UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

[X]

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended                     June 30, 2017

 

[  ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ______________

 

Commission File number 0-15641

 

CALIFORNIA FIRST NATIONAL BANCORP

(Exact name of registrant as specified in its charter)

 

California	33-0964185
(State or other jurisdiction of Incorporation or organization)	(I.R.S. Employer Identification No.)

 

28 Executive Park, Irvine, CA 92614

(Address of principal executive offices)

 

Registrant's telephone number, including area code:

(949) 255-0500

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class	Name of Each Exchange on Which Registered
Common Stock, $.01 par value	The NASDAQ Stock Market LLC

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act   Yes ☐     No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act   Yes ☐     No ☒

 

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 and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒     No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒     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 Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “accelerated filer, large accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ☐     Accelerated filer ☐     Non-accelerated filer ☐

Smaller reporting company ☒      Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐     No ☒

 

The aggregate market value of the Common Stock held by non-affiliates of the Registrant as of December 31, 2016 was $34,236,253. Number of shares outstanding as of September 25, 2017: Common Stock 10,284,139.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III incorporates information by reference from Registrant's definitive Proxy Statement to be filed with the Commission within 120 days after the close of the Registrant's fiscal year ended June 30, 2017.

 

 

 

TABLE OF CONTENTS

 

PART I		Page
Item 1.	Business	2-10
Item 1A.	Risk Factors	10-14
Item 1B.	Unresolved Staff Comments	15
Item 2.	Properties	15
Item 3.	Legal Proceedings	15
Item 4.	Mine Safety Disclosures	15
PART II
Item 5.	Market for Company's Common Equity and Related Stockholder Matters and
	Issuer Purchases of Equity Securities	15-16
Item 6.	Selected Financial Data	17
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	18-28
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 8.	Financial Statements and Supplementary Data	30-54
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	55
Item 9A.	Controls and Procedures	55
Item 9B.	Other Information	55
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	56-57
Item 11.	Executive Compensation	57-59
Item 12.	Security Ownership of Certain Beneficial Owners and Management
	and Related Stockholder Matters	59
Item 13.	Certain Relationships and Related Transactions, and Director Independence	60
Item 14.	Principal Accountant Fees and Services	60
PART IV
Item 15.	Exhibits and Financial Statement Schedules	61
Signatures		62

 

 

 

PART I

 

ITEM 1. BUSINESS

 

California First National Bancorp, a California corporation (the “Company”), is a bank holding company headquartered in Orange County, California with a bank subsidiary, California First National Bank (“CalFirst Bank” or the “Bank”) and leasing subsidiary, California First Leasing Corp (“CalFirst Leasing”). The Company is regulated by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of San Francisco (“FRB”) under the U.S. Bank Holding Company Act of 1956, as amended. CalFirst Bank is regulated by the Office of the Comptroller of the Currency, U.S. Department of the Treasury (“OCC”).

 

The primary business of the Company is secured financing provided through leasing and financing capital assets, commercial loans acquired through participation in the syndicated commercial loan market, by providing non-recourse loans to third parties secured by leases and equipment, and direct commercial loans. CalFirst Bank, now responsible for substantially all lease and loan origination, gathers deposits through posting rates on the Internet and conducts all banking and other operations from one central location. Over the past few years, the Company migrated from primarily leasing equipment toward a broader commercial lending program with commercial loans accounting for 53% of the Company’s bookings in fiscal 2017 and 68% in fiscal 2016.

 

At June 30, 2017, the Company had total assets of $715.6 million, down 19% from the prior year, leases and loans of $496.8 million, total deposits of $468.6 million, and a conservative capital profile with stockholders’ equity of $196.1 million producing regulatory capital ratios at June 30, 2017 of 33.1% Tier 1 capital, 34.3% total capital and 26.0% Tier 1 leverage capital, well above required regulatory thresholds.

 

Recent Events

 

During the third quarter of fiscal 2017, CalFirst Bank was advised by the OCC to cease originating new leveraged or non-leveraged syndicated commercial loans and to take action to substantially reduce its concentration of leveraged loans. The restrictions on the Bank’s loan activities continue at the date of this filing, and as a result, the Company has originated no loans since January 2017. While the Bank has worked to have the restrictions on its loan activities removed, it cannot predict if it will be successful, or what the conditions of any relief might be. As of August 31, 2017, the Company’s loan portfolio has declined to approximately $250 million, 19% below the level at June 30, 2017 and down 45% from December 31, 2016. Management projects the Bank’s loan portfolio will continue to decline in fiscal 2018, and this will continue to have an adverse effect on the ability of the Company to grow its net interest income and profitably deploy the capital invested in the Bank. The Board of Directors continues to evaluate all options available that might serve the best interests of its shareholders.

