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, 2004
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.)
1899 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 12, 2004
- -------------- ------------------------------------------
Common Stock 3,447,622
No Par Value
PART I
ITEM 1. FINANCIAL STATEMENTS
PACIFIC STATE BANCORP
Condensed Consolidated Balance Sheet
September 30 December 31,
2004 2003
------------ ------------
(Unaudited)
Assets
- ------
Cash and due from banks $ 12,394,983 $ 5,317,323
Federal funds sold 13,375,000 7,456,000
Interest -bearing deposits in banks 1,500,000 4,000,000
Investment securities - available for sale (amortized cost of
$17,602,391 in 2004 and $12,096,100 in 2003) 17,452,973 12,106,562
Loans, less allowance for loan losses of $2,011,660 in 2004 and
$1,652,583 in 2003 188,188,698 155,484,998
Bank premises and equipment, net 9,512,150 8,755,992
Accrued interest receivable and other assets 8,261,084 7,803,318
------------ ------------
Total assets $250,684,888 $200,924,193
============ ============
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits:
Non-interest bearing $ 51,499,688 $ 40,400,662
Interest bearing 167,512,398 135,891,546
------------ ------------
Total deposits 219,012,086 176,292,208
Short-term borrowings 1,000,000 1,000,000
Long-term borrowings 4,000,000 4,000,000
Subordinated debentures 8,764,000 5,155,000
Accrued interest payable and other liabilities 1,973,460 1,018,450
------------- ------------
Total liabilities 234,749,546 187,465,658
Commitments and contingencies
Shareholders' equity
- --------------------
Preferred stock - no par value; 2,000,000 shares authorized;
none issued and outstanding -- --
Common stock - no par value; 24,000,000 shares authorized;
shares issued and outstanding 3,411,622 in 2004 and
3,377,656 in 2003 7,056,596 6,936,786
Retained earnings 8,785,148 6,456,766
Accumulated other comprehensive income, net of tax 93,598 64,983
------------ ------------
Total shareholders' equity 15,935,342 13,458,535
------------ ------------
Total liabilities and shareholders' equity $250,684,888 $200,924,193
============ ============
See notes to unaudited condensed consolidated financial statements
2
Pacific State Bancorp
Condensed Consolidated Statement of Income
(Unaudited)
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
-------------------------- -------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Interest income:
Interest and fees on loans $ 3,200,369 $ 2,785,575 $ 9,093,865 $ 7,748,713
Interest on federal funds sold 26,771 4,805 41,771 73,066
Interest on investment securities 144,190 117,959 372,403 347,774
----------- ----------- ----------- -----------
Total interest income 3,371,330 2,908,339 9,508,039 8,169,553
Interest expense:
Interest on deposits 671,243 578,245 1,747,674 1,852,192
Interest on subordinated debentures 101,388 60,988 250,990 179,188
Interest on borrowings 31,112 33,741 95,625 96,769
----------- ----------- ----------- -----------
Total interest expense 803,743 672,974 2,094,289 2,128,149
----------- ----------- ----------- -----------
Net interest income 2,567,587 2,235,365 7,413,750 6,041,404
Provision for loan losses 138,000 138,000 366,000 398,000
----------- ----------- ----------- -----------
Net interest income after
provision for loan losses 2,429,587 2,097,365 7,047,750 5,643,404
----------- ----------- ----------- -----------
Non-interest income
Service charges 286,382 168,951 891,254 477,100
Other fee income 291,450 163,408 785,086 477,508
Gain from sale of loans 240,044 81,924 312,793 390,473
----------- ----------- ----------- -----------
Total non-interest income 817,876 414,283 1,989,133 1,345,081
Other expenses:
Salaries and employee benefits 852,527 804,887 2,580,241 2,282,964
Occupancy 200,186 171,514 535,851 500,671
Furniture and equipment 125,590 126,361 353,681 365,448
Other 661,787 545,293 1,849,078 1,605,431
----------- ----------- ----------- -----------
Total other expenses 1,840,090 1,648,055 5,318,851 4,754,514
----------- ----------- ----------- -----------
Income before income taxes 1,407,373 863,593 3,718,032 2,233,971
Income tax expense 513,200 333,500 1,389,650 821,900
