---

 

 

 

 

x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

 

 

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

 

 

 

 

(Exact name of registrant as specified in its charter)

California	20-0711133
State or other jurisdiction of incorporation or organization	I.R.S. Employer Identification Number
3200 Wilshire Blvd.
Los Angeles, California	90010
Address of principal executive offices	Zip Code
(213) 387-3200
Registrant’s telephone number, including area code

______________________

 

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 [X] No [_]

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes [X] No [_]

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: The number of shares of Common Stock of the registrant outstanding as of October 31, 2004 was 14,062,315.

 

Part I  FINANCIAL INFORMATION                             

 

 

Item 1. FINANCIAL STATEMENTS
WILSHIRE BANCORP, INC. CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)

 

		September 30, 2004			December 31, 2003
ASSETS:
Cash and due from banks		$	47,712,502		$	62,486,069
Federal funds sold and other cash equivalents			68,000,000			58,000,000
Cash and cash equivalents			115,712,502			120,486,069
Interest-bearing deposits in other financial institutions			2,506			201,496
Securities available for sale - at fair value (amortized cost of
$65,597,533 and $56,701,168 at September 30, 2004 and
December 31, 2003, respectively)			65,497,472			56,995,301
Securities held to maturity - at amortized cost (fair value of
$26,320,241 and $23,391,193 at September 30, 2004 and
December 31, 2003, respectively)			26,309,348			23,427,296
Interest only strip - at fair value (amortized cost of $1,492,758
and $725,410 at September 30, 2004 and December 31, 2003, respectively)			1,456,102			847,306
Loans held for sale, at the lower of cost or market			24,463,543			18,101,665
Loans receivable, net of allowance for loan losses of $11,130,565
and $9,011,071 at September 30, 2004 and
December 31, 2003, respectively			937,235,351			729,892,686
Bank premises and equipment, net			5,338,416			4,802,489
Federal Home Loan Bank stock			4,278,200			1,509,500
Accrued interest receivable			3,571,657			2,685,200
Other real estate owned			-			377,200
Deferred income taxes			4,454,670			3,797,678
Servicing asset			4,064,135			3,282,683
Due from customers on acceptances			2,312,226			2,750,315
Cash surrender value of life insurance			11,435,024			11,101,704
Other assets			5,769,427			3,004,974
TOTAL		$	1,211,900,579		$	983,263,562
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits :
Noninterest-bearing		$	255,719,171		$	238,018,220
Interest-bearing:
Savings			24,913,514			26,467,729
Time deposits of $100,000 or more			418,103,529			307,710,163
Other time deposits			120,623,172			113,528,786
Money markets and Nows			228,224,968			170,791,279
Total deposits			1,047,584,354			856,516,177
Federal Home Loan Bank borrowing			45,000,000			29,000,000
Junior subordinated debentures			25,464,000			25,464,000
Accrued interest payable			2,747,947			2,103,244
Acceptances outstanding			2,312,226			2,750,315
Other liabilities			5,424,329			8,688,485
Total liabilities			1,128,532,856			924,522,221
COMMITMENTS AND CONTINGENCIES (Note 7)
SHAREHOLDERS’ EQUITY:
Preferred stock, no par value; authorized, 1,000,000 shares;			-			-
Common stock, no par value; authorized, 80,000,000 shares;
issued and outstanding, 14,052,195 and 12,951,364 shares at
September 30, 2004 and December 31, 2003, respectively			38,997,171			28,391,427
Accumulated other comprehensive (loss) income - unrealized (loss) gain on available
for sale securities and interest only strip			(44,545	)		203,331
Retained earnings			44,415,097			30,146,583
Total shareholders’ equity			83,367,723			58,741,341
TOTAL		$	1,211,900,579		$	983,263,562
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

	1

WILSHIRE BANCORP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
INTEREST INCOME:
Interest and fees on loans		$	14,836,911		$	10,023,611		$	39,448,958		$	27,127,013
Interest on investment securities and deposits in other financial institutions			786,613			590,992			2,149,865			1,761,672
Interest on federal funds sold and other cash equivalents			301,619			113,379			584,397			487,969
Total interest income			15,925,143			10,727,982			42,183,220			29,376,654
INTEREST EXPENSE:
Deposits			4,312,714			2,816,913			11,150,356			8,114,068
Interest on other borrowings			498,933			163,226			1, 276,079			464,780
Total interest expense			4,811,647			2,980,139			12,426,435			8,578,848
NET INTEREST INCOME BEFORE
PROVISION FOR LOAN LOSSES			11,113,496			7,747,843			29,756,785			20,797,806
PROVISION FOR LOAN LOSSES			1,450,000			755,123			3,016,711			1, 550,763
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES			9,663,496			6,992,720			26,740,074			19,247,043
NONINTEREST INCOME:
Service charges on deposit accounts			1,892,169			1,571,808			5,548,730			5,076,599
Gain on sale of loans			2,730,952			1,644,038			6,902,066			3,757,616
Loan-related servicing income			590,129			378,908			1,763,441			1,413,633
Loan referral fee income			-			126,410			99,520			312,737
Loan packaging fee			64,317			112,131			324,361			312,443
Income from other earning assets			175,223			143,864			476,313			339,772
Other income			494,083			217,111			1,092,203			529,067
Total noninterest income			5,946,873			4,194,270			16,206,634			11,741,867
NONINTEREST EXPENSES:
Salaries and employee benefits			3,709,045			3,114,934			10,385,656			8,798,142
Occupancy and equipment			711,130			569,317			1,996,194			1,570,826
Data processing			454,921			355,719			1,228,322			1,198,809
Loan referral fees			292,997			309,704			896,621			646,019
Professional fees			332,798			273,681			752,433			544,870
Directors’ fees			123,550			116,150			332,100			315,300
Office supplies			137,723			116,687			383,296			354,893
Advertising			175,972			54,565			378,697			94,617
Communications			82,000			83,854			244,551			267,875
Deposit insurance premiums			32,865			26,951			95,244			161,810
Outsourced service for customers			361,061			250,349			985,625			683,665
Other operating			714,026			462,466			1,594,455			886,235
Total noninterest expenses			7,128,088			5,734,377			19,273,194			15,523,061
INCOME BEFORE INCOME TAX PROVISION			8,482,281			5,452,613			23,673,514			15,465,849
INCOME TAX PROVISION			3,382,000			2,122,000			9,405,000			6,128,000
NET INCOME		$	5,100,281		$	3,330,613		$	14,268,514		$	9,337,849
EARNINGS PER SHARE
Basic		$	0.36		$	0.26		$	1.04		$	0.73
Diluted		$	0.36		$	0.23		$	1.00		$	0.65

