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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD
FROM _________ TO ________.
UNITED SECURITY BANCSHARES
(Exact name of registrant as specified in its charter)
| CALIFORNIA | 91-2112732 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) | |
| 1525 East Shaw Ave., Fresno, California | 93710 | |
| (Address of principal executive offices) | (Zip Code) |
| Registrants telephone number, including area code (559) 248-4943 | |
| Securities registered pursuant to Section 12(g) of the Act (Title of Class): Common Stock, no par value | |
| Shares outstanding as of February 29, 2002: 5,386,382 | |
| Aggregate market value of the Common Stock held by non-affiliates at February 29, 2002: $60,753,801 | |
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 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 registrants knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this form 10-K or any amendment to this Form 10-K. [ ]
DOCUMENTS INCORPORATED BY REFERENCE
| Certain portions of the Proxy Statement for the 2002 Meeting of Shareholders (to be filed with the commission under regulation 14A within 120 days after the end of the registrant's fiscal year and, upon such filing, to be incorporated by reference into Part III). | Part III, Items 10, 11, 12 and 13 |
UNITED SECURITY BANCSHARES AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10K FOR THE YEAR ENDED
DECEMBER 31, 2001
TABLE OF CONTENTS
| PART I | Page | |
| Item 1 - Business | 3 | |
| Item 2 - Properties | 10 | |
| Item 3 - Legal Proceedings | 11 | |
| Item 4 - Submission of Matters to a Vote of Security Holders | 11 | |
| PART II | ||
| Item 5 - Market for the Registrant's Common Equity and Related Stockholder Matters | 12 | |
| Item 6 - Selected Financial Data | 13 | |
| Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations | 14 | |
| Item 7A - Quantitative and Qualitative Disclosure About Market Risk | 33 | |
| Item 8 - Financial Statements and Supplementary Data | 34 | |
| Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 58 | |
| PART III | ||
| Item 10 - Directors and Executive Officers of the Registrant | 58 | |
| Item 11 - Executive Compensation | 58 | |
| Item 12 - Security Ownership of Certain Beneficial Owners and Management | 58 | |
| Item 13 - Certain Relationships and Related Transactions | 58 | |
| PART IV | ||
| Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K | 59 | |
| Signatures | 61 |
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PART 1
Certain matters discussed or incorporated by reference in this Annual Report of Form 10-K including, but not limited to, those described in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations", are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, among others, (1) competitive pressure in the banking industry increases significantly; (2) changes in the interest rate environment reduces margins; (3) general economic conditions, either nationally or regionally, are less favorable than expected, resulting in, among other things, a deterioration in credit quality; (4) changes in the regulatory environment; (5) changes in business conditions and inflation; and (6) changes in securities markets. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company.
GeneralUnited Security Bancshares (the “Company”) is a California corporation incorporated during March of 2001and is registered with the Board of Governors of the Federal Reserve System as a bank holding company under the Bank Holding Company Act of 1956, as amended. United Security Bank (the “Bank”) is a wholly-owned bank subsidiary of the Company and was formed in 1987. United Security Bancshares Capital Trust I (the “Trust”) is also a wholly-owned subsidiary of the Company and was formed during June of 2001 as a Delaware business trust for the sole purpose of issuing Trust Preferred securities. At present, the Company does not engage in any material business activities other than ownership of the Bank. References to the Company are references to United Security Bancshares, Inc. (including the Bank), except for periods prior to June 12, 2001, in which case, references to the Company are references to the Bank.
United Security BankOn June 12, 2001, the Bank became the wholly owned subsidiary of United Security Bancshares, through a tax free holding company reorganization, accounted for on a basis similar to the pooling of interest method. In the transaction, each share of Bank stock was exchanged for a share of Company stock on a one-to-one basis.
The Bank is a California state-chartered bank headquartered in Fresno, California. It is also a member of the Federal Reserve System (“Fed member”). The Bank originally commenced business on December 21, 1987 as a national bank and, during the fourth quarter of 1998, filed an application with the California State Banking Department and other regulatory authorities to become a state-chartered bank. The shareholders approved the conversion in January of 1999, and the Bank was granted approval to operate as a state-chartered bank on February 3, 1999. The Bank’s operations are currently subject to federal and state laws applicable to state-chartered, Fed member banks and its deposits are insured up to the applicable limits by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is also subject to certain provisions of the Federal Deposit Insurance Act and regulatory reporting requirements of the FDIC. As a state-chartered bank and a member of the Federal Reserve System, the Bank is subject to supervision and regular examinations by the Board of Governors of the Federal Reserve System (the “FRB”) and the California Department of Financial Institutions (the “DFI”). In addition, the Bank is required to file reports with the FRB and provide such additional information as the FRB may require.
Effective August 25, 1995, the Bank consummated a merger with Golden Oak Bank, a two branch California state chartered bank located in Oakhurst, California, with assets of approximately $45 million at the date of merger. The merger was accounted for as a pooling of interests.
During February of 1997, the Bank completed the purchase of the deposits and certain assets of two branches of Wells Fargo Bank located in Caruthers and San Joaquin, both located in Fresno County. This brought the total branches operated at that time by the Bank to six and the total assets to approximately $190 million. The Bank paid a premium of approximately $1.2 million to purchase deposit accounts totaling approximately $33.4 million. The Bank also purchased cash balances as well as certain fixed assets of the branch operations.
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During October of 1997, the Bank completed the purchase from Bank of America of two of its branches located in Firebaugh and Coalinga, both located in Fresno County. The acquisition brought the total branches operated by the Bank to eight at that time and the total assets to approximately $238 million. The premium paid by the Bank totaled approximately $3.0 million which purchased deposits of approximately $44.4 million. The transaction included the receipt of cash balances of approximately $1.0 million and the purchase of premises and equipment totaling approximately $0.6 million.
At December 31, 2001, the Company operated seven (7) bank branches and one (1) construction lending office; seven (7) in Fresno County and one (1) in Madera County. The Bank operates two branches (including its main office) and one construction lending office in Fresno and one branch each, in Oakhurst, Caruthers, San Joaquin, Firebaugh, and Coalinga. In addition, the Company and Bank have administrative headquarters at 1525 East Shaw Avenue, Fresno, California, 93710.
At December 31, 2001, the consolidated Company had approximately $450.9 million in total assets, $331.2 million in net loans, $368.7 in deposits, and $36.1 million in shareholders' equity.
The following discussion of the Company's services should be read in conjunction with "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."As a state-chartered commercial bank, United Security Bank offers a full range of commercial banking services primarily to the business and professional community and individuals located in Fresno and Madera Counties.
The Bank offers a wide range of deposit instruments including personal and business checking accounts and savings accounts, interest-bearing negotiable order of withdrawal ("NOW") accounts, money market accounts and time certificates of deposit. Most of the Bank's deposits are attracted from individuals and from small and medium-sized business-related sources.
The Bank also engages in a full complement of lending activities, including real estate mortgage, commercial and industrial, real estate construction, as well as agricultural and consumer loans, with particular emphasis on short and medium-term obligations. The Bank's loan portfolio is not concentrated in any one industry, although approximately 69% of the Bank's loans are secured by real estate. A loan may be secured (in whole or in part) by real estate even though the purpose of the loan is not to facilitate the purchase or development of real estate. At December 31, 2001, the Bank had loans (net of unearned fees) outstanding of $335.6 million, which represented approximately 91% of the Bank's total deposits and approximately 74% of its total assets.
Real estate mortgage loans are secured by deeds of trust primarily on commercial property. Repayment of real estate mortgage loans is generally from the cash flow of the borrower. Commercial and industrial loans have a high degree of industry diversification. A substantial portion of the commercial and industrial loans are secured by accounts receivable, inventory, leases or other collateral. The remainder are unsecured; however extensions of credit are predicated on the financial capacity of the borrower. Repayment of commercial loans is generally from the cash flow of the borrower. Real estate construction loans consist of loans to residential contractors which are secured by single family residential properties. All real estate loans have established equity requirements. Repayment of real estate construction loans is generally from long-term mortgages with other lending institutions. Agricultural loans are generally secured by land, equipment, inventory and receivables. Repayment of this loan category is from the cash flow of the borrower.
In the normal course of business, the Bank makes various loan commitments and incurs certain contingent liabilities. At December 31, 2001 and 2000, loan commitments of the Bank aggregated $108.1 million and $84.3 million, respectively. Of the $108.1 million in loan commitments outstanding at December 31, 2001, $51.4 million or 48% were on loans with maturities of one year or less. Due to the nature of the business of the Bank's customers, there are no seasonal patterns or absolute predictability to the utilization of unused loan commitments; therefore the Bank is unable to forecast the extent to which these commitments will be exercised within the current year. The Bank does not believe that any such utilization will constitute a material liquidity demand.
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In addition to the loan and deposit services discussed above, the Bank also offers a wide range of specialized services designed to attract and service the needs of commercial customers and account holders. These services include cashier's checks, traveler's checks, money orders, and foreign drafts. The Bank does not operate a trust department; however, it makes arrangements with its correspondent bank to offer trust services to its customers on request. Most of the Bank's business originates within Fresno and Madera Counties. Neither USB's business or liquidity is seasonal, and there has been no material effect upon the Bank's capital expenditures, earnings or competitive position as a result of federal, state or local environmental regulation.
