FORM 10-Q

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

ý  Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

 

for the Quarterly Period Ended June 30, 2002

or

 

o  Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

for the Transition Period from                 to                

 

Commission File Number:  0-27384

 

 

Registrant’s telephone number, including area code:  (209) 725-2200

 

Former name, former address and former fiscal year, if changed since last report:  Not applicable

 

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 ý No o

 

The number of shares outstanding of the registrant’s common stock, no par value, as of June 30, 2002 was 5,296,423.  No shares of preferred stock, no par value, were outstanding at June 30, 2002.

 

 

Capital Corp of the West

Table of Contents

 

PART I. — FINANCIAL INFORMATION
Item 1.	Financial Statements
		Consolidated Balance Sheets (unaudited)
		Consolidated Statements of Income and Comprehensive Income (unaudited)
		Consolidated Statement of Changes in Stockholders Equity (unaudited)
		Consolidated Statements of Cash Flows (unaudited)
		Notes to the Consolidated Financial Statements (unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
PART II. — OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of matters to a vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
SIGNATURES

 

2

 

Capital Corp of the West

Consolidated Balance Sheets

(Unaudited)

 

		June 30, 2002			December 31, 2001
		(Dollars in thousands)
Assets
Cash and noninterest-bearing deposits in other banks		$	40,340		$	38,003
Federal funds sold		15,340			11,285
Time deposits at other financial institutions		500			500
Investment securities available for sale, at fair value		230,831			229,852
Investment securities held to maturity at cost, fair value of $65,410,000, and $42,185,000 at June 30, 2002 and December 31, 2001		64,399			41,559
Loans, net of allowance for loan losses of  $11,261,000 and $9,743,000 at June 30, 2002 and December 31, 2001		572,393			522,677
Interest receivable		5,771			5,757
Premises and equipment, net		13,956			13,143
Intangible assets		3,665			3,493
Other assets		28,637			28,058
Total assets		$	975,832		$	894,327
Liabilities and Shareholders’ Equity
Deposits
Noninterest-bearing demand		$	138,851		$	132,496
Negotiable orders of withdrawal		100,019			102,055
Savings		221,840			203,721
Time, under $100,000		158,793			163,195
Time, $100,000 and over		154,380			131,174
Total deposits		773,883			732,641
Borrowed funds		120,607			80,685
Accrued interest, taxes and other liabilities		5,519			10,881
Total liabilities		900,009			824,207
Capital Securities and minority interests		6,031			6,000
Preferred Stock, no par value; 10,000,000 shares authorized;  None outstanding		—			—
Common stock, no par value; 20,000,000 shares authorized;5,296,423 and 5,173,838 issued & outstanding at June 30, 2002 and December 31, 2001		45,898			40,089
Retained earnings		22,004			22,372
Accumulated other comprehensive income		1,890			1,659
Total shareholders’ equity		69,792			64,120
Total liabilities, Capital Securities and minority interests and shareholders’ equity		$	975,832		$	894,327

 

See accompanying notes

 

3

 

Capital Corp of the West

Consolidated Statements of Income and Comprehensive Income

(Unaudited)

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2002			2001			2002			2001
		(In thousands, except per share data)
Interest income:
Interest and fees on loans		$	10,678		$	10,497		$	20,815		$	21,277
Interest on deposits with other financial institutions		3			5			5			7
Interest on investments held to maturity:
Taxable		968			551			1,895			1,127
Non-taxable		55			55			110			111
Interest on investments available for sale:
Taxable		2,526			2,539			4,998			4,795
Non-taxable		273			272			545			544
Interest on federal funds sold		87			227			99			571
Total interest income		14,590			14,146			28,467			28,432
Interest expense:
Interest on negotiable orders of withdrawal		58			61			112			152
Interest on savings deposits		859			1,614			1,690			3,421
Interest on time deposits, under $100,000		1,345			2,099			2,884			4,191
Interest on time, $100,000 and over		1,169			1,431			2,348			2,922
Interest on other borrowings		1,226			463			2,174			853
Total interest expense		4,657			5,668			9,208			11,539
Net interest income		9,933			8,478			19,259			16,893
Provision for loan losses		1,451			789			2,231			1,539
Net interest income after provision for loan losses		8,482			7,689			17,028			15,354
Noninterest income:
Service charges on deposit accounts		1,279			1,004			2,406			1,906
Income from real estate held for sale		33			—			33			—
Other		818			570			1,470			1,021
Total noninterest income		2,130			1,574			3,909			2,927
Noninterest Expenses:
Salaries and related benefits		3,839			3,328			7,783			6,641
Equipment		704			680			1,420			1,304
Premises and occupancy		571			519			1,140			984
Professional fees		317			99			570			216
Marketing		219			230			407			441
Intangible amortization		170			198			340			396
Supplies		171			252			357			454
Dividend Expense on Capital Securities		152			155			306			218
Other		1,370			1,015			2,615			2,161
Total noninterest expenses		7,513			6,476			14,938			12,815
Income before income taxes		3,099			2,787			5,999			5,466
Provision for income taxes		715			806			1,391			1,573
Net income		$	2,384		$	1,981		$	4,608		$	3,893
Comprehensive Income:
Unrealized gain (loss) on securities arising during the period, net		1,617			(97		)	231			1,118
Comprehensive income		$	4,001		$	1,884		$	4,839		$	5,011
Basic earnings per share		$	0.45		$	0.39		$	0.88		$	0.77
Diluted earnings per share		$	0.44		$	0.38		$	0.85		$	0.75

 

See accompanying notes

 

4

 

Capital Corp of the West

Consolidated Statement of Changes in Shareholders’ Equity

(Unaudited)

 

		Common Stock								Accumulated other comprehensive income
(Amounts in thousands)		Number of shares		Amounts			Retained earnings						Total
Balance, December 31, 2001		5,174		$	40,089		$	22,372		$	1,659		$	64,120
Exercise of stock options		98		458			—			—			458
Issuance of shares pursuant to 401K and ESOP plans		24		387			—			—			387
Net Change in fair market value of  investment securities, net of tax benefit of  $924		—		—			—			231			231
5% stock dividend, including cash payment for fractional shares		—		4,964			(4,976		)	—			(12		)
Net income		—		—			4,608			—			4,608
Balance, June 30, 2002		5,296		$	45,898		$	22,004		$	1,890		$	69,792

 

See accompanying notes

 

5

 

Capital Corp of the West

Consolidated Statements of Cash Flows

(Unaudited)

 

(Dollars in thousands)		6 months ended June 30, 2002			6 months ended June 30, 2001
Operating activities:
Net income		$	4,608		$	3,893
Adjustments to reconcile net income to net cash provided by Operating activities:
Provision for loan losses		2,231			1,539
Depreciation, amortization and accretion, net		1,829			1,447
Gain on sale of real estate owned		33			—
Net increase in interest receivable & other assets		(1,133		)	(7,657		)
Net increase in deferred loan fees		347			52
Net (decrease) increase in accrued interest payable & other liabilities		(5,362		)	2,328
Net cash provided by operating activities		2,553			1,602
Investing activities:
Investment securities purchases		(56,227		)	(64,595		)
Proceeds from maturities of investment securities		25,727			14,778
Proceeds from sales of AFS investment securities		6,969			—
Net increase in time deposits in other financial institutions		—			(400		)
Proceeds from sales of commercial and real estate loans		1,633			1,605
Net increase in loans		(54,002		)	(38,540		)
Purchases of premises and equipment		(1,769		)	(1,497		)
Purchase of subsidiary		(520		)	—
Net cash used in investing activities		(78,189		)	(88,649		)
Financing activities:
Net increase in demand, NOW and savings deposits		22,438			13,198
Net increase in certificates of deposit		18,804			41,440
Net proceeds from other borrowings		39,922			19,350
Issuance of Capital Securities and increase in minority interests		31			6,000
Issuance of shares pursuant to 401K and ESOP plans		387			350
Exercise of stock options		458			334
Cash in lieu fractional shares from stock dividend		(12		)	(7		)
Net cash provided by financing activities		82,028			80,665
Net increase (decrease) in cash and cash equivalents		6,392			(6,382		)
Cash and cash equivalents at beginning of period		49,288			47,768
Cash and cash equivalents at end of period		$	55,680		$	41,386
Cash paid during the quarter:
Interest paid		$	7,107		$	11,705
Income tax payments		1,775			2,325
Supplemental disclosure of noncash investing and financing activities:
Investment securities unrealized gains, net of tax		231			1,118
Loans transferred to other real estate owned		—			335