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

	2

WILSHIRE BANCORP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
			2004			2003			2004			2003
Net income		$	5,100,281		$	3,330,613		$	14,268,514		$	9,337,849
Other comprehensive income, net of tax:
Unrealized gains(losses) on securities available for sale and interest-only strip:
Unrealized holding gains (losses) on securities available for sale arising during period,
net of tax expense of $335,648 for the three months ended September 30,2004 and
net of tax benefit of $204,420 for the three months ended September 30, 2003 and
net of tax benefit of $165,562 for the nine months ended September 30, 2004 and
net of tax benefit of $19,014 for the nine months ended September 30, 2003			463,514			(282,294	)		(228,632	)		(26,258	)
Unrealized holding gains (losses) on interest only strips arising during period,
net of tax expense of $35,157 for the three months ended September 30, 2004 and
net of tax benefit of $33,825 for the three months ended September 30,2003 and
net of tax benefit of $101,346 for the nine months ended September 30, 2004 and
net of tax benefit of $19,097 for the nine months ended September 30, 2003			34,197			(46,711	)		(57,206	)		(26,372	)
Unrealized holding gains on interest rate SWAP arising during period,
net of tax expense of $25,308 for the nine months ended September 30, 2004			-			-			37,962			-
Other comprehensive income (expense), net of tax:			497,711			(329,005	)		(247,876	)		(52,630	)
Comprehensive income		$	5,597,992		$	3,001,608		$	14,020,638		$	9,285,219

 

	3

WILSHIRE BANCORP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

		Nine Months Ended September 30,
		2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	14,268,514		$	9,337,849
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization			814,545			953,863
Provision for loan losses			3,016,711			1,550,763
Deferred tax benefit			(352,122	)		(318,490	)
Gain on disposition of bank premises and equipment			(4,706	)		(22,974	)
Gain on sale of loans			(6,902,066	)		(3,757,616	)
Origination of loans held for sale			(78,155,201	)		(43,970,077	)
Tax benefit from exercise of stock options			8,841,664			7,308
Proceeds from sale of loans held for sale			67,387,602			48,942,983
Loss on sale of other real estate owned			3,967			-
Purchase of Bank Owned Life Insurance			-			(10,500,000	)
Change in cash surrender value of life insurance			(333,320	)		(287,595	)
Servicing assets capitalization			(1,503,058	)		(1,155,716	)
Servicing assets amortization			721,606			414,678
Increase in interest-only strip			(767,348	)		(422,022	)
Increase in accrued interest receivable			(886,457	)		(325,748	)
Increase in other assets			(2,764,453	)		(1,530,621	)
Increase in accrued interest payable			644,703			343,289
(Decrease) Increase in other liabilities			(3,264,156	)		2,102,208
Net cash provided by operating activities			766,425			1,362,082
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in interest-bearing deposits in other financial institutions			198,990			988,215
Purchases of investment securities available for sale			(40,854,028	)		(45,935,938	)
Purchases of investment securities held to maturity			(8,987,338	)		(18,826,250	)
Proceeds from matured or called securities (AFS)			31,725,795			36,970,989
Proceeds from matured or called securities (HTM)			6,100,000			17,443,208
Net increase in loans receivable			(210,359,376	)		(176,166,768	)
Proceeds from sale of other loans			11,307,787			-
Proceeds from sale of other real estate owned			373,233			-
Purchases of premises and equipment			(1,109,647	)		(757,907	)
Purchase of FHLB stock			(2,768,700	)		(996,700	)
Proceeds from disposition of bank equipment			1,036			(28,894	)
Net cash used in investing activities			(214,372,248	)		(187,310,045	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits			191,068,177			167,614,434
Increase in Federal Home Loan Bank borrowing			16,000,000			20,000,000
Stock dividend paid in cash for fractional shares			-			(1,077	)
Proceeds from exercise of stock options			1,764,079			292,092
Net cash provided by financing activities			208,832,256			187,905,449
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS			(4,773,567	)		1,957,486
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			120,486,069			99,263,503
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	115,712,502		$	101,220,989
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid		$	11,781,732		$	5,015,460
Income taxes paid		$	130,000		$	1,775,800

	4

 

 

 

Wilshire Bancorp, Inc. (the “Company,” "we," "us," or "our," hereafter)) succeeded to the business and operations of Wilshire State Bank, a California state-chartered commercial bank (the “Bank”), upon consummation of the reorganization of the Bank into a holding company structure, effective as of August 25, 2004. Wilshire State Bank was incorporated under the laws of the State of California on May 20, 1980 and commenced operations on December 30, 1980. The Company was incorporated in December 2003 as a wholly owned subsidiary of the Bank for the purpose of facilitating the issuance of trust preferred securities for the Bank and eventually serving as the holding company of the Bank. The Bank’s shareholders approved a reorganization into a holding company structure at a meeting held on August 25, 2004.  As a result of the reorganization, shareholders of the Bank are now shareholders of the Company and the Bank is a direct subsidiary of the Company.

 

Prior to the completion of the reorganization, the Bank was subject to the information, reporting and proxy statement requirements of the Exchange Act, pursuant to the regulations of its primary regulator, the Federal Deposit Insurance Corporation, or FDIC. Accordingly, the Bank filed annual and quarterly reports, proxy statements and other information with the FDIC. Pursuant to Rule 12g-3 of the Exchange Act, the Company has succeeded to the reporting obligations of the Bank and the reporting obligations of the Bank to the FDIC have terminated. Filings by the Company under the Exchange Act, like this Form 10-Q, are to be made with the SEC. Note that while we refer generally to the “Company” throughout this filing, all references to the Company prior to August 26, 2004, except where otherwise indicated, are to the Bank.

 

Our Corporate Headquarters and the Bank’s Main Office are located at 3200 Wilshire Boulevard, Los Angeles, California 90010. In addition, we have twelve full-service Bank branch offices in southern California located in Koreatown, downtown Los Angeles, Huntington Park, Gardena, the San Fernando Valley, Cerritos, Tustin, Rowland Heights, Buena Park, and Garden Grove. We also have six loan production offices utilized primarily for the origination of loans under our the BankSmall Business Administration (“SBA”) lending program in Oklahoma City, Oklahoma; Seattle, Washington; Dallas, Texas; San Antonio, Texas; Las Vegas, Nevada; and the San Jose, California area (Milpitas, California).

 

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company (the Bank for periods prior to August 26, 2004) and its wholly owned subsidiary. The financial statements have been prepared in accordance with the Securities and Exchange Commission (“SEC”) rules and regulations for interim financial reporting and therefore do not necessarily include all information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America. The information provided by these interim financial statements reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the Company’s financial condition as of September 30, 2004 and December 31, 2003, the related statements of operations and comprehensive income for the three months and nine months ended September 30, 2004 and 2003, and the statements of cash flows for the nine months ended September 30, 2004 and 2003. Such adjustments are of a normal recurring nature unless otherwise disclosed in the Form 10-Q. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year.

The unaudited financial statements should be read in conjunction with the audited financial statements and notes thereto included in Bank’s Annual Report on Form 10-K for the year ended December 31, 2003. The accounting policies used in the preparation of these interim financial statements were consistent with those used in the preparation of the financial statements for the year ended December 31, 2003, unless otherwise noted.

	5

Note 3. Earnings per Share

 

Basic earnings per share (“EPS”) excludes dilution and is computed by dividing earnings available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings. There was a two-for-one stock split of the Company’s common shares for shareholders of record at the close of business on July 31, 2002, effective August 15, 2002, and a 100% stock dividend on November 30, 2003, effective December 17, 2003. There was a 10% stock dividend in May 2003 for the shareholders of record at the close of business on April 30, 2003. All basic and diluted earnings per share and number of shares outstanding in this report have been retroactively restated for the stock split and the stock dividends.

