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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934. For the fiscal year ended December 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE
ACT OF 1934. For the transition period from __________ to __________
Commission file number: 000-49892
PACIFIC STATE BANCORP
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
California 61-1407606
- --------------------------------------------- -------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
1889 W. March Lane
Stockton, CA 95207
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (209) 870-3213
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share
As of March 15, 2004, there were 1,700,301 shares of the Registrant's Common
Stock outstanding.
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference to Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 126-2 of the Exchange Act. Yes [ ] No [X]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $7,858,651 as of June 30, 2003, which was the last
business day of the Company's most recently completed second fiscal quarter.
This calculation does not reflect a determination that certain persons are
affiliates of the Registrant for any other purpose.
DOCUMENTS INCORPORATED BY REFERENCE
Annual Report to Security Holders for
Fiscal Year Ended December 31, 2003 (Part II)
Proxy Statement for 2004 Annual Meeting of Shareholders (Part III)
TABLE OF CONTENTS
-----------------
Page
PART 1.
Item 1. Business........................................................ 3
Item 2. Properties....................................................... 9
Item 3. Legal Proceedings................................................ 10
Item 4. Submission of Matters to a Vote of Security Holders.............. 10
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters........................................................ 10
Item 6. Selected Financial Data.......................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....... 11
Item 8. Financial Statements and Supplemental Data....................... 11
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure........................................... 11
Item 9A Controls and Procedures.......................................... 11
PART III.
Item 10. Directors and Executive Officers of the Registrant............... 12
Item 11. Executive Compensation........................................... 12
Item 12. Security Ownership of Certain Beneficial Owners and Management... 12
Item 13. Certain Relationships and Related Transactions................... 12
Item 14. Principal Accountant Fees and Services........................... 12
PART IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on
Form 8-K....................................................... 13
Signatures....................................................... 14
Index of Exhibits................................................ 18
PACIFIC STATE BANCORP
STOCKTON, CALIFORNIA
FORM 10-K
FISCAL YEAR ENDED DECEMBER 31, 2003
PART I
------
ITEM 1. BUSINESS.
--------
Certain statements discussed or incorporated by reference in this
Annual Report including, but not limited to, information concerning possible or
assumed future results of operations of the Company set forth matters in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations, are forward-looking statements within the meaning of the Securities
Exchange Act of 1934 (the "Exchange Act"). Forward-looking statements include
statements in which words such as "expect," "anticipate," "intend," "plan,"
"believe," "estimate," "consider" or similar expressions are used. The Company's
actual future results and shareholder values may differ materially from those
anticipated and expressed in these forward-looking statements, which are based
on management's beliefs and assumptions and on information currently available
to management, and are subject to risks and uncertainties that could cause
actual results to differ materially from those projected. Such risks and
uncertainties include, among others, (1) competitive pressures in the banking
industry; (2) changes in the interest rate environment; (3) general economic
conditions, either nationally or regionally; (4) changes in the regulatory
environment; (5) changes in business conditions and inflation; and (6) changes
in securities markets. Many of these factors are beyond the Company's ability to
control or predict. Investors are cautioned not to put undue reliance on any
forward-looking statements. In addition, the Company does not have any intention
or obligation to update forward-looking statements contained in this Annual
Report, even if new information, future events or other circumstances have made
them incorrect or misleading. Except as specifically noted herein all references
to the "Company" refer to Pacific State Bancorp, a California corporation.
General Description of Business
-------------------------------
Pacific State Bancorp is a holding company with one bank subsidiary,
Pacific State Bank, (the "Bank"), and two unconsolidated subsidiary guarantor
trusts, Pacific State Statutory Trusts I and II. Pacific State Bancorp commenced
operations on June 24, 2002 when it acquired all the then issued and outstanding
shares of Pacific State Bank under a plan of reorganization approved by the
Bank's shareholders on May 9, 2002. The Bank is a California state chartered
bank and the Bank is a member of the Federal Reserve System. The Bank's primary
source of revenue is providing loans to customers who are predominately small to
middle-market businesses and middle-income individuals. Pacific State Statuatory
Trusts I and II are unconsolidated, wholly owned statutory business trusts
formed in June 2002 and March 2004 for the exclusive purpose of issuing and
selling trust preferred securities.
The Bank has engaged since November 2, 1987 in a general commercial
banking business, primarily in Stockton and San Joaquin County, and offers
commercial banking services to residents and employers of businesses in the
Bank's service area, including professional firms and small to medium sized
retail and wholesale businesses and manufacturers. The Company as of January 22,
2004 had 60 employees, including 26 officers. The Bank does not engage in any
non-bank lines of business. The business of the Bank is not to any significant
degree seasonal in nature. The Bank has no operations outside California and has
no material amount of loans or deposits concentrated among any one or few
persons, groups or industries. The Bank's main office is located at 6 So. El
Dorado Street, in Stockton, California; additional branches are located
elsewhere in Stockton and in the communities of Angels Camp, Arnold, Groveland,
Modesto and Tracy, California.
Business Plan
-------------
The focus of the Company's business plan is to attract "middle market"
accounts, but not to the exclusion of any other business which the Company can
reasonably and profitably attract. In order to provide a level of service to
attract such customers, the Company has structured its specific services and
charges on a basis which management believes to be profitable, taking into
consideration other aspects of the account relationship. The Company offers a
range of banking services to its customers intended to attract the following
specific types of accounts: relatively large consumer accounts; professional
group and association accounts, including the accounts of groups or firms of
physicians, dentists, attorneys and accountants; and accounts of small to
medium-sized businesses engaged in retail, wholesale, light industrial and
service activities.
Trust Subsidiaries
------------------
The Company during 2002 and 2004 established business trust
subsidiaries (the "Trusts") for the sole purpose of issuing capital securities
("Capital Securities") pursuant to declarations of trust (the "Declarations").
The proceeds from the sale of the Capital Securities were loaned to the Company
under deeply subordinated debentures (the "Debentures") issued to the Trusts
pursuant to indentures (the "Indentures"). Interest payments on the Debentures
will flow through the Trusts to the Pooling Vehicles which are the holders of
the Capital Securities and similar securities issued by other financial
institutions. Payments of distributions by the Trusts to the Pooling Vehicles
are guaranteed by the Company. See note 8 in the company's consolidated
financial statement.
Proceeds from the issuance of the 2002 subordinated debentures were
used to provide the Bank with an additional $4.5 million in capital in order to
support the continued growth of the Bank. The remaining $500,000 was placed in
the Company for general corporate purposes. Proceeds from the issuance of the
2004 subordinated debentures were used to provide the Bank with an additional
$3.5 million in capital in order to support the continued growth of the Bank.
Product Lines and Services
--------------------------
The Bank currently offers the following general banking services at all
of its branches: commercial, construction and real estate loans and personal
credit lines, interest on checking, U.S. Savings bond services, domestic and
foreign drafts, banking by appointment, automatic transfer of funds between
savings and checking accounts, business courier services, checking and savings
accounts for personal and business purposes, domestic letters of credit, a
depository for MasterCard and Visa drafts, federal depository services, cash
management assistance, wire and telephone transfers, travelers' checks,
Individual Retirement Accounts, time certificates of deposit, courier service
for non-cash deposits, Visa and MasterCard, revolving lines of credit to
consumers secured by deeds of trust on private residences, unsecured overdraft
protection credit lines attached to checking accounts, ATM cards and MasterMoney
debit cards via the Star, Cirrus, Plus, Mastercard and Visa networks.
The Bank is not authorized to offer trust services. The Federal Reserve
Bank of San Francisco is the Company's primary correspondent relationship. The
Bank currently also has correspondent relationships with City National Bank in
Beverly Hills, Bank of America in San Francisco, First Tennessee Bank in
Memphis, Tennessee, Compass Bank in Birmingham, Alabama, Wells Fargo Bank and
Pacific Coast Bankers Bank.
The Bank recognizes that, in order to be competitive, it must attract a
certain number of consumer accounts. Travelers checks, Individual Retirement
Accounts, Visa and MasterCard, revolving lines of credit to consumers secured by
deeds of trust on private residences, and unsecured overdraft protection credit
2
lines attached to checking accounts currently offered by the Bank are designed
to appeal particularly to consumers. Moreover, participation in a large-scale
ATM network assists the Company in competing for consumer accounts.
The Bank is an approved Small Business Administration and 504 lender,
FarmerMac I and II, USDA, USDA Part-time Farmer Program, FHA and VA lender and
California Capital lender. The Bank is a national leader in the underwriting of
U.S. Department of Agriculture business and industry loans, as well as a
Preferred Lender for this program.
Marketing
---------
The basic marketing strategy of the Bank is to retain the Bank's
initial market share and to increase the Bank's penetration of the market over
the long term via expansion east and west of Stockton in small to medium sized
communities. The Bank attempts to accomplish this by providing a full range of
personalized Banking services to small and medium size businesses, professionals
and individuals within Calaveras, San Joaquin, Stanislaus and Tuolumne Counties.
The Bank's marketing plan aims to provide for strong continuity in
banker-customer relationships, a high degree of convenience for customers,
prompt response in the handling of loan requests, and personal attention to
needs of individual customers. The marketing plan also includes a commitment to
lend the Bank's deposits back into the areas from which they are derived,
thereby assisting in the building activity, population growth and other changes,
which are occurring in the market area. By focusing the Bank's relationship
toward its community the Bank attempts to establish strong continuity with its
customers.
The Directors of the Company are active in business development through
personal contacts and personal participation in local activities. The Directors
of the Company have a strong commitment to community banking. They believe in
business development by actively participating in community events.
Local advertising and publicity in local papers also are used to
attract business and to acquaint potential customers with the Bank's services.
Competition
-----------
The Bank's service area consists of Calaveras, San Joaquin, Stanislaus
and Tuolumne Counties. The banking business in California generally, and
specifically in the Bank's primary market area, is highly competitive with
respect to both loans and deposits. The Banking business is dominated by a
relatively small number of major Banks, which have many offices operating over
wide geographic areas. Many of the major commercial Banks offer certain services
(such as international trust and securities brokerage services), which are not
offered directly by the Bank. By virtue of their greater total capitalization,
such Banks have substantially higher lending limits than the Bank and
substantial advertising and promotional budgets.
In the past, an independent bank's principal competitors for deposits
and loans have been other banks (particularly major banks) savings and loan
associations and credit unions. To a lesser extent, competition was also
provided by thrift and loans, mortgage brokerage companies and insurance
companies. Other institutions, such as brokerage houses, credit card companies,
and even retail establishments have offered new investment vehicles, such as
money-market funds, which also compete with banks. The direction of federal
legislation in recent years seems to favor competition between different types
of financial institutions and to foster new entrants into the financial services
market, and it is anticipated that this trend will continue.
To compete with major financial institutions in its service area, the
Bank relies upon specialized services, responsive handling of customer needs,
local promotional activity, and personal contacts by its officers, directors and
staff, as opposed to large multi-branch banks, which compete primarily by
interest rates and multiple branch locations. For customers whose loan demands
exceed the Bank's lending limits, the Bank seeks to arrange funding for such
loans on a participation basis with its correspondent Banks or other independent
commercial banks.
3
Supervision and Regulation
--------------------------
The Company is principally regulated by the Federal Reserve Board
("FRB") and the Securities and Exchange Commission ("SEC"). The Bank is
principally regulated by the California Commissioner of Financial Institutions
("Commissioner"), but is also subject to regulation by the Federal Deposit
Insurance Corporation ("FDIC") and by it's primary federal regulator, the FRB.
These agencies govern most of the Company's and the Bank's business, including
capital requirements, loans, investments, mergers and acquisitions, borrowings,
dividends, branch locations and other similar matters. In addition, the Bank's
business is affected by general economic conditions and by the monetary and
fiscal policies of the United States government. These policies influence, for
example, the Federal Reserve's open market operations in U.S. Government
securities, the reserve requirements imposed upon commercial Banks, the discount
rates applicable to borrowings from the Federal Reserve by Banks, and other
similar matters which impact the growth of the Bank's loans, investments and
deposits and the interest rates which the Bank charges and pays.
Proposals to change the laws and regulations governing the operations
and taxation of financial institutions are frequently made in Congress, in the
California legislature and before various regulatory and professional agencies.
The likelihood of any major changes and the impact such changes might have are
difficult to predict with accuracy. Certain significant recently proposed or
enacted laws and regulations are discussed below.
Interstate Banking. Since 1995, initial entry into California by merger
or acquisition involving an out-of state institution must be accomplished by
acquisition of or merger with an existing whole bank which has been in existence
for at least five years.
Capital Requirements. The Company and the Bank are subject to certain
regulatory capital requirements administered by the FRB and the FDIC. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of its assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The Company's and the Bank's
capital amounts and classifications are also subject to qualitative judgments by
the regulators about the components, risk weightings and other factors.
The Uniform Financial Institutions Rating System ("UFIRS") classifies
and evaluates the soundness of financial institutions according to the so-called
"CAMELS" criteria, including capital adequacy, asset quality, management,
earnings, liquidity and sensitivity to market risk, (changes in interest rates,
foreign exchange rates, commodity prices or equity prices which may adversely
affect an institution's earnings and capital).
Prompt Corrective Action regulations (the "PCA Regulations") of the
federal bank regulatory agencies establish five capital categories in descending
order (well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized), assignment to which depends
upon the institution's total risk-based capital ratio, Tier 1 risk-based capital
ratio, and leverage ratio. Institutions classified in one of the three
undercapitalized categories are subject to certain mandatory and discretionary
supervisory actions, which include increased monitoring and review,
implementation of capital restoration plans, asset growth restrictions,
limitations upon expansion and new business activities, requirements to augment
capital, restrictions upon deposit gathering and interest rates, replacement of
senior executive officers and directors, and requiring divestiture or sale of
the institution. The Bank is currently classified as a well capitalized bank
pursuant to the PCA regulations.
As of December 31, 2003, the Bank's total risk-based capital ratio
(approximately 11.1%) and its leverage ratio (approximately 8.2%) exceeded
minimum levels. It is not expected that compliance with the risk-based capital
guidelines or minimum leverage requirements will have a materially adverse
effect on the business of the Bank in the reasonably foreseeable future.
Deposit Insurance Assessments. The Bank's deposit insurance assessment
was $26,085 for the year 2003; the Company estimates that its deposit insurance
assessment for 2004 will not differ materially from its 2003 assessment.
4
Community Reinvestment Act. Community Reinvestment Act ("CRA")
regulations evaluate the Bank's lending to low and moderate income individuals
and businesses across a four-point scale from "outstanding" to "substantial
noncompliance," and are a factor in regulatory review of applications to merge,
establish new branches. In addition, any Bank rated in "substantial
noncompliance" with the CRA regulations may be subject to enforcement
proceedings. The Bank has a current rating of "satisfactory" CRA compliance.
Safety and Soundness Standards. Federal bank regulations for insured
financial institutions establish safety and soundness standards for (1) internal
controls, information systems and internal audit systems; (2) loan
documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset
growth; (6) compensation, fees and benefits; and (7) excessive compensation. If
an agency determines that an institution fails to meet any standard established
by the guidelines, the agency may require the financial institution to submit to
the agency an acceptable plan to achieve compliance with the standard. Agencies
may elect to initiate enforcement action in certain cases where failure to meet
one or more of the standards could threaten the safe and sound operation of the
institution. The Company has not been and does not expect to be required to
submit a safety and soundness compliance plan because of a failure to meet any
of the safety and soundness standards.
Recently Enacted Legislation
----------------------------
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act
of 2002 (the "SOA"). The stated goals of the SOA are to increase corporate
responsibility, to provide for enhanced penalties for accounting and auditing
improprieties at publicly traded companies and to protect investors by improving
the accuracy and reliability of corporate disclosures pursuant to the securities
laws.
The SOA is the most far-reaching U.S. securities legislation enacted in
many years. The SOA generally applies to all companies, both U.S. and non-U.S.,
that file or are required to file periodic reports with the Securities and
Exchange Commission, ("the SEC"), under the Securities Exchange Act of 1934.
Given the extensive SEC role in implementing rules relating to many of the SOA's
new requirements, the final scope of these requirements remains to be
determined.
The SOA includes very specific additional disclosure requirements and
new corporate governance rules, requires the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules and mandates further studies of specified issues by the SEC and the
Comptroller General. The SOA represents significant federal involvement in
matters traditionally left to state regulatory systems, such as the regulation
of the accounting profession, and to state corporate law, such as the
relationship between a board of directors and management and between a board of
directors and its committees.
The SOA addresses, among other matters:
o Duties, responsibilities and qualifications of the audit committee;
o certification of financial statements by the chief executive officer
and the chief financial officer;
o the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and senior
officers in the twelve month period following initial publication of
any financial statements that later require restatement;
o a prohibition on insider trading during pension plan black out periods;
o disclosure of off-balance sheet transactions;
o a prohibition on certain personal loans to directors and officers;
o expedited filing requirements for forms which disclose transactions by
officers and directors in Company stock;
o disclosure of a code of ethics and of any change or waiver of such
code;
5
o "real time" filing of periodic reports;
o the formation of a public accounting oversight board;
o auditor independence; and
o various increased criminal penalties for violations of securities laws.
The SEC has issued final rules covering most of these topics, but it is
to be expected that these rules may be altered as future experience requires.
Although we anticipate that we will incur additional expense in
complying with the provisions of the SOA, management does not expect that such
compliance will have a material impact on our results of operations or financial
condition.
In October 2001, the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the
"Patriot Act ") was enacted in response to the terrorist attacks in New York,
Pennsylvania and Washington, D.C. which occurred on September 11, 2001. The
Patriot Act is intended to strengthen U.S. law enforcement's and the
intelligence communities' abilities to work cohesively to combat terrorism on a
variety of fronts. The potential impact of the Patriot Act on financial
institutions of all kinds is significant and wide ranging. The Patriot Act
contains sweeping anti-money laundering and financial transparency laws and
imposes various regulations, including standards for verifying client
identification at account opening, and rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.
The federal banking agencies Have proposed and begun to implement
regulations pursuant to the Patriot Act which will require financial
institutions to begin to the policies and procedures contemplated by the new
law. The Company cannot be certain of the effect of the foregoing recently
enacted legislation on its business, although there is likely to be
consolidation among financial services institutions and increased competition
for the company.
