FORM 10-Q

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Commission File Number: 0-27384

 

CAPITAL CORP OF THE WEST

(Exact name of registrant as specified in its charter)

 

 

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

 

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

 

The number of shares outstanding of the registrant’s common stock, no par value, as of November 6, 2003 was 5,631,887.

 

 

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

Item 4.  Controls and Procedures

PART II.  — OTHER INFORMATION

Item 1.  Legal Proceedings

Item 2.  Changes in Securities and Use of Proceeds

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

Exhibit Index

 

2

 

Capital Corp of the West

Consolidated Balance Sheets

(Unaudited)

 

		September 30, 2003			December 31, 2002
		(Dollars in thousands)
Assets
Cash and noninterest-bearing deposits in other banks		$	40,540		$	46,628
Federal funds sold		28,290			26,555
Time deposits at other financial institutions		350			500
Investment securities available for sale, at fair value		237,114			231,392
Investment securities held to maturity at cost, fair value of $89,380 and $57,905 at September 30, 2003 and December 31, 2002		89,480			55,628
Loans, net of allowance for loan losses of  $13,177 and $12,134 at September 30, 2003 and December 31, 2002		708,745			621,639
Interest receivable		5,378			5,532
Premises and equipment, net		14,429			13,942
Intangible assets		2,815			3,325
Other assets		35,250			29,069
Total assets		$	1,162,391		$	1,034,210
Liabilities and Shareholders’ Equity
Deposits
Noninterest-bearing demand		$	172,945		$	164,852
Negotiable orders of withdrawal		125,076			120,449
Savings		308,254			223,404
Time, under $100,000		175,060			164,959
Time, $100,000 and over		193,497			160,715
Total deposits		974,832			834,379
Borrowed funds		90,235			110,204
Accrued interest, taxes and other liabilities		5,711			6,458
Total  liabilities		1,070,778			951,041
Capital Securities		6,000			6,000
Preferred Stock, no par value; 10,000,000 shares authorized;  None outstanding		—			—
Common stock, no par value; 20,000,000 shares authorized; 5,619,770 and 5,591,336 issued & outstanding at September 30, 2003 and December 31, 2002		53,436			46,436
Retained earnings		31,228			27,824
Accumulated other comprehensive income		949			2,909
Total shareholders’ equity		85,613			77,169
Total liabilities, Capital Securities and shareholders’ equity		$	1,162,391		$	1,034,210

 

See accompanying notes to consolidated financial statements

 

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Capital Corp of the West

Consolidated Statements of Income and Comprehensive Income

(Unaudited)

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2003			2002			2003			2002
		(In thousands, except per share data)
Interest income:
Interest and fees on loans		$	12,735		$	11,292		$	36,154		$	32,107
Interest on deposits with other financial institutions		2			3			7			8
Interest on investments held to maturity:
Taxable		621			846			2,101			2,741
Non-taxable		328			55			438			165
Interest on investments available for sale:
Taxable		2,271			2,697			6,766			7,695
Non-taxable		—			272			545			817
Interest on federal funds sold		95			127			185			226
Total interest income		16,052			15,292			46,196			43,759
Interest expense:
Interest on negotiable orders of withdrawal		14			47			42			159
Interest on savings deposits		728			787			1,951			2,477
Interest on time deposits, under $100,000		1,127			1,416			3,351			4,300
Interest on time, $100,000 and over		1,103			1,229			3,153			3,577
Interest on other borrowings		1,012			1,237			3,356			3,411
Total interest expense		3,984			4,716			11,853			13,924
Net interest income		12,068			10,576			34,343			29,835
Provision for loan losses		751			1,190			1,904			3,421
Net interest income after provision for loan losses		11,317			9,386			32,439			26,414
Noninterest income:
Service charges on deposit accounts		1,430			1,326			4,064			3,732
Other		1,114			960			3,202			2,463
Total noninterest income		2,544			2,286			7,266			6,195
Noninterest Expense:
Salaries and related benefits		4,742			4,232			14,179			12,015
Equipment		875			745			2,336			2,165
Premises and occupancy		727			676			2,109			1,816
Professional fees		310			322			1,068			892
Marketing		208			270			716			677
Intangible amortization		170			170			510			510
Supplies		183			201			615			558
Other		1,934			1,714			5,120			4,635
Total noninterest expense		9,149			8,330			26,653			23,268
Income before income taxes		4,712			3,342			13,052			9,341
Provision for income taxes		1,084			356			3,002			1,747
Net income		$	3,628		$	2,986		$	10,050		$	7,594
Comprehensive Income:
Unrealized (loss) gain on securities and swaps arising during the period, net		(1,368		)	1,199			(1,960		)	1,430
Comprehensive income		$	2,260		$	4,185		$	8,090		$	9,024
Basic earnings per share		$	0.65		$	0.54		$	1.79		$	1.38
Diluted earnings per share		$	0.62		$	0.52		$	1.73		$	1.34

 

See accompanying notes to consolidated financial statements

 

4

 