CompetitionThe banking business in California generally, and in the market area served by the Company specifically, is highly competitive with respect to both loans and deposits. The Company competes for loans and deposits with other commercial banks, savings and loan associations, finance companies, money market funds, credit unions and other financial institutions, including a number that are substantially larger than the Company. As of December 31, 2001, there were more than 90 banking offices, including more than 40 offices of three major chain banks, operating within the Company's primary market areas in the San Joaquin Valley and Eastern Madera County. Deregulation of the banking industry, increased competition from non-bank entities for the cash balances of individuals and businesses, and continuing developments in the computer and communications industries have had, and most likely will continue to have, a significant impact on the Company's competitive position. With the enactment of interstate banking legislation in California, bank holding companies headquartered outside of California may enter the California market and provide further competition for the Company. Additionally, with the Gramm-Leach-Bliley Act of 1999, traditional competitive barriers between insurance companies, securities underwriters, and commercial banks have been eased, allowing a greater number of financial intermediaries to offer a wider assortment of financial services. Many of the major commercial banks operating in the Company's market areas offer certain services such as trust and international banking services, which the Company does not offer directly. In addition, banks with larger capitalization have larger lending limits and are thereby able to serve larger customers.
Supervision and RegulationThe Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is registered as such with the FRB. A bank holding company is required to file with the FRB annual reports and other information regarding its business operations and those of its subsidiaries and is also subject to examination by the FRB.
In 1999 the Gramm-Leach-Bliley Act (the “GLBA”) was enacted. The GLBA became effective in March of 2000 and is a financial services modernization law that, among other things, facilitates broad new affiliations among securities firms, insurance companies and bank holding companies by repealing the 66-year old provisions of the Glass-Steagall Act. The GLBA allows the formation of financial holding companies (“FHC’s”), which are bank holding companies with substantially expanded powers. A bank holding company must acquire the approval of the FRB to become a FHC. Under these expanded powers, affiliations may occur between bank holding companies, securities firms and insurance companies, subject to a blend of umbrella supervision and regulation of the newly formed consolidated entity by the Federal Reserve, oversight of the FHC’s bank and thrift subsidiaries by their primary federal and state banking regulators and financial regulation of the FHC’s nonbank subsidiaries by their respective specialized regulators.
The BHC Act requires, among other things, prior approval before acquiring, directly or indirectly, ownership or control of any voting shares of any bank, if after such acquisition it would directly or indirectly own or control more than 5% of the voting stock of that bank, unless it already owns a majority of the voting stock of that bank. The BHC Act also provides that the FRB shall not approve any acquisition that would result in or further the creation of a monopoly, or the effect of which may be substantially to lessen competition, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the probable effect in meeting the convenience and needs of the community served.
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Furthermore, under the BHC Act, a bank holding company is, with limited exceptions, prohibited from (i) acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or (ii) engaging in any activity other than managing or controlling banks. With the prior approval of the FRB, however, a bank holding company may own shares of a company engaged in activities which the FRB has determined to be so closely related to banking or managing or controlling banks as to be proper incident thereto.
The BHC Act requires a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. It is the FRB’s policy that a bank holding company should stand ready to use available resources to provide adequate capital funds to subsidiary banks during periods of financial stress and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting a subsidiary bank. Under certain conditions, the FRB may conclude that certain actions of a bank holding company, such as payment of cash dividends, would constitute unsafe and unsound banking practices because they violate the FRB’s “source of strength” doctrine.
A bank holding company and its subsidiaries are prohibited from certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, a bank may not condition an extension of credit on a promise by its customer to obtain other services by it, its holding company or other subsidiaries, or on a promise by its customer not to obtain services from a competitor. In addition, federal law imposes certain restrictions between the Company and its subsidiaries, including the Bank. As an affiliate of the Bank, the Company is subject, with certain exceptions, to provisions of federal law imposing limitations on, and requiring collateral for, extensions of credit by the Bank to its affiliates.
The Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, which include but are not limited to the filing of annual, quarterly and other current reports with the SEC.
The BankThe Bank as a state-chartered bank, is subject to regulation, supervision and regular examination by the California Department of Financial Institutions. In addition, The Bank is also a member of the Federal Reserve System and, as such, is subject to applicable provisions of the Federal Reserve Act and regulations issued thereunder and, is subject to regulation, supervision and regular examination by the Board of Governors. The Bank is subject to California law, insofar as they are not preempted by federal banking law. Deposits of the Bank are insured by the FDIC in an amount up to $100,000 per customer, and, as such, the Bank is subject to the regulations of the FDIC and the Federal Deposit Insurance Act. As a consequence of the extensive regulation of commercial banking activities in California and the United States, the Bank’s business is particularly susceptible to changes in California and federal legislation and regulation, which may have the effect of increasing the cost of doing business, limiting permissible activities or increasing competition.
Various other requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes and regulations relate to many aspects of the Bank’s operations, including capital requirements and disclosure requirements to depositors and borrowers, requirements to maintain reserves against deposits, limitations on interest rates payable on deposits, loans, investments, and restrictions on borrowings and on payment of dividends. The DFI regulates the number and location of branch offices of a state-chartered bank, and may permit a bank to maintain branches only to the extent allowable under state law for state banks. California law presently permits a bank to locate a branch in any locality in the state. Additionally, California law exempts banks from California usury laws.
Effect of Governmental Policies and Recent LegislationBanking has traditionally been a business that depends on rate differentials. In general, the difference between the interest rate paid by the Company on its deposits and other borrowings and the interest rate received on loans extended to its customers and securities held in the Company's portfolio comprise the major portion of the Company's earnings. These rates are highly sensitive to many factors which are beyond the control of the Company. Accordingly, the earnings and growth of the Company are subject to the influence of domestic and foreign economic conditions, including, but not limited to, inflation, recession and unemployment.
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The monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the FRB, influence the earnings and growth of the Company. The FRB implements national monetary policies (with objectives such as to curb inflation and combat recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rates applicable to borrowing by depository institutions. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits and also affect the interest rates charged on loans and paid on deposits. The nature and impact of any future change in monetary policies cannot be predicted.
From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks and other financial institutions are frequently made in Congress, in the California legislature and before various bank regulatory agencies. The likelihood of any major change and the impact such change may have on the Company is impossible to predict. Certain of the potentially significant changes which have been enacted recently and other which are currently under consideration by Congress or various regulatory agencies or professional agencies are discussed below.
Recent Legislation and Other ChangesThe terrorist attacks in September 2001 impacted the financial services industry and led to federal legislation that attempts to address certain issues involving financial institutions. On October 26, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”).
Part of the USA Patriot Act is the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”). IMLAFATA authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to banks, bank holding companies, and/or other financial institutions. These measures may include enhanced recordkeeping and reporting requirements for certain financial transactions that are of primary money laundering concern, due diligence requirements concerning the beneficial ownership of certain types of accounts, and restrictions or prohibitions on certain types of accounts with foreign financial institutions.
Among its other provisions, IMLAFATA requires each financial institution to: (i) establish an anti-money laundering program; (ii) establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks; and (iii) avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, IMLAFATA contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. IMLAFATA expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours. IMLAFATA also amends the Bank Holding Company Act and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing an application under these acts.
Treasury regulations implementing the due diligence requirements must be issued no later than April 24, 2002. Whether or not regulations are adopted, IMLAFATA becomes effective July 23, 2002. Additional regulations are to be adopted during 2002 to implement minimum standards to verify customer identity, to encourage cooperation among financial institutions, federal banking agencies, and law enforcement authorities regarding possible money laundering or terrorist activities, to prohibit the anonymous use of “concentration accounts,” and to require all covered financial institutions to have in place a Bank Secrecy Act compliance program.
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The Board of Governors of the Federal Reserve System and the Secretary of the Treasury in January 2001 jointly adopted a final rule governing merchant banking investments made by financial holding companies. The rule implements provisions of the Gramm-Leach-Bliley Act discussed below that permit financial holding companies to make investments as part of a bona fide securities underwriting or merchant or investment banking activity. The rule provides that a financial holding company may not, without Federal Reserve Board approval, directly or indirectly acquire any additional shares, assets or ownership interests or make any additional capital contribution to any company the shares, assets or ownership interests of which are held by the financial holding company subject to the rule if the aggregate carrying value of all merchant banking investments held by the financial holding company exceeds: (i) 30 percent of the Tier 1 capital of the financial holding company or (ii) after excluding interests in private equity funds, 20 percent of the Tier 1 capital of the financial holding company. A separate final rule will establish the capital charge of merchant banking investments for the financial holding company.