The following is a reconciliation of the numerators and denominators of the basic and diluted per share computations for the specified periods:

		Three months ended September 30, 2004									Three months ended September 30, 2003
		Income (Numerator)			Weighted Average Shares (Denominator)			Per Share Amount			Income (Numerator)			Weighted Average Shares (Denominator)			Per Share Amount
Basic EPS		$	5,100,281			14,022,645		$	0.36		$	3,330,613			12,916,734		$	0.26
Effect of dilution			-			328,921			(0.00	)		-			1,581,227			(0.03	)
Diluted EPS		$	5,100,281			14,351,566		$	0.36		$	3,330,613			14,497,961		$	0.23

 

 

 

		Nine months ended September 30, 2004									Nine months ended September 30, 2003
		Income (Numerator)			Weighted Average Shares (Denominator)			Per Share Amount			Income (Numerator)			Weighted Average Shares (Denominator)			Per Share Amount
Basic EPS		$	14,268,514			13,728,005		$	1.04		$	9,337,849			12,875,036		$	0.73
Effect of dilution			-			491,080			(0.04	)		-			1,454,616			(0.08	)
Diluted EPS		$	14,268,514			14,219,085		$	1.00		$	9,337,849			14,329,652		$	0.65

There were 2,000 and 13,000 anti-dilutive stock options outstanding for the three months and nine months ended September 30, 2004 and 2003, respectively, for which the exercise price exceeded the average market price of the Company’s common stock during the period.    

 

In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. Under this rule, goodwill and other intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives.

The Company adopted the new rules on accounting for goodwill and other intangible assets on January 1, 2002. At adoption and as of September 30, 2004, the Company does not have any intangible assets that will be subject to annual impairment testing in accordance with these Statements. The Company’s intangible assets that continue to be subject to amortization, loan servicing rights, were $4,064,135 and $2,902,855 (net of $1,273,679 and $1,045,822 accumulated amortization) as of September 30, 2004 and 2003, respectively. Amortization expense for intangible assets subject to amortization was $135,457 and $96,994 for the three months ended September 30, 2004 and 2003, respectively, and $381,840 and $284,751 for nine months ended September 30, 2004 and 2003, respectively, and is estimated to be approximately $542,000 annually for the next five fiscal years.

The following disclosure about segments of the Company is made in accordance with the requirements of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The Company segregates its operations into three primary segments: Banking Operations, Trade Finance Services (“TFS”), and Small Business Administration Lending Services. The Company determines the operating results of each segment based on an internal management system that allocates certain expenses to each segment.

Banking Operations - The Company provides lending products, including commercial, consumer and real estate loans to its customers.

Trade Finance Services - The Trade Finance department allows the Company’s import/export customers to handle their international transactions. Trade finance products include, among others, the issuance and collection of letters of credit, international collection, and import/export financing.

Small Business Administration Lending Services - The SBA department mainly provides customers of the Company access to the U.S. SBA-guaranteed lending program.

(Dollars in Thousands)		Three Months Ended September 30, 2004												Three Months Ended September 30, 2003
Business Segment		Banking Operations			TFS			SBA			Company			Banking Operations			TFS			SBA			Company
Net interest income		$	8,112		$	517		$	2,485		$	11,114		$	5,451		$	302		$	1,995		$	7,748
Less Provision for loan losses			294			841			315			1,450			815			(107	)		47			755
Other operating income			2,575			467			2,904			5,946			1,732			388			2,074			4,194
Net revenue			10,393			143			5,074			15,610			6,368			797			4,022			11,187
Other operating expenses			5,944			162			1,022			7,128			4,730			185			819			5,734
Income(loss) before taxes		$	4,449		$	(19	)	$	4,052		$	8,482		$	1,638		$	612		$	3,203		$	5,453
Business segment assets		$	801,760		$	42,739		$	136,849		$	981,348		$	561,753		$	25,804		$	119,317		$	706,874
Non-business segment assets												230,553												185,143
Total assets											$	1,211,901											$	892,017

 

 

		Nine Months Ended September 30, 2004												Nine Months Ended September 30, 2003
Business Segment		Banking Operations			TFS			SBA			Company			Banking Operations			TFS			SBA			Company
Net interest income		$	21,625		$	1,322		$	6,810		$	29,757		$	14,768		$	930		$	5,100		$	20,798
Less Provision for loan losses			1,878			1,234			(95	)		3,017			1,233			(118	)		436			1,551
Other operating income			7,195			1,389			7,623			16,207			5,521			1,181			5,040			11,742
Net revenue			26,942			1,477			14,528			42,947			19,056			2,229			9,704			30,989
Other operating expenses			16,079			516			2,678			19,273			12,925			560			2,038			15,523
Income before taxes		$	10,863		$	961		$	11,850		$	23,674		$	6,131		$	1,669		$	7,666		$	15,466
Business segment assets		$	801,760		$	42,739		$	136,849		$	981,348		$	561,753		$	25,804		$	119,317		$	706,874
Non-business segment assets												230,553												185,143
Total assets											$	1,211,901											$	892,017

During 1997, the Bank established a new stock option plan that provides for the issuance of up to 3,249,900 shares of the Company’s authorized but unissued common stock to managerial employees and directors. Exercise prices may not be less than the fair market value at the date of grant. As of September 30, 2004, 571,176 shares were outstanding under this option plan. The outstanding stock options granted under the Company’s 1990 plan were transferred to this plan. Options granted under the stock option plans expire not more than 10 years after the date of grant.

 

 

	6

For the first nine months of 2004 and 2003, 3,000 shares and 13,000 shares were granted respectively. The estimated fair value of options granted during 2004 was $7.93 and was estimated on the date of grant using the Black-Scholes option pricing model under the following assumptions - no dividend yield, expected volatility of 19%, and risk-free interest rate of 3.45%. The estimated fair value of options granted during 2003 was $4.28 and was estimated on the date of grant using the Black-Scholes option pricing model under the following assumptions - no dividend yield, expected volatility of 20%, and risk-free interest rate of 2.58%. Had compensation cost for the Company’s stock option plan been determined based on the fair values at the grant dates for awards under the plan consistent with the fair value method of SFAS No. 123, the Company’s net income and earnings per share for the three and nine months ended September 30 would have been reduced to the pro forma amounts indicated below:

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
Net income - as reported		$	5,100,281		$	3,330,613		$	14,268,514		$	9,337,849
Deduct: Total stock-based employee compensation expenses determined under fair value-based method for all awards - net of related tax effects			(45,653	)		(38,671	)		(111,398	)		(110,573	)
Pro forma net income		$	5,054,628		$	3,291,942		$	14,157,116		$	9,227,276
Earnings per share:
Basic - as reported		$	0.36		$	0.26		$	1.04		$	0.73
Basic - pro forma		$	0.36		$	0.25		$	1.03		$	0.72
Diluted - as reported		$	0.36		$	0.23		$	1.00		$	0.65
Diluted - pro forma		$	0.35		$	0.22		$	1.00		$	0.64

 

 

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statements of financial condition. Our exposure to credit loss in the event of nonperformance on commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for extending loan facilities to customers. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; and income-producing properties. Commitments at September 30, 2004 are summarized as follows:

Commitments to extend credit    $52,268,000

Standby letters of credit        $ 2,907,000

Commercial letters of credit    $ 9,311,000

As part of our asset and liability management strategy, we may engage in derivative financial instruments, such as interest rate swaps, with the overall goal of minimizing the impact of interest rate fluctuations on our net interest margin. Interest rate swaps involve the exchange of fixed-rate and variable-rate interest payment obligations without the exchange of the underlying notional amounts. In September 2003, we entered into one interest rate swap agreement, under which we receive a fixed rate and pay a variable rate based on three-month LIBOR on the notional amount of $3 million. In January 2004, the swap arrangement was terminated without any gain or loss by mutual agreement between the Company and the brokerage company.

