FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

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

 

Quarter Ended    March 31, 2004

 

Commission File Number    0-10232

 

FIRST REGIONAL BANCORP

(Exact name of registrant as specified in its charter)

 

 

(310) 552-1776

Registrant’s telephone number, including area code

 

Not applicable

Former name, former address, and former fiscal year, if changed since last report

 

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

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

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

 

Common Stock, No Par Value		3,500,795
Class		Outstanding on May 12, 2004

 

 

FIRST REGIONAL BANCORP

INDEX

 

Part I - Financial Information
	Item 1.	Financial Statements
		Condensed Consolidated Statements of Financial Condition (unaudited)
		Condensed Consolidated Statements of Income (unaudited)
		Condensed Consolidated Statements of Cash Flows (unaudited)
		Notes to Condensed 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 6.	Exhibits and Reports on Form 8-K
Signatures

 

2

 

PART I - FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

FIRST REGIONAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(In Thousands)

(unaudited)

 

		March 31, 2004			December 31, 2003
ASSETS
Cash and due from banks		39,327			$	43,006
Investment securities, available for sale, at fair value		1,847			4,440
Interest-bearing deposits in financial institutions		3,023			3,016
Loans, net of allowance for losses of 8,659 in 2004 and $7,660 in 2003		791,629			705,326
Premises and equipment, net of accumulated depreciation		1,965			1,866
Accrued interest receivable and other assets		20,006			17,648
Total Assets		$	857,797		$	775,302
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits:
Noninterest bearing		$	254,515		$	251,976
Interest bearing:
Savings deposits		35,608			33,072
Money market deposits		295,391			251,380
Time deposits		142,988			127,518
Total deposits		728,502			663,946
Federal Home Loan Bank advances		32,500			42,000
Note payable		675			712
Accrued interest payable and other liabilities		7,552			5,725
Subordinated debentures		35,619			27,887
Total Liabilities		804,848			740,270
Shareholders’ Equity:
Common Stock, no par value, 50,000,000 shares authorized; 3,501,000 and 2,927,000 shares outstanding in 2004 and 2003, respectively		32,983			16,552
Less: Unearned ESOP shares; 71,000 and 75,000 outstanding in 2004 and 2003, respectively		(640		)	(675		)
Total common stock, no par value; outstanding 3,430,000 (2004) and 2,852,000 (2003) shares		32,343			15,877
Retained earnings		20,606			19,155
Total Shareholders’ Equity		52,949			35,032
Total Liabilities and Shareholders’ Equity		$	857,797		$	775,302

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

 

FIRST REGIONAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In Thousands Except Per Share Amounts)

(Unaudited)

 

		Three Months Ended March 31,
		2004			2003
INTEREST INCOME:
Interest and fees on loans		$	10,663		6,542
Interest on investment securities		16			14
Interest on federal funds sold		33			61
Total interest income		10,712			6,617
INTEREST EXPENSE:
Interest on deposits		992			514
Interest on subordinated debentures		375			152
Interest on FHLB advances		145			0
Interest on funds purchased		1			2
Total interest expense		1,513			668
Net interest income		9,199			5,949
PROVISION FOR LOAN LOSSES		887			300
Net interest income after provision for loan losses		8,312			5,649
OTHER OPERATING INCOME:
Customer service fees		1,162			877
Other, net		157			131
Total other operating income		1,319			1,008
OPERATING EXPENSES:
Salaries and related benefits		4,534			3,323
Occupancy expense		425			345
Equipment expense		193			178
Promotion expense		77			66
Professional service expense		437			337
Customer service expense		224			137
Supply/communication expense		232			188
Other expenses		719			534
Total operating expenses		6,841			5,108
Income before provision for income taxes		2,790			1,549
PROVISION FOR INCOME TAXES		1,128			636
NET INCOME		$	1,662		$	913
EARNINGS PER SHARE (Note 2)
Basic		$	0.59		$	0.34
Diluted		$	0.50		$	0.33

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4

 

FIRST REGIONAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 

		Three Months Ended March 31,
		2004			2003
OPERATING ACTIVITIES
Net Income		$	1,662		$	913
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		887			300
Depreciation and amortization		107			87
Accretion of investment security discounts		(8		)	(14		)
Increase in interest receivable		(195		)	(52		)
Increase (decrease) in interest payable		95			(14		)
Increase in taxes payable		827			871
Net increase in other assets		(2,163		)	(607		)
Net increase in other liabilities		905			2,680
Net cash provided by operating activities		2,117			4,164
INVESTING ACTIVITIES
Increase in investment in time deposits, with other financial institutions		(7		)	0
Decrease (increase) in investment securities		2,601			(4,072		)
Decrease in guaranteed loans		756			1,783
Net increase in other loans		(87,946		)	(43,861		)
Increase in premises and equipment		(206		)	(157		)
Net cash used in investing activities		(84,802		)	(46,307		)
FINANCING ACTIVITIES
Net increase in noninterest bearing deposits, money market deposits, and other deposits		$	49,086		$	22,317
Net increase in time deposits		15,470			2,123
Decrease in note payable		(37		)	(37		)
Decrease in Federal Home Loan Bank advances		(9,500		)	0
Issuance of subordinated debentures		7,732			0
Proceeds from issuance of common stock, net		16,395			2,831
Other changes in shareholders’ equity		(140		)	(497		)
Net cash provided by financing activities		$	79,006		$	26,737
Decrease in cash and cash equivalents		$	(3,679	)	$	(15,406	)
Cash and cash equivalents, beginning of period		43,006			49,974
Cash and cash equivalents, end of period		$	39,327		$	34,568
Supplemental Disclosures of Cash Flow Information:
Interest paid		$	1,417		$	681
Income taxes paid		$	300		$	175

