UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 2005.

Or

 

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from                                                to                                               

 

Commission File Number 000-50266

 

 

TRINITY CAPITAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

 

 

 

 

 

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 Securities Exchange Act of 1934).  Yes ý No o

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 6,603,873 shares of common stock, no par value, outstanding as of May 6, 2005.

 

TRINITY CAPITAL CORPORATION AND SUBSIDIARIES

 

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Securities Holders
Item 5.	Other Information
Item 6.	Exhibits
	SIGNATURES
	CERTIFICATIONS

 

1

 

PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

TRINITY CAPITAL CORPORATION & SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

March 31, 2005 and December 31, 2004

 (Amounts in thousands, except share data)

(Unaudited)

 

		March 31,			December 31,
		2005			2004
ASSETS
Cash and due from banks		$	38,047		$	23,678
Interest bearing deposits with banks		23,208			96
Federal funds sold and securities purchased under resell agreements		301			40
Cash and cash equivalents		61,556			23,814
Investment securities available for sale		41,786			44,105
Investment securities held to maturity, at amortized cost (fair value of $52,384 at March 31, 2005 and $61,883 at December 31, 2004)		52,377			61,658
Other investments		7,321			7,480
Loans (net of allowance for loan losses of $8,689 at March 31, 2005 and $8,367 at December 31, 2004)		925,038			885,954
Loans held for sale		8,319			8,634
Premises and equipment, net		24,774			25,450
Accrued interest receivable		6,547			5,941
Mortgage servicing rights, net		8,628			8,371
Other real estate owned		3,523			6,438
Other assets		3,019			2,548
Total assets		$	1,142,888		$	1,080,393
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits:
Noninterest bearing		$	72,929		$	63,070
Interest bearing		889,160			817,511
Total deposits		962,089			880,581
Short-term borrowings		—			34,400
Long-term borrowings		78,111			60,006
Junior subordinated debt owed to unconsolidated trusts		22,682			22,682
Borrowings made by Employee Stock Ownership Plan (ESOP) to outside parties		1,214			1,686
Accrued interest payable		2,834			2,768
Other liabilities		4,138			5,314
Total liabilities		1,071,068			1,007,437
Stock owned by Employee Stock Ownership Plan (ESOP) participants; 636,896 shares and 636,915 shares at March 31, 2005 and December 31, 2004, respectively, at fair value; net of unearned ESOP shares of 73,347 shares and 98,318 shares at March 31, 2005 and December 31, 2004, respectively, at historical cost		16,981			18,078
Commitments and contingencies (Note 8)
Stockholders’ equity
Common stock, no par, authorized 20,000,000 shares; issued 6,856,800 shares, shares outstanding 6,603,873 and 6,732,748 at March 31, 2005 and December 31, 2004, respectively		6,836			6,836
Additional paid-in capital		1,172			997
Retained earnings		51,746			47,849
Accumulated other comprehensive loss		(311		)	(200		)
Total stockholders’ equity before treasury stock		59,443			55,482
Treasury stock, at cost, 179,580 shares and 25,734 shares at March 31, 2005 and December 31, 2004, respectively		(4,604		)	(604		)
Total stockholders’ equity		54,839			54,878
Total liabilities and stockholders’ equity		$	1,142,888		$	1,080,393

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

 

2

 

TRINITY CAPITAL CORPORATION & SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

For the Three Months Ended March 31, 2005 and 2004

(Amounts in thousands except share and per share data)

(Unaudited)

 

		Three Months Ended
		March 31, 2005			March 31, 2004
Interest income:
Loans, including fees		$	14,222		$	11,938
Investment securities:
Taxable		656			973
Nontaxable		180			158
Federal funds sold and repurchase agreements		4			—
Other interest bearing deposits		20			6
Investment in unconsolidated trusts		16			13
Total interest income		15,098			13,088
Interest expense:
Deposits		3,981			2,968
Short-term borrowings		102			67
Long-term borrowings		577			607
Junior subordinated debt owed to unconsolidated trusts		519			439
Total interest expense		5,179			4,081
Net interest income		9,919			9,007
Provision for loan losses		525			600
Net interest income after provision for loan losses		9,394			8,407
Other income:
Mortgage loan servicing fees		602			574
Loan and other fees		588			557
Service charges on deposits		331			331
Gain on sale of loans		463			1,016
Gain on sale of securities		—			272
Other operating income		76			267
		2,060			3,017
Other expenses:
Salaries and employee benefits		4,058			3,853
Occupancy		799			494
Data processing		490			435
Marketing		324			226
Amortization and valuation of mortgage servicing rights		130			987
Supplies		209			172
Other		1,648			1,362
		7,658			7,529
Income before income taxes		3,796			3,895
Income taxes		1,428			1,445
Net income		$	2,368		$	2,450
Basic earnings per common share		$	0.35		$	0.36
Diluted earnings per common share		$	0.35		$	0.36

 

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

 

3

 

 TRINITY CAPITAL CORPORATION & SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31, 2005 and 2004

(Amounts in thousands)

(Unaudited)

 

