UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(mark one)

ý QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2003

 

OR

 

o TRANSITION REPORT UNDER SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to               

 

Commission File Number     0-24024

 

First Community Financial Group, Inc.

(Exact name of registrant as specified in its charter)

 

 

721 College Street. SE, P.O. Box 3800, Lacey, WA  98509

(Address of principal executive offices)

 

Issuer’s telephone number:    (360) 459-1100

 

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 past 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:              ý  Yes  o  No

 

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act)     Yes  o  ý  No

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

 

 

 

First Community Financial Group, Inc.

 

Table of Contents

 

PART I - FINANCIAL INFORMATION

 

Item 1	Financial Statements
	Condensed Consolidated Balance Sheets
	Condensed Consolidated Statements of Income and Comprehensive Income
	Condensed Consolidates Statement of Stockholders’ Equity
	Condensed Consolidated Statements of Cash Flows
	Notes to Condensed Consolidated Financial Statements
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3	Quantitative and Qualitative Disclosures about Market Risk
Item 4	Disclosure Controls and Procedures
PART II - OTHER INFORMATION
Item 6	Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS

 

2

 

FIRST COMMUNITY FINANCIAL GROUP, INC. and SUBSIDIARIES

Condensed Consolidated Balance Sheets (Unaudited)

 

(Dollars in thousands)

 

		March 31 2003			December 31 2002
Assets
Cash and due from banks		$	22,572		$	30,965
Interest bearing deposits in banks		66			76
Federal funds sold		7,500			7,000
Securities available for sale		32,435			33,622
Securities held to maturity		505			505
FHLB Stock		1,109			877
Loans held for sale		10,162			7,432
Loans		358,971			362,132
Allowance for credit losses		8,216			7,947
Net loans		350,755			354,185
Premises and equipment		11,137			11,141
Foreclosed real estate		4,785			4,899
Accrued interest receivable		1,930			1,884
Cash surrender value of life insurance		8,966			8,863
Intangible assets		11,680			11,708
Other assets		1,319			1,293
Total assets		$	464,921		$	474,450
Liabilities
Deposits:
Demand		$	75,598		$	82,267
Savings and interest bearing demand		161,052			156,031
Time deposits		136,165			145,909
Total deposits		372,815			384,207
Short term borrowing		17,607			16,547
Long term debt		23,000			24,000
Accrued interest payable		292			315
Other liabilities		5,866			5,172
Total liabilities		419,580			430,241
Stockholders’ Equity
Common stock, (no par value); 10,000,000 shares authorized, shares issued: 2003 - 4,392,798; 2002 -  4,389,236		28,033			28,430
Retained earnings		16,808			15,246
Accumulated other comprehensive income, net of tax		500			533
Total stockholders’ equity		45,341			44,209
Total liabilities and stockholders’ equity		$	464,921		$	474,450

 

See notes to condensed consolidated financial statements

 

3

 

FIRST COMMUNITY FINANCIAL GROUP, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited)

 

(Dollars in thousands, except per share amounts)

 

		Three months ended March 31
		2003			2002
Interest income
Loans		$	7,883		$	6,629
Federal funds sold and deposits in banks		2			2
Securities		351			305
Total interest income		8,236			6,936
Interest Expense
Deposits		1,260			1,645
Other		358			71
Total interest expense		1,618			1,716
Net interest income		6,618			5,220
Provision for credit losses		577			621
Net interest income after provision for credit losses		6,041			4,599
Non-interest income
Service charges on deposit accounts		920			723
Origination fees on mortgage loans sold		858			557
Other operating income		788			536
Total non-interest income		2,566			1,816
Non-interest expense
Salaries and employee benefits		3,146			2,265
Occupancy and equipment		803			642
Other expense		2,031			1,502
Total non-interest expense		5,980			4,409
Operating income before income taxes		2,627			2,006
Income Taxes		845			627
Net income		$	1,782		$	1,379
Other comprehensive income, net of tax:
Unrealized holding losses on securities arising during the period		(33		)	(264		)
Comprehensive Income		$	1,749		$	1,115
Earnings per Share Data
Basic earnings per share		$	.41		$	.32
Diluted earnings per share		$	.39		$	.31
Dividends declared per share		$	0.05		$	0.05
Weighted average number of common shares outstanding		4,381,610			4,374,186
Weighted average number of common shares outstanding, Including dilutive stock options		4,562,704			4,384,819
Return on average assets		1.52		%	1.50		%

 

See notes to condensed consolidated financial statements

 

4

 

