ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In the following pages, Management discusses its analysis of the financial condition and results of operations for the
first quarter of 2013
compared to the
first quarter of 2012
and to the
fourth quarter of 2012
. This discussion should be read in conjunction with the related consolidated financial statements in this Form 10-Q and with the audited consolidated financial statements and accompanying notes included in our 2012 Annual Report on Form 10-K. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.
Forward-Looking Statements
This discussion of financial results includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the "1933 Act") and Section 21E of the Securities Exchange Act of 1934, as amended, (the "1934 Act"). Those sections of the 1933 Act and 1934 Act provide a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their financial performance so long as they provide meaningful, cautionary statements identifying important factors that could cause actual results to differ significantly from projected results.
Our forward-looking statements include descriptions of plans or objectives of Management for future operations, products or services, and forecasts of its revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words "believe," "expect," "intend," "estimate" or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could" or "may."
Forward-looking statements are based on Management's current expectations regarding economic, legislative, and regulatory issues that may impact our earnings in future periods. A number of factors—many of which are beyond Management’s control—could cause future results to vary materially from current Management expectations. Such factors include, b
ut are not limited to, general economic conditions, the economic uncertainty in the United States and abroad, changes in interest rates, deposit flows, real estate values, expected future cash flows on acquired loans, and competition; changes in accounting principles, policies or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory and technological factors affecting Bancorp's operations, pricing, products and services. These and other important factors are detailed in the Risk Factors section of our 2012 Form 10-K as filed with the SEC, c
opies of which are available from us at no charge. Forward-looking statements speak only as of the date they are made. We do not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
Highlights of the financial results are presented in the following table:
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For the three months ended
|
|
(dollars in thousands, except per share data; unaudited)
|
March 31, 2013
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|
|
December 31, 2012
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|
|
March 31, 2012
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|
|
For the period:
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Net income
|
$
|
4,866
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|
|
$
|
4,702
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|
|
$
|
4,940
|
|
|
Net income per share
|
|
|
|
|
|
|
|
|
|
Basic
|
$
|
0.90
|
|
|
$
|
0.88
|
|
|
$
|
0.93
|
|
|
Diluted
|
$
|
0.89
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|
|
$
|
0.86
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|
|
$
|
0.91
|
|
|
Return on average equity
|
12.76
|
|
%
|
12.50
|
|
%
|
14.39
|
|
%
|
Return on average assets
|
1.38
|
|
%
|
1.28
|
|
%
|
1.41
|
|
%
|
Common stock dividend payout ratio
|
19.96
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%
|
20.58
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%
|
18.28
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%
|
Average shareholders’ equity to average total assets
|
10.83
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%
|
10.27
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%
|
9.79
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%
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Efficiency ratio
|
57.36
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%
|
54.42
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%
|
54.96
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%
|
Tax equivalent net interest margin
|
4.48
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%
|
4.62
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|
%
|
4.97
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|
%
|
|
|
|
|
|
|
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At period end:
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|
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|
|
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Book value per common share
|
$
|
28.88
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|
|
$
|
28.17
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|
|
$
|
26.18
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Total assets
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$
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1,427,022
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|
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$
|
1,434,749
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|
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$
|
1,421,284
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|
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Total loans
|
$
|
1,071,835
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|
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$
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1,073,952
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|
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$
|
1,032,207
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Total deposits
|
$
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1,231,551
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|
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$
|
1,253,289
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|
|
$
|
1,245,641
|
|
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Loan-to-deposit ratio
|
87.0
|
|
%
|
85.7
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|
%
|
82.9
|
|
%
|
Total risk based capital ratio - Bancorp
|
14.0
|
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%
|
13.7
|
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%
|
13.6
|
|
%
|
Executive Summary
Earnings totaled $4.9 million for the first quarter of 2013, compared to $4.7 million in the fourth quarter of 2012, and $4.9 million in the first quarter of 2012. Diluted earnings per share totaled
$0.89
in the first quarter of 2013, compared to
$0.86
in the prior quarter and
$0.91
in the same period last year.
Our strong performance demonstrates the solid customer relationships we have built while also maintaining our high credit quality standards. Gross loans totaled $1.1 billion at March 31, 2013, up $39.6 million or 3.8% when compared to $1.0 billion at March 31, 2012. However, the current competitive banking environment continues to be a challenge for community banks. Gross loans remained relatively unchanged at March 31, 2013 when compared to December 31, 2012. Loan fundings in the first quarter totaled $39.1 million, offset by payoffs/payments of $41.2 million.
Credit quality remains solid as classified loans continue to trend downward to $31.1 million at the end of the first quarter of 2013, compared to $36.9 million at December 31, 2012 and $55.6 million a year ago. Non-performing loans totaled $15.3 million, or 1.43% of the total loan portfolio at March 31, 2013, compared to $17.7 million, or 1.64% at December 31, 2012 and $14.4 million, or 1.40% a year ago. The decrease in non-performing loans from the prior quarter primarily relates to a commercial loan that is being paid down gradually as the borrower liquidates collateral, and pay-downs on two commercial real estate loans.
As a result of the release of specific reserves, primarily due to improved collateral values related to the receipt of updated appraisals, as well as net recoveries, and a lower level of non-performing loans, we reversed $230 thousand of the provision for loan losses in the first quarter of 2013. The provision for loan losses totaled $700 thousand in the prior quarter and there was no provision in the same quarter a year ago. Net recoveries in the first quarter of 2013 totaled $3 thousand, compared to charge-offs of $178 thousand in the prior quarter and charge-offs of $1.1 million in the first quarter of 2012.
Deposits totaled
$1.2 billion
at
March 31, 2013
compared to
$1.3 billion
at
December 31, 2012
. Non-interest bearing deposits totaled 39.5% of total deposits at
March 31, 2013
, compared to 31.1% in the prior quarter and 32.9% a year ago.
The total risk-based capital ratio for Bancorp grew to 14.0%, up from 13.7% at
December 31, 2012
, and continues to be well above industry requirements for a well-capitalized institution.
The continued low interest rate environment has resulted in net interest margin compression. Net interest income in the
first quarter of 2013
totaled
$14.8 million
, compared to
$15.8 million
last quarter and
$16.2 million
in the first quarter of 2012. The tax-equivalent net interest margin was
4.48%
in the
first quarter of 2013
compared to
4.62%
in the prior quarter and
4.97%
in the first quarter last year. The decrease in the net interest income and the tax-equivalent net interest margin in the first quarter of 2013 compared to the prior quarter primarily relate to 1) a decline in gains on pay-offs of purchased credit-impaired ("PCI") loans recognized in interest income; 2) a lower level of accretion on PCI loans; 3) rate concessions and downward repricing on existing loans; and 4) lower yields on new loans due to the low interest rate environment. These decreases are partially offset by a shift in the mix of average interest-earning assets from lower-yielding due from banks toward higher-yielding loans, as well as a higher level of accretion on non-credit impaired acquired loans. Going forward, we expect to see continued pressure on the margin, as the low interest rate environment is expected to continue. As the higher yielding loans repay and investment securities are called or mature, we expect them to continue to be replaced at the lower market rates. In this historically low interest rate environment, our cost of deposits totaled 12 basis points for the three months ended
March 31, 2013
, which does not leave much room for additional downward pricing of deposits to manage pressure on the net interest margin. Nonetheless, we continue to focus on growing our loan volume, which would favorably impact our net interest margin. Our loan pipeline is currently strong. Average loan balances increased by $42.2 million when compared to the prior quarter and we expect continued loan growth in 2013.