The American Homeownership and Economic Opportunity Act of 2000 was enacted in late 2000 and provides for certain regulatory and financial relief to depository institutions. With respect to savings and loan associations, the Home Owners’ Loan Act was amended to (i) repeal the savings association liquidity requirements, and (ii) permit a savings and loan holding company with prior approval to acquire more than 5% of the voting shares of a nonsubsidiary savings association or nonsubsidiary savings and loan holding company. With respect to national banks, the Banking Act of 1933 was amended to allow a national bank to (i) specifically reorganize into a bank holding company structure or merge with subsidiaries and nonbank affiliates, (ii) have more than 25 directors as may be allowed by the Comptroller, (iii) have director terms of up to three years, (iv) have a classified board, and (iv) allow the repurchase of stock to prevent loss upon a previously contracted debt without having to dispose of it within a period of six months. In addition, federal banking law was amended to authorize the Comptroller to waive the citizenship requirement for a minority of the directors on national bank board and to repeal the 20% surplus requirement for national banks. As to depository institutions, in general, the federal banking agencies are to develop a system for the electronic filing and dissemination of depository institution call reports.
The Gramm-Leach-Bliley Act (“GLBA”) was enacted in late 1999. GLBA among other things repeals the Glass-Steagall Act. The Glass-Steagall Act enacted in the Depression era prohibits banks from affiliating with securities firms. In addition, GLBA will allow for a new type of bank holding company under the Bank Holding Company Act. The new bank holding company will be allowed to engage in insurance and securities underwriting, merchant banking and insurance company portfolio investment activities. Currently, bank holding companies are strictly limited in the amount of insurance and securities underwriting activities in which they may engage.
GLBA will also allow bank holding company companies to engage in any activity considered “financial” in nature or incidental to such financial activities. Under the existing Bank Holding Company Act, incidental activities are limited to those that are “banking” in nature or incidental to such banking activities.
Financial activities include as well as lending, providing insurance as an agent, broker or as principal, issuing annuities, underwriting, and dealing in or making a market in securities. All insurance activities that are to be conducted must be conducted in compliance with applicable state laws. In connection with insurance sales the United States Supreme Court case of Barnett Bank of Marion County N.A. v. Nelson, 116 S. Ct. 1103 (1996) is followed by GLBA, and GLBA further provides that “no state may, by statute, regulation, order, interpretation, or other action, prevent or significantly interfere with the ability of an insured depository institution, or a subsidiary or affiliate thereof, to engage, directly or indirectly, either by itself or in conjunction with a subsidiary, affiliate, or any other party, in any insurance sales, solicitation, or cross-marketing activity.”
The Community Reinvestment Act provisions in GLBA require that any new bank holding company that is formed meet the conditions that all of the company’s insured depository institutions are well capitalized and well managed or received at least a satisfactory rating in the most recent Community Reinvestment Act examination.
Other key aspects of GLBA include the following:
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On October 1, 1998, the FDIC adopted two new rules governing minimum capital levels that FDIC-supervised banks must maintain against the risks to which they are exposed. The first rule makes risk-based capital standards consistent for two types of credit enhancements (i.e., recourse arrangements and direct credit substitutes) and requires different amounts of capital for different risk positions in asset securitization transactions. The second rule permits limited amounts of unrealized gains on equity securities to be recognized for risk-based capital purposes.
In August 1997, Governor Wilson of California signed Assembly Bill 1432 ("AB1432") which provides for certain changes in the banking laws of California. Effective January 1, 1998 AB1432 eliminates the provisions regarding impairment of contributed capital and the assessment of shares when there is impairment of capital. AB1432 now allows the Commissioner of the California Department of Financial Institutions (the "Commissioner") to close a bank, if the Commissioner finds the bank's tangible shareholders' equity is less than the greater of 3% of the bank's total assets or $1 million. AB1432 also moved administration of the Local Agency Program from the California Department of Financial Institutions to the California State Treasurer's Office.
The Economic Growth and Regulatory Paperwork Reduction Act (the "1996 Act") as part of the Omnibus Appropriations Bill was enacted on September 30, 1996 and includes many banking related provisions. The most important banking provision is the recapitalization of the Savings Association Insurance Fund ("SAIF"). The 1996 Act provides for a one-time assessment of approximately 65 basis points over $100 of deposits of SAIF insured deposits including Oaker deposits payable on November 30, 1996. For the years 1997 through 1999 the banking industry will assist in the payment of interest on FICO bonds that were issued to help pay for the cleanup of the savings and loan industry. Banks will pay approximately 1.3 cents per $100 of deposits for this special assessment, and after the year 2000, banks will pay approximately 2.4 cents per $100 of deposits until the FICO bonds mature in 2017. There is a three-year moratorium on conversions of SAIF deposits
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to Bank Insurance Fund ("BIF") deposits. The 1996 Act also has certain regulatory relief provisions for the banking industry. Lender liability under the Superfund is eliminated for lenders who foreclose on property that is contaminated, provided that the lenders were not involved with the management of the entity that contributed to the contamination. There is a five-year sunset provision for the elimination of civil liability under the Truth in Savings Act. The FRB and the Department of Housing and Urban Development are to develop a single format for the Real Estate Settlement Procedures Act and Truth in Lending Act ("TILA") disclosures. TILA disclosures for adjustable mortgage loans are to be simplified. Significant revisions are made to the Fair Credit Reporting Act ("FCRA") including requiring that entities which provide information to credit bureaus conduct an investigation if a consumer claims the information to be in error. Regulatory agencies may not examine for FCRA compliance unless there is a consumer complaint investigation that reveals a violation or where the agency otherwise finds a violation. In the area of the Equal Credit Opportunity Act, the banks that self-test for compliance with fair lending laws will be protected from the results of the test provided that the appropriate corrective action is taken when violations are found.
Community Reinvestment Act ("CRA") regulations effective as of July 1, 1995 evaluate 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 or form bank holding companies. In addition, any bank rated in "substantial noncompliance" with the CRA regulations may be subject to enforcement actions.
The Company had its most recent CRA examination in June of 2000, and received a rating of "outstanding" CRA compliance.
It is impossible to predict what effect the enactment of the above-mentioned legislation will have on the Company and on the financial institutions industry in general. It is likely that other bills affecting the business of banks may be introduced in the future by the United States Congress or California legislature.
EmployeesAt December 31, 2001, the Company employed 83 persons on a full-time equivalent basis. The Company believes its employee relations are excellent.
Item 2 - PropertiesThe Company's Main bank branch is located at 2151 West Shaw Avenue, Fresno, California. The Company owns the building and leases the land under a sublease dated December 1, 1986 between Central Bank and USB. The current sublessor under the master ground lease is Bank of the West, which acquired the position through the purchase of Central Bank. The lessor under the ground lease (Master Lease) is Thomas F. Hinds. The lease expires on December 31, 2015 and the Company has options to extend the term for four (4) ten-year periods and one seven (7) year period.
The Company occupies the banking premises of approximately 3,600 square feet for its East Shaw branch under a lease extension expiring August 31, 2002 with additional extensions to August 31, 2011.
The Company owns the Oakhurst bank branch located at the Old Mill Village Shopping Center, 40074 Highway 49, Oakhurst, California, which was completed during April of 1999. The Company had originally maintained two branches in the Oakhurst area, and at this time consolidated its two Oakhurst branches into the new facility. The current facility, which consists of approximately 5,000 square feet, will be leased for a term of 15 years with two five-year options to extend the lease term.
The Company leases the Caruthers bank branch located at 13356 South Henderson, Caruthers, California which consists of approximately 5,000 square feet of floor space. The branch was acquired from Wells Fargo Bank in February 1997 under a lease which expires 1/19/2006 with extensions to 1/19/2021.
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The Company previously leased the San Joaquin bank branch, which was also acquired from Wells Fargo Bank during February of 1997. During 1999, the Company completed the construction of new facilities at 21574 Manning Avenue, San Joaquin, California and the branch operations were moved to that locality during November 1999. The new bank branch is approximately 2,500 square feet and is owned by the Company.
The Company owns the Firebaugh bank branch located at 1067 O Street, Firebaugh, California which was purchased from Bank of America during October 1997 for a total consideration of $211,500. The premises are comprised of approximately 4,666 of interior floor space situated on land totaling approximately one-third of an acre.
The Company owns the Coalinga bank branch located at 145 East Durian, Coalinga, California which also purchased from Bank of America during October 1997. The total price paid for the premises was $268,000 which purchased 6,184 square feet of interior floor space situated on approximately 0.45 acres.
The Company owns its administrative headquarters located at 1525 East Shaw Avenue, Fresno, California. The building consists of approximately 10,000 square feet of interior floor space and was purchased from Security Mutual Life Insurance Company during December of 1997.From time to time, the Company is party to claims and legal proceedings arising in the ordinary course of business. At this time, the management of the Company is not aware of any material pending litigation proceedings to which it is a party or has recently been party to, which will have a material adverse effect on the financial condition or results of operations of the Company.
Item 4 - Submission of Matters to a Vote of Security Holders11
PART II
Item 5 - Market for the Registrant's Common Equity and Related Stockholder MattersThe Company became a NASDAQ listed company on May 31, 2001. It is anticipated that the NASDAQ listing will provide greater exposure for the Company. The Company's common stock was previously quoted on the OTCBB (over-the-counter bulletin board), a quotation service for securities not listed or traded on NASDAQ or a national securities exchange. Volumes traded are shown below.
