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UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
Of the Securities Exchange Act of 1934
For Quarter Ended September 30, 2003
Commission file number: 0-49892
-------------------------------
PACIFIC STATE BANCORP
------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
California 61-1407606
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1889 W. March Lane, Stockton, CA 95207
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code (209) 943-7400
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports,) and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 126-2 of the Exchange Act.
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the registrant issuer's
classes of common stock, as of the latest practicable date:
Title of Class Shares outstanding as of November 10, 2003
-------------- ------------------------------------------
Common Stock
No Par Value 1,670,068
PART I
ITEM 1. FINANCIAL STATEMENTS
PACIFIC STATE BANCORP
Consolidated Balance Sheet
September 30, December 31,
2003 2002
------------- ------------
(Unaudited)
Assets
- ------
Cash and due from banks $ 12,482,686 $ 18,465,668
Federal funds sold 1,625,000 5,000,000
Investment securities (market value of
$15,415,522 in 2003 and $12,764,300 in 2002) 15,388,379 12,767,400
Loans, less allowance for loan losses of
$1,514,127 in 2003 and $1,306,309 in 2002 159,737,158 133,965,914
Other real estate -0- 48,704
Bank premises and equipment, net 8,360,401 6,429,899
Accrued interest receivable and other assets 7,706,934 3,462,899
------------ ------------
Total assets $205,300,558 $180,140,484
============ ============
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits:
Non-interest bearing $ 42,317,759 $ 30,697,547
Interest bearing 139,606,582 127,442,460
------------ ------------
Total deposits 181,924,341 158,140,007
Borrowed funds 5,000,000 5,000,000
Accrued interest payable and other liabilities 623,839 680,615
Mandatorily redeemable cumulative trust
preferred securities of subsidiary grantor
trust 5,000,000 5,000,000
------------ ------------
Total liabilities 192,548,180 168,820,622
Shareholders' equity:
Preferred stock - no par value; 4,000,000
shares authorized; none issued and outstanding -- --
Common stock - no par value; 24,000,000
shares authorized; shares issued and
outstanding 1,669,868 in 2003 and 1,612,874
in 2002 6,918,722 6,915,534
Retained earnings 5,816,149 4,404,078
Accumulated other comprehensive income 17,507 250
------------ ------------
Total shareholders' equity 12,752,378 11,319,862
------------ ------------
Total liabilities and shareholders' equity $205,300,558 $180,140,484
============ ============
See notes to unaudited condensed consolidated financial statements
2
Pacific State Bancorp
Statement of Income
(Unaudited)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Interest income:
Interest and fees on loans $2,785,575 $2,174,095 $7,748,713 $6,112,177
Interest on federal funds sold 4,805 21,628 73,066 46,788
Interest on investment securities
Taxable 68,372 125,067 197,546 340,684
Exempt from Federal income taxes 49,586 50,322 150,228 178,647
---------- ---------- ---------- ----------
Total interest income 2,904,325 2,371,112 8,169,553 6,678,296
Interest expense:
Interest on deposits 578,245 725,155 1,852,192 2,140,438
Trust preferred securities 60,988 958 179,188 1,297
Interest on short-term borrowings 33,741 68,194 96,769 68,194
---------- ---------- ---------- ----------
Total interest expense 672,973 794,307 2,128,149 2,209,929
---------- ---------- ---------- ----------
Net interest income 2,235,366 1,576,805 6,041,404 4,468,367
Provision for loan losses 138,000 81,500 398,000 239,500
---------- ---------- ---------- ----------
Net interest income after
provision for loan losses 2,097,365 1,495,305 5,643,404 4,228,867
---------- ---------- ---------- ----------
Non-interest income:
Service charges 168,951 151,129 477,100 388,935
Other fee income 160,288 100,847 464,668 347,830
Rental income from other real estate 3,120 4,860 12,840 14,580
Gain from sale of securities -- -- -- 26,334
Gain from sale of loans 81,924 73,179 390,473 382,938
---------- ---------- ---------- ----------
Total non-interest income 414,283 330,015 1,345,081 1,160,617
Other expenses:
Salaries and employee benefits 804,887 684,990 2,282,964 1,851,580
Occupancy 171,514 142,611 500,671 405,476
Furniture and equipment 126, 361 135,724 365,448 431,942
Other 545,293 608,225 1,605,431 1,604,476
---------- ---------- ---------- ----------
Total other expenses 1,648,055 1,571,550 4,754,514 4,293,474
---------- ---------- ---------- ----------
Income before income taxes 863,593 253,770 2,233,971 1,096,010
Income tax expense 333,500 79,500 821,900 370,000
---------- ---------- ---------- ----------
Net income $ 530,093 $ 174,270 $1,412,071 $ 726,010
========== ========== ========== ==========
Basic earnings per share $ 0.32 $ 0.11 $ 0.85 $ 0.45
========== ========== ========== ==========
Diluted earnings per share $ 0.31 $ 0.10 $ .083 $ 0.43
========== ========== ========== ==========
Weighted average common shares outstanding 1,651,540 1,638,066 1,658,360 1,600,910
Weighted average common and
common equivalent shares outstanding 1,697,476 1,716,546 1,704,296 1,685,376
See notes to unaudited condensed financial statements
3
Pacific State Bancorp and Subsidiaries
Statement of Cash Flows
(Unaudited)
For the Nine Months Ended
September 30,
2003 2002
----------- -----------
Cash flows from operating activities:
Net income 1,412,071 726,010
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 398,000 239,500
Deferred loan origination fess and costs, net 35,771 (40,456)
Depreciation and amortization 331,447 203,582
Net increase in cash surrender value of life
insurance policies (25,780)
Oreo write-downs charged to expense -- 35,605
Gain on sale of available-for-sale investment
securities (2,116)
Increase in accrued interest receivable and other assets (217,320) (790,630)
Decrease in accrued interest payable and other
liabilities (56,776) (347,175)
----------- -----------
Net cash provided by operating activities 1,875,297 26,436
Cash flows from investing activities:
Net increase in interest bearing deposits in banks (3,500,000)
Proceeds from matured and called available-for-sale
investment securities 150,000 8,646,667
Purchase of available-for-sale investment securities (3,740,530) (14,890,909)