Non-interest income in the
first quarter of 2013
totaled
$2.1 million
, compared to
$1.8 million
last quarter, an increase of $290 thousand, or 16.0%. Non-interest income increased $411 thousand, or 24.2% from
$1.7 million
in the first quarter of 2012. The increase in the first quarter compared to the prior periods primarily relates to a $223 thousand BOLI death benefit, as well as higher Wealth Management and Trust Services income due to new assets and market value appreciation of existing assets.
Non-interest expense totaled
$9.7 million
in the
first quarter of 2013
, compared to
$9.6 million
in the prior quarter and
$9.8 million
in the first quarter of 2012.
We reported a provision for income taxes of
$2.6 million
at an effective tax rate of 34.6%, compared to
$2.6 million
at an effective tax rate of 35.8% in the previous quarter and
$3.1 million
at an effective tax rate of 38.7% in the same quarter of last year. There are normal fluctuations in the effective tax rate from period to period based on the relationship of net permanent differences to income before tax.
Critical Accounting Policies
Critical accounting policies are those that are both most important to the portrayal of our financial condition and results of operations and require Management's most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Management has determined the following five accounting policies to be critical: Allowance for Loan Losses, Acquired Loans, Other-than-temporary Impairment of Investment Securities, Accounting for Income Taxes and Fair Value Measurements.
Allowance for Loan Losses
Allowance for loan losses is based upon estimates of loan losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan portfolio. The allowance is increased by provisions charged to expense and reduced by charge-offs, net of recoveries. In periodic evaluations of the adequacy of the allowance balance, Management considers our past loan loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors. We formally assess the adequacy of the allowance for loan losses on a quarterly basis. These assessments include the periodic re-grading of loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment, and other factors as warranted. Loans are initially graded when originated. They are reviewed as they are renewed, when there is a new loan to the same borrower and/or when facts demonstrate heightened risk of default. Confirmation of the quality of our grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies. Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are deemed impaired, formal impairment measurement is performed at least quarterly on a loan-by-loan basis.
Our method for assessing the appropriateness of the allowance includes specific allowances for identified problem loans, an allowance factor for categories of credits, and allowances for changing environmental factors (e.g., portfolio trends, concentration of credit, growth and economic factors). Allowances for identified problem loans are based on specific analysis of individual credits. Loss estimation factors for loan categories are based on analysis of local economic factors applicable to each loan category, including consideration of our charge-off history. Allowances for changing environmental factors are Management's best estimate of the probable impact on the loan portfolio as a whole.
For our methodology on estimating the allowance for loan losses on acquired loans, refer to the section
Acquired Loans
below
.
Acquired Loans
Acquired loans are recorded at their estimated fair values at acquisition date in accordance with ASC 805
Business Combinations
, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded for acquired loans as of the acquisition date.
The process of estimating fair values of the acquired loans, including the estimate of losses that are expected to be incurred over the estimated remaining lives of the loans at acquisition date and the ongoing updates to Management's expectation of future cash flows, requires significant subjective judgments and assumptions, particularly considering the current economic environment. The economic environment and the lack of market liquidity and transparency are factors that have influenced, and may continue to affect, these assumptions and estimates.
We estimated the fair value of acquired loans at the acquisition date based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, risk classification, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques. The estimate of expected cash flows incorporates our best estimate of current key assumptions, such as property values, default rates, loss severity and prepayment speeds. The discount rates used for loans were based on current market rates for new originations of comparable loans, where available, and include adjustments for liquidity concerns.
To the extent comparable market rates are not readily available, a discount rate was derived based on the assumptions of market participants' cost of funds, servicing costs and return requirements for comparable risk assets. In either case, the discount rate does not include a factor for credit losses, as that has been considered in estimating the cash flows. The initial estimate of cash flows to be collected was derived from assumptions such as default rates, loss severities and prepayment speeds.
In conjunction with the Acquisition, we purchased certain loans with evidence of credit quality deterioration subsequent to their origination and for which it was probable, at acquisition, that we would be unable to collect all contractually required payments. Management has applied significant subjective judgment in determining which loans are PCI loans. Evidence of credit quality deterioration as of the purchase date may include data such as past due and nonaccrual status, risk grades and recent loan-to-value percentages. Revolving credit agreements (e.g. home equity lines of credit and revolving commercial loans), where the borrower had revolving privileges at acquisition date, are not considered PCI loans because the timing and amount of cash flows cannot be reasonably estimated.
The accounting guidance for PCI loans provides that the excess of the cash flows initially expected to be collected over the fair value of the loans at the acquisition date (i.e., the accretable yield) should be accreted into interest income at a level rate of return over the remaining term of the loan, provided that the timing and amount of future cash flows is reasonably estimable. The difference between the contractually required payments and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference and is not recorded.
The initial estimate of cash flows expected to be collected is updated each quarter and requires the continued usage of key assumptions and estimates similar to the initial estimate of fair value. Given the current economic environment, we apply judgment to develop our estimate of cash flows for PCI loans given the impact of real estate value changes, changing probability of default, loss severities and prepayment speeds.
For purposes of accounting for the PCI loans purchased in the Acquisition, we elected not to apply the pooling method but to account for these loans individually. Disposals of loans, which may include sales of loans to third parties, receipt of payments in full by the borrower, or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.
If we have probable and significant increases in cash flows expected to be collected on PCI loans, we first reverse any previously established allowance for loan loss and then increase interest income as a prospective yield adjustment over the remaining life of the loans. The impact of changes in variable interest rates is recognized prospectively as adjustments to interest income. All PCI loans that were classified as nonperforming loans prior to Acquisition were no longer classified as nonperforming because, at Acquisition, we believed that we would fully collect the new carrying value of these loans. Subsequent to Acquisition, specific allowances are allocated to PCI loans that have experienced credit deterioration through an increase to the allowance for loan losses.
The amount of cash flows expected to be collected and, accordingly, the adequacy of the allowance for loan losses are particularly sensitive to changes in loan credit quality. When there is doubt as to the timing and amount of future cash flows to be collected, PCI loans are classified as non-accrual loans. It is important to note that judgment is required to classify PCI loans as performing or non-accrual, and is dependent on having a reasonable expectation about the timing and amount of cash flows expected to be collected.