 

See accompanying notes

 

6

 

Capital Corp of the West

Notes to Consolidated Financial Statements

March 31, 2002 and December 31, 2001

(Unaudited)

 

GENERAL - COMPANY

 

Capital Corp of the West (the “Company” or “Capital Corp”) is a bank holding company incorporated under the laws of the State of California on April 26, 1995.  On November 1, 1995, the Company became registered as a bank holding company, and is a holder of all of the capital stock of County Bank (the “Bank”).  During 1998, the Company formed Capital West Group, a subsidiary that engages in the financial institution advisory business but is currently inactive.  The Company’s primary asset is the Bank and the Bank is the Company’s primary source of income.  The Company’s securities consist of 20,000,000 shares of Common Stock, no par value, 10,000,000 shares of Authorized Preferred Stock, and 6,000,000 of Trust Preferred 10.20% Capital Securities which have a liquidation amount of $1,000 per capital security.  As of June 30, 2002 there were 5,296,423 common shares outstanding, held of record by approximately 2,000 shareholders.  There were no preferred shares outstanding at June 30, 2002.  On June 28, 2002, the Company acquired Regency Investment Advisors, Incorporated (“RIA”) as a wholly owned subsidiary from California Bank & Trust, a subsidiary of Zions Bancorporation.  RIA provides financial advisory services for individuals, small business and retirement programs.  The Bank has three wholly owned subsidiaries, Merced Area Investment & Development, Inc. (“MAID”), County Asset Advisors (“CAA”) and County Investment Trust (“REIT”).  During January 2002, the board approved the dissolution of County Investment II (“REIT 2”) which was completed in the second quarter of 2002.  CAA is currently inactive.  All references herein to the “Company” include the Bank and the Bank’s subsidiaries, unless the context otherwise requires.

 

GENERAL - BANK

 

The Bank was organized on August 1, 1977, as County Bank of Merced, a California state banking corporation.  The Bank commenced operations on December 22, 1977.  In November 1992, the Bank changed its legal name to County Bank.  The Bank’s securities consist of one class of Common Stock, no par value and is wholly owned by the Company.  The Bank’s deposits are insured under the Federal Deposit Insurance Act by the Federal Deposit Insurance Corporation (“FDIC”) up to applicable limits stated therein.  Like most state-chartered banks of its size in California, it is not a member of the Federal Reserve System.

 

INDUSTRY AND MARKET AREA

 

The Bank engages in general commercial banking business primarily in Fresno, Madera, Mariposa, Merced, San Francisco, San Joaquin, Stanislaus and Tuolomne counties.  The Bank has eighteen full service branch offices; two of which are located in Merced with the branch located in downtown Merced currently serving as both a branch and as administrative headquarters. There are offices in Atwater, Dos Palos, Hilmar, Livingston, Los Banos, Madera, Mariposa, San Francisco, Sonora, Stockton and two offices in Modesto, two in Fresno and two offices in Turlock.  The Bank’s administrative headquarters also provides accommodations for the activities of Merced Area Investment & Development (“MAID”), the Bank’s wholly owned real estate subsidiary.

 

7

 

OTHER FINANCIAL NOTES

 

All adjustments which in the opinion of Management are necessary for a fair presentation of the Company’s financial position at June 30, 2002 and December 2001 and the results of operations for the three and six month periods ended June 30, 2002 and 2001, and the statements of cash flows for the six months ended June 30, 2002 and 2001 have been included.  Earnings per share have been adjusted to reflect the affect of the 5% stock dividend that was paid April 26, 2002 to shareholders of record on April 5, 2002.  The interim results for the three and six months ended June 30, 2002 and 2001 are not necessarily indicative of results for the full year.  These financial statements should be read in conjunction with the financial statements and the notes included in the Company’s Annual Report for the year ended December 31, 2001.

 

The accompanying unaudited financial statements have been prepared on a basis consistent with the generally accepted accounting principles and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.

 

Basic earnings per share (EPS) is computed by dividing net income available to shareholders by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period plus potential common shares outstanding.  Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company.

 

The following table provides a reconciliation of the numerator and denominator of the basic and diluted earnings per share computation of the three and six month periods ended June 30, 2002 and 2001:

 

		For The Three Months Ended June 30,						For The Six Months Ended June 30,
(Dollars in thousands, except per share data)		2002			2001			2002			2001
Basic EPS computation:
Net income		$	2,384		$	1,981		$	4,608		$	3,893
Average common shares outstanding		5,279			5,087			5,238			5,066
Basic EPS		$	0.45		$	0.39		$	0.88		$	0.77
Diluted EPS Computations:
Net income		$	2,384		$	1,981		$	4,608		$	3,893
Average common shares outstanding		5,279			5,087			5,238			5,066
Effect of stock options		157			156			162			146
		5,436			5,243			5,400			5,212
Diluted EPS		$	0.44		$	0.38		$	0.85		$	0.75

 

On February 22, 2001, the Company issued $6,000,000 in Capital Securities through its 100% ownership position in the County Statutory Trust I.  The Capital Securities pay quarterly cumulative cash distributions at an annual rate of 10.2% of the liquidation value of $1,000 per share.  The Capital Securities represent undivided beneficial interests in the Trust.  The Company owns all of the issued and outstanding common securities of the Trust.  Proceeds from the offering and from the issuance of common securities were invested in the Trust in the Company’s 10.2% Junior Subordinated Deferrable

 

8

 

Interest Debentures due February 22, 2031 with an aggregate principal amount of $6,000,000.  The primary asset of the Trust is the Junior Debentures.  The obligations of the Trust with respect to the Capital Securities are fully and unconditionally guaranteed by the Company to the extent provided in the Guarantee Agreement with respect to the Capital Securities.  The proceeds are to be used for general corporate purposes.  The all-in costs of the Capital Securities was 10.39%.  The Capital Securities have the added benefit of qualifying as Tier 1 capital for regulatory purposes.

 

During January, 2002, the County Investment Trust real estate investment trust (“REIT”) issued $31,000 in Preferred Stock to 123 individual investors that was accounted for on the balance sheet as other minority interests.  County Bank owns 100% of the common stock of the REIT.  The REIT may issue, at management’s discretion, Preferred Stock or other capital instruments in the future in the normal course of operations.  Management has no such plans to issue additional common or preferred stock in the REIT at this time.  The REIT’s primary business purpose is to invest in mortgage related assets of the Bank and to provide management with an additional channel through which equity capital may be raised in the future.

 

On April 26, 2002, the Company entered into an agreement to purchase Regency Investment Advisors, Incorporated (“RIA”) from California Bank and Trust, a subsidiary of Zions Bancorporation.  The all cash purchase was completed on June 28, 2002 at a price of $520,000.  RIA’s purchase price included no physical assets but provided the Company with expected future financial advisory fee income.  The entire purchase price was recorded as a purchase of goodwill.  In future periods, the estimates and assumptions utilized in recording this additional goodwill will be reviewed.  If it is determined that valuations have permanently declined and goodwill is deemed impaired, the amount of the impairment will be written-off to expense in that period.

 

Effective January 1, 2002, the Company was required to adopt the provisions of SFAS 142. Accordingly, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate accounting literature. The Company was also required to reassess the useful lives and residual values of all such intangible assets and make any necessary amortization period adjustments by March 31, 2002. As a result of this assessment, management determined that no accounting adjustments were necessary. As of June 30, 2002 and December 31, 2001, the Company had recorded goodwill of $1,925,000 and $1,405,000.  The recording of goodwill occurred with the acquisition of Town and Country Finance and Thrift (“T&C”) in June, 1996 and RIA in June, 2002.  The original amount of recorded goodwill at the time of the T&C and RIA acquisitions was $2,023,000 and $520,000, respectively.  From July 1, 1996 through December 31, 2001, goodwill attributable to the T&C acquisition was amortized at a rate of $98,000 per quarter. During the first six months of 2001, the goodwill amortization lowered earnings by $196,000 or $0.05 per share on an after tax basis when compared with the same period in 2002.  There has been no recorded amortization of the RIA acquisition and there has been no impairment losses recognized on the T&C and RIA recorded goodwill as of June 30, 2002.