 

Leasing Activities

 

At June 30, 2017, leases accounted for 38% of the Company’s lease and loan portfolio, compared with 37% and 55% at June 30, 2016 and 2015, respectively. The Company leases and finances most capital assets used by businesses and organizations, with a focus on high technology systems and other mission critical assets, but has seen an increase in the volume of other assets over the last few years. In addition to computer systems and networks, property leased includes manufacturing production systems, automated warehouse distribution systems, retail point-of-sale and inventory tracking systems, telecommunications systems such as wireless networks, voice over Internet protocol (“VoIP”) systems, and satellite tracking systems. Other equipment leased includes robotic surgical systems, ultrasound and medical imaging systems, electronic patient monitoring systems, testing equipment, copying and digital printing equipment. In addition, the Company leases a wide variety of non-electronic property, including office equipment, mining equipment, machine tools, school buses, trucks, exercise equipment and office and dormitory furniture. The mixture of property subject to leases booked varies year by year. In fiscal 2017, leases involving computer equipment and software accounted for 27% of property, down from 35% the prior year but up from 15% in fiscal 2015. A comparison of the mix of property subject to new leases booked in each of the three years ending June 30, 2017 is set forth below (dollars in thousands):

 

Year End June 30,			2017			%					2016			%					2015			%
Manufacturing Equipment		$	32,716				30	%		$	3,174				3	%		$	23,554				11	%
Computer Hardware and Software			28,937				27	%			38,372				35	%			32,857				15	%
Transportation equipment			15,560				14	%			14,077				13	%			16,331				7	%
Furniture & Fixtures			12,522				12	%			10,118				9	%			27,123				12	%
Medical Equipment			10,080				9	%			10,354				9	%			17,906				8	%
Warehouse Management Systems			3,835				4	%			24,414				22	%			33,240				15	%
Office Equipment			962				1	%			1,195				1	%			10,068				5	%
Yellow Equipment			378				0	%			3,426				3	%			9,179				4	%
Air Transport Equipment			-				0	%			-				0	%			25,000				11	%
Other			2,634				2	%			5,240				5	%			22,527				10	%
Cost of Property on Leases Booked		$	107,624							$	110,370							$	217,785

 

 

 

The Company provides leasing and financing to customers throughout the United States and across a breadth of industries and disciplines, including commercial, industrial and financial companies, as well as educational, government and non-profit entities. The average size of the lease transactions booked during fiscal 2017 was approximately $1.1 million, compared with $751,000 during fiscal 2016 and $1.1 million during fiscal 2015. Three customers accounted for 12%, 10% and 9%, of the property cost subject to leases booked during fiscal 2017, while in fiscal 2016 two customers accounted for 18% and 13% of leases booked and in fiscal 2015 two customer accounted for 14% and 12% of leases booked in that year. Leases primarily are originated directly through a centralized marketing program and direct delivery channels, or through other banks or origination sources. During fiscal 2017, all of property cost subject to leases booked was originated directly by the Company, compared to 97% originated directly in fiscal 2016 and 94% originated directly in fiscal 2015. The marketing program includes a database of current and potential users of business property, as well as in-house customer relations management systems. The marketing programs have been augmented through the expanded use of web sites and the Internet to identify and communicate with potential customers. Prospect management software is utilized to enhance the productivity of the sales effort. Specific information about potential customers is entered into a confidential database accessible to sales professionals and their managers that allows them to efficiently focus on the most likely purchaser or lessee of capital assets.

 

Leases generally are for initial terms ranging from two to five years and are structured individually to accommodate a variety of our customers’ objectives. Substantially all leases are non-cancelable "net" leases which contain "hell-or-high-water" provisions under which the lessee must make all lease payments regardless of any defects in the property, and which require the lessee to maintain and service the property, insure the property against casualty loss and pay all property, sales and other taxes. CalFirst Bank or CalFirst Leasing retain ownership of the property on leases they originate, and in the event of default by the lessee, they may declare the lessee in default, accelerate all lease payments due under the lease and pursue other available remedies, including repossession of the property. Upon the expiration of the lease term, the lessee typically has an option, which is dependent upon each lease's defined end of term options, to either purchase the property at a negotiated price, or in the case of a "conditional sales contract," at a predetermined minimum price, or to renew the lease. If the original lessee does not exercise the purchase option, once the leased property is returned, the Company will seek to sell the leased property.

