Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10–Q

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.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

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 May 09, 2003

Table of Contents

PACIFIC MERCANTILE BANCORP
QUARTERLY REPORT ON FORM 10Q
FOR
THE QUARTER ENDED March 31, 2003

TABLE OF CONTENTS

(i)

Table of Contents

PART I. — FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)

The accompanying notes are an integral part of these consolidated financial statements.

1

Table of Contents

Part I.     Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except for per share data)
(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

2

Table of Contents

Part I.     Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

3

Table of Contents

Part I.     Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

4

Table of Contents

Part I.     Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

1.         Nature of Business

            The consolidated financial statements include the accounts of Pacific Mercantile Bancorp (“PMBC”) and its wholly owned subsidiaries Pacific Mercantile Bank, PMB Securities Corp, Pacific Mercantile Capital Trust I, PMB Capital Trust I, and  PMB Statutory Trust III (which, together with PMBC, shall be referred to as the “Company”).  PMBC, which was incorporated on January 7, 2000 in the State of California, is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended.  It was organized to acquire all of the outstanding shares of Pacific Mercantile Bank (the “Bank”), which is a California banking corporation that 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, deposit accounts of the Bank’s customers are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the maximum amount allowed by law.

            PMBC’s acquisition of the Bank was consummated on June 12, 2000, by means of a merger which resulted in the Bank becoming a wholly owned subsidiary of the Company and the Bank’s shareholders becoming the Company’s shareholders, owning the same number and percentage of the Company’s shares as they had owned in the Bank (the “Holding Company Reorganization”).  Prior to the Holding Company Reorganization, PMBC had only nominal assets and had not conducted any business.  All financial information included herein has been restated as if the holding company reorganization was effective for all periods presented.  Additionally, the number of common shares outstanding gives retroactive effect to a 2 for 1 stock split of the Bank’s outstanding shares that became effective on April 14, 2000.

            The Bank, which accounts for substantially all of the operations and income and expenses of the Company, provides a full range of banking services to small and medium-size businesses, professionals and the general public in Orange, Los Angeles and San Diego Counties of California and is subject to competition from other financial institutions conducting operations in those same markets.

            In June 2002, PMB Securities Corp, a wholly owned subsidiary of the Company, commenced operations.  PMB Securities Corp is a securities broker–dealer that is engaged in the retail securities brokerage business.  It is registered with the Securities and Exchange Commission and is a member firm of the National Association of Securities Dealers.

            In June 2002, Pacific Mercantile Capital Trust I, a Delaware trust, was organized by the Company to facilitate its sale of an issue of $5,000,000 trust preferred securities to an institutional investor in a private placement.

            In August 2002, PMB Capital Trust I, a Delaware trust, was organized by the Company to facilitate its sale of an issue of $5,000,000 of trust preferred securities to an institutional investor in a private placement.

            In September 2002, PMB Statutory Trust III, a Connecticut trust, was organized by the Company to facilitate the sale of an issue of $7,000,000 of trust preferred securities to an institutional investor in a private placement.

2.         Significant Accounting Policies

            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 accordance with accounting principles generally accepted in the United States of America (“US GAAP”). 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

5

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.–)

2.        Significant Accounting Policies (Cont.-)

consolidated financial statements have been prepared in accordance with US GAAP 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, 2002 and the notes thereto included in the Company’s Annual Report on Form 10–K for the fiscal year ended December 31, 2002 filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934.

            The Company’s consolidated financial position at March 31, 2003, and the results of its operations for the three month period ended March 31, 2003, are not necessarily indicative of the results of operations that may be expected for any other interim period during or for the full year ending December 31, 2003.

            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.  See “Item 2 -- Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained below in this Report.

            Principles of Consolidation

            The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

            Nonperforming Loans

            At March 31, 2003, the Company had $3,000 in nonaccrual loans and $3,000 in loans delinquent 90 days or more with principal that were still accruing interest.  There were no impaired or restructured loans as of March 31, 2003.

            Income Per Share

            Basic income per share is computed by dividing net income available to shareholders by the weighted average number of common shares outstanding during the period.  Fully diluted income per share reflects the potential dilution that could occur if convertible securities or options, or contracts to issue common stock, were exercised or converted into common stock or resulted in the issuance of common stock that then shared in net income available to shareholders.