 

As of the date of adoption, the Company had identifiable intangible assets consisting of core deposit premiums and goodwill.  Core deposit premiums are amortized using an accelerated method over a period of ten years. Intangible assets related to goodwill will no longer be amortized after December 31, 2001 but will be reviewed for potential impairment.  Management has determined there was no impairment of goodwill as of January 1, 2002.  As of June 30, 2002 and December 31, 2001, the Company had unamortized core deposit premiums of $1,723,000 and $2,088,000, respectively.  Amortization of core deposit premiums was $340,000 for the six months ended June 30, 2002 and 2001.  Core deposit premiums are scheduled to amortize at a rate of approximately $170,000 per quarter through the quarter ended September 30, 2004 and at a rate of  $47,000 during the fourth quarter of 2004.  Core deposit premiums of $460,000 and $4,340,000 were initially recorded as the result of purchasing deposits from T&C in July, 1996 and from the purchase of three branches from Bank of America in December, 1997, respectively.

 

9

 

Item 2.      Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward­looking statements that are subject to risks and uncertainties and include information about possible or assumed future results of operations.  Many possible events or factors could affect the future financial results and performance of the company.  This could cause results or performance to differ materially from those expressed in our forward-looking statements.  Words such as “experts”, “anticipates”, “believes”, “estimates”, variations of such words and other similar expressions are intended to identify such forward-looking statements.  These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict.  Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements.

 

Readers of the Company’s Form 10-Q should not rely solely on forward looking statements and should consider all uncertainties and risks discussed throughout this report, as well as those discussed in the Company’s 2001 Annual Report on Form 10-K filed March 29, 2002.  These statements are representative only on the date hereof, and the Company undertakes no obligation to update any forward-looking statements made.  Some possible events or factors that could occur that may cause differences from expected results include the following: the Company’s loan growth is dependent on economic conditions, as well as various discretionary factors, such as decisions to sell, or purchase certain loans or loan portfolios; participations of loans and the management of borrower, industry, product and geographic concentrations and the mix of the loan portfolio.  The rate of charge-offs and provision expense can be affected by local, regional and international economic and market conditions, concentrations of borrowers, industries, products and geographical conditions, the mix of the loan portfolio and management’s judgements regarding the collectibility of loans.  Liquidity requirements may change as a result of fluctuations in assets and liabilities and off-balance sheet exposures, which will impact the capital and debt financing needs of the Company and the mix of funding sources.  Decisions to purchase, hold, or sell securities are also dependent on liquidity requirements and market volatility, as well as on and off-balance sheet positions.  Factors that may impact interest rate risk include local, regional and international economic conditions, levels, mix, maturities, yields or rates of assets and liabilities and the wholesale and retail funding sources of the Company.

 

The Company is also exposed to the potential of losses arising from adverse changes in market rates and prices which can adversely impact the value of financial products, including securities, loans, and deposits.  In addition, the banking industry in general is subject to various monetary and fiscal policies and regulations, which include those determined by the Federal Reserve Board, the Federal Deposit Insurance Corporation and state regulators, whose policies and regulations could affect the Company’s results.

 

Other factors that may cause actual results to differ from the forward-looking statements include the following: competition with other local and regional banks, savings and loan associations, credit unions and other nonbank financial institutions, such as investment banking firms, investment advisory firms, brokerage firms, mutual funds and insurance companies, as well as other entities which offer financial services; interest rate, market and monetary fluctuations; inflation; market volatility; general economic conditions; introduction and acceptance of new banking-related products, services and enhancements; fee pricing strategies, mergers and acquisitions and their integration into the Company and management’s ability to manage these and other risks.

 

10

 

Critical accounting policies and estimates

 

The company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, the Company evaluates its estimates, including those related to the adequacy of the allowance for loan losses, intangible assets and contingencies.  The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions. (See caption “Allowance for Loan Losses” for a more detailed discussion).

 

11

 

The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to the Company and its subsidiaries’ financial condition, operating results, asset and liability management, liquidity and capital resources and should be read in conjunction with the Consolidated Financial Statements of the Company and the Notes thereto.

 

Results Of Operations

 

Three and Six Months Ended June 30, 2002 Compared With Three and Six Months Ended June 30, 2001

 

Overview.  For the three and six months ended June 30, 2002 the Company reported record net income of $2,384,000 and $4,608,000.  This compares to $1,981,000 and $3,893,000 for the same periods in 2001 and represents an increase of $403,000 and $715,000 or 20% and 18%.  Basic earnings per share were $.45 and $.88 for the three and six months ended June 30, 2002. Fully diluted earnings per share were $.44 and $.85 for the three and six months ended June 30, 2002.  This compares to basic and fully diluted earnings per share of $.39 and $.38 for the three months and $.77 and $.75 for the six months ended June 30, 2001 and represents an increase of $0.06 per share for both basic and fully diluted earnings per share for the three months ended June 30, 2002 and an increase of $.11 and $.10 for the six months ended June 30, 2002.  The basic and fully diluted earnings per share are reflective of the 5% stock dividend paid in April, 2002.  The annualized return on average assets was 1.01% for both the three and six months ended June 30, 2002 which compares with 1.08% and 1.09% of the three and six months ended June 30, 2001 a decrease of 7 and 8 basis points, respectively.  The Company’s annualized return on average equity was 14.10% and 13.87% for the three and six months ended June 30, 2002 which compares with 13.80% and 13.87% for the three and six months ended June 30, 2001 an increase of 30 and 0 basis points.  The increased return on equity was the result of growth in net interest income that exceeded the growth in noninterest expenses.  The decreased return on assets were primarily due to the lower rates of interest earned during the first six months of 2002 as compared to the same period in 2001 which caused a decrease in net interest margin.  Between June 30, 2001 and June 30, 2002, general market interest rates have declined significantly.

 

Net Interest Income.  The Company’s primary source of income is net interest income and is determined by the difference between interest income and fees derived from earning assets and interest paid on interest bearing liabilities.  Net interest income for the three and six months ended June 30, 2002 totaled $9,933,000 and $19,259,000 which represents an increase of $1,455,000 and $2,366,000 or 17% and 14% when compared to the $8,478,000 and $16,893,000 achieved during the three and six months ended June 30, 2001.

 

Total interest on earning assets were $14,590,000 and $28,467,000 for the three and six months ended June 30, 2002, an increase of $444,000 and $35,000 or 3% and less than 1% from the $14,146,000 and $28,432,000 achieved during the same periods in 2001.  The level of interest income is affected by changes in volume of and rates earned on interest-earning assets.  Interest-earning assets consist primarily of loans, investment securities and federal funds sold.  The small increase in total interest income for the three and six months ended June 30, 2002 was primarily the result of a decrease in the rates earned on interest-earning assets and an increase in volumes of interest-earnings assets generated.  Average interest-earning assets for the three and six months ended June 30, 2002 were $876,327,000 and $843,946,000 which compares with $668,802,000 and $650,423,000 for the three and six months ended June 30, 2001, an increase of $207,525,000 and $193,523,000 or 31% and 30%, respectively.

 

12

 

Interest expense is a function of the volume of and the rates paid on interest-bearing liabilities.  Interest-bearing liabilities consist primarily of certain deposits and borrowed funds.  Total interest expense was $4,657,000 and $9,208,000 for the three and six months ended June 30, 2002, compared with $5,668,000 and $11,539,000 for the three and six months ended June 30, 2001, a decrease of $1,011,000 and $2,331,000 or 18% and 20%.  This decrease was primarily the result of a decrease in the interest rate paid on interest-bearing liabilities.  Average interest-bearing liabilities were $741,766,000 and $714,701,000 for the three and six months ended June 30, 2002 compared with $563,895,000 and $546,964,000 for the same three and six months in 2001, an increase of $177,871,000 and $167,737,000 or 32% and 31%.  Average interest rates paid on interest-bearing liabilities were 2.51% and 2.58% for the three and six months ending June 30, 2002 compared with 4.02% and 4.22% for the same three and six months of 2001, a decrease in interest rates paid of 151 and 164 basis points or 38% and 39%.