The Company currently has three market makers for its common stock. These include First Security Van Kasper, Sutro & Company, and Hill Thompson, Magid & Company. The Company is aware of two other securities dealers: Smith Barney and Dean Witter Reynolds Inc., which periodically act as brokers in the Company's stock.The following table sets forth the high and low bid quotations by quarter for the Company's common stock, as reported by Sutro & Company for the years ended December 31, 2001 and 2000. These quotations reflect the price that would have been received by the seller, without retail mark-up, mark-down or commissions and may have represented actual transactions.
Bid Prices
--------------------------------------------------
Quarter High Low Volume
-----------------------------------------------------------------------
4th Quarter 2001 $17.25 $16.00 170,000
3rd Quarter 2001 $17.50 $16.00 203,900
2nd Quarter 2001 $17.75 $16.25 102,000
1st Quarter 2001 $17.75 $15.75 113,200
4th Quarter 2000 $17.38 $16.31 107,700
3rd Quarter 2000 $17.25 $16.50 225,200
2nd Quarter 2000 $18.00 $15.00 136,000
1st Quarter 2000 $20.50 $17.50 103,700
At February 28, 2002, there were approximately 627 record holders of common stock of the Company.
DividendsThe Company's shareholders are entitled to cash dividends when and as declared by the Company’s Board of Directors out of funds legally available therefor. Dividends paid to shareholders by the Company are subject to restrictions set forth in California General Corporation Law, which provides that a corporation may make a distribution to its shareholders if retained earnings immediately prior to the dividend payout are at least equal the amount of the proposed distribution. As a bank holding company without significant assets other than its equity position in the Bank, the Company’s ability to pay dividends to its shareholders depends primarily upon dividends it receives from the Bank. Such dividends paid by the Bank to the Company are subject to certain limitations. See “Management’s Discussion and Analysis of Financial and Results of Operations – Regulatory Matters”.
The Company paid cash dividends to shareholders of $ 0.10 per share on January 24, 2001, and paid $0.115 per share on April 25, 2001, July 25, 2001 and October 24, 2001. During the previous year, the Company paid cash dividends of $ 0.08 per share on January 28, 2000 and April 26, 2000, and $0.10 per share on July 26, 2000.
The amount and payment of dividends by the Company to shareholders are set by the Company's Board of Directors with numerous factors involved including the Company's earnings, financial condition and the need for capital for expanded growth and general economic conditions. No assurance can be given that cash or stock dividends will be paid in the future.
12
The following table sets forth certain selected financial data for the Bank for each of the years in the five-year period ended December 31, 2001 and should be read in conjunction with the more detailed information and financial statements contained elsewhere herein (in thousands except per share data and ratios).
December 31,
----------------------------------------------------------------------------------------------------------
(in thousands except per share data) 2001 2000 1999 1998 1997
----------------------------------------------------------------------------------------------------------
Summary of Earnings:
Interest income and loan fees $30,063 $28,941 $21,920 $21,519 $17,267
Interest expense 13,411 11,544 7,925 8,605 6,331
---------------------------------------------------------------
Net interest income 16,652 17,397 13,995 12,914 10,936
Provision for credit losses 1,733 1,580 1,025 1,200 1,200
---------------------------------------------------------------
Net interest income after
provision for credit losses 14,919 15,817 12,970 11,714 9,736
Noninterest income 4,277 2,538 2,781 2,797 2,354
Noninterest expense 9,818 8,648 7,898 7,591 5,806
---------------------------------------------------------------
Income before taxes on income 9,378 9,707 7,853 6,920 6,284
Taxes on income 3,185 3,450 2,930 2,704 2,543
---------------------------------------------------------------
Net Income $6,193 $6,257 $4,923 $4,216 $3,741
===============================================================
Per Share Data:
Net Income - Basic $1.14 $1.16 $0.95 $0.82 $0.74
Net Income - Diluted $1.11 $1.12 $0.89 $0.77 $0.70
Average shares outstanding - Basic 5,443,734 5,374,734 5,202,324 5,154,748 5,065,100
Average shares outstanding - Diluted 5,563,855 5,587,292 5,514,544 5,490,891 5,335,675
Cash dividends paid $0.445 $0.36 $0.28 $0.24 $0.213
Financial Position:
Total assets $450,928 $356,832 $281,531 $279,950 $243,596
Total net loans and leases 331,163 256,802 195,233 152,052 140,144
Total deposits 368,651 271,862 238,863 252,474 220,016
Total shareholders' equity 36,059 33,749 28,316 24,989 21,651
Book value per share $6.68 $6.23 $5.41 $4.83 $4.23
Selected Financial Ratios:
Return on average assets 1.55% 1.95% 1.77% 1.58% 1.93%
Return on average shareholders' equity 17.25% 20.05% 18.31% 17.85% 18.60%
Average shareholders' equity
to average assets 9.00% 9.71% 9.69% 8.86% 10.38%
Net charge-offs to average loans 0.35% 0.19% 0.17% 0.96% 0.52%
Allowance for credit losses as a percentage
of period-end loans 1.33% 1.45% 1.34% 1.24% 1.51%
Dividend payout ratio 40.09% 32.14% 31.50% 31.30% 30.48%
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Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, but are not limited to, those described in Management’s Discussion and Analysis of Financial Condition and Results of Operations. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company.
On June 12, 2001, the United Security Bank (the “Bank”) became the wholly owned subsidiary of United Security Bancshares, Inc. (the “Company”) through a tax free holding company reorganization, accounted for on a basis similar to the pooling of interest method. In the transaction, each share of Bank stock was exchanged for a share of Company stock on a one-to-one basis. No additional equity was issued as part of this transaction. In the following discussion, references to the Bank are references to United Security Bank. References to the Company are references to United Security Bancshares, Inc. (including the Bank), except for periods prior to June 12, 2001, in which case, references to the Company are references to the Bank.
On June 28, 2001, United Security Bancshares Capital Trust I (the “Trust”) was formed as a Delaware business trust for the sole purpose of issuing Trust Preferred securities. On July 16, 2001, the Trust completed the issuance of $15 million in Trust Preferred securities, and concurrently, the Trust used the proceeds from that offering to purchase Junior Subordinated Debentures of the Company. The Company contributed $13.7 million of the $14.5 million in net proceeds received from the Trust to the Bank to increase its regulatory capital and will use the rest for future expansion of the Company’s business.
The Company currently has seven banking branches and one construction lending office, which provide financial services in Fresno and Madera counties. As a community-oriented bank, the Company continues to seek ways to better meet its customers' needs for financial services, and to expand its business opportunities in today's ever-changing financial services environment. The Company's strategy is to be a better low-cost provider of services to its customer base while enlarging its market area and corresponding customer base to further its ability to provide those services.
Results of OperationsAs a result of continued asset growth, the Company continues to generate strong earnings. This has been accomplished even in an environment of volatile interest rates such as we have seen over the past several years. For the year ended December 31, 2001, the Company reported net income of $6.2 million or $1.14 per share ($1.11 diluted) as compared to $6.3 million or $1.16 per share ($1.12 diluted) for the year ended December 31, 2000, and $4.9 million or $0.95 per share ($0.89 diluted) for the year ended December 31, 1999. The results for 2001 were down slightly from the previous year as the result of additional costs associated with the formation of the holding company and its infrastructure, including the issuance of Trust Preferred Securities. This has strategically positioned the Company for long-term growth and profitability.
The Company’s return on average assets was 1.55% for the year ended December 31, 2001 as compared to 1.95% and 1.77% for the same twelve-month periods of 2000 and 1999, respectively. The Bank’s return on average equity was 17.25% for the year ended December 31, 2001 as compared to 20.05% and 18.31% for the same twelve-month periods of 2000 and 1999, respectively.
Net Interest IncomeNet interest income, the most significant component of earnings, is the difference between the interest and fees received on earning assets and the interest paid on interest-bearing liabilities. Earning assets consist primarily of loans, and to a lesser extent, investments in securities issued by federal, state and local authorities, and corporations. These earning assets are funded by a combination of interest-bearing and noninterest-bearing liabilities, primarily customer deposits and short-term and long-term borrowings. Net interest income before provision for credit losses totaled $16.7 million for the year ended December 31, 2001, representing a decrease of $745,000 or 4.3% over the previous year, but an increase of $2.7 million or 19.0% over the year ended December 31, 1999. The decrease in net interest income between 2000 and 2001 is primarily the result of the substantial decline in market rates of interest between those two twelve-month periods which more than offset the growth in average earning assets. Net interest income increased between 1999 and 2000 as a result of significant growth in earning assets and interest-bearing liabilities which was enhanced by an increase in market rates of interest during the 2000.