 

Through its lease purchase operations, the Bank purchases lease receivables on a non-recourse basis from other intermediaries. All banks or lessors from whom the Bank purchases lease receivables are subject to an individual credit review and investigation by the Bank and must be approved by the Bank’s board of directors prior to establishing a discounting relationship. The Bank generally does not assume any obligations as lessor for these transactions, and the original lessor retains ownership of any underlying asset, with the Bank taking a priority first lien position. Periodically, the Bank will purchase a whole lease and assume the role as lessor and take a residual interest in the property subject to such lease. The Bank verifies the completeness of all lease documentation prior to purchase, confirms that the Bank’s position is secure and that liens have been perfected, and legal documentation has been filed as appropriate. The Company did not acquire any leases from third parties in fiscal 2017 while leases purchased from unaffiliated third parties during fiscal 2016 of $2.9 million were 3% of total leases booked and purchased leases of $13.5 million in fiscal 2015 represented 6% of total bookings.

 

The Company conducts the leasing business in a manner designed to minimize risk, however, we are subject to risks through the investment in lease receivables held in our own portfolios, lease transactions-in-process, and residual investments. We do not purchase leased property until we have received a binding non-cancelable lease from the customer. A portion of lease originations are discounted to banks or finance companies on a non-recourse basis at fixed interest rates that reflect the customers' financial condition. The lender to which a lease has been assigned has no recourse against the Company, unless we are in default under the terms of the agreement by which the lease was assigned. The institution to which a lease has been assigned may take title to the leased property, but only in the event the lessee fails to make lease payments or otherwise defaults under the terms of the lease. If this occurs, the Company may not realize our residual investment, if any, in the leased property.

 

Lease Portfolio

 

During the fiscal year ended June 30, 2017, 100% of the total dollar amount of new leases completed by the Company was booked by CalFirst Bank, up from 93.5% in fiscal 2016 and 90.4% in fiscal 2015. CalFirst Leasing no longer has a direct lease origination effort.

 

During the fiscal years ended June 30, 2017, 2016 and 2015, 80%, 89% and 88%, respectively, of the total dollar amount of new leases completed by the Company were retained in the Company’s portfolios, with the balance of such leases discounted to unaffiliated financial institutions. The Bank’s strategy is to develop a conservative, diversified portfolio of leases with credit worthy lessees through a portfolio management system that balances risk and reward while also managing exposures to any one credit or industry. The Bank’s credit committee has established underwriting standards and criteria for the lease portfolio and performs an independent credit analysis and due diligence on each lease transaction originated or purchased. The committee applies the same underwriting standards to all leases, regardless of how they are sourced. Through the use of non-recourse financing, the Company avoids risks that do not meet our risk/reward requirements or reduces its exposure to meet internal or regulatory requirements. A small portion of the portfolio, primarily held by CalFirst Leasing, includes leases where the credit profile of the lessee or the underlying leased property is not acceptable to other financial institutions.

 

 

The table below presents the discounted minimum lease payments receivable (“Net Lease Receivable") related to leases retained in the Company’s portfolios at June 30, 2017, 2016 and 2015, respectively. Of the Bank’s Net Lease Receivable, approximately 92%, 88% and 82%, respectively, represented leases originated directly by the Bank, with 8%, 12% and 16%, of the Bank’s Net Lease Receivables at June 30, 2017, 2016 and 2015, respectively, related to leases purchased from unaffiliated parties.

 

(dollars in thousands)		As of June 30,
		2017								2016								2015
		Net Lease				Percent of				Net Lease				Percent of				Net Lease				Percent of
		Receivable				Total				Receivable				Total				Receivable				Total
California First National Bank		$	178,703				96	%		$	213,355				94	%		$	270,657				94	%
California First Leasing		$	6,525				4	%		$	14,554				6	%		$	15,727				6	%

 

The Company often makes payments to purchase leased property prior to the commencement of the lease. The disbursements for such lease transactions-in-process are generally made to facilitate the property implementation schedule of the lessees. The lessee generally is contractually obligated to make rental payments during the period that the transaction is in process, and obligated to reimburse the Company for all disbursements under certain circumstances. Income is not recognized while a transaction is in process and prior to the commencement of the lease. At June 30, 2017, 2016, and 2015, the Company’s total investment in property acquired for transactions-in-process amounted to $17.1 million, $30.9 million and $31.3 million, respectively.

 

Commercial Loans

 

Commercial loans of $306.0 million accounted for 62% of the Company’s net investment in leases and loans at June 30, 2017, down from $403.7 million or 63% of the Company’s investment at June 30, 2016 but up from $243.5 million, or 45% of the Company’s investment, at June 30, 2015. During fiscal 2017, the Company boarded $123.5 million of new commercial loans, 48% below fiscal 2016 bookings of $238.1 million, and offset by payoffs and principal reductions of $220.6 million. As noted under “Recent Events”, the Bank did not originate any new loans after January 2017 and had a high volume of loan payoffs during the last six months of fiscal 2017, occurring both in the normal course and accelerated by the Bank’s inability to participate in extending the term of certain loans. The restrictions on the Bank’s loan activities continue, and it currently is projected that the loan portfolio will continue to decline in fiscal 2018.