            Stock Option Plan

            The Company accounts for stock-based employee compensation as prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and has adopted the disclosure provisions of Statements of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock Based Compensation.”  SFAS No. 123 requires pro-forma disclosures of the Company’s net income and net income per share as if the fair value based method of accounting for stock based awards had been applied.  Under the fair value based method, compensation cost is recorded based on the value of the award at the grant date and is recognized over the service period.  In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”, which amended the disclosure requirements of FASB No. 123 to require certain disclosures about stock-based employee compensation plans in an entity’s accounting policy note.  The disclosure requirements for interim financial information are effective for interim periods beginning after December 15, 2002 and in the case of calendar year-end entities, such as the Company, the new interim period disclosures are required to be included in their interim financial statements beginning with the first quarter of 2003.  The Company has adopted the disclosure provisions of SFAS No. 148 in the accompanying footnotes to the consolidated financial statements.

6

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.–)

2.        Significant Accounting Policies (Cont.-)

            Stock Option Plan (Cont.-)

            Effective March 2, 1999, the Board of Directors adopted a stock option plan (the “Option Plan”), which was subsequently approved by the Company’s shareholders.  The Option Plan authorizes the granting of options to directors, officers and other key employees, that entitle them to purchase shares of common stock of the Company at a price per share equal to or above the fair market value of the Company’s shares on the date the option is granted.  Options may vest immediately or over various periods of up to five years, determined at the time the options are granted and expire 10 years after the grant date, or following termination of service, if sooner.   A total of 1,248,230 shares were authorized for issuance under the Option Plan (which number has been adjusted for stock splits effectuated subsequent to the Plan’s adoption).  

            The Company continues to account for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” under which no compensation cost for stock options is recognized for stock option awards granted at or above fair market value.  Had compensation expense for the Company’s Option Plan been determined based upon the fair value at the grant date for awards under the Plan in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s net income and income per share would have been reduced to the pro forma amounts indicated below:

            The fair value of these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions for the three months ended March 31, 2003 and 2002, respectively:  dividend yield of 2.43% and 2.43%, expected volatility of  38% and a range from 46% to 48%, risk-free interest rate of 3.17% and a range from 4.49% to 4.52%, and, in each case, an expected option life of 5 years.

            Comprehensive Income

            Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income.  Although certain changes in assets and liabilities, such as unrealized gains and losses on securities available for sale, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

7

Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.–)

            Recent Accounting Pronouncements

            In December 2002, the FASB has issued Interpretation No. 46, “Consolidation of Variable Interest Entities” – an interpretation of Accounting Research Bulletin (“ARB”) No. 51.   This Interpretation defines a variable interest entity and provides that if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities and results of the activities of the variable interest entity should be included in consolidated financial statements with those of the business enterprise.   Furthermore, the FASB indicates that the voting interest approach of ARB No. 51 is not effective in identifying controlling financial interests in entities that are not controllable through voting interest or in which the equity investors do not bear the residual economic risk.   This Interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date.   It applies in the first fiscal year or interim period beginning after June 15, 2003 to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003.   The Interpretation applies to public enterprises as of the beginning of the applicable interim or annual period.  Management believes the implementation of this Interpretation will not have a material effect upon the Company’s financial statements.

            Reclassification

            Certain amounts in the accompanying 2002 consolidated financial statements have been reclassified to conform to 2003 presentation.

3.        Commitments and Contingencies

            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.  These financial instruments include 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 March 31, 2003, the Company was committed to fund loans totaling approximately $154,977,000 (inclusive of mortgages held for sale).  The contractual amounts of credit-related financial instruments such as commitments to extend credit, credit-card arrangements, and letters of credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer default, and the value of any existing collateral become worthless.

           The Company uses the same credit policies in making commitments to extend credit and conditional obligations as it does 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.  The Company evaluates each customer’s credit worthiness 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.

           In the ordinary course of business, the Company is subject to legal actions normally associated with financial institutions.  At March 31, 2003, the Company was not a party to any pending legal actions that would be material to its consolidated financial condition or results of operations.