 

The increase in interest-earning assets is primarily the result of increased market penetration within our target markets by increasing the utilization of existing facilities.  Deposit and loan growth has been achieved primarily through existing product lines.  The increase in average interest-bearing liabilities was primarily achieved through the increased use of borrowed funds in the form of Federal Home Loan Bank advances and increased savings and certificate of deposit balances.

 

The Company’s taxable equivalent net interest margin, the ratio of net interest income to average interest-earning assets, was 4.59% and 4.62% for the three and six months ended June 30, 2002 compared with 5.12% and 5.24% for the same period in 2001.  The decrease in net interest margin in 2002 compared with 2001 was primarily the result of a decrease in prevailing market interest rates.  Net interest margin provides a measurement of the Company’s ability to employ funds profitably during the period being measured.  The Company’s decrease in net interest margin was primarily attributable to a decrease in prevailing market interest rates.  Loans as a percentage of average interest-earning assets were 64% and 65% for the three and six months ended June 30, 2002 equaling the 64% for the three months ended June 30, 2001 and 100 basis points better than the 64% for the six months ended June 30, 2001.

 

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Average Balances And Rates Earned And Paid.  The following table presents condensed average balance sheet information for the Company, together with interest rates earned and paid on the various sources and uses of its funds for each of the periods indicated.  Nonaccruing loans are included in the calculation of the average balances of loans, but the nonaccrued interest on such loans is excluded.

 

AVERAGE BALANCE SHEET & ANALYSIS OF NET INTEREST EARNINGS

 

		Three months ended June 30, 2002								Three months ended June 30, 2001
		Average Balance			Taxable Equivalent Interest			Taxable Equivalent Yield/rate		Average Balance			Taxable Equivalent Interest			Taxable Equivalent Yield/rate
		(Dollars in thousands)
Assets
Federal funds sold		$	20,576		$	87		1.69	%	$	20,759		$	227		4.37	%
Time deposits at other financial institutions		500			3			2.40		427			5			4.68
Taxable investment securities  (1)		264,050			3,524			5.34		193,888			3,131			6.46
Nontaxable investment securities (1)		28,946			423			5.85		28,991			376			5.19
Loans, gross: (2)		562,255			10,678			7.60		424,737			10,497			9.89
Total interest-earning assets:		876,327			14,715			6.72		668,802			14,236			8.51
Allowance for loan losses		(10,655		)						(8,608		)
Cash and due from banks		28,337								26,453
Premises and equipment, net		13,044								13,323
Interest receivable and other assets		38,721								33,108
Total assets		$	945,774							$	733,078
Liabilities And Shareholders’ Equity
Negotiable order of withdrawal		$	101,901		$	58		0.23		$	81,995		$	61		0.30
Savings deposits		217,504			859			1.58		193,457			1,614			3.34
Time deposits		304,922			2,514			3.30		255,454			3,530			5.53
Other borrowings		117,439			1,226			4.18		32,989			463			5.61
Total interest-bearing liabilities		741,766			4,657			2.51		563,895			5,668			4.02
Noninterest-bearing deposits		124,917								100,391
Accrued interest, taxes and other liabilities		5,430								5,387
Total liabilities		872,113								669,673
Capital Securities and other minority interests		6,031								6,000
Total shareholders’ equity		67,630								57,405
Total liabilities and shareholders’ equity		$	945,774							$	733,078
Net interest income and margin (3)					$	10,058		4.59	%				$	8,568		5.12	%

 

(1)                                  Tax-equivalent adjustments included in nontaxable investment securities income totaled $95,000 and $49,000 for the three months ended June 30, 2002 and 2001, respectively.  Tax equivalent income adjustments included in the nontaxable investment securities income were derived from nontaxable municipal interest income.  Tax equivalent income adjustments included in taxable investment securities income were created by a dividends received deduction of $30,000 and $41,000 for the three months ended June 30, 2002 and 2001.

(2)                                  Amounts of interest earned includes loan fees of $477,000 and $533,000 for June 30, 2002 and 2001 respectively.

(3)                                  Net interest margin is computed by dividing net interest income by total average interest-earning assets.

 

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Average Balances And Rates Earned And Paid.  The following table presents condensed average balance sheet information for the Company, together with interest rates earned and paid on the various sources and uses of its funds for each of the periods indicated.  Nonaccruing loans are included in the calculation of the average balances of loans, but the nonaccrued interest on such loans is excluded.

 

AVERAGE BALANCE SHEET & ANALYSIS OF NET INTEREST EARNINGS

 

		Six months ended June 30, 2002									Six months ended June 30, 2001
		Average Balance				Taxable Equivalent Interest			Taxable Equivalent Yield/rate		Average Balance			Taxable Equivalent Interest			Taxable Equivalent Yield/rate
		(Dollars in thousands)
Assets
Federal funds sold		$		11,755		$	99		1.68	%	$	22,761		$	571		5.02	%
Time deposits at other financial institutions		500				5			2.00		269			7			5.20
Taxable investment securities  (1)		256,416				6,967			5.43		180,711			5,972			6.61
Nontaxable investment securities (1)		28,951				820			5.66		28,997			750			5.17
Loans, gross: (2)		546,324				20,815			7.62		417,685			21,277			10.19
Total interest-earning assets:		843,946				28,706			6.80		650,423			28,577			8.79
Allowance for loan losses		(10,351			)						(8,506		)
Cash and due from banks		28,214									26,716
Premises and equipment, net		13,086									13,190
Interest receivable and other assets		38,698									29,769
Total assets		$	913,593								$	711,592
Liabilities And Shareholders’ Equity
Negotiable order of withdrawal		$	99,771			$	112		0.22		$	81,224		$	152		0.37
Savings deposits		213,989				1,690			1.58		190,159			3,421			3.60
Time deposits		294,715				5,232			3.55		246,254			7,113			5.78
Other borrowings		106,226				2,174			4.09		29,327			853			5.82
Total interest-bearing liabilities		714,701				9,208			2.58		546,964			11,539			4.22
Noninterest-bearing deposits		120,760									98,548
Accrued interest, taxes and other liabilities		5,675									5,652
Total liabilities		841,136									651,164
Capital Securities and other minority interests		6,026									4,276
Total shareholders’ equity		66,431									56,152
Total liabilities and shareholders’ equity		$	913,593								$	711,592
Net interest income and margin (3)						$	19,498		4.62	%				$	17,038		5.24	%

 

(1)                                  Tax-equivalent adjustments included in nontaxable investment securities income totaled  $165,000 and $95,000 for the three months ended June 30, 2002 and 2001, respectively.  Tax equivalent income adjustments included in the nontaxable investment securities income were derived from nontaxable municipal interest income.  Tax equivalent income adjustments included in taxable investment securities income were created by a dividends received deduction of $74,000 and $50,000 for the six months ended June 30, 2002 and 2001.

(2)                                  Amounts of interest earned includes loan fees of $695,000 and $533,000 for June 30, 2002 and 2001 respectively.

(3)                                  Net interest margin is computed by dividing net interest income by total average interest-earning assets.

 

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Net Interest Income Changes Due To Volume And Rate.  The following table sets forth, for the periods indicated, a summary of the changes in average asset and liability balances and interest earned and interest paid resulting from changes in average asset and liability balances (volume) and changes in average interest rates and the total net change in interest income and expenses.  The changes in interest due to both rate and volume have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each.

 

Net Interest Income Variance Analysis:

 

 

 

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Provision For Loan Losses.  The provision for loan losses for the three and six months ended June 30, 2002 was $1,451,000 and $2,231,000 compared with $789,000 and $1,539,000 for the three and six months ended June 30, 2001, an increase of $662,000 and $692,000 or 84% and 45% . See “Allowance for Loan Losses” contained herein.  As of June 30, 2002 the allowance for loan losses was $11,261,000 or 1.93% of total loans which compares to the allowance for loan losses of $9,743,000 or 1.83% as of December 31, 2001.  At June 30, 2002, nonperforming assets totaled $6,785,000 or 0.69% of total assets, nonperforming loans totaled $6,725,000 or 1.15% of total loans and the allowance for loan losses totaled 167% of nonperforming loans.  At December 31, 2001, nonperforming assets totaled $5,328,000 or 0.60% of total assets, nonperforming loans totaled $4,856,000 or 0.91% of total loans and the allowance for loan losses totaled 201% of nonperforming loans.  No assurance can be given that nonperforming loans will not increase or that the allowance for loan losses will be adequate to cover losses inherent in the loan portfolio.