For acquired loans not considered PCI loans, we elect to recognize the entire fair value discount accretion based on the acquired loan's contractual cash flows using an effective interest rate method for term loans, and on a straight line basis to interest income for revolving lines, as the timing and amount of cash flows under revolving lines are not predictable. Subsequent to Acquisition, if the probable and estimable losses for non-PCI loans exceed the amount of the remaining unaccreted discount, the excess is established as an allowance for loan losses.
For further information regarding our acquired loans, see Note 5 to our Consolidated Financial Statements in this Form 10-Q.
Other-than-temporary Impairment of Investment Securities
At each financial statement date, we assess whether declines in the fair value of held-to-maturity and available-for-sale securities below their costs are deemed to be other than temporary. We consider, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. Evidence evaluated includes, but is not limited to, the remaining payment terms of the instrument and economic factors that are relevant to the collectability of the instrument, such as: current prepayment speeds, the current financial condition of the issuer(s), industry analyst reports, credit ratings, credit default rates, interest rate trends and the value of any underlying collateral. Credit-related other-than-temporary impairment results in a charge to earnings and the corresponding establishment of a new cost basis for the security. Non-credit-related other-than-temporary impairment results in a charge to other comprehensive income, net of applicable taxes, and the corresponding establishment of a new cost basis for the security. The other-than-temporary impairment recognized in other comprehensive income for debt securities classified as held-to-maturity is accreted from other comprehensive income to the amortized cost of the debt security over the remaining life of the debt security in a prospective manner on the basis of the amount and timing of future estimated cash flows.
Accounting for Income Taxes
Income taxes reported in the financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences that have been recognized in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more likely than not that they will be realized. In evaluating our ability to recover the deferred tax assets, Management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, Management develops assumptions including the amount of future state and federal pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. Bancorp files consolidated federal and combined state income tax returns.
We recognize the financial statement effect of a tax position when it is more likely than not, based on the technical merits and all available evidence, that the position will be sustained upon examination, including the resolution through protests, appeals or litigation processes. For tax positions that meet the more-likely-than-not threshold, we measure the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described previously is recognized as a liability for unrecognized tax benefits, along with any related interest and penalties. Interest and penalties related to unrecognized tax benefits are recognized as a component of tax expenses.
In deciding whether or not our tax positions taken meet the more-likely-than-not recognition threshold, we must make judgments and interpretations about the application of inherently complex state and federal tax laws. To the extent tax authorities disagree with tax positions taken by us, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. Revision of our estimate of accrued income taxes also may result from our own income tax planning, which may affect our effective tax rates and our results of operations for any given quarter.
Fair Value Measurements
We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Securities available-for-sale and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record certain assets at fair value on a non-recurring basis, such as purchased loans recorded at acquisition date, certain impaired loans held for investment and securities held-to-maturity that are other-than-temporarily impaired. These non-recurring fair value adjustments typically involve write-downs of individual assets due to application of lower-of-cost or market accounting.
We have established and documented a process for determining fair value. We maximize the use of observable inputs when developing fair value measurements. Whenever there is no readily available market data, Management uses its best estimate and assumptions in determining fair value, but these estimates involve inherent uncertainties and the application of Management's judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures could have been materially different from those reflected in these financial statements. For detailed information on our use of fair value measurements and our related valuation methodologies, see Note 3 to the Consolidated Financial Statements in this Form 10-Q.
Net Interest Income
Net interest income is the difference between the interest earned on loans, investments and other interest-earning assets and the interest expense incurred on deposits and other interest-bearing liabilities. Net interest income is impacted by changes in general market interest rates and by changes in the amounts and composition of interest-earning assets and interest-bearing liabilities. Interest rate changes can create fluctuations in the net interest margin due to an imbalance in the timing of repricing or maturity of assets or liabilities. We manage interest rate risk exposure with the goal of minimizing the impact of interest rate volatility on net interest margin.
Net interest margin is expressed as net interest income divided by average interest-earning assets. Net interest rate spread is the difference between the average rate earned on total interest-earning assets and the average rate incurred on total interest-bearing liabilities. Both of these measures are reported on a taxable-equivalent basis. Net interest margin is the higher of the two because it reflects interest income earned on assets funded with non-interest-bearing sources of funds, which include demand deposits and stockholders’ equity.
The following table, Average Statements of Condition and Analysis of Net Interest Income, compares interest income and average interest-earning assets with interest expense and average interest-bearing liabilities for the periods presented. The table also indicates net interest income, net interest margin and net interest rate spread for each period presented.
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|
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|
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|
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Average Statements of Condition and Analysis of Net Interest Income
|
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Three months ended
|
|
Three months ended
|
|
Three months ended
|
|
|
March 31, 2013
|
|
December 31, 2012
|
|
March 31, 2012
|
|
|
|
Interest
|
|
|
|
Interest
|
|
|
|
Interest
|
|
|
|
Average
|
Income/
|
Yield/
|
|
Average
|
Income/
|
Yield/
|
|
Average
|
Income/
|
Yield/
|
(Dollars in thousands; unaudited)