Proceeds from principal repayments from available-for-
sale mortgage-backed securities 4,358,309 140,921
Proceeds from principal repayments from held-to-
maturity mortgage-backed securities 102,435 53,933
Net increase in loans (26,286,189) (20,657,964)
Proceeds from sale of other real estate 49,704 130,415
Purchases of bank premises and equipment (2,053,794) (1,075,671)
Proceeds from the sale of equipment -- 3,043
Net liabilities assumed in acquisition of cb&T BRANCH -- 13,805,923
Purchase of life insurance policies (4,135,250)
----------- -----------
Net cash used in investing activities (35,055,315) (13,843,642)
Cash flows from financing activities:
Net increase in demand, interest-bearing and savings deposits 10,492,676 8,454,348
Net increase in time deposits 13,291,658 (1,225,874)
Net increase in short-term borrowings -- 2,000,000
Issuance of manditorily redeemable cumulative trust preferred
securities of subsidiary grantor trust -- 5,000,000
Repurchase of common stock (170,546)
Proceeds from stock options exercised 208,248 144,861
----------- -----------
Net cash provided by financing activities 23,822,036 14,373,335
----------- -----------
(Decrease) increase in cash and cash equivalents (9,357,982) 556,129
Cash and cash equivalents at beginning of year 23,465,668 6,825,720
----------- -----------
Cash and cash equivalents at end of period 14,107,686 7,381,849
=========== ===========
See notes to unaudited condensed financial statements
4
Pacific State Bancorp
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
1. CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the unaudited consolidated financial statements
contain all adjustments (consisting of only normal recurring adjustments)
necessary to present fairly the consolidated financial position of Pacific State
Bancorp (the "Company") at September 30, 2003 and December 31, 2002, and the
results of its operations and its cash flows for the month periods ended
September 30, 2003 and 2002.
Certain disclosures normally presented in the notes to the financial statements
prepared in accordance with generally accepted accounting principles have been
omitted. These interim consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 2002 Annual Report to Shareholders. The results of
operations for the three month and nine month periods ended September 30, 2003
may not necessarily be indicative of the operating results for the full year.
In preparing such financial statements, management is required to make estimates
and assumptions that affect the reported amounts of assets and liabilities as of
the date of the balance sheet and revenues and expenses for the period. Actual
results could differ significantly from those estimates. Material estimates that
are particularly susceptible to significant changes in the near term relate to
the determination of the allowance for loan and lease losses, the provision for
taxes and the estimated fair value of investment securities.
2. STOCK-BASED COMPENSATION
As of September 30, 2003, the Company had two stock-based employee compensation
plans, the Pacific State Bancorp 1997 Stock Option Plan and the Pacific State
Bancorp 1987 Stock Option Plan (the "Plans"). The Company accounts for these
plans under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under these plans had an exercise price equal to the market
value of the underlying common stock on the date of grant.
Pro forma adjustments to the Company's consolidated net earnings and earnings
per share are disclosed during the years in which the options become vested. The
following table illustrates the effect on net income and earnings per share if
the Company had applied the fair value recognition provisions of FASB Statement
No. 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
For the Three Months For the Nine Months
Ended Ended
--------------------- -----------------------
2003 2002 2003 2002
--------- --------- ----------- ---------
Net income, as reported $ 530,093 $ 174,270 $ 1,412,071 $ 726,010
Deduct: Total stock-based
employee
compensation expense
determined
under the fair value method
for all awards, net of
related tax effects 9,552 7,477 28,656 22,432
--------- --------- ----------- ---------
520,540 166,793 1,383,415 703,578
========= ========= =========== =========
Basic earning per share - as
reported $ 0.32 $ 0.11 $ 0.85 $ 0.45
Basic earning per share - pro
forma $ 0.32 $ 0.10 $ 0.83 $ 0.44
Diluted earnings per share -
as reported $ 0.31 $ 0.10 $ 0.83 $ 0.43
Diluted earnings per share -
pro forma $ 0.31 $ 0.16 $ 0.81 $ 0.42
5
3. EARNINGS PER SHARE COMPUTATION
Basic earnings per share is computed by dividing net income by the weighted
average common shares outstanding for the period. Diluted earnings per share
reflect the potential dilution that could occur if outstanding stock options
were exercised. Diluted earnings per share is computed by dividing net income by
the weighted average common shares outstanding for the period plus the dilutive
effect of options
4. COMPREHENSIVE INCOME
Comprehensive income is reported in addition to net income for all periods
presented. Comprehensive income is made up of net income plus other
comprehensive income (loss). Other comprehensive income (loss), net of taxes, is
comprised of the unrealized gains (losses) on available-for-sale investment
securities. The following table shows comprehensive income and it's components
for the periods indicated:
Three Months Ended Nine Months Ended
----------------------- ------------------------
9/30/2003 9/30/2002 9/30/2003 9/30/2002
---------- ---------- ---------- ----------
Net Income $ 530,093 $ 174,270 $1,412,071 $ 726,010
Other Comprehensive Income Loss):
Change in unrealized gain (loss)
on available for sale securities -84,000 48,000 18,000 139,000
Reclassification adjustment 0 0 0 (16,000)
---------- ---------- ---------- ----------
Total Other Comprehensive Income (Loss) -84,000 48,000 18,000 123,000
Total Comprehensive Income 446,093 222,270 1,430,071 849,010
========== ========== ========== ==========
5. COMMITMENTS AND CONTINGENCIES
In the normal course of business there are outstanding various commitments to
extend credit which are not reflected in the financial statements, including
loan commitments of approximately $37,569,000 and letters of credit of $381,000
at September 30, 2003. However, all such commitments will not necessarily
culminate in actual extensions of credit by the Company during 2003.