14
--------------------------------------------------------------------------------------
2001 2000 1999
--------------------------------------------------------------------------------------
Average Yield/ Average Yield/ Average Yield/
(dollars in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
- ----------------------------------------------------------------------------------------------------------------------------
Assets:
Interest-earning assets:
Loans (1) $297,653 $26,412 8.87% $230,305 $24,739 10.74% $175,324 $17,780 10.14%
Investment Securities - taxable 55,285 3,218 5.82% 54,652 3,798 6.95% 50,959 2,993 5.87%
Investment Securities - nontaxable(2) 3,357 155 4.62% 3,346 162 4.84% 3,420 165 4.82%
Federal funds sold and reverse repos 7,766 278 3.58% 4,080 242 5.93% 19,725 982 4.98%
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Total interest-earning assets 364,061 $30,063 8.26% 292,383 $28,941 9.90% 249,428 $21,920 8.79%
================== ================== ===================
Allowance for possible loan losses (4,114) (3,206) (2,349)
Noninterest-bearing assets:
Cash and due from banks 14,154 13,455 13,339
Premises and equipment, net 3,265 3,670 3,719
Accrued interest receivable 3,352 2,792 1,698
Other real estate owned 4,179 909 677
Other assets 13,863 11,442 11,027
----------- ---------- ----------
Total average assets $398,760 $321,445 $277,539
=========== ========== ==========
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
NOW accounts $24,382 $360 1.48% $24,025 $411 1.71% $25,479 $437 1.72%
Money market accounts 47,440 1,604 3.38% 43,665 1,701 3.90% 36,955 1,307 3.54%
Savings accounts 18,337 322 1.76% 19,286 416 2.16% 20,465 445 2.17%
Time deposits 169,720 8,917 5.25% 121,529 7,166 5.90% 109,102 5,625 5.16%
Other borrowings 33,752 1,667 4.94% 27,846 1,850 6.64% 1,957 111 5.67%
Trust Preferred securities 6,945 541 7.79% 0 0 0.00% 0 0 0.00%
--------------------------------------------------------------------------------------
Total interest-bearing liabilities 300,576 $13,411 4.46% 236,351 $11,544 4.88% 193,958 $7,925 4.09%
================== ================= ==================
Noninterest-bearing liabilities:
Noninterest-bearing checking 59,389 51,554 54,551
Accrued interest payable 1,388 1,035 1,003
Other liabilities 1,504 1,300 1,145
---------- ----------- -----------
Total Liabilities 362,857 290,240 250,657
Total shareholders' equity 35,903 31,205 26,882
----------- ---------- -----------
Total average liabilites and
shareholders' equity $398,760 $321,445 $277,539
=========== ========== ===========
Interest income as a percentage
of average earning assets 8.26% 9.90% 8.79%
Interest expense as a percentage
of average earning assets 3.68% 3.95% 3.18%
---------- ---------- ----------
Net interest margin 4.58% 5.95% 5.61%
========== ========== ==========
| (1) Loan amounts include nonaccrual loans, but the related interest income has been included only if collected for the period prior to the loan being placed on a nonaccrual basis. Loan interest income includes loan fees of approximately $1,468,000, $856,000 and $876,000 for the years ended December 31, 2001, 2000, and 1999, respectively. | ||
| (2) Applicable nontaxable securities yields have not been calculated on a tax-equivalent basis because they are not material to the Company’s results of operations. |
As summarized in Table 2, the increase in net interest income between the two twelve-month periods ended December 31, 2001 and 2000 is comprised of an increase in total interest income of approximately $1.1 million, which was more than offset by an increase in total interest expense of approximately $1.9 million. The Bank's net interest margin, as shown in Table 1, decreased to 4.58% at December 31, 2001 from 5.95% at December 31, 2000, a decrease of 137 basis points (100 basis points = 1%) between the two periods. The net margin reported during 2001 also represents a decrease of 103 basis points from the 5.61% net margin realized by the Company during 1999. While assets have grown over the past three years and the balance sheet mix has changed, interest rate movements over those three years have played a significant role in net interest income trends. Market rates of interest increased between the years ended December 31, 1999 and 2000, but then decreased
15
significantly between the years ended December 31, 2000 and 2001. The Prime rate, for example (the rate to which most of the Company’s floating-rate loans are tied), increased by 100 basis point during 2000, but declined by an unprecedented 475 basis points between December 31, 2000 and December 31, 2001. As a result of the Federal Reserve’s actions, the prime rate averaged 6.93% for the year ended December 31, 2001 as compared to 9.24% and 7.99% for the years ended December 31, 2000 and 1999.
Both the Company's net interest income and net interest margin are affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." Both are also affected by changes in yields on interest-earning assets and rates paid on interest-bearing liabilities, referred to as "rate change". The following table sets forth the changes in interest income and interest expense for each major category of interest-earning asset and interest-bearing liability, and the amount of change attributable to volume and rate changes for the years indicated.
Table 2. Rate and Volume Analysis
2001 compared to 2000 2000 compared to 1999
--------------------------------------------------------------
(In thousands) Total Rate Volume Total Rate Volume
- -----------------------------------------------------------------------------------------------------------
Increase (decrease) in interest income:
Loans $1,673 $(4,772) $6,445 $6,959 $1,105 $5,854
Investment securities (587) (631) 44 802 582 220
Federal funds sold and securities
purchased under agreements to resell 36 (122) 158 (740) 159 (899)
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Total interest income 1,122 (5,525) 6,647 7,021 1,846 5,175
Increase (decrease) in interest expense:
Interest-bearing demand accounts (148) (272) 124 368 214 154
Savings accounts (94) (74) (20) (29) (4) (25)
Time deposits 1,751 (848) 2,599 1,541 860 681
Other borrowings (183) (530) 347 1,739 22 1,717
Trust Preferred securities 541 0 541 -- -- --
---------------------------------------------------------------
Total interest expense 1,867 (1,724) 3,591 3,619 1,092 2,527
---------------------------------------------------------------
Increase in net interest income $(745) $(3,801) $3,056 $3,402 $754 $2,648
===============================================================
For the year ended December 31, 2001, total interest income increased approximately $1.1 million or 3.9% as compared to the year ended December 31, 2000. The change is attributable primarily to an increase in the overall volume of earning assets, which was only partially offset by a decrease in market rates of interest. Earning asset growth was mainly in loans, which are traditionally the Company’s highest earning asset and, to a smaller degree, in federal funds sold, repurchase agreements, and investment securities. On average, loan growth totaled nearly $67.4 million or 29.2% during 2001. The Company continues to improve its earning asset mix with loans averaging 81.8% of total earning assets for the year ended December 31, 2001, as compared to 78.8% and 70.3% for the years ended December 31, 2000 and 1999, respectively.
For the year ended December 31, 2000, total interest income increased $7.0 million or 32.0% as compared to the year ended December 31, 1999. This increase is attributable primarily to a substantial increase in loan volume, which was enhanced by an increase in the average yield on all earning assets during the year. Average loans increased $55.0 million and average investment securities increased $3.6 million between December 31, 1999 and December 31, 2000. Average overnight federal funds and reverse repurchase agreements decreased between the years ended December 31, 1999 and 2000 as a result of high loan demand. This more than outweighed the increase in yield on these funds and, as a result, interest income on overnight funds declined between those two years.
For the year ended December 31, 2001, total interest expense increased approximately $1.9 million or 16.2% as compared to the year ended December 31, 2000. The increase between these two periods is primarily the result of an increase in average time deposits of more than $48.2 million, which more than offset the 65 basis point decrease in the average cost of those deposits. As a result of the increased volume in time deposits, interest expense on those deposits increased by almost $1.8 million for the year. Other borrowings, including federal funds purchased and repurchase agreements, as well as trust-preferred securities, increased by $12.9 million on average between the years ended December 31, 2000 and December 31, 2001. Being short-term in nature, the cost of other borrowings declined by 170 basis points between those two twelve-month periods as market rates of interest dropped significantly during 2001.
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For the year ended December 31, 2000, interest expense totaling $11.5 million represents an increase of $3.6 million or 45.7% as compared to the year ended December 31, 1999. The increase was attributable to both an increase in average volumes of deposits and borrowings, as well as an increase in the rates paid on those interest-bearing liabilities. Average time deposits increased $12.4 million and short-term borrowings increased $25.9 million between December 31, 1999 and December 31, 2000. As interest rates began to rise during 2000, so did the cost of time deposits, as renewals and new deposits were taken at the higher rates. Borrowings are short-term and repriced upwards as the year progressed. As a result of volume increases combined with rate increases, interest expense on time deposits and short-term borrowings increased $1.5 million and $1.7 million, respectively, between the years ended December 31, 1999 and December 31, 2000.
Provisions for credit losses and the amount added to the allowance for credit losses is determined on the basis of management's continuous credit review of the loan portfolio, consideration of past loan loss experience, current and future economic conditions, and other pertinent factors. Such factors consider the allowance for credit losses to be adequate when it covers estimated losses inherent in the loan portfolio. Based on the condition of the loan portfolio, management believes the allowance is sufficient to cover risk elements in the loan portfolio. For the year ended December 31, 2001 the provision to the allowance for credit losses amounted to $1.7 million as compared to $1.6 and $1.0 million for the years ended December 31, 2000 and 1999, respectively. The amount provided to the allowance for credit losses during 2001 brought the allowance to 1.33% of net outstanding loan balances at December 31, 2001, as compared to 1.45% of net outstanding loan balances at December 31, 2000, and 1.34% at December 31, 1999.