----------- ----------- ----------- -----------
Net income $ 894,173 $ 530,093 $ 2,328,382 $ 1,412,071
=========== =========== =========== ===========
Basic earnings per share $ 0.26 $ 0.16 $ 0.68 $ 0.43
=========== =========== =========== ===========
Diluted earnings per share $ 0.24 $ 0.16 $ 0.63 $ .042
=========== =========== =========== ===========
Weighted average common shares outstanding 3,437,575 3,303,080 3,407,185 3,316,720
Weighted average common and common equivalent
shares outstanding 3,784,982 3,394,952 3,710,882 3,408,592
See notes to unaudited condensed consolidated financial statements
3
Pacific State Bancorp and Subsidiaries
Condensed Consolidated Statement of Cash Flows
(Unaudited)
For the Nine Months Ended
September 30,
-----------------------------
2004 2003
------------ ------------
Cash flows from operating activities:
Net income $ 2,328,382 $ 1,412,071
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 366,000 398,000
Deferred loan origination fees and costs, net 67,931 35,771
Depreciation and amortization 363,542 331,447
Net gain on sale of available-for-sale investment
Securities -- (2,116)
Net increase in cash surrender value of life
insurance Policies -- (25,780)
Increase in accrued interest receivable and other
assets (433,425) (217,320)
Increase (decrease) in accrued interest payable and
other liabilities 955,009 (56,776)
------------ ------------
Net cash provided by operating activities 3,647,439 1,875,297
------------ ------------
Cash flows from investing activities:
Net increase in interest-bearing deposits in banks 2,500,000 (3,500,000)
Proceeds from sale of available-for-sale investment
securities 1,633,950 150,000
Purchases of available-for-sale investment securities (7,475,900) (3,740,530)
Proceeds from principal repayments from available-for-sale
mortgage-backed securities 423,456 4,358,309
Proceeds from principal repayments from held-to-maturity
mortgage-backed securities 33,326 102,435
Net decrease in loans (33,137,631) (26,286,189)
Proceeds from sale of other real estate -- 49,704
Purchases of bank premises and equipment (1,075,958) (2,053,794)
Purchase of life insurance policy -- (4,135,250)
------------ ------------
Net cash used in investing activities (37,098,757) (35,055,315)
------------ ------------
Cash flows from financing activities:
Net increase in demand, interest-bearing
and savings deposits 43,046,937 10,492,676
Net increase (decrease) in time deposits (327,059) 13,291,658
Proceeds from the issuance of subordinated debentures 3,609,000 --
------------ ------------
Repurchase of common stock -- (170,546)
------------ ------------
Proceeds from stock options exercised 119,100 208,248
------------ ------------
Net cash provided by financing activities 46,447,978 23,822,036
------------ ------------
Increase in cash and cash equivalents 12,996,660 (9,357,982)
Cash and cash equivalents at beginning of year 12,773,323 23,465,668
------------ ------------
Cash and cash equivalents at end of period $ 25,769,983 $ 14,107,686
============ ============
See notes to unaudited condensed consolidated financial statements
4
Pacific State Bancorp
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
1. BASIS OF PRESENTATION AND CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the unaudited condensed 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, 2004 and December 31,
2003, and the results of its operations for the three and nine month periods
ended September 30, 2004 and 2003 and its cash flows for the nine month periods
ended September 30, 2004 in conformity with the instructions to Form 10-Q and
Article 10 of Regulation S-X.
Certain disclosures normally presented in the notes to the consolidated
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America for annual financial statements have
been omitted. These interim condensed consolidated financial statements should
be read in conjunction with the consolidated financial statements and notes
thereto included in the Company's 2003 Annual Report to Shareholders. The
results of operations for the three month and nine month periods ended September
30, 2004 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.