 

	7

In the normal course of business, we are involved in various legal claims. We have reviewed all legal claims against us with counsel and have taken into consideration the views of such counsel as to the outcome of the claims. In our opinion, the final disposition of all such claims will not have a material adverse effect on our financial position and results of operations.

 

In March 2004, the Emerging Issues Task Force (EITF) reached consensus on the guidance provided in EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (EITF 03-1) as applicable to debt and equity securities that are within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and equity securities that are accounted for using the cost method specified in Accounting Policy Board Opinion No. 18 The Equity Method of Accounting for Investments in Common Stock.  An investment is impaired if the fair value of the investment is less than its cost.  EITF 03-1 outlines that an impairment would be considered other-than-temporary unless: a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment, and b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary.  Although not presumptive, a pattern of selling investments prior to the forecasted recovery of fair value may call into question the investor’s intent.  In addition, the severity and duration of the impairment should also be considered in determining whether the impairment is other-than-temporary.

 

In September 2004 the FASB staff issued a proposed Board-directed FASB Staff Position, FSP EITF Issue 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1. The proposed FSP would provide implementation guidance with respect to debt securities that are impaired solely due to interest rates and/or sector spreads and analyzed for other-than-temporary impairment under paragraph 16 of Issue 03-1. The Board also issued FSP EITF Issue 03-1-b, which delays the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-1. The delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature.

 

Adoption of this standard may cause the Company to recognize impairment losses in the Consolidated Statements of Operations which would not have been recognized under the current guidance or to recognize such losses in earlier periods, especially those due to increases in interest rates.  Since fluctuations in the fair value for available-for-sale securities are already recorded in Accumulated Other Comprehensive Income, adoption of this standard is not expected to have a significant impact on stockholders’ equity

 

In January 2003, the FASB issued Interpretation No. 46 — Consolidation of Variable Interest Entities (“FIN 46”). In December 2003, the FASB revised FIN 46 and codified certain FASB Staff Positions previously issued for FIN 46 (“FIN 46R”). The objective of FIN 46, as originally issued, and as revised by FIN 46R, was to improve financial reporting by companies involved with variable interest entities. Prior to the effectiveness of FIN 46, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 changed that standard by requiring a variable interest entity to be consolidated by a company, if that company was subject to a majority of the expected losses from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. For other variable interest entities, the latest effective date applicable to the Company was for the quarter ended September 30, 2004. The provisions of FIN 46R for us are required to be adopted prior to the first reporting period that ends after March 15, 2004. Our adoption of FIN 46 and FIN 46R did not have a significant impact on our financial position, results of operations or cash flows.

 

Certain reclassifications were made to the prior periods’ presentation to confirm to the current year’s presentation.

 

	8

 

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

 

This discussion presents management’s analysis of our results of operations and financial condition as of and for the three month and nine month periods ended September 30, 2004 and 2003, respectively. All per share amounts and number of shares outstanding in this item have been retroactively adjusted and restated to give effect to two 10% stock dividends in March 2000 and in May 2003, a two-for-one stock split in August 2002, and a 100% stock dividend in December 2003. The discussion should be read in conjunction with our financial statements and the notes related thereto which appear elsewhere in this Quarterly Report on Form 10-Q.

 

Statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, including our expectations, intentions, beliefs, or strategies regarding the future. Any statements in this document about expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and are forward-looking statements. These statements are often, but not always, made through theuse of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “will continue,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” and similar expressions. Accordingly, these statements involve estimates, assumptions and uncertainties, which could cause actual results to differ materially from those expressed in them. Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this document. All forward-looking statements concerning economic conditions, rates of growth, rates of income or values as may be included in this document are based on information available to us on the dates noted, and we assume no obligation to update any such forward-looking statements. It is important to note that our actual results may differ materially from those in such forward-looking statements due to fluctuations in interest rates, inflation, government regulations, economic conditions, customer disintermediation and competitive product and pricing pressures in the geographic and business areas in which we conduct operations, including our plans, objectives, expectations and intentions and other factors discussed under the section entitled “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2003, including the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

	9

 

·	increases in our allowance for loan losses could materially adversely affect our earnings,

 

 

·	our directors and executive officers  beneficially own a significant portion of our  outstanding common stock,

 

 

·	the market for our  common stock is  limited, and potentially subject to volatile changes in price,

 

 

·	we  face substantial competition in our primary market area,

 

 

·	we  are subject to significant government regulation and legislation that increases the cost of doing business and inhibits our ability to compete,

 

 

·	we could be negatively impacted by downturns in the South Korean economy, and

 

 

·	no assurance can be given that our recent bank holding company reorganization will ultimately benefit shareholders.

 

These factors and the risk factors referred to in our Annual Report on Form 10-K for the year ended December 31, 2003 could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us, and you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made and we do not undertake any obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

	10

The following table presents selected historical financial information (unaudited) as of and for the three months and nine months ended September 30, 2004 and 2003. In the opinion of our management, the information presented reflects all adjustments considered necessary for a fair presentation of the results of such periods. The operations results of the interim periods are not necessarily indicative of our future operating results.

 