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5

 

FIRST REGIONAL BANCORP AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2004

(Unaudited)

 

NOTE 1  -               First Regional Bancorp, a bank holding company (the “Company”), and one of its wholly-owned subsidiaries, First Regional Bank, a California state-chartered bank (the “Bank”), primarily serve Southern California through their branches. The Company’s primary source of revenue is providing loans to customers, which are predominantly small and midsize businesses. First Regional Bancorp has three other subsidiaries, First Regional Statutory Trust I, First Regional Statutory Trust II and First Regional Statutory Trust III, that exist for the sole purpose of issuing trust securities and investing the proceeds thereof in junior subordinated deferrable debentures issued by the Company and engaging in certain other limited activities.  These Trusts were previously reported on a consolidated basis, with the capital securities issued by the Trusts shown on the balance sheet consistent with accounting principles generally accepted in the United States of America. As of December 31, 2003, in accordance with Financial Accounting Standards Board (“FASB”) Interpretation 46 (“FIN 46”) (revised December 2003), the Trusts are no longer reported on a consolidated basis. Therefore, the Trust Preferred Securities no longer appear on the balance sheet. Instead, the subordinated debentures payable by the Company to the Trusts and the investment in the Trusts’ common stock are separately reported. This change primarily impacted the balance sheet and had no material effect on net income.

 

Certain amounts in the 2003 financial statements have been reclassified to be comparable with the classifications used in the 2004 financial statements.

 

In the opinion of the Company, the accompanying condensed consolidated financial statements contain all adjustments (which consist only of normal recurring adjustments) necessary to present fairly the financial position as of March 31, 2004 and the results of operations for the three month periods ended March 31, 2004 and 2003.  Interim results may not be indicative of annual operations.

 

While the Company believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the financial statements and the notes included in the Company’s 2003 annual report on Form 10K.

 

Stock Compensation Plans

 

At March 31, 2004, the Company had two stock-based employee incentive plans, which are described more fully in Note 10 to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003. 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.  No stock-based employee 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 stock on the date of the grant.  No stock options were granted during the first three months of 2004 or 2003.  The following table illustrates the pro forma net income and pro forma earnings per share as if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

 

6

 

		Three Months Ended
		March 31, 2004			March 31, 2003
Net income to common shareholders:
As Reported		$	1,662,000		$	913,000
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects		(63,000		)	(35,000		)
Pro forma net income		$	1,599,000		$	878,000
Basic earnings per share:
As reported		$	0.59		$	0.34
Pro forma		$	0.57		$	0.33
Diluted earnings per share:
As reported		$	0.50		$	0.33
Pro forma		$	0.48		$	0.31

 

Recent Accounting Pronouncements

 

FIN No. 46- Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. FIN No. 46 (revised December 2003) requires that variable interest entities be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. FIN No. 46 also requires disclosures about variable interest entities that companies are not required to consolidate but in which a company has a significant variable interest. The consolidation requirements of FIN No. 46 applied immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to entities established prior to January 31, 2003 in the first fiscal year or interim period beginning after December 15, 2003. The Company adopted this interpretation effective for the year ended December 31, 2003 and it did not have a material impact on its results of operations, financial position or cash flows.  However, as previously mentioned, adoption of FIN No. 46 did result in the deconsolidation of statutory trusts previously consolidated by the Company.

 

SFAS No. 149-Amendment of Statement 133 on Derivative Instruments and Hedging Activities, in April 2003 which is effective for contracts entered into or modified and hedging relationships designated after June 30, 2003.  This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Implementation of this standard did not have a material effect on the Company’s results of operations, financial position or cash flows.

 

NOTE 2  -                                            Basic earnings per share are computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during each period.  The computation of diluted earnings per share also considers the number of shares issuable upon the assumed exercise of outstanding common stock options.  A reconciliation of the numerator and the denominator used in the computation of basic and diluted earnings per share is:

 

7

 

		Three Months Ended March 31, 2004
		Income (Numerator)			Weighted Average Shares (Denominator)		Per Share Amount
Basic EPS
Income available to common shareholders		$	1,662,000		2,828,975		$	0.59
Effect of Dilutive Securities
Incremental shares from assumed exercise of outstanding options					199,528		(0.04		)
Incremental shares from assumed conversion of convertible subordinated debentures		$	132,750		545,455		(0.05		)
Diluted EPS
Income available to common shareholders		$	1,794,750		3,573,958		$	0.50

 

		Three Months Ended March 31, 2003
		Income (Numerator)			Weighted Average Shares (Denominator)		Per Share Amount
Basic EPS
Income available to common shareholders		$	913,000		2,668,402		$	0.34
Effect of Dilutive Securities
Incremental shares from assumed exercise of outstanding options					86,422		(0.01		)
Diluted EPS
Income available to common shareholders		$	913,000		2,754,824		$	0.33

 

NOTE 3  -                                            As of March 31, 2004 the Bank had a total of $5,761,000 in standby letters of credit outstanding.  No losses are anticipated as a result of these transactions.

