEMENT
The objective of asset/liability management is to reduce our exposure to
interest rate fluctuations, which can affect our net interest margins and,
therefore, our net interest income and net earnings. We seek to achieve this
objective by matching interest-rate sensitive assets and liabilities, and
maintaining the maturity and repricing of these assets and liabilities at
appropriate levels given the interest rate environment. Generally, if rate
sensitive assets exceed rate sensitive liabilities, the net interest income will
be positively impacted during a rising rate environment and negatively impacted
during a declining rate environment. When rate sensitive liabilities exceed rate
sensitive assets, the net interest income will generally be positively impacted
during a declining rate environment and negatively impacted during a rising rate
environment. However, because interest rates for different asset and liability
products offered by depository institutions respond differently to changes in
the interest rate environment, the gap is only a general indicator of interest
rate sensitivity.
The table below sets forth information concerning our rate sensitive assets
and rate sensitive liabilities as of June 30, 2002. The assets and liabilities
are classified by the earlier of maturity or repricing date in accordance with
their contractual terms. Certain shortcomings are inherent in the method of
analysis presented in the following table.
13
For example, although certain assets and liabilities may have similar
maturities or periods of repricing, they may react in different degrees and at
different times to changes in market interest rates. Rates on some assets and
liabilities change in advance of changes in market rates of interest, while
rates on other assets or liabilities may lag behind changes in market rates of
interest. Additionally, loan and securities available for sale prepayments, and
early withdrawals of certificates of deposit, could cause the interest
sensitivities to vary from those which appear in the table.
Over Three Over One
Three Through Year Over Non-
Months Twelve Through Five Interest
Or Less Months Five Years Years Bearing Total
------- ------ ---------- ----- ------- -----
Assets
- ------
Interest-earning deposits in other
financial institutions $ 495,000 $ 1,191,000 $ -- $ -- $ -- $ 1,686,000
Securities available for sale 1,753,500 762,300 42,821,000 36,487,400 -- 81,824,200
Federal Reserve Bank and Federal Home
Loan bank stock -- -- -- 1,899,500 -- 1,899,500
Federal funds sold 35,850,000 -- -- -- -- 35,850,000
Loans, gross 142,274,700 29,422,900 24,490,400 3,945,600 -- 200,133,600
Non-interest earning assets -- -- -- -- 23,813,500 23,813,500
------------ ------------ ----------- ----------- ------------ ------------
Total assets $180,373,200 $ 31,376,200 $67,311,400 $42,332,500 $ 23,813,500 $345,206,800
============ ============ =========== =========== ============ ============
Liabilities and Stockholders' Equity:
- ------------------------------------
Noninterest-bearing deposits $ 83,783,000 $ -- $ -- $ -- $ 21,898,500 $105,681,500
Interest-bearing deposits 119,480,600 43,421,700 5,198,000 -- -- 168,100,300
Other borrowings 8,022,600 -- 15,000,000 -- -- 23,022,600
Investment in trust preferred securities 5,000,000 -- -- -- -- 5,000,000
Other liabilities -- -- -- -- 6,656,100 6,656,100
Stockholders' equity -- -- -- -- 36,746,300 36,746,300
------------ ------------ ----------- ----------- ------------ ------------
Total liabilities and stockholders equity $216,286,200 $ 43,421,700 $20,198,000 $ -- $ 65,300,900 $345,206,800
------------ ------------ ----------- ----------- ------------ ------------
Interest rate sensitivity gap $(35,913,000) $(12,045,500) $47,113,400 $42,332,500 $(41,487,400) $ --
============ ============ =========== =========== ============ ============
Cumulative interest rate sensitivity gap $(35,913,000) $(47,958,500) $ (845,100) $41,487,400 $ -- $ --
============ ============ =========== =========== ============ ============
Cumulative % of rate sensitive assets in
maturity period 52.25% 61.34% 80.84% 93.10% 100.00%
===== ===== ===== ===== ======
Rate sensitive assets to rate sensitive
liabilities 0.83 0.72 3.33 N/A N/A
==== ==== ==== === ===
Cumulative ratio 0.83 0.82 1.00 1.15 N/A
==== ==== ==== ==== ===
At June 30, 2002, our rate sensitive balance sheet was shown to be in a negative
gap position. This implies that our net interest margin would decrease in the
short-term if interest rates rise and would increase in the short-term if
interest rates were to fall. However, as noted above, the extent to which our
net interest margin will be impacted by changes in prevailing interests rates
will depend on a number of factors, including how quickly rate sensitive assets
and liabilities react to interest rate changes.