New Accounting Pronouncements
The Company adopted no new accounting policies in 2003 that had a
material impact on its consolidated financial position or results of operations.
Please see Item 7, Management's Discussion and Analysis of Financial Condition
and Results of Operations, for a discussion of critical accounting policies and
see Note 2 to the consolidated financial statements at Item 8, Financial
Statements and Supplemental Data, for a summary of significant accounting
policies.
ITEM 2. PROPERTIES.
----------
The Company owns its March Lane (Stockton), Modesto, Groveland, Angels
Camp and Arnold branch facilities. The Company purchased the March Lane office
for $866,700 in 1992. The Company's executive officers and support staff were
relocated to the March Lane building in 1997. During 2001 the Company purchased
an adjacent building to the March Lane office, for $747,000, in order to expand
its administrative functions. The executive offices, finance department, central
operations and data processing have been moved into these offices. The Company
repossessed the Modesto building and converted it to a banking branch in 1996.
The Modesto land was purchased in 1999 for $524,000. The Company purchased the
Arnold Branch for $600,000 as part of its 1997 expansion into branches acquired
from Valliwide Bank. A portion of the building, located at 1013 Blagen Road, is
leased to First American Title. The lease is expected to generate $9,000 in
2004. During 2000 the Company purchased a lot in Groveland and purchased a lot
in Angels Camp in order to build and relocate the current Branch offices. The
new sites in both locations offer the Company better visibility and demonstrate
commitment to the communities we serve. The Groveland property was purchased for
6
$148,000 and construction was completed in January 2003. The Angels Camp
property was purchased for $200,000 and was completed in the third quarter of
2003.
All other Company premises are leased. The Company's total rentals for
premises and equipment for fiscal year 2003 were approximately $273,000, and its
minimum future commitments under lease payments as of December 31, 2003, totaled
$1,279,000.
The Company is currently in the thirteenth year of a sixteen-year gross
level lease for its main office located at 6 South El Dorado Street in downtown
Stockton. The lease cost is $0.70 per square foot per month over the life of the
lease. The Company's projected lease expense through 2004 will be approximately
$252,000 per year.
The Company in 1997 entered into a 5-year lease for the 3,500 square
foot building located at 358 N. Main Street, Angels Camp, California. The base
annual rental for the Angels Camp branch is $48,000. The lease ended on July 31,
2003. The branch has been relocated to the new office at 501 S. Main Street,
Angels Camp, California.
In 1999, the Company entered into a 10-year lease with two options to
extend for an additional 5 years each for the 3,861 square foot building in
Tracy. The Tracy office is located at 2850 Tracy Boulevard. The annual rent on
the Tracy office is $69,000 for the first five years at which time it will
increase annually at a rate of 3% per year.
ITEM 3. LEGAL PROCEEDINGS.
-----------------
There are no material pending legal proceedings, other than ordinary
routine litigation incidental to its business, to which the Company is a party
or of which any of its property is the subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
Not applicable.
Item (*) Executive Officers of the Registrant.
------------------------------------
The following table presents certain information regarding the
executive officers of the Company:
NAME AGE POSITION(S) SINCE
- ---- --- ----------- -----
Steven A. Rosso 48 President and CEO/Director 1992
Gary A. Stewart 53 Executive VP/CCO/Director 1996
JoAnne Roberts 47 Vice President/CFO 2004
(*) Included pursuant to General Instruction (G(3).
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
---------------------------------------------------------------------
See information under the caption "Market for Registrant's Common
Equity and Related Shareholder Matters" in the Company's 2003 Annual Report to
Shareholders), which information is incorporated here by reference.
ITEM 6. SELECTED FINANCIAL DATA.
-----------------------
See information under the caption "Five Year Selected Financial Data"
in the Company's 2003 Annual Report to Shareholders (see page 1), which
information is incorporated here by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
-----------------------------------------------------------------------
See information under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operation" in the Company's 2003 Annual
Report to Shareholders which information is incorporated here by reference.
7
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISLOSURES ABOUT MARKET RISK.
---------------------------------------------------------
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.
------------------------------------------
See Independent Auditor's Report, Consolidated Balance Sheet,
Consolidated Statement of Income, Consolidated Statement of Changes in
Shareholders' Equity, Statement of Cash Flows and Notes to Consolidated
Financial Statements, all contained in the Company's 2003 Annual Report to
Shareholders, which information is incorporated here by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
---------------------------------------------------------------
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
-----------------------
The Chief Executive Officer and Chief Financial Officer of the Company
have concluded, based on their evaluation as of a date within 90 days prior to
the date of the filing of this Annual Report on Form 10-K, that the Company's
disclosure controls and procedures are effective to ensure that information
required to be disclosed by the Company in the reports filed or submitted by it
under the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission, and include controls and procedures
designed to ensure that information required to be disclosed by the Company in
such reports is accumulated and communicated to the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure. The design
of any system of controls is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions,
regardless of how remote.
There were no significant changes in the Company's internal controls or
in other factors that significantly affect these controls subsequent to the date
of such evaluation.
PART III
--------
Certain information required by Part III is incorporated by reference
to the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the solicitation of proxies for the
Company's 2004 Annual Meeting of Shareholders (the "Proxy Statement").
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
--------------------------------------------------
The information required by this item is incorporated by reference from
the table of directors in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION.
----------------------
The information required by this item is incorporated by reference from
the Proxy Statement, all information under the caption "Compensation and Certain
Transactions" except for information under the subheading "Transactions with
Management."
8
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
--------------------------------------------------------------
The information required by this item is incorporated by reference from
the Proxy Statement, including information under the captions "Principal
Shareholders" and "Stock Ownership of Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
----------------------------------------------
The information required by this item is incorporated by reference
Proxy Statement, including all information under the subheading "Transactions
with Management."
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
--------------------------------------
The information required by this item is incorporated by reference from
the Proxy Statement, including all information under the subheading "Principal
Accountant Fees and Services."
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
----------------------------------------------------------------
The following financial statements of the Company included in the
Annual Report to Shareholders for the year ended December 31, 2003, are
incorporated by reference in Item 8 of this report.
(a) Financial Statements.
(1) Financial Statements:
(i) Independent Auditor's Report dated February 20 2004.
(ii) Consolidated Balance Sheet, December 31, 2003 and 2002.
(iii) Consolidated Statement of Income: Years ended December
31, 2003, 2002 and 2001.
(iv) Consolidated Statement of Changes in Shareholders'
Equity: Years ended December 31, 2003, 2002 and 2001.
(v) Consolidated Statement of Cash Flows: Years ended
December 31, 2003, 2002 and 2001.
(vi) Notes to Consolidated Financial Statements.
(2) All Schedules have been omitted because they are not
applicable or not required, or because the information is
included in the financial statements or the notes thereto or
is not material.
(3) Exhibits filed with this report are listed in the Index to
Exhibits below, which is incorporated herein by reference.
(b) The Company did not file any reports on Form 8-K during the last
quarter of the period covered by this report.
10
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
Date: March 18, 2004 PACIFIC STATE BANCORP
By: /s/ Steven A. Rosso
-------------------------------------
Steven A. Rosso
President/Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Date: March 18, 2004 By: /s/ Steven A. Rosso
-------------------------------------
Steven A. Rosso
President and Chief Executive Officer
Director
Date: March 18, 2004 By: /s/ JoAnne Roberts
-------------------------------------
JoAnne Roberts
Vice President/CFO
(Principal Financial Officer)
(Principal Accounting Officer)
Date: March 18, 2004 By: /s/ Michael L. Dalton
-------------------------------------
Michael L. Dalton
Director and Vice Chairman
Chairman of the Audit Committee
Date: March 18, 2004 By: /s/ Harold Hand
-------------------------------------
Harold Hand
Director and Chairman of the Board
Date: March 18, 2004 By: /s/ Patricia A. Hatton
-------------------------------------
Patricia A. Hatton
Director and Chairperson of the
Director Loan Committee
Date: March 18, 2004 By: /s/ Steven J. Kikuchi
-------------------------------------
Steven J. Kikuchi
Director and Secretary of the Board
Date: March 18, 2004 By: /s/ Maxwell Freeman
-------------------------------------
Maxwell Freeman
Director
Date: March 18, 2004 By: /s/ Yoshikazu Mataga
-------------------------------------
Yoshikazu Mataga
Director
11
Date: March 18, 2004 By: /s/ Gary A. Stewart
-------------------------------------
Gary A. Stewart
Executive Vice President/CLO
Director
Date: March 18, 2004 By: /s/ Kathleen Verner
-------------------------------------
Kathleen Verner
Director
Date: March 18, 2004 By: /s/ Philip B. Wallace
-------------------------------------
Philip B. Wallace
Director
12
LIST OF EXHIBITS
3.1 Articles of Incorporation. Incorporated by reference from Exhibit 3.1
filed with the Company's Registration Statement No. 333-84908 on Form
S-4EF (the "S-4").
3.2 Bylaws. Incorporated by reference from Exhibit 3.2 filed with the S-4.
4 Agreement to file copy of Indenture for the Company's $5 Million of
Floating Rate Junior Subordinated Deferrable Interest Debentures due
2032 issued to Pacific State Statutory Trust I. Incorporated by
reference from the Company's Form 10-K for the year ended December 31,
2002.
4.1 Agreement to file copy of Indenture for the Company's $3.5 Million of
Floating Rate Junior Subordinated Deferrable Interest Debentures due
2034 issued to Pacific State Statutory Trust II.
10.1 Lease Agreement for Main Office. Incorporated by reference from Exhibit
10.1filed with the S-4.
10.2 Intentionally left blank
10.3 Lease Agreement, Tracy Branch Office. Incorporated by reference from
Exhibit 10.3 filed with the S-4.
10.4* Employment Agreement (Steven A. Rosso). Incorporated by reference from
Exhibit 10.4 filed with the S-4.
10.5 Intentionally left blank
10.6* 1997 Stock Option Plan. Incorporated by reference from Exhibit 10.6
filed with the Company's Quarterly Report on Form 10-Q for the
quarterly period ending September 30, 2003.
13 The portions of the Pacific State Bancorp 2003 Annual Report to
Shareholders which have been incorporated by reference in Items 5-8
herein are filed with the Commission.
21 List of Subsidiaries
23 Independent Auditor's Consent
31.1 Certification of the Chief Executive Officer (section 302 of
Sarbanes-Oxley Act).
31.2 Certification of the Chief Financial Officer (section 302 of
Sarbanes-Oxley Act).
32 Certifications of Report (section 906 of Sarbanes-Oxley Act).
* Denotes management contract or compensatory arrangement.
13
Dear Shareholders, Customers, and Friends:
We are proud to be addressing you as part of the 17th Annual Report of Pacific
State Bank and its parent company, Pacific State Bancorp. During 2003 your
organization grew both literally and institutionally, expanding assets,
increasing earnings, and enhancing market reputation. Pacific State Bancorp's
financial performance speaks for itself with assets increasing by $20,628,709 or
11.44%, net profit growth of $890,068 or 76.56%, return on assets of 1.07% and a
return on equity of 16.86%. In addition Pacific State Bancorp generated $1.22
basic earnings per share and $1.18 diluted earnings per share for 2003.
In 2003 the Company stock also increased its presence in the small bank
investment community with a 2 for 1 stock split was effected on September 30,
2003. Looking back, PSBC achieved a significant increase in market value as the
stock rose from $8.00 per share (after split valuation) on January 1, closing at
$16.15 per share (after split valuation) on December 31, 2003, a 102% increase
on the year. As of December 31 the market capitalization was $27,274,572, a
significant increase in the overall market value of your company.
Pacific State Bank was recognized as the number one lender for United States
Department of Agriculture, Business and Industry, Loans in California. As well,
the Bank was honored as the USDA, Business and Industry Loan Program's Lender of
the Year for 2003. In addition, Laura Maffei, Senior Vice President and Tracy
Area Manager, and Ron Ashwanden, Senior Vice President and Calaveras County
Regional Manager, were honored as the Rural Bankers of the Year through the
USDA, Business and Industry Loan Program. This type of local, statewide, and
national publicity enables Pacific State Bank to maintain its ever improving
corporate image in our four county service area.
The Company has also completed the successful relocation of two new branch
offices in 2003; in the first quarter we opened the new Groveland Branch and in
the fourth quarter the bank opened our new Angels Camp Branch. Both of these new
branches have been received favorably by each community and helped increase
asset growth within Pacific State Bank. In the fourth quarter of 2003, Pacific
State Bancorp began the remodeling of our administrative offices at 1899 W.
March Lane in Stockton. In Early March 2004 the transition took place,
relocating all of our executive, information technology, and financial staff to
this new annex. Management is planning to complete the final upgrade of our
operating units with the pending remodel of our Arnold Branch scheduled for
early summer 2004.
It is our hope that you share the growth in Company pride and success that was
attained in 2003. We believe that 2004 will see a continuation of the Company's
strong asset growth and steadily improving financial performance. Our team of
banking professionals looks forward to your next visit to Pacific State Bank.
On behalf of the Board of Directors, Officers and Staff of Pacific State Bancorp
and Pacific State Bank we thank you for your support.
Sincerely,
/s/ Harold Hand, M.D. /s/ Steven A. Rosso
- ---------------------------------- -------------------------------------
Harold Hand, M.D. Steven A. Rosso
Chairman of the Board of Directors President and C.E.O.
14
CONSOLIDATED FINANCIAL DATA
The information set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's audited consolidated financial statements and
notes thereto, included elsewhere in this report.
(dollars in thousands, except per share data)
Year Ended December 31,
-----------------------------------------------------------------------------------------
Statements of Income: 2003 2002 2001 2000 1999
------------- ------------- ------------- ------------- -------------
Total Interest Income ............... $ 11,117 $ 9,232 $ 9,195 $ 9,720 $ 7,586
Net Interest Income ................. 8,356 6,289 5,614 5,735 4,693
Provision for Loan Losses ........... 536 286 383 300 330
Total Other Income .................. 1,978 1,635 1,259 748 1,180
Net Income .......................... 2,053 1,163 1,036 1,009 743
Balance Sheets:
Total Assets ........................ 200,924 180,295 121,295 113,809 104,264
Total Loans ......................... 155,485 135,272 98,280 83,644 71,853
Allowance for Loan Losses (ALL) ..... 1,653 1,306 1,172 1,001 796
Total Deposits ...................... 176,292 158,140 111,104 104,747 96,586
Shareholders' Equity ................ $ 13,459 $ 11,320 $ 9,378 $ 8,047 $ 6,165
Performance Ratios:
Return on Average Assets ............ 1.07% .77% .87% .92% .80%
Return on Average Equity ............ 16.86% 11.27% 12.04% 13.93% 12.02%
Average Equity to Average Assets .... 6.36% 6.80% 7.24% 6.57% 6.64%
Tier 1 Risk-Based Capital ........... 10.10% 9.40% 9.15% 9.06% 8.40%
Total Risk-Based Capital ............ 11.60% 11.40% 10.29% 10.20% 9.40%
Net Interest Margin ................. 4.85% 4.63% 5.15% 5.66% 5.57%
Average Earning Assets to
Average Total Assets .............. 89.93% 89.48% 90.98% 90.80% 90.70%
Nonperforming Assets to
Total Assets ...................... -- .48% .63% .79% .34%
ALL to Total Loans .................. 1.06% .97% 1.19% 1.20% 1.10%
Nonperforming Loans to ALL .......... -- 15.54% 65.41% 74.33% 7.91%
Share Data (Common Shares
Outstanding) ....................... 1,688,828 1,651,374 1,519,388 1,462,598 1,313,046
Book Value Per Share ................ $ 7.97 $ 6.85 $ 6.17 $ 5.50 $ 4.70
Basic Earnings Per Share ............ $ 1.22 $ 0.72 $ 0.70 $ 0.71 $ 0.57
Diluted Earnings Per Share .......... $ 1.18 $ 0.69 $ 0.66 $ 0.67 $ 0.54
15
INDEPENDENT AUDITOR'S REPORT
----------------------------
The Shareholders and
Board of Directors
Pacific State Bancorp
and Subsidiary
We have audited the accompanying consolidated balance sheet of Pacific
State Bancorp and subsidiary as of December 31, 2003 and 2002 and the related
consolidated statements of income, changes in shareholders' equity and cash
flows for each of the years in the three-year period ended December 31, 2003.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Pacific State Bancorp and subsidiary as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
/s/ Perry-Smith LLP
Sacremento, California
February 20, 2004
16
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
December 31, 2003 and 2002
2003 2002
------------ ------------
ASSETS
Cash and due from banks $ 5,317,323 $ 18,465,668
Federal funds sold 7,456,000 5,000,000
Interest-bearing deposits in banks 4,000,000
Investment securities (market value of $12,096,100 in
2003 and $12,764,300 in 2002) (Notes 3 and 7) 12,106,562 12,767,400
Loans, less allowance for loan losses of $1,652,853 in
2003 and $1,306,309 in 2002 (Notes 4, 7, 9 and 13) 155,484,998 133,965,914
Other real estate 48,704
Bank premises and equipment, net (Note 5) 8,755,992 6,429,899
Accrued interest receivable and other assets (Notes 12
and 14) 7,803,318 3,617,899
------------ ------------
$200,924,193 $180,295,484
============ ============
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 40,400,662 $ 30,697,547
Interest bearing (Note 6) 135,891,546 127,442,460
------------ ------------
Total deposits 176,292,208 158,140,007
Short-term borrowings (Note 7) 1,000,000 1,000,000
Long-term debt (Note 7) 4,000,000 4,000,000
Subordinated debentures (Note 8) 5,155,000 5,155,000
Accrued interest payable and other liabilities 1,018,450 680,615
------------ ------------
Total liabilities 187,465,658 168,975,622
------------ ------------
Commitments and contingencies (Note 9)
Shareholders' equity (Note 10):
Preferred stock - no par value; 2,000,000 shares
authorized; none issued and outstanding -- --
Common stock - no par value; 24,000,000 shares
authorized; issued and outstanding - 1,688,828
shares in 2003 and 1,651,374 shares in 2002 6,936,786 6,915,534
Retained earnings 6,456,766 4,404,078
Accumulated other comprehensive income
(Notes 3 and 15) 64,983 250
------------ ------------
Total shareholders' equity 13,458,535 11,319,862
------------ ------------
$200,924,193 $180,295,484
============ ============
The accompanying notes are an integral
part of these consolidated financial statements.