 

NOTE 4  -                                            The Company’s comprehensive income includes all items which comprise net income plus the unrealized holding gains on available-for-sale securities.  For the three month periods ended March 31, 2004 and 2003, the Company’s comprehensive income was as follows:

 

 

8

 

NOTE 5  - -                                            Management has evaluated the Company’s overall operation and determined that its business consists of three reportable business segments as of March 31, 2004 and 2003:  core banking operations, the administrative services in relation to TASC (as defined below), and Trust Services.  The following describes these three business segments:

 

Core Bank Operations - The principal business activities of this segment are attracting funds from the general public and originating commercial and real estate loans for small and midsize businesses in Southern California.  This segment’s primary sources of revenue are interest income from loans and investment securities and fees earned in connection with loans and deposits.  This segment’s principal expenses consist of interest paid on deposits, personnel, and other general and administrative expenses.  Our core banking services also includes the Bank’s merchant services operations, which provides credit card deposits and clearing services to retailers and other credit card accepting businesses and which generates fee income.

 

Administrative Services - The principal business activity of this segment is providing administrative services for self-directed retirement plans.  The primary source of revenue for this segment is fee income from self-directed accounts.  The segment’s principal expenses consist of personnel, rent, data processing, and other general and administrative expenses.

 

Trust Services - The principal business activity of this segment is providing trust services for living trusts, investment agency accounts, IRA rollovers, and all forms of court-related matters. The primary source of revenue for this segment is fee income.  The segment’s principal expenses consist of personnel, data processing, professional fees, and other general and administrative expenses.

 

Total assets of TASC at March 31, 2004 and December 31, 2003 were $548,000 and $506,000, respectively, and total assets of Trust Services at March 31, 2004 and December 31, 2003 were $60,000 and $63,000, respectively.  The remaining assets reflected on the balance sheets of the Company are associated with the core banking operations.

 

The following table shows the net income (loss) (in thousands) for the core banking operations, the administrative, and the trust services for the three month periods ended March 31, 2004 and 2003.

 

		Core Banking Operations			Administrative Services			Trust Services			Three Month Period Ended March 31, 2004
Net interest income		$	9,199								$	9,199
Provision for Loan Losses		887									887
Other operating income		729			$	381		$	209		1,319
Other operating expenses		6,460			190			191			6,841
Provision for income taxes		1,043			78			7			1,128
Net income		$	1,538		$	113		$	11		$	1,662

 

9

 

		Core Banking Operations			Administrative Services			Trust Services			Three Month Period Ended March 31, 2003
Net interest income		$	5,949								$	5,949
Provision for Loan Losses		300									300
Other operating income		539			$	318		$	151		1,008
Other operating expenses		4,679			225			204			5,108
Provision for income taxes		598			38						636
Net income		$	911		$	55		$	(53	)	$	913

 

The operations of the administrative services positively affect the results of core banking operations by providing a low-cost source of deposits.

 

10

 

ITEM 2.                             MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

SUMMARY

 

First Regional Bancorp did not conduct any significant business activities independent of First Regional Bank and the Bank’s subsidiary, TASC.  The following discussion and analysis relates primarily to the Bank.

 

For a more complete understanding of the Company and its operations reference should be made to the financial statements included in this report and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.  Certain statements in this report on Form 10-Q constitute “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  All statements, other than statements of historical fact, included herein may constitute forward-looking statements.  Although First Regional believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct.  Important factors that could cause actual results to differ materially from First Regional’s expectations include fluctuations in interest rates, inflation, government regulations, and economic conditions and competition in the geographic and business areas in which First Regional conducts its operations.  For additional information concerning these factors, see “Item 1. Business” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

The Company has established various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of the Company’s financial statements. Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company. The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its condensed consolidated financial statements. In estimating the allowance for loan losses, management utilizes historical experience as well as other factors including the effect of changes in the local real estate market on collateral values, the effect on the loan portfolio of current economic indicators and their probable impact on borrowers and increases or decreases in nonperforming and impaired loans. Changes in these factors may cause management’s estimate of the allowance to increase or decrease and result in adjustments to the Company’s provision for loan losses.

 

As of March 31, 2004 total assets were $857,797,000 compared to $775,302,000 at December 31, 2003, an increase of $82,495,000 or 10.6% and the March 31, 2004 asset level represents an improvement over the $498,441,000 that existed on the same date in 2003. The 2004 asset increase reflects a corresponding increase in total deposits of $64,556,000 or 9.7%, from $663,946,000 at the end of 2003 to $728,502,000 at March 31, 2004.  While overall deposits increased, the deposit growth was centered in money market deposits, and time deposits, while noninterest bearing deposits and savings deposits remained relatively constant.  There were several changes in the composition of the Bank’s assets during the first quarter. The Bank’s core loan portfolio grew significantly by $86,303,000 during the three month period, bringing the Bank’s total loans to $791,629,000 at March 31, 2004 from the December 31, 2003 total of $705,326,000.  The combined effect of the substantial increase in loans and the growth in deposits was a decrease in the level of total liquid

 

11

 

assets (cash and due from banks and investment securities). Investment securities decreased by $2.6 million, while cash and cash equivalents (cash and due from banks) fell by $3.7 million in order to accommodate the changes that took place in the rest of the balance sheet.