FIRST COMMUNITY FINANCIAL GROUP, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)

 

(Dollars in thousands)

 

Three Months Ended March 31, 2002 and 2003

 

		Common Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Unearned KSOP Shares			Total
Balance, December 31, 2001		$	28,596		$	9,912		$	312		$	(25	)	$	38,795
Net income		—			1,379			—			—			1,379
Stock options exercised		17			—			—			—			17
Cash dividend ($0.05 per share)		—			(219		)	—			—			(219		)
Other comprehensive loss		—			—			(264		)	—			(264		)
Net decrease in unearned KSOP shares		—			—			—			25			25
Balance, March 31, 2002		$	28,613		$	11,072		$	48		$	0		$	39,733
Balance, December 31, 2002		$	28,430		$	15,246		$	533		$	0		$	44,209
Net income		—			1,782			—			—			1,782
Stock options exercised		778			—			—			—			778
Stock repurchased		(1,175		)	—			—			—			(1,175		)
Cash dividend ($0.05 per share)		—			(220		)	—			—			(220		)
Other comprehensive loss		—			—			(33		)	—			(33		)
Balance, March 31, 2003		$	28,033		$	16,808		$	500		$	0		$	45,341

 

See notes to condensed consolidated financial statements

 

5

 

FIRST COMMUNITY FINANCIAL GROUP, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

(Dollars in thousands)

 

		Three months ended March 31
		2003			2002
Cash Flows from Operating Activities
Net Income		$	1,782		$	1,379
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses		577			621
Depreciation and amortization		353			302
Amortization of other intangible assets		28			—
Other - net		306			(1,060		)
Originations of loans held for sale		(37,351		)	(22,667		)
Proceeds from sales of loans held for sale		34,621			23,992
Net cash provided by operating activities		316			2,567
Cash Flows from Investing Activities
Net decrease in interest bearing deposits in banks		10			11
Net increase in Federal funds sold		(500		)	—
Proceeds from maturities and prepayments of available-for-sale securities		1,108			739
Purchase of securities available for sale		—			(2,424		)
Purchase of FHLB stock		(215		)	—
Net decrease in loans		2,853			757
Proceeds from sale of other real estate		333			—
Additions to premises and equipment		(349		)	(86		)
Net cash provided (used) by investing activities		3,240			(1,003		)
Cash Flows from Financing Activities
Net decrease in deposits		(11,392		)	(3,409		)
Net increase in short-term borrowings		1,060			10,287
Sale of common stock		778			17
Repurchase of common stock		(1,175		)	—
Repayment of long-term borrowings		(1,000		)	(25		)
Payment of cash dividends		(220		)	(219		)
Net cash provided (used) by financing activities		(11,949		)	6,651
Net change in cash and due from banks		(8,393		)	8,215
Cash and Due from Banks:
Beginning of period		30,965			21,383
End of period		$	22,572		$	29,598
Supplemental Disclosures of Cash Flow Information:
Cash payments for:
Interest		$	1,641		$	1,832
Taxes		—			200
Supplemental Disclosures of Non-Cash Investing and Financing Activities:
Decrease in unearned KSOP shares		—			(25		)
Fair value adjustment of securities available for sale, net		(33		)	(264		)

 

See notes to condensed consolidated financial statements

 

6

 

FIRST COMMUNITY FINANCIAL GROUP, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

1.                                      Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, adjustments considered necessary for a fair presentation (consisting of normally recurring accruals) have been included.  The interim condensed consolidated financial statements should be read in conjunction with the December 31, 2002 consolidated financial statements, including notes thereto, included in the Company’s 2002 Annual Report to Shareholders.  Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results anticipated for the year ending December 31, 2003.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

In December 2002, the Financial Accounting Standards Board issued FASB Statement No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure.  This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, and APB Opinion No. 28, Interim Financial Reporting, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  This statement does not require any change from the method currently used by the Company to account for stock-based compensation, but does require more prominent disclosure in the annual and interim financial statements about the method of accounting for such compensation and the effect of the method used on reported results.  This statement was effective for fiscal years ending after December 15, 2002.  The Company has adopted the disclosure provisions of SFAS No. 148 in the accompanying financial statements, and accordingly, the disclosure requirements are set forth in Note 4 – Stock Based Compensation.

 

2.                                      Basic and Diluted Earnings per Share

 

Basic and diluted earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding during the periods presented.  Diluted earnings per share assumes that all dilutive stock options outstanding are issued such that their dilutive effect is maximized.