Capital Corp of the West

Consolidated Statement of Changes in Shareholders’ Equity

(Unaudited)

 

(Amounts in thousands)		Common Stock					Retained earnings			Accumulated Other comprehensive income (loss)			Total
		Number of shares		Amounts
Balance, December 31, 2002		5,325		$	46,436		$	27,824		$	2,909		$	77,169
Exercise of stock options		28		325			—			—			325
Issuance of shares pursuant to 401K plan		1		43									43
Net Change in fair market value of  investment securities and swaps, net of  tax benefit of $1,307		—		—			—			(1,960		)	(1,960		)
5% stock dividend, including cash payment for fractional shares		266		6,632			(6,646		)				(14		)
Net income		—		—			10,050			—			10,050
Balance, September 30, 2003		5,620		$	53,436		$	31,228		$	949		$	85,613

 

See accompanying notes to consolidated financial statements

 

5

 

Capital Corp of the West

Consolidated Statements of Cash Flows

(Unaudited)

 

(Dollars in thousands)		9 months ended September 30, 2003			9 months ended September 30, 2002
Operating activities:
Net income		$	10,050		$	7,594
Adjustments to reconcile net income to net cash provided by Operating activities:
Provision for loan losses		1,904			3,421
Depreciation, amortization and accretion, net		4,069			2,827
(Gain) loss on sale of real estate owned		(81		)	33
Net increase in interest receivable & other assets		(4,970		)	(1,016		)
Net increase in deferred loan fees		560			579
Net decrease in accrued interest payable & other liabilities		(747		)	(5,691		)
Net cash provided by operating activities		10,785			7,747
Investing activities:
Investment securities purchases		(167,156		)	(66,311		)
Proceeds from maturities of investment securities		119,196			37,724
Proceeds from sales of available for sale securities		4,034			11,057
Net decrease in time deposits in other financial institutions		150			—
Proceeds from sales of  loans		3,210			1,901
Net increase in loans		(93,775		)	(84,312		)
Purchase of premises and equipment		(1,716		)	(2,301		)
Proceeds from sales of real estate owned		81			—
Purchase of subsidiary		—			(520		)
Net cash used in investing activities		(135,976		)	(102,762		)
Financing activities:
Net increase in demand, NOW and savings deposits		97,570			29,066
Net increase in certificates of deposit		42,883			38,203
Net (repayments) proceeds from other borrowings		(19,969		)	50,462
Issuance of shares pursuant to 401K and ESOP plans		43			471
Exercise of stock options		325			551
Cash in lieu fractional shares from stock dividend		(14		)	(12		)
Net cash provided by financing activities		120,838			118,741
Net (decrease) increase in cash and cash equivalents		(4,353		)	23,726
Cash and cash equivalents at beginning of period		73,183			49,288
Cash and cash equivalents at end of period		$	68,830		$	73,014
Cash paid during the quarter:
Interest paid		$	11,757		$	13,972
Income tax payments		3,775			3,075
Supplemental disclosure of noncash investing and financing activities:
Investment securities unrealized (losses) gains and swaps, net of tax		(1,960		)	1,430
Transfer of securities from available for sale to held to maturity		24,557			—

 

See accompanying notes to consolidated financial statements

 

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Capital Corp of the West

Notes to Consolidated Financial Statements

September 30, 2003 and December 31, 2002

(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 September 30, 2003 there were 5,619,770 common shares outstanding, held of record by approximately 1,700 shareholders.  There were no preferred shares outstanding at September 30, 2003.  The Bank has three wholly owned subsidiaries, Merced Area Investment & Development, Inc. (“MAID”), County Asset Advisors (“CAA”), and County Investment Trust (“REIT”).  CAA is currently inactive.  The Company purchased Regency Investment Advisors, Incorporated (“RIA”) on June 28, 2002.  RIA performs asset management and advisory services for businesses and individuals.  The Company has two other wholly owned subsidiaries, County Statutory Trust (“Trust”), and Capital West Group, Inc.  The Trust is used in connection with the Capital Securities issued by the Company.  Capital West Group, Inc. is currently inactive.  All references herein to the “Company” include the Company, the Company’s subsidiaries, 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.  The Bank is 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 nineteen 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, two offices in Modesto, three 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.

 

OTHER FINANCIAL NOTES

 

All adjustments which in the opinion of Management are necessary for a fair presentation of the Company’s financial position at September 30, 2003 and December 2002 and the results of operations for

 

7

 

the three and nine month periods ended September 30, 2003 and 2002, and the statements of cash flows for the nine months ended September 30, 2003 and 2002 have been included.  Earnings per share have been adjusted to reflect the affect of the 5% stock dividend that was paid April 25, 2003 to shareholders of record on April 1, 2003.  The interim results for the three and nine months ended September 30, 2003 are not necessarily indicative of results to be expected 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 on From 10-K for the year ended December 31, 2002.