 

The Company earned a profit of $1,662,000 in the first quarter of 2004, compared to earnings of $913,000 in the three months ended March 31, 2003.

 

NET INTEREST INCOME

 

Net interest income is the excess of interest income earned on interest-earning assets over interest expense incurred on interest-bearing liabilities.  Interest income or expense are determined by the average volume of interest-bearing assets or liabilities, and the average rate of interest earned or paid on those assets or liabilities.  As was the case during 2003, in the first three months of 2004 the Company’s continued growth efforts resulted in an increase in interest earning assets, including loans.  The Bank’s core loan portfolio increased significantly during first three months of 2004.  The 2004 asset growth reflects a corresponding increase in total deposits resulting from an increase in full service bank branches during 2003 and an increase in personnel in 2003 and 2004.

 

Total interest income increased by $4,095,000 (62%) for the three months ended March 31, 2004 compared to the same period in 2003 as total earning assets were substantially higher (75%) in 2004 than in 2003. The majority of the increase in interest income arises from a substantial increase of $4,121,000 (63%) in interest on loans from $6,542,000 for the three months ended March 31, 2003 compared to $10,663,000 for the same period in 2004. Although there was an increase in the loan portfolio of $349,998,000 (79%) from March 31, 2003 to March 31, 2004, the interest income increase was tempered by the Federal Reserve’s series of interest rate reductions.  For the three months ended March 31, 2004 interest expense on deposits increased by $478,000 (93%), to $992,000 from the 2003 level of $514,000 due to an increase in total deposits of $281,932,000 (63%) from March 31, 2003 to March 31, 2004.  The increases were primarily in noninterest bearing demand deposit accounts, time deposits and money market deposits.  For the three months ended March 31, 2004 interest expense on subordinated debentures increased by $223,000 (146%), to $375,000 from the 2003 level of $152,000 due to an increase of $22,500,000 in subordinated debentures at March 31, 2004 compared to March 31, 2003.  The net result was an increase in net interest income of $3,250,000 (55%), from $5,949,000 in the first quarter of 2003 to $9,199,000 for the first three months of 2004.

 

Interest Rates and Interest Differential

 

The following table sets forth the average balances outstanding for major categories of interest earning assets and interest bearing liabilities and the average interest rates earned and paid thereon:

 

		For the Three Month Period Ended March 31,
		2004								2003
		Average Balance			Interest Income(2)/ Expense			Average Yield/ Rate %		Average Balance			Interest Income(2)/ Expense			Average Yield/ Rate %
		(Dollars in Thousands)
Interest Earning Assets:
Loans(1)		$	746,446		$	10,663		5.7	%	$	429,605		$	6,542		6.1	%
Investment Securities		3,561			8			0.9	%	4,284			14			1.3	%
Interest-bearing deposits in financial institutions		3,019			8			1.1	%	0			0			0.0	%
Federal Funds Sold		13,898			33			0.9	%	21,132			61			1.2	%
Total Interest Earning Assets		$	766,924		$	10,712		5.6	%	$	455,021		$	6,617		5.8	%

 

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		For the Three Month Period Ended March 31,
		2004								2003
		Average Balance			Income(2)/ Expense			Yield/ Rate %		Average Balance			Income(2)/ Expense			Yield/ Rate %
		(Dollars in Thousands)
Interest Bearing Liabilities:
Savings deposits		$	6,871		$	12		0.7	%	$	4,346		$	8		0.7	%
Money market accounts		292,170			518			0.7	%	217,392			347			0.6	%
Time deposits		139,099			462			1.3	%	47,713			159			1.3	%
Subordinated debentures		28,991			375			5.2	%	12,887			152			4.7	%
Other borrowings		$	53,886		$	146		1.1	%	$	245		$	2		3.3	%
Total interest Bearing liabilities		$	521,017		$	1,513		1.2	%	$	282,583		$	668		0.9	%

 

(1)                        This figure reflects total loans, including non-accrual loans, and is not net of the allowance for losses, which had an average balance in the first quarter of $8,129,000 in 2004 and $5,603,000 in 2003.

 

(2)                        Includes loan fees in the first quarter of $967,000 in 2004 and $562,000 in 2003.

 

The following table shows the net interest earnings and the net yield on average interest earning assets:

 

		For the Three Month Period Ended March 31,
		2004			2003
		(Dollars in Thousands)
Total interest income (1)		$	10,712		$	6,617
Total interest expense		1,513			668
Net interest earnings		$	9,199		$	5,949
Average interest earning assets		$	766,924		$	455,021
Average interest bearing liabilities		$	521,017		$	282,583
Net yield on average interest earning assets		4.8		%	5.2		%

 

(1)                                  Includes loan fees in the first quarter of $967,000 in 2004 and $562,000 in 2003.

