UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2005
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------- ----------
Commission File Number: 000-23575
COMMUNITY WEST BANCSHARES
(Exact name of registrant as specified in its charter)
California 77-0446957
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
445 Pine Avenue, Goleta, California 93117
(Address of principal executive offices) (Zip Code)
(805) 692-5821
(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.
[X] YES [_] NO
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). [_] YES [X] NO
Number of shares of common stock of the registrant outstanding as of May 10,
2005: 5,745,014
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
- ------- --------------------- ----
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS 3
CONSOLIDATED INCOME STATEMENTS 4
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY 5
CONSOLIDATED STATEMENTS OF CASH FLOWS 6
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL 7
STATEMENTS
The financial statements included in this Form 10-Q should be read with
reference to Community West Bancshares' Annual Report on Form 10-K for the
fiscal year ended December 31, 2004.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 22
ITEM 4. CONTROLS AND PROCEDURES 22
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 1. LEGAL PROCEEDINGS 22
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF 22
SECURITY HOLDERS
ITEM 5. OTHER INFORMATION 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 22
SIGNATURES
- ----------
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -------- ---------------------
COMMUNITY WEST BANCSHARES
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2005 2004
(UNAUDITED)
------------ --------------
ASSETS (DOLLARS IN THOUSANDS)
Cash and due from banks $ 5,084 $ 8,769
Interest-earning deposits in other financial institutions - 9,700
Federal funds sold 10,190 11,736
------------ --------------
Cash and cash equivalents 15,274 30,205
Time deposits in other financial institutions 639 647
Investment securities available-for-sale, at fair value; amortized cost of $22,101 at
March 31, 2005 and $22,380 at December 31, 2004 21,951 22,258
Investment securities held-to-maturity, at amortized cost; fair value of $8,159 at March 31,
2005 and $6,122 at December 31, 2004 8,168 6,094
Federal Home Loan Bank stock, at cost 1,340 1,200
Federal Reserve Bank stock, at cost 812 812
Interest only strips, at fair value 2,459 2,715
Loans:
Loans held for sale, at lower of cost or fair value 42,608 45,988
Loans held for investment, net of allowance for loan losses of $2,964 at March 31, 2005 and
$2,785 at December 31, 2004 246,440 222,153
Securitized loans, net of allowance for loan losses of $1,122 at March 31, 2005 and $1,109
at December 31, 2004 20,284 22,365
------------ --------------
Total loans 309,332 290,506
Servicing assets 3,302 3,258
Other real estate owned, net 81 13
Premises and equipment, net 1,878 1,763
Other assets 5,742 5,732
------------ --------------
TOTAL ASSETS $ 370,978 $ 365,203
============ ==============
LIABILITIES
Deposits:
Non-interest-bearing demand $ 31,153 $ 44,384
Interest-bearing demand 91,429 92,395
Savings 15,259 15,370
Time certificates of $100,000 or more 44,938 40,393
Other time certificates 91,880 92,026
------------ --------------
Total deposits 274,659 284,568
Securities sold under agreements to repurchase 10,629 13,672
Federal Home Loan Bank advances 28,500 10,500
Bonds payable in connection with securitized loans 12,726 13,910
Other liabilities 6,044 4,984
------------ --------------
Total liabilities 332,558 327,634
------------ --------------
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized; shares issued and outstanding,
5,745,014 at March 31, 2005 and 5,729,869 at December 31, 2004 30,139 30,020
Retained earnings 8,369 7,621
Accumulated other comprehensive income (loss), net (88) (72)
------------ --------------
Total stockholders' equity 38,420 37,569
------------ --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 370,978 $ 365,203
============ ==============
See accompanying notes.
3
COMMUNITY WEST BANCSHARES
CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------------
2005 2004
-------------------------
(IN THOUSANDS)
INTEREST INCOME
Loans $ 5,991 $ 4,836
Investment securities 301 207
Other 36 60
------------ -----------
Total interest income 6,328 5,103
------------ -----------
INTEREST EXPENSE
Deposits 1,509 1,154
Bonds payable and other borrowings 551 785
------------ -----------
Total interest expense 2,060 1,939
------------ -----------
NET INTEREST INCOME 4,268 3,164
Provision for loan losses 170 95
------------ -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 4,098 3,069
NON-INTEREST INCOME
Gains from loan sales, net 759 928
Other loan fees 592 727
Loan servicing fees, net 149 516
Document processing fees 190 203
Other 135 118
------------ -----------
Total non-interest income 1,825 2,492
------------ -----------
NON-INTEREST EXPENSES
Salaries and employee benefits 2,937 2,797
Occupancy and equipment expenses 581 505
Professional services 285 187
Other operating expenses 739 774
------------ -----------
Total non-interest expenses 4,257 4,076
------------ -----------
Income before provision for income taxes 1,666 1,485
Provision for income taxes 688 611
------------ -----------
NET INCOME $ 978 $ 874
============ ===========
INCOME PER SHARE - BASIC $ 0.17 $ 0.15
============ ===========
INCOME PER SHARE - DILUTED $ 0.16 $ 0.15
============ ===========
See accompanying notes.
4
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
ACCUMULATED
COMMON COMMON OTHER TOTAL
STOCK STOCK RETAINED COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT EARNINGS INCOME (LOSS) EQUITY
-------------- -------------- --------------- ---------------- -----------------
(IN THOUSANDS)
BALANCES AT
JANUARY 1, 2005 5,730 $ 30,020 $ 7,621 $ (72) $ 37,569
Exercise of stock options 15 79 79
Tax benefit from stock options 40 40
Comprehensive income:
Net income 978 978
Change in unrealized losses on
securities available-for-sale, net (16) (16)
-----------------
Comprehensive income 962
Cash dividends paid
($0.04 per share) (230) (230)
-------------- -------------- --------------- ---------------- -----------------
BALANCES AT
MARCH 31, 2005 5,745 $ 30,139 $ 8,369 $ (88) $ 38,420
============== ============== =============== ================ =================
See accompanying notes.
5
COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
--------------------------
2005 2004
------------ ------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income 978 874
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 170 95
Depreciation and amortization 231 342
Net amortization of discounts and premiums for securities (9) (128)
Gains on:
Sale of other real estate owned 3 (2)
Sale of loans held for sale (670) (891)
Changes in:
Fair value of interest only strips, net of accretion 256 196
Servicing assets, net of amortization and valuation adjustments (44) (361)
Other assets (11) 986
Other liabilities 1,124 1,007
------------ ------------
Net cash provided by operating activities 2,028 2,118
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity securities (2,227) -
Purchase of available-for-sale securities - (5,933)
Purchase of Federal Home Loan Bank stock (140) (805)
Principal paydowns and maturities of held-to-maturity securities 159 996
Principal paydowns and maturities of available-for-sale securities 282 190
Unrealized accumulated gains/losses on available-for-sale securities 28 -
Loan originations and principal collections, net (18,438) (13,728)
Proceeds from sale of other real estate owned 2 529
Net decrease in time deposits in other financial institutions 8 198
Purchase of premises and equipment, net (262) (100)
------------ ------------
Net cash used in investing activities (20,588) (18,653)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of stock options 79 27
Cash dividends paid to shareholders (230) -
Net (decrease) increase in demand deposits and savings accounts (14,308) 4,178
Net increase in time certificates of deposit 4,399 8,325
Repayments of securities sold under agreements to repurchase (3,043) (139)
Proceeds from Federal Home Loan Bank Advances 18,000 -
Repayments of bonds payable in connection with securitized loans (1,268) (3,428)
------------ ------------
Net cash provided by financing activities 3,629 8,963
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (14,931) (7,572)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 30,205 22,056
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 15,274 $ 14,484
============ ============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 1,476 $ 1,526
Cash paid for income taxes - -
Supplemental Disclosure of Noncash Investing Activity:
Transfers to other real estate owned $ 112 -
See accompanying notes.