 

		Three Months Ended March 31,
		2003				2002
Basic EPS computation Numerator - Net Income
		$	1,782,000			$	1,379,000
Denominator - Weighted Average common shares outstanding		4,381,610				4,374,186
Basic EPS		$		.41		$		.32

 

7

 

		Three Months Ended March 31,
		2003			2002
Diluted EPS computation Numerator - Net Income		$	1,782,000		$	1,379,000
Denominator - Weighted average common shares outstanding		4,381,610			4,374,186
Effect of dilutive stock options		181,094			10,633
Weighted average common shares and common stock equivalents		4,562,704			4,384,819
Diluted EPS		$	.39		$	.31

 

3.             Issuance of Trust Preferred Securities

 

On April 10, 2003, the Company completed an offering of trust preferred securities and received net proceeds of approximately $5,910,000.  The proceeds are expected to be used for general Company purposes, which may include utilization in a stock repurchase program or to provide additional capital to First Community Bank.  Trust preferred securities consist of the issuance of subordinated debt securities to a wholly owned subsidiary business trust, which then issues preferred stock to investors.  The wholly owned subsidiary trust will be consolidated in the Consolidated Financial Statements.  The interest payments on the debt securities are approximately equal to the dividend payments on the preferred stock of the trust.  The Company will be able to recognize a deduction of the interest cost for income tax purposes, while the net proceeds will qualify as Tier 1 capital.

 

4.             Stock-Based Compensation

 

The Company accounts for stock-based awards to employees and directors using the intrinsic value method, in accordance with APB No. 25, Accounting for Stock Issued to Employees.  Accordingly, no compensation expense has been recognized in the consolidated financial statements for employee and director stock arrangements where the grant price is equal to market price.  However, the required pro forma disclosures of the effects of all options granted on or after January 1, 1995 have been provided in accordance with SFAS No. 123, Accounting for Stock-Based Compensation.

 

At March 31, 2003, the Company has two stock-based employee and director compensation plans.  The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25 Accounting for Stock Issued to Employees, and related interpretations.  Accordingly, no stock-based compensation cost is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common tock on the date of grant.  The following illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based compensation awards for the effects of all options granted on or after January 1, 1995 for the years ended December 31:

 

		2003			2002
Net income, as reported		$	1,782		$	1,379
Less total stock-based compensation expense determined under fair value method for all qualifying awards		4			3
Pro forma net income		$	1,778		$	1,376
Earnings per Share
Basic:
As reported		$	0.41		$	0.32
Pro forma		0.41			0.31
Diluted:
As reported		0.39			0.31
Pro forma		0.39			0.31

 

8

 

5.                                      Recent Accounting Pronouncements

 

In January 2003, FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (VIE).  It define a VIE as a corporation, partnership, trust, or any other legal structure used for the business purpose that either a) does not have equity investors with voting rights or b) has equity investors that do not provide sufficient financial resources for the entity to support its activities.  This interpretation will require a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or entitled to receive a majority of the entity’s residual return.  The provisions of interpretation No. 46 are required to be applied immediately to VIE’s created after January 31, 2003.  The Company does not have any VIE and accordingly the implementation of the Interpretation did not result in an impact on its financial position or results of operation.

 

9

 

Item 2                     Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion contains a review of the Company’s and its subsidiaries operating results and financial condition for the first quarter of 2003.  When warranted, comparisons are made to the same period in 2002, and to the previous year ended December 31, 2002.  The discussion should be read in conjunction with the financial statements (unaudited) and related notes contained elsewhere in this report.  The reader is assumed to have access to the Company’s Form 10-K for the year ended December 31, 2002, which contains additional statistics and explanations.  All numbers, except per share data, are expressed in thousands.

 

Forward-Looking Information

 

In addition to historical information, statements appearing in this report which are not historical in nature, including the discussions of the adequacy of the Company’s capital resources and allowance for credit losses, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (“PLSRA”).  Any statements that expressly or implicitly predict future results, performance, or events should be considered forward-looking.  Forward-looking statements are subject to the risks and uncertainties that may cause actual future results to differ materially.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report.  The Company does not undertake any obligation to publicly release any revisions to forward-looking statements contained in this Quarterly Report, with respect to events or circumstances after the date of this Report, or to reflect the occurrence of unanticipated events.