 

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

 

EARNINGS PER SHARE

 

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 tables provide a reconciliation of the numerator and denominator of the basic and diluted earnings per share computation for the three and nine month periods ended September 30, 2003 and 2002:

 

		For The Three Months Ended September 30,						For The Nine Months Ended September 30,
(Dollars in thousands, except per share data)		2003			2002			2003			2002
Basic EPS computation:
Net income		$	3,628		$	2,986		$	10,050		$	7,594
Average common shares outstanding		5,610			5,568			5,602			5,522
Basic EPS		$	0.65		$	0.54		$	1.79		$	1.38
Diluted EPS Computations:
Net income		$	3,628		$	2,986		$	10,050		$	7,594
Average common shares outstanding		5,610			5,568			5,602			5,522
Effect of stock options		238			133			211			155
		5,848			5,701			5,813			5,677
Diluted EPS		$	0.62		$	0.52		$	1.73		$	1.34

 

8

 

INTANGIBLE ASSETS

 

The Company has 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 are no longer amortized after December 31, 2001 but will be reviewed for potential impairment.  Management has determined there was no impairment of goodwill as of December 31, 2002.  Additionally, there have been no events that have occurred during the first nine months of 2003 that would require another assessment.  As of September 30, 2003 and December 31, 2002, the Company had unamortized core deposit premiums of $890,000 and $1,390,000, respectively.  Amortization of core deposit premiums and other intangibles was $170,000 during the third quarter of 2003 and 2002 and $510,000 for the nine months ended September 30, 2003 and 2002.  Core deposit premiums and other intangibles are scheduled to amortize at a rate of approximately $167,000 per quarter through the quarter ended September 30, 2004, $153,000 during the fourth quarter of 2004, $11,499 for all of 2005 and the first quarter of 2006 and $11,505 during the second quarter of 2006.  Core deposit premiums of $460,000 and $4,340,000 were initially recorded as a result of purchasing deposits from Town and Country Finance and Thrift in July, 1996 and from the purchase of three branches from Bank of America in December, 1997, respectively.

 

STOCK COMPENSATION

 

The Company provides stock-based compensation to certain officers and directors.  The Company uses the intrinsic value method to account for its stock option plans (in accordance with the provisions of Accounting Principles Board Opinion No. 25).  Under this method, compensation expense is recognized for awards of options to purchase shares of common stock to employees under compensatory plans only if the fair market value of the stock at the option grant date (or other measurement date, if later) is greater than the amount the employee must pay to acquire the stock.  Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123) permits companies to continue using the intrinsic value method or to adopt a fair value based model  to account for stock option plans.  The fair value based method results in recognizing as expense over the vesting period the fair value of all stock-based awards on the date of grant.  The Company has elected to continue to use the intrinsic value method.

 

9

 

Had compensation cost for the Company’s option plans been determined in accordance with SFAS 123, the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated as follows:

 

		For the three months ended September 30,						For the nine months ended September 30,
(dollars in thousands except per share amounts)		2003			2002			2003			2002
Net income:
As reported		$	3,628		$	2,986		$	10,050		$	7,594
Pro forma		$	3,446		$	2,891		$	9,580		$	7,256
Basic earnings per share:
As reported		$	0.65		$	0.54		$	1.79		$	1.38
Pro forma		$	0.61		$	0.52		$	1.71		$	1.31
Diluted earnings per share:
As reported		$	0.62		$	0.52		$	1.73		$	1.34
Pro forma		$	0.59		$	0.51		$	1.65		$	1.28
Stock-based employee compensation cost included in salaries and related benefits:
As reported		$	—		$	—		$	—		$	—
Pro forma		$	189		$	101		$	486		$	357
Stock-based employee compensation cost, net of related tax effects, included in net income:
As reported		$	—		$	—		$	—		$	—
Pro forma		$	182		$	95		$	470		$	338

 

10

 

RECENT ACCOUNTING PRONOUNCEMETS

 

In January 2003, the FASB issued FIN 46, which clarifies the application of Accounting Research Bulletin (“ARB”) 51, consolidated financial statements, to certain entities (called variable interest entities) in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The disclosure requirements of this Interpretation are effective for all financial statements issued after January 31, 2003. The consolidation requirements apply to all variable interest entities created after January 31, 2003 and are effective for all financial statements issued after January 31, 2003.  In addition, public companies must apply the consolidation requirements to variable interest entities that existed prior to February 1, 2003 and remain in existence.  This interpretation’s effective date was postponed to December 31, 2003 as the FASB is expected to propose additional modifications by that date.

 

In April, 2003, the FASB issued FASB No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which established accounting and reporting standards for derivative instruments including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities.  Statement No. 149 amends Statement 133 for decisions made (1), as part of the Derivatives Implementation Group process that effectively required amendments to Statement 133, (2) in connection with other FASB projects dealing with financial instruments, and (3) in connection with implementation issues raised in relation to the application of the definition of a derivative.  This Statement was effective on July 1, 2003.  This statement requires that an issuer classify a financial instrument that is within its scope as a liability (or asset in some circumstances).  The Company does have a derivative instrument in the form of a $20,000,000 notional amount interest rate swap that was entered into in the fourth quarter of 2001 and that matures on August 23, 2004.  This interest rate swap has served as an effective cash flow hedge, and this Statement did not have a material effect in the financial condition or operating results of the Company.