 

Noninterest Income.  Noninterest income increased by $556,000 and $982,000 or 35% and 34% to $2,130,000 and $3,909,000 for the three and six months ended June 30, 2002 compared with $1,574,000 and $2,927,000 during the same period in 2001.  Service charges on deposit accounts increased by $275,000 and $500,000 or 27% and 26% to $1,279,000 and $2,406,000 for the three and six months ended June 30, 2002 compared with $1,004,000 and $1,906,000 for the same period in 2001.  The increase in fees is the result of increased customer use of fee based products.  Income from the sale of real estate increase totaled $33,000 for the three and six months ended June 30, 2002.  During the 2^nd quarter of 2002 the Company sold two other real estate owned properties for a net gain of $33,000.  There were no real estate sales during the comparable period in 2001.  Other income increased by $248,000 and $449,000 or 44% and 44% for the three and six month periods ended June 30, 2002 when compared to the same periods in 2001.  The primary source of this increased other income is an increase in interest income accrued and included in the cash surrender value of bank owned life insurance.

 

Noninterest Expense.  Noninterest expenses increased by $1,037,000 and $2,123,000 or 16% and 17% to $7,513,000 and $14,938,000 for the three and six months ended June 30, 2002 compared with $6,476,000 and $12,815,000 for the same periods in 2001.  The primary components of noninterest expenses were salaries and employee benefits, furniture and equipment expenses, occupancy expenses, professional fees, marketing expenses, goodwill and intangible amortization, supplies expense and other expense.

 

For the three and six months ended June 30, 2002, salaries and related benefits increased by $511,000 and $1,142,000 or 15% and 17% to $3,839,000 and $7,783,000 from the $3,328,000 and $6,641,000 recorded for the same periods in 2001. The salary expense increase was primarily the result of increased staffing levels needed for expanded business volumes and normal salary progression.  Equipment expenses decreased by $109,000 and $164,000 or 16% and 13% to $571,000 and $680,000 during the three and six months ended June 30, 2002 from the $1,140,000 and $1,304,000 experienced during the same periods in 2001.  The reduction in equipment expense is primarily the result of decreased spending on technology during 2002 as compared to 2001.  Premises and occupancy expenses increased by $185,000 and $436,000 or 36% and 44% to $704,000 and $1,420,000 for the three and six months ended June 30, 2002 from $519,000 and $984,000 recorded during the same period in 2001.  The primary reason for the increase in occupancy costs in 2002 is related to retrofit charges for branch facilities in Atwater, Fresno, and Merced and the costs of branch expansion into Stockton and San Francisco.  When comparing the results of the three and six months ending June 30, 2002 to the three and six months ended June 30, 2001, professional fees increased by $218,000 and $354,000 or 220% or 164%, marketing expenses decreased by $11,000 and $34,000 or 5% and 8%, goodwill and intangible amortization expense decreased by $28,000 and $56,000 or 14% in both periods, supplies expense decreased by $81,000 and $97,000 or 32% and 21%, dividend expense on Capital Securities decreased by $3,000 and

 

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increased by 88,000 or 2% and 40% and other expenses increased $355,000 and $454,000 or 35% and 21% from 2001 levels. Increased professional fees in 2002 were the result of an increased use of consultants used to identify new business profitability and tax saving strategies and consulting fees related to the RIA acquisition.  The decreased dividend expense on Capital Securities during the three months ended June 30, 2002 as compared with the same period in 2001 was primarily the result or an adjustment in amortized cost related to the issuance of the securities.  The increased dividend expense on Capital Securities during the six months ended June 30, 2002 as compared to the same period in 2001 was due to the fact that the securities were issued during the latter part of the first quarter of 2001 and therefore were only outstanding during a small portion of that quarter.

 

Provision For Income Taxes.  The Company recorded a decrease of $91,000 and $182,000 or 11% and 12% in the income tax provision to $715,000 and $1,391,000 for the three and six months ended June 30, 2002 compared to the $806,000 and $1,573,000 recorded for the same period in 2001.  During the three and six months ended June 30, 2002, the Company achieved an effective tax rate of 23% compared to 29% recorded for the same periods in 2001. During 2002, the reduced effective tax rate was made possible by the continued utilization of a real estate investment trust established during the fourth quarter of 2001 that provides the Company with a means to potentially generate future additional capital for the Bank as well as to currently reduce state income tax expense.

 

Interest Rate Risk

 

A measure of interest rate sensitivity that the Company monitors through a detailed model is its expected change in net interest income.  This model’s estimate of interest rate sensitivity takes into account the differing time intervals and differing rate change increments of each type of interest-sensitive asset and liability.  It then measures the projected impact of changes in market interest rates on the Company’s net interest income.  Based upon the June 30, 2002 mix of interest-sensitive assets and liabilities, given an immediate and sustained decrease in the market interest rates of 1%, this model estimates the Company’s net interest income over the next year would decrease by $512,000 or 1% of net interest income.  No assurance can be given that the actual net interest income would not decrease by more than $512,000 or 1% in response to a 1% decrease in market interest rates or that actual net interest income would not decrease substantially if market interest rates decreased by more than 1%.

 

Financial Condition

 

Total assets at June 30, 2002 were $975,832,000, an increase of $81,505,000 or 9% compared with total assets of $894,327,000 at December 31, 2001.  Net loans were $572,393,000 at June 30, 2002, an increase of $49,716,000 or 10% compared with net loans of $522,677,000 on December 31, 2001.  Deposits totaled $773,883,000 at June 30, 2002, an increase of $41,242,000 or 6% compared with deposits of $732,641,000 at December 31, 2001.  The increase in total assets of the Company between December 31, 2001 and June 30, 2002 was primarily the result of an increase in leverage that was maintained in the Company’s investment portfolio that were funded with increased borrowed funds and increased cash utilization and an increase in the overall size of the loan portfolio.

 

On February 22, 2001, the Company issued $6,000,000 in Capital Securities through its 100% ownership position in the County Statutory Trust I.  The Capital Securities pay quarterly cumulative cash distributions at an annual rate of 10.2% of the liquidation value of $1,000 per share.  The Capital Securities represent undivided beneficial interests in the Trust.  The Company owns all of the issued and outstanding common securities of the Trust.  Proceeds from the offering and from the issuance of common securities were invested in the Trust in the Company’s 10.2% Junior Subordinated Deferrable Interest Debentures due February 22, 2031 with an aggregate principal amount of $6,000,000.  The

 

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primary asset of the Trust is the Junior Debentures.  The obligations of the Trust with respect to the Capital Securities are fully and unconditionally guaranteed by us to the extent provided in the Guarantee Agreement with respect to the Capital Securities.  The proceeds were used for general corporate purposes.  The all-in costs of the Capital Securities was 10.39%.  The Capital Securities have the added benefit of qualifying as Tier 1 capital for regulatory purposes.

 

Total shareholders’ equity was $69,792,000 at June 30, 2002, an increase of $5,672,000 or 9% from $64,120,000 at December 31, 2001. The growth in shareholders’ equity between December 31, 2001 and June 30, 2002 was achieved through the retention of accumulated earnings.  Other comprehensive increased by $231,000 to $1,890,000 at June 30, 2002 compared with $1,659,000 at December 31, 2001.  Other comprehensive income consists of changes in the fair market value compared to book value of available for sale investment securities and valuation changes in the Bank’s interest rate swap, net of estimated federal and state income taxes.

 

Investment Portfolio.  At June 30, 2002 and December 31, 2001 the carrying amount (fair value) of available for sale investment securities totaled $230,831,000 and $229,852,000 respectively.  At June 30, 2002 and December 31, 2001 the amortized cost of available for sale investment securities totaled $228,099,000 and $227,866,000.  The amortized cost of held to maturity securities at June 30, 2002 and December 31, 2001 was $64,399,000 and $41,559,000.  The fair value of held to maturity securities at June 30, 2002 and December 31, 2001 was $65,410,000 and $42,185,000.