 

Approximately 97% of the commercial loan portfolio consists of participations in syndicated transactions led primarily by major money center banks, with approximately 3% of the loan portfolio at June 30, 2017 the result of a direct origination effort. Direct loan origination is directed toward the Company’s existing and targeted customer database as a complementary product leveraging existing resources and extending customer longevity. Commercial loan products offered include commercial mortgages, term loans and lines of credit, and generally will be secured, but unsecured loans will be considered, depending on the nature of the credit. The Bank had three direct commercial loans aggregating to $10.8 million outstanding as of June 30, 2017, all at fixed rates, ranging in size from $1.4 million to $6.4 million, and with remaining terms of 23 months to 14 years. One loan is unsecured with the other two secured by real estate used in the borrower’s business.

 

Syndicated loans have accounted for a substantial portion of the Company’s growth over the past five years, and the structure, terms and other characteristics of the loans have not changed over this period. Syndicated bank loans are almost all term loans secured by substantially all of the borrower’s assets, although in some cases term loans have a second lien on working capital assets and less than 100% security interest in certain foreign assets. At June 30, 2017, approximately 87% of syndicated loans were characterized as “Term Loan B” loans that generally have initial seven-year terms and amortize less than 10% of the principle balance over the term. All Bank syndicated loans are priced at floating rates, and generally are made to larger corporations with debt ratings of BB or Ba, or higher, as rated by Standard & Poor’s (“S&P”) or Moody’s Investors Service (“Moody’s), respectively. At June 30, 2017, 23% of the syndicated loan portfolio is rated investment grade (Baa3 or higher by Moody's or BBB- or higher by S&P) by one or more of the rating agencies, compared to 24% of the syndicated loan portfolio at June 30, 2016, while approximately 8.7% of the syndicated loan portfolio at June 30, 2017 relates to companies that are rated lower than Ba, down from 11.9% at June 30, 2016. Public companies made up 90% of the Company’s syndicated loan portfolio at June 30, 2017, with equity market capitalizations ranging from $326 million to $46 billion and a weighted average market value of $7.9 billion.

 

Approximately 62% of the loan portfolio at June 30, 2017 is characterized as “leveraged loans” under guidance promulgated by federal bank regulators in 2013, compared to 79% under such guidance at June 30, 2016. Credits that the Company characterized as higher risk leveraged loans accounted for approximately 15% of the syndicated loan portfolio at June 30, 2017, compared to 8% at June 30, 2016. The Bank’s credit policies and administrative processes have been augmented significantly to incorporate the 2013 guidance issued by federal banking regulators regarding leveraged lending, but have been criticized by the OCC as not meeting the guidance. As noted in “Recent Events”, the OCC has indicated that the concentration of leveraged loans held by the Bank is too high.

 

 

The Bank’s syndicated loan portfolio is diversified across industries, with the loans to individual credits ranging in size from $573,000 to $10.4 million. At June 30, 2017, the average principal outstanding on 61 credits was $5.1 million, and the remaining terms range from one to six years. The Bank’s underwriting of commercial loans is consistent with its credit standards for leases, although its policies have been augmented to address credit issues related to the larger average investment in individual loans and regulatory issues governing the participation market. The risks associated with loans in which the Bank participates as part of a syndicate of financial institutions are similar to those of directly originated commercial loans; however, additional risks may arise from the Bank’s limited ability to control actions of the syndicate. Existing staff administer loan operations including documentation, lien perfection, funding, payments and collections. The Bank’s current computer systems are capable of fully processing loans and have the requisite connectivity to the Company’s accounting, customer service and collections processes.

 

The table below presents the commercial loan balance net of unearned income and discounts and before allowances by loan type in the Company’s portfolios at June 30, 2017, 2016 and 2015, respectively.

 

(dollars in thousands)		As of June 30,
		2017								2016								2015
		Net Loan				Percent of				Net Loan				Percent of				Net Loan				Percent of
		Balance				Total				Balance				Total				Balance				Total
Commercial term loans		$	303,604				97.6	%		$	398,240				97.5	%		$	238,424				96.7	%
Revolving lines of credit		$	3,222				1.0	%		$	3,389				0.8	%		$	562				0.2	%
Commercial real estate loans		$	4,387				1.4	%		$	6,679				1.6	%		$	7,523				3.1	%

 

Commercial loan transactions funded during fiscal 2017 of $123.5 million to 38 different credits compared to $233.9 million through participations and $4.7 million through real estate loans during fiscal 2016. All commercial term loans are held by CalFirst Bank for all periods, except for one loan for $2.0 million held by CalFirst Leasing at June 30, 2017.