FINANCIAL CONDITION
Assets
We increased our total assets by 29.6% to $345,206,800 at June 30, 2002
from $266,434,000 at December 31, 2001. The increase in assets was funded by
increases in deposits and borrowings and by the issuance of $5,000,000 of trust
preferred securities. The additional funds from these sources were used
primarily to sell federal funds to other banks, fund loans, and purchase
securities available for sale.
Loans Held for Sale
Loans held for sale totaled $21,202,800 at June 30, 2002, down from
$63,696,600 at December 31, 2001. This decrease was attributable primarily to a
decrease in loans originated from approximately $63 million for the month of
December 2001 to approximately $49 million for the month of June 2002 and a
decrease in processing
14
time by the investors. Loans held for sale are carried at the lower of cost or
estimated fair value in the aggregate except for those that are designated as
fair value hedges which are carried at fair value. There were approximately
$21.2 million of loans held for sale designated as fair value hedges at June 30,
2002. Net unrealized losses, if any, are recognized through a valuation
allowance by charges to income.
Loans
Loans outstanding at June 30, 2002 and December 31, 2001 (exclusive of
loans held for sale) were made to customers in Southern California, the primary
market areas being Orange and Los Angeles Counties. The greatest concentration
of our loans are in real estate and commercial loans, which represented 59% and
35%, respectively, of the loan portfolio at June 30, 2002 and 46% and 45%,
respectively, at December 31, 2001.
The loan portfolio consisted of the following at June 30, 2002 and December
31, 2001:
June 30, December 31,
2002 Percent 2001 Percent
------------- ------- -------------- -------
Real estate loans $ 104,686,900 58.6% $ 68,447,200 45.8%
Commercial loans 61,955,000 34.7% 66,842,400 44.8%
Construction loans 6,325,100 3.5% 7,040,000 4.7%
Consumer loans 5,806,700 3.2% 6,992,300 4.7%
------------- ----- ------------- -----
Gross loans 178,773,700 100.0% 149,321,900 100.0%
===== =====
Deferred loan origination costs, net 157,100 138,200
Allowance for loan losses (1,895,800) (1,695,500)
------------- -------------
Loans, net $ 177,035,000 $ 147,764,600
============= =============
Commercial loans are loans to businesses to finance capital purchases or
improvements, or to provide cash flow for operations. Real estate loans are
loans secured by trust deeds on real property, including commercial property and
single family and multifamily residences. Construction loans are interim loans
to finance specific projects. Consumer loans include installment loans to
consumers.
The following table sets forth the maturity distribution of the Bank's loan
portfolio (excluding consumer loans) at June 30, 2002:
Over One
Year
One Year Through Over Five
Or Less Five Years Years Total
----------- ----------- ----------- -----------
Real estate loans
Floating rate $ 5,162,600 $ 8,713,700 $85,498,200 $ 99,374,500
Fixed rate 2,133,600 2,349,500 829,300 5,312,400
Commercial loans
Floating rate 34,842,000 8,318,800 1,761,900 44,922,700
Fixed rate 9,926,700 5,084,300 2,021,300 17,032,300
Construction loans
Floating rate 2,255,500 -- -- 2,255,500
Fixed rate 4,069,600 -- -- 4,069,600
----------- ----------- ----------- ------------
Total $58,390,000 $24,466,300 $90,110,700 $172,967,000
=========== =========== =========== ============
Allowance for Loan Losses
The allowance for loan losses at December 31, 2001 was $1,695,500, which
represented 1.1% of outstanding loans, excluding loans held for sale, at that
date. At June 30, 2002, the allowance had increased to $1,895,800, which
represented 1.1% of outstanding loans, excluding loans held for sale, at that
date. The Bank carefully monitors changing economic conditions, the loan
portfolio by category, borrowers' financial condition and the history of the
portfolio in determining the adequacy of the allowance for loan losses. We are
not currently aware of any information indicating that there will be material
deterioration in our loan portfolio, and we believe that the allowance for loan
losses at June 30, 2002 is adequate to provide for losses inherent in the
portfolio. However, the allowance was established on the basis of estimates
developed primarily from historical industry loan loss data
15
because the Bank commenced operations in March 1999 and lacks any long-term
historical data relating to the performance of loans in its loan portfolio. As a
result, ultimate losses may vary from the estimates used to establish the
allowance. As the volume of loans increases, additional provisions for loan
losses will be required to maintain the allowance at adequate levels.