 

Off-Balance Sheet Commitments.  The following table shows the distribution of the Company’s undisbursed loan commitments at the dates indicated.

 

 

Other Interest-Earning Assets.  The following table relates to other interest–earning assets not disclosed previously for the dates indicated.  This item consists of a salary continuation plan for the Company’s executive management and deferred retirement benefits for participating board members.  The plan is informally linked with universal life insurance policies for the salary continuation plan.  Income from these policies is reflected in noninterest income.

 

(Dollars in thousands)		At June 30, 2002			At  December 31, 2001
Cash surrender value of life insurance		$	16,607		$	16,160

 

Nonperforming Assets.  Nonperforming assets include nonaccrual loans, loans 90 days or more past due, restructured loans and other real estate owned.

 

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Nonperforming loans are those which the borrower fails to perform in accordance with the original terms of the obligation and include loans on nonaccrual status, loans past due 90 days or more and restructured loans.  The Company generally places loans on nonaccrual status and accrued but unpaid interest is reversed against the current year’s income when interest or principal payments become 90 days or more past due unless the outstanding principal and interest is adequately secured and, in the opinion of management, is deemed in the process of collection.  Interest income on nonaccrual loans is recorded on a cash basis.  Payments may be treated as interest income or return of principal depending upon management’s opinion of the ultimate risk of loss on the individual loan.  Cash payments are treated as interest income where management believes the remaining principal balance is fully collectible.  Additional loans not 90 days past due may also be placed on nonaccrual status if management reasonably believes the borrower will not be able to comply with the contractual loan repayment terms and collection of principal or interest is in question.

 

A “restructured loan” is a loan on which interest accrues at a below market rate or upon which certain principal has been forgiven so as to aid the borrower in the final repayment of the loan, with any interest previously accrued, but not yet collected, being reversed against current income.  Interest is reported on a cash basis until the borrower’s ability to service the restructured loan in accordance with its terms is established.  The Company had no restructured loans as of the dates indicated in the table below.

 

The following table summarizes nonperforming assets of the Company at June 30, 2002 and December 31, 2001:

 

 

Contractual accrued interest income on loans on nonaccrual status as of June 30, 2002 and 2001, that would have been recognized if the loans had been current in accordance with their original terms was approximately $129,000 and $81,000 for the six months ended June 30, 2002 and 2001.

 

At June 30, 2002, nonperforming assets represented ..70% of total assets, an increase of 10 basis point when compared to the .60% at December 31, 2001.  Nonperforming loans represented 1.15% of total loans at June 30, 2002, an increase of 24 basis points compared to the .91% at December 31, 2001.  Nonperforming loans that were secured by first deeds of trust on real property were $0 at June 30, 2002 and December 31, 2001.   Other forms of collateral such as inventory and equipment secured the remaining nonperforming loans as of each date.  No assurance can be given that the collateral securing nonperforming loans will be sufficient to prevent losses on such loans.

 

The increase in nonperforming loans and nonperforming assets as of June 30, 2002 compared with their levels as of December 31, 2001, was due to a growth in nonperforming loans in the agricultural segment of the loan portfolio.

 

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At June 30, 2002, the Company had $60,000 invested in one property acquired through foreclosure.  This property is carried at the lower of its estimated market value, as evidenced by an independent appraisal, or the recorded investment in the related loan, less estimated selling expenses.  At foreclosure, if the fair value of the real estate is less than the Company’s recorded investment in the related loan, a charge is made to the allowance for loan losses.  The Company expects to sell this property within a twelve month period.  No assurance can be given that the Company will sell this property during 2002 or at any time or the amount for which such property might be sold.

 

Management defines impaired loans, regardless of past due status on loans, as those on which principal and interest are not expected to be collected under the original contractual loan repayment terms.  An impaired loan is charged off at the time management believes the collection process has been exhausted.  At June 30, 2002 and December 31, 2001, impaired loans were measured based on the present value of future cash flows discounted at the loan’s effective rate, the loan’s observable market price or the fair value of collateral if the loan is collateral-dependent.  Impaired loans at June 30, 2002 were $6,725,000 on account of which the Company had made provisions to the allowance for loan losses of approximately $702,000.

 

Except for loans that are disclosed above, there were no assets as of June 30, 2002, where known information about possible credit problems of borrower causes management to have serious doubts as to the ability of the borrower to comply with the present loan repayment terms and which may become nonperforming assets.  Given the magnitude of the Company’s loan portfolio, however, it is always possible that current credit problems may exist that may not have been discovered by management.

 

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Allowance for Loan Losses

 

The following table summarizes the loan loss experience of the Company for the three months ended June 30, 2002 and 2001, and for the year ended December 31, 2001.

 

		June 30						December 31
		2002			2001			2001
		(Dollars in thousands)
Allowance for Loan Losses:
Balance at beginning of period		$	9,743		$	8,207		$	8,207
Provision for loan losses		2,231			1,539			4,115
Charge-offs:
Commercial and  agricultural		572			188			864
Consumer		560			1,088			2,288
Total charge-offs		1,132			1, 276			3,152
Recoveries
Commercial and agricultural		133			125			159
Consumer		186			207			414
Total recoveries		419			332			573
Net charge-offs		713			944			2,579
Balance at end of period		$	11,261		$	8,802		$	9,743
Loans outstanding at period-end		$	583,625		$	448,612		$	532,420
Average loans outstanding		$	546,324		$	417,685		$	453,503
Annualized net charge-offs to average loans		0.26		%	0.45		%	0.57		%
Allowance for loan losses
To total loans		1.93		%	1.96		%	1.83		%
To nonperforming assets		165.97		%	289.99		%	182.85		%

 

The Company maintains an allowance for loan losses at a level considered by management to be adequate to cover the inherent risks of loss associated with its loan portfolio under prevailing and anticipated economic conditions.  In determining the adequacy of the allowance for loan losses, management takes into consideration growth trends in the portfolio, examination of financial institution supervisory authorities, prior loan loss experience for the Company, concentrations of credit risk, delinquency trends, general economic conditions, the interest rate environment and internal and external credit reviews.  In addition, the risks management considers vary depending on the nature of the loan.  The normal risks considered by management with respect to agricultural loans include the fluctuating value of the collateral, changes in weather conditions and the availability of adequate water resources in the Company’s local market area.  The normal risks considered by management with respect to real estate construction loans include fluctuation in real estate values, the demand for improved commercial and industrial properties and housing, the availability of permanent financing in the Company’s market area and borrowers’ ability to obtain permanent financing.  The normal risks considered by management with respect to real estate mortgage loans include fluctuations in the value of real estate.  Additionally, the Company relies on data obtained through independent appraisals for significant properties to determine loss exposure on nonperforming loans.

 

The balance in the allowance is affected by the amounts provided from operations, amounts charged off and recoveries of loans previously charged off.  The Company recorded provisions for loan losses for the three and six months ended June 30, 2002 of $1,451,000 and $2,231,000 compared with

 

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$789,000 and $1,539,000 during the same periods in 2001. The increase in loan loss provisions in 2002 was recorded to adequately provide for the general loan growth of the Company that has occurred during the period.

 

The Company’s charge-offs, net of recoveries, were $713,000 for the six months ended June 30, 2002 compared with $944,000 for the same six months in 2001.  The decrease in net charge-offs for the six months ended June 30, 2002 when compared to the same period in 2001 was primarily due to decreased charge-offs that occurred within the consumer installment segment of the loan portfolio.  The decreased charge-offs in this segment of the portfolio are primarily attributable to a tightening of the credit standards in the indirect automobile contract segment of the loan portfolio that occurred during the second half of 2001.

 

As of June 30, 2002, the allowance for loan losses was $11,261,000 or 1.93% of total loans outstanding, compared with $9,743,000 or 1.83% of total loans outstanding as of December 31, 2001 and $8,802,000 or 1.96% of total loans outstanding as of June 30, 2001.  Between June 30, 2001 and 2002, the allowance for loan loss increased $2,459,000 or 28%.