		Three Months Ended
		March 31,			March 31,
		2005			2004
Cash Flows From Operating Activities
Net income		$	2,368		$	2,450
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		631			527
Net amortization of:
Mortgage servicing rights		694			624
Premiums and discounts on investment securities		293			387
Junior subordinated debt owed to unconsolidated trusts issuance costs		5			4
Provision for loan losses		525			600
Change in mortgage servicing rights valuation allowance		(564		)	364
Loss on sale or disposal of premises and equipment		143			—
Gain on sale of available for sale securities		—			(272		)
Federal Home Loan Bank (FHLB) stock dividends received		(41		)	(20		)
Gain on sale of loans		(463		)	(1,016		)
Loss on disposal of other real estate owned		211			159
Write-down of value of other real estate owned		307			—
(Increase) decrease in other assets		(1,082		)	1,600
Increase (decrease) in other liabilities		1,005			(2,008		)
Release of Employee Stock Ownership Plan (ESOP) shares		606			587
Net cash provided by operating activities before originations and gross sales of loans		4,638			3,986
Gross sales of loans held for sale		38,581			61,980
Origination of loans held for sale		(38,190		)	(68,480		)
Net cash provided by (used in) provided by operating activities		5,029			(2,514		)
Cash Flows From Investing Activities
Proceeds from maturities and paydowns of investment securities available for sale		2,025			19,585
Proceeds from maturities and paydowns of investment securities held to maturity		9,106			26
Proceeds from maturities and paydowns of investment securities, other		325			—
Proceeds from sale of investment securities, available for sale		—			28,388
Purchase of investment securities available for sale		—			(1,620		)
Purchase of investment securities held to maturity		—			—
Purchase of investment securities, other		(125		)	—
Proceeds from sale of other real estate owned		2,872			1,505
Loans funded, net of repayments		(40,084		)	(30,038		)
Purchases of premises and equipment		(198		)	(2,528		)
Proceeds from sale of premises and equipment		100			—
Net cash provided by (used in) investing activities		(25,979		)	15,318
Cash Flows From Financing Activities
Net increase in demand deposits, NOW accounts and savings accounts		33,558			9,673
Net increase (decrease) in time deposits		47,950			(3,153		)
Proceeds from issuances of borrowings		20,000			83,600
Repayment of borrowings		(36,295		)	(89,818		)
Repayment of ESOP debt		(472		)	(471		)
Purchase of treasury stock		(4,000		)	—
Dividend payments		(2,049		)	(2,048		)
Net cash provided by (used in) provided by financing activities		58,692			(2,217		)
Net increase in cash and cash equivalents		$	37,742		$	10,587
Cash and cash equivalents:
Beginning of year		23,814			43,111
End of period		$	61,556		$	53,698
Supplemental Disclosures of Cash Flow Information
Cash payments (receipts) for:
Interest		$	5,113		$	4,419
Income taxes		404			(230		)
Non-cash investing and financing activities:
Transfers from loans to other real estate owned		475			1,124
Change in unrealized (loss) gain on investment securities, net of taxes		(111		)	12

 

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

 

4

 

TRINITY CAPITAL CORPORATION & SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (Unaudited)

 

Note 1.  Basis of Presentation

 

                The accompanying unaudited consolidated financial statements include the consolidated balances and results of operations of Trinity Capital Corporation (“Trinity” or the “Company”) and its wholly owned subsidiaries: Los Alamos National Bank (the “Bank”) and Title Guaranty & Insurance Company (“Title Guaranty”), collectively referred to as the “Company.”  Trinity Capital Trust I (“Trust I”), Trinity Capital Trust II (“Trust II”) and Trinity Capital Trust III (“Trust III”), collectively referred to as the “Trusts”, which are also wholly owned subsidiaries of Trinity, are not consolidated in these financial statements (see “Consolidation” accounting policy below.)  The business activities of the Company consist solely of the operations of its wholly owned subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.  In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods have been made.  The results of operations for the three months ended March 31, 2005 are not necessarily indicative of the results to be expected for the entire fiscal year.

 

                The unaudited interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and industry practice.  Certain information in footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America and industry practice has been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission.  These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s December 31, 2004 audited financial statements filed on Form 10-K.

 

                The preparation of financial statements in conformity with accounting principals generally accepted in the United States of America requires management to make estimates and assumptions which affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, as well as the reported amounts of income and expenses during the reported periods.  Actual results could differ from those estimates.

 

Note 2.  Comprehensive Income

 

                Comprehensive income includes net income, as well as the change in net unrealized (loss) gain on investment securities available for sale, net of tax.  Comprehensive income was $2.3 million and $2.5 million for the three month periods ended March 31, 2005 and 2004, respectively.

 

Note 3.  Earnings Per Share Data

 

                The following table sets forth the computation of basic and diluted earnings per share for the periods indicated:

 

		Three Months Ended March 31,
		2005			2004
		(Unaudited; In thousands except for share and per share data)
Net income		$	2,368		$	2,450
Weighted average common shares issued		6,856,800			6,856,800
LESS: Weighted average treasury stock shares		(99,238		)	(29,128		)
LESS: Weighted average unearned Employee Stock Ownership Plan (ESOP) stock shares		(78,619		)	(105,270		)
Weighted average common shares outstanding, net		6,678,943			6,722,402
Basic earnings per common share		$	0.35		$	0.36
Weighted average dilutive shares from stock option plan		98,879			117,782
Weighted average common shares outstanding including dilutive shares		6,777,822			6,840,184
Diluted earnings per common share		$	0.35		$	0.36

 

5

 

Note 4.  Recent Accounting Pronouncements and Regulatory Developments

 

                In September 2004, the FASB issued FASB Staff Position (FSP) Emerging Issues Task Force (EITF) Issue No. 03-1-1 delaying the effective date of paragraphs 10-20 of EITF 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which provides guidance for determining the meaning of “other-than-temporarily impaired” and its application to certain debt and equity securities within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and investments accounted for under the cost method.  The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the Company can assert and demonstrate its intention to hold the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity.  The delay of the effective date of EITF 03-1 will be superseded concurrent with the final issuance of proposed FSP Issue 03-1-a. Proposed FSP Issue 03-1-a is intended to provide implementation guidance with respect to all securities analyzed for impairment under paragraphs 10-20 of EITF 03-1.  Management continues to closely monitor and evaluate how the provisions of EITF 03-1 and proposed FSP Issue 03-1-a will affect the Company.