 

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The following table sets forth changes in interest income and interest expense.  The net change as shown in the column “Net Increase (Decrease)” is segmented into the change attributable to variations in volume and the change attributable to variations in interest rates.  Non-performing loans are included in average loans.

 

		Increase (Decrease) For the Three Month Periods Ended March 31, 2004 over 2003
		Volume			Rate			Net
		(Dollars in Thousands)
Interest Income(1)
Loans (2)		$	4,499		$	(378	)	$	4,121
Interest-bearing deposits In financial institutions		8			0			8
Investment securities		(2		)	(4		)	(6		)
Funds sold		(18		)	(10		)	(28		)
Total Interest Earning Assets		$	4,487		$	(392	)	$	4,095
Interest Expense (1)
Savings		$	4		$	0		$	4
Money market		129			42			171
Time		304			(1		)	303
Subordinated debentures		207			16			223
Other borrowings		144			0			144
Total interest bearing liabilities		$	788		$	57		$	845

 

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

 

(2)                                  Includes loan fees in the first quarter of $967,000 in 2004 and $562,000 in 2003.

 

OTHER OPERATING INCOME

 

Other operating income rose to $1,319,000 in the first quarter of 2004 from $1,008,000 in the three months ended March 31, 2003.  The Bank’s merchant services operation, which provides credit card deposit and clearing services to retailers and other credit card accepting businesses, had revenue that totaled $320,000 for the three months ended March 31, 2004 in contrast with $222,000 in the corresponding period of 2003.  The Bank’s Trust Administration Services Corp., a wholly owned subsidiary that provides administrative and custodial services to self-directed retirement plans, had revenue which

 

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increased from $318,000 in first quarter of 2003 to $379,000 in the first quarter of 2004. The Bank’s Trust Department that provides trust services for living trusts, investment agency accounts, IRA rollovers, and all forms of court-related matters had revenue of $211,000 in first quarter of 2004 and $154,000 in first quarter of 2003.  No gains or losses on securities sales were realized in the first quarter of 2004 or 2003.

 

LOAN PORTFOLIO AND PROVISION FOR LOAN LOSSES

 

The loan portfolio consisted of the following at March 31, 2004 and December 31, 2003:

 

			March 31, 2004			December 31, 2003
			(Dollars in Thousands)
Commercial loans			$	117,496		$	113,563
Real estate construction loans			74,421			90,596
Real estate loans			602,416			501,317
Government guaranteed loans			8,642			9,398
Other loans			1,851			2,232
Total loans			$	804,826		$	717,106
Less	– Allowances for loan losses		8,659			7,660
	– Deferred loan fees		4,538			4,120
Net loans			$	791,629		$	705,326

 

The allowance for loan losses is intended to reflect the known and unknown risks which are inherent in a loan portfolio.  The adequacy of the allowance for loan losses is continually evaluated in light of many factors, including loan loss experience and current economic conditions. The allowance for loan losses is increased by provisions for loan losses, and is decreased by net charge-offs.  Management believes the allowance for loan losses is adequate in relation to both existing and potential risks in the loan portfolio.

 

In determining the adequacy of the allowance for loan losses, management considers such factors as historical loan loss experience, known problem loans, evaluations made by bank regulatory authorities, assessment of economic conditions and other appropriate data to identify the risks in the loan portfolio.

 

The first major element includes a detailed analysis of the loan portfolio in two phases. The first phase is conducted in accordance with SFAS No. 114, “Accounting by Creditors for the Impairment of a Loan.”, as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosures.” Individual loans are reviewed to identify loans for impairment. A loan is impaired when principal and interest are deemed uncollectable in accordance with the original contractual terms of the loan. Impairment is measured as either the expected future cash flows discounted at each loan’s effective interest rate, the fair value of the loan’s collateral if the loan is collateral dependent, or an observable market price of the loan (if one exists). Upon measuring the impairment, the Bank will insure an appropriate level of allowance is present or established.

 

Central to the first phase and the Bank’s credit risk management is its loan risk rating system. The originating credit officer assigns borrowers an initial risk rating, which is based primarily on a thorough analysis of each borrower’s financial capacity in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit administration personnel. Credits are monitored by line and credit administration personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract.  Risk ratings are adjusted as necessary.

 

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Based on the risk rating system specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicates the probability that a loss has been incurred. Management performs a detailed analysis of these loans, including, but not limited to, cash flows, appraisals of the collateral, conditions of the marketplace for liquidating the collateral and assessment of the guarantors. Management then determines the inherent loss potential and allocates a portion of the allowance for losses as a specific allowance for each of these credits.

 

The second phase is conducted by evaluating or segmenting the remainder of the loan portfolio into groups or pools of loans with similar characteristics in accordance with SFAS No. 5, “Accounting for Contingencies”. In this second phase, groups or pools of homogeneous loans are reviewed to determine a portfolio allowance. Additionally groups of non-homogeneous loans, such as construction loans are also reviewed to determine a portfolio allowance.  The risk assessment process in this case emphasizes trends in the different portfolios for delinquency, loss, and other-behavioral characteristics of the subject portfolios.