Additionally, if economic conditions were to deteriorate, which would have the
effect of increasing the risk that borrowers would encounter difficulty meeting
their loan obligations, it would become necessary to increase the allowance by
means of additional provisions for loan losses.
We also measure and reserve for impairment on a loan by loan basis using
either the present value of expected future cash flows discounted at the loan's
effective interest rate, or the fair value of the collateral if the loan is
collateral dependent. We exclude from our impairment calculations smaller,
homogeneous loans such as consumer installment loans and lines of credit. Also,
loans that experience insignificant payment delays or payment shortfalls are
generally not considered impaired. The Bank had no impaired loans as of June 30,
2002 or December 31, 2001.
A summary of the transactions in the allowance for loan losses for the
three months ended June 30, 2002 and the year ended December 31, 2001 is as
follows:
June 30, 2002 December 31, 2001
------------- -----------------
Balance, beginning of period $ 1,695,500 $ 1,145,500
Provision for loan losses 205,000 550,000
Recoveries -- --
Amounts charged off (4,700) --
----------- -----------
Balance, end of period $ 1,895,800 $ 1,695,500
=========== ===========
Nonperforming Assets
As of June 30, 2002, the Bank had $81,000 in nonaccrual loans and $90,000
in loans delinquent 90 days or more. The Bank had no restructured or impaired
loans as of June 30, 2002. There were no nonaccrual loans, restructured loans or
loans which were considered impaired at December 31, 2001.
Deposits
At June 30, 2002 deposits totaled $273,781,800, which included $54,092,200
of certificates of deposits of $100,000 or more. By comparison, at December 31,
2001, deposits totaled $211,461,900, which included $39,952,400 of certificates
of deposit of $100,000 or more. Noninterest bearing demand deposits totaled
$105,681,500 or 38.6% of total deposits at June 30, 2002. By comparison
noninterest bearing demand deposits totaled $88,832,900, or 42.0% of total
deposits, at December 31, 2001.
Set forth below is maturity schedule of domestic time certificates of
deposits outstanding at June 30, 2002:
Certificates Certificates of
of Deposit Deposit of
Maturities Under $100,000 $100,000 or more
---------- -------------- ----------------
Three months or less $ 6,891,700 $28,346,800
Over three through six months 10,037,600 15,108,200
Over six through twelve months 8,883,400 9,392,500
Over twelve months 3,953,300 1,244,700
----------- -----------
$29,766,000 $54,092,200
=========== ===========
Business Segment Reporting
The Company has two reportable business segments, the commercial banking
division and the mortgage banking division. The commercial bank segment provides
small and medium-size businesses, professional firms and
16
individuals with a diversified range of products and services such as various
types of deposit accounts, various types of commercial and consumer loans, cash
management services, and Internet banking services. The mortgage banking segment
originates and purchases residential mortgages that, for the most part, are
resold within 30 days to long-term investors in the secondary residential
mortgage market.
Since the Company derives all of its revenues from interest and noninterest
income and interest expense is its most significant expense, these two segments
are reported below using net interest income (interest income less interest
expense) and noninterest income (net gains on sales of loans held for sale and
fee income) for the six months ended June 30, 2002 and 2001. The Company does
not allocate general and administrative expenses or income taxes to the
segments.