6
COMMUNITY WEST BANCSHARES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The interim consolidated financial statements reflect all adjustments and
reclassifications that, in the opinion of management, are necessary for the fair
presentation of the results of operations and financial condition for the
interim periods. The unaudited consolidated financial statements include
Community West Bancshares ("CWBC") and its wholly-owned subsidiary, Community
West Bank N.A. ("CWB"). CWBC and CWB are referred to herein as "the Company".
All adjustments and reclassifications in the periods presented are of a normal
and recurring nature. Results for the period ended March 31, 2005 are not
necessarily indicative of results that may be expected for any other interim
period or for the year as a whole.
These unaudited consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto of Community West
Bancshares included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2004.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ALLOWANCE FOR LOAN LOSSES - The Company maintains a detailed, systematic
analysis and procedural discipline to determine the amount of the allowance for
loan losses ("ALL"). The ALL is based on estimates and is intended to be
adequate to provide for probable losses inherent in the loan portfolio. This
process involves estimating probable losses that are based on individual loan
loss, migration analysis/historical loss rates and management's judgment.
The Company employs several methodologies for estimating probable losses.
Methodologies are determined based on a number of factors, including type of
asset, risk rating, concentrations, collateral value and the input of the
Special Assets group, functioning as a workout unit.
The Company calculates the required ALL on a monthly basis. Any difference
between estimated and actual observed losses from the prior month are reflected
in the current period required ALL calculation and adjusted as deemed necessary.
The Company's ALL is maintained at a level believed adequate by management to
absorb known and inherent probable losses on existing loans.
INTEREST ONLY STRIPS AND SERVICING RIGHTS - The guaranteed portion of certain
SBA loans can be sold into the secondary market. Servicing rights are recognized
at fair market value as separate assets when loans are sold with servicing
retained. Servicing rights are amortized in proportion to, and over the period
of, estimated future net servicing income. Also, at the time of the loan sale,
it is the Company's policy to recognize the related gain on the loan sale in
accordance with generally accepted accounting principles ("GAAP"). The Company
uses industry prepayment statistics and its own prepayment experience in
estimating the expected life of the loans. Management periodically evaluates
servicing rights for impairment. Servicing rights are evaluated for impairment
based upon the fair value of the rights as compared to amortized cost on a
loan-by-loan basis. Fair value is determined using discounted future cash flows
calculated on a loan-by-loan basis and aggregated to the total asset level.
Impairment to the asset is recorded if the aggregate fair value calculation
drops below the net book value of the asset. The initial servicing rights and
resulting gain on sale are calculated based on the difference between the best
actual par and premium bids on an individual loan basis. Additionally, on
certain SBA loan sales that occurred prior to 2003, the Company retained
interest only strips ("I/O Strips"), which represent the present value of excess
net cash flows generated by the difference between (a) interest at the stated
rate paid by borrowers and (b) the sum of (i) pass-through interest paid to
third-party investors and (ii) contractual servicing fees.
The I/O strips are classified as trading securities. Accordingly, the Company
records the I/O strips at fair value with the resulting increase or decrease in
fair value being recorded through operations in the current period. Quarterly,
the Company verifies the reasonableness of its valuation estimates by comparison
to the results of an independent third party valuation analysis.
SECURITIZED LOANS AND BONDS PAYABLE - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
trusts ("Trusts"). The transfers have been accounted for as secured borrowings
and, accordingly, the mortgage loans and related bonds issued are included in
the Company's consolidated balance sheets. Such loans are accounted for in the
same manner as loans held to maturity. Deferred debt issuance costs and bond
discount related to the bonds are amortized on a method that approximates the
level yield method over the estimated life of the bonds.
OTHER REAL ESTATE OWNED - Other real estate owned ("OREO") is real estate
acquired through foreclosure on the collateral property and is recorded at fair
value at the time of foreclosure less estimated costs to sell. Any excess of
loan balance over the fair value of the OREO is charged-off against the
allowance for loan losses. Subsequent to foreclosure, management periodically
performs a new valuation and the asset is carried at the lower of carrying
7
amount or fair value. Operating expenses or income, and gains or losses on
disposition of such properties, are charged to current operations.
RECENT ACCOUNTING PRONOUNCEMENTS - On December 16, 2004, the Financial
Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004),
Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting
for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and amends FASB Statement No. 95,
Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar
to the approach described in Statement 123. However, Statement 123(R) requires
all share-based payments to employees, including grants of employee stock
options, to be recognized in the income statement based on their fair values.
Pro forma disclosure will no longer be an alternative. Statement 123(R) must be
adopted no later than the first fiscal year beginning after June 15, 2005. The
Company expects to adopt Statement 123(R) as of January 1, 2006. While the
ultimate impact of adoption of this guidance is unknown at this time, the
Company does not expect the impact to be significantly different from the
proforma disclosures presented in Note 5.
2. LOAN SALES AND SERVICING
SBA LOAN SALES - The Company sells the guaranteed portion of selected SBA loans
into the secondary market, on a servicing retained basis, in exchange for a
combination of a cash premium, servicing rights and/or I/O strips. A portion of
the proceeds is recognized as servicing fee income as it occurs and the
remainder is capitalized as excess servicing and is included in the gain on sale
calculation. The Company retains the unguaranteed portion of these loans and
services the loans as required under the SBA programs to retain specified yield
amounts. The SBA program stipulates that the Company retains a minimum of 5% of
the loan balance, which is unguaranteed. The percentage of each unguaranteed
loan in excess of 5% may be periodically sold to a third party for a cash
premium. The Company records servicing liabilities for the unguaranteed loans
sold calculated based on the present value of the estimated future servicing
costs associated with each loan. A portion of this cost is included as a
reduction to the premium collected on the loan sale, and the remainder is
accrued and recognized as a reduction of servicing expense as it occurs. The
balance of all servicing rights and obligations is subsequently amortized over
the estimated life of the loans using an estimated prepayment rate of 20-25%.
Quarterly, the servicing and I/O strip assets are analyzed for impairment.
The Company also periodically sells SBA loans originated under the 504 loan
program into the secondary market, on a servicing released basis, in exchange
for a cash premium.
As of March 31, 2005 and December 31, 2004, the Company had approximately $39.9
and $43.6 million, respectively, in SBA loans held for sale.