 

The Company uses a method developed by management for determining the appropriate level of its allowance for loan losses.  This method applies relevant risk factors to the entire loan portfolio, including nonperforming loans.  The methodology is based, in part, on the Company’s loan grading and classification system.  The Company grades its loans through internal reviews and periodically subjects loans to external reviews which then are assessed by the Company’s audit committee and management.  Credit reviews are performed on a monthly basis and the quality grading process occurs on a quarterly basis. Risk factors applied to the performing loan portfolio are based on the Company’s past loss history considering the current portfolio’s characteristics, current economic conditions and other relevant factors.  General reserves are applied to various categories of loans at percentages ranging up to 1.8% based on the Company’s assessment of credit risks for each category.  Risk factors are applied to the carrying value of each classified loan: (i) loans internally graded “Watch” or “Special Mention” carry a risk factor from 1.0% to 2.0%; (ii) ”Substandard” loans carry a risk factor from 15% to 40% depending on collateral securing the loan, if any; (iii) “Doubtful” loans carry a 50% risk factor; and (iv) “Loss” loans are charged off 100%.  In addition, a portion of the allowance is specially allocated to identified problem credits.  The analysis also includes reference to factors such as the delinquency status of the loan portfolio, inherent risk by type of loans, industry statistical data, recommendations made by the Company’s regulatory authorities and outside loan reviewers, and current economic environment.  Important components of the overall credit rating process are the asset quality rating process and the internal loan review process.

 

The allowance is based on estimates and ultimate future losses may vary from current estimates.  It is always possible that future economic or other factors may adversely affect the Company’s borrowers, and thereby cause loan losses to exceed the current allowance.  In addition, there can be no assurance that future economic or other factors will not adversely affect the Company’s borrowers, or that the Company’s asset quality may not deteriorate through rapid growth, failure to enforce underwriting standards, failure to maintain appropriate underwriting standards, failure to maintain an adequate number of qualified loan personnel, failure to identify and monitor potential problem loans or for other reasons, and thereby cause loan losses to exceed the current allowance.

 

The allocation of the allowance to loan categories is an estimate by management of the relative risk characteristics of loans in those categories.  No assurance can be given that losses in one or more loan categories will not exceed the portion of the allowance allocated to that category or even exceed the entire allowance.

 

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External Factors Affecting Asset Quality.  As a result of the Company’s loan portfolio mix, the future quality of its assets could be affected by adverse economic trends in its region or in the agricultural community.  These trends are beyond the control of the Company.

 

California is an earthquake-prone region.  Accordingly, a major earthquake could result in material loss to the Company.  At times the Company’s service area has experienced other natural disasters such as floods and droughts.  The Company’s properties and substantially all of the real and personal property securing loans in the Company’s portfolio are located in California.  The Company faces the risk that many of its borrowers face uninsured property damage, interruption of their businesses or loss of their jobs from earthquakes, floods or droughts.  As a result these borrowers may be unable to repay their loans in accordance with their terms and the collateral for such loans may decline significantly in value.  The Company’s service area is a largely agricultural region and therefore is highly dependent on a reliable supply of water for irrigation purposes.  The area obtains nearly all of its water from the run-off of melting snow in the mountains of the Sierra Nevada to the east.  Although such sources have usually been available in the past, water supply can be adversely affected by light snowfall over one or more winters or by any diversion of water from its present natural courses.  Any such natural disaster could impair the ability of many of the Company’s borrowers to meet their obligations to the Company.

 

Parts of California have experienced significant floods in the late 1990s. No assurance can be given that future flooding will not have an adverse impact on the Company and its borrowers and depositors.

 

Liquidity. In order to maintain adequate liquidity, the Company must have sufficient resources available at all times to meet its cash flow requirements.  The need for liquidity in a banking institution arises principally to provide for deposit withdrawals, the credit needs of its customers and to take advantage of investment opportunities as they arise.  The Company may achieve desired liquidity from both assets and liabilities.  The Company considers cash and deposits held in other banks, federal funds sold, other short term investments, maturing loans and investments, payments of principal and interest on loans and investments and potential loan sales as sources of asset liquidity.  Deposit growth and access to credit lines established with correspondent banks and market sources of funds are considered by the Company as sources of liability liquidity.  The holding company’s primary source of liquidity is from dividends received from the Bank.  Dividends from the Bank are subject to certain regulatory restrictions.

 

The Company reviews its liquidity position on a regular basis based upon its current position and expected trends of loans and deposits. These assets include cash and deposits in other banks, available-for-sale securities and federal funds sold.  The Company’s liquid assets totaled $287,011,000 and $279,640,000 on June 30, 2002 and December 31, 2001, respectively, and constituted 29% and 31% of total assets on those dates.  Liquidity is also affected by the collateral requirements of its public deposits and certain borrowings.  Total pledged securities were $230,961,000 at June 30, 2002 compared with $141,386,000 at December 31, 2001.

 

Although the Company’s primary sources of liquidity include liquid assets and a stable deposit base, the Company maintains lines of credit with the Federal Reserve Bank of San Francisco, Federal Home Loan Bank of San Francisco and Pacific Coast Bankers’ Bank aggregating $148,164,000 of which $111,307,000 was outstanding as of June 30, 2002 and $73,759,000 was outstanding as of December 31, 2001. The increase in borrowings outstanding during the first six months of 2002 produced an inflow of funds that were used to purchase additional investment securities and fund loan production.  Management believes that the Company maintains adequate amounts of liquid assets to meet its liquidity needs.  The Company’s liquidity might be insufficient if deposit withdrawals were to exceed anticipated levels.

 

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Deposit withdrawals can increase if a company experiences financial difficulties or receives adverse publicity for other reasons, or if its pricing, products or services are not competitive with those offered by other institutions.

 

Capital Resources.  Capital serves as a source of funds and helps protect depositors against potential losses.  The primary source of capital for the Company has been internally generated capital through retained earnings.  The Company’s shareholders’ equity increased by $5,672,000 or 9% from December 31, 2001 to June 30, 2002.

 

The Company is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate mandatory and possibly additional discretionary actions by the regulators that, if undertaken, could have a material adverse effect on the Company’s financial statements.  Management believes, as of June 30, 2002, that the Company and the Bank met all applicable capital requirements.  The Company’s leverage capital ratio at June 30, 2002 was 7.46% as compared with 7.72% as of December 31, 2001.  The Company’s total risk based capital ratio at June 30, 2002 was 10.76% as compared to 10.74% as of December 31, 2001.

 

The Company’s and Bank’s actual capital amounts and ratios met all regulatory requirements as of June 30, 2002 and were summarized as follows:

 

		Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions:
Dollars in thousands		Amount			Ratio		Amount			Ratio		Amount			Ratio
Consolidated
As of June 30, 2002
Total capital (to risk weighted assets)		$	79,572		10.76	%	$	59,141		8.0	%	$	73,926		10.0	%
Tier 1 capital (to risk weighted assets)		70,306			9.51		29,571			4.0		44,356			6.0
Leverage ratio*		70,306			7.46		37,706			4.0		47,132			5.0
The Bank:
As of June 30, 2002
Total capital (to risk weighted assets)		$	76,955		10.43	%	$	59,002		8.0	%	$	73,753		10.0	%
Tier 1 capital (to risk weighted assets)		67,711			9.18		29,501			4.0		44,252			6.0
Leverage ratio*		67,711			7.19		37,658			4.0		47,073			5.0

 

* The leverage ratio consists of Tier 1 capital divided by adjusted 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.

 

The Company has no formal dividend policy, and dividends are issued solely at the discretion of the Company’s Board of Directors, subject to compliance with regulatory requirements.  In order to pay any cash dividends, the Company must receive payments of dividends or management fees from the Bank.  There are certain regulatory limitations on the payment of cash dividends by banks.

 

Deposits.  Deposits are the Company’s primary source of funds.  At June 30, 2002, the Company had a deposit mix of 29% in savings deposits, 40% in time deposits, 13% in interest-bearing checking accounts and 18% in noninterest-bearing demand accounts.  Noninterest-bearing demand deposits enhance the Company’s net interest income by lowering its costs of funds.

 

The Company obtains deposits primarily from the communities it serves.  No material portion of its deposits has been obtained from or is dependent on any one person or industry.  The Company’s

 

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business is not seasonal in nature.  The Company accepts deposits in excess of $100,000 from customers.  These deposits are priced to remain competitive.  At June 30, 2002, the Company had brokered deposits of $15,495,000.