 

In May 2003, the FASB issued FASB No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which provides accounting guidance for the classification and recording of financial instruments that have characteristics of both liabilities and equity.  The Statement requires reporting the cumulative effect of a change in accounting principle for financial instruments created before May 15, 2003 and still existing at the beginning of the interim period of adoption.  Restatement is not permitted.  Certain provisions of this Statement have been deferred to periods ending December 15, 2003.  The Company does not expect the application of this Statement to have a material effect on the financial statements.

 

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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 forward-looking 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 “expects”, “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 2002 Annual Report on Form 10-K filed March 27, 2003.  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, civil disturbances or terrorist threats or acts, or apprehension about the possible future occurrences or acts of this type, outbreak or escalation of hostilities in which the United States is involved, any declaration of war by the

 

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U.S. Congress or any other national or international calamity, crisis or emergency, and management’s ability to manage these and other risks.

 

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).

 

13

 

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 Nine Months Ended September 30, 2003 Compared With Three and Nine Months Ended September 30, 2002

 

Overview.  For the three and nine months ended September 30, 2003 the Company reported record net income of $3,628,000 and $10,050,000.  This compares to $2,986,000 and $7,594,000 for the same periods in 2002 and represents an increase of $642,000 and $2,456,000 or 22% and 32%.  Basic earnings per share were $.65 and $1.79 for the three and nine months ended September 30, 2003 and fully diluted earnings per share were $.62 and $1.73.  This compares to basic and fully diluted earnings per share of $.54 and $.52 for the three months and $1.38 and $1.34 for the nine months ended September 30, 2002 and represents an increase of $0.11 and $0.10 per share for basic and fully diluted earnings per share for the three months and $.41 and $.39 per share for the nine months ended September 30, 2003.  The basic and fully diluted earnings per share reflect the 5% stock dividend paid in April, 2003.  The annualized return on average assets was 1.26% and 1.23% for the three and nine months ended September 30, 2003 which compares with 1.20% and 1.08% for the three and nine months ended September 30, 2002.  The Company’s annualized return on average equity was 17.27% and 16.43% for the three and nine months ended September 30, 2003 which compares with 16.72% and 14.87% for the same periods in 2002.  The increased return on assets and increased return on equity were primarily achieved through an increase in interest earning assets and a reduction in the provision for loan losses.

 

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 nine months ended September 30, 2003 rose 14% and 15% to a total of $12,068,000 and $34,343,000, an increase of $1,492,000 and $4,508,000 when compared to the $10,576,000 and $29,835,000 achieved during the three and nine months ended September 30, 2002.

 

Total interest and fees on earning assets were $16,052,000 and $46,196,000 for the three and nine months ended September 30, 2003, rising 5% and 6% or $760,000 and $2,437,000 when compared to the $15,292,000 and $43,759,000 achieved during the three and nine months ended September 30, 2002.  Total 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 increase in total interest income for the three and nine months ended September 30, 2003 was primarily the result of an increase in volume of interest earning assets.  Average interest-earning assets for the three and nine months ended September 30, 2003 were $1,074,219,000 and $1,009,309,000 compared with $921,822,000 and $870,188,000 for the three and nine months ended September 30, 2002, an increase of $152,397,000 and $139,121,000 or 17% and 16%, respectively.

 

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 $3,984,000 and $11,853,000 for the three and nine months ended September 30, 2003, compared with $4,716,000 and $13,924,000 for the three and nine months ended September 30, 2002, a decrease of $732,000 and $2,071,000 or 16% and 15% for these periods. This decrease was primarily the result of a

 

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decrease in the average interest rate paid on interest-bearing liabilities which was due to a decrease in prevailing market interest rates. Average interest-bearing liabilities were $889,912,000 and $837,045,000 for the three and nine months ended September 30, 2003 compared with $773,105,000 and $734,383,000 for the same three and nine months in 2002, an increase of $116,807,000 and $102,662,000 or 15% and 14%.  Average interest rates paid on interest-bearing liabilities were 1.80% and 1.89% for the three and nine months ended September 30, 2003 compared with 2.45% and 2.53% for the same three and nine months of 2002, a decrease in interest rates paid of 65 and 64 basis points or 27% and 25%.

 

The increase in interest-earning assets and interest-bearing liabilities is primarily the result of increased market penetration within our target markets, accomplished by increasing the loan and deposit production of existing facilities and the addition of one new retail banking facility in Fresno, California.

 

The Company’s taxable equivalent net interest margin, the ratio of net interest income to average interest-earning assets, was 4.50% and 4.54% for the three and nine months ended September 30, 2003 compared with 4.66% and 4.65% for the same periods in 2002.  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 drop in overall yields that was partially offset by an increase in volume in earning assets.  Loans as a percentage of average interest-earning assets increased to 66% and 67% for the three and nine months ended September 30, 2003 compared with 65% and 65% for the three and nine months ended September 30, 2002.