Noninterest IncomeThe following table summarizes significant components of noninterest income for the years ended December 31, 2001, 2000 and 1999 and the net changes between those years:
Year Ended December 31, Change during Year
-------------------------------------------------------------
(In thousands) 2001 2000 1999 2001 2000
- ------------------------------------------------------------------------------------------------
Customer service fees $3,086 $2,234 $2,379 $852 $(145)
Gain on sale of securities 770 6 0 764 6
Gain on sale of OREO 34 62 158 (28) (96)
Gain on sale of fixed assets 8 2 3 6 (1)
Other 379 234 241 145 (7)
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Total $4,277 $2,538 $2,781 $1,739 $(243)
=============================================================
Noninterest income consists primarily of fees and commissions earned on services that are provided to the Company’s banking customers. Noninterest income for the year ended December 31, 2001 increased $1.7 million when compared to the same period last year, and increased $1.5 million when compared to the year ended December 31, 1999. An increase in gains from sales of available-for-sale securities accounted for $764,000 or 43.9% of the increase in total noninterest income between the years ended December 31, 2000 and December 31, 2001. Increases in customer service fees accounted for another $852,000 or 50.0% of the total increase in noninterest income between those two periods. Increases in customer service fees are attributable to growth in checking service charges, as well as overdraft and ATM fee income.
Total noninterest income for the year ended December 31, 2000 decreased $243,000 or 8.7% when compared to the year ended December 31, 1999. Customer service fees, the primary category of total noninterest income, decreased $145,000 or 6.1% during 2000, primarily as the result of a decline in ATM fee income. In addition to the decline in ATM fee income, gains on the sale of other real estate owned through foreclosure declined by almost $96,000 during 2000 from the $158,000 realized during 1999.
17
The following table sets forth the components of total noninterest expense in dollars and as a percentage of average earning assets for the years ended December 31, 2001, 2000 and 1999:
2001 2000 1999
----------------------------------------------------------------------------
% of % of % of
Average Average Average
Earning Earning Earning
(In thousands) Amount Assets Amount Assets Amount Assets
- ---------------------------------------------------------------------------------------------------------------
Salaries and employee benefits $4,525 1.24% $3,954 1.35% $3,219 1.29%
Occupancy expense 1,731 0.48% 1,608 0.55% 1,590 0.64%
Data processing 544 0.15% 540 0.18% 514 0.21%
Professional fees 591 0.15% 312 0.11% 539 0.22%
Directors fees 202 0.06% 174 0.06% 167 0.07%
Amortization of intangibles 360 0.10% 360 0.12% 372 0.15%
Correspondent bank service charges 218 0.06% 202 0.07% 184 0.07%
Other 1,647 0.46% 1,498 0.51% 1,313 0.53%
-----------------------------------------------------------------------------
Total $9,818 2.70% $8,648 2.96% $7,898 3.17%
=============================================================================
Noninterest expense, excluding provision for credit losses and income tax expense, totaled $9.8 million for the year ended December 31, 2001 as compared to $8.6 million and $7.9 million for the years ended December 31, 2000 and 1999, respectively. These figures represent an increase of $1.2 million or 13.5% between the years ended December 31, 2001 and 2000 and an increase of $750,000 or 9.5% between the years ended December 31, 2000 and 1999. Expense increases between the three years presented are associated primarily with normal, anticipated growth of the Company. As a percentage of average earning assets, total noninterest expense has actually declined over the past three years as the Company has controlled overhead expenses while experiencing profitable growth. Noninterest expense declined to 2.70% of average earning assets for the year ended December 31, 2001 from 2.96% at December 31, 2000, and 3.17% at December 31, 1999.
Increases in salaries and employee benefits over the three years presented were the result of additional staff to support the Company’s strategic long-term growth objectives, as well as normal wage and benefit increases combined with increased medical insurance costs incurred. Professional fees fluctuated between the three years presented as the result of additional expenses incurred during 2001 related to the Company’s becoming listed on NASDAQ, the formation of the holding company, and the issuance of Trust Preferred securities. Additional costs were incurred during 1999 for legal proceedings between the Company and former its president, as well as increased legal expenses for the workout of impaired loans. Increases in other noninterest expense over the three years presented are associated with normal business growth and, include a number of items such as telephone, postage, insurance, and armored car expenses.
Financial ConditionTotal assets increased by $94.1 million or 26.4% during the year to $450.9 million at December 31, 2001, up from $356.8 million at the end of the same period last year, and up from the balance of $281.5 million at December 31, 1999. Substantial asset growth during 2001 was primarily the result of increased loan demand, which was funded predominantly by deposit growth during the year. During the year ended December 31, 2001, loan growth totaled $75.0 million, while securities and other short-term investments increased $16.7 million. Total deposits of $368.7 million at December 31, 2001 increased $96.8 million or 35.6% from the balance reported at December 31, 2000, and increased $129.8 million or 54.3% from the balance of $238.9 million reported at December 31, 1999.
Earning assets averaged approximately $364.1 million during the year ended December 31, 2001, as compared to $292.4 million and $249.4 million for the years ended December 31 2000 and 1999, respectively. Average interest-bearing liabilities increased to $300.6 million for the year ended December 31, 2001, as compared to $236.4 million for the year ended December 31, 2000, and $194.0 million for the year ended December 31, 1999.
LoansThe Company's primary business is that of acquiring deposits and making loans, with the loan portfolio representing the largest and most important component of its earning assets. Loans totaled $336.3 million at December 31, 2001, an increase of $74.9 million or 28.7% when
18
compared to the balance of $261.4 million at December 31, 2000, and an increase of $138.0 million or 69.6% when compared to the balance of $198.3 million reported at December 31, 1999. Average loans totaled $297.7 million, $230.3 million, and $175.3 million for the years ended December 31, 2001, 2000 and 1999, respectively. During 2001 average loans increased 29.2% when compared to the year ended December 31, 2000 and increased 69.8% compared to the year ended December 31, 1999.
The following table sets forth the amounts of loans outstanding by category and the category percentages as of the year-end dates indicated:
2001 2000 1999 1998 1997
-------------------------------------------------------------------------------------------
Dollar % of Dollar % of Dollar % of Dollar % of Dollar % of
(In thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- ----------------------------------------------------------------------------------------------------------------------
Commercial and industrial $102,280 30.4% $66,435 25.4% $52,275 26.4% $43,358 28.1% $33,777 23.6%
Real estate - mortgage 111,425 33.1 113,140 43.3 77,694 39.2 65,833 42.6 70,801 49.5
Real estate - construction 92,764 27.6 61,038 23.4 55,574 28.0 33,913 22.0 28,226 19.8
Agricultural 12,987 3.9 7,240 2.8 7,003 3.5 6,479 4.2 4,746 3.3
Installment/other 6,647 2.0 10,291 3.9 5,723 2.9 4,837 3.1 5,383 3.8
Lease financing 10,184 3.0 3,225 1.2 0 0.0 0 0.0 0 0.0
--------------------------------------------------------------------------------------------
Total Loans $336,287 100.0% $261,369 100.0% $198,269 100.0% $154,420 100.0% $142,933 100.0%
============================================================================================
Loan growth continues to be greatest in what has historically been the Bank’s primary lending emphasis: commercial, real estate mortgage, and construction lending. Almost half of the loan growth experienced during 2001 occurred in commercial and industrial loans, which increased by $35.8 million or 54.0% during the year as compared to $14.2 million or 27.1% during 2000. Growth also continues in construction loans, which increased $31.7 million or 52.0% during 2001, and increased $5.5 million or 9.8% during 1999. Agricultural loans increased $5.7 million or 79.3% between December 31, 2000 and December 31, 2001, while installment loans decreased $3.6 million or 35.4% during that same period. During 2000, the Company purchased an existing leasing portfolio and, with growth experienced during 2001, this category grew by $7.0 million or 215.8% during the year ended December 31, 2001.
The real estate mortgage loan portfolio totaling $111.4 million at December 31, 2001 consists of commercial real estate, residential mortgages, and home equity loans. Commercial real estate is the core of this segment of the portfolio, with balances of $83.3 million, $89.5 million, and $56.2 million at December 31, 2001, 2000, and 1999, respectively. The Company does not currently offer residential mortgage loans and, as a result, that portion of the portfolio generally has declined over time with balances of $13.4 million, $6.1 million, and $7.8 million at December 31, 2001, 2000 and 1999, respectively. The Company purchased a portfolio of jumbo mortgages during 2001, which accounted for $8.7 million of the outstanding mortgage loans at December 31, 2001. The Company began offering home equity loans early in 1997 and since that time balances have remained strong with $14.8 million at December 31, 2001, $17.5 million at December 31, 2000, and $13.8 million at December 31, 1999.