 

Such risks and uncertainties with respect to the Company include, among others, those related to the general economic environment, particularly in the region in which the Company operates, competitive products and pricing, that may lead to pricing pressures on rates the Bank charges on loans and pays on deposits, loss of customers of greatest value to the Bank, or other losses, fiscal and monetary policies of the federal government, changes in government regulations affecting financial institutions and small loan practices, including regulatory fees and capital requirements, changes in prevailing interest rates that could lead to decreased net interest margin, acquisitions and the integration of acquired businesses, credit risk management and asset/liability management, the financial and securities markets, changes in technology or required investments in technology, and the availability of and costs associated with sources of liquidity.

 

Financial Condition

 

General

 

The Company’s consolidated total assets at March 31, 2003 of $464,921,000 represents a 2.0% decrease from December 31, 2002 assets of $474,450,000.  The decrease in assets was primarily caused by a decrease of cash in banks of nearly $8.4 million and a decrease in loans of $3.1 Million.  This was partially offset by an increase in loans held for sale of $2.8 million.  Other assets were largely unchanged.   Loan balances, net of allowance for credit losses, decreased $3,400,000 in the first quarter to $350,755,000 from $354,185,000 at December 31, 2002.

 

Loans

 

The composition of the loan portfolio is as follows (dollars in thousands):

 

 

10

 

The total non-performing loans, defined as those loans on non-accrual and accruing loans over 90-days past due, increased since December 31, 2002 by $1,834,000 as shown in the following table of non-performing assets (dollars in thousands):

 

		March 31 2003			December 31 2002
Non-accrual loans		$	7,074		$	6,543
Accruing loans past due 90 days or more		2,581			1,278
Foreclosed real estate		4,785			4,899
Other assets		99			55
		$	14,539		$	12,775

 

Non-accrual loans increased $531,000 during the first quarter of 2003.  Accruing loans past due 90 days or more increased $1,303,000 over the same period, centered in one loan of $1,689,000, for a warehouse facility located in Pierce County, Washington, that went over 90 days past due during the quarter.  Accruing loans past due 90 days or more are well secured and in the process of collection for the accrual of interest to continue.  These loans are monitored and may be reclassified as non-accrual as conditions warrant.  The percentage of non-performing loans to total loans increased to 2.69% on March 31, 2003 from 2.16% on December 31, 2002.

 

Allowance for Credit Losses

 

The allowance for credit losses reflects management’s current estimate of the amount required to absorb losses on existing loans and commitments to extend credit.  Determination of the appropriate level of the allowance is based on an analysis of various factors including historical loss experience based on volumes and types of loans; volumes and trends in delinquencies and non-accrual loans; trends in portfolio volume; results of internal and independent external credit reviews; and economic conditions.  All loans in the portfolio are assigned a grade indicating credit quality by the originating loan officer at the time of loan origination.  These grades are reviewed at regular intervals and, if performance concerns arise on an individual loan, the grade is lowered to the appropriate level.  Management reviews the composite changes in loan grades within the portfolio in its assessment of the adequacy of the allowance.  If a loan becomes impaired, the Company’s loss exposure on that loan is measured based on expected cash flows or collateral values, and if necessary, a portion of the allowance for credit losses is allocated to that loan.   After reviewing the composition of the loan portfolio at March 31, 2003, the levels of classified loans, losses experienced during the period, and the changes in the economy, management has determined the allowance for credit losses to be adequate to cover the loss exposure in the loan portfolio at that date.  An analysis of the adequacy of the allowance is subject to quarterly review by the Board of Directors.

 

The allowance for credit losses increased $269,000 in the first quarter of 2003, with the ratio of the allowance for credit losses to total loans at 2.28% on March 31, 2003, compared to 2.19% on December 31, 2002.  During the quarter an additional $577,000 was reserved for potential losses, and net charge-offs were $308,000, or 0.08% of the loan portfolio.  The charge-offs were centered in the Bank’s small loan portfolio.  Non-performing loans equated to 117.5% of the allowance for credit losses on March 31, 2003, compared to 98.4% on December 31, 2002.  Management believes the allowance is at an appropriate level.

 

Investment Portfolio

 

Investment securities decreased by $1,187,000, or 3.5% during the first quarter of 2003 to a total of $32,940,000.    The decrease in investment balances is due to maturity and prepayments on securities in the portfolio.  Although no securities were purchased during the first quarter, securities are purchased from time to time as either collateral for various operational purposes or for additional income in times of excess liquidity.

 

Deposits and Borrowings

 

Total deposits decreased $11,392,000, or 3.0% in the three months ended March 31, 2003 to $372,815,000.  Increases were shown in savings and interest-bearing deposits while demand deposits and time deposits experienced decreases.  Short term borrowings have also been used as a funding source due to their relatively low cost as compared to time deposits.  Short term borrowings increased during the quarter by $1,060,000 to $17,607,000.