 

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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 September 30, 2003								Three months ended September 30, 2002
		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		$	39,055		$	95		0.98	%	$	29,802		$	127		1.71	%
Time deposits at other financial institutions		510			2			1.57		500			3			2.41
Taxable investment securities  (1)		298,688			2,926			3.93		265,241			3,581			5.42
Nontaxable investment securities (1)		30,763			438			5.71		28,923			430			5.96
Loans, gross: (2)		705,203			12,735			7.24		597,346			11,292			7.58
Total interest-earning assets:		1,074,219			16,196			6.05		921,812			15,433			6.72
Allowance for loan losses		(12,962		)						(11,750		)
Cash and due from banks		35,422								32,127
Premises and equipment, net		15,238								14,085
Interest receivable and other assets		42,870								38,649
Total assets		$	1,154,787							$	994,923
Liabilities And Shareholders’ Equity
Negotiable order of withdrawal		$	123,275		$	14		0.05		$	102,565		$	47		0.18
Savings deposits		305,228			728			.96		221,130			787			1.43
Time deposits		373,908			2,230			2.39		331,509			2,645			3.20
Other borrowings		87,501			1,012			4.64		117,901			1,237			4.21
Total interest-bearing liabilities		889,912			3,984			1.80		773,105			4,716			2.45
Noninterest-bearing deposits		168,849								138,441
Accrued interest, taxes and other liabilities		5,999								5,965
Total liabilities		1,064,760								917,511
Capital Securities		6,000								6,000
Total shareholders’ equity		84,027								71,412
Total liabilities and shareholders’ equity		$	1,154,787							$	994,923
Net interest income and margin (3)					$	12,212		4.56	%				$	10,717		4.66	%

 

(1)                                  Tax-equivalent adjustments included in the nontaxable investment securities portfolio created by nontaxable investment securities interest are $110,000 and $103,000 for the three months ended September 30, 2003 and 2002, respectively.  Tax equivalent adjustments included in the taxable investment securities created by a dividends received deduction were $34,000 and $38,000 for the three months ended September 30, 2003 and 2002, respectively.

(2)                                  Amounts of interest earned includes loan fees of $308,000 and $155,000 for the three months ended September 30, 2003 and 2002, respectively.

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

 

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AVERAGE BALANCE SHEET & ANALYSIS OF NET INTEREST EARNINGS

 

		Nine months ended September 30, 2003								Nine months ended September 30, 2002
		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		$	23,215		$	185		1.07	%	$	17,837		$	226		1.69	%
Time deposits at other financial institutions		556			7			1.68		500			8			2.14
Taxable investment securities  (1)		283,558			8,968			4.23		259,389			10,550			5.44
Nontaxable investment securities (1)		29,610			1,305			5.89		28,943			1,287			5.95
Loans, gross: (2)		672,370			36,154			7.19		563,519			32,107			7.62
Total interest-earning assets:		1,009,309			46,619			6.18		870,188			44,178			6.69
Allowance for loan losses		(12,735		)						(10,823		)
Cash and due from banks		34,198								29,533
Premises and equipment, net		14,951								13,422
Interest receivable and other assets		41,341								38,680
Total assets		$	1,087,064							$	941,001
Liabilities And Shareholders’ Equity
Negotiable order of withdrawal		$	119,517		$	42		0.05		$	100,713		$	159		0.21
Savings deposits		259,356			1,951			1.01		216,396			2,477			1.53
Time deposits		346,955			6,504			2.51		307,114			7,877			3.43
Other borrowings		111,217			3,356			4.03		110,160			3,411			4.14
Total interest-bearing liabilities		837,045			11,853			1.89		734,383			13,924			2.53
Noninterest-bearing deposits		156,638								126,718
Accrued interest, taxes and other liabilities		5,843								5,794
Total liabilities		999,526								866,895
Capital Securities		6,000								6,000
Total shareholders’ equity		81,538								68,106
Total liabilities and shareholders’ equity		$	1,087,064							$	941,001
Net interest income and margin (3)					$	34,766		4.61	%				$	30,254		4.65	%

 

(1)                                  Tax-equivalent adjustments included in the nontaxable investment securities portfolio created by nontaxable investment securities interest are $322,000 and $305,000 for  the nine months ended September 30, 2003 and 2002, respectively.  Tax equivalent adjustments included in the taxable investment securities created by a dividends received deduction were $101,000 and $114,000 for the nine months ended September 30, 2003 and 2002, respectively.