Management has determined that all of the commercial banking products and
services offered by the Company are available in each branch of Pacific State
Bank (the "Bank"), its wholly owned bank subsidiary, that all branches are
located within the same economic environment and that management does not
allocate resources based on the performance of different lending or transaction
activities, Accordingly, the Company and it's subsidiary operate as one business
segment. No customer accounts for more than 10% of the revenue for the Bank or
the Company.
2. STOCK-BASED COMPENSATION
As of September 30, 2004, the Company had one stock-based employee compensation
plan, the Pacific State Bancorp 1997 Stock Option Plan (the "Plan"). The Company
accounts for this plan 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 the Plan had an exercise price equal to the
market value of the underlying common stock on the date of grant.
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation, as amended, requires the disclosure of pro forma net
income and earnings per share had the Company adopted the fair value method of
accounting for stock-based compensation. Under SFAS No. 123, the fair value of
stock-based awards to employees is calculated through the use of option pricing
models, even though such models were developed to estimate the fair value of
freely tradable, fully transferable options without vesting restrictions, which
significantly differ from the Company's stock option awards. These models also
require subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affect the calculated values. The
Company's calculations were made using the Black-Scholes option pricing model
with the following assumptions: expected life, 5 years following vesting;
average stock volatility of 20.34% for 2004 and 2003; risk free interest rates
of 3.21% for 2004 and 2003; and no cash dividends during the expected term for
2004 and 2003. The Company's calculations are based on a multiple option
valuation approach and forfeitures are recognized as they occur. 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
5
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 Ended For the Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net income, as reported $ 894,173 $ 530,093 $ 2,328,382 $ 1,412,071
Deduct: Total stock-based employee
compensation expense determined
under the fair value method
for all awards, net of related tax effects 66,000 10,000 198,000 30,000
------------ ------------ ------------ ------------
$ 828,173 $ 520,093 $ 2,130,382 $ 1,382,071
============ ============ ============ ============
Basic earning per share - as reported $ 0.26 $ 0.16 $ 0.68 $ 0.43
Basic earning per share - pro forma $ 0.24 $ 0.16 $ 0.63 $ 0.42
Diluted earnings per share - as reported $ 0.24 $ 0.16 $ 0.63 $ 0.42
Diluted earnings per share - pro forma $ 0.22 $ 0.16 $ 0.59 $ 0.41
3. EARNINGS PER SHARE COMPUTATION
Basic earnings per share are 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 or loss. Other comprehensive income or loss, net of taxes,
is comprised of the unrealized gains or 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
09/30/04 09/30/03 09/30/04 09/30/03
------------ ------------ ------------ ------------
Net Income $ 894,173 $ 530,093 $ 2,328,382 $ 1,412,071
Other Comprehensive Gain (Loss) Income:
Change in unrealized gain (loss) on
available for sale securities 214,000 (84,000) 29,000 18,000
Reclassification adjustment 0 0 0 0
------------ ------------ ------------ ------------
Total Other Comprehensive (Loss) Income 214,000 (84,000) 29,000 18,000
Total Comprehensive Income $ 1,108,173 $ 446,093 $ 2,357,382 $ 1,430,071
============ ============ ============ ============
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 $49,675,563 and stand-by letters of credit of
$585,671 at September 30, 2004. However, all such commitments will not
necessarily culminate in actual extensions of credit by the Company during 2004.
6
Approximately $19,946,000 of the loan commitments outstanding at September 30,
2004 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 fully 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. Deferred fees related to stand-by letters of credit are not
significant.
6. STOCK SPLIT
On September 16, 2004 the Company's board of directors declared a two-for-one
stock split payable to shareholders of record on September 30, 2004. 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
affected on the first day of all periods presented.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is management's discussion and analysis of the significant changes
in Pacific State Bancorp (the "Company") balance sheet accounts between
September 30, 2004 and December 31, 2003 and its income and expense accounts for
the three and nine month periods ended September 30, 2004 and 2003. 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.