Commercial Mortgage Other Total
---------- ---------- --------- ----------
Net interest income for the
six months ended June 30:
2002 $2,756,300 $1,115,000 $963,900 $4,835,200
2001 1,931,100 735,600 1,186,400 3,853,100
Noninterest income for the
six months ended June 30:
2002 332,200 1,757,400 15,900 2,105,500
2001 325,500 938,500 -- 1,264,000
Segment Assets at:
June 30, 2002 177,773,700 21,472,000 145,961,100 345,206,800
December 31, 2001 148,368,900 26,383,100 91,682,000 266,434,000
LIQUIDITY
Our liquidity needs are actively managed to insure sufficient funds are
available to meet the ongoing needs of the Bank's customers. We project the
future sources and uses of funds and maintain sufficient liquid funds for
unanticipated events. The primary sources of funds include payments on loans,
the sale or maturity of investments and growth in deposits. The primary uses of
funds includes funding new loans, making advances on existing lines of credit,
purchasing investments, funding deposit withdrawals and paying operating
expenses. The Bank maintains funds in overnight federal funds and other
short-term investments to provide for short-term liquidity needs. The Bank also
maintains credit lines with the Federal Home Loan Bank and other financial
institutions to meet any additional liquidity requirements.
Cash flow provided by financing activities, primarily representing
increases in deposits, totaled $74,299,000 for the six months ended June 30,
2002. Cash flow provided by operating activities, primarily representing the net
decrease in loans held for sale, totaled $46,636,300. Cash flow used in
investing activities, primarily representing increases in loans offset by
purchases of securities available for sale, totaled $100,636,600 for the six
months ended June 30, 2002.
At June 30, 2002, liquid assets, which included cash and due from banks,
federal funds sold, interest earning deposits with financial institutions and
unpledged securities available for sale (excluding Federal Reserve Bank stock
and Federal Home Loan Bank stock) totaled $129,403,800 or 37% of total assets.
Our primary uses of funds are loans and our primary sources of the funds
that we use to make loans are deposits. Accordingly, the relationship between
gross loans and total deposits provides a useful measure of our liquidity. Since
repayment of loans tends to be less predictable than the maturity of investments
and other liquid resources, the higher the loan to deposit ratio the less liquid
are our assets. On the other hand, since we realize greater yields and higher
interest income on loans than we do on investments, a lower loan to deposit
ratio can adversely affect interest income and earnings. As a result,
management's goal is to achieve a loan to deposit ratio that appropriately
balances the requirements of liquidity and the need to generate a fair return on
assets. At June 30, 2002, the ratio of loans to deposits (excluding loans held
for sale) was 65.4%, compared to 70.7% at December 31, 2001.
As of June 30, 2002, the Company had $8.0 million in securities sold under
agreements to repurchase which are classified as secured borrowings and mature
within one day from the transaction date. Securities sold under agreements to
repurchase are reflected at the amount of cash received in connection with the
transaction. The Bank monitors the fair value of the underlying securities to
ensure that sufficient collateral exists. In addition, the
17
Company had $15,000,000 in advances from the Federal Home Loan Bank which
are for a two-year term and bear interest at 3.17% per annum. These advances are
scheduled to mature on June 21, 2004.
INVESTMENTS AND INVESTMENT POLICY
Our investment policy is designed to provide for our liquidity needs and to
generate a favorable return on investments without undue interest rate risk,
credit risk or asset concentrations. Our investment policy authorizes us to
invest in obligations issued or fully guaranteed by the United States
government, certain federal agency obligations, certain time deposits, certain
municipal securities and federal funds sold. It is our policy that there will be
no trading account. The weighted average duration life of U.S. government
obligations, federal agency securities and municipal obligations cannot exceed
five years. Time deposits must be placed with federally insured financial
institutions, cannot exceed $100,000 in any one institution and may not have a
maturity exceeding twenty-four months.
Securities available for sale are those that we intend to hold for an
indefinite period of time, but that may be sold in response to changes in
liquidity needs, changes in interest rates, changes in prepayment risks or other
similar factors. The securities are recorded at fair value. Any unrealized gains
and losses are reported as "Other Comprehensive Income (Loss)" rather than
included in or deducted from earnings.