 

Liquidity

 

Liquidity management involves the ability to meet cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs.  Liquidity is generated from both internal and external sources.  Internal sources are those assets that can be

 

11

 

converted to cash with little or no risk of loss.  These include overnight investments in interest bearing deposits in banks and federal funds sold and investment securities, particularly those of shorter maturity, and are the principal source of asset liquidity.  At March 31, 2003, cash, deposits in banks, federal funds sold and securities available for sale totaled $62,573,000.  External sources refer to the ability to attract new liabilities and capital.  They include increasing savings and demand deposits, federal funds purchased, borrowings and the issuance of capital and debt securities.  At March 31, 2003, borrowing lines of credit totaled $46,148,000.  These credit facilities are being used regularly as a source of funds. At March 31, 2003, $10,000,000 was borrowed against these lines of credit in the form of long term advances.

 

Cash flows from operations contribute significantly to liquidity as well as proceeds from maturities of securities, a decrease in loans outstanding and increase in short-tem borrowings.  As indicated on the Company’s Condensed Consolidated Statement of Cash Flows, net cash from operating activities for the three months ended March 31, 2003 contributed $316,000 to liquidity compared to $2,567,000 for the three months ended March 31, 2002.  The majority of the Company’s funding comes from short-term borrowings.  Short-term borrowings provided $1,060,000 for the three months ended March 31, 2003 compared to $10,287,000 for the three months ended March 31, 2002.

 

Management believes the Bank’s liquidity position at March 31, 2003, was adequate to meet its short term funding requirements.

 

Capital

 

Consolidated capital of the Company increased $1,132,000 during the first quarter of 2003.  The net income for the first quarter and its corresponding increase to retained earnings was the primary component of this increase along with the exercising of stock options, which added $778,000.  Capital decreases were the result of $1,175,000 worth of stock being repurchased and retired, the quarterly cash dividend paid to shareholders in the amount of $220,000 and a reduction in the market value of securities available for sale of $33,000 on an after-tax basis.

 

There are regulatory constraints placed upon capital adequacy, and it is necessary to maintain an appropriate ratio between capital and assets.  Regulations require banks and holding companies to maintain a minimum “leverage” ratio (primary capital ratio) of total assets.  For the most highly rated holding companies this ratio must be at least 3%, and for others it must be 4 to 5%.  At March 31, 2003, the Company’s leverage ratio was 10.13%, compared to 11.60% at year-end 2002.  In addition, banks and holding companies are required to meet minimum risk-based capital guidelines under which risk percentages are assigned to various categories of assets and off-balance-sheet items to calculate a risk-adjusted capital ratio.  Tier I capital generally consists of common stockholders’ equity, less goodwill, while total capital includes the allowance for possible credit losses, subject to 1.25% limitation of risk-adjusted assets.  The rules require Tier I capital of 4% of risk-adjusted assets and total capital of 8%.  At March 31, 2003, the Company’s Tier I capital ratio was 10.75%, and total capital was 12.01%.  At December 31, 2002 the Company’s Tier I capital ratio was 10.23% and the total capital ratio was 11.49%.

 

Issuance of Trust Preferred Securities

 

On April 10, 2003, the Company completed an offering of trust preferred securities and received net proceeds of approximately $5,910,000.  The proceeds are expected to be used for general Company purposes, which may include utilization in a stock repurchase program or to provide additional capital to First Community Bank.  Trust preferred securities consist of the issuance of subordinated debt securities to a wholly owned subsidiary business trust, which then issues preferred stock to investors.  The wholly owned subsidiary trust will be consolidated in the Consolidated Financial Statements.  The interest payments on the debt securities are approximately equal to the dividend payments on the preferred stock of the trust.  The Company will be able to recognize a deduction of the interest cost for income tax purposes, while the net proceeds will qualify as Tier 1 capital.

 

Results of Operations

 

General

 

Net income for the three months ended March 31, 2003 was $1,782,000, compared to $1,379,000 for the three months ended March 31, 2002.

 

Net interest income increased $1,398,000, an increase of 26.8% for the three months ended March 31, 2003 over the same period for 2002.  The increase in the Company’s net interest income is primarily the result of the reduction in

12

 

interest rates, and corresponding reduction in cost of funds.  The Company’s small loan product also impacted the growth in net interest income for the quarter.    This product’s contribution to net interest income grew to $1,432,000 in the first quarter of 2003 from $1,156,000 in the first quarter of 2002, a $276,000 increase.