 

                In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which is an Amendment of FASB Statement Nos. 123 and 95.  SFAS No. 123R changes, among other things, the manner in which share-based compensation, such as stock options, will be accounted for by both public and non-public companies.  For public companies, the cost of employee services received in exchange for equity instruments including options and restricted stock awards generally will be measured at fair value at the grant date.  The grant date fair value will be estimated using option-pricing models adjusted for the unique characteristics of those options and instruments, unless observable market prices for the same or similar options are available.  The cost will be recognized over the requisite service period, often the vesting period, and will be remeasured at each reporting date through settlement date.

 

            The changes in accounting will replace existing requirements under SFAS No. 123, Accounting for Stock-Based Compensation, and will eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, which does not require companies to expense options if the exercise price is equal to the trading price at the date of grant.  The accounting for similar transactions involving parties other than employees or the accounting for employee stock ownership plans that are subject to AICPA Statement of Position 93-6, Employers’ Accounting for Employee Stock Ownership Plans, would remain unchanged.

 

            On April 14, 2005, the Securities and Exchange Commission (SEC) announced the adoption of a new rule that amends the compliance dates for SFAS No. 123R.  Under SFAS No. 123R, the Company would have been required to implement the standard as of the beginning of the first interim period that begins after June 15, 2005.  The SEC’s new rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005.  The SEC’s new rule does not change the accounting required by SFAS No. 123R; it changes only the dates for compliance with the standard.

 

 

 

Note 5.  Short Term Borrowings

 

                The Company had no borrowings with maturities of less than one year as of March 31, 2005.  As of December 31, 2004, the Company had Federal Home Loan Bank advances with maturities of less than one year of $34.4 million.

 

Note 6.  Long Term Borrowings

 

                The Company had Federal Home Loan Bank advances with maturity dates greater than one year of $78.1 million and $60.0 million as of March 31, 2005 and December 31, 2004, respectively.  As of March 31, 2005, the advances have fixed interest rates ranging from 3.22% to 6.34%.

 

6

 

Note 7.  Junior Subordinated Debt Owed to Unconsolidated Trusts

 

                    The following table presents details on the junior subordinated debt owed to unconsolidated trusts as of March 31, 2005:

 

		Trust I			Trust II			Trust III
		(Dollars in thousands)
Date of issue		March 23, 2000			November 28, 2001			May 11, 2004
Amount of trust preferred securities issued		$	10,000		$	6,000		$	6,000
Rate on trust preferred securities		10.875		%	9.95		%	5.61% (variable)
Maturity		March 8, 2030			December 8, 2031			September 8, 2034
Date of first redemption		March 8, 2010			December 8, 2006			September 8, 2009
Common equity securities issued		$	310		$	186		$	186
Junior subordinated deferrable interest debentures owed		$	10,310		$	6,186		$	6,186
Rate on junior subordinated deferrable interest debentures		10.875		%	9.95		%	5.61% (variable)

 

                    On the dates of issue indicated above, the Trusts, being Delaware statutory business trusts, issued trust preferred securities (the “trust preferred securities”) in the amount and at the rate indicated above.  These securities represent preferred beneficial interests in the assets of the Trusts.  The trust preferred securities will mature on the dates indicated, and are redeemable in whole or in part at the option of the Company at any time after the date of first redemption indicated above, with the approval of the Federal Reserve Board and in whole at any time upon the occurrence of certain events affecting their tax or regulatory capital treatment.  The Trusts also issued common equity securities to Trinity in the amounts indicated above.  The Trust s used the proceeds of the offering of the trust preferred securities to purchase junior subordinated deferrable interest debentures (the debentures) issued by the Company, which have terms substantially similar to the trust preferred securities.  The Company has the right to defer payments of interest on the debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods with respect to each interest payment deferred.  Under the terms of the debentures, in the event that under certain circumstances there is an event of default under the debentures or the Company has elected to defer interest on the debentures, the Company may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock.  The Company used the majority of the proceeds from the sale of the debentures to add to Tier 1 capital in order to support its growth.

 

                    Trinity owns all of the outstanding common stock of the Trusts.  The Trusts are considered variable interest entities (VIEs) under Financial Accounting Standards Board Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51”, as revised.  Prior to FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity.  Under FIN 46, a VIE should be consolidated by its primary beneficiary.  The Company implemented FIN 46 during the fourt h quarter of 2003.  Because Trinity is not the primary beneficiary of the Trusts, the financial statements of the Trusts are no longer included in the consolidated financial statements of the Company.  The Company’s prior financial statements have been reclassified to de-consolidate the Company’s investment in the Trusts.