3. LOANS HELD FOR INVESTMENT AND SECURITIZED LOANS
The composition of the Company's loans held for investment and securitized loan
portfolio follows:
MARCH 31, DECEMBER 31,
2005 2004
------------- ------------
(IN THOUSANDS)
Real estate $ 94,500 $ 85,357
Manufactured housing 73,023 66,423
SBA 40,492 35,265
Commercial 34,634 30,893
Securitized 20,998 23,005
Other installment 8,630 8,645
------------- ------------
272,277 249,588
Less:
Allowance for loan losses 4,086 3,894
Deferred fees, net of costs (100) (180)
Purchased premiums on securitized loans (340) (392)
Discount on SBA loans 1,907 1,748
------------- ------------
Loans held for investment, net $ 266,724 $ 244,518
============= ============
8
An analysis of the allowance for loan losses for loans held for investment
follows:
THREE MONTHS ENDED
MARCH 31,
------------------------
2005 2004
----------- -----------
(IN THOUSANDS)
Balance, beginning of period $ 2,785 $ 2,652
Provision for loan losses 139 152
Loans charged off (52) (1)
Recoveries on loans previously charged off 92 55
----------- -----------
Balance, end of period $ 2,964 $ 2,858
=========== ===========
An analysis of the allowance for loan losses for securitized loans follows:
THREE MONTHS ENDED
MARCH 31,
------------------------
2005 2004
----------- -----------
(IN THOUSANDS)
Balance, beginning of period $ 1,109 $ 2,024
Provision for loan losses 31 (57)
Loans charged off (247) (579)
Recoveries on loans previously charged off 229 127
----------- -----------
Balance, end of period $ 1,122 $ 1,515
=========== ===========
The recorded investment in loans that is considered to be impaired:
MARCH 31, DECEMBER 31,
2005 2004
-------------- ------------
(IN THOUSANDS)
Impaired loans without specific valuation allowances $ 88 $ 49
Impaired loans with specific valuation allowances 3,714 3,926
Specific valuation allowances allocated to impaired loans (413) (425)
-------------- ------------
Impaired loans, net $ 3,389 $ 3,550
============== ============
Average investment in impaired loans $ 3,884 $ 5,137
============== ============
4. EARNINGS PER SHARE
Earnings per share - Basic has been computed based on the weighted average
number of shares outstanding during each period. Earnings per share - Diluted
has been computed based on the weighted average number of shares outstanding
during each period plus the dilutive effect of granted options. Earnings per
share were computed as follows:
THREE MONTHS ENDED
MARCH 31,
------------------------
2005 2004
----------- -----------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
Weighted average shares - Basic 5,741 5,707
Dilutive effect of options 214 127
----------- -----------
Weighted average shares - Diluted 5,955 5,834
=========== ===========
Net income $ 978 $ 874
Earnings per share - Basic .17 .15
Earnings per share - Diluted .16 .15
9
5. STOCK-BASED COMPENSATION
STOCK-BASED COMPENSATION - GAAP permits the Company to use either of two
methodologies to account for compensation cost in connection with employee stock
options. The first method requires issuers to record compensation expense over
the period the options are expected to be outstanding prior to exercise,
expiration or cancellation. The amount of compensation expense to be recognized
over this term is the "fair value" of the options at the time of the grant as
determined by the Black-Scholes valuation model. Black-Scholes computes fair
value of the options based on the length of their term, the volatility of the
stock price in past periods and other factors. Under this method, the issuer
recognizes compensation expense regardless of whether or not the employee
eventually exercises the options.
Under the second methodology, if options are granted at an exercise price equal
to the market value of the stock at the time of the grant, no compensation
expense is recognized. The Company believes that this method better reflects the
motivation for its issuance of stock options, as they are intended as incentives
for future performance rather than compensation for past performance. GAAP
requires that issuers electing the second method must present pro forma
disclosure of net income and earnings per share as if the first method had been
elected.
The fair value of each stock option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions:
THREE MONTHS ENDED
MARCH 31,
------------------------
2005 2004
----------- -----------
Annual dividend yield 1.6% 0.0%
Expected volatility 35.0% 30.6%
Risk-free interest rate 4.3% 3.8%
Expected life (in years) 6.8 6.8
Statement of Financial Accounting Standards No. 123 requires pro forma
disclosure of net income and earnings per share using the fair value method. If
the computed fair values of the awards had been amortized to expense over the
vesting period of the awards, the Company's net income, basic net income per
share and diluted net income per share would have been reduced to the pro forma
amounts following:
THREE MONTHS ENDED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) MARCH 31,
------------------------
2005 2004
----------- -----------
Income:
As reported $ 978 $ 874
Pro forma 950 838
Income per common share - basic
As reported .17 .15
Pro forma .17 .15
Income per common share - diluted
As reported .16 .15
Pro forma .16 .14
6. BORROWINGS
REPURCHASE AGREEMENTS - The Company has a financing arrangement with a third
party by which its government-guaranteed securities can be pledged as collateral
for short-term borrowings. As of March 31, 2005 and December 31, 2004, the
Company had $10.6 million and $13.7 million, respectively, of outstanding
repurchase agreements, with interest rates of 1.75% to 2.35%, all of which
mature by July 2005. Securities with a carrying value of $11.8 million and $14.0
million were pledged as collateral for short-term borrowings as of March 31,
2005 and December 31, 2004, respectively.
FEDERAL HOME LOAN BANK ADVANCES - The Company has a blanket lien credit line
with the Federal Home Loan Bank ("FHLB") As of March 31, 2005, and December 31,
2004, the Company had $28.5 million and $10.5 million of outstanding advances
with interest rates of 1.77% to 3.28% and terms of up to three years. This total
includes $18.0 million borrowed at variable rates which adjust to current LIBOR
rate either monthly or quarterly. As of March 31, 2005 and December 31, 2004,
the Company had $33.3 million and $33.8 million of loans and $18.2 million and
$14.1 million of securities, respectively, held by the FHLB and available to be
pledged as collateral for current and future FHLB advances.
10
BONDS PAYABLE - The following is a summary of bonds payable:
MARCH 31, DECEMBER 31,
2005 2004
------------- -------------
(IN THOUSANDS)
Series 1998-1 $ - $ 179
Series 1999-1 13,243 14,332
------------- -------------
13,243 14,511
Less: Bond issuance costs 197 228
Bond discount 320 373
------------- -------------
Total bonds payable, net $ 12,726 $ 13,910
============= =============
The Series 1999-1 bonds have interest rates ranging form 7.85% - 8.75% with
stated maturity of May 25, 2025. The Series 1999-1 bonds are collateralized by
securitized loans with an outstanding balance of $15.3 million and $16.4 million
at March 31, 2005 and December 31, 2004, respectively.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This discussion is designed to provide insight into management's assessment of
significant trends related to the Company's consolidated financial condition,
results of operations, liquidity, capital resources and interest rate
sensitivity. It should be read in conjunction with the unaudited interim
consolidated financial statements and notes thereto and the other financial
information appearing elsewhere in this report. See discussion under "Factors
That May Affect Future Results of Operations" for further information on risks
and uncertainties as well as information on the strategies adopted by the
Company to address these risks.
FORWARD LOOKING STATEMENTS
This Report on Form 10-Q contains statements that constitute forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Those forward-looking statements include statements regarding the intent, belief
or current expectations of the Company and its management. Any such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties, and actual results may differ materially from those
projected in the forward-looking statements. The Company does not undertake any
obligation to revise or update publicly any forward-looking statements for any
reason.
The following discussion should be read in conjunction with the Company's
financial statements and the related notes provided under "Item 1-Financial
Statements" above.