The following is a summary of the major components of securities available
for sale and a comparison of the amortized cost, estimated fair values and gross
unrealized gains and losses as of June 30, 2002 and December 31, 2001:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
June 30, 2002 Cost Gains (Losses) Value
------------- ---- ----- -------- -----
Available-For-Sale:
U.S. Treasury Securities $ 3,519,100 $ -- $ (3,100) $ 3,516,000
U.S. Agency Securities 75,432,200 232,300 (322,800) 75,341,700
Collateralized Mortgage Obligations 2,886,400 80,100 -- 2,966,500
----------- ----------- ----------- -----------
Subtotal 81,837,700 312,400 (325,900) 81,824,200
Federal Reserve Bank Stock 892,900 -- -- 892,900
Federal Home Loan Bank Stock 1,006,600 -- -- 1,006,600
----------- ----------- ----------- -----------
Total $83,737,200 $ 312,400 $ (325,900) $83,723,700
=========== =========== =========== ===========
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 2001 Cost Gains (Losses) Value
----------------- ---- ----- -------- -----
Available-For-Sale:
U.S. Agency Securities $ 8,206,500 $ 133,900 $ -- $ 8,340,400
Collateralized Mortgage Obligations 3,450,100 55,700 (300) 3,505,500
----------- ----------- ----------- -----------
Subtotal 11,656,600 189,600 (300) 11,845,900
Federal Reserve Bank Stock 861,700 -- -- 861,700
Federal Home Loan Bank Stock 645,000 -- -- 645,000
----------- ----------- ----------- -----------
Total $13,163,300 $ 189,600 $ (300) $13,352,600
=========== =========== =========== ===========
At June 30, 2002, U.S. Treasury securities, U.S. Government agency
securities and collateralized mortgage obligations with a fair market value of
$9,522,400 were pledged to secure repurchase agreements and debtor in possession
accounts.
The amortized cost and estimated fair value of debt securities at June 30,
2002 by contractual maturities are shown in the following table. Expected
maturities and scheduled payments will differ from contractual maturities shown,
particularly with respect to collateralized mortgage obligations, because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
Maturing in
Over one year
One year Through five Over five years
Or less Years Through ten years Over ten years Total
------- ----- ----------------- -------------- -----
Available for sale, amortized cost $ 1,499,900 $40,090,600 $37,039,000 $ 3,208,200 $81,837,700
Available for sale, estimated fair value $ 1,499,700 $40,224,900 $36,896,500 $ 3,203,100 $81,824,200
18
CAPITAL RESOURCES
The Company and the Bank are subject to various regulatory capital
requirements administered by federal and state banking agencies. Failure to meet
minimum capital requirements can lead to certain mandatory and possible
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's operating results or financial
condition. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action that apply to all bank holding companies and FDIC
insured banks in the United States, the Company (on a consolidated basis) and
the Bank must meet specific capital guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance sheet items as
calculated under regulatory accounting practices. The Company's capital and
classifications 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 (on a consolidated basis) and the Bank to maintain minimum
amounts and ratios of total and Tier I capital (as defined in the regulations)
to risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management believes that, as of June 30, 2002, the
Company (on a consolidated basis) and the Bank met all capital adequacy
requirements to which they are subject.
In June 2002, the Company's newly formed wholly owned subsidiary, Pacific
Mercantile Capital Trust I, a Delaware trust, sold $5,000,000 of trust preferred
securities to an institutional investor in a private placement. These securities
mature in 30 years, are redeemable at the Company's option beginning after 5
years, and require quarterly distributions, initially at a rate of 5.65%, which
will reset quarterly at the three month LIBOR rate plus 3.75%. The trust
preferred securities are subordinated to other borrowings that may be obtained
by the Company in the future. The securities also qualify as tier one capital
for regulatory purposes which will enable us to support further growth. We
intend to seek additional trust preferred financing to support our continued
growth. Our ability to obtain such financing will depend on a number of factors,
including conditions in the financial markets and our future financial
performance and financial condition.
As of June 30, 2002, based on applicable capital regulations, the Company
(on a consolidated basis) and the Bank are categorized as well capitalized under
the regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Company and the Bank must maintain minimum total risk-based,
Tier I risk-based and Tier I leverage ratios as set forth in the following table
which contains a comparison of the Company and Bank's capital and capital ratios
at June 30, 2002 to the regulatory requirements applicable to them.