17
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
For the Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
----------- ----------- -----------
Interest income:
Interest and fees on loans $10,578,035 $ 8,508,163 $ 8,167,597
Interest on Federal funds sold 74,994 64,423 219,034
Interest on investment securities:
Taxable 262,281 425,816 555,042
Exempt from Federal income taxes 201,810 237,707 253,067
----------- ----------- -----------
Total interest income 11,117,120 9,236,109 9,194,740
----------- ----------- -----------
Interest expense:
Interest on deposits (Note 6) 2,393,143 2,795,719 3,580,965
Interest on borrowings (Note 7) 128,974 10,357 182
Interest on subordinated debentures (Note 8) 238,998 141,380
----------- ----------- -----------
Total interest expense 2,761,115 2,947,456 3,581,147
----------- ----------- -----------
Net interest income 8,356,005 6,288,653 5,613,593
Provision for loan losses (Note 4) 536,000 285,500 382,500
----------- ----------- -----------
Net interest income after provision
for loan losses 7,820,005 6,003,153 5,231,093
----------- ----------- -----------
Non-interest income:
Service charges 693,613 531,456 403,154
Net gain on sale of investments (Note 3) 2,116 28,957 69,067
Gain on sale of loans 663,689 583,741 427,520
Other 618,142 491,314 359,713
----------- ----------- -----------
Total non-interest income 1,977,560 1,635,468 1,259,454
----------- ----------- -----------
Other expenses:
Salaries and employee benefits (Notes 4
and 14) 3,067,584 2,600,516 2,217,034
Occupancy (Notes 5 and 9) 668,987 542,859 527,781
Furniture and equipment (Notes 5 and 9) 507,460 567,404 578,206
Other (Note 11) 2,253,846 2,135,222 1,611,546
----------- ----------- -----------
Total other expenses 6,497,877 5,846,001 4,934,567
----------- ----------- -----------
Income before income taxes 3,299,688 1,792,620 1,555,980
Income taxes (Note 12) 1,247,000 630,000 520,000
----------- ----------- -----------
Net income $ 2,052,688 $ 1,162,620 $ 1,035,980
=========== =========== ===========
Basic earnings per share (Note 10) $ 1.22 $ 0.72 $ 0.70
=========== =========== ===========
Diluted earnings per share (Note 10) $ 1.18 $ 0.69 $ 0.66
=========== =========== ===========
The accompanying notes are an integral
part of these consolidated financial statements.
18
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2003, 2002 and 2001
Accumulated
Common Stock Other
---------------------------- Retained Comprehensive Shareholders'
Shares Amount Earnings (Loss) Income Equity
------------ ------------ ------------ -------------- ------------
Balance, January 1, 2001 1,462,598 $ 5,955,337 $ 2,205,478 $ (114,047) $ 8,046,768
Net income 1,035,980 1,035,980
Unrealized gains on available-for-sale
investment securities 58,340 58,340
Stock options exercised and related tax
benefit (Note 10) 56,790 236,851 236,851
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2001 1,519,388 6,192,188 3,241,458 (55,707) 9,377,939
Net income 1,162,620 1,162,620
Unrealized gains on available-for-sale
investment securities 55,957 55,957
Stock options exercised and related tax
benefit (Note 10) 57,986 242,346 242,346
Issuance of common stock (Note 17) 74,000 481,000 481,000
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2002 1,651,374 6,915,534 4,404,078 250 11,319,862
Net income 2,052,688 2,052,688
Unrealized gains on available-for-sale
investment securities (Note 3) 64,733 64,733
Stock options exercised and related tax
benefit (Note 10) 56,650 191,798 191,798
Repurchase and retirement of common
stock (19,196) (170,546) (170,546)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2003 1,688,828 $ 6,936,786 $ 6,456,766 $ 64,983 $ 13,458,535
============ ============ ============ ============ ============
2003 2002 2001
------------ ------------ ------------
Comprehensive income (Note 15):
Net income $ 2,052,688 $ 1,162,620 $ 1,035,980
------------ ------------ ------------
Other comprehensive income:
Unrealized holding gains arising during the
year, net of tax 66,098 74,634 99,780
Less: reclassification adjustment for gains included
in net income, net of tax 1,365 18,677 41,440
------------ ------------ ------------
64,733 55,957 58,340
------------ ------------ ------------
Total comprehensive income $ 2,117,421 $ 1,218,577 $ 1,094,320
============ ============ ============
The accompanying notes are an integral
part of these consolidated financial statements.
19
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 2,052,688 $ 1,162,620 $ 1,035,980
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 536,000 285,500 382,500
Deferred loan origination fees and costs,
net (19,041) 52,210 (108,257)
Depreciation and amortization 628,077 738,104 501,661
Net gain on available-for-sale investment
securities (2,116) (28,957) (69,067)
Net loss (gain) on sale of equipment 13,364 (3,042)
Net increase in cash surrender value of life
insurance policies (58,000)
Provision for losses on other real estate 1,578
Decrease (increase) in accrued interest
receivable and other assets 21,362 (480,971) 143,375
Increase (decrease) in accrued interest
payable and other liabilities 337,835 (155,614) (201,674)
Deferred tax benefit (262,000) (191,000) (81,000)
------------ ------------ ------------
Net cash provided by operating
activities 3,248,169 1,378,850 1,605,096
------------ ------------ ------------
Cash flows from investing activities:
Net increase in interest-bearing deposits
in banks (4,000,000)
Proceeds from matured and called available-
for-sale investment securities 4,296,616 16,110,967 7,299,300
Proceeds from sale of available-for-sale
investment securities 1,977,707 3,551,478
Purchases of available-for-sale investment
securities (4,959,672) (20,757,409) (4,957,587)
Proceeds from principal repayments from
available-for-sale government-guaranteed
mortgage-backed securities 1,276,441 544,054 306,620
Proceeds from principal repayments from
held-to-maturity government-guaranteed
mortgage-backed securities 109,845 60,954 71,025
Net increase in loans (22,036,043) (29,200,549) (14,882,274)
Proceeds from sale of other real estate 48,704 140,867 109,255
Proceeds from sale of bank premises and
equipment 5,841 17,000
Purchases of bank premises and equipment (2,839,987) (2,294,647) (1,563,537)
Net cash received in branch acquisition
(Note 17) 13,721,772
Deposit on single premium life insurance
policies (4,000,000)
------------ ------------ ------------
Net cash used in investing activities (32,098,255) (19,679,284) (10,065,720)
------------ ------------ ------------
(Continued)
20
PACIFIC STATE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(Continued)
For the Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
------------ ------------ ------------
Cash flows from financing activities:
Net increase in demand, interest-bearing and
savings deposits $ 9,711,056 $ 13,037,246 $ 8,325,687
Net increase (decrease) in time deposits 8,441,145 11,577,826 (1,969,354)
Proceeds from exercise of stock options 176,086 170,310 147,113
Share repurchase and retirement (170,546)
Proceeds from the issuance of mandatorily
redeemable trust preferred securities 5,155,000
Net increase (decrease) in short-term
borrowings 1,000,000
Proceeds from issuance of long-term debt 4,000,000
------------ ------------ ------------
Net cash provided by financing
activities 18,157,741 34,940,382 6,503,446
------------ ------------ ------------
(Decrease) increase in cash and cash
equivalents (10,692,345) 16,639,948 (1,957,178)
Cash and cash equivalents at beginning of year 23,465,668 6,825,720 8,782,898
------------ ------------ ------------
Cash and cash equivalents at end of year $ 12,773,323 $ 23,465,668 $ 6,825,720
============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest expense $ 2,837,784 $ 3,278,121 $ 3,652,210
Income taxes $ 1,356,000 $ 512,000 $ 570,109
Non-cash investing activities:
Real estate acquired through foreclosure $ 29,934 $ 141,950
Net change in unrealized gain on available-
for-sale investment securities $ 100,361 $ 86,807 $ 90,431
Common stock issued in connection with
branch acquisition $ 481,000
The accompanying notes are an integral
part of these consolidated financial statements.
21
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
On June 24, 2002, Pacific State Bancorp ("Bancorp") commenced operations as
a bank holding company by acquiring all of the outstanding shares of
Pacific State Bank (the "Bank") in a one bank holding company
reorganization. The new corporate structure gives Bancorp and the Bank
greater flexibility in terms of operation, expansion, and diversification.
The reorganization was approved by the Bank's shareholders on May 9, 2002,
and all required regulatory approvals or non-disapprovals with respect to
the reorganization were obtained.
Pacific State Bancorp's subsidiaries include the Bank and Pacific State
Statutory Trust I, an unconsolidated Delaware statutory business trust
which was formed in June 2002 for the exclusive purpose of issuing and
selling trust preferred securities and holding subordinated debentures
issued by Bancorp. The proceeds from the issuance of subordinated
debentures were utilized by Bancorp to provide capital to the Bank and for
general corporate purposes.
The Bank commenced operations in 1987 and is a California state-chartered
member bank of the Federal Reserve System. The Bank operates seven branches
in California, including two branches in Stockton and branches in Modesto,
Groveland, Arnold, Angels Camp and Tracy. The Bank's primary source of
revenue is providing loans to customers who are predominately small and
middle-market businesses and individuals.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Pacific State Bancorp and its
subsidiary (collectively, the "Company") conform with accounting principles
generally accepted in the United States and prevailing practice within the
banking industry. The more significant of these policies applied in the
preparation of the accompanying consolidated financial statements are
discussed below.
Principles of Consolidation
---------------------------
The accompanying consolidated financial statements include the accounts of
Bancorp and its wholly-owned subsidiary, Pacific State Bank. Significant
intercompany transactions and balances have been eliminated in
consolidation. For financial reporting purposes, the Company's investment
in Pacific State Statutory Trust I is not consolidated under provisions of
Financial Accounting Standards Board (FASB) Interpretation No. 46,
Consolidation of Variable Interest Entities.
Use of Estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.
Reclassifications
-----------------
Certain reclassifications have been made to prior years' balances to
conform to classifications used in 2003.
Cash and Cash Equivalents
-------------------------
For purposes of the statement of cash flows, cash and cash equivalents
include cash and due from banks and federal funds sold. Generally, federal
funds are sold for one-day periods. Cash held with other federally-insured
institutions in excess of FDIC limits as of December 31, 2003 was
$3,697,000.
22
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Investment Securities
---------------------
Investments are classified into the following categories:
o Available-for-sale securities, reported at fair value, with unrealized
gains and losses excluded from earnings and reported, net of taxes, as
accumulated other comprehensive income or loss within shareholders'
equity.
o Held-to-maturity securities, which management has the positive intent
and ability to hold to maturity, reported at amortized cost, adjusted
for the accretion of discounts and amortization of premiums.
Management determines the appropriate classification of its investments at
the time of purchase and may only change the classification in certain
limited circumstances. All transfers between categories are accounted for
at fair value.
Gains or losses on the sale of securities are computed on the specific
identification method. Interest earned on investment securities is reported
in interest income, net of applicable adjustments for accretion of
discounts and amortization of premiums. In addition, unrealized losses that
are other than temporary are recognized in earnings for all investments.
As a member of the Federal Reserve System, the Federal Home Loan Bank
System and the Farmer Mac Home Administration System, the Bank is required
to maintain an investment in restricted capital stock of each system. These
investments are carried at cost as investment securities and are redeemable
at par.
Loans
-----
Loans are stated at principal balances outstanding, except for loans
transferred from loans held for sale which are carried at the lower of
principal balance or market value at the date of transfer, adjusted for
accretion of discounts. Interest is accrued daily based upon outstanding
loan balances. However, when, in the opinion of management, loans are
considered to be impaired and the future collectibility of interest and
principal is in serious doubt, loans are placed on nonaccrual status and
the accrual of interest income is suspended. Any interest accrued but
unpaid is charged against income. Payments received are applied to reduce
principal to the extent necessary to ensure collection. Subsequent payments
on these loans, or payments received on nonaccrual loans for which the
ultimate collectibility of principal is not in doubt, are applied first to
earned but unpaid interest and then to principal.
An impaired loan is measured based on the present value of expected future
cash flows discounted at the loan's effective interest rate or, as a
practical matter, at the loan's observable market price or the fair value
of collateral if the loan is collateral dependent. A loan is considered
impaired when, based on current information and events, it is probable that
the Bank will be unable to collect all amounts due (including both
principal and interest) in accordance with the contractual terms of the
loan agreement.
Loan origination fees, commitment fees, direct loan origination costs and
purchase premiums and discounts on loans are deferred and recognized as an
adjustment of yield, to be amortized to interest income over the
contractual term of the loan. The unamortized balance of deferred fees and
costs is reported as a component of net loans.
23
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loan Sales and Servicing
------------------------
Government Guaranteed Loans
Included in the portfolio are loans which are 75% to 90% guaranteed by the
Small Business Administration (SBA), Business and Industrial, Farmer Mac
and California Capital. The guaranteed portion of these loans may be sold
to a third party, with the Bank retaining the unguaranteed portion. The
Bank generally receives a premium in excess of the adjusted carrying value
of the loan at the time of sale. The Bank may be required to refund a
portion of the sales premium if the borrower defaults or prepays within
ninety days of the settlement date. At December 31, 2003, there were no
premiums subject to these recourse provisions.
The Bank's investment in the loan is allocated between the retained portion
of the loan, the servicing asset, the interest-only (IO) strip, and the
sold portion of the loan based on their relative fair values on the date
the loan is sold. The gain on the sold portion of the loan is recognized as
income at the time of sale. The carrying value of the retained portion of
the loan is discounted based on the estimated value of a comparable
non-guaranteed loan. The servicing asset is amortized over the estimated
life of the related loan. Assets (accounted for as interest-only (IO)
strips) are recorded at the fair value of the difference between note rates
and rates paid to purchasers (the interest spread) and contractual
servicing fees, if applicable. The IO strip asset is not significant at
December 31, 2003 and 2002. Significant future prepayments of these loans
will result in the recognition of additional amortization of related
servicing assets and an adjustment to the carrying value of related IO
strips.
The Bank serviced government-guaranteed loans for others totaling
$40,003,000 and $25,697,000 as of December 31, 2003 and 2002 respectively.
Servicing Rights
Servicing rights acquired through 1) a purchase or 2) the origination of
loans which are sold or securitized with servicing rights retained are
recognized as separate assets or liabilities. Servicing assets or
liabilities are recorded at the difference between the contractual
servicing fees and adequate compensation for performing the servicing, and
are subsequently amortized in proportion to and over the period of the
related net servicing income or expense. Servicing assets are periodically
evaluated for impairment. Servicing rights are not material at December 31,
2003 and 2002.
Allowance for Loan Losses
-------------------------
The allowance for loan losses is maintained to provide for losses related
to impaired loans and other losses that can be expected to occur in the
normal course of business. The determination of the allowance is based on
estimates made by management, to include consideration of the character of
the loan portfolio, specifically identified problem loans, potential losses
inherent in the portfolio taken as a whole and economic conditions in the
Bank's service area.
Loans determined to be impaired or classified are individually evaluated by
management for specific risk of loss. In addition, reserve factors are
assigned to currently performing loans based on management's assessment of
the following for each identified loan type: (1) inherent credit risk, (2)
historical losses and, (3) where the Bank has not experienced losses, the
loss experience of peer banks. These estimates are particularly susceptible
to changes in the economic environment and market conditions.
24
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan Losses (Continued)
-------------------------
The Bank's Loan Committee reviews the adequacy of the allowance for loan
losses at least quarterly, to include consideration of the relative risks
in the portfolio and current economic conditions. The allowance is adjusted
based on that review if, in the judgment of the Loan Committee and
management, changes are warranted.
This allowance is established through a provision for loan losses which is
charged to expense. Additions to the allowance are expected to maintain the
adequacy of the total allowance after net charge-offs and loan growth. The
allowance for loan losses at December 31, 2003 and 2002, respectively,
reflects management's estimate of possible losses in the portfolio.
Other Real Estate
-----------------
Other real estate includes real estate acquired in full or partial
settlement of loan obligations. When property is acquired, any excess of
the Bank's recorded investment in the loan balance and accrued interest
income over the estimated fair market value of the property, net of
estimated selling costs, is charged against the allowance for loan losses.
A valuation allowance for losses on other real estate is maintained to
provide for temporary declines in value. The allowance is established
through a provision for losses on other real estate which is included in
other expenses. Subsequent gains or losses on sales or writedowns resulting
from permanent impairments are recorded in other income or expenses as
incurred.
Bank Premises and Equipment
---------------------------
Bank premises and equipment are carried at cost. Depreciation is determined
using the straight-line method over the estimated useful lives of the
related assets. The useful lives of Bank premises are estimated to be
twenty to twenty-seven years. The useful lives of furniture, fixtures and
equipment are estimated to be two to seven years. Leasehold improvements
are amortized over the life of the asset or the life of the related lease,
whichever is shorter. When assets are sold or otherwise disposed of, the
cost and related accumulated depreciation and amortization are removed from
the accounts, and any resulting gain or loss is recognized in income for
the period. The cost of maintenance and repairs is charged to expense as
incurred.
Intangible Assets
-----------------
The Company recorded its acquisition in 2002 of the assets and liabilities
of the Stockton branch of California Bank & Trust (see Note 17) as a
business combination resulting in recognition of a core deposit intangible
asset of $448,000 and goodwill of $718,000. The valuation of the core
deposit intangible was based on the estimated fair value of deposits
acquired and is amortized on a straight-line basis over a period of ten
years. Goodwill is not amortized, but is measured annually for impairment.
At December 31, 2003, no impairment of goodwill has been recognized in the
Company's consolidated financial statements.
Income Taxes
------------
The Company files its income taxes on a consolidated basis with its
subsidiary. The allocation of income tax expense (benefit) represents each
entity's proportionate share of the consolidated provision for income
taxes.
25
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes (Continued)
------------
Deferred tax assets and liabilities are recognized for the tax consequences
of temporary differences between the financial statement and tax bases of
existing assets and liabilities. Deferred tax assets and liabilities are
adjusted for the effects of changes in tax laws and rates on the date of
enactment. On the consolidated balance sheet, net deferred tax assets are
included in accrued interest receivable and other assets.