OVERVIEW OF EARNINGS PERFORMANCE
The Company earned net income of $978,000 or $0.17 per basic share and $0.16 per
diluted share for the first quarter of 2005. This represents an 11.9% increase
in net income over the comparable period of 2004. The significant factors
impacting net income for the first quarter of 2005 were:
- Net loan portfolio growth in the first quarter of 2005 of $18.8
million, or 6.5%, primarily in commercial real estate and manufactured
housing loans.
- Continued prepayments of the securitized loans and the related
bonds which declined $2.1 million and $1.2 million, respectively, in
the first quarter of 2005.
- A net increase in total assets of $5.8 million, or 1.6%, and a
net decrease in total deposits of $9.9 million, or 3.5%, for the first
quarter of 2005.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions about future events that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ
significantly from those estimates. The Company believes that the following
discussion addresses the Company's most critical accounting policies, which are
those that are most important to the portrayal of the Company's financial
condition and results of operations and require management's most difficult,
subjective and complex judgments.
ALLOWANCE FOR LOAN LOSSES - The Company maintains a detailed, systematic
analysis and procedural discipline to determine the amount of the allowance for
loan losses ("ALL"). The ALL is based on estimates and is intended to be
adequate to provide for probable losses inherent in the loan portfolio. This
process involves estimating probable losses that are based on individual loan
loss, migration analysis/historical loss rates and management's judgment.
The Company employs several methodologies for estimating probable losses.
Methodologies are determined based on a number of factors, including type of
asset, risk rating, concentrations, collateral value and the input of the
Special Assets group, functioning as a workout unit.
The Company calculates the required ALL on a monthly basis. Any difference
between estimated and actual observed losses from the prior month are reflected
in the current period required ALL calculation and adjusted as deemed necessary.
The Company's ALL is maintained at a level believed adequate by management to
absorb known and inherent probable losses on existing loans.
INTEREST ONLY STRIPS AND SERVICING RIGHTS - The guaranteed portion of certain
SBA loans can be sold into the secondary market. Servicing rights are recognized
at fair market value as separate assets when loans are sold with servicing
retained. Servicing rights are amortized in proportion to, and over the period
of, estimated future net servicing income. Also, at the time of the loan sale,
it is the Company's policy to recognize the related gain on the loan sale in
accordance with GAAP. The Company uses industry prepayment statistics and its
own prepayment
12
experience in estimating the expected life of the loans. Management periodically
evaluates servicing rights for impairment. Servicing rights are evaluated for
impairment based upon the fair value of the rights as compared to amortized cost
on a loan-by-loan basis. Fair value is determined using discounted future cash
flows calculated on a loan-by-loan basis and aggregated to the total asset
level. Impairment to the asset is recorded if the aggregate fair value
calculation drops below the net book value of the asset. The initial servicing
rights and resulting gain on sale are calculated based on the difference between
the best actual par and premium bids on an individual loan basis. Additionally,
on certain SBA loan sales that occurred prior to 2003, the Company retained
interest only strips ("I/O Strips"), which represent the present value of excess
net cash flows generated by the difference between (a) interest at the stated
rate paid by borrowers and (b) the sum of (i) pass-through interest paid to
third-party investors and (ii) contractual servicing fees.
The I/O strips are classified as trading securities. Accordingly, the Company
records the I/O strips at fair value with the resulting increase or decrease in
fair value being recorded through operations in the current period. Quarterly,
the Company verifies the reasonableness of its valuation estimates by comparison
to the results of an independent third party valuation analysis.
SECURITIZED LOANS AND BONDS PAYABLE - In 1999 and 1998, respectively, the
Company transferred $122 million and $81 million in loans to special purpose
trusts ("Trusts"). The transfers have been accounted for as secured borrowings
and, accordingly, the mortgage loans and related bonds issued are included in
the Company's consolidated balance sheets. Such loans are accounted for in the
same manner as loans held to maturity. Deferred debt issuance costs and bond
discount related to the bonds are amortized on a method that approximates the
level yield method over the estimated life of the bonds.
OTHER REAL ESTATE OWNED - Other real estate owned ("OREO") is real estate
acquired through foreclosure on the collateral property and is recorded at fair
value at the time of foreclosure less estimated costs to sell. Any excess of
loan balance over the fair value of the OREO is charged-off against the
allowance for loan losses. Subsequent to foreclosure, management periodically
performs a new valuation and the asset is carried at the lower of carrying
amount or fair value. Operating expenses or income, and gains or losses on
disposition of such properties, are charged to current operations.
STOCK-BASED COMPENSATION - GAAP permits the Company to use either of two
methodologies to account for compensation cost in connection with employee stock
options. The first method requires issuers to record compensation expense over
the period the options are expected to be outstanding prior to exercise,
expiration or cancellation. The amount of compensation expense to be recognized
over this term is the "fair value" of the options at the time of the grant as
determined by the Black-Scholes valuation model. Black-Scholes computes fair
value of the options based on the length of their term, the volatility of the
stock price in past periods and other factors. Under this method, the issuer
recognizes compensation expense regardless of whether or not the employee
eventually exercises the options.
Under the second methodology, if options are granted at an exercise price equal
to the market value of the stock at the time of the grant, no compensation
expense is recognized. The Company believes that this method better reflects the
motivation for its issuance of stock options, as they are intended as incentives
for future performance rather than compensation for past performance. GAAP
requires that issuers electing the second method must present pro forma
disclosure of net income and earnings per share as if the first method had been
elected.
RECENT ACCOUNTING PRONOUNCEMENTS - On December 16, 2004, the Financial
Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004),
Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting
for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and amends FASB Statement No. 95,
Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar
to the approach described in Statement 123. However, Statement 123(R) requires
all share-based payments to employees, including grants of employee stock
options, to be recognized in the income statement based on their fair values.
Pro forma disclosure will no longer be an alternative. Statement 123(R) must be
adopted no later than the first fiscal year beginning after June 15, 2005. The
Company expects to adopt Statement 123(R) as of January 1, 2006. While the
ultimate impact of adoption of this guidance is unknown at this time, the
Company does not expect the impact to be significantly different from the
proforma disclosures presented in Note 5.
RESULTS OF OPERATIONS-FIRST QUARTER COMPARISON
The Company recorded net income of $978,000 for the three months ended March 31,
2005, or $.17 per share basic, compared to net income of $874,000, or $.15 per
share basic, during the three months ended March 31, 2004.