 

The average volumes of both earning assets, primarily loans, and interest bearing liabilities, deposits, increased significantly due to the acquisition of Harbor Bank, N.A. in the fourth quarter of 2002.  The impact of this acquisition on average balances is evident in the year to year comparisons for the first quarters of 2002 and 2003.

 

Interest income for the three months ended March 31, 2003 increased $1,300,000, or 18.7%, from the same period of the prior year.   Increased volume of earning assets provided an additional $4,121,000 of interest income, which was partially offset by the $2,821,000 reduction in interest income due to the reduced earnings rate of these assets.   Average earning assets for the first three months of 2003 were $89,815,000, or 28.6% higher than in the same period of 2002.  The average rate earned on assets decreased from 8.95% in the first quarter of 2002 to 8.27% for the same period of 2003, a decrease of 68 basis points.

 

Total interest expense for the three months ended March 31, 2003 decreased $98,000, or 5.7%, from the comparable period of the prior year.  The decrease in the interest rate paid on deposits and borrowings, which declined 66 basis points, to 1.89% in the first quarter of 2003 from 2.55% in the first quarter of 2002, resulted in a reduction to interest expense of $1,372,000.  Of this amount, $1,274,000 was offset by an increase in the volume of these liabilities, which rose from an average of $273,003,000 in 2002 to $347,831,000 in 2003.

 

Net interest margin, defined as net interest income as a percentage of average earning assets, decreased by 10 basis points to 6.64% from 6.74% in the first quarter of 2003 compared to the same period in 2002.

 

The yield and cost of funds for earning assets and interest bearing liabilities were as follows as of and for the three months ended March 31 (dollars in thousands):

 

		2003								2002
		Average Balance			Interest Income (Expense)			Average Rates		Average Balance			Interest Income (Expense)			Average Rates
Earning Assets:
Loans (Interest and fees)		$	370,528		$	7,883		8.63	%	$	293,042		$	6,629		9.17	%
Federal funds sold		650			2			1.25	%	224			2			1.81	%
Investment securities		32,895			351			4.33	%	20,992			305			5.91	%
Total earning assets and interest income		$	404,073		$	8,236		8.27	%	$	314,258		$	6,936		8.95	%
Interest bearing liabilities:
Deposits:
Savings, NOW, and Money Market Deposits		$	157,611		$	(381	)	0.98	%	$	129,040		$	(411	)	1.29	%
Time deposits		142,638			(879		)	2.50	%	130,535			(1,234		)	3.83	%
Total interest bearing deposits		$	300,249		$	(1,260	)	1.70	%	$	259,575		$	(1,645	)	2.57	%
Other borrowings		47,582			(358		)	3.05	%	13,428			(71		)	2.14	%
Total interest bearing liabilities and interest expense		$	347,831		$	(1,618	)	1.89	%	$	273,003		$	(1,716	)	2.55	%
Net interest income					$	6,618							$	5,220
Net interest margin as a percent percentage of average earning assets:								6.64	%							6.74	%

 

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An analysis of the change in net interest income is as follows for the three months ended March 31 (dollars in thousands):

 

		2003 compared to 2002 Increase (decrease) due to
		Volume			Rate			Net
Interest earned on:
Loans		$	3,636		$	(2,382	)	$	1,254
Federal funds sold and deposits in banks		3			(2		)	1
Investment securities		482			(437		)	45
Total interest income		4,121			(2,821		)	1,300
Interest paid on:
Savings, NOW and MMA		370			(400		)	(30		)
Time deposits		658			(1,013		)	(355		)
Other borrowings		246			41			287
Total Interest expense		1,274			(1,372		)	(98		)
Net interest income		$	2,847		$	(1,449	)	$	1,398

 

The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

 

Non-interest income for the quarter ended March 31, 2003 was $750,000, or 41.3% greater than the same period for 2002.  Service charges, primarily due to the increased relationships generated from the addition of Harbor Bank in the fourth quarter of 2002, increased $197,000, or 27.2%, over the first quarter of 2002.  Origination fees on mortgage loans sold continued a strong performance, increasing by $301,000, or 54.0% over the same period in 2002.  The increase in other income was due to a $219,000 gain on the sale of other real estate owned and a $32,000 increase in debit card revenues.

 

Non-interest expenses for the first quarter of 2003 increased by $1,571,000, or 35.6% over the first quarter of 2002.  Salaries and employee benefits increased by $881,000, or 38.9%, reflecting the additional employees related to the Harbor Bank acquisition as well as increased commission compensation associated with the large increase in origination fees on mortgage loans.  Occupancy expense which reflects the operation of the additional branches not in operation for the same period in 2002 increased $161,000, or 25.1%.  Other expense increased by $529,000, or 35.2% from the prior year, due to increased operational costs associated with the new branches and consulting costs associated with developing our brand strategy.