Approximately $10,962,000 of the loan commitments outstanding at September 30,
2003 are for real estate loans and are expected to fund within the next twelve
months. The remaining commitments primarily relate to revolving lines of credit
or other commercial loans, and many of these are expected to expire without
being drawn upon. Therefore, the total commitments do not necessarily represent
future cash requirements. Each potential borrower and the necessary collateral
are evaluated on an individual basis. Collateral varies, but may include real
property, bank deposits, debt or equity securities or business assets.
Stand-by letters of credit are commitments written to guarantee the performance
of a customer to a third party. These guarantees are issued primarily relating
to purchases of inventory by commercial customers and are typically short term
in nature. Credit risk is similar to that involved in extending loan commitments
to customers and accordingly, evaluation and collateral requirements similar to
those for loan commitments are used. Virtually all such commitments are
collateralized.
6. ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 148, Accounting for
Stock-Based Compensation--Transition and Disclosure--an amendment of SFAS
Statement No. 123. This Statement amends SFAS No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
transition guidance and annual disclosure provisions of SFAS No. 148 are
effective for fiscal years ending after December 15, 2002. The interim
6
disclosure provisions are effective for financial reporting containing financial
statements for interim periods beginning after December 15, 2002. Because the
Company accounts for the compensation cost associated with its stock option plan
under the intrinsic value method, the alternative methods of transition will not
apply to the Company. The additional disclosure requirements of the Statement
are included in these consolidated financial statements. In management's
opinion, the adoption of this Statement did not have a material impact on the
Company's consolidated financial position or results of operations.
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45).
FIN 45 requires that a liability for the fair value of an obligation for
guarantees issued or modified after December 31, 2002 be recorded in the
financial statements of the guarantor. Guarantees existing before the
implementation of FIN 45 are required to be disclosed in financial statements
issued after December 15, 2002. While the Company has various guarantees
included in contracts in the normal course of business, primarily in the form of
indemnities, these guarantees would only result in immaterial increases in
future costs, and do not represent significant commitments or contingent
liabilities of the indebtedness of others.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46), which requires the consolidation of
variable interest entities, as defined. FIN 46 is currently applicable to
variable interest entities created after January 31, 2003. In October 2003, the
FASB agreed to defer the effective date of FIN 46 for variable interests held by
public companies in all entities that were acquired prior to February 1, 2003.
This deferral is to allow time for certain implementation issues to be addressed
through the issuance of a potential modification to the interpretation. The
deferral revised the effective date for consolidation of these entities to the
period ended December 31, 2003 for calendar year end companies. Based on the
current rules, the Company does not believe that the implementation of the
interpretation will have a material impact on the Company's financial position
or results of operations
On April 30, 2003, the FASB issued Statement SFAS No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities. This Statement
amends and clarifies the accounting for derivative instruments by providing
guidance related to circumstances under which a contract with a net investment
meets the characteristics of a derivative as discussed in Statement 133. The
Statement also clarifies when a derivative contains a financing component. The
Statement is intended to result in more consistent reporting for derivative
contracts and must be applied prospectively for contracts entered into or
modified after June 30, 2003, except for hedging relationships designated after
June 30, 2003. In management's opinion, adoption of this statement is not
expected to have a material effect on the Company's consolidated financial
position or results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). This Statement is effective
for financial instruments entered into or modified by the Company after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The Company has previously accounted for its
mandatorily redeemable cumulative trust preferred securities in a manner
consistent with the Statement and, in management's opinion, adoption of this
Statement did not have a material effect on the Company's consolidated financial
position or results of operations.
7. STOCK SPLIT
On September 18, 2003 the Company's board of directors declared a two-for-one
payable to shareholders of record on September 30, 2003. All references to share
and per share data included in these unaudited condensed consolidated financial
statements have been restated as if the stock split was effected on the first
day of all periods presented.