The following table sets forth for the periods indicated, certain items in the
consolidated statements of income of the Company and the related changes between
those periods:
13
THREE MONTHS ENDED
MARCH 31,
------------------------------- INCREASE
2005 2004 (DECREASE)
--------------- --------------- ----------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest income $ 6,328 $ 5,103 $ 1,225
Interest expense 2,060 1,939 121
--------------- --------------- ----------------
Net interest income 4,268 3,164 1,104
--------------- --------------- ----------------
Provision for loan losses 170 95 75
--------------- --------------- ----------------
Net interest income after provision for loan losses 4,098 3,069 1,029
Non-interest income 1,825 2,492 (667)
Non-interest expenses 4,257 4,076 181
--------------- --------------- ----------------
Income before provision for income taxes 1,666 1,485 181
Provision for income taxes 688 611 77
--------------- --------------- ----------------
Net income $ 978 $ 874 $ 104
=============== =============== ================
Earnings per share - Basic $ .17 $ .15 $ .02
=============== =============== ================
Earnings per share - Diluted $ .16 $ .15 $ .01
=============== =============== ================
Comprehensive income $ 962 $ 959 $ 3
=============== =============== ================
The following table sets forth the changes in interest income and expense
attributable to changes in rate and volume:
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2005 VERSUS 2004
-----------------------------
CHANGE DUE TO
TOTAL ------------------
CHANGE RATE VOLUME
--------- ------------------
(IN THOUSANDS)
Interest-earning deposits in other financial
institutions (including time deposits) $ (16) $ 6 $ (22)
Federal funds sold (8) 20 (28)
Investment securities 94 11 83
Loans, net 1,565 328 1,237
Securitized loans (410) (30) (380)
--------- -------- --------
Total interest-earning assets 1,225 335 890
--------- -------- --------
Interest-bearing demand 424 141 283
Savings 12 26 (14)
Time certificates of deposit (81) (33) (48)
Bonds payable (367) (59) (308)
Other borrowings 133 57 76
--------- -------- --------
Total interest-bearing liabilities 121 132 (11)
--------- -------- --------
Net interest income $ 1,104 $ 203 $ 901
========= ======== ========
Interest Income
Total interest income increased $1.2 million, or 24.0%, for the first quarter of
2005 compared to the first quarter of 2004. The increase was primarily due to
increases in interest income from loans. Loan interest income increased by $1.2
million, or 23.9%, for the first quarter of 2005 compared to 2004. Loan interest
income increased a net of $857,000, which includes a decrease in securitized
loan interest of $380,000, was due to overall loan growth. Generally, rising
interest rates contributed an additional $335,000 in interest income for all
interest-earning assets.
Interest Expense
Total interest expense increased $121,000, or 6.2%, for the first quarter of
2005 compared to 2004. Interest on deposits increased by $355,000, or 30.8%, for
the first quarter of 2005 compared to 2004. Of this increase, $221,000 was
attributed to deposit growth and $134,000 to increased interest rates on
deposits. Interest expense on bonds payable and other borrowings declined by
$234,000, or 29.8%, due to a decrease in bonds payable expense of $367,000
primarily caused by paydowns, that were partially offset by an increase in
interest expense on other borrowings of $133,000 for the comparable quarters.
Provision for Loan Losses
14
The provision for loan losses increased slightly for the first quarter of 2005
compared to the first quarter of 2004. The increase was primarily a result of
volume related provision increases due to portfolio growth adjusted for
improvements in credit quality factors and a slight decline in the provision for
the securitized loan portfolio.
Non-Interest Income
Non-interest income includes loan document fees, service charges on deposit
accounts, gains on sale of loans, servicing fees and other revenues not derived
from interest on earning assets. Total non-interest income declined by $667,000
or 26.8%, for the three months ended March 31, 2005 as compared to the same
period in 2004 primarily due to a $367,000 decrease in net loan servicing. The
decline in net servicing income was the result of increased prepayments within
the SBA 7(a) loan portfolio. In addition, net gains on loan sales declined by
$169,000 for the comparable periods due to a decrease in net premiums received
on 7(a) loan sales and a slight decline in mortgage loan refinance activity.
Total mortgage loan related non-interest income, which includes origination fees
and gains on loan sales, declined $398,000 for the first quarter of 2005
compared to 2004.
Non-Interest Expenses
Total non-interest expense increased by $181,000, or 4.4%, for the first quarter
of 2005 compared to the same period of 2004. This increase is primarily due to
a net increase in salaries and employee benefits of $140,000, or 5%.
INTEREST RATES AND DIFFERENTIALS
The following table illustrates average yields on our interest-earning assets
and average rates on our interest-bearing liabilities for the periods indicated.
These average yields and rates are derived by dividing interest income by the
average balances of interest-earning assets and by dividing interest expense by
the average balances of interest-bearing liabilities for the periods indicated.
Amounts outstanding are averages of daily balances during the applicable
periods.
THREE MONTHS
ENDED MARCH 31,
------------------------------
2005 2004
-------------- --------------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Interest-earning deposits in other financial institutions:
Average balance $ 2,364 $ 5,793
Interest income 16 32
Average yield 2.68% 2.21%
Federal funds sold:
Average balance $ 3,346 $ 10,935
Interest income 20 28
Average yield 2.40% 1.02%
Investment securities:
Average balance $ 31,730 $ 22,974
Interest income 301 207
Average yield 3.85% 3.60%
Gross loans, excluding securitized:
Average balance $ 285,010 $ 218,284
Interest income 5,328 3,763
Average yield 7.58% 6.89%
Securitized loans:
Average balance $ 22,649 $ 35,686
Interest income 663 1,073
Average yield 11.87% 12.03%
TOTAL INTEREST-EARNING ASSETS:
Average balance $ 345,099 $ 293,672
Interest income 6,328 5,103
Average yield 7.44% 7.03%
15
THREE MONTHS
ENDED MARCH 31,
------------------------------
2005 2004
-------------- --------------
(DOLLARS IN THOUSANDS)
INTEREST-BEARING LIABILITIES:
Interest-bearing demand deposits:
Average balance $ 93,495 $ 34,446
Interest expense 529 105
Average cost of funds 2.29% 1.22%
Savings deposits:
Average balance $ 15,560 $ 19,769
Interest expense 70 58
Average cost of funds 1.82% 1.17%
Time certificates of deposit:
Average balance $ 129,954 $ 136,941
Interest expense 910 991
Average cost of funds 2.84% 2.89%
Bonds payable:
Average balance $ 13,393 $ 24,657
Interest expense 370 737
Average cost of funds 11.21% 11.96%
Other borrowings:
Average balance $ 29,818 $ 14,340
Interest expense 181 48
Average cost of funds 2.46% 1.34%
TOTAL INTEREST-BEARING LIABILITIES:
Average balance $ 282,220 $ 230,153
Interest expense 2,060 1,939
Average cost of funds 2.96% 3.37%
NET INTEREST INCOME $ 4,268 $ 3,164
NET INTEREST SPREAD 4.48% 3.58%
AVERAGE NET MARGIN 5.02% 4.31%
Nonaccrual loans are included in the average balance of loans outstanding.
Net interest income is the difference between the interest and fees earned on
loans and investments and the interest expense paid on deposits and other
liabilities. The amount by which interest income will exceed interest expense
depends on the volume or balance of earning assets compared to the volume or
balance of interest-bearing deposits and liabilities and the interest rate
earned on those interest-earning assets compared to the interest rate paid on
those interest-bearing liabilities.
Net interest margin is net interest income expressed as a percentage of average
earning assets. It is used to measure the difference between the average rate of
interest earned on assets and the average rate of interest that must be paid on
liabilities used to fund those assets. To maintain its net interest margin, the
Company must manage the relationship between interest earned and paid.
FINANCIAL CONDITION
Average assets for the three months ended March 31, 2005 were $359.9 million
compared to $310.2 million for the three months ended March 31, 2004. Average
equity increased to $38.2 million for the three months ended March 31, 2005,
from $35.1 million for the same period in 2004.
The book value per share increased to $6.69 at March 31, 2005 from $6.56 at
December 31, 2004.