 

                    The trust preferred securities are currently included in the Tier 1 capital of Trinity for regulatory capital purposes.  However, because the Trusts are no longer a part of the Company’s financial statements, the Federal Reserve Board may in the future disallow inclusion of the trust preferred securities in Tier 1 capital for regulatory capital purposes.  The most recent rule issued by the Federal Reserve Board indicated that it will continue to recognize these trust preferred securities as Tier 1 capital within certain limitations.  Please refer to Note 4, “Recent Accounting and Regulatory Developments”, for more information.  However, there can be no assurance that the Federal Reserve Board will continue to permit institutions to include trust preferred securities in Tier I capital for regulatory capital purposes.  As of March 31, 2005, assuming the Company was not permitted to include the $23 million in trust preferred securities issued by the Trusts in its Tier 1 capital, the Company would still exceed the regulatory required minimums for capital adequacy purposes.  If the trust preferred securities were no longer permitted to be included in Tier 1 capital, the Company would also be permitted to redeem the capital securities without penalty.

 

                    Payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities are guaranteed by the Company on a limited basis.  The Company also entered into an agreement as to expenses and liabilities with the Trusts pursuant to which it agreed, on a subordinated basis, to pay any costs, expenses or liabilities of the Trusts other than those arising under the trust preferred securities.  The obligations of the Company under the junior subordinated debentures, the related indenture, the trust agreement establishing the Trusts, the guarantee and the agreement as to expenses and liabilities, in the aggregat e, constitute a full and unconditional guarantee by the Company of the Trusts’ obligations under the trust preferred securities.

 

7

 

                Issuance costs of $615 thousand related to the trust preferred securities were deferred and are being amortized over the period until mandatory redemption of the securities in March 2030, December 2031 and September 2034, respectively.  During the three months ended March 31, 2005 and 2004, respectively, $5 thousand and $4 thousand of these issuance costs were amortized.  Unamortized issuance costs were $534 thousand and $476 thousand at March 31, 2005 and 2004, respectively.

 

                Distributions accrued and unpaid to securities holders totaled $286 thousand and $265 thousand on March 31, 2005 and 2004, respectively.

 

Note 8.  Commitments, Contingencies and Off-Balance Sheet Activities

 

                Credit-related financial instruments:  The Company is a party to credit-related commitments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These credit-related commitments include commitments to extend credit, standby letters of credit and commercial letters of credit.  Such credit-related commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.

 

                The Company’s exposure to credit loss is represented by the contractual amount of these credit-related commitments.  The Company follows the same credit policies in making credit-related commitments as it does for on-balance-sheet instruments.

 

                At March 31, 2005 and December 31, 2004, the following credit-related commitments were outstanding whose contract amounts represent credit risk:

 

 

                Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require a payment of a fee.  The commitments for equity lines of credit may expire without being drawn upon.  Therefore, the total commitment amounts do not necessarily represent future cash requirements.  The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.  Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers.  Overdraft protection agreements are uncollateralized, but most other unfunded commitments have collateral.  These unfunded lines of credit usually do not contain a specified maturity date and may not necessarily be drawn upon to the total extent to which the Company is committed.

 

                Commercial and standby letters of credit are conditional credit-related commitments issued by the Company to guarantee the performance of a customer to a third party.  Those letters of credit are primarily issued to support public and private borrowing arrangements.  Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers.  The Company generally holds collateral supporting those credit-related commitments, if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the credit-related commitment.  The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount shown in the summary above.  If the credit-related commitment is funded, the Company would be entitled to seek recovery from the customer.  At March 31, 2005 and December 31, 2004, no amounts have been recorded as liabilities for the Company’s potential obligations under these credit-related commitments.  The fair value of these credit-related commitments is approximately equal to the fees collected when granting these letters of credit.  These fees collected were $132 thousand and $60 thousand as of March 31, 2005 and December 31, 2004, respectively, and are included in “other liabilities” on the Company’s balance sheet.

 

                Concentrations of credit risk:  The majority of the loans, commitments to extend credit, and standby letters of credit have been granted to customers in Los Alamos, Santa Fe and surrounding communities.  Although the Company has a diversified loan portfolio, a substantial portion of its loans are made to businesses and individuals associated with, or employed by, Los Alamos National Laboratory (“the Laboratory”).  The ability of such borrowers to honor their contracts is predominately dependent upon the continued operation and funding of the Laboratory.  Investments in securities issued by states and political subdivisions involve governmental entities within the state of New Mexico.  The distribution of commitments to extend credit approximates the distribution of loans outstanding.  Standby letters of credit were granted primarily to commercial borrowers.

 

8

 

                Contingencies:  In the normal course of business, the Company is involved in various legal proceedings.  In the opinion of management, after consulting with counsel, probable liabilities resulting from such proceedings would not have a material adverse effect on the Company’s consolidated financial statements.

 

Note 9.  Pro Forma Impact of Stock-Based Compensation Plans

 

                As allowed under SFAS No. 123, Accounting for Stock-Based Compensation, the Company measures stock-based compensation cost in accordance with the methods prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.  As stock options are granted at fair value, there are no charges to earnings associated with stock options granted.  Accordingly, no compensation cost has been recognized for grants made to date.  Had compensation cost been determined based on the fair value method prescribed in FASB Statement No. 123, reported net income and earnings per common share would have been reduced to the pro forma amounts shown below:

		Three Months Ended
		March 31,
		2005			2004
		(In thousands, except
		per share amounts)
Net income as reported		$	2,368		$		2,450
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		28			28
Pro forma net income		$	2,340		$			2,422
Earnings per share:
Basic — as reported		$	0.35		$		0.36
Basic — pro forma		$	0.35		$		0.36
Diluted — as reported		$	0.35		$	0.36
Diluted — pro forma		$	0.35		$	0.35

 

9

 

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

 

                This discussion is intended to focus on certain financial information regarding the Company and the Bank and is written to provide the reader with a more thorough understanding of its financial statements. The following discussion and analysis of the Company’s financial position and results of operations should be read in conjunction with the information set forth in Item 3, Quantitative and Qualitative Disclosures about Market Risk and the annual audited consolidated financial statements filed on Form 10-K.