8. SALARY CONTINUATION PLANS
As of July 17, 2003, the Board of Directors approved salary continuation plans
for certain key executives. Under these plans, the executives will receive
annual benefits for twenty years after retirement. These benefits are
substantially equivalent to those available under split-dollar life insurance
policies purchased by the Bank on the life of the executives. In addition, the
estimated present value of these future benefits is accrued from the effective
date of the plan until the executives' expected retirement dates. The expense
recognized under these plans for the quarter ending September 30, 2003 totaled
$1,734.00.
In connection with these plans, the Bank purchased single life insurance
policies with cash surrender values totaling approximately $4,160,030.00 at
September 30, 2003. On the balance sheet, the cash surrender values are included
in accrued interest receivable and other assets. Income earned on these
policies, net of expenses, totaled $25,780 for the quarter ended September 20,
2003.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF PACIFIC STATE BANCORP
The following is management's discussion and analysis of the significant changes
in Pacific State Bancorp (the "Company") balance sheet accounts between
September 30,2003 and December 31, 2002 and its income and expense accounts for
the three and nine-month periods ended September 30, 2003 and 2002. The
discussion is designed to provide a better understanding of significant trends
related to the Company's financial condition, results of operations, liquidity,
capital resources and interest rate sensitivity.
7
In addition to the historical information contained herein, this report on Form
10-Q contains certain forward-looking statements. The reader of this report
should understand that all such forward-looking statements are subject to
various uncertainties and risks that could affect their outcome. The Company's
actual results could differ materially from those suggested by such
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, variances in the actual versus
projected growth in assets, return on assets, loan losses, expenses, changes in
the interest rate environment including interest rates charged on loans, earned
on securities investments and paid on deposits, competition effects, fee and
other noninterest income earned, general economic conditions, nationally,
regionally and in the operating market areas of the Company and its
subsidiaries, changes in the regulatory environment, changes in business
conditions and inflation, changes in securities markets, data processing
problems, a decline in real estate values in the Company's market area, the
effects of terrorism, the threat of terrorism or the impact of potential
military conflicts and the conduct of the war on terrorism by the United States
and its allies, as well as other factors. This entire report should be read to
put such forward-looking statements in context. To gain a more complete
understanding of the uncertainties and risks involved in the Company's business,
this report should be read in conjunction with the Company's annual report on
Form 10-K for the year ended December 31, 2002.
General Description of Business
Pacific State Bancorp is a holding company with one bank subsidiary, Pacific
State Bank, (the "Bank"), and a subsidiary trust, Pacific State Statutory Trust
I. Pacific State Bancorp commenced operations on June 24, 2002 when it acquired
all the then issued and outstanding shares of Pacific State Bank under a plan of
reorganization approved by the Bank's shareholders on May 9, 2002. The Bank is a
California state chartered bank. The Bank's primary source of revenue is
providing loans to customers who are predominately small to middle-market
businesses and middle-income individuals. Pacific State Statuatory Trust I is a
statuatory business trust formed in June 2002 for the exclusive purpose of
issuing and selling trust preferred securities.
The Bank has engaged since November 2, 1987 in a general commercial banking
business, primarily in Stockton and San Joaquin County, and offers commercial
banking services to residents and employers of businesses in the Bank's service
area, including professional firms and small to medium sized retail and
wholesale businesses and manufacturers. The Company as of January 22, 2003 had
56 employees, including 25 officers. The Bank does not engage in any non-bank
lines of business. The business of the Bank is not to any significant degree
seasonal in nature. The Bank has no operations outside California and has no
material amount of loans or deposits concentrated among any one or few persons,
groups or industries. The Bank is a member of the Federal Reserve System.The
Bank's main office is located at 6 So. El Dorado Street; additional branches are
located elsewhere in Stockton and in the communities of Angels Camp, Arnold,
Groveland, Modesto and Tracy, California.
Business Plan
- -------------
The focus of the Company's business plan is to attract "middle market" accounts,
but not to the exclusion of any other business which the Company can reasonably
and profitably attract. In order to provide a level of service to attract such
customers, the Company has structured its specific services and charges on a
basis which management believes to be profitable, taking into consideration
other aspects of the account relationship. The Company offers a range of banking
services to its customers intended to attract the following specific types of
accounts: relatively large consumer accounts; professional group and association
accounts, including the accounts of groups or firms of physicians, dentists,
attorneys and accountants; and accounts of small to medium-sized businesses
engaged in retail, wholesale, light industrial and service activities.
Critical Accounting Policies
General
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP). The
financial information contained within our statements is, to a significant
extent, financial information that is based on measures of the financial effects
of transactions and events that have already occurred. A variety of factors
could affect the ultimate value that is obtained either when earning income,
recognizing an expense, recovering an asset or relieving a liability. We use
historical loss factors as one factor in determining the inherent loss that may
be present in our loan portfolio. Actual losses could differ significantly from
the historical factors that we use. Other estimates that we use are related to
the expected useful lives of our depreciable assets. In addition, GAAP itself
may change from one previously acceptable method to another method. Although the
economics of our transactions would be the same, the timing of events that would
impact our transactions could change.