16
PERCENT OF
SELECTED BALANCE SHEET ACCOUNTS MARCH 31, DECEMBER 31, INCREASE INCREASE
(DOLLARS IN THOUSANDS) 2005 2004 (DECREASE) (DECREASE)
---------- ------------- ----------- -----------
Cash and cash equivalents $ 15,274 $ 30,205 $ (14,931) (49.4%)
Time deposits in other financial institutions 639 647 (8) (1.2%)
Investment securities available-for-sale 21,951 22,258 (307) (1.4%)
Investment securities held-to-maturity 8,168 6,094 2,074 34.0%
I/O strips 2,459 2,715 (256) (9.4%)
Loans-Held for sale 42,608 45,988 (3,380) (7.3%)
Loans-Held for investment, net 246,440 222,153 24,287 10.9%
Securitized loans, net 20,284 22,365 (2,081) (9.3%)
Federal Home Loan Bank stock, at cost 1,340 1,200 140 11.7%
Federal Reserve Bank stock, at cost 812 812 - -
Total Assets 370,978 365,203 5,775 1.6%
Total Deposits 274,659 284,568 (9,909) (3.5%)
Securities sold under agreements to repurchase 10,629 13,672 (3,043) (22.3%)
Federal Home Loan Bank advances 28,500 10,500 18,000 171.4%
Bonds payable in connection with securitized loans 12,726 13,910 (1,184) (8.5%)
Total Stockholders' Equity $ 38,420 $ 37,569 $ 851 2.3%
The securitized loans paid down in the first quarter of 2005 at a current
annualized rate of 37.2%. The Company has effectively focused on replacing these
loans with growth in the manufactured housing, commercial and commercial real
estate loan portfolios.
The following schedule shows the balance and percentage change in the various
deposits:
PERCENT OF
MARCH 31, DECEMBER 31, INCREASE INCREASE
2005 2004 (DECREASE) (DECREASE)
---------- ------------- ----------- -----------
(DOLLARS IN THOUSANDS)
Non-interest-bearing deposits $ 31,153 $ 44,384 $ (13,231) (29.8%)
Interest-bearing deposits 91,429 92,395 (966) (1.0%)
Savings 15,259 15,370 (111) (0.7%)
Time certificates of $100,000 or more 44,938 40,393 4,545 11.3%
Other time certificates 91,880 92,026 (146) (0.2%)
---------- ------------- ----------- -----------
Total deposits $ 274,659 $ 284,568 $ (9,909) (3.5%)
========== ============= =========== ===========
NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS
A loan is considered impaired when, based on current information, it is probable
that the Company will be unable to collect the scheduled payments of principal
or interest under the contractual terms of the loan agreement. Factors
considered by management in determining impairment include payment status,
collateral value and the probability of collecting scheduled principal and
interest payments. Loans that experience insignificant payment delays or payment
shortfalls generally are not classified as impaired. Management determines the
significance of payment delays or payment shortfalls on a case-by-case basis.
When determining the possibility of impairment, management considers the
circumstances surrounding the loan and the borrower, including the length of the
delay, the reasons for the delay, the borrower's prior payment record and the
amount of the shortfall in relation to the principal and interest owed. For
collateral-dependent loans, the Company uses the fair value of collateral method
to measure impairment. All other loans, except for securitized loans, are
measured for impairment based on the present value of future cash flows.
Impairment is measured on a loan-by-loan basis for all loans in the portfolio
except for the securitized loans, which are evaluated for impairment on a
collective basis.
17
The recorded investment in loans that is considered to be impaired:
MARCH 31, DECEMBER 31,
2005 2004
------------ ------------
(IN THOUSANDS)
Impaired loans without specific valuation allowances $ 88 $ 49
Impaired loans with specific valuation allowances 3,714 3,926
Specific valuation allowances allocated to impaired loans (413) (425)
------------ ------------
Impaired loans, net $ 3,389 $ 3,550
============ ============
Average investment in impaired loans $ 3,884 $ 5,137
============ ============
The following schedule reflects recorded investment at the dates indicated in
certain types of loans:
MARCH 31, DECEMBER 31,
2005 2004
--------------- ---------------
(DOLLARS IN THOUSANDS)
Nonaccrual loans $ 8,461 $ 8,350
SBA guaranteed portion of loans included above (5,867) (5,287)
--------------- ---------------
Nonaccrual loans, net $ 2,594 $ 3,063
=============== ===============
Troubled debt restructured loans, gross $ 123 $ 124
Loans 30 through 89 days past due with interest accruing 1,379 1,804
Allowance for loan losses to gross loans 1.30% 1.32%
CWB generally repurchases the guaranteed portion of SBA loans from investors
when those loans become past due 120 days. After the foreclosure and collection
process is complete, the SBA reimburses CWB for this principal balance.
Therefore, although these balances do not earn interest during this period, they
generally do not result in a loss of principal to CWB.
- --------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
LIQUIDITY MANAGEMENT
The Company has established policies as well as analytical tools to manage
liquidity. Proper liquidity management ensures that sufficient funds are
available to meet normal operating demands in addition to unexpected customer
demand for funds, such as high levels of deposit withdrawals or increased loan
demand, in a timely and cost effective manner. The most important factor in the
preservation of liquidity is maintaining public confidence that facilitates the
retention and growth of core deposits. Ultimately, public confidence is gained
through profitable operations, sound credit quality and a strong capital
position. The Company's liquidity management is viewed from both a long-term and
short-term perspective as well as from an asset and liability perspective.
Management monitors liquidity through regular reviews of maturity profiles,
funding sources and loan and deposit forecasts to minimize funding risk. The
Company has asset/liability committees ("ALCO") at the Board and CWB management
level to review asset/liability management and liquidity issues. The Company
maintains strategic liquidity and contingency plans. The liquidity ratio of the
Company was 22% and 27% as of March 31, 2005 and December 31, 2004,
respectively. The liquidity ratio consists of cash and due from banks, deposits
in other financial institutions, available for sale investments, federal funds
sold and loans held for sale, divided by total assets.
The Company has invested resources in the purchase of government-guaranteed
investment securities and obtained a financing arrangement, repurchase
agreements ("Repos") that allow it to pledge these securities as collateral for
short-term borrowings in case of increased liquidity needs. At March 31, 2005
and December 31, 2004, the Company had $10.6 million and $13.7 million,
respectively, of outstanding Repos, with interest rates of 1.75% to 2.35%, all
of which mature by July 2005.
As a member of the Federal Home Loan Bank of San Francisco ("FHLB"), the Company
established a credit line under which the borrowing capacity is determined using
a percentage of its total assets, subject to collateralization from the pledging
option under requirements of FHLB's "Blanket Lien". Approval in March 2005, for
FHLB's "Blanket Lien" option represents an enhancement of the Bank's borrowing
capacity with FHLB, which was previously based on "delivery status". Advances
are collateralized in the aggregate by CWB's FHLB stock, deposits maintained
with FHLB, certain mortgages or deeds of trust and securities of the U.S.
Government and its
18
agencies. The maximum amount of credit available to CWB will change in
accordance with FHLB policies. As of March 31, 2005 and December 31, 2004, the
Company had $28.5 million and $10.5 million, respectively, of FHLB advances with
interest rates of 1.77% to 3.28% and terms of up to three years. As of March 31,
2005, $18.0 million of these advances have variable interest rates that adjust
to current LIBOR rate either monthly or quarterly. As of March 31, 2005, CWB had
approximately $42.0 million available for future borrowing.