 

The second major element in the Bank’s methodology for assessing the appropriateness of the allowance consists of management’s considerations of all known relevant internal and external factors that may affect a loan’s collectibility. This includes management’s estimates of the amounts necessary for concentrations, economic uncertainties, the volatility of the market value of collateral, and other relevant factors. The relationship of the two major elements of the allowance to the total allowance may fluctuate from period to period.

 

When considered necessary by management, the Bank also establishes special reserves to reflect unusual conditions that could impact the repayment performance of the Bank’s borrowers.  In 2001, for example, the bank established special reserves relating to California’s energy crisis and the economic recession.  In 2002, Management concluded that these factors would no longer influence borrower performance, and the associated reserves were discontinued.

 

Reflecting the Company’s ongoing analysis of the risks presented by its loan portfolio, the allowance for losses was $8,659,000 and $7,660,000 (or 1.08% and 1.07% of gross outstanding loans) at March 31, 2004 and December 31, 2003 respectively.  Provisions for loan losses were $887,000 for the three month period ended March 31, 2004, compared to $300,000 for the same period of 2003. For the three months ended March 31, 2004 and 2003, the Company generated no net loan charge-offs.  The company had loan recoveries of $113,000 and $0 during the three months ended March 31, 2004 and 2003.

 

For the quarter ended March 31, 2004, the Company identified loans having an aggregate average balance of $2,709,000 which it concluded were impaired under SFAS No. 114.  The Company’s policy is generally to discontinue the accrual of interest income on impaired loans, and to recognize income on such loans only after the loan principal has been repaid in full and to establish a loss reserve for each of the loans which at March 31, 2004 totaled $533,000 for the loans as a group.

 

OTHER OPERATING EXPENSES

 

Overall operating expenses increased in the first quarter of 2004 compared to the same period of 2003.  Operating expenses rose to a total of $6,841,000 for the first quarter of 2004 from $5,108,000 for the three months ended March 31, 2003.

 

Salary and related benefits increased by $1,211,000, rising from a total of $3,323,000 for the first quarter of 2003 to $4,534,000 for the same period in 2004.  The increase principally reflects increases in staffing which took place during 2003 and 2004 in the regional offices and also reflects employee salary adjustments.  Occupancy expense rose to $425,000 for the three months ended March 31, 2004 from $345,000 in the first quarter of 2003, the increase reflects the rent paid on the various facilities which house the Bank’s regional offices and additional space at the bank headquarters.  Total other

 

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operating expenses rose in 2004 compared to the prior year, increasing from $1,440,000 for the first quarter of 2003 to $1,882,000 for the first three months of 2004.

 

The combined effects of the above-described factors resulted in income before taxes of $2,790,000 for the three months ended March 31, 2004 compared to $1,549,000 for the first quarter of 2003.  In the first quarter, the Company’s provision for taxes increased from $636,000 in 2003 to $1,128,000 in 2004.  This brought Net Income for the first quarter of 2004 to $1,662,000 compared to $913,000 for the same period in 2003.

 

LIQUIDITY, SOURCES OF FUNDS, AND CAPITAL RESOURCES

 

The Company’s financial position remains liquid.  Total liquid assets (cash and due from banks, investment securities, federal funds sold, and interest gearing deposits in financial institutions) stood at 6.1% of total deposits at March 31, 2004.  This level represents a decrease from the 7.6% liquidity level which existed on December 31, 2003. In addition, at March 31, 2004 some $8.6 million of the Bank’s total loans consisted of government guaranteed loans, which represent a significant sources of liquidity due to the active secondary markets which exist for these assets.  The ratio of net loans (including government guaranteed loans) to deposits was 108.7% and 106.2% as of March 31, 2004 and December 31, 2003, respectively.

 

Total shareholders equity was $52,949,000 and $35,032,000 as of March 31, 2004 and December 31, 2003, respectively.  The Company completed a private placement during the current period and issued 583,645 shares of common stock and increased equity by net proceeds of $16,395,000.  The Company’s and the Bank’s capital ratios for those dates in comparison with regulatory capital requirements were as follows:

 

		3-31-04		12-31-03
Leverage Ratio (Tier I Capital to Average Assets):
Regulatory requirement		4.00	%	4.00	%
Company		8.61	%	6.60	%
Bank		10.45	%	8.80	%

 

The “regulatory requirement” listed represents the level of capital required for Adequately Capitalized status.

 

In addition, bank regulators have issued risk-adjusted capital guidelines which assign risk weighting to assets and off-balance sheet items and place increased emphasis on common equity.  The Company’s and the Bank’s risk adjusted capital ratios for the dates listed in comparison with the risk adjusted regulatory capital requirements were as follows:

 

		3-31-04		12-31-03
Tier I Capital to Risk-weighted Assets:
Regulatory requirement		4.00	%	4.00	%
Company		9.19	%	6.80	%
Bank		11.17	%	9.10	%

 

		3-31-04		12-31-03
Total Capital to Risk-weighted Assets:
Regulatory requirement		8.00	%	8.00	%
Company		12.60	%	10.30	%
Bank		12.32	%	10.20	%

 

At March 31, 2004, the Company and the Bank exceeded the minimum risk-based capital ratio and leverage ratio required to be considered “well capitalized”.  The Company and the Bank believe that it will continue to meet all applicable capital standards.