Earnings Per Share
------------------
Basic earnings per share (EPS), which excludes dilution, is computed by
dividing income available to common shareholders by the weighted-average
number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock, such as stock options, result in the issuance of common
stock which shares in the earnings of the Company. The treasury stock
method has been applied to determine the dilutive effect of stock options
in computing diluted EPS. Earnings per share is retroactively restated to
give effect to stock splits and dividends.
Stock-Based Compensation
------------------------
At December 31, 2003, the Company had two stock-based employee compensation
plans, the Pacific State Bancorp 1997 Stock Option Plan and the Pacific
State Bancorp 1987 Stock Option Plan (the "Plans"), which are described
more fully in Note 10. The Company accounts for these plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting
for Stock Issued to Employees, and related Interpretations. No stock-based
employee compensation cost is reflected in net income, as all options
granted under these plans had an exercise price equal to the market value
of the underlying common stock on the date of grant.
Pro forma adjustments to the Company's consolidated net earnings and
earnings per share are disclosed during the years in which the options
become vested. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation.
2003 2002 2001
--------------- --------------- ----------------
Net income, as reported $ 2,052,688 $ 1,162,620 $ 1,035,980
Deduct: Total stock-based employee com-
pensation expense determined under
the fair value based method for all awards,
net of related tax effects 94,800 29,900 28,600
--------------- --------------- ----------------
Pro forma net income $ 1,957,888 $ 1,132,720 $ 1,007,380
=============== =============== ================
Basic earnings per share - as reported $ 1.22 $ 0.72 $ 0.70
Basic earnings per share - pro forma $ 1.16 $ 0.70 $ 0.68
Diluted earnings per share - as reported $ 1.18 $ 0.69 $ 0.66
Diluted earnings per share - pro forma $ 1.13 $ 0.68 $ 0.65
Weighted average fair value of options
granted during the year $ 3.75 $ 1.83 $ 1.34
26
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock-Based Compensation (Continued)
------------------------
The fair value of each option is estimated on the date of grant using an
option-pricing model with the following assumptions:
2003 2002 2001
------- ---------------- ------
Dividend yield N/A N/A N/A
Expected volatility 20.34% 12.45% to 12.80% 14.90%
Risk-free interest rate 3.21% 4.87% to 5.39% 5.35%
Expected option life 5 years 5 years 5 years
Impact of New Financial Accounting Standards
--------------------------------------------
In December, 2003, the Financial Accounting Standards Board ("FASB")
revised FASB Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46). This interpretation of Accounting Research Bulletin No.
51, Consolidated Financial Statements, addresses consolidation by business
enterprises of variable interest entities ("VIE") that posses certain
characteristics. FIN 46 requires that if a business enterprise has a
controlling financial interest in a variable interest entity, the assets,
liabilities, and results of the activities of the variable interest entity
must be included in the consolidated financial statements with those of the
business enterprise. The Company adopted FIN 46 on December 31, 2003.
Adoption of this standard required the Company to deconsolidate its
investment in Pacific State Statutory Trust I, a Delaware statutory
business trust, organized in June 2002. The deconsolidation of Pacific
State Statutory Trust I, formed in connection with the issuance of trust
preferred securities, appears to be an unintended consequence of FIN 46. In
management's opinion, the effect of deconsolidation on the Company's
financial position and results of operations was not material. As of
December 31, 2003, management believes that the Company does not have any
VIEs which would be consolidated under the provisions of FIN 46.
In July 2003, the Board of Governors of the Federal Reserve Systems issued
a supervisory letter instructing bank holding companies to continue to
include the trust preferred securities in their Tier I capital for
regulatory capital purposes until notice is given to the contrary. The
Federal Reserve intends to review the regulatory implications of this
accounting change and, if necessary or warranted, provide further
appropriate guidance. There can be no assurance that the Federal Reserve
will continue to allow institutions to include trust preferred securities
in Tier I capital for regulatory capital purposes.
On April 30, 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. This Statement amends and
clarifies the accounting for derivative instruments by providing guidance
related to circumstances under which a contract with a net investment meets
the characteristics of a derivative as discussed in SFAS No. 133. The
Statement also clarifies when a derivative contains a financing component.
The Statement is intended to result in more consistent reporting for
derivative contracts and must be applied prospectively for contracts
entered into or modified after June 30, 2003, except for hedging
relationships designated after June 30, 2003. In management's opinion, the
adoption of this Statement did not have a material impact on the Company's
consolidated financial position or results of operations.
27
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Impact of New Financial Accounting Standards (Continued)
--------------------------------------------
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
Statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003, except for mandatorily
redeemable financial instruments of nonpublic entities. For mandatorily
redeemable financial instruments of a nonpublic entity, this Statement
shall be effective for existing or new contracts for fiscal periods
beginning after December 15, 2004. In management's opinion, adoption of
this Statement did not have a material effect on the Company's consolidated
financial position or results of operations.
3. INVESTMENT SECURITIES
The amortized cost and estimated market value of investment securities at
December 31, 2003 and 2002 consisted of the following:
Available-for-Sale:
------------------
2003
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------- --------------- --------------- ----------------
U.S. Treasury securities $ 2,517,048 $ 1,952 $ 2,519,000
U.S. Government agencies 499,715 7,985 507,700
Obligations of states and
political sub-divisions 5,294,873 60,958 $ (63,731) 5,292,100
Mortgage-backed securities 1,697,336 67,656 (5,592) 1,759,400
Corporate bonds 1,220,879 31,521 1,252,400
Federal Reserve Bank stock 335,100 335,100
Federal Home Loan Bank stock 250,000 250,000
Farmer Mac Home
Administration stock 9,800 9,800
---------------- --------------- --------------- ----------------
$ 11,824,751 $ 170,072 $ (69,323) $ 11,925,500
================ =============== =============== ================
Net unrealized gains on available-for-sale investment securities totaling
$100,749 were recorded, net of $35,766 in tax liabilities, as accumulated
other comprehensive income within shareholders' equity at December 31,
2003. Proceeds and gross realized gains from the call of available-for-sale
investment securities for the year ended December 31, 2003 totaled $996,268
and $2,116, respectively.
28
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. INVESTMENT SECURITIES (Continued)
Available-for-Sale: (Continued)
------------------
2002
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------- --------------- --------------- ----------------
U.S. Government agencies $ 2,521,098 $ 6,133 $ (6,531) $ 2,520,700
Obligations of states and
political sub-divisions 6,096,947 33,353 (94,200) 6,036,100
Mortgage-backed securities 2,025,449 45,964 (10,913) 2,060,500
Corporate bonds 1,236,518 27,615 (1,033) 1,263,100
Federal Reserve Bank stock 335,100 335,100
Federal Home Loan Bank stock 250,000 250,000
Farmer Mac Home
Administration stock 9,800 9,800
---------------- --------------- --------------- ----------------
$ 12,474,912 $ 113,065 $ (112,677) $ 12,475,300
================ =============== =============== ================
Net unrealized gains on available-for-sale investment securities totaling
$388 were recorded, net of $138 in tax liabilities, as accumulated other
comprehensive income within shareholders' equity at December 31, 2002.
Proceeds, gross realized gains and gross realized losses from the sale of
available-for-sale investment securities for the year ended December 31,
2002 totaled $1,977,707, $31,765 and $(2,808), respectively. Proceeds,
gross realized gains and gross realized losses from the sale of
available-for-sale investment securities for the year ended December 31,
2001 totaled $3,551,478, $73,111 and $(4,044), respectively.
Held-to-Maturity:
2003
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------- --------------- --------------- ----------------
Mortgage-backed securities $ 181,062 $ - $ (10,462) $ 170,600
================ =============== =============== ================
2002
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------- --------------- --------------- ----------------
Mortgage-backed securities $ 292,100 $ 1,245 $ (4,345) $ 289,000
================ =============== =============== ================
There were no sales or transfers of held-to-maturity investment securities
during the years ended December 31, 2003, 2002 and 2001.
29
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. INVESTMENT SECURITIES (Continued)
Investment securities with unrealized losses at December 31, 2003 are
summarized and classified according to the duration of the loss period as
follows:
Less than 12 Months 12 Months or More Total
------------------------ ------------------------ -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----------- ----------- ----------- ----------- ----------- -----------
Obligations of states and
political sub-divisions $ 1,220,500 $ (63,731) $ 1,220,500 $ (63,731)
Mortgage-backed
obligations $ 98,300 $ (5,717) 123,800 (10,337) 222,100 (16,054)
----------- ----------- ----------- ----------- ----------- -----------
$ 98,300 $ (5,717) $ 1,344,300 $ (74,068) $ 1,442,600 $ (79,785)
=========== =========== =========== =========== =========== ===========
At December 31, 2003, investment securities with an estimated market value
of $98,300 were in a loss position for less than twelve months and
investment securities with an estimated market value of $1,344,300 were in
a loss position for twelve months or more. Management periodically
evaluates each investment security relying primarily on industry analyst
reports, observation of market conditions and interest rate fluctuations.
Management believes it will be able to collect all amounts due according to
the contractual terms of the underlying investment securities and that the
noted decline in fair value is due only to interest rate fluctuations.
The amortized cost and estimated market value of investment securities at
December 31, 2003 by contractual maturity are shown below. Expected
maturities will differ from contractual maturities because the issuers of
the securities may have the right to call or prepay obligations with or
without call or prepayment penalties.
Available-for-Sale Held-to-Maturity
--------------------------------- ---------------------------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
---------------- --------------- --------------- ----------------
Within one year $ 1,768,274 $ 1,796,100
After one year through five
years 4,229,183 4,274,400
After five years through ten
years 205,000 215,200
After ten years 3,330,058 3,285,500
---------------- --------------- --------------- ----------------
9,532,515 9,571,200
Investment securities not
due at a single maturity
date:
Mortgage-backed securities 1,697,336 1,759,400 $ 181,062 $ 170,600
Federal Reserve Bank stock 335,100 335,100
Federal Home Loan Bank
stock 250,000 250,000
Farmer Mac Home Adminis-
tration stock 9,800 9,800
---------------- --------------- --------------- ----------------
$ 11,824,751 $ 11,925,500 $ 181,062 $ 170,600
================ =============== =============== ================
30
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. INVESTMENT SECURITIES (Continued)
Investment securities with amortized costs totaling $3,994,367 and
$4,071,719 and estimated market values totaling $3,958,000 and $4,043,000
were pledged to secure treasury tax and loan accounts, public deposits and
short-term borrowings at December 31, 2003 and 2002, respectively.
4. LOANS
Outstanding loans are summarized below:
December 31,
-----------------------------------
2003 2002
----------------- ----------------
Commercial $ 46,782,455 $ 30,938,399
Agricultural 10,855,408 9,287,655
Real estate - commercial mortgage 60,173,514 53,159,804
Real estate - construction 28,219,071 33,887,183
Installment 10,823,379 7,734,199
----------------- ----------------
156,853,827 135,007,240
Deferred loan origination costs, net 284,024 264,983
Allowance for loan losses (1,652,853) (1,306,309)
----------------- ----------------
$ 155,484,998 $ 133,965,914
================= ================
Changes in the allowance for loan losses were as follows:
Year Ended December 31,
----------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Balance, beginning of year $ 1,306,309 $ 1,171,608 $ 1,000,999
Provision charged to operations 536,000 285,500 382,500
Losses charged to allowance (194,641) (198,934) (228,401)
Recoveries 5,185 48,135 16,510
------------------ ------------------ ------------------
Balance, end of year $ 1,652,853 $ 1,306,309 $ 1,171,608
================== ================== ==================
The recorded investment in impaired loans totaled $199,000 at December 31,
2002. There were no impaired loans at December 31, 2003. There were no
valuation allowances for impaired loans as determined under SFAS No. 114 at
December 31, 2003 and 2002. The average recorded investment in impaired
loans for the years ended December 31, 2003, 2002 and 2001 was $67,000,
$293,000 and $787,000, respectively. The Bank did not recognize interest
income on impaired loans during 2003, 2002 and 2001.
At December 31, 2002, nonaccrual loans totaled $199,000. Interest foregone
on nonaccrual loans totaled approximately $72,000 and $74,000 for the years
ended December 31, 2002 and 2001, respectively. There were no nonaccrual
loans and no interest foregone on nonaccrual loans at December 31, 2003.
Salaries and employee benefits totaling $222,921, $554,824 and $654,941
have been deferred as loan origination costs for the years ended December
31, 2003, 2002 and 2001, respectively.
31
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
5. BANK PREMISES AND EQUIPMENT
Bank premises and equipment consisted of the following:
December 31,
--------------------------------------
2003 2002
------------------ ------------------
Land $ 3,009,182 $ 1,793,101
Bank premises 3,668,856 1,487,797
Furniture, fixtures and equipment 3,660,125 3,560,604
Leasehold improvements 1,183,772 526,778
Construction in progress 646,618 2,023,133
------------------ ------------------
12,168,553 9,391,413
Less accumulated depreciation
and amortization (3,412,561) (2,961,514)
------------------ ------------------
$ 8,755,992 $ 6,429,899
================== ==================
Depreciation and amortization included in occupancy, furniture and
equipment expense totaled $494,689, $470,937 and $505,327 for the years
ended December 31, 2003, 2002 and 2001, respectively.
6. INTEREST-BEARING DEPOSITS
Interest-bearing deposits consisted of the following:
December 31,
--------------------------------------
2003 2002
------------------ ------------------
Savings $ 5,901,102 $ 6,574,174
Money market 36,288,254 35,964,405
NOW accounts 15,997,548 15,640,384
Time, $100,000 or more 44,792,676 37,589,426
Other time 32,911,966 31,674,071
------------------ ------------------
$ 135,891,546 $ 127,442,460
================== ==================
Aggregate annual maturities of time deposits are as follows:
Year Ending
December 31,
------------
2004 $ 70,885,748
2005 6,419,267
2006 71,216
2007 228,411
2008 100,000
-----------------
$ 77,704,642
=================
32
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
6. INTEREST-BEARING DEPOSITS (Continued)
Interest expense recognized on interest-bearing deposits consisted of the
following:
Year Ended December 31,
----------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Savings $ 11,423 $ 11,892 $ 23,352
Money market 349,574 653,261 613,333
NOW accounts 53,047 44,372 65,619
Time, $100,000 or more 979,141 883,141 1,100,273
Other time 999,958 1,203,053 1,778,388
------------------ ------------------ ------------------
$ 2,393,143 $ 2,795,719 $ 3,580,965
================== ================== ==================
7. BORROWING ARRANGEMENTS
The Bank has unsecured short-term borrowing arrangements totaling
$5,000,000 with two of its correspondent banks. There were no borrowings
outstanding under these arrangements at December 31, 2003 and 2002.
Additionally, the Bank has a borrowing arrangement with the Federal Reserve
Bank secured by investment securities with amortized costs totaling
$2,197,032 and $173,622 and estimated market values totaling $2,267,000 and
$171,000 at December 31, 2003 and 2002, respectively. At December 31, 2003
and 2002, the Bank had no outstanding borrowings under this arrangement.
During 2003, the Bank entered into a borrowing arrangement with the Federal
Home Loan Bank of San Francisco which allowed the Bank to borrow on either
a short-term or long-term basis up to approximately $10,412,000 as of
December 31, 2003 based on specific percentages of the collateral pledged.
Various residential mortgage loans and Bank-owned investment securities
totaling approximately $7,401,000 and $4,000,000, respectively, secure this
borrowing arrangement. At December 31, 2003, the Bank had $1,000,000 in
short-term advances outstanding from the Federal Home Loan Bank with an
interest rate of 1.47% and a maturity date of December 9, 2004. At December
31, 2003, the Bank had $4,000,000 in long-term advances outstanding from
the Federal Home Loan Bank with an interest rate of 2.79% and a maturity
date of December 9, 2005.
8. SUBORDINATED DEBENTURES
Pacific State Statutory Trust I is a Delaware business trust wholly owned
by the Company and formed for the sole purpose of issuing trust preferred
securities fully and unconditionally guaranteed by the Company. In
accordance with the provisions of FIN 46, the Trust is not consolidated and
the Company's equity interest in the Trust is accounted for under the
equity method and the Floating Rate Junior Subordinated Deferrable Interest
Debentures (the "Subordinated Debentures") issued and guaranteed by the
Company are reflected in the Company's consolidated balance sheet.
33
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8. SUBORDINATED DEBENTURES (Continued)
During the second quarter of 2002, Pacific State Statutory Trust I issued
5,000 Floating Rate Capital Trust Pass-Through Securities (Trust Preferred
Securities), with a liquidation value of $1,000 per security, for gross
proceeds of $5,000,000. The entire proceeds of the issuance were invested
by Pacific State Statutory Trust I in $5,155,000 of Subordinated Debentures
issued by the Company, with identical maturity, repricing and payment terms
as the Trust Preferred Securities issued by the Trust. The Subordinated
Debentures represent the sole assets of Pacific State Statutory Trust I.
The Subordinated Debentures mature on December 26, 2031, bear a current
interest rate of 4.62% (based on 6-month London Interbank Offered Rate
(LIBOR) plus 3.45%), with repricing and payments due semi-annually. The
Subordinated Debentures are redeemable by the Company, subject to receipt
by the Company of prior approval from the Federal Reserve Bank of San
Francisco, on any June 26th or December 26th on or after June 26, 2007. The
redemption price is par plus accrued and unpaid interest, except in the
case of redemption under a special event which is defined in the
Subordinated Debentures. The Trust Preferred Securities are subject to
mandatory redemption to the extent of any early redemption of the
Subordinated Debentures and upon maturity of the Subordinated Debentures on
June 26, 2032.
Holders of the Trust Preferred Securities are entitled to a cumulative cash
distribution on the liquidation amount of $1,000 per security at the
current rate per annum of 4.62%. For each successive period beginning on
June 26th of each year, the rate will be adjusted to equal the 6-month
LIBOR plus 3.45%; provided, however, that prior to June 26, 2007, such
annual rate does not exceed 11.95%. The distributions on the Trust
Preferred Securities are treated as interest expense in the consolidated
statement of income. The Company has the option to defer payment of the
distributions for a period of up to five years, as long as the Company is
not in default on the payment of interest on the Subordinated Debentures.
The Trust Preferred Securities issued in the offering were sold in private
transactions pursuant to an exemption from registration under the
Securities Act of 1933, as amended. The Company has guaranteed, on a
subordinated basis, distributions and other payments due on the Trust
Preferred Securities.