(Dollars in thousands, except per share data)		Three Months Ended September 30,						Nine Months Ended September 30,
As of and for the Three months Ended		2004			2003			2004			2003
Net income		$	5,100		$	3,331		$	14,269		$	9,338
Net income per share, basic			0.36			0.26			1.04			0.73
Net income per share, diluted			0.36			0.23			1.00			0.65
Net interest income			11,113			7,748			29,757			20,798
Average balances:
Assets			1,223,991			831,570			1,109,718			775,068
Cash and cash equivalents			138,847			82,415			115,567			91,466
Investment debt securities			95,468			72,534			85,731			70,183
Net loans			945,462			648,312			867,439			588,847
Total deposits			1,053,700			740,618			955,648			692,718
Shareholders’ equity			80,783			53,722			73,175			50,463
Performance Ratios:
Annualized return on average assets			1.67	%		1.60	%		1.71	%		1.61	%
Annualized return on average equity			25.25	%		24.80	%		26.00	%		24.67	%
Net interest margin			3.97	%		4.07	%		3.91	%		3.90	%
Efficiency ratio1			41.78	%		48.06	%		41.93	%		47.71	%
Capital Ratios:
Tier 1 capital to adjusted total assets			8.03	%		6.61	%		8.03	%		6.61	%
Tier 1 capital to risk-weighted assets			9.84	%		7.58	%		9.84	%		7.58	%
Total capital to risk-weighted assets			12.01	%		10.10	%		12.01	%		10.10	%
Period-end balances as of:		September 30, 2004			December 31, 2003			September 30, 2003
Total assets		$	1,211,901		$	983,264		$	892,017
Investment securities			91,807			80,423			69,614
Total loans, net of unearned income			972,829			757,005			699,756
Total deposits			1,047,584			856,516			786,470
Junior subordinated debentures			25,464			25,464			10,000
FHLB borrowings			45,000			29,000			30,000
Shareholders’ equity			83,368			58,741			54,975
Asset Quality Ratios:
Net charge-off (recoveries) to average total loans for the quarter			0.05	%		0.05	%		(0.02	%)
Nonperforming loans to total loans			0.31	%		0.50	%		0.61	%
Nonperforming assets to total loans and other real estate owned			0.31	%		0.54	%		0.61	%
Allowance for loan losses to total loans			1.14	%		1.19	%		1.17	%
Allowance for loan losses to nonperforming loans			370	%		240	%		192	%

 

	11

 

 

Wilshire Bancorp, Inc. (the “Company,” "we," "us," or "our," hereafter) succeeded to the business and operations of Wilshire State Bank (the “Bank”) upon consummation of the reorganization of the Bank into a holding company structure, effective as of August 25, 2004. Prior to the completion of the reorganization, the Bank was subject to the information, reporting and proxy statement requirements of the Exchange Act, pursuant to the regulations of its primary regulator, the Federal Deposit Insurance Corporation, or FDIC. Accordingly, the Bank filed annual and quarterly reports, proxy statements and other information with the FDIC. Pursuant to Rule 12g-3 of the Exchange Act, the Company has succeeded to the reporting obligations of the Bank and the reporting obligations of the Bank to the FDIC have terminated. Filings by the Company under the Exchange Act, like this Form 10-Q, are to be made with the SEC. Note that while we refer generally to the “Company” throughout this filing, all references to the Company prior to August 26, 2004, except where otherwise indicated, are to the Bank.

 

We operate community banks in the general commercial banking business, with our primary market encompassing the multi-ethnic population of the Los Angeles County area. Our full-service offices are located primarily in areas where a majority of the businesses are owned by Korean-speaking immigrants, with many of the remaining businesses owned by Hispanic and other minority groups.

 

At September 30, 2004, we had approximately $1.21 billion in assets, $973.0 million in total loans, and $1.05 billion in deposits.

 

Over the past few years, our network of branches and loan production offices has been expanded geographically. We currently maintain thirteen full-service offices and six loan production offices. This year we opened two branch offices, one in downtown Los Angeles in March and the other in the City of Buena Park in October. We also added three additional loan production offices in Oklahoma City, Oklahoma, San Antonio, Texas, and Las Vegas, Nevada. During 2003, we opened two full service branches in the mid-Wilshire area of Los Angeles and the Irvine area (City of Tustin, California). We intend to continue our growth strategy in future years through the opening of additional branches and loan production offices as our needs and resources permit.

 

In 2002 and 2003, we raised an aggregate of $25.5 million through the issuance of junior subordinated debentures. We believe that the supplemental capital raised in connection with the issuance of these debentures will allow us to achieve and maintain our status as a well-capitalized institution and sustain our continued loan growth.

 

As evidenced by our past several years of operations, we have experienced significant balance sheet growth. Since its installation in 1999, our new management team has implemented a strategy of building our core banking foundation by focusing on commercial loans and business transaction accounts. This strategic change significantly changed our portfolio profile and, among other things, increased fee income and our loan portfolio. Since 2003, we slightly modified our strategy by emphasizing risk management as our loan portfolio increased to approximately $1 billion at September 30, 2004. We have further expanded and diversified our business by focusing on the development of our consumer lending divisions. Going forward, management believes that this strategy should increase recurring revenue streams, reduce excessive reliance on one strategic product, and continue to build shareholder value.

 

 

We believe the following were key indicators of our performance for operations through the third quarter of 2004:

 

·	our total assets grew to $1.21 billion at the end of the third quarter of 2004, an increase of 23% from $983.3 million at the end of 2003.

 

·	our total deposits grew to $1.05 billion at the end of the third quarter of 2004, an increase of 22% from $856.5 million at the end of 2003.

 

·	our total loans grew to $973 million at the end of the third quarter of 2004, an increase of 29% from $757 million at the end of 2003.

 

 

	12

 

·	our ratio of total non-performing loans to total loans decreased to 0.31% in the third quarter of 2004 from 0.61% in the third quarter of 2003.

 

·	total noninterest income increased to $5.9 million in the third quarter of 2004, an increase of 40.5% from $4.2 million in the third quarter of 2003. We primarily attribute this increase to our efforts to diversify and expand our non-interest revenue sources.

 

·

total noninterest expenses increased from $5.7 million in the third quarter of 2003 to $7.1 million in the third quarter of 2004, reflecting the expanded personnel and premises associated with our business growth, including the recent opening of new branch offices and the recent formation of two new departments. With the continued efforts to minimize operating expenses, we were able to lower the noninterest expenses as a percentage of average assets to 0.58% in the third quarter of 2004 as compared with 0.69% in the same period of 2003. Management believes that its efforts in cost-cutting and revenue diversification have improved our operational efficiency significantly, as evidenced by the decrease in our efficiency ratio (the ratio of noninterest expense to the sum of net interest income before provision for loan losses and total noninterest income) from 48.06% in the third quarter of 2003 to 41.78% in the third quarter of 2004.

 

These items, as well as other factors, contributed to the increase in net income for the third quarter of 2004 to $5.1 million from $3.3 million for the same period in 2003, or $.36 per common share as compared to $.23 per common share for the same period in 2003 - assuming dilution and as discussed in further detail in this "Management's Discussion and Analysis of Financial Condition and Results of Operations."

 

 

As we look to the remainder of 2004 and ahead to 2005, we anticipate continued good financial performance as evidenced by our results of operations in the first nine months of 2004. We will continue to pursue opportunities for growth in our existing markets, as well as opportunities to expand into new markets through de novo branching and regional loan production offices. Further, we expect that our portfolio of unsecured business loans and consumer loans will continue to grow as a result of target marketing efforts in these areas.

 

We intend to continue our focus on loan and account growth and managing our net interest margin, while attempting to control expenses and credit losses to achieve our net income and other objectives. We will continue to utilize strategies to control other operating expenses. We will continue to strive to be more efficient and focus on controlling the growth of these expenses so that they grow more slowly than loans.