 

Special Note Concerning Forward-Looking Statements

 

                This Form 10-Q (including information incorporated by reference) contains, and our future oral and written statements may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to our financial condition, results of operations, plans, objectives, future performance and business.  Forward-looking statements, which may be based upon beliefs, expectations and assumptions of our management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and we undertake no obligation to update any statement in light of new information or future events.

 

                Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to, the following:

 

•                                          The strength of the United States economy in general and the strength of the local economies in which we conduct our operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of our assets.

 

•                                          The economic impact of any future terrorist threats or attacks, and the response of the United States to any such threats and attacks.

 

•                                          The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters.

 

•                                          The effects of changes in interest rates (including the effects of changes in the rate of prepayments of our assets) and the policies of the Federal Reserve.

 

•                                          Our ability to compete with other financial institutions as effectively as we currently intend due to increases in competitive pressures in the financial services sector.

 

•                                          Our ability to obtain new customers and to retain existing customers.

 

•                                          The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet.

 

•                                          Technological changes implemented by us and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to us and our customers.

 

•                                          Our ability to develop and maintain secure and reliable electronic systems.

 

•                                          Our ability to retain key executives and employees and the difficulty that we may experience in replacing key executives and employees in an effective manner.

 

•                                          Consumer spending and saving habits which may change in a manner that affects our business adversely.

 

•                                          Business combinations and the integration of acquired businesses which may be more difficult or expensive than expected.

 

•                                          The costs, effects and outcomes of existing or future litigation.

 

•                                          Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.

 

10

 

•                                          Our ability to manage the risks associated with the foregoing as well as anticipated.

 

•                                          Changes in the management and national policy regarding the primary employer in Los Alamos County, Los Alamos National Laboratory (the “Laboratory”), including changes in the level of funding.

 

                These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning us and our business, including other factors that could materially affect our financial results, will be included in our filings with the SEC.

 

Critical Accounting Policies

 

                Allowance for Loan Losses:  Management believes the allowance for loan losses accounting policy is critical to the portrayal and understanding of our financial condition and results of operations. As such, selection and application of this “critical accounting policy” involves judgments, estimates, and uncertainties that are susceptible to change. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.

 

                The allowance for loan losses is maintained at an amount that management believes will be adequate to absorb probable losses on existing loans, based on an evaluation of the collectibility of loans and prior loss experience.  Three methods are used to evaluate the adequacy of the allowance for loan losses: (1) historical loss experience, based on loss experience by quality classification in the previous twelve calendar quarters; (2) specific identification, based upon management’s assessment of loans and the probability that a charge off will occur in the upcoming quarter; and (3) loan concentrations, based on current or expected economic factors in the geographic and industry sectors where management believes we may eventually experience some loan losses.  This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, the value of underlying collateral, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to pay.

 

                While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, as an integral part of their examination process regulatory agencies periodically review our allowance for loan losses and may require us to make additions to the allowance based on their evaluation of information available at the time of their examinations.  Although we believe the allowance for loan losses is sufficient to cover probable losses inherent in the loan portfolio, there can be no assurance that the allowance will prove sufficient to cover actual future loan losses.

 

 

                    Mortgage Servicing Right (MSR) Assets:  Servicing residential mortgage loans for third-party investors represents a significant business activity of the Bank.  As of March 31, 2005, mortgage loans serviced for others totaled $918.5 million.  The MSRs on these loans total $8.6 million as of March 31, 2005.  The expected and actual rates of mortgage loan prepayments are the most significant factors driving the value of MSRs.  Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced.  In determining the fair value of the MSRs, mortgage interest rates, which are used to determine prepayment rates and disco unt rates are held constant over the estimated life of the portfolio.  Fair values of the MSRs are provided by an independent third-party broker of MSRs on a monthly basis.  The values given by the broker are based upon current market conditions and assumptions, which incorporate the expected life of the loans, estimated costs to service the loans, servicing fees to be received and other factors.  MSRs are carried at the lower of the initial capitalized amount, net of accumulated amortization, or fair value.

 

                    The fair value of the MSRs is driven primarily by the effect current mortgage interest rates have on the likelihood borr owers will prepay the underlying mortgages by refinancing at a lower rate.  Accordingly, higher interest rates decrease the likelihood of repayment, extending the life of the MSRs and increasing the value of these assets.  Lower interest rates increase the likelihood of repayment, contracting the life of the MSRs and decreasing the value of these assets.  This can have a significant impact on our income.  In the first three months of 2005, we recognized income of $564 thousand due to a decrease in the valuation allowance associated with MSRs; in the first three months of 2004, we incurred an expense of $364 thousand due to a increase in the valuation allowance associated with MSRs.  We can have no certainty on the direction and amount of interest rate changes looking forward, and therefore, the amount or direction of the change in valuation.