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, 2003.
General Description of Business
Pacific State Bancorp is a holding company with one bank subsidiary, Pacific
State Bank, (the "Bank"), and two unconsolidated subsidiary guarantor trusts,
Pacific State Statutory Trusts I and II. 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 is a member of the Federal Reserve System. 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
7
Trusts I and II are unconsolidated, wholly owned statutory business trusts
formed in June 2002 and March 2004 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 September 30, 2004 had
64 employees, including 24 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's main office is located at 6 So. El Dorado
Street, in Stockton, California; 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.
Trust Subsidiaries
During 2002 and 2004 the Company established business trust subsidiaries (the
"Trusts") for the sole purpose of issuing capital securities ("Capital
Securities") pursuant to declarations of trust. The proceeds from the sale of
the Capital Securities were loaned to the Company under deeply subordinated
debentures issued to the Trusts pursuant to indentures (the "Indentures").
Interest payments on the Debentures will flow through the Trusts to the Pooling
Vehicles, which are the holders of the Capital Securities and similar securities
issued by other financial institutions. Payments of distributions by the Trusts
to the Pooling Vehicle are guaranteed by the Company. See note 8 to the
consolidated financial statements in the Company's 2003 Annual Report to
Shareholders.
Proceeds from the issuance of the 2002 Debentures were used to provide the Bank
with an additional $4.5 million in capital in order to support the continued
growth of the Bank. The remaining $500,000 was placed in the Company for general
corporate purposes. Proceeds from the issuance of the 2004 Debentures were used
to provide the Bank with an additional $3.5 million in capital in order to
support the continued growth of the Bank.
Product Lines and Services
The Bank currently offers the following general banking services at all of its
branches: commercial, construction and real estate loans and personal credit
lines, interest on checking, U.S. Savings bond services, domestic and foreign
drafts, banking by appointment, automatic transfer of funds between savings and
checking accounts, business courier services, checking and savings accounts for
personal and business purposes, domestic letters of credit, a depository for
MasterCard and Visa drafts, federal depository services, cash management
assistance, wire and telephone transfers, travelers' checks, Individual
Retirement Accounts, time certificates of deposit, courier service for non-cash
deposits, Visa and MasterCard, revolving lines of credit to consumers secured by
deeds of trust on private residences, unsecured overdraft protection credit
lines attached to checking accounts, ATM cards and MasterMoney debit cards via
the Star, Cirrus, Plus, MasterCard and Visa networks.
The Bank is not authorized to offer trust services. The Federal Reserve Bank of
San Francisco is the Company's primary correspondent relationship. The Bank
currently also has correspondent relationships with City National Bank in
Beverly Hills, Bank of America in San Francisco, First Tennessee Bank in
Memphis, Tennessee, Compass Bank in Birmingham, Alabama, Wells Fargo Bank and
Pacific Coast Bankers Bank.
The Bank recognizes that, in order to be competitive, it must offer a certain
consumer products. These products include, Individual Retirement Accounts, Visa
and MasterCard, revolving lines of credit to consumers secured by deeds of trust
on private residences, and unsecured overdraft protection credit lines attached
to checking accounts.
8
These products currently offered by the Bank are designed to appeal particularly
to consumers. Moreover, participation in a large-scale ATM network assists the
Company in competing for consumer accounts.
The Bank is an approved Small Business Administration and 504 lender, FarmerMac
I and II, USDA, USDA Part-time Farmer Program, FHA and VA lender and California
Capital lender. The Bank is a national leader in the underwriting of U.S.
Department of Agriculture business and industry loans, as well as, a Preferred
Lender for this program.
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.