|
Balance
|
Expense
|
Rate
|
|
Balance
|
Expense
|
Rate
|
|
Balance
|
Expense
|
Rate
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing due from banks
1
|
$
|
5,710
|
|
$
|
8
|
|
0.56
|
%
|
|
$
|
80,884
|
|
$
|
66
|
|
0.32
|
%
|
|
$
|
87,101
|
|
$
|
50
|
|
0.23
|
%
|
|
Investment securities
2, 3
|
284,429
|
|
1,780
|
|
2.50
|
%
|
|
265,316
|
|
1,779
|
|
2.68
|
%
|
|
198,243
|
|
1,710
|
|
3.45
|
%
|
|
Loans
1, 3, 4
|
1,062,957
|
|
13,808
|
|
5.20
|
%
|
|
1,020,737
|
|
14,788
|
|
5.67
|
%
|
|
1,028,573
|
|
15,473
|
|
5.95
|
%
|
|
Total interest-earning assets
1
|
1,353,096
|
|
15,596
|
|
4.61
|
%
|
|
1,366,937
|
|
16,633
|
|
4.76
|
%
|
|
1,313,917
|
|
17,233
|
|
5.19
|
%
|
|
Cash and non-interest-bearing due from banks
|
28,250
|
|
|
|
|
44,225
|
|
|
|
|
52,011
|
|
|
|
|
Bank premises and equipment, net
|
9,425
|
|
|
|
|
9,173
|
|
|
|
|
9,383
|
|
|
|
|
Interest receivable and other assets, net
|
37,892
|
|
|
|
|
37,512
|
|
|
|
|
34,808
|
|
|
|
Total assets
|
$
|
1,428,663
|
|
|
|
|
$
|
1,457,847
|
|
|
|
|
$
|
1,410,119
|
|
|
|
Liabilities and Stockholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing transaction accounts
|
$
|
129,379
|
|
$
|
11
|
|
0.03
|
%
|
|
$
|
160,605
|
|
$
|
14
|
|
0.03
|
%
|
|
$
|
143,159
|
|
$
|
44
|
|
0.12
|
%
|
|
Savings accounts
|
96,561
|
|
8
|
|
0.03
|
%
|
|
91,609
|
|
16
|
|
0.07
|
%
|
|
78,831
|
|
22
|
|
0.11
|
%
|
|
Money market accounts
|
432,154
|
|
99
|
|
0.09
|
%
|
|
442,006
|
|
145
|
|
0.13
|
%
|
|
436,333
|
|
183
|
|
0.17
|
%
|
|
CDARS® time accounts
|
12,866
|
|
5
|
|
0.16
|
%
|
|
22,497
|
|
11
|
|
0.19
|
%
|
|
40,091
|
|
32
|
|
0.32
|
%
|
|
Other time accounts
|
140,254
|
|
232
|
|
0.67
|
%
|
|
141,375
|
|
241
|
|
0.68
|
%
|
|
149,228
|
|
304
|
|
0.82
|
%
|
|
FHLB fixed-rate and overnight advances
1
|
18,513
|
|
79
|
|
1.71
|
%
|
|
15,010
|
|
80
|
|
2.08
|
%
|
|
19,835
|
|
107
|
|
2.13
|
%
|
|
Subordinated debenture
1
|
—
|
|
—
|
|
—
|
%
|
|
—
|
|
—
|
|
—
|
%
|
|
5,000
|
|
40
|
|
3.16
|
%
|
|
Total interest-bearing liabilities
|
829,727
|
|
434
|
|
0.21
|
%
|
|
873,102
|
|
507
|
|
0.23
|
%
|
|
872,477
|
|
732
|
|
0.34
|
%
|
|
Demand accounts
|
429,335
|
|
|
|
|
420,517
|
|
|
|
|
384,774
|
|
|
|
|
Interest payable and other liabilities
|
14,892
|
|
|
|
|
14,524
|
|
|
|
|
14,814
|
|
|
|
|
Stockholders' equity
|
154,709
|
|
|
|
|
149,704
|
|
|
|
|
138,054
|
|
|
|
Total liabilities & stockholders' equity
|
$
|
1,428,663
|
|
|
|
|
$
|
1,457,847
|
|
|
|
|
$
|
1,410,119
|
|
|
|
Tax-equivalent net interest income/margin
1
|
|
$
|
15,162
|
|
4.48
|
%
|
|
|
$
|
16,126
|
|
4.62
|
%
|
|
|
$
|
16,501
|
|
4.97
|
%
|
Reported net interest income/margin
1
|
|
$
|
14,796
|
|
4.37
|
%
|
|
|
$
|
15,791
|
|
4.52
|
%
|
|
|
$
|
16,201
|
|
4.88
|
%
|
Tax-equivalent net interest rate spread
|
|
|
4.40
|
%
|
|
|
|
4.53
|
%
|
|
|
|
4.85
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
Interest income/expense is divided by actual number of days in the period times 360 days to correspond to stated interest rate terms, where applicable.
|
2
Yields on available-for-sale securities are calculated based on amortized cost balances rather than fair value, as changes in fair value are reflected as a component of stockholders' equity. Investment security interest is earned on 30/360 day basis monthly.
|
3
Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the Federal statutory rate of 35 percent.
|
4
Average balances on loans outstanding include non-performing loans. The amortized portion of net loan origination fees is included in interest income on loans, representing an adjustment to the yield.
|
First Quarter of 2013 Compared to First Quarter of 2012
The tax-equivalent net interest margin was
4.48%
in the
first quarter of 2013
, compared to
4.97%
in the same quarter last year. The decrease of forty-nine basis points was primarily due to a lower yield on interest-earning assets, mainly relating to rate concessions and downward repricing on existing loans, as well as new loans yielding lower rates. In addition, a lower level of accretion on purchased loans and a lower level of gains on pay-offs of PCI loans were recorded in the
first quarter of 2013
compared to a year ago. These decreases were partially offset by a shift in the mix of interest-earning assets from lower-yielding interest-bearing due from banks towards higher-yielding loans and securities, as well as the downward repricing of deposits. The net interest spread decreased forty-five basis points over the same period for the same reasons.
The average yield on interest-earning assets decreased fifty-eight basis points in the
first quarter of 2013
compared to the
first quarter of 2012
due to the reasons listed above. The loan portfolio as a percentage of average interest-earning assets was 79% and 78% for the
first quarter of 2013
and the
first quarter of 2012
, respectively. Total average
interest-earning assets increased $39.2 million, or 3.0%, in the
first quarter of 2013
, compared to the
first quarter of 2012
.
The average rate on interest-bearing liabilities decreased thirteen basis points in the
first quarter of 2013
compared to the same period a year ago. A higher-costing FHLB advance matured in January 2012 and offered rates on all interest-bearing deposits were reduced since the
first quarter of 2012
.
Market interest rates are, in part, based on the target Federal funds interest rate (the interest rate banks charge each other for short-term borrowings) implemented by the Federal Reserve Open Market Committee. In December of 2008, the target interest rate reached a historic low with a range of 0% to 0.25% where it remains as of
March 31, 2013
. Other monetary policy measures taken by the Federal Reserve, including quantitative easing, also impact the interest rate environment. In September of 2012, the Federal Reserve announced a third round of quantitative easing, which is expected to exert further downward pricing pressure on our interest-earning assets as interest rates remain low.
First Quarter of 2013 Compared to Fourth Quarter of 2012
The tax-equivalent net interest margin was
4.48%
in the
first quarter of 2013
, compared to
4.62%
in the prior quarter. The decrease of fourteen basis points was primarily due to a lower yield on interest-earning assets, mainly relating to a lower level of gains on pay-offs of PCI loans and a lower level of accretion on PCI loans. In addition, rate concessions and downward repricing on existing loans, as wells as new loans yielding lower rates continue to negatively impact the loan yield. The decreases were partially offset by a shift in the mix of interest-earning assets from lower-yielding interest-bearing due from banks towards higher-yielding loans, as well as a higher level of accretion on non-credit impaired loans. The net interest spread decreased thirteen basis points over the same period for the same reasons.
The average yield on interest-earning assets decreased fifteen basis points in the
first quarter of 2013
compared to the
fourth quarter of 2012
due to the reasons listed above. The loan portfolio as a percentage of average interest-earning assets was 79% and 75% for the
first quarter of 2013
and the
fourth quarter of 2012
, respectively. Total average interest-earning assets decreased $13.8 million, or 1.0%, in the
first quarter of 2013
, compared to the
fourth quarter of 2012
.