9. COMMITMENTS AND CONTINGENCIES
Leases
------
The Bank leases branch offices and certain equipment under non-cancelable
operating leases. The leases expire on various dates through 2009 and have
various renewal options ranging from five to ten years. The lease on one
branch office includes scheduled rent increases. The total amount of the
rent payments is being charged to expense using a straight-line method over
the term of the lease. The Bank has recorded a deferred credit to reflect
the excess of rent expense over cash payments since inception of the lease.
Future minimum lease payments are as follows:
Year Ending
December 31,
------------
2004 $ 252,117
2005 252,117
2006 235,164
2007 235,164
2008 235,164
Thereafter 69,498
-----------------
$ 1,279,224
=================
34
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. COMMITMENTS AND CONTINGENCIES (Continued)
Leases (Continued)
------
Rental expense included in occupancy, furniture and equipment expense
totaled $267,000, $273,000 and $267,000 for the years ended December 31,
2003, 2002 and 2001, respectively.
Financial Instruments With Off-Balance-Sheet Risk
-------------------------------------------------
The Bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business in order to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments consist of commitments to extend credit and
letters of credit. These instruments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized on the
balance sheet.
The Bank's exposure to credit loss in the event of nonperformance by the
other party for commitments to extend credit and letters of credit is
represented by the contractual amount of those instruments. The Bank uses
the same credit policies in making commitments and letters of credit as it
does for loans included on the balance sheet.
The following financial instruments represent off-balance-sheet credit
risk:
December 31,
--------------------------------------
2003 2002
------------------ ------------------
Commitments to extend credit $ 42,536,000 $ 50,935,000
Letters of credit $ 837,000 $ 639,000
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since some of the commitments are
expected to expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The Bank evaluates
each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank upon extension of
credit, is based on management's credit evaluation of the borrower.
Collateral held varies, but may include accounts receivable, inventory,
equipment, income-producing commercial properties and residential real
estate.
Letters of credit are conditional commitments issued by the Bank to
guarantee the performance or financial obligation of a customer to a third
party. The credit risk involved in issuing letters of credit is essentially
the same as that involved in extending loans to customers.
At December 31, 2003, commercial loan commitments represent approximately
48% of total commitments and are generally secured by various assets of the
borrower. Real estate loan commitments represent approximately 44% of total
commitments and are generally secured by property with a loan-to-value
ratio not to exceed 75% to 80%. Consumer loan commitments represent the
remaining 8% of total commitments and are generally unsecured. In addition,
the majority of the Bank's commitments have variable interest rates.
35
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. COMMITMENTS AND CONTINGENCIES (Continued)
Significant Concentrations of Credit Risk
-----------------------------------------
The Bank's customers are primarily located in San Joaquin, Stanislaus,
Calaveras and Tuolumne Counties. Approximately 30% of the Bank's loans are
for general commercial uses, including professional, retail and small
business, and 7% are for agricultural uses. Additionally, 18% of the Bank's
loans are for the construction of residential and commercial real estate
and 38% are loans which are collateralized by mortgages on residential and
commercial real estate. Generally, real estate loans are secured by real
property while commercial and other loans are secured by funds on deposit
and business or personal assets. The remaining 7% of the Bank's loans are
consumer installment loans. Repayment is generally expected from the
proceeds of property sales and permanent financing for real estate
construction loans and borrower cash flows for other loans.
Contingencies
-------------
The Company is subject to legal proceedings and claims which arise in the
ordinary course of business. In the opinion of management, the amount of
ultimate liability with respect to such actions will not materially affect
the consolidated financial position or results of operations of the
Company.
Federal Reserve Requirements
----------------------------
Banks are required to maintain a combination of reserves with the Federal
Reserve Bank and vault cash equal to a percentage of their reservable
deposits. The reserve balances held with the Federal Reserve Bank or in the
form of vault cash totaled $1,160,000 and $711,000 as of December 31, 2003
and 2002, respectively.
10. SHAREHOLDERS' EQUITY
Stock Split
-----------
On September 18, 2003, the Company's Board of Directors approved a
two-for-one stock split to shareholders of record at the close of business
on September 30, 2003, effective on the same date. All shares outstanding,
stock option and per share data in the consolidated financial statements
have been retroactively restated to reflect the stock split as if it had
been declared on January 1, 2001.
Dividends
---------
The Company's ability to pay cash dividends is dependent on dividends paid
to it by the Bank and limited by California corporation law. Under
California law, the holders of common stock of the Company are entitled to
receive dividends when and as declared by the Board of Directors, out of
funds legally available, subject to certain restrictions. The California
general corporation law prohibits the Company from paying dividends on its
common stock unless: (i) its retained earnings, immediately prior to the
dividend payment, equals or exceeds the amount of the dividend or (ii)
immediately after giving effect to the dividend, the sum of the Company's
assets (exclusive of goodwill and deferred charges) would be at least equal
to 125% of its liabilities (not including deferred taxes, deferred income
and other deferred liabilities) and the current assets of the Company would
be at least equal to its current liabilities, or, if the average of its
earnings before taxes on income and before interest expense for the two
preceding fiscal years was less than the average of its interest expense
for the two preceding fiscal years, at least equal to 125% of its current
liabilities.
36
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. SHAREHOLDERS' EQUITY (Continued)
Dividends (Continued)
---------
Upon declaration by the Board of Directors of the Company, all shareholders
of record will be entitled to receive dividends. A significant source of
cash for the Company is dividends from the Bank. The California Financial
Code restricts the total dividend payment of any bank in any calendar year
to the lesser of (1) the bank's retained earnings or (2) the bank's net
income for its last three fiscal years, less distributions made to
shareholders during the same three-year period. As a member of the Federal
Reserve System, the Bank is also subject to similar restrictions imposed by
Federal law. At December 31, 2003, Bank retained earnings of $4,198,000
were free of such restrictions and available for dividend payments to
Bancorp.
Earnings Per Share
------------------
A reconciliation of the numerators and denominators of the basic and
diluted earnings per share computations is as follows:
Year Ended December 31,
----------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Basic Earnings Per Share
------------------------
Numerator:
Net income $ 2,052,688 $ 1,162,620 $ 1,035,980
Denominator:
Weighted average shares outstanding 1,681,038 1,613,092 1,484,482
------------------ ------------------ ------------------
Basic earnings per share $ 1.22 $ 0.72 $ 0.70
================== ================== ==================
Diluted Earnings Per Share
--------------------------
Numerator:
Net income $ 2,052,688 $ 1,162,620 $ 1,035,980
Denominator:
Weighted average shares outstanding 1,681,038 1,613,092 1,484,482
Dilutive effect of stock options 59,847 82,644 85,062
------------------ ------------------ ------------------
1,740,885 1,695,756 1,569,544
------------------ ------------------ ------------------
Diluted earnings per share $ 1.18 $ 0.69 $ 0.66
================== ================== ==================
Options to purchase 23,000 shares of common stock at a price of $5.19
outstanding during the first quarter were not included in the computation
of diluted earnings per share for the year ended December 31, 2001 because
their exercise prices were greater than the average market prices of the
Company's common shares. All of the options were included in the
computation of diluted earnings per share for the year ended December 31,
2003 and 2002.
37
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. SHAREHOLDERS' EQUITY (Continued)
Stock Options
-------------
During 1997 and 1987, the Company established Stock Option Plans. At
December 31, 2003, 952 shares of common stock are reserved under the 1997
plan for issuance to employees and directors through incentive and
nonstatutory agreements. Outstanding options under the 1987 Plan are
exercisable until their expiration; however, no new options will be granted
under that plan. The plans require that the option price may not be less
than the fair market value of the stock at the date the option is granted,
and that the stock must be paid in full at the time the option is
exercised. The options under the plans expire on dates determined by the
Board of Directors, but not later than ten years from the date of grant.
The vesting period is determined by the Board of Directors and is generally
over five years.
A summary of the activity within the plans follows:
2003 2002 2001
------------------------ ------------------------ -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- ----------- ----------- ----------- ----------- -----------
Incentive Agreements
--------------------
Options outstanding,
beginning of year 167,612 $ 5.03 135,112 $ 3.76 145,512 $ 3.81
Options granted 193,750 $ 15.00 57,500 $ 7.49 5,000 $ 5.00
Options exercised (47,862) $ 3.22 (23,000) $ 3.60 (9,400) $ 4.01
Options canceled (19,652) $ 6.29 (2,000) $ 7.50 (6,000) $ 5.19
----------- ----------- -----------
Options outstanding,
end of year 293,848 $ 11.80 167,612 $ 5.03 135,112 $ 3.76
=========== =========== ===========
Options exercisable,
end of year 57,018 $ 4.67 87,840 $ 3.52 90,020 $ 3.30
=========== =========== ===========
Nonstatutory Agreements
-----------------------
Options outstanding,
beginning of year 14,538 $ 2.28 49,524 $ 2.44 96,914 $ 2.38
Options granted 200,000 $ 15.00
Options exercised (8,788) $ 2.50 (34,986) $ 2.50 (47,390) $ 2.31
Options canceled
----------- ----------- -----------
Options outstanding,
end of year 205,750 $ 14.64 14,538 $ 2.28 49,524 $ 2.44
=========== =========== ===========
Options exercisable,
end of year 5,750 $ 2.00 11,590 $ 2.25 46,576 $ 2.44
=========== =========== ===========
38
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. SHAREHOLDERS' EQUITY (Continued)
Stock Options (Continued)
-------------
A summary of options outstanding at December 31, 2003 follows:
Number of Weighted Number of
Options Average Options
Outstanding Remaining Exercisable
December 31, Contractual December 31,
Range of Exercise Prices 2003 Life 2003
------------------------ ------------------ ------------------ ------------------
Incentive
---------
$ 2.00 1,848 .3 years 1,848
$ 2.50 5,000 .3 years 5,000
$ 4.25 8,400 3.0 years 8,400
$ 4.44 15,800 3.5 years 15,800
$ 5.06 500 4.3 years 500
$ 4.38 2,800 4.7 years 2,800
$ 4.40 15,400 6.0 years 9,240
$ 5.19 8,400 6.6 years 5,040
$ 7.50 36,950 8.0 years 7,390
$ 7.45 5,000 8.2 years 1,000
$ 15.00 193,750 9.8 years
------------------ ------------------
293,848 57,018
================== ==================
Nonstatutory
------------
$ 2.00 5,750 .3 years 5,750
$ 15.00 200,000 9.8 years
------------------ ------------------
205,750 5,750
================== ==================
Regulatory Capital
------------------
The Company and the Bank are subject to certain regulatory capital
requirements administered by the Board of Governors of the Federal Reserve
System and the Federal Deposit Insurance Corporation (FDIC). Failure to
meet these minimum capital requirements can initiate certain mandatory, and
possibly additional discretionary, actions by regulators that, if
undertaken, could have a direct material effect on the Company's
consolidated financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of their
assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's and the Bank's capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of
total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to
average assets as set forth on the following table. Each of these
components is defined in the regulations. Management believes that the
Company and the Bank meet all their capital adequacy requirements as of
December 31, 2003 and 2002.
39
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. SHAREHOLDERS' EQUITY (Continued)
Regulatory Capital (Continued)
------------------
In addition, the most recent notification from the FDIC categorized the
Bank as well capitalized under the regulatory framework for prompt
correction action. To be considered well capitalized, the Bank must
maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage
ratios as set forth below. There are no conditions or events since December
31, 2003 that management believes have changed the Bank's category.
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------------- ------------------------ -------------------------
Minimum Minimum Minimum Minimum
Amount Ratio Amount Ratio Amount Ratio
------------ --------- ------------- --------- -------------- ---------
December 31, 2003
-----------------
Company:
Total capital (to risk-
weighted assets) $ 19,125,000 11.6% $ 13,239,000 8.0% N/A N/A
Tier I capital (to risk-
weighted assets) $ 16,782,000 10.1% $ 6,619,000 4.0% N/A N/A
Tier I capital (to average
assets) $ 16,782,000 8.3% $ 8,129,000 4.0% N/A N/A
Bank:
Total capital (to risk-
weighted assets) $ 18,273,000 11.1% $ 13,179,000 8.0% $ 16,474,000 10.0%
Tier I capital (to risk-
weighted assets) $ 16,620,000 10.1% $ 6,589,000 4.0% $ 9,884,000 6.0%
Tier I capital (to average
assets) $ 16,620,000 8.2% $ 8,129,000 4.0% $ 10,161,000 5.0%
December 31, 2002
-----------------
Company:
Total capital (to risk-
weighted assets) $ 16,497,000 11.4% $ 11,558,000 8.0% N/A N/A
Tier I capital (to risk-
weighted assets) $ 13,588,000 9.4% $ 5,779,000 4.0% N/A N/A
Tier I capital (to average
assets) $ 13,588,000 8.1% $ 6,693,000 4.0% N/A N/A
Bank:
Total capital (to risk-
weighted assets) $ 16,293,000 11.0% $ 11,529,000 8.0% $ 14,412,000 10.0%
Tier I capital (to risk-
weighted assets) $ 14,617,000 10.1% $ 5,765,000 4.0% $ 8,647,000 6.0%
Tier I capital (to average
assets) $ 14,617,000 8.9% $ 6,690,000 4.0% $ 8,362,000 5.0%
40
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11. OTHER EXPENSES
Other expenses consisted of the following:
Year Ended December 31,
----------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Professional fees $ 479,604 $ 483,501 $ 319,461
Postage, stationery and supplies 212,371 186,437 177,262
Directors fees 176,693 126,492 57,700
Telephone 157,128 150,674 126,226
Advertising and promotion 98,361 120,333 81,978
Other operating expenses 1,129,689 1,067,785 848,919
------------------ ------------------ ------------------
$ 2,253,846 $ 2,135,222 $ 1,611,546
================== ================== ==================
12. INCOME TAXES
Income tax expense for the years ended December 31, 2003, 2002 and 2001
consisted of the following:
2003 2002 2001
------------------ ------------------ ------------------
Current:
Federal $ 1,159,000 $ 698,000 $ 478,000
State 350,000 123,000 123,000
------------------ ------------------ ------------------
1,509,000 821,000 601,000
------------------ ------------------ ------------------
Deferred:
Federal (211,000) (175,000) (58,000)
State (51,000) (16,000) (23,000)
------------------ ------------------ ------------------
(262,000) (191,000) (81,000)
------------------ ------------------ ------------------
$ 1,247,000 $ 630,000 $ 520,000
================== ================== ==================
41
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12. INCOME TAXES (Continued)
Deferred tax assets (liabilities) consisted of the following:
December 31,
--------------------------------------
2003 2002
------------------ ------------------
Deferred tax assets:
Allowance for loan losses $ 652,000 $ 493,000
Bank premises and equipment 129,000 132,000
Future benefit of State tax deduction 122,000 51,000
Organization costs 21,000 19,000
Deposit purchase premium 72,000 49,000
Mark-to-market adjustment 45,000
------------------ ------------------
Total deferred tax assets 1,041,000 744,000
------------------ ------------------
Deferred tax liabilities:
Future federal liability of state deferred
tax asset (63,000) (46,000)
Goodwill (34,000) (16,000)
Unrealized gain on available-for-sale
investment securities (36,000)
------------------ ------------------
Total deferred tax liabilities (133,000) (62,000)
------------------ ------------------
Net deferred tax assets $ 908,000 $ 682,000
================== ==================
The provision for income taxes differs from amounts computed by applying
the statutory Federal income tax rates to operating income before income
taxes. The items comprising these differences for the years ended December
31, 2003, 2002 and 2001 consisted of the following:
2003 2002 2001
------------------------- ------------------------ -------------------------
Amount Rate % Amount Rate % Amount Rate%
-------------- ------- ------------- -------- -------------- ---------
Federal income tax
expense, at statu-
tory rate $ 1,121,894 34.0 $ 609,491 34.0 $ 529,033 34.0
State franchise tax,
net of Federal tax
effect 199,417 6.0 96,924 5.4 62,416 4.0
Interest on obligations
of states and political
subdivisions (63,285) (1.9) (72,906) (4.1) (81,840) (5.3)
Other (11,026) (.3) (3,509) (.2) 10,391 .7
-------------- --------- ------------- --------- -------------- --------
Total income tax
expense $ 1,247,000 37.8 $ 630,000 35.1 $ 520,000 33.4
============== ========= ============= ========= ============== ========
42
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13. RELATED PARTY TRANSACTIONS
During the normal course of business, the Bank enters into transactions
with related parties, including executive officers and directors. These
transactions include borrowings from the Bank with substantially the same
terms, including rates and collateral, as loans to unrelated parties. The
following is a summary of the aggregate activity involving related party
borrowers during 2003:
Balance, January 1, 2003 $ 3,188,000
Disbursements 902,000
Amounts repaid (1,205,000)
------------------
Balance, December 31, 2003 $ 2,885,000
==================
Undisbursed commitments to related
parties, December 31, 2003 $ 1,502,000
==================
14. EMPLOYEE BENEFIT PLANS
In 1990, the Bank initiated a 401(k) Savings Plan. Under the provisions of
the plan, the Bank matches one-half of the employees' contributions up to a
maximum of three percent of an employee's annual salary. All employees who
are at least 21 years of age and have completed one year of service are
eligible under the plan. The Bank's contributions vest at a rate of 20%
after one year of service and an additional 20% for each year thereafter.
Contributions to the plan totaled $41,000 in 2003, $42,000 in 2002 and
$28,000 for the year ended December 31, 2001.
Salary Continuation and Retirement Plans
----------------------------------------
Effective September 30, 2003, the Board of Directors approved salary
continuation and retirement plans for six key executives. Under these
plans, the executives will receive monthly payments for twenty years after
retirement. These benefits are substantially equivalent to those available
under split-dollar life insurance policies purchased by the Bank on the
lives of the executives. In addition, the estimated present value of these
future benefits is accrued over the period from the effective dates of the
plans until the participants' expected retirement dates.
In connection with these plans, the Bank purchased single premium life
insurance policies with cash surrender values totaling $4,000,000 at
December 31, 2003. On the consolidated balance sheet, the cash surrender
values are included in accrued interest receivable and other assets. Income
earned on these policies, net of expenses, totaled $58,000 for the year
ended December 31, 2003. Income earned on these policies is not subject to
Federal or state income tax under certain circumstances.