(2)                                  Amounts of interest earned includes loan fees of $1,408,000 and $850,000 for the nine months ended September 30, 2003 and 2002, 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 nine months ended September 30, 2003 was $751,000 and $1,904,000 compared with $1,190,000 and $3,421,000 for the three and nine months ended September 30, 2002, a decrease of $439,000 and $1,517,000 or 37% and 44%.  See “Allowance for Loan Losses” contained herein.  As of September 30, 2003 the allowance for loan losses was $13,177,000 or 1.83% of total loans which compares to the allowance for loan losses of $12,134,000 or 1.91% of total loans as of December 31, 2002.  At September 30, 2003, nonperforming assets totaled $1,793,000 or 0.15% of total assets, nonperforming loans totaled $1,733,000 or 0.24% of total loans and the allowance for loan losses totaled 760% of nonperforming loans.  At December 31, 2002, nonperforming assets totaled $2,443,000 or 0.24% of total assets, nonperforming loans totaled $2,383,000 or 0.38% of total loans and the allowance for loan losses totaled 509% 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 $258,000 and $1,071,000 or 11% and 17% to $2,544,000 and $7,266,000 for the three and nine months ended September 30, 2003 compared with $2,286,000 and $6,195,000 for the same periods during 2002.  Service charges on deposit accounts increased by $104,000 and $332,000 or 8% and 9% to $1,430,000 and $4,064,000 for the three and nine months ended September 30, 2003 compared with $1,326,000 and $3,732,000 achieved during for the same periods in 2002.  The increase in fees is the result of increased customer use of existing fee based products.  Other income increased by $154,000 and $739,000 or 16% and 30% for the three and nine month periods ended September 30, 2003 when compared to the same periods in 2002.  The primary source of this increased other income is the sale of the consumer credit card portfolio in March, 2003 for a gain of $82,000, the gain on sale of foreclosure property with a book basis of $0 for an $81,000 gain, an increase in mortgage packaging fees of $167,000 and $265,000, and the $13,000 and $266,000 in fees generated by Regency Investment Advisors, Incorporated for the three and nine months ended September 30, 2003.  Regency Investment Advisors, Incorporated was acquired in June, 2002.

 

Noninterest Expense.  Noninterest expenses increased by $819,000 and $3,385,000 or 10% and 15% to $9,149,000 and $26,653,000 for the three and nine months ended September 30, 2003 compared with the $8,330,000 and $23,268,000 recorded during for the same periods in 2002.  The primary components of noninterest expenses were salaries and employee benefits, premises and occupancy expense, equipment expense, professional fees, marketing expense, supplies expense and other operating expenses.

 

For the three and nine months ended September 30, 2003, salaries and related benefits increased by $510,000 and $2,164,000 or 12% and 18% to $4,742,000 and $14,179,000 from the $4,232,000 and $12,015,000 recorded for the same period in 2002. The salary expense increase was primarily the result of normal salary progression and incentive bonus payments.  Equipment expense increased by $130,000 and $171,000 or 17% and 8% to $875,000 and $2,336,000 for the three and nine months ended September 30, 2003 from the $745,000 and $2,165,000 recorded during the same periods in 2002.  The increased equipment costs were related to branch equipment upgrades and increased technology spending.  Premises and occupancy expenses increased by $51,000 and $293,00 to $727,000 and $2,109,000 for the three and nine months ended September 30, 2003 from $676,000 and $1,816,000 during the same periods in 2002.  The primary reason for the increase in occupancy costs in 2003 is related to retrofit charges for branch facilities in Atwater, Fresno, and Merced, and the addition of a new retail banking facility in Fresno.  When comparing the results of the three and nine months ended September 30, 2003 to three and nine months ended September 30, 2002, professional fees decreased by $12,000 and increased by $176,000 or 4% and 20%, marketing expenses decreased by $62,000 and

 

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increased by $39,000 or 23% and 6%, goodwill and intangible amortization expense were constant at $170,000 and $510,000, supplies expense decreased by $18,000 and increased by $57,000 or 9% and 10%, and other expenses increased $220,000 and $485,000 or 13% and 10% from 2002 levels. Increased professional fees for the first nine months of 2003 were the result of an increased use of consultants to identify new business profitability strategies and potential business combinations while decreases for the three months resulted primarily from the timing of receipt of consulting services.  The increased other expenses were primarily the result of valuation write-downs of $102,000 related to the bankruptcy of a mortgage brokerage company that dishonored its funding commitments on approximately $7,000,000 in loan originations during the third quarter of 2003.

 

Provision For Income Taxes.  The Company recorded an increase in the income tax provision of $728,000 and $1,255,000 or 204% and 72% to $1,084,000 and $3,002,000 for the three and nine months ended September 30, 2003 compared to $356,000 and $1,747,000 recorded for the same period in 2002.  During the three and nine months ended September 30, 2003, the Company achieved an effective tax rate of 23%, compared with 11% and 19% achieved during the same periods in 2002. During the third quarter of 2002, the Company received a one-time tax benefit of $290,000 related to a change in state tax law. This benefit was the primary reason for the lower 2002 effective tax rate. Increases in pretax income levels achieved during 2003 over 2002 levels have also contributed to the increase in the 2003 provision for income tax. Effective tax rates below statutory tax rate levels have been achieved primarily through 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.