Provision for Loan Losses
Management assesses the adequacy of the allowance for loan losses on a quarterly basis based on several factors including growth of the loan portfolio, analysis of probable losses in the portfolio, recent loss experience and the current economic climate. Actual losses on loans are charged against the allowance, and the allowance is increased by loss recoveries and through the provision for loan losses charged to expense. For further discussion, see the section captioned “Critical Accounting Policies.”
As a result of the release of specific reserves, primarily due to improved collateral values related to the receipt of updated appraisals, as well as net recoveries, and a lower level of non-performing loans, $230 thousand of the provision for loan losses was reversed in the first quarter of 2013. The provision for loan losses totaled
$700 thousand
in the prior quarter and zero in the same quarter a year ago.
The allowance for loan losses totaled
1.25%
of loans at
March 31, 2013
, compared to
1.27%
at
December 31, 2012
and
1.31%
at
March 31, 2012
. Non-performing loans totaled
$15.3 million
, or
1.43%
of Bancorp's loan portfolio at
March 31, 2013
, compared to
$17.7 million
, or
1.64%
at
December 31, 2012
and
$14.4 million
, or
1.40%
a year ago. The decrease in non-performing loans from the prior quarter primarily relates to a commercial loan that is being paid down gradually as the borrower liquidates collateral, and pay-downs on two commercial real estate loans.
Impaired loan balances decreased to $27.2 million at
March 31, 2013
, compared to $30.3 million at
December 31, 2012
and $41.7 million at
March 31, 2012
, with specific valuation allowances of $1.9 million, $2.4 million, and $1.9 million, respectively. The decrease in impaired loan balances from March 31, 2012 is primarily due to the removal of two impaired construction loans totaling $5.9 million that paid-off, an impaired commercial loan that decreased $3.9 million as it is being paid-down gradually as the borrower liquidates the collateral and the partial charge-off of an impaired commercial real estate loan totaling $2.0 million.
Net recoveries in the
first
quarter of
2013
totaled
$3 thousand
, compared to net charge-offs of
$178 thousand
in the prior quarter and net charge-offs of
$1.1 million
in the
first quarter of 2012
. The percentage of net charge-offs to average loans was
0.00%
in the
first quarter of 2013
, compared to
0.02%
in the
fourth quarter of 2012
, and
0.11%
in the
first quarter of 2012
.
Non-interest Income
The table below details the components of non-interest income.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2013
|
|
March 31, 2013
|
|
|
|
|
|
compared to
|
|
compared to
|
|
|
|
|
|
December 31, 2012
|
|
March 31, 2012
|
|
Three months ended
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
(dollars in thousands; unaudited)
|
March 31, 2013
|
|
December 31,
2012
|
|
March 31, 2012
|
|
|
Increase (Decrease)
|
|
|
Increase (Decrease)
|
|
|
Increase (Decrease)
|
|
|
Increase (Decrease)
|
|
Service charges on deposit accounts
|
$
|
521
|
|
$
|
529
|
|
$
|
524
|
|
|
$
|
(8
|
)
|
|
(1.5
|
)%
|
|
$
|
(3
|
)
|
|
(0.6
|
)%
|
Wealth Management and Trust Services
|
547
|
|
513
|
|
456
|
|
|
34
|
|
|
6.6
|
%
|
|
91
|
|
|
20.0
|
%
|
Debit card interchange fees
|
252
|
|
261
|
|
234
|
|
|
(9
|
)
|
|
(3.4
|
)%
|
|
18
|
|
|
7.7
|
%
|
Merchant interchange fees
|
205
|
|
177
|
|
193
|
|
|
28
|
|
|
15.8
|
%
|
|
12
|
|
|
6.2
|
%
|
Earnings on Bank-owned life insurance
|
401
|
|
190
|
|
188
|
|
|
211
|
|
|
111.1
|
%
|
|
213
|
|
|
113.3
|
%
|
Other income
|
180
|
|
146
|
|
100
|
|
|
34
|
|
|
23.3
|
%
|
|
80
|
|
|
80.0
|
%
|
Total non-interest income
|
$
|
2,106
|
|
$
|
1,816
|
|
$
|
1,695
|
|
|
$
|
290
|
|
|
16.0
|
%
|
|
$
|
411
|
|
|
24.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
First quarter 2013 service charges on deposit accounts decreased slightly when compared to the prior quarter and the same quarter last year primarily due to less overdraft fees. This was partially offset by higher business analysis fee income due to decreases in the earnings rate credit in the second and third quarters of 2012 and the first quarter of 2013.
The increase in Wealth Management and Trust Services income, when compared to the prior quarter and the same quarter a year ago is due to the acquisition of new assets and market value appreciation of existing assets under management. Assets under management totaled approximately $304.4 million at
March 31, 2013
, $285.4 million at
December 31, 2012
and $276.0 million at
March 31, 2012
.
Debit card interchange fees in the
first quarter of 2013
decreased slightly when compared to the prior quarter, primarily due to a decrease in the volume of debit card usage. The increase when compared to the same quarter in 2012 is primarily attributable to a steady increase in the volume of debit card usage during 2012.
Merchant interchange fees increased in the
first quarter of 2013
when compared to both the prior quarter and the same quarter a year ago due to actions resulting from a customer profitability review, as well as the addition of a new vendor.
Bank-owned life insurance (“BOLI”) income increased when compared to both the prior quarter and the same quarter a year ago due to a $223 thousand death benefit realized on the death of an insured employee.
Other income increased
for the three months ended March 31, 2013
when compared to the previous quarter, primarily due to net losses in the fourth quarter of 2012 on disposals of fixed assets, as well as a gain on the sale of repossessed assets in the first quarter of 2013. The increase in other income from the same quarter last year is due to losses on the sales of investments and repossessed assets in the first quarter of 2012 totaling $41 thousand that did not recur. The increase is also due to higher current quarter income from our FHLB stock.