8
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be sustained
in our loan portfolio. The allowance is based on two basic principles of
accounting. (1) Statement of Financial Accountings Standards (SFAS) No. 5
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and estimable and (2) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued based
on the differences between the value of collateral, present value of future cash
flows or values that are observable in the secondary market and the loan
balance. The Company employs a comprehensive methodology for estimating inherent
losses consistent with SFAS 5 and SFAS 114; however, actual losses could vary
significantly from these estimates. For further discussion, see "Allowance for
loan losses (ALL)'.
Results of Operations
Period Ended September 30, 2003 Compared to Period Ended September 30, 2002
Net income for the three month period ended September 30, 2003, was $530,000,
representing an increase of $356,000, or 205%, over net income of $174,000 for
the three month period ended September 30, 2002. A contributing factor to the
increase in net income was an increase in interest income of 22.7% as well as an
increase in the gain on sale of loans of 12%.
Return on average assets (ROA) was 1.25% and return on average common equity
(ROE) was 17.79% for the three month period ended September 30, 2003 compared
with .47% and 8.23% respectively in 2002. Diluted earnings per share for 2003
and 2002 were $0.31 and $0.10, respectively, an increase of 208%. The increase
in earnings per share was due to the increase in net income.
Net income for the nine month period ended year ended September 30, 2003, was
$1,412,000 representing an increase of $686,000, or 94.5%, over net income of
$726,000 for the nine month period ended September 30, 2002. A contributing
factor to the increase in net income was an increase in interest income of
$1,491,000.
Return on average assets (ROA) was 1.03% and return on average common equity
(ROE) was 15.987% for the nine month period ended September 30, 2003 compared
with .66% and 9.62% respectively in 2002. Diluted earnings per share for 2003
and 2002 were $0.83 and $.043, respectively, an increase of 93%. The increase in
earnings per share is due to the increase in income of 88.9%.
Net Interest Income
The primary source of income for the Company is derived from net interest
income. Net interest income represents the excess of interest and fees earned on
interest-earning assets (loans, securities and federal funds sold) over the
interest paid on deposits and borrowed funds.
Net interest income increased to $6.0 million for the nine month period in 2003
versus $4.7 million in 2002 representing a 27.66% increase. The average balance
of total earning assets during 2003 increased 23.25% to $168.6 million from
$136.8 million. Average loan balances outstanding during 2003 increased $36.3
million or 32.45%, while average balances of investments and federal funds sold
decreased by $4.7 million or 27.25%. The average yields on loans and federal
funds sold in 2003 were lower by 54 and 69 basis points respectively, while the
average yield on securities decreased by 54 basis points.
Total interest expense decreased to $2.1 million in 2003, from $2.2 million for
2002, representing a 4.76% decrease. Average balances of interest-bearing
liabilities increased to $148.6 million from $110.9 million for the period ended
September 30, 2003, or 33.99%.
9
Average certificates of deposit increased to $73.8 million in 2003 from $53.4
million in 2002, a 38.20% increase. The average rate paid on certificates of
deposit during 2003 decreased 146 basis points, while the overall average rate
paid on interest bearing deposits and borrowings decreased 65 basis points to
1.38% from 2.03% for 2002.
The Company's net interest margin (net interest income divided by average
earning assets) was 4.90% in 2003 and 4.59% in 2002. The combined effect of the
increase in volume of earning assets and decrease in yield on earning assets,
coupled with stable funding sources resulted in an increase of $1.6 million
(35.2%) in net interest income for the period ended September 30, 2003 over
2002.
Non-interest Income
The Company's non-interest income consists primarily of service charges on
deposit accounts, gain on sale of loans and other service fees. Non-interest
income also includes ATM fees earned at various locations. For the three month
period ended September 30 2003, non-interest income represented 12.48% of the
Company's revenues versus 12.22% in 2002. For the nine month period ended
September 30 2003, non-interest income represented 14.14% of the Company's
revenues versus 17.17% in 2002. Historically, the Company's service charges on
deposit accounts have lagged peer levels for similar services. This is
consistent with the Company's philosophy of allowing customers to pay for
services with compensating balances and the emphasis on core deposits as a
significant funding source.
Total non-interest income increased to $.414 million for the three months ended
September 30, 2003 over $.330 million in 2002, representing an increase of
25.56%. Total non-interest income increased to $1,346 million for the nine
months ended September 30, 2003 over $1,161 million in 2002, representing an
increase of 15.98%.
The following table sets forth a summary of non-interest income for the periods
indicated.
Three Month Period Ended September 30, 2003 2002
----- -----
(Dollars in thousands)
Non-interest Income:
Service Charges 169 151
Rental Income from Other Real Estate 3 5
Gain on Sale of Guaranteed Loans 82 73
Other Income 160 101
----- -----
Total Non-interest Income 414 330
===== =====
================================================================================
Nine Month Period Ended September 30, 2003 2002
----- -----
(Dollars in thousands)
Non-interest Income:
Service Charges 477 389
Rental Income from Other Real Estate 13 15
Gain on Sale of Guaranteed Loans 390 383
Gain on Sale of Investment Securities -- 26
Other Income 465 348
----- -----
Total Non-interest Income 1,345 1,161
===== =====
================================================================================
Non-interest Expense
Non-interest expense consists of salaries and related employee benefits,
occupancy and equipment expenses, data processing fees, professional fees,
directors' fees and other operating expenses. Non-interest expense for the three
month period ended September 30, 2003 was $1.65 million compared to $1.57
million for 2002 an increase of 4.9% for 2003. Non-interest expense for the nine
month period ended September 30, 2003 was $4.8 million compared to $4.3 million
for 2002 an increase of 10.74% for 2003. Increases in salaries and benefits are
indicative of the additions to staff to expand branch operations in line with
10
their respective growth for the year. The increase in occupancy is attributable
to the completion of two buildings in Groveland and Angels Camp to house the
existing branches that were previously located in leased buildings.