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 Accounting 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 for
impaired loans 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
Three and Nine Month Periods Ended September 30, 2004 Compared to the Same
Periods Ended September 30, 2003
Net income for the three month period ended September 30, 2004, was $894,000
representing an increase of $364,000, or 68.6%, over net income of $530,000 for
the three month period ended September 30, 2003. Contributing factors include an
increase in gain on sale of loans of 193.0%, an increase in service charge
income of 69.5% and an increase in other fee income of 81.8% and net interest
income increased by 14.86%. The increase in gain on sale of loan income is due
to the timing of the loan sales. The increase in service charge income is the
result of a new overdraft protection product offered by the bank. The increase
in other income is the result of an increase in mortgage referral fees and an
increase in income from an investment in bank-owned life insurance. The increase
in net interest income is a result of the growth in the investments and loans
offset by the growth in deposit and the effect of the change in rates. These
increases were offset by increases in salaries and benefit expense, occupancy,
other expenses and income tax expense.
Annualized return on average assets (ROA) was 1.40% and return on average common
equity (ROE) was 14.70% for the three month period ended September 30, 2004
compared with 1.07% and 19.09% respectively in 2003. Diluted earnings per share
for 2004 and 2003 were $0.24 and $0.15, respectively, an increase of 60.0%. The
increase in earnings per share was due to the increase in net income.
9
Net income for the nine month period ended September 30, 2004, was $2,328,000
representing an increase of $916,000, or 64.89%, over net income of $1,412,000
for the nine month period ended September 30, 2003. Contributing factors to the
increase in net income was an increase in service charge income of 86.81%, an
increase in other fee income of 68.96% and an increase in net interest income of
22.72% from the nine month period ended September 30, 2003. These increases were
offset by decreases on the gain on sale of loans of 19.9% and by increases in
salaries and benefit expense, occupancy, other expenses and income tax expense.
The increase in service charge income is the result of a new overdraft
protection product offered by the bank. The increase in other income is the
result of an increase in mortgage referral fees and an increase in income from
an investment in bank-owned life insurance. The increase in net interest income
is a result of the growth in the investments and loans offset by the growth in
deposit and the effect of the change in rates
Annualized return on average assets (ROA) was 1.49% and return on average common
equity (ROE) was 23.84% for the nine month period ended September 30, 2004
compared with 1.07% and 19.90% respectively in 2003. Diluted earnings per share
for 2004 and 2003 were $0.68 and $0.42, respectively, an increase of 61.9%. The
increase in earnings per share was due to the increase in net income.
Net Interest Income
The primary source of income for the Company is 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 $2.6 million for the three month period ended
September 30, 2004 versus $2.2 million in 2003 representing a 14.86% increase.
Net interest income increased to $7.4 million for the nine month period in 2004
versus $6.0 million in 2003 representing a 22.72% increase The average balance
of total earning assets, during 2004, increased 22.46% to $212.3 million from
$173.4 million. Average loan balances outstanding during 2004 increased $30.0
million or 19.14%. Average balances of investments and federal funds sold
increased by $1.3 million or 6.07%. The average yields on loans and federal
funds sold in 2004 was lower by 19 and 4 basis points respectively, while the
average yield on securities decreased by 78 basis points.
Total interest expense increased to $806,000 for the three month period in 2004
from $673,000 for 2003, representing a 19.4% increase. For the nine month period
ended September 30, 2004 total interest expense decreased slightly to $2,100,000
from $2,128,000, representing an 1.6% decrease. While expense decreased
slightly, average balances of interest-bearing liabilities increased to $150.7
million from $130.1 million for the period ended September 30, 2004, or 15.8%.
Average certificates of deposit increased to $88.5 million in 2004 from $73.8
million in 2003, a 20.0% increase. The average rate paid on certificates of
deposit during 2004 decreased 62 basis points to 1.87% from 2.49% for 2003,
while the overall average rate paid on interest bearing deposits and borrowings
decreased 12 basis points to 1.26% from 1.38% for 2003.
The Company's net interest margin (net interest income divided by average
earning assets) decreased 32 basis points to 4.80% for the nine months ended
September 30, 2004 compared to 5.12% in 2003. 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 $332,000 (14.9%)
in net interest income for the three month period ended September 30, 2004 over
2003 and an increase of $1,372,000 (22.72%) for the nine month period ended
September 30, 2004 over 2003.