Non-interest Expense
The table below details the components of non-interest expense.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2013
|
|
March 31, 2013
|
|
|
|
|
|
|
|
compared to
|
|
compared to
|
|
|
|
|
|
December 31, 2012
|
|
March 31, 2012
|
|
Three months ended
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
(dollars in thousands; unaudited)
|
March 31, 2013
|
|
|
December 31,
2012
|
|
|
March 31, 2012
|
|
|
Increase (Decrease)
|
|
|
Increase (Decrease)
|
|
|
Increase (Decrease)
|
|
|
Increase (Decrease)
|
|
Salaries and related benefits
|
$
|
5,298
|
|
|
$
|
5,010
|
|
|
$
|
5,604
|
|
|
$
|
288
|
|
|
5.7
|
%
|
|
$
|
(306
|
)
|
|
(5.5
|
)%
|
Occupancy and equipment
|
1,073
|
|
|
1,098
|
|
|
987
|
|
|
(25
|
)
|
|
(2.3
|
)%
|
|
86
|
|
|
8.7
|
%
|
Depreciation and amortization
|
336
|
|
|
334
|
|
|
341
|
|
|
2
|
|
|
0.6
|
%
|
|
(5
|
)
|
|
(1.5
|
)%
|
Federal Deposit Insurance Corporation
|
214
|
|
|
245
|
|
|
233
|
|
|
(31
|
)
|
|
(12.7
|
)%
|
|
(19
|
)
|
|
(8.2
|
)%
|
Data processing
|
549
|
|
|
652
|
|
|
606
|
|
|
(103
|
)
|
|
(15.8
|
)%
|
|
(57
|
)
|
|
(9.4
|
)%
|
Professional services
|
527
|
|
|
720
|
|
|
585
|
|
|
(193
|
)
|
|
(26.8
|
)%
|
|
(58
|
)
|
|
(9.9
|
)%
|
Other non-interest expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Advertising
|
117
|
|
|
129
|
|
|
115
|
|
|
(12
|
)
|
|
(9.3
|
)%
|
|
2
|
|
|
1.7
|
%
|
Other expense
|
1,581
|
|
|
1,394
|
|
|
1,364
|
|
|
187
|
|
|
13.4
|
%
|
|
217
|
|
|
15.9
|
%
|
Total other non-interest expense
|
1,698
|
|
|
1,523
|
|
|
1,479
|
|
|
175
|
|
|
11.5
|
%
|
|
219
|
|
|
14.8
|
%
|
Total non-interest expense
|
$
|
9,695
|
|
|
$
|
9,582
|
|
|
$
|
9,835
|
|
|
$
|
113
|
|
|
1.2
|
%
|
|
$
|
(140
|
)
|
|
(1.4
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salary and benefit expenses increased when comparing the
first quarter of 2013
to the
fourth quarter of 2012
, mainly due to higher payroll taxes, 401k matching and incentive bonuses, partially offset by higher capitalized and deferred loan boarding costs. Salaries and benefits decreased in the
first quarter of 2013
when compared to the
first quarter of 2012
due to higher capitalized and deferred loan boarding costs and lower incentive bonus, partially offset by higher salaries.
Occupancy and equipment expenses decreased when compared to the prior quarter primarily due to lower common area maintenance expenses at our headquarter office and Sonoma branch. The increase when compared to the same quarter a year ago is primarily due to costs related to the relocation of our Tiburon branch and the expansion of our headquarter office, as well as higher rent in our headquarter office, partially offset by lower rent in our relocated Tiburon office.
Depreciation and amortization expenses remained relatively unchanged compared to the prior quarter and the same quarter a year ago.
FDIC insurance expenses decreased when compared to the prior quarter and the same quarter a year ago, primarily due to a lower assessment rate.
The decrease in data processing expenses when compared to the previous quarter primarily reflects a one-time charge in the fourth quarter of 2012 for our upgraded general ledger system. The decrease in data processing in the first quarter of 2013 from the same quarter a year ago primarily reflects the re-negotiation and execution of a new contract with our current data processing vendor that resulted in a reduction of our ongoing data processing expenses effective July 1, 2012.
Professional service expenses decreased when compared to the prior quarter and the same quarter a year ago. The decrease when compared to prior quarter is primarily due to decreases in legal fees (reflecting a $118 thousand reimbursement of loan workout costs from a customer) and accounting fees relating to internal audit services. The decrease in professional service expenses in the
first quarter of 2013
compared to the
first quarter of 2012
is mainly due to a decrease in legal fees and accounting fees as discussed above, partially offset by increases in investment advisory fees and other professional fees.
Advertising expenses decreased when compared to the prior quarter primarily due to the timing of our various bank advertising programs. Advertising expenses remained relatively unchanged from the same quarter a year ago.
Other expenses in the
first quarter of 2013
increased when compared to the prior quarter and the
first quarter of 2012
. The increase when compared to the prior quarter is primarily due to increases in promotion and development expenses, the provision for losses on off-balance sheet commitments, education and training expenses and information technology costs. The increase in other expenses compared to the same quarter last year primarily reflected increases in promotion and development expenses, a higher provision for losses on off-balance sheet commitments, director expenses and information technology costs.
Provision for Income Taxes
The provision for income taxes for the
first quarter of 2013
is
$2.6 million
at an effective tax rate of 34.6%, compared to
$2.6 million
at an effective tax rate of 35.8% in the previous quarter and
$3.1 million
at an effective tax rate of 38.7% in the same quarter last year. These provisions reflect accruals for taxes at the applicable rates for federal income tax and California franchise tax based upon pre-tax income, and adjusted for the effects of all permanent differences between income for tax and financial reporting purposes (such as earnings on qualified municipal securities, BOLI and certain tax-exempt loans). Therefore, there are normal fluctuations in the effective rate from period to period based on the relationship of net permanent differences to income before tax.
Bancorp and the Bank have entered into a tax allocation agreement which provides that income taxes shall be allocated between the parties on a separate entity basis. The intent of this agreement is that each member of the consolidated group will incur no greater tax liability than it would have incurred on a stand-alone basis.
We file a consolidated return in the U.S. Federal tax jurisdiction and a combined return in the State of California tax jurisdiction. We are no longer subject to tax examinations by taxing authorities for years beginning before 2009 for U.S. Federal or before 2008 for California. There were no federal or state income tax examinations at the issuance of this report.
In 2012, the California Franchise Tax Board ("FTB") examined our 2009 and 2010 corporation income tax returns. We received the final notice of proposed adjustments and paid
$80 thousand
in connection with the enterprise zone net interest deduction in the fourth quarter of 2012.
FINANCIAL CONDITION
Summary
During the first three months of 2013, total assets decreased $7.7 million, or 0.5%, to
$1.4 billion
. This decrease in assets primarily reflects a decrease in investment securities of $11.8 million and net loans of $1.9 million, partially offset by increases in cash and cash equivalents of $3.0 million and interest receivable and other assets of $2.9 million. While we had a relatively strong level of loan originations this year, it was more than offset by early pay-offs and refinancing activity, in line with current market pressure and strong competition for quality loans, as well as maturities. The following table presents the composition of our loans outstanding by class:
|
|
|
|
|
|
|
|
|
Loans Outstanding
(Dollars in thousands; March 31, 2013 unaudited)
|
March 31, 2013
|
|
|
December 31, 2012
|
|
Commercial and industrial
|
$
|
175,735
|
|
|
$
|
176,431
|
|
Real estate
|
|
|
|
|
|
Commercial owner-occupied
|
196,803
|
|
|
196,406
|
|
Commercial investor-owned
|
509,829
|
|
|
509,006
|
|
Construction
|
32,835
|
|
|
30,665
|
|
Home equity
|
90,495
|
|
|
93,237
|
|
Other residential
1
|
45,879
|
|
|
49,432
|
|
Installment and other consumer loans
|
20,259
|
|
|
18,775
|
|
Total loans
|
1,071,835
|
|
|
1,073,952
|
|
Allowance for loan losses
|
(13,434
|
)
|
|
(13,661
|
)
|
Total net loans
|
$
|
1,058,401
|
|
|
$
|
1,060,291
|
|
1
Our residential loan portfolio includes no sub-prime loans, nor is it our normal practice to underwrite loans commonly referred to as "Alt-A mortgages", the characteristics of which are loans lacking full documentation, borrowers having low FICO scores or collateral compositions reflecting high loan-to-value ratios. However, substantially all of our residential loans are indexed to Treasury Constant Maturity Rates and have provisions to reset five years after their origination dates.