15. COMPREHENSIVE INCOME
Comprehensive income is reported in addition to net income for all periods
presented. Comprehensive income is a more inclusive financial reporting
methodology that includes disclosure of other comprehensive income that
historically has not been recognized in the calculation of net income.
Unrealized gains and losses on the Company's available-for-sale investment
securities are included in other comprehensive income. Total comprehensive
income and the components of accumulated other comprehensive income are
presented in the consolidated statement of changes in shareholders' equity.
43
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
15. COMPREHENSIVE INCOME (Continued)
At December 31, 2003, 2002 and 2001, the Company held securities classified
as available-for-sale which had unrealized gains as follows:
2003 2002 2001
--------------- --------------- ----------------
Other comprehensive income:
Unrealized holding gains $ 102,477 $ 115,764 $ 159,498
Tax expense on unrealized holding gains (36,379) (41,130) (59,718)
--------------- --------------- ----------------
Net unrealized holding gains 66,098 74,634 99,780
--------------- --------------- ----------------
Less: reclassification adjustment for gains
included in net income 2,116 28,957 69,067
Tax benefit on reclassification adjustment (751) (10,280) (27,627)
--------------- --------------- ----------------
Net reclassification adjustment 1,365 18,677 41,440
--------------- --------------- ----------------
Total other comprehensive income $ 64,733 $ 55,957 $ 58,340
=============== =============== ================
16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Estimated fair values are disclosed for financial instruments for which it
is practicable to estimate fair value. These estimates are made at a
specific point in time based on relevant market data and information about
the financial instruments. These estimates do not reflect any premium or
discount that could result from offering the Company's entire holdings of a
particular financial instrument for sale at one time, nor do they attempt
to estimate the value of anticipated future business related to the
instruments. In addition, the tax ramifications related to the realization
of unrealized gains and losses can have a significant effect on fair value
estimates and have not been considered in any of these estimates.
Because no market exists for a significant portion of the Company's
financial instruments, fair value estimates are based on judgments
regarding current economic conditions, risk characteristics of various
financial instruments and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions could
significantly affect the fair values presented.
The following methods and assumptions were used by management to estimate
the fair value of the Company's financial instruments at December 31, 2003
and 2002:
Cash and cash equivalents: For cash and cash equivalents, the carrying
amount is estimated to be fair value.
Interest-bearing deposits in banks: The fair values of interest-bearing
deposits in banks are estimated using discounted cash flow analysis, using
interest rates available at the reporting date for similar deposits.
Investment securities: For investment securities, fair values are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are estimated using quoted market prices for similar
securities and indications of value provided by brokers.
44
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Loans: For variable-rate loans that reprice frequently with no significant
change in credit risk, fair values are based on carrying values. The fair
values for the remaining loans are estimated using discounted cash flow
analyses, using interest rates being offered at each reporting date for
loans with similar terms to borrowers of comparable creditworthiness. The
carrying amount of accrued interest receivable approximates its fair value.
Cash surrender value of life insurance policies: The fair values of life
insurance policies are based on current cash surrender values at each
reporting date provided by the insurers.
Deposits and short-term borrowings: The fair values for demand deposits
are, by definition, equal to the amount payable on demand at the reporting
date represented by their carrying amount. Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow analysis
using interest rates offered at each reporting date by the Bank for
certificates with similar remaining maturities. The carrying amount of
accrued short-term borrowings and interest payable approximates their fair
value.
Long-term debt: The fair value of long-term debt is estimated using a
discounted cash flow analysis using interest rates currently available to
the Company for similar debt instruments.
Subordinated debentures: The fair value of subordinated debentures was
determined based on the current market value for the like-kind instruments
of similar rates and terms.
Commitments to extend credit: Commitments to extend credit are primarily
for variable rate loans. For these commitments, there is no difference
between the committed amounts and their fair values. Commitments to fund
fixed rate loans and letters of credit are at rates which approximate fair
value at each reporting date.
December 31, 2003 December 31, 2002
--------------------------------- ---------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------- --------------- --------------- ----------------
Financial assets:
Cash and due from banks $ 5,317,323 $ 5,317,323 $ 18,465,668 $ 18,465,668
Federal funds sold 7,456,000 7,456,000 5,000,000 5,000,000
Interest-bearing deposits
in banks 4,000,000 4,000,000
Investment securities 12,106,562 12,096,100 12,767,400 12,764,300
Loans, net 155,484,998 155,811,000 133,965,914 134,139,000
Cash surrender value of
life insurance policies 4,058,000 4,058,000
Accrued interest receivable 1,067,743 1,067,743 1,056,680 1,056,680
Financial liabilities:
Deposits $ 176,292,208 $ 176,627,600 $ 158,140,007 $ 158,316,211
Short-term borrowings 1,000,000 1,000,743 1,000,000 1,000,000
Long-term debt 4,000,000 4,002,209 4,000,000 4,000,000
Subordinated debentures 5,155,000 5,155,000 5,155,000 5,155,000
Accrued interest payable 361,971 361,971 438,640 438,640
Off-balance-sheet financial
instruments (notional amount):
Commitments to extend credit $ 42,536,000 $ 42,536,000 $ 50,935,000 $ 50,935,000
Standby letters of credit 837,000 837,000 639,000 639,000
45
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
17. SUPPLEMENTAL DISCLOSURES FROM THE ACQUISITION OF BRANCH ASSETS AND
LIABILITIES
On March 18, 2002, the Bank consummated its agreement to acquire assets
(principally loans) and assume liabilities (consisting mainly of deposits)
of the Stockton Branch Office of California Bank & Trust. The purchase
price of $1,082,194 included the issuance of 74,000 shares of common stock
with an estimated fair value of $481,000 and with the remainder paid in
cash. An allocation of the settlement of this transaction between the fair
value of liabilities assumed and assets acquired follows.
Liabilities assumed and equity issued:
Demand, interest-bearing transaction and savings
and savings accounts $ 12,645,067
Time deposits 9,776,230
Other liabilities 22,756
Common stock issued 481,000
------------------
22,925,053
------------------
Assets acquired:
Loans 8,002,294
Other assets 34,642
Core deposit intangible 448,426
Goodwill 717,919
------------------
9,203,281
------------------
Net cash received $ 13,721,772
==================
46
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
18. PARENT ONLY CONDENSED FINANCIAL STATEMENTS
The Company commenced operation on June 24, 2002. As a result, comparative
financial information for each of the years in the period ended December
31, 2003 is not available. The information below is presented as if the
reorganization had taken place on January 1, 2002.
BALANCE SHEET
December 31, 2003 and 2002
2003 2002
------------------ ------------------
ASSETS
Cash and due from banks $ 14,720 $ 72,279
Investment in bank subsidiary 17,761,562 15,746,394
Investment in Pacific State Statutory Trust I 155,000 155,000
Investment in other securities 204,365 204,988
Other assets 498,405 298,934
------------------ ------------------
Total assets $ 18,634,052 $ 16,477,595
================== ==================
LIABILITIES AND
SHAREHOLDERS' EQUITY
Liabilities:
Junior subordinated debentures due to subsidiary
grantor trust $ 5,155,000 $ 5,155,000
Other liabilities 20,517 2,733
------------------ ------------------
Total liabilities 5,175,517 5,161,984
------------------ ------------------
Shareholders' equity:
Common stock 6,936,786 6,915,534
Retained earnings 6,456,766 4,404,078
Accumulated other comprehensive income 64,983 250
------------------ ------------------
Total shareholders' equity 13,458,535 11,319,862
------------------ ------------------
Total liabilities and shareholders' equity $ 18,634,052 $ 16,477,595
================== ==================
47
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
18. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)
STATEMENT OF INCOME
For the Years Ended December 31, 2003 and 2002
2003 2002
------------------ ------------------
Income:
Dividends declared by bank subsidiary $ 350,000 $ 123,000
Interest on investment securities 4,233 1,820
Earnings from investment in Pacific State
Statutory Trust I 7,762 4,251
------------------ ------------------
Total income 361,995 129,071
------------------ ------------------
Expenses:
Interest on junior subordinated debentures 238,998 141,380
Salaries and employee benefits 68,573 42,824
Professional 61,000 77,228
Other expenses 64,171 7,031
------------------ ------------------
Total expenses 432,742 268,463
------------------ ------------------
Loss before equity in undistributed income
of subsidiary (70,747) (139,329)
Equity in undistributed income of subsidiary 1,950,435 1,212,012
------------------ ------------------
Income before income tax benefit 1,879,688 1,072,620
Income tax benefit (173,000) (90,000)
------------------ ------------------
Net income $ 2,052,688 $ 1,162,620
================== ==================
48
PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
18. PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)
STATEMENT OF CASH FLOWS
For the Years Ended December 31, 2003 and 2002
2003 2002
------------------ ------------------
Cash flows from operating activities:
Net income $ 2,052,688 $ 1,162,620
Adjustments to reconcile net income to net cash
used in operating activities:
Undistributed net income of subsidiary (1,950,435) (1,212,012)
Amortization of other securities 623
Increase in other assets (183,759) (298,934)
Increase in other liabilities 17,784 2,733
------------------ ------------------
Net cash used in operating activities (63,099) (345,593)
------------------ ------------------
Cash flows from investing activities:
Investment in bank subsidiary (4,543,199)
Investment in Pacific State Statutory Trust I (159,251)
Investment in other securities (204,988)
------------------ ------------------
Net cash used in investing activities (4,907,438)
------------------ ------------------
Cash flows from financing activities:
Proceeds from the issuance of junior subordinated
debentures due to subsidiary grantor trust 5,155,000
Proceeds from exercise of stock options 176,086 170,310
Repurchase of common stock (170,546)
------------------ ------------------
Net cash provided by financing activities 5,540 5,325,310
------------------ ------------------
(Decrease) increase in cash and cash equivalents (57,559) 72,279
Cash and cash equivalents at beginning of year 72,279
------------------ ------------------
Cash and cash equivalents at end of year $ 14,720 $ 72,279
================== ==================
49
BUSINESS OF THE COMPANY
Certain statements discussed or incorporated by reference in this
Annual Report including, but not limited to, information concerning possible or
assumed future results of operations of the Company set forth in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations, are forward-looking statements within the meaning of the Securities
Exchange Act of 1934 (the "Exchange Act"). Forward-looking statements include
statements in which words such as "expect," "anticipate," "intend," "plan,"
"believe," "estimate," "consider" or similar expressions are used. The Company's
actual future results and shareholder values may differ materially from those
anticipated and expressed in these forward-looking statements, which are based
on management's beliefs and assumptions and on information currently available
to management, and are subject to risks and uncertainties that could cause
actual results to differ materially from those projected. Such risks and
uncertainties include, among others, (1) competitive pressures in the banking
industry; (2) changes in the interest rate environment; (3) general economic
conditions, either nationally or regionally; (4) changes in the regulatory
environment; (5) changes in business conditions and inflation; and (6) changes
in securities markets. Many of these factors are beyond the Company's ability to
control or predict. Investors are cautioned not to put undue reliance on any
forward-looking statements. In addition, the Company does not have any intention
or obligation to update forward-looking statements contained in this Annual
Report, even if new information, future events or other circumstances have made
them incorrect or misleading. Except as specifically noted herein all references
to the "Company" refer to Pacific State Bancorp, a California corporation.
General Description of Business
-------------------------------
Pacific State Bancorp is a holding company with one bank subsidiary,
Pacific State Bank, (the "Bank"), and two unconsolidated subsidiary guarantor
trusts, Pacific State Statutory Trusts I and II. Pacific State Bancorp commenced
operations on June 24, 2002 when it acquired all the then issued and outstanding
shares of Pacific State Bank under a plan of reorganization approved by the
Bank's shareholders on May 9, 2002. The Bank is a California state chartered
bank. The Bank is a member of the Federal Reserve System. The Bank's primary
source of revenue is providing loans to customers who are predominately small to
middle-market businesses and middle-income individuals. Pacific State Statuatory
Trusts I and II are unconsolidated, wholly owned statutory business trusts
formed in June 2002 and March 2004 for the exclusive purpose of issuing and
selling trust preferred securities.
The Bank has engaged since November 2, 1987 in a general commercial
banking business, primarily in Stockton and San Joaquin County, and offers
commercial banking services to residents and employers of businesses in the
Bank's service area, including professional firms and small to medium sized
retail and wholesale businesses and manufacturers. The Company as of January 22,
2004 had 60 employees, including 26 officers. The Bank does not engage in any
non-bank lines of business. The business of the Bank is not to any significant
degree seasonal in nature. The Bank has no operations outside California and has
no material amount of loans or deposits concentrated among any one or few
persons, groups or industries. The Bank's main office is located at 6 So. El
Dorado Street, in Stockton, California; additional branches are located
elsewhere in Stockton and in the communities of Angels Camp, Arnold, Groveland,
Modesto and Tracy, California.
50
Business Plan
-------------
The focus of the Company's business plan is to attract "middle market"
accounts, but not to the exclusion of any other business which the Company can
reasonably and profitably attract. In order to provide a level of service to
attract such customers, the Company has structured its specific services and
charges on a basis which management believes to be profitable, taking into
consideration other aspects of the account relationship. The Company offers a
range of banking services to its customers intended to attract the following
specific types of accounts: relatively large consumer accounts; professional
group and association accounts, including the accounts of groups or firms of
physicians, dentists, attorneys and accountants; and accounts of small to
medium-sized businesses engaged in retail, wholesale, light industrial and
service activities.
Trust Subsidiaries
------------------
The Company during 2002 and 2004 established business trust
subsidiaries (the "Trusts") for the sole purpose of issuing capital securities
("Capital Securities") pursuant to declarations of trust (the "Declarations").
The proceeds from the sale of the Capital Securities were loaned to the Company
under deeply subordinated debentures (the "Debentures") issued to the Trusts
pursuant to indentures (the "Indentures"). Interest payments on the Debentures
will flow through the Trusts to the Pooling Vehicles which are the holders of
the Capital Securities and similar securities issued by other financial
institutions. Payments of distributions by the Trusts to the Pooling Vehicles
are guaranteed by the Company. See note 8 in the company's consolidated
financial statement.
Proceeds from the issuance of the 2002 subordinated debentures were
used to provide the Bank with an additional $4.5 million in capital in order to
support the continued growth of the Bank. The remaining $500,000 was placed in
the Company for general corporate purposes. Proceeds from the issuance of the
2004 subordinated debentures were used to provide the Bank with an additional
$3.5 million in capital in order to support the continued growth of the Bank.
Product Lines and Services
--------------------------
The Bank currently offers the following general banking services at all
of its branches: commercial, construction and real estate loans and personal
credit lines, interest on checking, U.S. Savings bond services, domestic and
foreign drafts, banking by appointment, automatic transfer of funds between
savings and checking accounts, business courier services, checking and savings
accounts for personal and business purposes, domestic letters of credit, a
depository for MasterCard and Visa drafts, federal depository services, cash
management assistance, wire and telephone transfers, travelers' checks,
Individual Retirement Accounts, time certificates of deposit, courier service
for non-cash deposits, Visa and MasterCard, revolving lines of credit to
consumers secured by deeds of trust on private residences, unsecured overdraft
protection credit lines attached to checking accounts, ATM cards and MasterMoney
debit cards via the Star, Cirrus, Plus, MasterCard and Visa networks.
The Bank is not authorized to offer trust services. The Federal Reserve
Bank of San Francisco is the Company's primary correspondent relationship. The
Bank currently also has correspondent relationships with City National Bank in
Beverly Hills, Bank of America in San Francisco, First Tennessee Bank in
Memphis, Tennessee, Compass Bank in Birmingham, Alabama, Wells Fargo Bank and
Pacific Coast Bankers Bank.
51
The Bank recognizes that, in order to be competitive, it must attract a
certain number of consumer accounts. Travelers checks, Individual Retirement
Accounts, Visa and MasterCard, revolving lines of credit to consumers secured by
deeds of trust on private residences, and unsecured overdraft protection credit
lines attached to checking accounts currently offered by the Bank are designed
to appeal particularly to consumers. Moreover, participation in a large-scale
ATM network assists the Company in competing for consumer accounts.
The Bank is an approved Small Business Administration and 504 lender,
FarmerMac I and II, USDA, USDA Part-time Farmer Program, FHA and VA lender and
California Capital lender. The Bank is a national leader in the underwriting of
U.S. Department of Agriculture business and industry loans, as well as a
Preferred Lender for this program.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
---------------------------------------------------------------
Critical Accounting Policies
General
Pacific State Bancorp's consolidated financial statements are prepared
in accordance with accounting principles generally accepted in the United States
of America (GAAP). The financial information contained within our statements is,
to a significant extent, financial information that is based on measures of the
financial effects of transactions and events that have already occurred. A
variety of factors could affect the ultimate value that is obtained either when
earning income, recognizing an expense, recovering an asset or relieving a
liability. We use historical loss factors as one factor in determining the
inherent loss that may be present in our loan portfolio. Actual losses could
differ significantly from the historical factors that we use. Other estimates
that we use are related to the expected useful lives of our depreciable assets.
In addition, GAAP itself may change from one previously acceptable method to
another method. Although the economics of our transactions would be the same,
the timing of events that would impact our transactions could change.
A critical accounting estimate is one that requires a company to make
assumptions about matters that are highly uncertain at the time the accounting
estimate is made. Different estimates that the company reasonably could have
used for the accounting estimate in the current period, or changes in the
accounting estimate that are reasonably likely to occur from period to period,
could have a material impact on the presentation of the company's financial
condition, changes in financial condition or results of operations.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basic principles
of accounting. (1) Statement of Financial Accountings Standards (SFAS) No. 5
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and estimable and (2) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses on impaired
loans be accrued and measured based on the differences between the value of
collateral, present value of future cash flows or values that are observable in
the secondary market and the loan balance.
52
Results of Operations
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Net income for the year ended December 31, 2003, was $2,053,000
representing an increase of $890,000, or 76.5%, over net income of $1,163,000
for the year ended December 31, 2002. A contributing factor to the increase in
net income was an increase in net interest income of $2,067,000 and a slight
increase in non interest income of $343,000, due to an increase in the sale of
loans.