 

Although interest rates decreased in 2003, 2002 and 2001, compressing our interest margins, we continued to exhibit growth in net interest income. As interest rates increased in 2004, our yield on earnings assets already somewhat increased. Should interest rates increase further, our interest margin will likely increase further. We can then decide whether to increase the interest rates we pay on our deposit accounts or change our promotional or other interest rates on new deposits in certain marketing activation programs to attempt to achieve a desirable net interest margin. Any increases in the rates we charge on our accounts could have an effect on our efforts to attract new customers and grow loans, particularly with the continuing competition in the commercial and consumer lending industry. The economies and real estate markets in our primary market areas will continue to be significant determinants of the quality of our assets in future periods and, thus, our results of operations, liquidity and financial condition. Current economic indicators suggest that the national economy and the economies in our primary market areas are improving from the downturn experienced in recent years.

 

Finally, we completed the reorganization into a holding company structure during the third quarter of 2004. In the reorganization, each of the Bank’s outstanding shares of common stock were converted into an equal number of shares of common stock in the Company, which now owns the Bank as its wholly-owned subsidiary. Management believes that operating within a holding company structure will, among other things:

 

·	allow us to use the proceeds from the issuance of our junior subordinated debentures as Tier 1 capital (within regulatory guidelines).

 

 

	13

 

·	provide greater operating flexibility;

 

·	facilitate the acquisition of related businesses as opportunities arise;

 

·	improve our ability to diversify;

 

·	enhance our ability to remain competitive in the future with other companies in the financial services industry that are organized in a holding company structure; and

 

·	enhance our ability to raise capital to support growth.

 

For the final quarter of 2004 and into 2005, management will be focused on the above challenges and opportunities and other factors affecting the business similar to the factors driving the results of the first nine months of 2004.

 

 

The discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

 

 

Accounting for allowance for loan losses involves significant judgment and assumptions by management and is based on historical data and management’s view of the current economic environment. At least on a quarterly basis, our management reviews the methodology and adequacy of allowance for loan losses and reports its assessment to the Board of Directors for its review and approval.

 

We base our allowance for loan losses on an estimation of probable losses inherent in our loan portfolio. Our methodology for assessing loan loss allowances are intended to reduce the differences between estimated and actual losses and involves a detailed analysis of our loan portfolio in three phases:

 

·

the specific review of individual loans in accordance with Statement of Financial Accounting Standards (SFAS) 114, Accounting by Creditors for Impairment of a Loan,

 

·

the segmenting and reviewing of loan pools with similar characteristics in accordance with SFAS No. 5, Accounting for Contingencies, and

 

·

our judgmental estimate based on various subjective factors

 

The first phase of our allowance analysis involves the specific review of individual loans to identify and measure impairment. We evaluate each loan by use of a risk-rating system, except for homogeneous loans, such as automobile loans and home mortgages. Specific risk-rated loans are deemed impaired with respect to all amounts, including principal and interest, which will likely not be collected in accordance with the contractual terms of the related loan agreement. Impairment for commercial and real estate loans is measured either based on the present value of the loan’s expected future cash flows or, if collection on the loan is collateral dependent, the estimated fair value of the collateral, less selling and holding costs.

 

The second phase involves the segmenting of the remainder of the risk-rated loan portfolio into groups or pools of loans, together with loans with similar characteristics for evaluation in accordance with SFAS No. 5. We perform loss migration analysis and calculate the loss migration ratio for each loan pool based on its historical net losses and benchmark it against the levels of other peer banks.

 

	14

 

In the third phase, we consider relevant internal and external factors that may affect the collectibility of a loan portfolio and each group of loan pools. As a general rule, the factors detailed below will be considered to have no impact (neutral) to our loss migration analysis. However, if there exists information to warrant adjustment to the loss migration ratios, the changes will be made in accordance with the established parameters and supported by narrative and/or statistical analysis. We use a credit risk matrix to determine the impact to the loss migration analysis. The credit risk matrix provides seven possible scenarios for each of the identified factors detailed below. The matrix allows for three positive/decrease (major, moderate, and minor), three negative/increase (major, moderate, and minor), and one neutral credit risk scenario within each factor for each loan pool. These possible scenarios enable management to adjust the loss migration ratio as much as 50 percent in either direction (positive or negative) for each loan pool. These adjustments are applied to the general allocation for each loan pool if warranted. The factors currently considered are, but are not limited to:

 

·

Concentration of Credits: Concentrations of credit are loans to any single borrower, affiliated group of borrowers, or borrowers engaged in or dependent upon one industry that exceeds 25% of Tier 1 capital and reserves. A concentration of credit can also result from an acquisition of a volume of loans from a single source, regardless of the diversity of the individual borrowers. The extent of the adjustment will depend on the level of the concentration(s) and a determination if the concentration adversely affects us. An adverse concentration may also occur where a disproportionate amount of our criticized and classified assets are derived from a single concentration source.

 

·

Delinquency Trends: As a matter of practice, an increased (negative) adjustment will be made whenever (i) our loan delinquency ratio exceeds 3% of total loans; and/or (ii) our loan delinquencies have increased by 1% of total loans in one period. The extent of the adjustment will depend on the severity of the trends. A decreased (positive) adjustment may occur when the levels exceed the thresholds established above, but are improving as supported over, at a minimum, two consecutive quarters. The extent of the adjustment will depend on the improvements of the trend. In instances where the levels are within the thresholds established above, a neutral risk posture will be taken.

 

·

Nature and Volume of Loan Trend: This factor will be adjusted for significant changes in the nature and volume of the loan portfolio. An increased (negative) adjustment to this factor generally may occur with: (i) the establishment of a new or untested loan pool (e.g., a loan category or type not previously underwritten by us); or (ii) a significant shift in the loan categories that is outside of the loan mix parameters. The decreased (positive) adjustment to this factor may occur if a problematic loan pool is eliminated or significantly reduced. Also, a decreased adjustment to this factor may occur if the total loan portfolio decreases to the point where (in conjunction with changes in the experience, ability, and depth of lending management and staff) the depth of lending management is more than sufficient to manage the risk within the loan portfolio.

 

·

Non-Accrual Loan Trend: This factor may be adjusted when there is a significant upward movement of non-accrual loans and Troubled Debt Restructuring (TDR’s). A Troubled Debt Restructuring is a formal restructure of a loan when, for economic or legal reasons related to a borrower’s financial difficulties, we grant a concession to the borrower we would not otherwise consider. An increased (negative) adjustment to this factor generally may occur when: (i) non-accrual loans exceed 1.5% of total loans and/or (ii) non-accrual loans over gross loans have increased by 0.5% in one period. In the case of TDR’s, a determination will be made on a case-by-case basis whether the amount and number of TDR’s, based on their performance and collateral protection, warrant increased reserves. The extent of the adjustment will depend on the severity of the trends. A decreased (positive) adjustment may occur when levels exceed the thresholds established above, but are improving as supported over, at a minimum, two consecutive quarters. The extent of the adjustment will depend on the improvements of the trend.

 

·

Problem Loan Trend: This factor may be adjusted depending on the trend of criticized and classified loans. An increased (negative) adjustment will be made whenever (1) classified loans exceed 75% of Tier 1 Capital and Reserves and/or (2) classified loans increased in one period by 1% of gross loans. A decrease (positive) adjustment may occur when the levels exceed the thresholds established above, but are improving as supported over, at minimum, two consecutive quarters. The extent of the adjustment will depend on the improvements of the trend. In instances where the levels are within the thresholds established above, a neutral risk posture will be taken.