The following table sets forth a summary of non-interest expense for the periods
indicated.
Three Month Period Ended September 30, 2003 2002
------ ------
Non-interest Expense:
Salaries & Benefits $ 805 $ 685
Occupancy 172 143
Furniture and Equipment 126 136
Other Expense 545 608
------ ------
Total Non-Interest Expenses $1,648 $1,572
====== ======
================================================================================
Three Month Period Ended September 30, 2,003 2,002
------ ------
Non-interest Expense:
Salaries & Benefits $2,283 $1,852
Occupancy 501 405
Furniture and Equipment 365 432
Other Expense 1,605 1,604
------ ------
Total Non-Interest Expenses $4,755 $4,293
====== ======
================================================================================
Income Taxes
The Company's provision for income taxes includes both federal income and state
franchise taxes and reflects the application of federal and state statutory
rates to the Company's net income before taxes. The principal difference between
statutory tax rates and the Company's effective tax rate is the benefit derived
from investing in tax-exempt securities and bank owned life insurance. Increases
and decreases in the provision for taxes reflect changes in the Company's net
income before tax.
The following table reflects the Company's tax provision and the related
effective tax rate for the periods indicated.
Three Month Period Ended September 30,
(Dollars in thousands)
================================================================================
2003 2002
- --------------------------------------------------------------------------------
Tax Provision $ 334 $ 80
Effective Tax Rate 38.62% 31.33%
================================================================================
Nine Month Period Ended September 30,
(Dollars in thousands)
================================================================================
2003 2002
- --------------------------------------------------------------------------------
Tax Provision $ 822 $ 370
Effective Tax Rate 36.79% 33.76%
================================================================================
11
Asset Quality
The Company concentrates its lending activities primarily within Calaveras, San
Joaquin, Stanislaus and Tuolumne Counties.
The Company manages its credit risk through diversification of its loan
portfolio and the application of underwriting policies and procedures and credit
monitoring practices. Although the Company has a diversified loan portfolio, a
significant portion of its borrowers' ability to repay the loans is dependent
upon the professional services and residential real estate development industry
sectors. Generally, the loans are secured by real estate or other assets and are
expected to be repaid from cash flows of the borrower or proceeds from the sale
of collateral.
The following table sets forth the amounts of loans outstanding by category as
of the dates indicated:
September 30, December 31,
------------------------------------------------------------
2003 2002
------------------------------------------------------------
dollars in thousands
Commercial and Agricultural $ 56,332 $ 40,226
Real estate - construction 30,352 33,887
Real estate - commercial 63,375 53,160
Installment & Other 10,963 7,734
Deferred Loan Fees and Costs 229 265
Allowance for Loan and
Lease Losses -1,514 -1,306
Total Net Loans $ 159,737 $ 133,966
------------------------------------------------------------
Net portfolio loans have increased $25.8 million or 19.24%, to $159.7 million at
September 30, 2003 over $133.9 million at December 31, 2002. Commercial and
agricultural loans have increased $16.1 million or 40.04%, real estate
construction projects have decreased $3.5 million or 10.43%, real estate
commercial loans have increased by $10.2 million or 19.21% and installment loans
have increased by 3.2 million or 41.75% over December 31, 2002. The portfolio
mix remains stable as compared with the mix of a year ago, with commercial and
agricultural loans of approximately 35.27% of total loans, real estate
construction loans of 19.0%, commercial and residential real estate loans at
39.67%, and 6.86% for installment loans.
The Company's practice is to place an asset on nonaccrual status when one of the
following events occurs:(i) Any installment of principal or interest is 90 days
or more past due (unless in management's opinion the loan is well-secured and in
the process of collection), (ii) management determines the ultimate collection
of principal or interest to be unlikely or iii) the terms of the loan have been
renegotiated due to a serious weakening of the borrower's financial condition.
Nonperforming loans are loans that are on nonaccrual, are 90 days past due and
still accruing or have been restructured.
The following table sets forth a summary of the Company's nonperforming loans
and other assets as of the dates indicated:
(Dollars in Thousands)
================================================================================
September 30, 2003 December 31, 2002
- --------------------------------------------------------------------------------
Nonaccrual loans $ 2,462 $ 199
Other Real Estate Owned 49
================================================================================
The Company's nonaccrual loans increased from $199,000 to $2,462,000 during 2003
and are comprised of one loan. Other real estate owned ("OREO") decreased to
$0.00 in 2003 from $49,000 in 2002.
12
The Company assigns all loans a credit risk rating and monitors ratings for
accuracy. The aggregate credit risk ratings are used to determine the allowance
for loan losses. Management reviews the credit risk report with the Director
Loan Committee on a weekly basis as well as with the full Board monthly.