 

Business Segment Reporting

 

The Company is managed along two major lines of business; community banking, its core business, and the small loan division, which was entered into in the fourth quarter of 2000.  Community Banking consists of all lending, deposit and administrative operations conducted through its 21 offices in Washington State.  The small loan division provides small, short-term consumer loans to customers in Alabama and Arkansas.

 

Prior to 2001, the Company was managed as a whole, not by discrete operating segments.  When the Company began offering small loans, its operating results were segregated in the General Ledger system to better manage financial performance.  The financial performance of the business lines is measured by the Company’s profitability

 

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reporting process, which utilizes various management accounting techniques to more accurately reflect each business line’s financial results.  Revenues and expenses are primarily assigned directly to business lines.

 

The organizational structure of the Company and its business line financial results are not necessarily comparable across companies.  As such, the Company’s business line performance may not be directly comparable with similar information from other financial institutions.

 

Selected comparative financial information for community banking and the small loan division, which are included in the overall financial results, as of and for the three months ended March 31, are as follows (dollars in thousands):

 

Three months ended March 31, 2003		Community Banking			Small Loans			Total
Net Interest income after provision for credit losses		$	4,886		$	1,155		$	6,041
Non-interest income		2,550			16			2,566
Non-interest expense		5,817			163			5,980
Income taxes		502			343			845
Net Income		$	1,117		$	665		$	1,782
Total assets		$	450,087		$	14,834		$	464,921
Total Loans		$	352,007		$	6,964		$	358,971

 

Three months ended March 31, 2002		Community Banking			Small Loans			Total
Net Interest income after provision for credit losses		$	3,914		$	685		$	4,599
Non-Interest income		1,798			18			1,816
Non-Interest expense		4,204			205			4,409
Income taxes		477			150			627
Net Income		$	1,031		$	348		$	1,379
Total assets		$	354,221		$	17,930		$	372,151
Total Loans		$	282,508		$	5,123		$	287,631

 

Item 3     Quantitative and Qualitative Disclosure About Market Risk

 

Rate Sensitivity

 

The Company’s assets and liabilities are managed to maximize long-term shareholder returns by optimizing net interest income within the constraints of maintaining high credit quality, conservative interest rate risk disciplines and prudent levels of liquidity.  The Asset/Liability Committee meets regularly to monitor the composition of the balance sheet, to assess current and projected interest rate trends, and to formulate strategies consistent with established objectives for liquidity, interest rate risk and capital adequacy.

 

Interest rate sensitivity is closely related to liquidity, as each is directly affected by the maturity of assets and liabilities.  The Company’s net interest margin is affected by changes in the level of market interest rates.  Management’s objectives are to monitor and control interest rate risk and ensure predictable and consistent growth in net interest income.

 

Management considers any asset or liability which matures, or is subject to repricing within one year to be interest sensitive, although continual monitoring is performed for other time intervals as well.  The difference between interest sensitive assets and liabilities for a defined period of time is known as the interest sensitivity “gap”, and may be either positive or negative.  If positive, more assets reprice before liabilities.  If negative, the reverse is true.  Gap analysis provides a general measure of interest rate risk but does not address complexities such as prepayment risk, interest rate floors and ceilings imposed on financial instruments, interest rate dynamics and customer responses to interest rate changes.  Currently the Bank’s interest sensitivity gap is negative within one year.  Assuming that general market interest rate changes affected the repricing of assets and liabilities in equal magnitudes, this indicates that the effects of rising interest rates on the Company would be a decrease in the net interest margin, whereas falling interest rates would cause a corresponding increase in the margin.

 

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Interest Rate Gap Analysis
March 31, 2003

 

(dollars in thousands)		Within One Year			After One But Within Five Years			After Five Years			Total
Loans		$	157,971		$	155,536		$	45,464		$	358,971
Securities:
Available for sale		4,514			18,842			8,417			31,773
Held to maturity		—			505			—			505
Federal funds sold		7,500			—			—			7,500
Interest bearing deposits with banks		66			—			—			66
Total Earning Assets		$	170,051		$	174,883		$	53,881		$	398,815
Deposits:
Savings, NOW and money market		$	161,052		—			—			$	161,052
Time deposits		103,188			$	32,977		—			136,165
Short-term borrowings		17,607			—			—			17,607
Long-term debt		—			10,000			13,000			23,000
Total Interest Bearing Liabilities		$	281,847		$	42,977		—			$	337,824
Net Interest Rate Sensitivity Gap		$	(111,796	)	$	131,906		$	40,881		$	60,991

 

The Company’s market risk is impacted by changes in interest rates.  Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business.