8

Table of Contents

ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

             Forward–Looking Information

            Statements contained in this Report that are not historical facts or that discuss our expectations or beliefs regarding our future operations or future financial performance, or financial or other trends in our business, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.  Often, they include the words “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “project,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” or “may.”  Such forward-looking statements are based on current information and assumptions about future events over which we do not have control and our business is subject to a number of risks and uncertainties that could cause our financial condition or operating results in the future to differ significantly from those expected at the current time.  Those risks and uncertainties are 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 the Company’s operations are conducted by the Bank, which accounts for substantially all of the Company’s revenues and operating costs. 

            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 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 Board of Governors of the Federal Reserve Board (the “Federal Reserve”) 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.

            Critical Accounting Policies

            The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) and general practices in the banking industry.  The information contained within our financial statements is, to a significant extent, based on approximate measures of the financial effects of transactions and events that have already occurred. Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities. Management considers such accounting policies to be critical accounting policies. Management believes accounting for allowance for loan losses and derivative financial instruments to be critical accounting policies in the presentation of the financial condition and results of operations requiring management to make approximate measurements of the financial effects based on transactions and events that have already occurred. We use historical loss factors, adjusted for current conditions, to determine the inherent loss that may be present in our loan portfolio.  Actual loan losses could differ significantly from the loss factors that we use. See “Provision for Loan Losses” below in this Section of this Report.  Other estimates that we use include the fair value of derivative financial instruments.  The derivative financial instruments that we enter into consist primarily of interest rate lock commitments that are designed to hedge mortgage loans held for sale upon their funding.  At March 31, 2003, approximately $46,054,000 of loans held for sale were hedged.

9

Table of Contents

            Recent Operating Results

            The Company’s first quarter 2003 net income grew to $715,000, or $0.11 per fully diluted share, compared to $120,000 or $0.02 per fully diluted share, during the same quarter of fiscal 2002.  

            Net interest income increased by $1,127,000 or 47% to $3,503,000 and total revenues (net interest income plus other income) increased 72% to $5,866,000 in the quarter ended March 31, 2003 from $3,411,000 in the same quarter of 2002.  The Company’s net interest margin was 2.56% in the first quarter ended March 31, 2003, compared with 3.65% in the first quarter of 2002.  Margins continued to decline due primarily to the impact of the prime lending rate decrease that took place in the fourth quarter 2002 as a result of an interest rate reduction by the Federal Reserve.

            First quarter operating income (non-interest income only), boosted by growth in mortgage banking and, to a lesser extent, gains on sale of securities, increased by 128% to $2,363,000 from $1,035,000 in the first quarter a year ago. 

            Operating expenses increased 37% to $4,337,000 in the first quarter of 2003 from $3,169,000 in the same quarter of 2002. The increase in operating expenses was due primarily to financial center expansion and related increases in staffing at the offices established during 2002 and to an increase in compensation related primarily to the expansion of mortgage lending activities.  However, despite that increase, our efficiency ratio (operating expenses as a percentage of total revenues) improved to 74% in the first quarter of 2003 from 93% in the same quarter of 2002, indicating a maturing of and increased business growth at our financial centers that has helped us to generate more revenue per employee than we did in fiscal 2002.

            Set forth below are key financial performance ratios for the periods indicated:

RESULTS OF OPERATIONS

            Net Interest Income

            We generated net interest income of $3,503,000 in the three months ended March 31, 2003 as compared to $2,376,000 for the corresponding period of 2002, an increase of 47%.  This increase was attributable to increases in interest income of $2,888,000, which more than offset the increases in interest expense of $1,761,000 over the corresponding period of 2002.

            The increase in interest income for the three months ended March 31, 2003, over the like period of 2002, was primarily attributable to increases of approximately $97,083,000 in our average loans outstanding during the three months ended March 31, 2003 as compared to the same period in 2002, along with an increase in the average volume of government and agencies securities of $193,984,000.  The increase in government and agency securities involved a shift of funds out of lower yielding federal funds sold, enabling the Company to offset to a significant extent the impact of declining interest rates on loans and other interest earning assets.