The Company, through the bank, also has the ability as a member of the Federal
Reserve System, to borrow at the discount window up to 50% of what is pledged at
the Federal Reserve Bank. The facility is available on a short-term basis,
typically overnight. CWB qualifies for primary credit as it has been deemed to
be in sound financial condition. The rate on primary credit will be 50 basis
points less than the secondary credit rate and will generally be granted on a
"no questions asked basis" at a rate that initially will be at 100 basis points
above the Federal Open Market Committee's (FOMC) target federal funds rate. As
the rate is currently not attractive, it is unlikely it will be used as a
regular source of funding, but is noted as available as an alternative funding
source.
CWB also maintains two unsecured federal funds purchased credit lines for a
total of $13.5 million from other financial institutions, which it may
periodically use for short-term liquidity needs.
CWBC's routine funding requirements primarily consist of certain operating
expenses. Normally, CWBC obtains funding to meet its obligations from dividends
collected from its subsidiary and has the capability to issue debt securities.
Federal banking laws regulate the amount of dividends that may be paid by
banking subsidiaries without prior approval.
CAPITAL RESOURCES
The Company's equity capital was $38.4 million at March 31, 2005. Under the
Prompt Corrective Action provisions of the Federal Deposit Insurance Act
("FDICIA"), national banks are assigned regulatory capital classifications based
on the specified capital ratios of the institutions. The capital classifications
are "well capitalized", "adequately capitalized", "undercapitalized",
"significantly undercapitalized" and "critically undercapitalized".
To be considered "well capitalized", an institution must have a core capital
ratio of at least 5% and a total risk-based capital ratio of at least 10%.
Additionally, FDICIA imposed in 1994 a new Tier 1 risk-based capital ratio of at
least 6% to be considered "well capitalized". Tier I risk-based capital is,
defined as common stock and retained earnings net of goodwill and other
intangible assets.
To be categorized as "well capitalized" or "adequately capitalized", CWB must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
and values as set forth in the tables below:
Risk- Adjusted Total Tier 1 Tier 1
Total Tier 1 Weighted Average Capital Capital Leverage
(dollars in thousands) Capital Capital Assets Assets Ratio Ratio Ratio
-------- -------- --------- --------- -------- -------- ---------
March 31, 2005
CWBC (Consolidated) $ 42,089 $ 38,177 $ 312,724 $ 362,900 13.46% 12.21% 10.52%
CWB 39,489 35,580 312,498 359,410 12.64 11.39 9.90
December 31, 2004
CWBC (Consolidated) 41,047 37,315 298,359 358,623 13.76% 12.51% 10.41%
CWB 38,550 34,819 298,309 354,889 12.92 11.67 9.81
Well capitalized ratios 10.00 6.00 5.00
Minimum capital ratios 8.00 4.00 4.00
- --------------------------------------------------------------------------------
SUPERVISION AND REGULATION
- --------------------------------------------------------------------------------
Banking is a complex, highly regulated industry. The banking regulatory scheme
serves not to protect investors, but is designed to maintain a safe and sound
banking system, to protect depositors and the FDIC insurance fund, and to
facilitate the conduct of sound monetary policy. In furtherance of these goals,
Congress and the states have created several largely autonomous regulatory
agencies and enacted numerous laws that govern banks, bank holding companies and
the banking industry. Consequently, the Company's growth and earnings
performance, as well as that of CWB, may be affected not only by management
decisions and general economic conditions, but also by the requirements of
applicable state and federal statutes and regulations and the policies of
various governmental regulatory authorities, including the Board of Governors of
the Federal Reserve Bank ("FRB"), the FDIC, the Office of the Comptroller of the
Currency ("OCC") and the California Department of Financial Institutions
("DFI"). For a detailed discussion of the regulatory scheme governing the
Company and CWB, please see the discussion in the
19
Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004
under the caption "Management's Discussion and Analysis of Financial Condition
and Results of Operation - Supervision and Regulation."
- --------------------------------------------------------------------------------
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
The Company's short and long-term success is subject to many factors that are
beyond its control. Shareholders and prospective investors in the Company should
carefully consider the following risk factors, in addition to other information
contained in this report. This Report on Form 10-Q contains forward-looking
statements. Those forward-looking statements include statements regarding the
intent, belief or current expectations of the Company and its management. Any
such forward-looking statements are not guarantees of future performance and
involve risks and uncertainties, and actual results may differ materially from
those projected in the forward-looking statements. Such risks and uncertainties
include:
INTEREST RATE RISK
The Company is exposed to different types of interest rate risks. These risks
include: lag, repricing, basis and prepayment risk.
- Lag Risk- lag risk results from the inherent timing difference
between the repricing of the Company's adjustable rate assets and
liabilities. For instance, certain loans tied to the prime rate index
may only reprice on a quarterly basis. However, at a community bank
such as CWB, when rates are rising, funding sources tend to reprice
more slowly than the loans. Therefore, for CWB, the effect of this
timing difference is generally favorable during a period of rising
interest rates and unfavorable during a period of declining interest
rates. This lag can produce some short-term volatility, particularly
in times of numerous prime rate changes.
- Repricing Risk - repricing risk is caused by the mismatch in the
maturities / repricing periods between interest-earning assets and
interest-bearing liabilities. If CWB was perfectly matched, the net
interest margin would expand during rising rate periods and contract
during falling rate periods. This is so since loans tend to reprice
more quickly than do funding sources. Typically, since CWB is somewhat
asset sensitive, this would also tend to expand the net interest
margin during times of interest rate increases.
- Basis Risk - item pricing tied to different indices may tend to
react differently, however, all CWB's variable products are priced off
the prime rate.
- Prepayment Risk - prepayment risk results from borrowers paying
down / off their loans prior to maturity. Prepayments on fixed-rate
products increase in falling interest rate environments and decrease
in rising interest rate environments. Since a majority of CWB's loan
originations are adjustable rate and set based on prime, and there is
little lag time on the reset, CWB does not experience significant
prepayments. However, CWB does have more prepayment risk on its
securitized and manufactured housing loans and its mortgage-backed
investment securities. Offsetting the prepayment risk on the
securitized loans are the related bonds payable, which were issued at
a fixed rate. When the bonds payable prepay, given the current
interest rate environment, this reduces CWB's interest expense as a
higher, fixed rate is, in effect, traded for a lower, variable rate
funding source.
MANAGEMENT OF INTEREST RATE RISK
To mitigate the impact of changes in market interest rates on the Company's
interest-earning assets and interest-bearing liabilities, the amounts and
maturities are actively managed. Short-term, adjustable-rate assets are
generally retained as they have similar repricing characteristics as our funding
sources. CWB sells mortgage products and a portion of its SBA loan originations.
While the Company has some interest rate exposure in excess of five years, it
has internal policy limits designed to minimize risk should interest rates rise.
Currently, the Company does not use derivative instruments to help manage risk,
but will consider such instruments in the future if the perceived need should
arise.