 

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Overview

 

                The first quarter of 2005 was characterized by strong asset growth and flat income growth due to the anticipated drop in the mortgage loan refinance business due to higher rates, which was largely offset by strong growth in net interest income.  Net income was $2.4 million, a 3.3% decrease from the prior year first quarter earnings of $2.5 million.  Total assets grew $62.5 million from the prior year end, which is an annualized growth rate of 23.1%.

 

                Net interest income (not tax-equivalent), our major source of income, increased $912 thousand (or 10.1%) over the prior year first quarter.  This increase was mainly due to our growth in earning assets, while our net interest margin (not tax-equivalent) decreased from 3.92% in the first quarter of 2004 to 3.89% in the first quarter of 2005.  This decrease in margin was due to our decision to be more competitive in interest rates paid on deposit products in order to attract new deposits in the new Santa Fe office and to fund increasing loan demand.

 

                Looking forward to the remainder of the year 2005, we expect continued growth in deposits and loans from the newly opened branch in Santa Fe.  We also anticipate that Title Guaranty’s operations in Santa Fe will generate additional income.  We believe that we have sufficient capital to support this growth and remain well-capitalized.  The additional personnel and other costs associated with the new Santa Fe office as well as the new Title Guaranty office will likely increase other expenses compared to the prior year, since in 2004 the new office was opened only for a partial year.  However, we believe the increased growth in business generated by these offices will likely offset a portion or all of these expenses.

 

Results of Operations-Income Statement Analysis

 

                Net Income-General.  Net income for the three months ended March 31, 2005 was $2.4 million, compared to $2.5 million for the same period of 2004.  Diluted earnings per share decreased by $0.01 to $0.35 for the three months ended March 31, 2005 from $0.36 for the same period of 2004.  This represented a decrease in earnings per share of 2.8%.  This decrease was primarily due to a decline in non-interest income of $957 thousand (31.7%), which was largely offset by an increase in net interest income of $912 thousand (10.1%).    The effect of these and other items, net of taxes, was a decline in unaudited net income of approximately $82 thousand for the first quarter of 2005 compared to the first quarter of 2004.

 

                The profitability of the Company’s operations depends primarily on its net interest income, which is the difference between total interest earned on interest earning assets and total interest paid on interest bearing liabilities.  The Company’s net income is affected by its provision for loan losses as well as other income and other expenses.  The provision for loan losses reflects the amount thought to be adequate to cover probable credit losses in the loan portfolio.  Non-interest income or other income consists of mortgage loan servicing fees, loan and other fees, service charges on deposits, gain on sale of loans, gain on sale of securities and other operating income.  Other expenses include salaries and employee benefits, occupancy expenses, data processing expenses, marketing, amortization and valuation of mortgage servicing rights, supplies expense and other expenses.

 

                The amount of net interest income is affected by changes in the volume and mix of interest earning assets, the level of interest rates earned on those assets, the volume and mix of interest bearing liabilities, and the level of interest rates paid on those interest bearing liabilities.  The provision for loan losses is dependent on changes in the loan portfolio and management’s assessment of the collectibility of the loan portfolio, as well as economic and market conditions.  Other income and other expenses are impacted by growth of operations and growth in the number of accounts through both acquisitions and core banking business growth.  Growth in operations affects other expenses as a result of additional employees, branch facilities and promotional marketing expenses.  Growth in the number of accounts affects other income including service fees as well as other expenses such as computer services, supplies, postage, telecommunications and other miscellaneous expenses.

 

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Net Interest Income.  The following tables present, for the periods indicated, the total dollar amount of interest income from average interest earning assets and the resultant yields, as well as the interest expense on average interest bearing liabilities, and the resultant costs, expressed both in dollars and rates. Borrowings made by the Company’s Employee Stock Ownership Plan (“ESOP”) from outside parties are not included in this analysis, as the interest expense on this borrowing is born by the ESOP. Funding for the ESOP is recognized as part of compensation expense:

 

		Three Months Ended March 31,
		2005								2004
		Average								Average
		Balance			Interest			Yield/Rate		Balance			Interest			Yield/Rate
		(Dollars in thousands)
Interest Earning Assets:
Loans(1)(2)		$	921,441		$	14,222		6.26	%	$	763,041		$	11,938		6.29	%
Taxable investment securities		89,509			656			2.97		137,337			973			2.85
Investment securities exempt from federal income taxes(3)		17,288			281			6.59		20,434			243			4.78
Federal funds sold		708			4			2.29		40			—			0.54
Other interest bearing deposits		3,618			20			2.24		2,607			6			0.93
Investment in unconsolidated trust subsidiaries		682			16			9.51		496			13			10.54
Total interest earning assets		1,033,246			15,199			5.97		923,955			13,173			5.73
Non-interest earning assets		69,706								78,662
Total assets		$	1,102,952							$	1,002,617
Interest Bearing Liabilities:
Deposits:
NOW and money market deposits		$	124,517		$	326		1.06	%	$	205,885		$	394		0.77	%
Savings deposits		374,263			1,045			1.13		211,278			549			1.05
Time deposits		378,205			2,610			2.80		334,540			2,025			2.43
Short-term borrowings		16,068			102			2.57		17,839			67			1.51
Long-term borrowings, including ESOP borrowings		62,917			577			3.72		66,346			607			3.68
Junior subordinated debt owed to unconsolidated trusts		22,682			519			9.28		16,496			439			10.70
Total interest bearing liabilities		978,652			5,179			2.15		852,384			4,081			1.93
Demand deposits—non-interest bearing		45,955								57,982
Other non-interest bearing liabilities		5,968								24,131
Stockholders’ equity, including stock owned by ESOP		72,377								68,120
Total liabilities and stockholders equity		$	1,102,952							$	1,002,617
Net interest income/interest rate Spread(4)					10,020			3.82	%				$	9,092		3.80	%
Net interest margin on a fully tax equivalent basis(5)								3.93	%							3.96	%
Net interest margin(5)								3.89	%							3.92	%

(1)                                  Includes non-accrual loans of $5.4 million and $3.2 million for March 31, 2005 and 2004, respectively.