 

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INFLATION

 

The impact of inflation on the Company differs significantly from other industries, since virtually all of its assets and liabilities are monetary. During periods of rising inflation, companies with net monetary assets will always experience a reduction in purchasing power.  Inflation continues to have an impact on salary, supply, and rent expenses, but the rate of inflation in general and its impact on these expenses in particular has remained moderate in recent years.

 

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

 

There were no material changes outside the ordinary course of our business, except for the issuance of $7,732,000 million of subordinated debentures, in our contractual obligations during the quarter ended March 31, 2004.

 

BORROWINGS

 

Convertible Subordinated Debentures

 

On October 30, 2003, the Company sold $15 million aggregate principal amount of convertible subordinated debentures due 2023 in a private placement. The debentures bear interest at a rate of 6 percent per annum and are convertible into the Company’s common stock at a conversion price of $27.50 per share. The debentures are senior to the Company’s trust securities but are subordinate to the Company’s other existing and future senior indebtedness.

 

Junior Subordinated Deferrable Debentures

 

During 2004, 2002 and 2001, the Company established Trust I, Trust II and Trust III (the “Trusts”), statutory business trusts and wholly owned subsidiaries of the Company. The Trusts were formed for the sole purpose of issuing securities and investing the proceeds thereof in obligations of the Company and engaging in certain other limited activities.

 

The Trusts issued Cumulative Preferred Capital Securities (the ”Trust Securities ”) in private placement transactions, which represent undivided preferred beneficial interests in the assets of the Trusts. Simultaneously, the Trusts purchased Junior Subordinated Deferrable Debentures totaling $20,619,000 at March 31, 2004 and $12,887,000 at December 31, 2003 (the “Debentures ”) from the Company. The Company then invested the net proceeds of the sale of the Debentures in the Bank as additional paid-in capital to support the Bank’s future growth. The structure of these transactions enabled the Company to obtain additional Tier 1 capital for regulatory reporting purposes while permitting the Company to deduct the payment of future cash distributions for tax purposes. The debentures, must be redeemed within 30 years and are recorded in the liability section of the consolidated balance sheet in accordance with accounting principles generally accepted in the United States of America even though they are treated as capital for regulatory purposes.  Holders of the debentures are entitled to receive cumulative cash distributions, payable quarterly in arrears, equal to three-month LIBOR plus an interest factor, not to exceed 11.90% during the first five years.

 

ITEM 3.                             QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Because customer deposits are the Company’s principal funding source outside of its capital, management has attempted to match rates and maturities of its deposits with its investment and loan portfolios as part of its liquidity and asset and liability management policies.  The objective of these policies is to manage the Company’s interest rate sensitivity and limit the fluctuations of net interest income resulting from interest rate changes.  The table which follows indicates the repricing or maturity characteristics of the major categories of the Bank’s assets and liabilities as of March 31, 2004, and thus the relative sensitivity of the Bank’s net interest income to changes in the overall level of interest rates.

 

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(In Thousands)

 

Category		Floating Rate		Less than one month		One month but less than six months		Six months but less than one year		One year but less than five years		Five years or more		Non- interest earning or bearing		Total
Fed funds sold		0		0		0		0		0		0		0		0
Time deposits with other banks		0		0		0		3,023		0		0		0		3,023
Investment securities		0		600		1,247		0		0		0		0		1,847
Subtotal		0		600		1,247		3,023		0		0		0		4,870
Loans		787,204		0		753		3,500		172		0		0		791,629
Total earning assets		787,204		600		2,000		6,523		172		0		0		796,499
Cash and due from banks		0		0		0		0		0		0		39,327		39,327
Premises and equipment		0		0		0		0		0		0		1,965		1,965
Other real estate owned		0		0		0		0		0		0		0		0
Other assets		0		0		0		0		0		0		20,006		20,006
Total non-earning assets		0		0		0		0		0		0		61,298		61,298
Total assets		787,204		600		2,000		6,523		172		0		61,298		857,797
Funds purchased		0		0		0		0		0		0		0		0
Advances from FHLB		0		32,500		0		0		0		0		0		32,500
Repurchase agreements		0		0		0		0		0		0		0		0
Subtotal		0		32,500		0		0		0		0		0		32,500
Savings deposits		35,608		0		0		0		0		0		0		35,608
Money market deposits		295,391		0		0		0		0		0		0		295,391
Time deposits		0		46,993		82,308		7,437		6,250		0		0		142,988
Subordinated Debentures		0		0		20,619		0		0		15,000		0		35,619
Total interest bearing liabilities		330,999		79,493		102,927		7,437		6,250		15,000		0		542,106
Demand deposits		0		0		0		0		0		0		254,515		254,515
Other liabilities		675		0		0		0		0		0		7,552		8,227
Equity capital		0		0		0		0		0		0		52,949		52,949
Total non-interest bearing liabilities and equity capital		675		0		0		0		0		0		315,016		315,691
Total liabilities and equity capital		331,674		79,493		102,927		7,437		6,250		15,000		315,016		857,797
GAP		455,530		(78,893	)	(100,927	)	(914	)	(6,078	)	(15,000	)	(253,718	)	0
Cumulative GAP		455,530		376,637		275,710		274,796		268,718		253,718		0		0

 

As the table indicates, the vast majority of the Company’s assets are either floating rate or, if fixed rate, have short maturities.  Since the yields on these assets quickly adjust to reflect changes in the overall level of interest rates, there are no significant unrealized gains or losses with respect to the Company’s assets, nor is there much likelihood of large realized or unrealized gains or losses developing in the future.