 

Maturities of time certificates of deposits of $100,000 or more outstanding at June 30, 2002 and December 31, 2001 are summarized as follows:

 

		June 30, 2002			December 31, 2001
		(Dollars in thousands)
Three months or less		$	38,596			$	53,879
Over three to six months		46,774				37,358
Over six to twelve months		38,765				30,776
Over twelve months		30,245				9,161
Total		$	154,380			$	131,174

 

Borrowed Funds

 

The increase in other borrowings during the first six months of 2002 was primarily due to the use of a leveraged investment strategy that uses additional FHLB borrowings to fund purchases of investment securities within the Bank’s investment portfolio.

 

Return on Equity and Assets

 

		Six months ended June 30 2002		Six months ended June 30 2001		Year ended December 31 2001
Annualized return on average assets		1.01	%	1.09	%	1.03	%
Annualized return on average equity		13.87	%	13.87	%	13.40	%
Average equity to average assets		7.27	%	7.89	%	7.69	%

 

Impact of Inflation

 

The primary impact of inflation on the Company is its effect on interest rates.  The Company’s primary source of income is net interest income which is affected by changes in interest rates.  The Company attempts to limit inflation’s impact on its net interest margin through management of rate sensitive assets and liabilities and the analysis of interest rate sensitivity.  The effect of inflation on premises and equipment, as well as on interest expenses, has not been significant for the periods covered in this report.

 

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Item 3.    Quantitative and Qualitative Disclosures about Market Risk

 

In the normal course of business, the Company is exposed to market risk which includes both price and liquidity risk.  Price risk is created from fluctuations in interest rates and the mismatch in repricing characteristics of assets, liabilities, and off balance sheet instruments at a specified point in time.  Mismatches in interest rate repricing among assets and liabilities arise primarily through the interaction of the various types of loans versus the types of deposits that are maintained as well as from management’s discretionary investment and funds gathering activities.  Liquidity risk arises from the possibility that the Company may not be able to satisfy current and future financial commitments or that the Company may not be able to liquidate financial instruments at market prices.  Risk management policies and procedures have been established and are utilized to manage the Company’s exposure to market risk.  Quarterly testing of the Company’s assets and liabilities under both increasing and decreasing interest rate environments are performed to insure the Company does not assume a magnitude of risk that is outside approved policy limits.

 

The Company’s success is largely dependent upon its ability to manage interest rate risk.  Interest rate risk can be defined as the exposure of the Company’s net interest income to adverse movements in interest rates.  Although the Company manages other risks, such as credit and liquidity risk in the normal course of its business, management considers interest rate risk to be its most significant market risk and could potentially have the largest material effect on the Company’s financial condition and results of operations.  Correspondingly, the overall strategy of the Company is to manage interest rate risk, through balance sheet structure, to be interest rate neutral.

 

The Company’s interest rate risk management is the responsibility of the Asset/Liability Management Committee (ALCO), which reports to the Board of Directors.  ALCO establishes policies that monitors and coordinates the Company’s sources, uses and pricing of funds.  ALCO is also involved in formulating the economic projections for the Company’s budget and strategic plan.  ALCO sets specific rate sensitivity limits for the Company.  ALCO monitors and adjusts the Company’s exposure to changes in interest rates to achieve predetermined risk targets that it believes are consistent with current and expected market conditions.  Balance sheet management personnel monitor the asset and liability changes on an ongoing basis and provide report information and recommendations to the ALCO committee in regards to those changes.

 

It is the opinion of management there has been no material change in the Company’s market risk during the first six months of 2002 when compared to the level of market risk at December 31, 2001.  If interest rates were to suddenly and materially fall from levels experienced during the first six months of 2002, the Company could become susceptible to an increased level of market risk.

 

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PART II - Other Information

 

Item 1.              Legal Proceedings

 

The Company is a party to routine litigation in the ordinary course of its business.  In the opinion of management, pending and threatened litigation is not likely to have a material adverse effect on the financial condition or results of operations of the Company.

 

Item 2.              Changes in Securities and Use of Proceeds.

 

None.

 

Item 3.              Defaults Upon Senior Securities.

 

None.

 

Item 4.              Submission of Matters to a Vote of Securities Holders.

 

(a.)	Annual Meeting was held April 23, 2002.  The number of shares represented in person or by proxy and constituting a quorum was 4,236,509 which equals approximately 86% of the shares outstanding.
(b.)	Election of directors			Votes For
	G. Michael Graves			3,913.010
	Bertyl W. Johnson			3,910,835
	James W. Tolladay			3,912,723
	Tom A. L. Van Groningen			3,913,901
	Gerald L. Tahajian			3,909,128
(c.)	Proposal to approve the Capital Corp of the West 2002 Stokc Option Plan.  The proposal was approved with 2,509,892 voting in favor and 896,848 were opposed.

 

Item 5.              Other Information.

 

In the opinion of management, there is no additional information relating to these periods being reported which warrants inclusion in the report.

 

Item 6.  Exhibits and Reports on Form 8-K.

 

(a)                                Exhibits.

 

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Exhibit Number		Exhibit
3.1		Articles of Incorporation (filed as Exhibit 3.1 of the Company’s September 30, 1996 Form 10-Q filed with the SEC on or about November 14, 1996).
3.2		Bylaws (filed as Exhibit 3.2 of the Company’s September 30, 1996 Form 10-Q filed with the SEC on or about November 14, 1996)
3.3		Rights Agreement between Capital Corp of the West and Harris Trust Company of California dated as of September 26, 1997, including Form of Right Certificate attached thereto as Exhibit B (filed as Exhibit 4 to the Company’s Registration Statement on Form 8-A filed with the SEC on October 1, 1997.
10.1		Administration Construction Agreement (filed as Exhibit 10.4 of the Company’s 1995 Form 10-K filed with the SEC on or about March 31, 1996).
10.2		Stock Option Plan (filed as Exhibit 10.6 of the Company’s 1995 Form 10-K filed with the SEC on or about March 31, 1996).
10.3		401(k) Plan (filed as Exhibit 10.7 of the Company’s 1995 Form 10-K filed with the SEC on or about March 31, 1996).
10.4		Employee Stock Ownership Plan (filed as Exhibit 10.8 of the Company’s 1995 Form 10-K filed with the SEC on or about March 31, 1996).
10.5		Purchase Agreement for three branches from Bank of America is incorporated herein by reference from Exhibit 2.1 Registration Statement on Form S-2 filed July 14, 1997, File No. 333-31193.
10.6		Change-in-Control Agreement between R. Dale McKinney and Capital Corp of the West (filed as Exhibit 10.6 of the Company’s 1999 Form  10-K with the SEC on or about March 17, 2000).		*
10.7		Deferred Compensation Agreement between members of the board of directors and Capital Corp of the West (filed as exhibit 10.7 of the Company’s 1999 Form 10-K with the SEC on or about March 17, 2000).		*
10.8		Executive Salary Continuation Agreement between certain members of executive management and Capital Corp of the West (filed as Exhibit 10.8 of the Company’s 1999 Form 10-K with the SEC in or about March 17, 2000).		*
10.9		Executive Salary Continuation Agreement between senior executive management and Capital Corp of the West (filed as Exhibit 10.9 of the Company’s 2001 Form 10-K with the SEC on or about March 29, 2002).		*
10.10		Employment Agreement between Thomas T. Hawker and Capital Corp. of the West		*
11		Statement Regarding the Computation of Earnings Per Share is incorporated herein by reference from Note 1 of the Company’s Consolidated Financial Statements.
13		Annual Report to Security Holders  (filed as Exhibit 13 of the Company’s 2001 Form 10-K with the SEC on March 29, 2002).
99.1		Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2		Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

*                         Denotes management contract or compensatory plan arrangement.

 

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Reports on Form 8-K

 

None

 

30

 

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.

 

	CAPITAL CORP OF THE WEST
	(Registrant)
August 13, 2002	By	/s/	Thomas T. Hawker
			Thomas T. Hawker
			President and
			Chief Executive Officer
	By	/s/	R. Dale McKinney
			R. Dale McKinney
			Chief Financial Officer

 

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