Return on average assets (ROA) was 1.07% and return on average common
equity (ROE) was 16.86% in 2003 compared with .77% and 11.27% respectively in
2002. Diluted earnings per share for 2003 and 2002 were $1.18 and $0.69,
respectively, an increase of 71.0%. The increase in earnings per share is due to
the increase in income of 76.5%.
The Company's average total assets increased to $191.4 million or 26.2%
over $151.7 million in 2002. Net loans increased to $155.5 million over $134.0
million in 2002, an increase of $21.5 million or 16.1%. Deposits in 2003 grew to
$176.3 million, or 11.5%, compared to $158.1 million at December 31, 2002. The
increases on the balance sheet are attributable to the growth of the bank.
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Net income for the year ended December 31, 2002, was $1,163,000,
representing an increase of $127,000, or 12.3%, over net income of $1,036,000
for the year ended December 31, 2001. A contributing factor to the increase in
net income was a slight increase in interest income of $37,000 and an increase
in non-interest income of 29.4%, due to an increase in the sale of loans.
Return on average assets (ROA) was .77% and return on average common
equity (ROE) was 11.27% in 2002 compared with .87% and 12.04% respectively in
2001. Diluted earnings per share for 2002 and 2001 were $.69 and $.66,
respectively, a increase of 3.8%. The increase in earnings per share was due to
the increase in income of 12.3%.
The Company's average total assets increased to $151.7 million or 27.7%
over $118.8 million in 2001. Net loans increased to $134.0 million over $97.1
million in 2001, an increase of $36.9 million or 38.0%. Deposits in 2002 grew to
$158.1 million, or 42.4%, compared to $111.1 million at December 31, 2001. The
increases reflected on the balance sheet are attributable in part to the
acquisition of $22.4 million in deposits and $8.0 million in loans from a branch
of California Bank & Trust.
53
Net Interest Income
The primary source of income for the Company is derived from net
interest income. Net interest income represents the excess of interest and fees
earned on interest-earning assets (loans, securities and federal funds sold)
over the interest paid on deposits and borrowed funds. Net interest margin is
net interest income expressed as a percentage of average earning assets.
Net interest income increased to $8.4 million in 2003 versus $6.3
million in 2002 and $5.6 million in 2001, representing a 32.9% increase in 2003
over 2002, and 12.0% decrease in 2002 over 2001. The average balance of total
earning assets during 2003 increased 26.8% to $172.2 million from $135.8
million. Average loan balances outstanding during 2003 increased $35.7 million
or 30.8%, while average balances of investments and federal funds sold increased
by $.5 million or 2.5%. The average yields on loans and federal funds sold in
2003 were lower by 37 and 45 basis points respectively, while the average yield
on U.S. government securities decreased by 80 basis points. The decrease in
average yields on loans is attributed to eleven decreases in the prime lending
rate or 475 basis points during 2001 which fully impacted all of 2002, as well
as a further decrease of 50 basis points in early 2002. During 2001, the prime
rate dropped from 9.5% to 4.75% to 4.25% in 2002. The overall yield on average
earning assets during 2003 declined 34 basis points to 6.46% from 6.80% for
2002.
Total interest expense decreased to $2.8 million in 2003, from $2.9
million for 2002, and $3.6 million for 2001, representing a 3.4% decrease for
2003 over 2002, and a 19.4% decrease for 2002 over 2001. Average balances of
interest-bearing liabilities increased to $142.4 million from $114.0 million for
the year ended December 31, 2002, or 24.9%.
Average certificates of deposit increased to $75.5 million in 2003 from
$55.8 million in 2002, a 35.3% increase. The average rate paid on certificates
of deposit during 2003 decreased 112 basis points, while the overall average
rate paid on interest bearing deposits and borrowings decreased 64 basis points
to 1.94% from 2.58% for 2002.
The Company's net interest margin (net interest income divided by
average earning assets) was 4.85% in 2003, 4.63% in 2002 and 5.15% in 2001. The
combined effect of the increase in volume of earning assets and decrease in
yield on earning assets, coupled with stable funding sources resulted in an
increase of $2.1 million (32.9%) in net interest income for the year ended
December 31, 2003 over 2002. The decrease in the Company's net interest margin
from 2003 to 2001 is directly attributable to the ongoing effect of a decrease
in prime rate of 475 basis points during 2001 and an additional decrease of 50
basis points during 2002, since most of the Bank's loans reprice when the prime
rate changes. In spite of the prime rate changes, the net interest margin
increased 22 basis points in 2003 which is attributed to growth and change in
mix of earning assets, which was funded by growth of both interest-bearing and
non-interest-bearing demand deposits.
The following table sets forth the Company's daily average balance
sheet, related interest income or expense and yield or rate paid for the periods
indicated. The yield on tax-exempt securities has not been adjusted to a
tax-equivalent yield basis.
54
Average Balances, Interest Income/Expense and Yields/Rates Paid
(Dollars in thousands)
Years Ended December 31,
-------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------- ------------------------------- -------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
--------- --------- ------ --------- --------- ------ --------- --------- ------
Earning Assets
Loans(1) $ 151,529 $ 10,578 6.98% $ 115,742 $ 8,508 7.35% $ 90,675 $ 8,168 9.00%
Investment Securities 13,570 464 3.42% 15,838 664 4.19% 12,741 808 6.34%
Federal Funds Sold 6,952 75 1.08% 4,183 64 1.53% 5,579 219 3.93%
Average Earning Assets $ 172,051 $ 11,117 6.46% $ 135,763 $ 9,236 6.80% $ 108,995 $ 9,195 8.44%
--------- --------- ---------
Cash & Due From Banks $ 9,129 $ 9,286 $ 5,000
Bank Premises 7,689 5,136 4,109
Other Assets 4,101 2,803 1,839
Less: Allowance for
loan loss (1,476) (1,264) (1,128)
--------- --------- ---------
Average Total Assets $ 191,494 $ 151,724 $ 118,815
========= ========= =========
Interest Bearing
Liabilities
Demand Interest Bearing $ 51,370 $ 403 .78% $ 50,190 $ 698 1.39% $ 34,515 $ 679 1.97%
Savings Deposits 5,473 14 .26% 5,084 14 .28% 3,814 24 .63%
Certificates of Deposit 75,549 1,976 2.61% 55,849 2,084 3.73% 49,961 2,878 5.76%
Other Borrowings 10,080 368 3.65% 2,914 151 5.18 -- -- --%
--------- --------- ---- --------- --------- ---- --------- --------- ----
Average Interest
Bearing Liabilities 142,472 $ 2,761 1.94% 114,037 $ 2,947 2.58% 88,290 $ 3,581 4.06%
--------- --------- ---------
Noninterest Demand 36,436 26,381 20,931
Other Liabilities 408 985 991
Shareholder Equity 12,178 10,321 8,603
--------- --------- ---------
Average Liabilities and
Shareholders Equity $ 191,494 $ 151,724 $ 118,815
========= ========= =========
Net Interest Income and
Net Interest Margin $ 8,356 4.85% $ 6,289 4.63% $ 5,614 5.15%
========= ========= =========
(1) Interest income on loans includes fee income of $546,000, $121,000 and
$127,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
55
The Company's average total assets increased from $118.8 million in
2001 to $151.7 million in 2002 and $191.5 million in 2003, representing a 27.7%
increase during 2002 over 2001, and a 26.2% increase in 2003 over 2002. Average
portfolio loans increased from $90.7 million to $115.7 million in 2002 and
$151.5 million in 2003, representing a 27.6% and 30.9% increase respectively. In
addition the Company's average non-interest bearing demand deposits increased
from $20.9 million in 2001 to $26.4 million in 2002 and $36.4 million in 2003,
representing a 26.3% and 27.6% increase respectively. The growth came from the
Bank's current market share.
The following table sets forth changes in interest income and expense
for each major category of earning assets and interest-bearing liabilities, and
the amount of change attributable to volume and rate changes for the periods
indicated. Changes attributable to rate/volume have been allocated to volume
changes. The yield on tax-exempt securities has not been adjusted to a
tax-equivalent yield basis.
Analysis of Changes in Net Interest Income
------------------------------------------
Years ended December 31,
------------------------------------------------------------------------
(Dollars in thousands) 2003 over 2002 2002 over 2001
--------------------------------- ---------------------------------
Volume Rate Total Volume Rate Total
------- ------- ------- ------- ------- -------
Increase (Decrease)
In Interest Income:
Loans $ 2,498 $ (428) $ 2,070 $ 1,843 $(1,503) $ 340
Investment securities (78) (122) (200) 130 (274) (144)
Federal Funds sold 30 (19) 11 (21) (134) (155)
------- ------- ------- ------- ------- -------
Total Increase(Decrease) $ 2,450 $ (569) $ 1,881 $ 1,952 $(1,911) $ 41
------- ------- ------- ------- ------- -------
Increase (Decrease)
In Interest Expense:
Interest-bearing Demand $ 9 $ (304) $ (295) $ 218 $ (199) $ 19
Savings Deposits 1 (1) 0 3 (13) (10)
Certificates of Deposit 515 (623) (108) 220 (1,014) (794)
Other Borrowings 262 (45) 217 151 0 151
------- ------- ------- ------- ------- -------
Total Increase (Decrease) $ 787 $ (973) $ (186) $ 592 $(1,226) $ (634)
------- ------- ------- ------- ------- -------
Net Increase (Decrease) $ 663 $ 404 $ 2,067 $ 1,360 $ (685) $ 675
======= ======= ======= ======= ======= =======
Non-interest Income
-------------------
The Company's non-interest income consists primarily of service charges
on deposit accounts, gain on sale of loans and other service fees. Non-interest
income also includes ATM fees earned at various locations. For the year ended
December 31, 2003, non-interest income represented 15.09% of the Company's
revenues versus 15.07% in 2002, and 12.08% in 2001. Historically, the Company's
service charges on deposit accounts have lagged peer levels for similar
services. This is consistent with the Company's philosophy of allowing customers
to pay for services with compensating balances and the emphasis on core deposits
as a significant funding source.
56
Total non-interest income increased to $2.0 million in 2003 over $1.6
million in 2002 and $1.3 million in 2001, representing an increase of 25.0% and
an increase of 29.4% respectively. The increase in 2003 is directly attributable
to the 13.7% increase in the gain from the sale of loans, an increase of 25.2%
in other income on fees collected from brokering mortgage loans and an increase
of 30.5% in service charges.
The following table sets forth a summary of non-interest income for the
periods indicated.
Years Ended December 31,
------------------------------
(Dollars in thousands) 2003 2002 2001
------ ------ ------
Non-interest Income:
Service Charges $ 694 $ 531 $ 403
Rental Income from Other Real Estate 15 21 12
Gain on Sale of Guaranteed Loans 664 584 428
Gain on Sale of Investment Securities 2 29 69
Other Income 603 470 347
------ ------ ------
Total Non-interest Income $1,978 $1,635 $1,259
====== ====== ======
Non-interest Expense
--------------------
Non-interest expense consists of salaries and related employee
benefits, occupancy and equipment expenses, advertising and promotion expenses,
postage, stationary and supplies expenses, telephone expenses, professional
fees, directors' fees and other operating expenses. Non-interest expense for
2003 was $6.5 million compared to $5.8 million for 2002 and $4.9 million in
2001, representing an increase of $652,000 or 11.2% for 2003, and $914,000 or
18.5% for 2002. Increases in salaries and benefits are indicative of the
additions to staff to expand branch operations in line with their respective
growth for the year. The increase in occupancy and equipment expense is
attributable to the general upgrade of technology systems.
The following table sets forth a summary of non-interest expense for
the periods indicated.
Years Ended December 31,
------------------------------
(Dollars in thousands) 2003 2002 2001
------ ------ ------
Non-interest Expense:
Salaries & Benefits $3,068 $2,601 $2,217
Occupancy & Equipment 1,176 1,110 1,106
Professional Fees 480 484 320
Advertising & Promotion 98 120 82
Postage, Stationery & Supplies 212 186 178
Telephone 157 151 126
Director Fees 176 126 58
Other Expense 1,131 1,068 848
------ ------ ------
Total Non-Interest Expenses $6,498 $5,846 $4,935
====== ====== ======
57
Income Taxes
------------
The Company's provision for income taxes includes both federal income
and state franchise taxes and reflects the application of federal and state
statutory rates to the Company's net income before taxes. The principal
difference between statutory tax rates and the Company's effective tax rate is
the benefit derived from investing in tax-exempt securities. Increases and
decreases in the provision for taxes reflect changes in the Company's net income
before tax.
The following table reflects the Company's tax provision and the
related effective tax rate for the periods indicated.
Years Ended December 31,
----------------------------------------
(Dollars in thousands) 2003 2002 2001
--------- -------- --------
Tax Provision $ 1,247 $ 630 $ 520
Effective Tax Rate 37.8% 35.1% 33.4%
Asset Quality
-------------
The Company concentrates its lending activities primarily within
Calaveras, San Joaquin, Stanislaus and Tuolumne Counties.
The Company manages its credit risk through diversification of its loan
portfolio and the application of underwriting policies and procedures and credit
monitoring practices. Although the Company has a diversified loan portfolio, a
significant portion of its borrowers' ability to repay the loans is dependent
upon the professional services and residential real estate development industry
sectors. Generally, the loans are secured by real estate or other assets and are
expected to be repaid from cash flows of the borrower or proceeds from the sale
of collateral.
The following table sets forth the amounts of loans outstanding by
category as of the dates indicated:
As of December 31,
-------------------------------------------------------------
(Dollars in thousands) 2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
Commercial and Agricultural $ 57,638 $ 40,226 $ 34,079 $ 34,128 $ 32,128
Real estate - construction 28,219 33,887 23,561 16,875 15,608
Real estate - commercial 60,174 53,160 36,831 29,703 21,699
Installment & Other 10,823 7,734 3,493 2,729 2,911
Deferred Loan Fees and Costs 284 265 317 209 33
Allowance for Loan Losses (1,653) (1,306) (1,172) (1,001) (796)
--------- --------- --------- --------- ---------
Total Net Loans $ 155,485 $ 133,966 $ 97,109 $ 82,643 $ 71,583
========= ========= ========= ========= =========
58
Net portfolio loans have increased $21.5 million or 16.06%, to $155.0
million at December 31, 2003 over $134.0 million at December 31, 2002.
Commercial and agricultural loans have increased $17.4 million or 43.3%, real
estate construction projects have decreased $5.7 million or 16.7%, real estate
commercial loans have increased by $7.0 million or 13.2% and installment loans
have increased by $3.1 million or 40.0% over 2002. The portfolio mix remains
stable as compared with the mix of a year ago, with commercial and agricultural
loans of approximately 37.1% of total loans, real estate construction loans of
18.1%, commercial and residential real estate loans at 38.7%, and 7.0% for
installment loans.
The Company's practice is to place an asset on nonaccrual status when
one of the following events occurs:(i) Any installment of principal or interest
is 90 days or more past due (unless in management's opinion the loan is
well-secured and in the process of collection), (ii) management determines the
ultimate collection of principal or interest to be unlikely or iii) the terms of
the loan have been renegotiated due to a serious weakening of the borrower's
financial condition. Nonperforming loans are loans that are on nonaccrual, are
90 days past due and still accruing or have been restructured.
The following table sets forth a summary of the Company's nonperforming
loans and other assets as of the dates indicated:
As of December 31,
-------------------------------------
(Dollars in thousands) 2003 2002 2001 2000 1999
----- ----- ----- ----- -----
Nonaccrual loans $ -0- $ 199 $ 585 $ 744 $ 47
90 days past due and still accruing
interest -0- -0- -0- -0- 16
Other Real Estate Owned -0- 49 182 151 29
The Company's nonaccrual loans decreased from $199,000 to $0.00 during
2003. Other real estate owned ("OREO") decreased to $-0- in 2003 from $49,000 in
2002. The charge offs of $195,000 accounted for most of the decrease in
nonaccrual loans.
The Company assigns all loans a credit risk rating and monitors ratings
for accuracy. The aggregate credit risk ratings are used to determine the
allowance for loan losses. Management reviews the credit risk report with the
Director Loan Committee on a weekly basis as well as with the full Board
monthly.
The following table sets forth the maturity distribution of the
Company's loans outstanding as of December 31, 2003, which, based on remaining
scheduled repayments of principal, were due within the periods indicated.
After One
Within through Five After Five
(Dollars in thousands) One Year Years Years Total
-------- ------------ ---------- --------
Commercial and agricultural loans $ 33,765 $ 18,325 $ 5,548 $ 57,638
Construction Loans 24,334 3,885 -- 28,219
-------- ------------ ---------- --------
Total $ 58,099 $ 22,210 $ 5,548 $ 85,857
======== ============ ========== ========
Loans due after one year with:
Fixed Rates $ 12,460 $ 2,718 $ 15,178
Variable Rates 9,750 2,829 12,579
------------ ---------- --------
59
Allowance for Loan Losses (ALL)
In determining the amount of the Company's Allowance for Loan Losses
("ALL"), management assesses the diversification of the portfolio. Each credit
is assigned a credit risk rating factor, and this factor, multiplied by the
dollars associated with the credit risk rating, is used to calculate one
component of the ALL. In addition, management estimates the probable loss on
individual credits that are receiving increased management attention due to
actual or perceived increases in credit risk.
The Company makes provisions to the ALL on a regular basis through
charges to operations that are reflected in the Company's statements of income
as a provision for loan losses. When a loan is deemed uncollectible, it is
charged against the allowance. Any recoveries of previously charged-off loans
are credited back to the allowance. There is no precise method of predicting
specific losses or amounts that ultimately may be charged-off on particular
categories of the loan portfolio. Similarly, the adequacy of the ALL and the
level of the related provision for possible loan losses is determined on a
judgment basis by management based on consideration of a number of factors
including (i) economic conditions, (ii) borrowers' financial condition, (iii)
loan impairment, (iv) evaluation of industry trends, (v) industry and other
concentrations, (vi) loans which are contractually current as to payment terms
but demonstrate a higher degree of risk as identified by management, (vii)
continuing evaluation of the performing loan portfolio, (viii) monthly review
and evaluation of problem loans identified as having a loss potential, (ix)
monthly review by the Board of Directors, (x) off balance sheet risks and (xi)
assessments by regulators and other third parties. Management and the Board of
Directors evaluate the allowance and determine its desired level considering
objective and subjective measures, such as knowledge of the borrowers'
businesses, valuation of collateral, the determination of impaired loans and
exposure to potential losses.