 

	15

 

·

Loss and Recovery Trend: This factor may be adjusted depending on the comparison of peer banks. An increased (negative) adjustment to this factor generally may occur when net charge-off ratio exceeds those of peer banks. The determination of whether the adjustments should be major, moderate, or minor depends on the severity of the difference between our and our peer banks’ net charge-off ratios.

 

·

Quality of Loan Review: This factor may be adjusted when there has been a noted and significant (as determined and documented from external or internal sources) deterioration or improvement in our loan review system and/or management’s oversight. The extent of the adjustment will depend on the significance of the changes noted. A positive (decrease) adjustment will generally occur when there had previously been a documented weakness and clear improvement was noted by external sources. A negative (increase) adjustment will generally occur when a significant deterioration was noted by external sources in our loan review system and/or the degree of oversight by management. In the absence of noted changes to the loan review system and/or the degree of oversight by the management, a neutral posture will be taken.

 

·

Lending and Management Staff: This factor will be adjusted with changes in the experience, ability, and depth of lending management and staff that are significant enough to warrant adjustment to the loss migration ratio. An increased (negative) adjustment would occur if we are understaffed and/or inexperienced to the point that the risk is measurably increased. The extent of the adjustment depends on the perceived impact the staffing problem may have on the supervision of the loan portfolio. Conversely, if we have been understaffed or have lacked experience in a particular loan category or loan type and management has taken the appropriate action to adequately address these issues then a decreased (positive) adjustment may be appropriate. The extent of the adjustment depends on the perceived impact the adequate staffing situation may have on the loan supervision of the portfolio. If the staffing or the experience level of lending staff is considered to be adequate (as determined by an external source) then, in general, a neutral posture will be taken.

 

·

Lending Policies and Procedures: This factor may be adjusted depending on the documented results of external reviews of our policies and procedures, including underwriting standards and collection, charge-off, and recovery practices. If it is determined that there are significant deficiencies noted in our policies, procedures, underwriting standards or practices then, as appropriate, the loss migration ratio may be adjusted to reflect the increased risk until such a time as the deficiencies are adequately addressed by management. The determination of whether the adjustments should be major, moderate, or minor depends on the extent and severity of the deficiency noted. It is the objective of our management to maintain at all times adequate policies, procedures, underwriting standards, and practices. As a general rule, this factor will not be below a neutral scenario situation.

 

·

Economic and Business Conditions: This factor may be adjusted depending on local, regional, and national economic trends and their perceived impact on our particular market segments. An increased (negative) adjustment to this factor would occur in periods where the economic forecast is lackluster or negative. The extent of the increased adjustment will depend on the forecast together with its perceived impact on our loan portfolio pools. In periods of recovery where economic forecasts are positive and vibrant, we may consider positive (decreased) adjustments to the loss migration ratio. The extent of the decreased adjustments will depend on the forecast together with its perceived impact on our loan portfolio pools. In periods of economic stability, with forecasts of continued stability, the impact of this factor will be considered to be neutral.

 

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Central to our credit risk management and our assessment of appropriate loss allowance is our loan risk rating system. Under this system, the originating credit officer assigns borrowers an initial risk rating based 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 may impact the ability of the borrower to perform under the contract. Although management has allocated a portion of the allowance to specific loans, specific loan pools, including off-balance sheet credit exposures which is reported separately as part of other liability, the adequacy of the allowance is considered in its entirety.

 

 

Certain Small Business Administration (“SBA”) loans that may be sold prior to maturity have been designated as held for sale at origination and are recorded at the lower of cost or market value, determined on an aggregate basis. A valuation allowance is established if the market value of such loans is lower than their cost, and operations are charged or credited for valuation adjustments. When we sell a loan, we usually sell the guaranteed portion of the loan and retain the non-guaranteed portion. We receive sales proceeds from: (i) the guaranteed principal of the loan, (ii) the deferred premium for the difference between the book value of the retained portion and the fair value allocated to the retained portion, and (iii) the loan excess servicing fee (i.e., the servicing fee less normal servicing costs - typically 40 basis points). At the time of sale, the deferred premium, which is amortized over the remaining life of the loan as an adjustment to yield, is recorded for the difference between the book value and the fair value allocated to the retained portion. The sales gain is recognized from the difference between the proceeds and the book value allocated to the sold portion.

We allocate the book value of the related loan among three portions on the basis of their relative fair value: (i) the sold portion, (ii) the retained portion, and (iii) the excess servicing fee. We estimate the fair value of each portion based on the following. The amount received for the sale represents the fair value of the sold portion. The fair value of the retained portion is computed by discounting, at 1% above the contract rate (note rate), its future cash flows over the estimated life of the loan. We calculate the fair value of the excess servicing fee (ESF) for the loan from the cash in-flow of the net servicing fee over the estimated life of the loan, discounted at 1.5% above the note rate.

We capitalize the fair value allocated to ESF in two categories: (i) intangible servicing assets, and (ii) interest-only strip receivables. The servicing asset is recorded based on the present value of the contractually specified servicing fee, net of servicing cost, over the estimated life of the loan, using a discount rate of 1.5% above the main note rate, with an average discount rate of 7.5% and a range of constant prepayment rates from 14% to 17% for the three months ended September 30, 2004. For the prior year’s same period, the discount rate was also 1.5% above the main note rate, with an average discount rate of 7.3% and a range of constant prepayment rates from 14% to 17%. The servicing asset is amortized in proportion to and over the period of estimated servicing income. Management periodically evaluates the servicing asset for impairment. Impairment, if it occurs, is recognized in a valuation allowance in the period of impairment. For purposes of measuring impairment, the servicing assets are stratified by collateral type. An interest-only strip is recorded based on the present value of the excess of future interest income, over the contractually specified servicing fee, calculated using the same assumptions as noted above. Interest-only strips are accounted for at their estimated fair value, with unrealized gains recorded as an adjustment in accumulated other comprehensive income in shareholders’ equity. If the estimated fair value is less than its cost, the loss is considered as other than temporary impairment and it is charged to the current earnings. During the 3^rd quarter of 2004, we had a impairment loss of interest-only strip of $59,921.

 

Interest on loans is credited to income as earned and is accrued only if deemed collectible. Accrual of interest is discontinued when a loan is over 90 days delinquent or if management believes that collection is highly uncertain. Generally, payments received on nonaccrual loans are recorded as principal reductions. Interest income is recognized after all principal has been repaid or an improvement in the condition of the loan has occurred that would warrant resumption of interest accruals.

 

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Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under our stock option plan have no intrinsic value at the grant date, and under APB No. 25 no compensation cost is recognized for them. We have elected to continue with the accounting methodology in APB No. 25 and, as a result, have provided pro forma disclosures of net income and earnings per share and other disclosures as if the fair value based method of accounting had been applied. The pro forma disclosures include the effects of all awards granted on or after January 1, 1995 (see Note 6 to the financial statements included herein.)