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, 2004, non-interest income represented 19.51% of the
Company's revenues versus 12.48% in 2003. For the nine month period ended
September 30, 2004, non-interest income represented 17.29% of the Company's
revenues versus 14.14% in 2003.
10
Total non-interest income increased $403,000 to $817,000 for the three months
ended September 30, 2004 from $414,000 for the same period in 2003, representing
an increase of 97.3%. Total non-interest income increased $644,000 for the nine
months ended September 30, 2004 to $1,989,000, representing an increase of
47.88%.
The following table sets forth a summary of non-interest income for the periods
indicated.
Non-interest Income
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
Non-interest income: 2004 2003 2004 2003
------------ ------------ ------------ ------------
Service charges 286,382 168,951 891,254 477,100
Other fee income 291,450 163,408 785,086 477,508
Gain from sale of loans 240,044 81,924 312,793 390,473
------------ ------------ ------------ ------------
Total non-interest income 817,876 414,283 1,989,133 1,345,081
============ ============ ============ ============
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, 2004 was $1.84 million compared to $1.65
million for 2003 an increase of 11.7% for 2004. Non-interest expense for the
nine month period ended September 30, 2004 was $5.31 million compared to $4.75
million for 2003 an increase of 11.9% for 2004. Increases in salaries and
benefits are indicative of the additions to staff to expand branch operations in
line with their respective growth for the year.
The following table sets forth a summary of non-interest expense for the periods
indicated.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
Noninterest expense: 2004 2003 2004 2003
------------ ------------ ------------ ------------
Salaries and employee benefits 852,527 804,887 2,580,241 2,282,964
Occupancy & FFE 200,186 171,514 535,851 500,671
Furniture & Equipment 125,590 126,361 353,681 365,448
Other operating expenses 661,787 545,293 1,849,078 1,605,431
------------ ------------ ------------ ------------
Total noninterest expense 1,840,090 1,648,055 5,318,851 4,754,514
============ ============ ============ ============
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 Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
(Dollars in thousands) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Tax Provision $ 513 $ 334 $ 1,390 $ 822
Effective Tax Rate 36.47% 38.68% 37.38% 36.79%
11
Balance Sheet Analysis
- ----------------------
Total assets increased by 24.8% from December 31, 2003 to September 30, 2004.
The increase in total assets was a result of an increase in deposits from $176.3
million to $219.0 million. Net loans during this period increased from $155.5
million to $188.2 million and investments increased from $16.1 million to $19.0
million.
Loans
The Company focuses 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,
------------- -----------
2004 2003
------------- -----------
Dollars in thousands
Commercial and Agricultural $ 50,061 $ 40,426
Real estate-Construction 34,061 28,219
Real estate-Commercial and Residential 93,781 77,386
Installment & Other 12,082 10,823
Deferred Loan Fees and Costs 216 284
Allowance for Loan and Lease Losses (2,012) (1,653)
Total Net Loans $ 188,189 $ 155,485
=========== ===========
Net portfolio loans have increased $32.7 million or 21.03%, to $188.2 million at
September 30, 2004 from $155.5 million at December 31, 2003. Commercial and
agricultural loans have increased $9.6 million or 23.83%, real estate
construction projects have increased $5.8 million or 20.70%, real estate
commercial loans have increased by $16.4 million or 21.19% and installment loans
have increased by $1.3 million or 11.63% over December 31, 2003. The portfolio
mix remains stable as compared with the mix of a year ago, with commercial and
agricultural loans of approximately 26.60% of total loans, real estate
construction loans of 18.10%, commercial and residential real estate loans at
49.83, and 6.42% for installment loans.
The Company's policy 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.
There were no non-accrual loans or other real estate owned at September 30, 2004
and December 31, 2003.
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 Board of Directors monthly.
12
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. 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 decreased to $366,000 for the nine months ended
September 30, 2004 versus $398,000 in 2003. The decrease 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. Management does not believe
that there were any trends indicated by the detail of the aggregate charge-offs
for any of the periods discussed.