While management uses available information to recognize losses on
loans, future additions to the allowance may be necessary based on changes in
economic conditions and other qualitative factors. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's ALL. Such agencies may require the Company to
provide additions to the allowance based on their judgment of information
available to them at the time of their examination. There is uncertainty
concerning future economic trends. Accordingly it is not possible to predict the
effect future economic trends may have on the level of the provision for
possible loan losses in future periods.
The Company's principal lines of lending are (i) commercial and
agricultural, (ii) real estate construction and (iii) commercial and residential
real estate. The primary sources of repayment of the Company's commercial loans
are the borrowers' conversion of short-term assets to cash and operating cash
flow. The net assets of the borrower or guarantor are usually identified as a
secondary source of repayment. The principal factors affecting the Company's
risk of loss from commercial lending include each borrower's ability to manage
its business affairs and cash flows, local and general economic conditions and
real estate values in the Company's service area. The Company manages its
commercial loan portfolio by monitoring its borrowers' payment performance and
their respective financial condition and makes periodic adjustments, if
necessary, to the risk grade assigned to each loan in the portfolio. The
Company's evaluations of its borrowers are facilitated by management's knowledge
of local market conditions and periodic reviews by a consultant of the Company's
credit administration policies.
The principal source of repayment of the Company's real estate
construction loans is the sale of the underlying collateral or the availability
of permanent financing from the Company or other lending source. The principal
risks associated with real estate construction lending include project cost
overruns in the project and deterioration of real estate values as a result of
various factors, including competitive pressures and economic downturns. The
Company manages its credit risk associated with real estate construction lending
60
by establishing loan-to-value ratios and loan-to-cost ratios on projects on an
as-completed basis, inspecting project status in advance of controlled
disbursements and matching maturities with expected completion dates. Generally,
the Company requires a loan-to-value ratio of not more than 80% on single family
residential construction loans.
The principal source of repayment of the Company's real estate mortgage
loans is the borrowers' operating cash flow. Similar to commercial loans, the
principal factors affecting the Company's risk of loss in real estate mortgage
lending include each borrower's ability to manage its business affairs and cash
flows, local and general economic conditions and real estate values in the
Company's service area. The Company manages its credit risk associated with real
estate mortgage lending primarily by establishing maximum loan-to-value ratios
and using strategies to match the borrower's cash flow to loan repayment terms.
The Company's specific underwriting standards and methods for each of
its principal lines of lending include industry-accepted analysis and modeling
and certain proprietary techniques. The Company's underwriting criteria are
designed to comply with applicable regulatory guidelines, including required
loan-to-value ratios. The Company's credit administration policies contain
mandatory lien position and debt service coverage requirements, and the Company
generally requires a guarantee from 20% or more owners of its corporate
borrowers.
The ALL should not be interpreted as an indication that charge-offs in
future periods will occur in the stated amounts or proportions. In management's
opinion the estimated charge-offs by loan category for the year ended December
31, 2004 are: $200,000 for commercial and agriculture, $20,000 for installment
and none for real estate construction or real-estate mortgage.
The adequacy of the ALL is calculated upon three components. First is
the credit risk rating of the loan portfolio, including all outstanding loans
and leases. Every extension of credit has been assigned a risk rating based upon
a comprehensive definition intended to measure the inherent risk of lending
money. Each rating has an assigned risk factor expressed as a reserve
percentage. Central to this assigned risk factor is the historical loss record
of the Company. Secondly, established specific reserves are available for
individual loans currently on management's watch and high-grade loan lists.
These are the estimated potential losses associated with specific borrowers
based upon the collateral and event(s) causing the risk ratings. The third
component is unallocated. This reserve is for qualitative factors that may
effect the portfolio as a whole, such as those factors described above.
Management believes the assigned risk grades and our methods for
managing risk are satisfactory.
The provision for loan losses increased to $536,000 for 2003 from
$286,000 in 2002. The increase in the amount of the provision is a direct result
of the Company's growth in loans during 2003 as well as in-depth analysis of the
loan portfolio and the loan loss history of the Company. Net charge-offs were
$195,000 or .13% of average loans during 2003. Management does not believe that
there were any trends indicated by the detail of the aggregate charge-offs for
any of the periods discussed.
61
The following table summarizes the activity in the ALL for the periods
indicated.
Years Ended December 31,
-------------------------------------------------------
(Dollars in thousands) 2003 2002 2001 2000 1999
------- ------- ------- ------- -------
Beginning Balance: $ 1,306 $ 1,172 $ 1,001 $ 796 $ 568
Provision for loan losses 536 286 383 300 331
Charge-offs:
Commercial (90) (171) (226) (70) (24)
Real Estate (--) (--) (--) (--) (--)
Other (105) (28) (2) (26) (79)
------- ------- ------- ------- -------
Total Charge-offs (195) (199) (228) (96) (103)
------- ------- ------- ------- -------
Recoveries:
Commercial 1 -- 16 -- --
Other 5 47 -- 1 --
------- ------- ------- ------- -------
Total Recoveries 6 47 16 1 --
------- ------- ------- ------- -------
Ending Balance $ 1,653 $ 1,306 $ 1,172 $ 1,001 $ 796
======= ======= ======= ======= =======
ALL to total loans 1.06% .97% 1.19% 1.20% 1.10%
Net Charge-offs to average loans .12% .13% .23% .12% .15%
Investment Portfolio
The Company classifies its investment securities as "held-to-maturity"
or "available-for-sale" at the time of investment purchase. Generally, all
securities are purchased with the intent and ability to hold the security for
long-term investment, and the Company has both the ability and intent to hold
"held-to-maturity" investments to maturity. The Company does not engage in
trading activities.
Investment securities held-to-maturity are carried at cost adjusted for
the accretion of discounts and amortization of premiums. Securities
available-for-sale may be sold to implement the Company's asset/liability
management strategies and in response to changes in interest rates, prepayment
rates and similar factors. Securities available-for-sale are recorded at market
value and unrealized gains or losses, net of income taxes, are reported as
accumulated other comprehensive income or loss, in a separate component of
shareholder's equity. Gain or loss on sale of investment securities is based on
the specific identification method.
Investment securities held-to-maturity at December 31, 2003, consisted
of mortgage-backed securities totaling $181,000 with a remaining contractual
maturity of 11 to 18 years and a weighted-average yield to maturity of 6.55%.
62
The following table summarizes the contractual maturities of the
Company's investment securities held as available-for-sale at their carrying
value and their weighted-average yields at December 31, 2003. The yield on
tax-exempt securities has not been adjusted to a tax-equivalent yield basis.
Within One Year One to Five Years Ten Years And Over Total
----------------- ----------------- ------------------ -----------------
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
------- ----- ------- ----- ------- ----- ------- -----
U.S. Government & Agencies $ 2,020 0.89% $ 1,549 2.97% $ 1,145 4.52% $ 4,714 2.45%
Obligations of State
and Political Subs 619 3.71% 1,143 4.67% 3,533 3.49% 5,295 3.77%
Equity Securities 595 3.37% 595 3.37%
Other Securities 651 4.59% 570 6.35% 1,221 5.42%
Total $ 3,290 2.15% $ 3,262 4.16% $ 5,273 3.32% $11,825 3.37%
======= ==== ======= ==== ======= ==== ======= ====
The following table summarizes the carrying value of the Company's
available for sale investment securities held on the dates indicated.
Years Ended December 31
-----------------------------------
(Dollars in thousands) 2003 2002 2001
------- ------- -------
U.S. Government & Agencies $ 4,714 $ 4,546 $ 4,314
Municipal Obligations 5,295 6,097 5,436
Corporate and Other Bonds 1,816 1,832 682
------- ------- -------
Total $11,825 $12,475 $10,432
======= ======= =======
63
Deposit Structure
-----------------
The Company primarily obtains deposits from local businesses and
professionals as well as through certificates of deposit, savings and checking
accounts.
The following table sets forth the remaining maturities of certificates
of deposit at December 31, 2003.
Deposit Maturity Schedule
-----------------------------------
(Dollars in thousands) Under $100,000 Over $100,000
------------- -------------
Three Months or less $ 9,758 $16,847
Over three through six months 11,194 10,947
Over six through twelve months 11,389 11,751
Over twelve months 571 6,248
------- -------
Total $32,912 $44,793
======= =======
Liquidity
---------
The purpose of liquidity management is to ensure efficient and
economical funding of the Company's assets consistent with the needs of the
Company's depositors and, to a lesser extent, shareholders. This process is
managed not by formally monitoring the cash flows from operations, investing and
financing activities as described in the Company's statement of cash flows, but
through an understanding principally of depositor and borrower needs. As loan
demand increases, the Company can use asset liquidity from maturing investments
along with deposit growth to fund the new loans.
With respect to assets, liquidity is provided by cash and money market
investments such as interest-bearing time deposits, federal-funds sold,
available-for-sale investment securities, and principal and interest payments on
loans. With respect to liabilities, liquidity is provided by core deposits,
shareholders' equity and the ability of the Company to borrow funds and to
generate deposits.
Because estimates of the liquidity need of the Company may vary from
actual needs, the Company maintains a substantial amount of liquid assets to
absorb short-term increases in loans or reductions in deposits. As loan demand
decreases or loans are paid off, investment assets can absorb these excess funds
or deposit rates can be decreased to run off excess liquidity. Therefore, there
is some correlation between financing activities associated with deposits and
investing activities associated with lending. The Company's liquid assets (cash
and due from banks, federal funds sold, and available-for-sale investment
securities) totaled $36.0 million or 20.0% of total assets at December 31, 2003,
$17.3 million or 14.3% of total assets at December 31, 2002 and $25.2 million or
22.2% of total assets at December 31, 2001. The Company expects that its primary
source of liquidity will be earnings of the Company, acquisition of core
deposits, and wholesale borrowing arrangements.
Capital Resources
-----------------
Capital adequacy is a measure of the amount of capital needed to
sustain asset growth and act as a cushion for losses. Capital protects
depositors and the deposit insurance fund from potential losses and is a source
of funds for the investments the Company needs to remain competitive.
Historically, capital has been generated principally from the retention of
earnings.
64
Overall capital adequacy is monitored on a day-to-day basis by the
Company's management and reported to the Company's Board of Directors on a
quarterly basis. The Bank's regulators measure capital adequacy by using a
risk-based capital framework and by monitoring compliance with minimum leverage
ratio guidelines. Under the risk-based capital standard, assets reported on the
Company's balance sheet and certain off-balance sheet items are assigned to risk
categories, each of which is assigned a risk weight.
This standard characterizes an institution's capital as being "Tier 1"
capital (defined as principally comprising shareholders' equity) and "Tier 2"
capital (defined as principally comprising the qualifying portion of the ALLL).
The minimum ratio of total risk-based capital to risk-adjusted assets,
including certain off-balance sheet items, is 8%. At least one-half (4%) of the
total risk-based capital is to be comprised of Tier 1 capital; the balance may
consist of debt securities and a limited portion of the ALLL.
As of December 31, 2003, the most recent notification by the Federal
Reserve Bank of San Francisco (FRBSF) categorized the Company as well
capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized the Company must meet the minimum ratios as set
forth below. There are no conditions or events since that notification that
management believes have changed the institution's category.
The Company's and the Bank's risk-based capital ratios are presented
below.
Pacific State Bancorp
December 31, 2003 December 31, 2002
----------------- -----------------
Total Risk-Based Capital 11.6% 11.4%
Tier 1 Capital to Risk-Based Assets 10.1% 9.4%
Tier 1 Capital to Average Assets
(Leverage ratio) 8.3% 8.1%
Pacific State Bank
For Bank
to be well
December 31, 2003 December 31, 2002 capitalized
----------------- ----------------- -----------
Total Risk-Based Capital 11.1% 11.0% > 10.00%
Tier 1 Capital to Risk-Based Assets 10.1% 10.1% > 6.00%
Tier 1 Capital to Average Assets
(Leverage ratio) 8.2% 8.9% > 5.00%
65
Certain Contractual Obligations
The following chart summarizes certain contractual obligations of the
Company as of December 31, 2003:
Less than More than
Total one year 1-3 years 3-5 years 5 years
---------- ----------- ----------- ---------- -----------
Subordinated Debentures, floating rate
of 4.62% payable June 26, 2032 $5,155 $5,155
FHLB Loan fixed rate of 1.47%, payable
on December 10, 2004 1,000 1,000 1,000
FHLB Loan fixed rate of 2.79%, payable
on December 10, 2005 4,000 4,000 4,000
---------- ----------- ----------- ---------- -----------
Total $10,155 $1,000 $4,000 $0 $10,155
========== =========== =========== ========== ===========
Impact of Inflation
Inflation affects the Company's financial position as well as its
operating results. It is management's opinion that the effects of inflation on
the financial statements have not been material.
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table presents the summary unaudited results for the
stated eight quarters:
(Dollars in thousands, except per share)
2003 2002
--------------------------------------------- ---------------------------------------------
Net Income Per Common Share:
Diluted $ 0.24 $ 0.27 $ 0.30 $ 0.36 $ 0.12 $ 0.21 $ 0.10 $ 0.25
Basic $ 0.25 $ 0.28 $ 0.31 $ 0.58 $ 0.13 $ 0.22 $ 0.11 $ 0.26
1st 2nd 3rd 4th 1st 2nd 3rd 4th
------- ------- ------- ------- ------- ------- ------- -------
Interest income $ 2,548 $ 2,713 $ 2,908 $ 2,948 $ 2,024 $ 2,284 $ 2,369 $ 2,558
Net interest income 1,795 2,011 2,235 2,315 1,316 1,576 1,577 1,820
Provision for loan losses 122 138 138 138 77 81 82 46
Total non-interest income 536 394 414 633 397 434 330 474
Total non-interest expense 1,579 1,527 1,648 1,744 1,332 1,390 1,571 1,551
Income before taxes 630 741 864 1,066 304 538 254 697
Net Income 406 476 530 641 200 352 174 437
66
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
---------------------------------------------------------------------
There is only a limited trading market for the Company's Common stock,
which is not listed on any exchange. Hoefer & Arnett (San Francisco) is the
Company's primary market maker. Trading information is available via the
internet on the OTC Bulletin Board (www.otcbb.com), under the symbol PSBC.OB.
The following table, which summarizes trading activity during the
Company's last two fiscal years, is based on information provided by Yahoo.com
Historical Quotes. The quotations reflect the price that would be received by
the seller without retail mark-up, mark-down or commissions and may not have
represented actual transactions.
Sales Price
------------------------
Quarter Ended: High Low Volume
- -------------- ------- ------- -------
March 31, 2003 $8.750 $8.000 18,150
June 30, 2003 $11.500 $8.550 8,050
September 30, 2003 $13.000 $10.000 19,400
December 31, 2003 $16.250 $12.250 74,943
March 31, 2002 $ 9.500 $ 7.250 16,600
June 30, 2002 $ 9.500 $ 7.500 47,600
September 30, 2002 $ 9.065 $ 7.375 26,000
December 31, 2002 $ 9.500 $ 8.050 7,600
As of March 15, 2004, there were approximately 330 holders of record of
the common stock of the Company.
The Company's primary source of cash is dividends from the Bank. The
Bank's ability to pay dividends is subject to certain regulatory requirements.
The California Financial Code restricts the total dividend payment of any bank
in any calendar year to the lesser of (1) the bank's retained earnings or (2)
the bank's net income for its last three fiscal years, less distributions made
to shareholders' during the same three-year period. As of December 31, 2003, the
Bank had $4,198,000 in retained earnings available for dividends to
shareholders.
The power of the board of directors of an insured depository
institution to declare a cash dividend or other distribution with respect to
capital is subject to statutory and regulatory restrictions which limit the
amount available for such distribution depending upon the earnings, financial
condition and cash needs of the institution, as well as general business
conditions.
67
- ----------------------------------------------------------------------------------------------------------
Company and Bank Officers
- -------------------------
Steven A. Rosso Noella Erichson
President & Chief Executive Officer Assistant Vice President & Credit Administration
Gary A. Stewart Dedra Davies
Executive Vice President & Chief Credit Officer Assistant Vice President & Branch Manager - Arnold
JoAnne Roberts Theresa Victor
Vice President & Chief Financial Officer Assistant Controller
Bank Officers Jamie Holland
- ------------ Lending Services Officer - March Lane
Laura Maffei Suzanne Fedi
Senior Vice President & Manager - Tracy Operations Officer - Stockton Main
Linda Ogata Lori Menchaca
Senior Vice President & Manager - March Lane Operations Officer - Arnold
Rick Simas Michelle Hendrix
Senior Vice President & Regional Manager - Operations Officer - Groveland
Stanislaus & Tuolumne Counties
Joanne Israel
Ron Aschwanden Operations Officer - Angles Camp
Senior Vice President & Regional Manager -
Calaveras County Shelly Urbanek
Operations Officer - Tracy
Patrick MacDonald
Vice President & Manager - Stockton Main Pamela Goodman
Operations Officer - Modesto
Allen Hafizi
Vice President & Note Department Manager
Glenn Scott
Vice President & MIS Director
Douglas van den Enden
Vice President & Commercial Loan Officer
Nick Hodgson
Vice President & Loan Officer
Sylvia Hanania
Vice President & Senior Operations Officer -
Stockton Main
Janita Cavanaugh
Assistant Vice President & Controller
- ---------------------------------------------------------------------------------------------------------
68
Board Of Directors
- ------------------
Harold Hand, M.D.
Chairman of the Board
Owner, Stockton, Eye Surgery
Steven A. Rosso
President & Chief Executive Officer
Pacific State Bancorp & Pacific State Bank
Michael L. Dalton, C.P.A.
Partner, Dalton & Lagorio, C.P.A.
Maxwell M. Freeman
Freeman, D'Auito, Pierce & Gurev
A Professional Law Corporation
Patricia A. Hatton, M.D.
Gynecologist
Gary A. Stewart
Executive Vice President & Chief Credit Officer
Pacific State Bancorp & Pacific State Bank
Steven J. Kikuchi
Landscape Architect
Kathleen M. Verner
Vice President
Verner Construction
Yoshikazu Mataga
Owner, Mataga Buick Pontiac & GMC
Mataga Cadillac
Tracy Pontiac Cadillac & GMC
Phillip B. Wallace
Chairman
Western Empire
69