As of
March 31, 2013
, impaired loans totaled $27.2 million (including TDRs of $17.3 million), compared to $30.3 million (including TDRs of $18.3 million) at
December 31, 2012
. Non-performing loans totaled $15.3 million or 1.43% of Bancorp's loan portfolio at
March 31, 2013
, compared to $17.7 million, or 1.64%, at
December 31, 2012
. The decrease in non-performing loans from the prior quarter is primarily related to a commercial loan that is being paid down gradually as the borrower liquidates collateral, and pay-downs on two commercial real estate loans. Accruing loans past due 30 to 89 days totaled $8.1 million at
March 31, 2013
and $588 thousand at
December 31, 2012
. The increase in past due loans in the first quarter of
2013 primarily relates to four loans totaling $7.1 million that have been renewed subsequent to quarter end.
Our investment securities portfolio decreased $11.8 million in the first three months of 2013, primarily due to $9.6 million of pay-downs and the sale of two available-for-sale privately issued CMO securities totaling $1.1 million. Investment securities in our portfolio that may be backed by mortgages having sub-prime or Alt-A features (certain privately issued CMOs) represent 6.0% of our total investment portfolio at
March 31, 2013
, compared to 6.4% at
December 31, 2012
.
At
March 31, 2013
, other assets included BOLI of $22.6 million, compared to $22.7 million at
December 31, 2012
. Other assets also include net deferred tax assets of $8.8 million and $6.7 million at
March 31, 2013
and
December 31, 2012
, respectively. These deferred tax assets consist primarily of tax benefits expected to be realized in future periods related to temporary differences for the allowance for loan losses, depreciation, state tax, stock-based compensation and deferred compensation. Management believes these assets to be realizable due to our consistent record of earnings and the expectation that earnings will continue at a level adequate to realize such benefits.
During the first three months of 2013, total liabilities decreased $12.8 million, primarily due to a decrease in deposits of $21.7 million, partially offset by an increase in FHLB overnight borrowings of $8.2 million. The lower level of deposits primarily reflects a decline in money market accounts reflecting fluctuations in the normal course of business. Non-interest bearing deposits increased $96.2 million to $485.9 million at
March 31, 2013
. The increase in non-interest
bearing deposits in the first quarter is primarily due to a strategic product change consisting of the discontinuation of interest on one type of consumer account. This resulted in a reclassification of the accounts from interest-bearing transaction to non-interest bearing accounts, with the affected balances totaling $87.3 million as of
March 31, 2013
. Non-interest bearing deposits comprised 39.5% of total deposits at
March 31, 2013
, compared to 31.1% at
December 31, 2012
.
Stockholders’ equity increased $5.1 million to $156.8 million during the first three months of 2013. The increase in stockholders’ equity primarily reflects the net income accumulated during the period, partially offset by cash dividends to shareholders.
Capital Adequacy
We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and the Bank’s prompt corrective action classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not directly applicable to bank holding companies such as Bancorp.
Quantitative measures established by regulation to ensure capital adequacy require Bancorp and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to quarterly average assets.
Capital ratios are reviewed by Management on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs. For all periods presented, the Bank’s ratios exceed the regulatory definition of “well capitalized” under the regulatory framework for prompt corrective action and Bancorp’s ratios exceed the required minimum ratios for capital adequacy purposes.
In December 2010, the Basel Committee on Bank Supervision finalized a set of international guidelines for determining regulatory capital known as “Basel III.” These guidelines were developed to address many of the perceived weaknesses in the banking industry that contributed to the past financial crisis, including excessive leverage, inadequate and low quality capital and insufficient liquidity buffers. The guidelines, among other things, increase minimum capital requirements of bank holding companies, including increasing the Tier 1 capital to risk-weighted assets ratio to 6%, introducing a new requirement to maintain a minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% initially and when fully phased in, a possible capital conservation buffer of an additional 2.5% of risk weighted assets. In June 2012, the U.S. regulatory bodies issued a set of proposed rules to implement Basel III that if adopted, would have come into effect on January 1, 2013 (subject to phase-in period). However, in light of the volume of comments received, and the wide range of views expressed during the comment period, the U.S. regulatory bodies decided to postpone the implementation of Basel III and are taking operational and other considerations into account to determine the appropriate implementation dates and associated transition periods. Additionally, a bipartisan letter has been sent to U.S. regulatory bodies signed by a majority of members of the U.S. Senate urging regulators to consider the impact that Basel III capital standards would have on "community banks" and the difference between community banks and large, complex financial institutions. The U.S. regulatory bodies are carefully considering these and all comments, and hope to finalize the rulemaking in the second quarter of 2013 or later. We continue to monitor the development of the proposed rules and their potential impact. We have modeled our ratios under the proposed rules and we do not expect that we would be required to hold a significantly larger amount of capital than we currently hold.
The Bank’s and Bancorp’s capital adequacy ratios as of
March 31, 2013
and
December 31, 2012
are presented in the following tables.