Allowance for Loan Losses (ALL)
In determining the amount of the Company's Allowance for Loan Losses ("ALL"),
management assesses the diversification of the portfolio. Each credit is
assigned a credit risk rating factor, and this factor, multiplied by the dollars
associated with the credit risk rating, is used to calculate one component of
the ALL. In addition, management estimates the probable loss on individual
credits that are receiving increased management attention due to actual or
perceived increases in credit risk.
The Company makes provisions to the ALL on a regular basis through charges to
operations that are reflected in the Company's statements of income as a
provision for loan losses. When a loan is deemed uncollectible, it is charged
against the allowance. Any recoveries of previously charged-off loans are
credited back to the allowance. There is no precise method of predicting
specific losses or amounts that ultimately may be charged-off on particular
categories of the loan portfolio. Similarly, the adequacy of the ALL and the
level of the related provision for possible loan losses is determined on a
judgment basis by management based on consideration of a number of factors
including (i) economic conditions, (ii) borrowers' financial condition, (iii)
loan impairment, (iv) evaluation of industry trends, (v) industry and other
concentrations, (vi) loans which are contractually current as to payment terms
but demonstrate a higher degree of risk as identified by management, (vii)
continuing evaluation of the performing loan portfolio, (viii) monthly review
and evaluation of problem loans identified as having a loss potential, (ix)
monthly review by the Board of Directors, (x) off balance sheet risks and (xi)
assessments by regulators and other third parties. Management and the Board of
Directors evaluate the allowance and determine its desired level considering
objective and subjective measures, such as knowledge of the borrowers'
businesses, valuation of collateral, the determination of impaired loans and
exposure to potential losses.
While management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions and other qualitative factors. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's ALL. Such agencies may require the Company to provide additions to
the allowance based on their judgment of information available to them at the
time of their examination. There is uncertainty concerning future economic
trends. Accordingly it is not possible to predict the effect future economic
trends may have on the level of the provision for possible loan losses in future
periods.
The adequacy of the ALL is calculated upon three components. First is the credit
risk rating of the loan portfolio, including all outstanding loans and leases.
Every extension of credit has been assigned a risk rating based upon a
comprehensive definition intended to measure the inherent risk of lending money.
Each rating has an assigned risk factor expressed as a reserve percentage.
Central to this assigned risk factor is the historical loss record of the
Company. Secondly, established specific reserves are available for individual
loans currently on management's watch and high-grade loan lists. These are the
estimated potential losses associated with specific borrowers based upon the
collateral and event(s) causing the risk ratings. The third component is
unallocated. This reserve is for qualitative factors that may effect the
portfolio as a whole, such as those factors described above.
Management believes the assigned risk grades and our methods for managing risk
are satisfactory.
The provision for loan losses increased to $398,000 for 2003 versus $240,000 in
2002. The increase in the amount of the provision is a direct result of the
Company's in-depth analysis of the loan portfolio and the loan loss history of
the Company. Net charge-offs were $190,000 or .13% of average loans during 2003.
Management does not believe that there were any trends indicated by the detail
of the aggregate charge-offs for any of the periods discussed.
13
The following table summarizes the activity in the ALL for the periods
indicated.
Three Months Ended Nine Months Ended
(Dollars in thousands) September 30, September 30,
================================================================================
2003 2002 2003 2002
- --------------------------------------------------------------------------------
Beginning Balance: 1,466 1,219 1,306 1,172
Provision for loan losses 138 82 398 240
Charge-offs:
Commercial -90 -72 -90 -183
Real Estate 0 0 0 0
Other -3 0 -105 0
----- ----- ----- -----
Total Charge-offs -93 -72 -195 -183
----- ----- ----- -----
Recoveries:
Commercial 0 0 0 0
Other 3 1 5 1
----- ----- ----- -----
Total Recoveries 3 1 5 1
----- ----- ----- -----
Ending Balance 1,514 1,230 1,514 1,230
===== ===== ===== =====
ALLL to total loans 0.93% 0.97% 0.93% 0.97%
Net Charge-offs to average
loans-annualized 0.22% 0.25% 0.52% 0.67%
================================================================================
Balance Sheet Analysis
- ----------------------
Total assets increased by 13.9% from December 31, 2002 to September 30, 2003.
The increase in total assets was a result of an increase in deposits from $158.1
million to $181.9 million. Net loans during this period increased from $134.0
million to $15.7 million and investments increased from $12.8 million to $15.4
million.
Non-performing assets (including nonaccrual loans, loans 90 days past due and
other real estate owned) totaled $2,462,000 at September 30, 2003, compared to
$248,000 on December 31, 2002 and $312,000 on September 30, 2002. The ratio of
non-performing assets to total loans was 1.53% at September 30, 2003, .18% at
December 31, 2002 and .25% at September 30, 2002.
The allowance for loan losses was $1.5 million at September 30, 2003, compared
to $1.3 million at December 31, 2002 and $1.2 million at September 30, 2002. The
provision for loan losses was $398,000 for the nine months ended September 30,
2003 versus $240,000 for the same period in 2002. Net charge-offs were $190,000
for the first nine months of 2003, compared to $182,000 for the first nine
months of 2002.
Liquidity
The purpose of liquidity management is to ensure efficient and economical
funding of the Company's assets consistent with the needs of the Company's
depositors and, to a lesser extent, shareholders. This process is managed not by
formally monitoring the cash flows from operations, investing and financing
activities as described in the Company's statement of cash flows, but through an
understanding principally of depositor and borrower needs. As loan demand
increases, the Company can use asset liquidity from maturing investments along
with deposit growth to fund the new loans.