            The increase in interest expense for the three months ended March 31, 2003 over the like period of 2002 was due primarily to increases in the volume of our interest bearing deposits, an increase in borrowings from the Federal Home Loan Bank, and the interest paid on the $17,000,000 of trust preferred securities issued during the second half of 2002, which more than offset the effect on interest expense of declining market rates of interest. Average interest

10

Table of Contents

bearing deposits outstanding during the three month period ended March 31, 2003 increased by approximately $185,847,000 as compared to the corresponding periods of 2002.  In addition, Federal Home Loan Bank average borrowings increased by $68,544,000 during the three months ended March 31, 2003, as compared to the same periods in 2002.

            Our ratio of net interest income to average earning assets (“net interest margin”) for the three month period ended March 31, 2003 declined to 2.56% from 3.65% in the same respective period of 2002, primarily as a result of the prime lending rate decrease in 2002 that was attributable to an interest rate reduction by the Federal Reserve and continued slowness in the economy.

            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 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 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 the volume of outstanding loans and 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 March 31, 2003, we made a provision for loan losses of $375,000 as compared to $50,000 for the quarter ended March 31, 2002.    This increase was made in response to the growth in the volume of our outstanding loans. Charge offs of loans during the quarter ended March 31, 2003 were $3,000.  For the three months ended March 31, 2002 loan charge offs were $5,000.  At March 31, 2003, the Allowance for Loan Losses represented 1.19% 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 can affect the ability of borrowers to meet their loan obligations. Future economic conditions 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 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 and net gains on sales of securities available for sale.  The mortgage loan division originates conforming and non–conforming, agency quality, residential first and home equity mortgage loans.

11

Table of Contents

            As indicated in the table that follows, noninterest income increased by $1,328,000 or 128% in the quarter ended March 31, 2003, as compared to the same quarter of 2002.  Those increases were primarily attributable to (i) substantial increases in mortgage loan refinancings prompted by declining market rates of interest, and (ii) net gains on sales of $98,746,000 principal amount of securities available for sale made during the three months end March 31, 2003 to reposition the Company’s securities portfolio in response to changes in market rates of interest.

            Noninterest Expense

            Total noninterest expense for the three months ended March 31, 2003 increased by 37% to $4,337,000 from $3,169,000 for the corresponding period of 2002.  As indicated in the table below, salaries and employee benefits constitute the largest components of noninterest expense.  The increase in noninterest expense in the first three months of 2003 was primarily attributable to financial center expansion and related increases in staffing at the offices established during 2002 and to compensation related to the expansion of mortgage lending activities.

            The following table sets forth the principal components of noninterest expense and the amounts thereof, incurred in the three months ended March 31, 2003 and March 31, 2002.

⁽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 74% for the quarter ended March 31, 2003 compared to 93% for the corresponding period of 2002. 

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

12

Table of Contents

assets and liabilities at appropriate levels given the interest rate environment.  Generally, if rate sensitive assets exceed rate sensitive liabilities, 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, net interest income generally will 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 March 31, 2003. 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.

            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.

            At March 31, 2003, our rate sensitive balance sheet was shown to be in a positive three month gap position. This implies that our net interest margin would increase in the short–term if interest rates rise and would decrease 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.

13

Table of Contents

FINANCIAL CONDITION

            Assets

            We increased our total assets by 8% to $619,919,000 at March 31, 2003 from $573,935,000 at December 31, 2002.  The increase in assets was funded by increases in deposits and borrowings.  The additional funds from these sources were used primarily to sell federal funds to other banks.

            Loans Held for Sale

            Loans held for sale (consisting primarily of mortgage loans) totaled $46,054,000 at March 31, 2003, down from $57,294,000 at December 31, 2002.  This decrease was attributable primarily to a decrease in the average number of days the loans were outstanding due to quicker processing times by 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 $46,054,000 of loans held for sale designated as fair value hedges at March 31, 2003. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

            Loans

            Loans outstanding at March 31, 2003 and December 31, 2002 (exclusive of loans held for sale) were made to customers in Southern California, the primary market areas being Orange, Los Angeles, and San Diego Counties.  The greatest concentration of our loans are in real estate and commercial loans, which represented 37% and 34%, respectively, of the loan portfolio at March 31, 2003 and 35% and 35%, respectively, at December 31, 2002. 

            At March 31, 2003 and December 31, 2002 the loan portfolio consisted of the following