The following table sets forth the maturities of the Bank's loan portfolio at December 31, 2001. Amounts presented are shown by maturity dates rather than repricing periods:
Due after one
Due in one Year through Due after
(In thousands) year or less Five years Five years Total
- ---------------------------------------------------------------------------------------------------
Commercial and agricultural $61,199 $30,966 $23,102 $115,267
Real estate - construction 60,781 23,776 8,207 92,764
----------------------------------------------------------------
121,980 54,742 31,309 208,031
Real estate - mortgage 9,895 52,954 48,576 111,425
All other loans 5,058 10,645 1,128 16,831
----------------------------------------------------------------
Total Loans $136,933 $118,341 $81,013 $336,287
================================================================
The average yield on loans was 8.87% for the year ended December 31, 2001, representing a decrease of 187 basis points when compared to the year ended December 31, 2000 and was a result of a significant decline in market rates of interest between those two periods. For the year ended December 31, 2000, the overall average yield on the loan portfolio was 10.74%, representing an increase of 60 basis points when compared to 10.14% for the same twelve-month period of 1999 and was a result of a general increase in average market rates of interest during
19
2000. The Bank’s loan portfolio is generally comprised of short-term or floating rate loans and is therefore susceptible to fluctuations in market rates of interest. At December 31, 2001, 2000 and 1999, approximately 65.2%, 65.5% and 67.5% of the Bank's loan portfolio consisted of floating rate instruments, with the majority of those tied to the prime rate.
SecuritiesFollowing is a comparison of the amortized cost and approximate fair value of available-for-sale and held-to-maturity securities for the three years indicated:
December 31, 2001 December 31, 2000
------------------------------------------ -----------------------------------------
Fair Fair
Gross Gross Value Gross Gross Value
Amortized Unrealized Unrealized (Carrying Amortized Unrealized Unrealized (Carrying
(In thousands) Cost Gains Losses Amount) Cost Gains Losses Amount)
- -----------------------------------------------------------------------------------------------------------------------
Available-for-sale:
U.S. Government agencies $42,341 $360 $(74) $42,627 $42,523 $489 $(79) $42,933
U.S. Government agency
collateralized mortgage
obligations 211 1 (2) 210 1,357 0 (16) 1,341
Obligations of state and
political subdivisions 3,464 72 (4) 3,532 3,317 72 0 3,389
Other debt securities 17,164 0 (168) 16,996 2,000 95 0 2,095
------------------------------------------ -----------------------------------------
Total available-for-sale $63,180 $433 $(248) $63,365 $49,197 $656 $(95) $49,758
========================================== =========================================
Held-to-maturity:
U.S. Government agencies $0 $0 $(0) $0 $10,248 $0 $(74) $10,174
========================================== =========================================
December 31, 1999
---------------------------------------------
Gross Gross Fair Value
Amortized Unrealized Unrealized (Carrying
(In thousands) Cost Gains Losses Amount)
- -----------------------------------------------------------------------------------------
Available-for-sale:
U.S. Government agencies $32,034 $115 $(489) $31,660
U.S. Government agency
collateralized mortgage obligations 1,845 0 (41) 1,804
Obligations of state and
political subdivisions 3,402 0 (247) 3,155
Other debt securities 9,929 0 0 9,929
---------------------------------------------
Total available-for-sale $47,210 $115 $(777) $46,548
=============================================
Held-to-maturity:
U.S. Government agencies $10,248 $0 $(351) $9,897
=============================================
Realized gains on securities available-for-sale totaled $769,000 during 2001, and $6,000 during 2000. There were no realized losses on securities available-for-sale during either of those years. There were no realized gains or losses for such securities during 1999.
Most of the $14.0 million increase in available-for-sale securities experienced during 2001 was in the other debt securities category. Included in other debt securities at December 31, 2001 are a short-term government securities mutual fund totaling $10.0 million, a CRA qualified investment fund totaling $4.0 million, and a Trust Preferred securities pool totaling $3.1 million. At December 31, 2000, other debt securities consisted solely of investments in Trust Preferred securities.
Total securities changed little during the year ended December 31, 2000, although the mix of the portfolio did change. At December 31, 1999, the Bank had approximately $9.9 million in short-term commercial paper which matured during the first quarter of 2000. Much of this money was reinvested in U.S. Government agencies during 2000.
20
The amortized cost and fair value of investment securities as well as yields on those securities at December 31, 2001, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.
December 31, 2001
----------------------------------------------
Weighted Amortized Fair
(In thousands) Average Yield(1) Cost Value
- ---------------------------------------------------------------------------------------
Available-for-sale:
Due in one year or less 4.80% $10,666 $10,567
Due after one year through five years 6.40% 28,561 28,748
Due after five years through ten years 7.60% 7,250 7,302
Due after ten years 7.34% 16,492 16,538
Collateralized mortgage obligations 5.38% 211 210
------------------------------------------
Total available-for-sale 6.42% $63,180 $63,365
==========================================
(1) Weighted average yields are not computed on a tax equivalent basis
Contractual maturities on collateralized mortgage obligations are difficult to anticipate due to allowed paydowns and therefore have been disclosed separately for the purpose of the above table. For further discussion on the maturities of collateralized mortgage obligations, see "Liquidity and Asset/Liability Management" presented later in this text.
At December 31, 2001, available-for-sale securities with an amortized cost of approximately $43.9 million (fair value of $44.2 million) were pledged as collateral for public funds and treasury tax and loan balances. At December 31, 2000, available-for-sale securities with an amortized cost of approximately $44.2 million (fair value of $44.6 million) were pledged as collateral for public funds and treasury tax and loan balances. At December 31, 2000, all held-to-maturity securities with an amortized cost of approximately $10.2 million (fair value of $10.2 million) were pledged as collateral for public funds (including the State of California) and the Federal Reserve Discount Window.
DepositsThe Bank attracts commercial deposits primarily from local businesses and professionals, as well as retail checking accounts, savings accounts and time deposits. Total deposits increased $96.8 million or 35.6% during the year to a balance of $368.7 million at December 31, 2001 and increased $33.0 million or 13.8% between December 31, 1999 and December 31, 2000. Core deposits, consisting of all deposits other than time deposits of $100,000 or more and brokered deposits, continue to provide the foundation for the Bank's principal sources of funding and liquidity. These core deposits amounted to 65.5%, 71.4% and 79.7% of the total deposit portfolio at December 31, 2001, 2000 and 1999, respectively.
The following table sets forth the amounts of deposits by category for the years indicated, and the dollar change in each category during the year:
Balance as of December 31, Change during Year
---------------------------------------------------------------------
(In thousands) 2001 2000 1999 2001 2000
- ---------------------------------------------------------------------------------------------------------
Noninterest bearing deposits $72,413 $52,898 $50,910 $19,515 $1,988
Interest bearing deposits:
NOW and money market account 83,316 62,143 62,239 21,173 (96)
Savings accounts 19,883 18,347 19,609 1,536 (1,262)
Time deposits:
Under $100,000 68,414 63,567 57,553 4,847 6,014
$100,000 and over 124,625 74,908 48,552 49,717 26,356
---------------------------------------------------------------------
Total interest bearing deposits 296,238 218,965 187,953 77,273 31,012
---------------------------------------------------------------------
Total deposits $368,651 $271,863 $238,863 $96,788 $33,000
=====================================================================
21
During the year ended December 31, 2001, increases were experienced in all deposit categories, with substantial increases in time deposits, as well as interest-bearing and noninterest-bearing checking accounts. The increase experienced in total deposits between December 31, 1999 and December 31, 2000 was almost exclusively in time deposits. Much of the increase in time deposits over the years presented has been the result of brokered deposits and time deposits from the State of California. The Company has utilized brokered deposits over the past several years to enhance its deposit growth, with brokered deposits totaling $51.3 million and $12.5 million at December 31, 2001 and 2000, respectively. The Company had no brokered deposits at December 31, 1999. In addition, the Company has been able to obtain time deposits from the State of California, which totaled $30.0 million, $25.0 million, and $10.0 million at December 31, 2001, 2000 and 1999, respectively. The time deposits of the State of California are collateralized by pledged securities in the Company’s investment portfolio.
The Company's deposit base consists of two major components represented by noninterest-bearing (demand) deposits and interest-bearing deposits. Interest-bearing deposits consist of time certificates, NOW and money market accounts and savings deposits. Total interest-bearing deposits increased $77.3 million or 35.3% between December 31, 2000 and December 31, 2001, while noninterest-bearing deposits increased $19.5 million or 36.9% between the same two periods presented. Between December 31, 1999 and December 31, 2000, total interest-bearing deposits increased $31.0 million or 16.5%, while noninterest-bearing deposits increased $2.0 million or 3.9%.
On a year-to-date average (refer to Table 1), the Company experienced an increase of $59.2 million or 22.8% in total deposits between the years ended December 31, 2000 and December 31, 2001. Between these two periods, average interest-bearing deposits increased $51.4 million or 24.6%, while total noninterest-bearing checking increased $7.8 million or 15.2% on a year-to-date average basis. On average, the Company experienced increases in all other deposit categories, except savings accounts, between the years ended December 31, 2000 and December 31, 2001, with the most significant increases being in time deposits and money market accounts. On a year-to-date average basis, total deposits increased $13.5 million or 5.5% between the years ended December 31, 1999 and December 31, 2000. Of that total, interest-bearing deposits increased by $16.5 million or 8.6%, while noninterest-bearing deposits declined $3.0 million or 5.5% during 2000. As with 2001, the most significant increases experienced in average deposits during 2000 were in time deposits and money market accounts. On average, NOW and savings accounts showed only slight decreases between the years ended December 31, 1999 and December 31, 2000.