|
|
|
|
|
|
|
|
|
|
|
|
Capital Ratios for Bancorp
(in thousands; March 31, 2013 unaudited)
|
Actual Ratio
|
|
Ratio to Capital
Adequacy Purposes
|
As of March 31, 2013
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
Ratio
|
Total Capital (to risk-weighted assets)
|
$
|
168,930
|
|
|
13.96
|
%
|
|
≥$96,826
|
|
≥ 8.0%
|
Tier 1 Capital (to risk-weighted assets)
|
$
|
154,965
|
|
|
12.80
|
%
|
|
≥$48,413
|
|
≥ 4.0%
|
Tier 1 Capital (to average assets)
|
$
|
154,965
|
|
|
10.87
|
%
|
|
≥$57,011
|
|
≥ 4.0%
|
|
|
|
|
|
|
|
|
As of December 31, 2012
|
|
|
|
|
|
|
|
|
|
Total Capital (to risk-weighted assets)
|
$
|
163,900
|
|
|
13.71
|
%
|
|
≥$95,655
|
|
≥ 8.0%
|
Tier 1 Capital (to risk-weighted assets)
|
$
|
149,737
|
|
|
12.52
|
%
|
|
≥$47,827
|
|
≥ 4.0%
|
Tier 1 Capital (to average assets)
|
$
|
149,737
|
|
|
10.30
|
%
|
|
≥$58,169
|
|
≥ 4.0%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital Ratios for the Bank
(in thousands; March 31, 2013 unaudited)
|
Actual Ratio
|
|
Ratio for Capital Adequacy Purposes
|
|
Ratio to be Well Capitalized under Prompt Corrective Action Provisions
|
As of March 31, 2013
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
Total Capital (to risk-weighted assets)
|
$
|
163,645
|
|
|
13.52
|
%
|
|
≥$96,824
|
|
≥ 8.0%
|
|
≥$121,030
|
|
≥ 10.0%
|
Tier 1 Capital (to risk-weighted assets)
|
$
|
149,680
|
|
|
12.37
|
%
|
|
≥$48,412
|
|
≥ 4.0%
|
|
≥$72,618
|
|
≥ 6.0%
|
Tier 1 Capital (to average assets)
|
$
|
149,680
|
|
|
10.50
|
%
|
|
≥$57,010
|
|
≥ 4.0%
|
|
≥$71,262
|
|
≥ 5.0%
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital (to risk-weighted assets)
|
$
|
162,554
|
|
|
13.60
|
%
|
|
≥$95,652
|
|
≥ 8.0%
|
|
≥$119,566
|
|
≥ 10.0%
|
Tier 1 Capital (to risk-weighted assets)
|
$
|
148,391
|
|
|
12.41
|
%
|
|
≥$47,826
|
|
≥ 4.0%
|
|
≥$71,739
|
|
≥ 6.0%
|
Tier 1 Capital (to average assets)
|
$
|
148,391
|
|
|
10.20
|
%
|
|
≥$58,168
|
|
≥ 4.0%
|
|
≥$72,710
|
|
≥ 5.0%
|
Liquidity
The goal of liquidity management is to provide adequate funds to meet both loan demand and unexpected deposit withdrawals. We accomplish this goal by maintaining an appropriate level of liquid assets, and formal lines of credit with the FHLB, FRB and correspondent banks that enable us to borrow funds as needed. Our Asset/Liability Management Committee (“ALCO”), which is comprised of certain directors of the Bank, is responsible for establishing and monitoring our liquidity targets and strategies.
Management regularly adjusts our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning securities and the objectives of our asset/liability management program. ALCO has also developed a contingency plan should liquidity drop unexpectedly below internal requirements.
We obtain funds from the repayment and maturity of loans as well as deposit inflows, investment security maturities and pay-downs, Federal funds purchases, FHLB advances, and other borrowings. Our primary uses of funds are the origination of loans, the purchase of investment securities, withdrawals of deposits, maturity of certificate of deposits, repayment of borrowings and dividends to common stockholders.
We must retain and attract new deposits, which depends upon the variety and effectiveness of our customer account products, service and convenience, and rates paid to customers, as well as our financial strength. Any long-term decline in retail deposit funding would adversely impact our liquidity. The Transaction Account Guarantee ("TAG") program, which fully insured non-interest bearing transactions, expired on December 31, 2012. We have not experienced any significant impact on our liquidity from the expiration of TAG. We do have borrowing capacity through
FHLB and FRB that can be drawn upon. Management anticipates our strong liquidity position will provide adequate liquidity to fund our operations. We have adequate collateral for such funding requirements.
As presented in the accompanying unaudited consolidated statements of cash flows, the sources of liquidity vary between periods. Our cash and cash equivalents at
March 31, 2013
totaled
$31.4 million
, an increase of
$3.0 million
over December 31, 2012. The primary sources of funds during the first three months of 2013 included $9.6 million in pay-downs and maturities of investment securities, $
1.9 million
from net loan principal collected, $8.2 million borrowed from FHLB and
$4.1 million
net cash provided by operating activities. The primary uses of funds were a decline in deposits amounting to $21.7 million which were primarily due to fluctuations in customer balances in the normal course of business, as well as declines in customer balances transferred for investment uses. The banking industry is still experiencing diminished loan demand from qualified borrowers and strong competition.
At
March 31, 2013
, our cash and cash equivalents and unpledged available-for-sale securities with estimated maturities within one year totaled $38.1 million. The remainder of the unpledged available for sale securities portfolio of $135.9 million provides additional liquidity. These liquid assets equaled 12.2% of our assets at
March 31, 2013
, compared to 12.7% at December 31, 2012.
We anticipate that cash and cash equivalents on hand and other sources of funds will provide adequate liquidity for our operating, investing and financing needs and our regulatory liquidity requirements for the foreseeable future. Management monitors our liquidity position daily, balancing loan funding/payments with changes in deposit activity and overnight investments. Our emphasis on local deposits combined with our well capitalized equity position, provides a very stable funding base. In addition to cash and cash equivalents, we have substantial additional borrowing capacity including unsecured lines of credit totaling $87.0 million with correspondent banks. Further, we have pledged a certain residential loan portfolio to secure our borrowing capacity with the FRB, which totaled $27.3 million at
March 31, 2013
. As of
March 31, 2013
, there is no debt outstanding to correspondent banks or the FRB. We are also a member of the FHLB and have a line of credit (secured under terms of a blanket collateral agreement by a pledge of essentially all of our financial assets) in the amount of $352.3 million, of which $329.1 million was available at
March 31, 2013
. Borrowings under the line are limited to eligible collateral. The interest rates on overnight borrowings with both correspondent banks and the FHLB are determined daily and generally approximate the Federal Funds target rate.
Undisbursed loan commitments, which are not reflected on the consolidated statements of condition, totaled
$265.3 million
at
March 31, 2013
at rates ranging from
1.75%
to
18.00%
. This amount included
$159.1 million
under commercial lines of credit (these commitments are contingent upon customers maintaining specific credit standards),
$74.6 million
under revolving home equity lines,
$7.3 million
under undisbursed construction loans,
$13.7 million
under standby letters of credit, and a remaining
$10.6 million
under personal and other lines of credit. These commitments, to the extent used, are expected to be funded primarily through the repayment of existing loans, deposit growth and existing balance sheet liquidity. Over the next twelve months $89.7 million of time deposits will mature. We expect these funds to be replaced with new time deposits.
Since Bancorp is a holding company and does not conduct regular banking operations, its primary sources of liquidity are dividends from the Bank. Under the California Financial Code, payment of a dividend from the Bank to Bancorp without advance regulatory approval is restricted to the lesser of the Bank’s retained earnings or the amount of the Bank’s undistributed net profits from the previous three fiscal years. The primary uses of funds for Bancorp are shareholder dividends and ordinary operating expenses. Bancorp held $5.2 million of cash at
March 31, 2013
. Bancorp obtained a dividend distribution from the Bank of $5.0 million in February of 2013, which is anticipated to be sufficient to meet Bancorp's funding requirements through February 2014.