With respect to assets, liquidity is provided by cash and money market
investments such as interest-bearing time deposits, federal-funds sold,
available-for-sale investment securities, and principal and interest payments on
loans. With respect to liabilities, liquidity is provided by core deposits,
shareholders' equity and the ability of the Company to borrow funds and to
generate deposits.
14
Because estimates of the liquidity need of the Company may vary from actual
needs, the Company maintains a substantial amount of liquid assets to absorb
short-term increases in loans or reductions in deposits. As loan demand
decreases or loans are paid off, investment assets can absorb these excess funds
or deposit rates can be decreased to run off excess liquidity. Therefore, there
is some correlation between financing activities associated with deposits and
investing activities associated with lending. The Company's liquid assets (cash
and due from banks, federal funds sold, and available-for-sale investment
securities) totaled $29.5 million or 14.4% of total assets at September 30, 2003
compared to $36.0 million or 20.0% of total assets at December 31, 2002. The
Company expects that its primary source of liquidity will be earnings of the
Company, acquisition of core deposits, and wholesale borrowing arrangements.
Capital Resources
Capital adequacy is a measure of the amount of capital needed to sustain asset
growth and act as a cushion for losses. Capital protects depositors and the
deposit insurance fund from potential losses and is a source of funds for the
investments the Company needs to remain competitive. Historically, capital has
been generated principally from the retention of earnings.
Overall capital adequacy is monitored on a day-to-day basis by the Company's
management and reported to the Company's Board of Directors on a quarterly
basis. The Bank's regulators measure capital adequacy by using a risk-based
capital framework and by monitoring compliance with minimum leverage ratio
guidelines. Under the risk-based capital standard, assets reported on the
Company's balance sheet and certain off-balance sheet items are assigned to risk
categories, each of which is assigned a risk weight.
This standard characterizes an institution's capital as being "Tier 1" capital
(defined as principally comprising shareholders' equity) and "Tier 2" capital
(defined as principally comprising the qualifying portion of the ALLL).
The minimum ratio of total risk-based capital to risk-adjusted assets, including
certain off-balance sheet items, is 8%. At least one-half (4%) of the total
risk-based capital is to be comprised of Tier 1 capital; the balance may consist
of debt securities and a limited portion of the ALLL.
As of September 30, 2003, the most recent notification by the Federal Reserve
Bank of San Francisco (FRBSF) categorized the Company as well capitalized under
the regulatory framework for prompt corrective action. To be categorized as well
capitalized the Company must meet the minimum ratios as set forth below. There
are no conditions or events since that notification that management believes
have changed the institution's category.
The Company's risk-based capital ratios are presented below.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------- ------------------- ------------------
Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------- ------- ------- -------
Company
As of September 30, 2003:
Total capital
(to risk weighted assets) $15,848 10.86% $11,671 8.00% N/A N/A
Tier I capital
(to risk weighted assets) $14,429 9.89% $ 5,835 4.00% N/A N/A
Tier I capital
(to average assets) $14,429 7.96% $ 7,254 4.00% N/A N/A
As of December 31, 2002:
Total capital
(to risk weighted assets) $15,882 10.95% $11,608 8.00% $14,509 10.00%
Tier I capital
(to risk weighted assets) $14,576 10.05% $ 5,804 4.00% $ 8,706 6.00%
Tier I capital
(to average assets) $14,576 8.74% $ 6,673 4.00% $ 8,400 5.00%
15
*The leverage ratio consists of Tier I capital divided by quarterly average
assets. The minimum leverage ratio is 3 percent for banking organizations that
do not anticipate significant growth and that have well-diversified risk,
excellent asset quality and in general, are considered top-rated banks. For all
other institutions the minimum rate is 4%.
ITEM 4. Controls and Procedures.
The Company's Chief Executive Officer and Acting Chief Financial Officer, based
on their evaluation within 90 days prior to the date of this report of the
Company's disclosure controls and procedures (as defined in Exchange Act Rule
13a--14(c15(e) or 15d-15(e))), have concluded that the Company's disclosure
controls and procedures are designed to ensure that information required to be
disclosed by the Company in its periodic SEC filings is recorded, processed and
reported within the time periods specified in the SEC's rules and forms. Based
upon that evaluation, the Chief Executive Officer and Acting Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company (including its consolidated subsidiaries) required to be included in the
Company's periodic SEC filings. There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures, including
cost limitations, judgments used in decision making, assumptions regarding the
likelihood of future events, soundness of internal controls, fraud, the
possibility of human error and the circumvention or overriding of the controls
and procedures. Accordingly, even effective disclosure controls and procedures
can provide only reasonable, and not absolute, assurance of achieving their
control objectives.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of their evaluation.
Part II - Other Information
None
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 State Bancorp
Date: November 14, 2003 BY: /s/ STEVEN A. ROSSO
----------------------------------------
Steven A. Rosso
President and Chief Executive Officer
and Acting Chief Financial Officer
EXHIBITS
31 Certification pursuant to section 302 of the Sarbanes-Oxley Act
32 Certification pursuant to section 906 of the Sarbanes-Oxley Act.
16