 

The Bank’s investment portfolio continues to be composed of high quality, low risk securities, primarily U.S. Treasury or Agency securities. As mentioned above, no gains or

 

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losses were recorded on securities sales in the first quarter of 2004 or 2003.  As of March 31, 2003 the Company’s investment portfolio contained unrealized gains $1,000 and no unrealized losses.  By comparison, at March 31, 2004 the Company’s investment portfolio contained no unrealized gains or losses.  Because the Company’s holdings of securities are intended to serve as a source of liquidity should conditions warrant, the securities have been classified by the Company as “available for sale.”

 

ITEM 4.                             CONTROLS AND PROCEDURES

 

The Company maintains controls and procedures designed to ensure that information is recorded and reported in all filings of financial reports.  Such information is reported to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, to allow timely and accurate disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e).  In designing these controls and procedures, management recognizes that they can only provide reasonable assurance of achieving the desired control objectives.  Management also evaluated the cost-benefit relationship of possible controls and procedures.

 

As of the end of the period covered by this report, the Company’s Senior Management carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer.  Based on the foregoing, the Company’s Chief Executive Officer and the Chief Financial Officer conclude that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

 

During management’s evaluation of the effectiveness of the Company’s disclosure controls and procedures, as described above, management did not identify any change in the Company’s internal controls over financial reporting that occurred during the fiscal quarter ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

ITEM 1.                             LEGAL PROCEEDINGS

 

Litigation

 

In the ordinary course of business, the Company and the Bank are involved in litigation.  Management does not expect the ultimate outcome of any pending litigation to have a material effect on the Company’s financial position or results of operations.

 

ITEM 2.                             CHANGES IN SECURITIES AND USE OF PROCEEDS

 

On March 25, 2004, the Company sold 583,465 shares of the Company’s common stock, no par value per share, at a price per share of $29.50, for aggregate proceeds of $17,212,218.  The shares were sold to accredited investors pursuant to Regulation D under the Securities Act of 1933, as amended.  In connection with the offering of such shares, the Company paid its placement agent, Keefe, Bruyette & Woods, Inc., a fee of $817,580, representing 4.75% of the aggregate offering price.  The majority of the proceeds from the issuance were invested in the Company’s subsidiary, First Regional Bank, for general corporate purposes and to promote future growth.

 

ITEM 6.                             EXHIBITS AND REPORTS ON FORM 8-K

 

(a)  Exhibits

 

The Company’s Bylaws were filed, on November 14, 2003, as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the three months ended September 30, 2003.  However, amended and restated Section 3.2 of the Bylaws, adopted by the shareholders of the Company on May 16, 1985, was inadvertently omitted from such exhibit, and is provided as Exhibit 3.1 hereto.  The following is a table of exhibits to this Quarterly Report on Form 10-Q.

 

Exhibit No.		Description
3.1		Amended and restated Section 3.2 of the Company’s Bylaws, adopted by the Company’s shareholders on May 16, 1985
31.1		Certification of the Chief Executive Officer furnished pursuant to Section 302 of the Sarbanes-Oxley Act
31.2		Certification of the Corporate Secretary furnished pursuant to Section 302 of the Sarbanes-Oxley Act
31.3		Certification of the Chief Financial Officer furnished pursuant to Section 302 of the Sarbanes-Oxley Act
32		Certification of the furnished pursuant to Section 906 of the Sarbanes-Oxley Act

 

(b)  Reports on Form 8-K

 

On January 13, 2004, the Company furnished a press release pursuant to Item 12 of Form 8-K, announcing financial results for the year and quarter ended December 31, 2003

 

Items 3, 4 and 5 of Part II of Form 10-Q are not applicable and have been omitted.

 

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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.

 

 

	FIRST REGIONAL BANCORP
Date:  May 14, 2004	/s/ Jack A. Sweeney
	Jack A. Sweeney, Chairman of the Board
	and Chief Executive Officer
Date:  May 14, 2004	/s/ Thomas E. McCullough
	Thomas E. McCullough, Corporate Secretary
Date:  May 14, 2004	/s/ Elizabeth Thompson
	Elizabeth Thompson, Chief Financial Officer

 

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Exhibit Index

 

Exhibit No.		Description
3.1		Amended and restated Section 3.2 of the Company’s Bylaws, adopted by the Company’s shareholders on May 16, 1985
31.1		Certification of the Chief Executive Officer furnished pursuant to Section 302 of the Sarbanes-Oxley Act
31.2		Certification of the Corporate Secretary furnished pursuant to Section 302 of the Sarbanes-Oxley Act
31.3		Certification of the Chief Financial Officer furnished pursuant to Section 302 of the Sarbanes-Oxley Act
32		Certification of the furnished pursuant to Section 906 of the Sarbanes-Oxley Act

 

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