 

Financial Condition

 

Total assets at September 30, 2003 were $1,162,391,000, an increase of $128,181,000 or 12% compared with total assets of $1,034,210,000 at December 31, 2002.  Net loans were $708,745,000 at September 30, 2003, an increase of $87,106,000 or 14% compared with net loans of $621,639,000 at December 31, 2002.  Deposits were $974,832,000 at September 30, 2003, an increase of $140,453,000 or 17% compared with deposits of $834,379,000 at December 31, 2002.  The increase in total assets of the Company between December 31, 2002 and September 30, 2003 was primarily the result of an increase in savings and certificate deposits that were obtained to fund additional purchases of interest earning assets.

 

Total shareholders’ equity was $85,613,000 at September 30, 2003, an increase of $8,444,000 or 11% from the $77,169,000 at December 31, 2002. The growth in shareholders’ equity between December 31, 2002 and September 30, 2003 was achieved through the retention of accumulated earnings, which was partially offset by a decline in other comprehensive income.  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.

 

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

 

 

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Other Interest-Earning Assets.  The following table relates to the cash surrender value of life insurance policies that are carried in other assets at the dates indicated.  The insurance polices are associated with employee benefit plans of the Company, including a salary continuation plan for the Company’s executive management and deferred retirement benefits for participating board members.  The salary continuation plan and deferred retirement benefits for participating board members are informally linked with approximately $7,732,000 in universal Life insurance policies purchased by the Company.  Income from these policies is reflected in noninterest income.

 

(Dollars in thousands)		At September 30, 2003			At  December 31, 2002
Cash surrender value of life insurance		$	20,936		$	17,240

 

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

 

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.

 

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The following table summarizes nonperforming assets of the Company at September 30, 2003 and December 31, 2002:

 

 

Contractual accrued interest income on loans on nonaccrual status as of September 30, 2003 and 2002, that would have been recognized if the loans had been current in accordance with their original terms was approximately $45,000 and $169,000, respectively.

 

At September 30, 2003, nonperforming assets represented .15% of total assets, a decrease of 9 basis points when compared to the .24% at December 31, 2002.  Nonperforming loans represented .24% of total loans at September 30, 2003, a decrease of 14 basis points compared to the .38% at December 31, 2002.  Nonperforming loans that were secured by first deeds of trust on real property were $0 at September 30, 2003 and December 31, 2002.   Other forms of collateral such as inventory and equipment secured the 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 decrease in nonperforming loans and nonperforming assets as of September 30, 2003 compared with their levels as of December 31, 2002, was due primarily to a decrease in the nonperforming agricultural segment of the loan portfolio.

 

At September 30, 2003 and December 31, 2002, the Company had $60,000 invested in one property, respectively, that had been acquired through foreclosure.  The property was 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 most of these properties within a twelve month period.  During the first quarter of 2003, one foreclosure property was acquired and sold for $81,000 that had no assigned book value for a gain on sale of $81,000.  No assurance can be given that the Company will sell the remaining property during 2003 or at any time or the amount for which the 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 September 30, 2003 and December 31, 2002, 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 September 30,

 

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2003 were $1,733,000 for which the Company made provisions to the allowance for loan losses of approximately $273,000.

 

Except for loans that are disclosed above, there were no assets as of September 30, 2003, where known information about possible credit problems of the 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.

 

Allowance for Loan Losses

 

The following table summarizes the loan loss experience of the Company for the nine months ended September 30, 2003 and 2002, and for the year ended December 31, 2002.

 

 

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

 

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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 a provision for loan losses of $751,000 and $1,904,000 for the three and nine months ended September 30, 2003 compared with 1,190,000 and $3,421,000 during the same periods of 2002. The decrease in loan loss provision during the first nine months of 2003 was recorded to coincide with the lower level of charge-offs experienced and reduced nonperforming loan levels during 2003 when compared to the same period in 2002.  The Company’s charge-offs, net of recoveries, were $861,000 for the nine months ended September 30, 2003 compared with $1,230,000 for the same nine months in 2002.  The decrease in net charge-offs for the first nine months of 2003 was primarily due to decreased charge-offs that occurred within the commercial and agricultural portfolio segments and increased recoveries within the consumer loan segment of the loan portfolio.

 

As of September 30, 2003, the allowance for loan losses was $13,177,000 or 1.83% of total loans outstanding, compared with $12,134,000 or 1.91% of total loans outstanding as of December 31, 2002 and $11,934,000 or 1.95% of total loans outstanding as of September 30, 2002.

 

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.

 

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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.

 

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 $306,294,000 and $305,075,000 on September 30, 2003 and December 31, 2002, respectively, and constituted 26% and 29% 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 $262,965,000 at September 30, 2003 compared with $193,962,000 at December 31, 2002.

 

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, Pacific Coast Bankers’ Bank, Union Bank of California, Wells Fargo

 

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Bank and First Tennessee Bank aggregating $153,725,000 of which $81,419,000 was outstanding as of September 30, 2003 and $100,841,000 was outstanding as of December 31, 2002. The decrease in borrowings between December 31, 2003 and September 30, 2003 were funded primarily with cash flows derived from principal repayments occurring within the investment portfolio.  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.  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 $8,444,000 or 10.9% from December 31, 2002 to September 30, 2003.