 

 

Other real estate owned (“OREO”), which represents real estate acquired through foreclosure, or deed in lieu of foreclosure in satisfaction of commercial and real estate loans, is carried at the lower of cost or estimated fair value less the estimated selling costs of the real estate. The fair value of the property is based upon a current appraisal. The difference between the fair value of the real estate collateral and the loan balance at the time of transfer is recorded as a loan charge off if fair value is lower. Subsequent to foreclosure, management periodically performs valuations and the OREO property is carried at the lower of carrying value or fair value, less cost to sell. The determination of a property’s estimated fair value incorporates (1) revenues projected to be realized from disposal of the property, (2) construction and renovation costs, (3) marketing and transaction costs, and (4) holding costs (e.g., property taxes, insurance and homeowners’ association dues). Any subsequent declines in the fair value of the OREO property after the date of transfer are recorded through a write-down of the asset. Any subsequent operating expenses or income, reduction in estimated fair values, and gains or losses on disposition of such properties are charged or credited to current operations.

 

 

Our investment policy seeks to provide and maintain liquidity, and to produce favorable returns on investments without incurring unnecessary interest rate or credit risk, while complementing our lending activities. Our investment securities portfolio is subject to interest rate risk. Fluctuations in interest rates may cause actual prepayments to vary from the estimated prepayments over the life of a security. This may result in adjustments to the amortization of premiums or accretion of discounts related to these instruments, consequently changing the net yield on such securities. Reinvestment risk is also associated with the cash flows from such securities. The unrealized gain/loss on such securities may also be adversely impacted by changes in interest rates.

 

Under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, investment securities that management has the positive intent and ability to hold to maturity are classified as “held-to-maturity” and recorded at amortized cost. Securities not classified as held-to-maturity or trading, with readily determinable fair values, are classified as “available-for-sale” and recorded at fair value. Purchase premiums and discounts are recognized in interest income using the interest method over the estimated lives of the securities.

 

Currently, all of our investment securities are classified as either available-for-sale or held-to-maturity. The unrealized gains and losses for available-for-sale securities are excluded from earnings and reported in other comprehensive income, as part of shareholders’ equity. In accordance with EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (EITF 03-1), we are obligated to assess, at each reporting date, whether there is “other than temporary” impairment to our investment securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. Gains and losses on the sale of securities are recorded on the trade date. As of September 30, 2004 and December 31, 2003, no investment securities were determined to have any other than temporary impairment.

 

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Our primary source of revenue is net interest income, which is the difference between interest and fees derived from earning assets and interest paid on liabilities obtained to fund those assets. Our net interest income is affected by changes in the level and mix of interest-earning assets and interest-bearing liabilities, referred to as volume changes. Our net interest income is also affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes. Interest rates charged on our loans are affected principally by the demand for such loans, the supply of money available for lending purposes and competitive factors. Those factors are, in turn, affected by general economic conditions and other factors beyond our control, such as federal economic policies, the general supply of money in the economy, legislative tax policies, governmental budgetary matters, and the actions of the Federal Reserve Board (“FRB”).

 

Average interest-earning assets increased by $359.0 million (47.1%) and $303.9 million (42.7%), to $1.12 billion and $1.01 billion in the third quarter and the first nine months of 2004, respectively, as compared with $761.5 million and $711.0 million, respectively, for the same periods in the prior year. We have also increased the loan composition to 85.5% of average interest-earning assets for the first nine months of 2004, as compared with 82.8% for the prior year’s same period. Average net loans increased by $297.2 million (45.8%) and $278.6 million (47.3%) to $945.5 million and $867.4 million in the third quarter and the first nine months of 2004, respectively, compared to $648.3 million and $588.8 million, respectively, for the prior year’s same periods. The FRB has raised the Fed Fund target rate by 75 basis point percentage since June 30, 2004, giving us additional benefit on yields on our earning assets, the majority of which bear variable interest rates. The average yields on interest-earning assets increased to 5.69% and 5.54% for the third quarter and the first nine months of 2004, respectively, as compared with 5.63% and 5.51%, respectively, for the prior year’s same periods. This growth of interest-earning assets, especially the loan portfolio, and the increase in yields significantly increased our total interest income by 48.4% and 43.6% to $15.9 million and $42.2 million for the third quarter and the first nine months of 2004, respectively, as compared with $10.7 million and $29.4 million, respectively, for the same periods in the prior year.

 

Average interest-bearing liabilities increased by 54.8% to $870.0 million and 49.5% to $779.0 million in the third quarter and the first nine months of 2004, respectively, compared to $562.1 and $520.9 million, respectively, in the same periods of 2003. Our average interest-bearing deposit portfolio also increased by 48.4% to $792.4 million and 42.4% to $708.9 million in the third quarter and the first nine months of 2004, respectively, as compared with $534.0 million and $497.7 million, respectively, in the same periods of 2003. We also increased other borrowings over the last 12 months (see “Deposits and Other Sources of Funds” below). Due mainly to the volume increase of interest-bearing liabilities, total interest expense increased by $1.8 million and $3.8 million to $4.8 million and $12.4 million for the three months and nine months ended September 30, 2004, respectively, as compared with $3.0 million and $8.6 million for the same periods of 2003. Due mainly to the competition for core deposits, we increased the more expensive jumbo time deposits by 55.4% to $398.9 million in the third quarter of 2004 from $256.8 million in the same quarter a year ago. Due to the increase in jumbo time deposits and the overall increase of fund costs in the third quarter of 2004, the average interest rate we paid for interest-bearing liabilities for the third quarter increased to 2.21% from 2.12% in the third quarter of 2003. For the first nine months of 2004, the average interest on interest-bearing liabilities was 2.13% lower than the 2.2% recorded for the same period in 2003 mainly due to the lower interest rates in the first six months of 2004.

 

The combined result of our growth and the interest rate increases was an increase in net interest income. Net interest income increased by $3.4 million (43.4%) to $11.1 million and by $9.0 million (43.1%) to $29.8 million in the third quarter and first nine months of 2004, respectively, from $7.7 million and $20.8 million in the same periods of 2003. With the said increase of the more expensive jumbo time deposits, our net interest margin decreased to 3.97% in the third quarter of 2004 from 4.07% in the same quarter of 2003. However, for the first nine months of 2004, our net interest margin was slightly increased to 3.91% from 3.90% in the same period of 2003 due to the positive impact of FRB’s rate increases on our asset-sensitive position. The net interest spread also slightly decreased in the third quarter of 2004 to 3.47% from 3.51% in 2003, but increased in the first nine months of 2004 to 3.41% from 3.31% in the same periods in the prior year.

 

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Since June 30, 2004, the FRB raised its overnight lending rate three times by an aggregate of three-quarters percent to 1.75%. The Wall Street Journal Prime Rate was correspondingly increased to 4.75%. We are in an asset-sensitive position, meaning that these rate increases positively affected our net interest income, because more earning assets were immediately re-priced than interest-bearing deposits. Although we price deposits competitively with the goal to continue to fund our growing loan portfolio, our models indicate that our margin should expand in a rising interest rate environment.

 

The following table sets forth, for the periods indicated, our average balances of assets, liabilities and shareholders’ equity, in addition to the major components of net interest income and net interest margin:

 

 

 

 

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