To be Well Capitalized
Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
------ ----------------- ----------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital to Risk Weighted Assets:
Bank $31,500,400 11.1% $22,757,000 8.0% $28,446,300 10.0%
Company 43,650,200 15.3% 22,831,000 8.0% 28,538,800 10.0%
Tier I Capital to Risk Weighted Assets:
Bank 29,604,600 10.4% 11,378,500 4.0% 17,067,800 6.0%
Company 41,754,400 14.6% 11,415,500 4.0% 17,123,300 6.0%
Tier I Capital to Average Assets:
Bank 29,604,600 9.6% 12,350,100 4.0% 15,437,700 5.0%
Company 41,754,400 13.5% 12,378,900 4.0% 15,473,600 5.0%
The Company intends to retain earnings to support future growth and,
therefore, does not intend to pay dividends for at least the foreseeable future.
19
FORWARD LOOKING INFORMATION AND UNCERTAINTIES REGARDING FUTURE FINANCIAL
PERFORMANCE
This Report, including Management's Discussion and Analysis of Financial
Condition and Results of Operations above, contains "forward-looking statements"
as defined in the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are estimates of, or statements about our
expectations or beliefs regarding, our future financial performance or
anticipated future financial condition that are based on current information.
Those estimates and expectations and beliefs, however, are subject to a number
of risks and uncertainties that could cause our actual operating results in the
future to differ significantly from those expected at the current time. Those
risks and uncertainties include, although they are not limited to, the
following:
Increased Competition. Increased competition from other banks and financial
service businesses, mutual funds and securities brokerage and investment banking
firms that offer competitive loan and investment products could require us to
reduce interest rates and loan fees to attract new loans or to increase interest
rates that we offer on time deposits, either or both of which could, in turn,
reduce net interest income and net interest margins.
Possible Adverse Changes in Economic Conditions. Adverse changes in
national or local economic conditions could (i) reduce loan demand which could,
in turn, reduce interest income and net interest margins; (ii) adversely affect
the financial capability of borrowers to meet their loan obligations which, in
turn, could require increases in provisions made for possible loan losses,
thereby adversely affecting operating results; and (iii) lead to reductions in
real property values that, due to our reliance on real property to secure many
of our loans, could make it more difficult for us to prevent losses from being
incurred on non-performing loans through the sale of such real properties.
Possible Changes in FRB Monetary Policies. Changes in national economic
conditions, such as increases in inflation or declines in economic output often
prompt changes in Federal Reserve Board monetary policies that could reduce
interest income or increase the cost of funds to us, either of which could
result in reduced earnings. During the past year there has been a slowing in
economic growth nationally, the continued duration of which is difficult to
predict at this time. In an effort to stimulate the economy, the Federal Reserve
Board has reduced market rates of interest, one of the effects of which has been
to reduce our net interest margins. How much longer the Federal Reserve Board
will continue to keep interest rates low is difficult to predict and if interest
rates remain low, it will be more difficult to increase income in future
periods. Additionally, uncertainties remain as to whether the national economy
will strengthen and there is the risk that political unrest in the Middle East
could lead to increases in energy prices that could adversely affect the economy
and, therefore, the demand for loans and the financial strength of borrowers.
Changes in Regulatory Policies. Changes in federal and state bank
regulatory policies, such as increases in capital requirements or in loan loss
reserve or asset/liability ratio requirements, could adversely affect earnings
by reducing yields on earning assets or increasing operating costs.
Effects of Growth. It is our intention to take advantage of opportunities
to increase our business, either through acquisitions of other banks or the
establishment of new banking offices. Additional growth will cause increases in
noninterest expense that could adversely affect our operating results, which is
what occurred during the six months ended June 30, 2002 as a result of our
opening of new financial centers and the commencement of operations of the
Company's securities brokerage subsidiary.