 

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 September 30, 2003, that the Company and the Bank met all applicable capital requirements.  The Company’s leverage capital ratio at September 30, 2003 was 7.66% as compared with 7.68% as of December 31, 2002.  The Company’s total risk based capital ratio at September 30, 2003 was 10.85% as compared to 10.74% as of December 31, 2002.

 

The Company’s and Bank’s actual capital amounts and ratios met all regulatory requirements as of September 30, 2003 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 September 30, 2003
Total capital (to risk weighted assets)		$	99,770		10.85	%	$	73,586		8.0	%	$	91,982		10.0	%
Tier 1 capital (to risk weighted assets)		88,250			9.59		36,793			4.0		55,189			6.0
Leverage ratio*		88,250			7.66		46,079			4.0		57,599			5.0
The Bank:
As of September 30, 2003
Total capital (to risk weighted assets)		$	96,983		10.59	%	$	73,292		8.0	%	$	91,615		10.0	%
Tier 1 capital (to risk weighted assets)		85,512			9.33		36,646			4.0		54,969			6.0
Leverage ratio*		85,512			7.43		46,015			4.0		57,519			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.

 

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Deposits.  Deposits are the Company’s primary source of funds.  At September 30, 2003, the Company had a deposit mix of 32% in savings deposits, 37% 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 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 September 30, 2003, the Company had brokered deposits of $44,299,000.

 

Maturities of time certificates of deposits of $100,000 or more outstanding at September 30, 2003 and December 31, 2002 are summarized as follows:

 

		September 30, 2003			December 31, 2002
		(Dollars in thousands)
Three months or less		$	93,878		$	69,661
Over three to six months		43,008			38,863
Over six to twelve months		39,981			23,319
Over twelve months		16,630			28,872
Total		$	193,497		$	160,715

 

Borrowed Funds

 

The decrease in other borrowings during the third quarter of 2003 was primarily due to the payment at maturity of short-term FHLB borrowings funded by new savings and certificate of deposit inflows from public agencies and water districts.

 

Return on Equity and Assets

 

		Three months ended September 30 2003		Three months ended September 30 2002		Year ended December 31 2002
Annualized return on average assets		1.26	%	1.20	%	1.09	%
Annualized return on average equity		17.27	%	16.72	%	14.94	%
Average equity to average assets		7.28	%	7.18	%	7.29	%

 

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 nine months ended September 30, 2003 when compared to the level of market risk at December 31, 2002.  If interest rates were to suddenly and materially fall from levels experienced during the third quarter of 2003, the Company could become susceptible to an increased level of market risk.

 

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Item 4.                                                         Controls and Procedures

 

Evaluation Of Disclosure Controls And Procedures

 

We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report, pursuant to Rule 15a – 15(e) under the Securities Exchange Act of 1934.

 

Based on their review of our disclosure controls and procedures, the principal executive officer and principal financial officer have concluded our disclosure controls and procedures are effective in timely alerting them to material information relating to us that is required to be included in our periodic SEC filings.

 

Changes In Internal Controls

 

There were no changes in our internal controls over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially effect, our internal controls over financial reporting.

 

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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.

 

None

 

Item 5.                                                           Other Information.

 

None

 

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

 

(a)                                  Exhibits.

 

Exhibit Number		Exhibit
4.1		Indenture, dated as of February 22, 2001 between Capital Corp of the West, as Issuer, and State Street Bank and Trust Company of Connecticut, National Association, as Trustee.
4.2		Amended and Restated Declaration of Trust  by and between State Street Bank and Trust Company of Connecticut, National Association, as Trustee, and Capital Corp of the West, as Sponsor.
10.10		Form of Capital Corp of the West Amended Salary Continuation Agreement Entered Into with Executive Officers in October 2003.		*
31.1		Certification of Registrant’s Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003
31.2		Certification of Registrant’s Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003
32.1		Certification of Registrant’s Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2		Certification of Registrant’s Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
*		Denotes management contract or compensatory plan arrangement.

 

The exhibit list is incorporated by reference to the exhibit index in this report.

 

Reports on Form 8-K

 

None

 

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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)
Date:  November 12, 2003	By		/s/	Thomas T. Hawker
				Thomas T. Hawker
				President and Chief Executive Officer
Date: November 12, 2003	By		/s/	R. Dale McKinney
				R. Dale McKinney
				Chief Financial Officer

 

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Exhibit Index

 

Exhibit		Description
4.1		Indenture, dated as of February 22, 2001 between Capital Corp of the West, as Issuer, and State Street Bank and Trust Company of Connecticut, National Association, as Trustee.
4.2		Amended and Restated Declaration of Trust by and between State Street Bank and Trust Company of Connecticut, National Association, as Trustee, and Capital Corp of the West, as Sponsor.
10.10		Form of Capital Corp of the West Amended Salary Continuation Agreement Entered Into with Executive Officers in October 2003.
31.1		Certification of Registrant’s Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003
31.2		Certification of Registrant’s Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003
32.1		Certification of Registrant’s Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2		Certification of Registrant’s Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

 

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