Loan sales - The Company's ability to originate, purchase and sell loans is also
significantly impacted by changes in interest rates. Increases in interest rates
may also reduce the amount of loan and commitment fees received by CWB. A
significant decline in interest rates could also decrease the size of the CWB's
servicing portfolio and the related servicing income by increasing the level of
prepayments.
20
OPERATIONAL RISK
Operational risk represents the risk of loss resulting from the Company's
operations, including but not limited to, the risk of fraud by employees or
persons outside the Company, the execution of unauthorized transactions by
employees, transaction processing errors and breaches of internal control system
and compliance requirements. This risk of loss also includes the potential legal
actions that could arise as a result of an operational deficiency or as a result
of noncompliance with applicable regulatory standards, adverse business
decisions or their implementation and customer attrition due to potential
negative publicity.
Operational risk is inherent in all business activities and the management of
this risk is important to the achievement of the Company's objectives. In the
event of a breakdown in the internal control system, improper operation of
systems or improper employee actions, the Company could suffer financial loss,
face regulatory action and suffer damage to its reputation. The Company manages
operational risk through a risk management framework and its internal control
processes. The framework involves business units, corporate risk management
personnel and executive management. Under this framework, the business units
have direct and primary responsibility and accountability for identifying,
controlling and monitoring operational risk. Business unit managers maintain a
system of controls with the objective of providing proper transaction
authorization and execution, proper system operations, safeguarding of assets
from misuse or theft and ensuring the reliability of financial and other data.
Business unit managers ensure that the controls are appropriate and are
implemented as designed. Business continuation and disaster recovery planning is
also critical to effectively manage operational risks. The Company's internal
audit function (currently outsourced to a third party) validates the system of
internal controls through risk-based regular and ongoing audit procedures and
reports on the effectiveness of internal controls to executive management and
the Audit Committee of the Board.
While the Company believes that it has designed effective methods to minimize
operational risks, there is no absolute assurance that business disruption or
operational losses would not occur in the event of disaster.
DEPENDENCE ON REAL ESTATE
Approximately 45% of the loan portfolio of the Company is secured by various
forms of real estate, including residential and commercial real estate. A
decline in current economic conditions or rising interest rates could have an
adverse effect on the demand for new loans, the ability of borrowers to repay
outstanding loans and the value of real estate and other collateral securing
loans. The real estate securing the Company's loan portfolio is concentrated in
California. If real estate values decline significantly, especially in
California, the change could harm the financial condition of the Company's
borrowers, the collateral for its loans will provide less security and the
Company would be more likely to suffer losses on defaulted loans.
CURTAILMENT OF GOVERNMENT GUARANTEED LOAN PROGRAMS COULD AFFECT A SEGMENT OF THE
COMPANY'S BUSINESS
A major segment of the Company's business consists of originating and selling
government guaranteed loans, in particular those guaranteed by the SBA. From
time to time, the government agencies that guarantee these loans reach their
internal limits and cease to guarantee loans. In addition, these agencies may
change their rules for loans or Congress may adopt legislation that would have
the effect of discontinuing or changing the programs. Non-governmental programs
could replace government programs for some borrowers, but the terms might not be
equally acceptable. Therefore, if these changes occur, the volume of loans to
small business, industrial and agricultural borrowers of the types that now
qualify for government guaranteed loans could decline. Also, the profitability
of these loans could decline. As the funding and sale of the guaranteed portion
of 7(a) loans is a significant portion of the Company's business, the long-term
resolution to the funding for the 7(a) loan program may have an unfavorable
impact on the Company's future performance and results of operations.
ECONOMIC CONDITIONS
The economy continued to expand at a moderate pace in the first quarter of 2005.
The retail, housing and manufacturing sectors of the economy all showed strength
as did travel and tourism. Banks have reported stronger lending activity,
particularly in business lending, while the Federal Reserve has continued to
raise the Federal discount rate, now at 2.75%. These increases to the discount
rate tend to enhance net interest margin for asset-sensitive financial
institutions but may be tempered by a lending environment that remains very
competitive.
COMPETITION
The banking industry is highly competitive. The Company faces competition not
only from other financial institutions within the markets it serves, but
deregulation has resulted in competition from companies not typically associated
with financial services as well as companies accessed through the internet. As a
community bank, the Company attempts to combat this increased competition by
developing and offering new products and increased quality of services.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no material change in the Company's market risk since the end of
the last fiscal year. For information about the Company's market risk, see the
information contained in the Company's Annual Report on Form 10-K under the
caption "Item 7A. Quantitative and Qualitative Disclosure about Market Risk,"
which is incorporated herein by this reference.
ITEM 4. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer, with the
participation of the Company's management, carried out an evaluation of the
effectiveness of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15(e). Based upon that evaluation, the Chief Executive
Officer and the Chief Financial Officer believe that, as of the end of the
period covered by this report, the Company's disclosure controls and procedures
are effective in making known to them material information relating to the
Company (including its consolidated subsidiaries) required to be included in
this report.
Disclosure controls and procedures, no matter how well designed and implemented,
can provide only reasonable assurance of achieving an entity's disclosure
objectives. The likelihood of achieving such objections is affected by
limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
There was no change in the Company's internal control over financial reporting,
known to the Chief Executive Officer or the Chief Financial Officer, that
occurred during the period covered by this report that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- ------ -----------------
The Company is involved in various litigation of a routine nature that is being
handled and defended in the ordinary course of the Company's business. In the
opinion of management, based in part on consultation with legal counsel, the
resolution of these litigation matters will not have a material impact on the
Company's financial position or results of operations.
ITEM 2. CHANGES IN SECURTIES AND USE OF PROCEEDS
- ------- ----------------------------------------
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ------- -------------------------------
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
Not applicable
ITEM 5. OTHER INFORMATION
- ------- -----------------
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------- --------------------------------
(a) Exhibits.
31.1 Certification by the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by the Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
22
32.1 Certification Pursuant to 18 U.S.C. 1350 adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
January 28, 2005: The Company furnished a Current Report on Form
8-K to report that, on January 27, 2005, the Company issued a press
release announcing its financial results for the quarter and year
ended December 31, 2004 and declared a dividend.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COMMUNITY WEST BANCSHARES
-------------------------
(Registrant)
Date: May 10, 2005 /s/Charles G. Baltuskonis
-------------------------
Charles G. Baltuskonis
Executive Vice President and
Chief Financial Officer
On Behalf of Registrant and as
Principal Financial and Accounting Officer
24
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
======= ===================================================================================================
31.1 Certification of Chief Executive Officer of the Registrant pursuant to Rule 13a-14(a) and Rule 15d-
14(a), promulgated under the Securities and Exchange Act of 1934, as amended.
31.2 Certification of Chief Financial Officer of the Registrant pursuant to Rule 13a-14(a) and Rule 15d-
14(a), promulgated under the Securities and Exchange Act of 1934, as amended.
32.1* Certification of Chief Executive Officer and Chief Financial Officer of the Registrant pursuant to
Rule 13a-13(b) and Rule 15d-14(b), promulgated under the Securities Exchange Act of 1934, as
amended, and 18 U.S.C.1350.
====================
* This certification is furnished to, but not filed, with the Commission.
This certification shall not be deemed to be incorporated by reference into
any filing under the Securities Act of 1933 or the Securities Exchange Act
of 1934, except to the extent that the Registrant specifically incorporates
it by reference.
25