Potential Credit Card Refund Claims. In the fourth quarter of 2001 the Bank
established a reserve of $700,000 for claims for refunds of credit card charges
that the Bank collected for a former merchant customer that encountered
financial difficulties during that quarter and subsequently filed for bankruptcy
protection in an effort to reorganize and resume its operations. Those financial
difficulties led to the assertion of claims against the Bank for refunds of
credit card charges by some of the merchant's consumers. The outcome of the
merchant's efforts to reorganize is uncertain. As a result, additional refund
claims could be asserted against the Bank in the future and it could become
necessary to establish additional reserves for such claims, the amount of which
is uncertain, but which could lead to increases in noninterest expense, which
would have the effect of reducing our earnings, possibly significantly, or even
causing us to incur losses. As of June 30, 2002, the remaining reserve for
credit card refund claims amounted to $240,000.
20
Other risks and uncertainties that could affect our financial performance
or financial condition in the future are described in the Section entitled "Risk
Factors" in the Prospectus dated June 14, 2000, included in our S-1 Registration
Statement filed with the Securities and Exchange Commission under the Securities
Act of 1933, as amended, and our Annual Report on Form 10-K for the fiscal year
ended December 31, 2001 filed with the Securities and Exchange Commission under
the Securities Exchange Act of 1934, as amended. Readers of this Report are
urged to review the discussion of those risks as well contained in that
Prospectus and that Annual Report.
Due to these and other possible uncertainties and risks, readers are
cautioned not to place undue reliance on the forward-looking statements
contained in this Report, which speak only as of the date of this Quarterly
Report, or to make predictions based solely on historical financial performance.
We also disclaim any obligation to update forward-looking statements contained
in this Report, in our Prospectus or in our Annual Report, whether as a result
of new information, future events or otherwise.
ITEM 3. MARKET RISK
Market risk is the risk of loss to future earnings, to fair values of
assets or to future cash flows that may result from changes in the price or
value of a financial instrument. The value of a financial instrument may change
as a result of changes in interest rates and other market conditions. Market
risk is attributed to all market risk sensitive financial instruments, including
loans, investment securities, deposits and borrowings. We do not engage in
trading activities or participate in foreign currency transactions for our own
account. Accordingly, our exposure to market risk is primarily a function of our
asset and liability management activities and of changes in market rates of
interest. Changes in rates can cause or require increases in the rates we pay on
deposits that may take effect more rapidly or may be greater than the increases
in the interest rates we are able to charge on loans and the yields that we can
realize on our investments. The extent of that market risk depends on a number
of variables including the sensitivity to changes in market interest rates and
the maturities of our interest earning assets and our deposits. See
"Asset/Liability Management."
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of the Company was held on May 21, 2002.
At that Meeting, the shareholders elected the Directors of the Company for a
term of one year, ending at the next Annual Meeting of Shareholders to be held
in 2003, and voted on ratification of the selection made by the Board of
Directors of the Company's independent public accountants for the fiscal year
ending December 31, 2002.
21
(1) Directors Elected at Annual Meeting. Set forth below is the name of (i)
-----------------------------------
each Director that was nominated and elected at the Annual Meeting and the
respective numbers of votes cast for their election and the respective number of
votes withheld. As the election was uncontested, there were no broker non-votes.
Votes Cast
------------------------------
Nominee/Director For Withheld
---------------- --- --------
Raymond E. Dellerba 3,936,397 14,950
George H. Wells 3,937,397 13,950
Ronald W. Chrislip 3,937,397 13,950
Julia M. DiGiovanni 3,937,397 13,950
Warren T. Finley 3,937,397 13,950
John Thomas, M. D. 3,937,397 13,950
Robert E. Williams 3,937,397 13,950
(2) Ratification of Selection of Accountants. The shareholders ratified the
----------------------------------------
Board of Directors' selection of Grant Thornton LLP as the Company's independent
public accountants for fiscal 2002 by the following vote:
Votes Cast
----------------------------- Shares Broker
For Against Abstaining Non-Votes
----------- ------- ---------- ---------
3,924,971 6,700 19,676 0
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit 99.1 Certification of Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
Exhibit 99.2 Certification of Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
(b) Reports on Form 8-K:
None
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PACIFIC MERCANTILE BANCORP
Date: August 14, 2002 By: /s/ NANCY A GRAY
-------------------------------------
Nancy A. Gray,
Executive Vice President
and Chief Financial Officer
S-1
Index to Exhibits
Exhibit No. Description of Exhibit
- ----------- ----------------------
99.1 Certification of Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
E-1