(2)                                  Interest income includes loan origination fees of $682 thousand and $730 thousand for the three months ended March 31, 2005 and 2004, respectively.

(3)                                  Non-taxable investment income is presented on a fully tax equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent tax differences.

(4)                                  Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.

(5)                                  Net interest margin represents net interest income as a percentage of average interest earning assets.

 

13

 

                For the first quarter of 2005, net interest income on a fully tax equivalent basis increased $928 thousand to $10.0 million from $9.1 million for the first quarter of 2004.  The increase in net interest income resulted from an increase in interest income on a fully tax equivalent basis of $2.0 million (15.4%), while interest expense increased $1.1 million (26.9%).  Interest income on a fully tax equivalent basis increased due primarily to an increase in average earning assets of $109.3 million (11.8%).  Interest expense increased due to an increase in average interest bearing liabilities of $126.3 million (14.8%), which accounted for $657 thousand of the increase.  The cost on interest bearing liabilities increased 22 basis points, which accounted for $441 thousand of the increase in interest expense.  The net interest margin expressed in a fully tax equivalent basis decreased 3 basis points to 3.93% for 2005 from 3.96% for 2004.

 

Based on management’s review of the adequacy of the allowance for loan losses, provision for loan losses of $525 thousand was recorded for the three-month period ended March 31, 2005 versus provision of $600 thousand recorded during the same period of 2004.  The decrease in the provision for loan losses for the period ended March 31, 2005 reflected a number of factors, including the level of charge-offs, management’s overall view on current credit quality, the amount and status of impaired loans and the amount and status of past due accruing loans (90 days or more), as discussed in more detail below in the analysis relating to the Company’s financial condition.

 

                Volume, Mix and Rate Analysis of Net Interest Income.  The following tables present the extent to which changes in volume, changes in interest rates, and changes in the interest rates times the changes in volume of interest earning assets and interest bearing liabilities have affected our interest income and interest expense during the periods indicated.  Information is provided on changes in each category due to: (i) changes attributable to changes in volume (change in volume times the prior period interest rate); (ii) changes attributable to changes in interest rate (changes in rate times the prior period volume); and (iii) changes attributable to changes in rate/volume (changes in interest rate times changes in volume).  Changes attributable to the combined impact of volume and rate have been allocated proportionally to the changes due to volume and the changes due to rate:

 

		Three Months Ended March 31,
		2005 Compared to 2004
		Change Due			Change Due			Total
		to Volume			to Rate			Change
		(In thousands)
Interest Earning Assets:
Loans		$	2,447		$	(163	)	$	2,284
Taxable investment securities		(348		)	31			(317		)
Investment securities exempt from federal income taxes(1)		(41		)	79			38
Federal funds sold		4			—			4
Other interest bearing deposits		3			11			14
Investment in unconsolidated trust subsidiaries		5			(2		)	3
Total increase (decrease) in interest income		2,070			(44		)	2,026
Interest Bearing Liabilities:
NOW and money market deposit accounts		(186		)	118			(68		)
Savings deposits		452			44			496
Time deposits		282			303			585
Short-term borrowings		(8		)	43			35
Long-term borrowings		(31		)	1			(30		)
Junior subordinated debt owed to unconsolidated trusts		148			(68		)	80
Total increase (decrease) in interest expense		657			441			1,098
Increase (decrease) in net interest income		$	1,413		$	(485	)	$	928

 

(1)                                  Non-taxable investment income is presented on a fully tax equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent tax differences.

 

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Other Income.  Changes in other income between the three months ended March 31, 2005 and 2004 are as follows:

 

		Three Months Ended
		March 31, 2005			March 31, 2004			Net difference
		(In thousands)
Other income:
Mortgage loan servicing fees		$	602		$	574		$	28
Loan and other fees		588			557			31
Service charges on deposits		331			331			—
Gain on sale of loans		463			1,016			(553		)
Gain on sale of securities		—			272			(272		)
Other operating income		76			267			(191		)
		$	2,060		$	3,017		$	(957	)

 

In the first quarter of 2005, other income decreased by $957 thousand (31.7%) to $2.1 million from $3.0 million for the first quarter of 2004.  Gain on sale of loans decreased $553 thousand due to a continued drop in mortgage loan refinance activity due to increasing interest rates.  This drop in refinancing was expected and was experienced generally in the financial services industry.  In the first quarter of 2004, other income also included a gain of $272 thousand on the sale of securities, while there was no gain on the sale of securities in the first quarter of 2005.