The following table summarizes the activity in the ALL for the periods
indicated.
13
Nine Months Ended
(Dollars in thousands) September 30,
---------------------------
2004 2003
----------- -----------
Beginning Balance: 1,653 1,306
Provision for loan losses 366 398
Charge-offs:
Commercial -7 -90
Real Estate 0 0
Other 0 -105
----------- -----------
Total Charge-offs -7 -195
----------- -----------
Recoveries:
Commercial 0 0
Other 0 5
----------- -----------
Total Recoveries 0 5
----------- -----------
Ending Balance 2,012 1,514
=========== ===========
ALLL to total loans 1.06% 0.97%
Net Charge-offs to average
loans-annualized 0.02% 0.52%
There were no non-performing assets (including impaired loans, nonaccrual loans,
loans 90 days past due and still accruing, and other real estate owned) at
September 30, 2004, December 31, 2003 or September 30, 2003. The ratio of
non-performing assets to total loans was nil at September 30, 2004, December 31,
2003 and September 30, 2003.
The allowance for loan losses was $2.01 million at September 30, 2004, compared
to $1.65 million at December 31, 2003 and $1.51 million at September 30, 2003.
The provision for loan losses was $366,000 for the nine months ended September
30, 2004 versus $398,000 for the same period in 2003. Net charge-offs were
$7,000 for the first nine months of 2004, compared to $195,000 for the first
nine months of 2003.
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.
Because estimates of the liquidity needs 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 $44.6 million or 17.8% of total assets at September 30, 2004
compared to $28.7 million or 14.28% of total assets at December 31, 2003. The
Company expects that its primary source of liquidity will be earnings of the
Company, acquisition of core deposits, and wholesale borrowing arrangements.
14
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.
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
--------------------- ---------------------- -----------------------
(in Thousands) Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
------------ ----- ------------ ------- ------------ -------
Company
As of September 30, 2004:
Total capital
(to risk weighted assets) $ 25,338 12.13% $ 14,827 8.00% N/A 10.00%
Tier I capital
(to risk weighted assets) $ 20,084 9.62% $ 7,413 4.00% N/A 6.00%
Tier I capital
(to average assets) $ 20,084 8.42% $ 9,537 4.00%* N/A 5.00%
As of December 31, 2003:
Total capital
(to risk weighted assets) $ 19,125 11.6% $ 13,239 8.00% N/A 10.00%
Tier I capital
(to risk weighted assets) $ 16,782 10.1% $ 6,619 4.00% N/A 6.00%
Tier I capital
(to average assets) $ 16,782 8.3% $ 8,129 4.00%* N/A 5.00%
- ----------
* 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 Chief Financial Officer, based on
their evaluation of the Company's disclosure controls and procedures (as defined
in Exchange Act Rule 13a--14(c15(e) or 15d-15(e))) as of the end of the period
covered by this report, have concluded that the Company's disclosure controls
and procedures are designed to ensure that information required to be disclosed
15
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 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 over financial
reporting subsequent to the date of their evaluation.
Part II - Other Information
Item 6. Exhibits
31.1 Certification of Chief Executive Officer (section 302 of Sarbannes-Oxley
Act
31.2 Certification of Chief Executive Officer (section 302 of Sarbannes-Oxley
Act
32 Certification pursuant to section 906 of the Sarbannes-Oxley Act
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 15, 2004 BY: /s/ STEVEN A. ROSSO
-------------------------------------
Steven A. Rosso
President and Chief Executive Officer
Date: November 15, 2004 BY: /s/ JOANNE ROBERTS
-------------------------------------
JoAnne Roberts
Vice President and
Chief Financial Officer
16
EXHIBITS
31.1 Certification of Chief Executive Officer (section 302 of the
Sarbanes-Oxley Act).
31.2 Certification of Chief Financial Officer (section 302 of the
Sarbanes-Oxley Act).
32 Certification pursuant to section 906 of the Sarbanes-Oxley Act.
17