 

The Company has market risk in the form of interest rate risk on its financial assets.  In an effort to understand the relative impact of this risk on the Company’s current financial situation, a process known as a rate shock is applied to the current financial assets.

 

Rate shock is a process wherein the characteristics of the financial assets of the Company are reviewed in the event they are subjected to an instantaneous and complete adjustment in the market rate of interest.  These results are modeled to determine the effects on interest rate margin for the succeeding twelve months from the repricing of variable rate assets and liabilities where applicable.  The level of impact on the various assets and liabilities are also estimated for their sensitivity to pricing changes of such a market interest rate change.  According to this model and its assumptions, the change in net interest income over a 12 month period in the event market interest rates were to immediately rise by 100 basis points is estimated to be a reduction of $1,520,000, or 5.5% of total estimated annual net interest income, whereas a decrease of 100 basis points is estimated to increase net interest income by $1,176,000, or 4.2%.

 

Item 4     Disclosure Controls and Procedures

 

(a)        Evaluation of Disclosure Controls and Procedures.

 

Management of the Company, including the Chief Executive Officer and the Principal Accounting Officer, have conducted an evaluation of the Company’s disclosure controls and procedures in accordance with rule 13a-14 under the Securities Exchange Act of 1934 as of a date (the “evaluation date”) within 90 days prior to the filing date of this report.  Based on that evaluation, the Chief Executive Officer and the Principal Accounting Officer have concluded that, as of the evaluation date, the Company’s disclosure controls and procedures were effective in ensuring that all material information relating to the Company required to be filed in this quarterly report has been made known to them in a timely manner.

 

(b)        Changes in Internal Controls

 

Since the evaluation date, there have been no changes to the Company’s internal controls or in other factors that could significantly affect those controls.

 

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First Community Financial Group, Inc.

 

PART II - OTHER INFORMATION

 

Item 6              Exhibits and Reports on Form 8-K

 

(a) Exhibits

 

The following exhibit is filed herewith, and this list constitutes the exhibit index:

 

99.1 Certification of CEO and Principal Accounting Officer under Section 906 of Sarbanes-Oxley Act of 2002

 

(b) Reports on Form 8-K

 

Year-end 2002 Earnings Report filed January 29, 2003

 

Stock Repurchase Program filed March 5, 2003

 

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First Community Financial Group, Inc.

 

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.

 

	FIRST COMMUNITY FINANCIAL GROUP, INC.
	(Registrant)
Date: May 14, 2003	By:	/s/ Ken F. Parsons
		Ken F. Parsons
		President, Chief Executive Officer
	By:	/s/ Catherine M. Reines
		Catherine M. Reines
		Chief Financial Officer
	By:	/s/ Thomas L. Dhamers
		Thomas L. Dhamers
		Principal Accounting Officer

 

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CERTIFICATION UNDER SECTION 302

OF SARBANES-OXLEY ACT OF 2002

 

I, Ken F. Parsons, Sr. certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of First Community Financial Group, Inc. (the “registrant”);

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this report (the “Evaluation Date”); and

 

c) presented in this report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6. The registrant’s other certifying officers and I have indicated in this report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date May 14, 2003	/s/ Ken F. Parsons, Sr.
	Ken F. Parsons, Sr. President, Chief Executive Officer

 

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CERTIFICATION UNDER SECTION 302

OF SARBANES-OXLEY ACT OF 2002

 

I, Catherine M. Reines certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of First Community Financial Group, Inc. (the “registrant”);

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this report (the “Evaluation Date”); and

 

c) presented in this report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6. The registrant’s other certifying officers and I have indicated in this report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date May 14, 2003	/s/ Catherine M. Reines
	Catherine M. Reines
	Chief Financial Officer

 

20

 

CERTIFICATION UNDER SECTION 302

OF SARBANES-OXLEY ACT OF 2002

 

I, Thomas L. Dhamers certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of First Community Financial Group, Inc. (the “registrant”);

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this report (the “Evaluation Date”); and

 

c) presented in this report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6. The registrant’s other certifying officers and I have indicated in this report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date May 14, 2003	/s/ Thomas L. Dhamers
	Thomas L. Dhamers
	Principal Accounting Officer

 

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