 

                Other Expenses.  Changes in other expenses between the three months ended March 31, 2005 and 2004 are as follows:

 

		Three Months Ended
		March 31, 2005			March 31, 2004			Net difference
		(In thousands)
Other expenses:
Salaries and employee benefits		$	4,058		$	3,853		$	205
Occupancy		799			494			305
Data processing		490			435			55
Marketing		324			226			98
Amortization and valuation of mortgage servicing rights		130			987			(857		)
Supplies		209			172			37
Other		1,648			1,362			286
		$	7,658		$	7,529		$	129

 

For the first quarter of 2005, other expenses increased $129 thousand (1.7%) to $7.7 million in 2005 from $7.5 million in the first quarter of 2004.  The largest change was in the amortization and valuation of mortgage servicing rights, which declined $857 thousand from the first quarter of 2004 to the first quarter of 2005.  This was due to a decrease in the valuation allowance of $564 thousand in the first quarter of 2005, compared to an increase in the valuation allowance of $364 thousand in the first quarter of 2004, for a net decline in expense of $928 thousand.  This was partially offset by an increase in the amortization expense of the mortgage servicing rights of $71 thousand.  Occupancy expenses increased $305 thousand (61.7%), mainly due to the operation of the Santa Fe Downtown office, which was opened in August 2004.  Salaries and employee benefits increased by $205 thousand (5.3%), mainly due to an increase in $231 thousand (8.4%) in salary expenses, which was partially offset by a decline in personnel benefits expenses.  This increase in salary expenses was mainly due to changes in staffing to open the new Santa Fe Downtown office.

                Income Taxes.  In the first quarter of 2005, income tax expense was virtually unchanged, decreasing $17 thousand (1.2%) from the first quarter of 2004 for a total of $1.4 million in both years.  The effective tax rate increased slightly to 37.6% in the first quarter of 2005, compared to 37.1% in the first quarter of 2004.  A lower balance of tax-exempt municipal securities accounted for this slight increase.

 

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Financial Condition-Balance Sheet Analysis

 

                General.  Total assets at March 31, 2005 remained at $1.1 billion, following an increase of $62.5 million (5.8%) from December 31, 2004.  During the same period, total liabilities increased $63.6 million (6.3%) to a total of $1.1 billion on March 31, 2005 from $1.0 billion on December 31, 2004.  The increase in total liabilities was primarily due to an increase in deposits of $81.5 million (9.3%), which was partially offset by a decrease in short-and long-term borrowings of $16.3 million (17.3%).   Stockholders’ equity (including stock owned by the Employee Stock Ownership Plan) decreased $1.1 million (1.6%) to $71.8 million on March 31, 2005 compared to $73.0 million on December 31, 2004.  This was primarily due to a large purchase of treasury stock in the first quarter of 2005 of $4.0 million, which was largely offset by an increase in retained earnings from current year operations of $2.4 million.

 

                Investment Securities.  The primary purposes of the investment portfolio are to provide a source of earnings, for liquidity management, to provide collateral to pledge against public deposits and to control interest rate risk.  In managing the portfolio, the Company seeks to obtain the objectives of safety of principal, liquidity, diversification and maximized return on funds.  For an additional discussion with respect to these matters, see  “Liquidity and Sources of Capital” under Item 2 and “Asset Liability Management” under Item 3 below.

 

                The following tables set forth the amortized cost and fair value of securities by accounting classification category and by type of security as indicated:

 

		At March 31, 2005						At December 31, 2004						At March 31, 2004
		Amortized						Amortized						Amortized
		Cost			Fair Value			Cost			Fair Value			Cost			Fair Value
		(In thousands)
Securities Available for Sale:
U.S. Government agencies		$	40,088		$	39,616		$	42,218		$	41,907		$	47,956		$	48,187
States and political subdivisions		2,198			2,165			2,210			2,191			—			—
Equity securities		1			5			1			7			1			7
Total securities available for sale		$	42,287		$	41,786		$	44,429		$	44,105		$	47,957		$	48,194
Securities Held to Maturity:
U.S. Government agencies		$	37,324		$	37,305		$	46,547		$	46,705		$	53,072		$	54,438
States and political subdivisions		15,053			15,079			15,111			15,178			20,442			20,638
Total securities held to maturity		$	52,377		$	52,384		$	61,658		$	61,883		$	73,514		$	75,076
Other securities:
Non-marketable equity securities (including FRB and FHLB stock)		$	6,639		$	6,639		$	6,798		$	6,798		$	6,305		$	6,305
Investment in unconsolidated trusts		682			682			682			682			496			496
Total other securities		$	7,321		$	7,321		$	7,480		$	7,480		$	6,801		$	6,801

 

                Loan Portfolio.  The following tables set forth the composition of the loan portfolio:

 

		At March 31, 2005					At December 31, 2004					At March 31, 2004
		Amount			Percent		Amount			Percent		Amount				Percent
		(Dollars in thousands)
Commercial		$	93,549		9.99	%	$	92,736		10.35	%	$		75,548		9.80	%
Commercial real estate		365,805			39.09		346,454			38.65		294,266				38.18
Residential real estate		288,515			30.82		282,380			31.50		232,995				30.22
Construction real estate		136,375			14.57		121,769			13.59		118,679				15.39
Installment and other		51,770			5.53		52,984			5.91		49,416				6.41
Total loans		936,014			100.00		896,323			100.00		770,904				100.00
Unearned income		(2,287		)			(2,002		)			(1,701			)
Gross loans		933,727					894,321					769,203
Allowance for loan losses		(8,689		)			(8,367		)			(7,734			)
Net loans		$	925,038				$	885,954				$	761,469

 

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