The following table sets forth the average deposits and average rates paid on those deposits for the years ended December 31, 2001, 2000 and 1999:
2001 2000 1999
------------------------------------------------------------------
Average Average Average
(In thousands) Balance Rate % Balance Rate % Balance Rate %
- --------------------------------------------------------------------------------------------------
Interest bearing deposits:
Checking accounts $71,822 2.73% $67,690 3.12% $62,434 2.80%
Savings 18,337 1.76% 19,286 2.16% 20,465 2.17%
Time deposits(1) 169,720 5.25% 121,529 5.90% 109,102 5.16%
Noninterest-bearing deposits 59,389 51,554 54,551
(1) Included at December 31, 2001, are $124.6 million in time certificates of deposit of $100,000 or more, of which $67.5 million matures in three months or less, $26.7 million matures in 3 to 6 months, $18.7 million matures in 6 to 12 months, and $11.7 million matures in more than 12 months.
The Company has the ability to obtain borrowed funds consisting of federal funds purchased, securities sold under agreements to repurchase ("repurchase agreements") and Federal Home Loan Bank ("FHLB") advances as alternatives to retail deposit funds. The Company has established collateralized and uncollateralized lines of credit with several correspondent banks, as well as a securities dealer, for the purpose of obtaining borrowed funds as needed. The Company may continue to borrow funds in the future as part of its asset/liability strategy, and may use these funds to acquire certain other assets as deemed appropriate by management for investment purposes and to better utilize the capital resources of the Bank. Federal funds purchased represent temporary overnight borrowings from correspondent banks and are generally unsecured. Repurchase agreements are collateralized by mortgage backed securities and securities of U.S. Government agencies, and generally have maturities of one to six months, but may have longer maturities if deemed appropriate as part of the Company's asset/liability management
22
strategy. FHLB advances are collateralized by all of the Company's stock in the FHLB and certain qualifying mortgage loans. In addition, the Company has the ability to obtain borrowings from the Federal Reserve Bank of San Francisco, which would be collateralized by certain pledged loans in the Company's loan portfolio. The lines of credit are subject to periodic review of the Company's financial statements by the grantors of the credit lines. Lines of credit may be modified or revoked at any time if the grantors feel there are adverse trends in the Company's financial position.
The Company had collateralized and uncollateralized lines of credit aggregating $119.6 million and $107.9 million, as well as repurchase agreement lines of credit totaling $5.3 million and $11.7 million, and FHLB lines of credit totaling $35.6 million and $13.2 million at December 31, 2001 and 2000, respectively. These lines of credit generally have interest rates tied to the Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR.
The table below provides further detail of the Company's federal funds purchased, repurchase agreements and FHLB advances for the years ended December 31, 2001 and 2000:
December 31,
-------------------------------
(In thousands) 2001 2000
- --------------------------------------------------------------------------
At period end:
Federal funds purchased $0 $22,630
Repurchase agreements 5,300 11,694
FHLB advances 22,200 13,200
--------------------------------
Total $27,500 $47,524
================================
Average ending interest rate - total 4.13% 6.35%
================================
Average for the year:
Federal funds purchased $1,480 $2,793
Repurchase agreements 12,048 17,077
FHLB advances 19,255 7,800
--------------------------------
Total $32,783 $27,669
================================
Average interest rate - total 4.82% 6.61%
================================
Maximum total borrowings outstanding
at any month-end during the year:
Federal funds purchased $19,870 $22,630
Repurchase agreements/FHLB advances 24,350 24,894
--------------------------------
Total $44,220 $47,524
================================
Asset Quality and Allowance for Credit Losses
Lending money is the Company's principal business activity, and ensuring appropriate evaluation, diversification, and control of credit risks is a primary management responsibility. Implicit in lending activities is the fact that losses will be experienced and that the amount of such losses will vary from time to time, depending on the risk characteristics of the loan portfolio as affected by local economic conditions and the financial experience of borrowers.
The allowance for credit losses is maintained at a level deemed appropriate by management to provide for known and inherent risks in existing loans and commitments to extend credit. The adequacy of the allowance for credit losses is based upon management's continuing assessment of various factors affecting the collectibility of loans and commitments to extend credit; including current economic conditions, past credit experience, collateral, and concentrations of credit. There is no precise method of predicting specific losses or amounts which may ultimately be charged off on particular segments of the loan portfolio. The conclusion that a loan may become uncollectible, either in part or in whole, is judgmental and subject to economic, environmental, and other conditions which cannot be predicted with certainty. When determining the adequacy of the allowance for credit losses, the Company follows the guidelines set forth in the Interagency Policy Statement on the Allowance for Loan and Lease Losses (“Statement”) issued jointly by banking regulators during December 1993. The Statement outlines characteristics that should be used in segmentation of the loan portfolio for purposes of the analysis including risk classification, past due status, type of loan, industry or collateral. It also outlines factors to consider when adjusting the loss factors for various segments of the loan portfolio. Securities and Exchange Commission Staff Accounting Bulletin No. 102 was also released at this time which represents the SEC staff’s view relating to methodologies and supporting documentation for the Allowance for Loan and Lease Losses that should be observed by all public companies in complying with the federal securities laws and the Commission’s interpretations. It is also generally consistent with the guidance published by the banking regulators.
23
The Company's methodology for assessing the adequacy of the allowance for credit losses consists of several key elements, which include:
In addition, the allowance analysis also incorporates the results of measuring impaired loans as provided in:
The formula allowance is calculated by applying loss factors to outstanding loans and certain unfunded loan commitments. Loss factors are based on the Company’s historical loss experience and on the internal risk grade of those loans and, may be adjusted for significant factors that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. Management determines the loss factors for problem graded loans (substandard, doubtful, and loss), special mention loans, and pass graded loans, based on a loss migration model. The migration analysis incorporates loan losses over the past twelve quarters (three years) and loss factors are adjusted to recognize and quantify the loss exposure from changes in market conditions and trends in the Company’s loan portfolio. For purposes of this analysis, loans are grouped by internal risk classifications which are “pass”, “special mention”, “substandard”, “doubtful”, and “loss”. Certain loans are homogenous in nature and are therefore pooled by risk grade. These homogenous loans include consumer installment and home equity loans. Special mention loans are currently performing but are potentially weak, as the borrower has begun to exhibit deteriorating trends, which if not corrected, could jeopardize repayment of the loan and result in further downgrade. Substandard loans have well-defined weaknesses which, if not corrected, could jeopardize the full satisfaction of the debt. A loan classified as “doubtful” has critical weaknesses that make full collection of the obligation improbable. Classified loans, as defined by the Company, include loans categorized as substandard, doubtful, and loss.
Specific allowances are established based on management’s periodic evaluation of loss exposure inherent in classified loans, impaired loans, and other loans in which management believes there is a probability that a loss has been incurred in excess of the amount determined by the application of the formula allowance.
The unallocated portion of the allowance is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The conditions may include, but are not limited to, general economic and business conditions affecting the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentrations, and other business conditions.
The Company’s methodology includes features that are intended to reduce the difference between estimated and actual losses. The specific allowance portion of the analysis is designed to be self-correcting by taking into account the current loan loss experience based on that portion of the portfolio. By analyzing the probable estimated losses inherent in the loan portfolio on a quarterly basis, management is able to adjust specific and inherent loss estimates using the most recent information available. In performing the periodic migration analysis, management believes that historical loss factors used in the computation of the formula allowance need to be adjusted to reflect current changes in market conditions and trends in the Company’s loan portfolio. There are a number of other factors which are reviewed when determining adjustments in the historical loss factors. They include 1) trends in delinquent and nonaccrual loans, 2) trends in loan volume and terms, 3) effects of changes in lending policies, 4) concentrations of credit, 5) competition, 6) national and local economic trends and conditions, 7) experience of lending staff, 8) loan review and Board of Directors oversight, and 9) other business conditions. During the fourth quarter of 2001, there were no changes in estimation methods or assumptions that affected the methodology for assessing the adequacy of the allowance for credit losses.
Management and the Company’s lending officers evaluate the loss exposure of classified and impaired loans on a weekly/monthly basis and through discussions and officer meetings as conditions change. The Company’s Loan Committee meets weekly and serves as a forum to discuss specific problem assets that pose significant concerns to the Company, and to keep the Board of Directors informed through committee minutes. All special mention and classified loans are reported quarterly on Criticized Asset Reports which are reviewed by senior management. With this information, the migration analysis and the impaired loan analysis are performed on a quarterly basis and adjustments are made to the allowance as deemed necessary.
24
Impaired loans are measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. The amount of impaired loans is not directly comparable to the amount of nonperforming loans disclosed later in this section. The primary differences between impaired loans and nonperforming loans are: i) all loan categories are considered in determining nonperforming loans while impaired loan recognition is limited to commercial and industrial loans, commercial and residential re