 

Credit Risk Management

 

The Company’s strategy for credit risk management includes stringent credit authority centered at the most senior levels of management. The strategy emphasizes diversification on both a geographic and customer level, and spreading risk across a breadth of leases and loans while managing the risk to any one area. The consolidated lease and loan portfolio at June 30, 2017 includes over 489 lease schedules and 61 commercial loans. No customer accounted for more than 4% of the net investment in leases and loans at June 30, 2017, 2016 or, 2015. The ten largest customers accounted for 22% of the lease and loan portfolio at June 30, 2017, compared to 18% of the portfolio at June 30, 2016 and 19% at June 30, 2015.

 

As a national bank, CalFirst Bank is subject to lending limit rules that restrict the maximum credit that the Bank may extend to any one entity at any one time to 15% of unimpaired capital and surplus. At June 30, 2017, the Bank’s “legal lending” limit was $20.0 million. The Company and CalFirst Leasing are not subject to any regulatory limits. At June 30, 2017, the largest single exposure of CalFirst Bank to one credit was $17.6 million that represents 3.5% of the Company’s net investment in leases and loans.

 

The credit policy requires each lease or loan, regardless of whether it is directly originated or acquired through syndication, to have viable repayment sources. The credit process primarily focuses on a customer’s ability to repay the lease or loan through their cash flow, and generally, collateral securing a transaction represents a secondary source of repayment. The credit process includes a policy of classifying all leases and loans in accordance with a risk rating classification system, monitoring changes in the risk ratings of lessees and borrowers, identification of problem leases and loans and special procedures for the collection of problem leases and loans. The lease and loan classification system is consistent with regulatory models under which leases and loans may be rated as “pass”, “special mention”, “substandard”, “doubtful” or “loss”.

 

An asset management (“AM”) group handles the day-to-day management and oversight of the lease and loan portfolios. The AM group monitors the performance of all leases held in the portfolios, transactions-in-process as well as lease transactions assigned to lenders, if the Company retains a residual investment in the leased property subject to the lease. The AM group conducts an ongoing review of all leases 10 or more days delinquent, contacts the lessee directly and generally sends the lessee a notice of non-payment within 15 days after the due date. In the event that payment is not then received, senior management becomes involved. Delinquent leases are coded in the AM tracking system in order to provide management visibility, periodic reporting, and appropriate reserves. Legal recourse is considered and promptly undertaken if alternative resolutions are not obtained. At 90 days past due, leases and loans will be placed on non-accrual status such that interest income no longer accretes into income, unless the Company believes the amounts due are otherwise recoverable.

 

 

Allowance for Credit Losses

 

The allowance for credit losses is an estimate of probable and assessable losses in the Company’s lease and loan portfolios applying the principles of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 450, “Contingencies,” and ASC Topic 310-35, “Loan Impairment.” The allowance recorded is based on a quarterly review of all leases and loans outstanding and transactions-in-process. The determination of the appropriate amount of any provision is based on management’s judgment at that time and takes into consideration all known relevant internal and external factors that may affect the lease and loan portfolios. The primary responsibility for setting reserves resides with executive management who report quarterly to the Company’s Audit Committee and Board of Directors regarding overall asset quality, problem leases and loans and the adequacy of valuation allowances. The Bank's classification of its assets and the amount of its valuation allowances are subject to review by regulators who can order the establishment of additional loss allowances.

 

The Company individually analyzes the net book value of each non-performing or problem lease and loan to determine whether the carrying value is less than or equal to the expected recovery anticipated to be derived from lease or loan payments, additional collateral or residual realization. The amount estimated as unrecoverable is recognized as a reserve specifically identified for the lease or impaired loan. An analysis of the remaining portfolios is conducted, taking into account recent loss experience, known and inherent risks in the portfolio, levels of delinquencies, adverse situations that may affect the customer’s ability to repay, trends in volume and other factors, including regulatory guidance and current and anticipated economic conditions in the market. This portfolio analysis includes a stratification of the lease and loan portfolio by risk classification and segments, and estimation of potential losses based on risk classification or segment. The composition of the portfolio based on risk ratings is monitored, and changes in the overall risk profile of the portfolio also is factored into the evaluation of inherent risks in the portfolios. Regardless of the extent of the Company's analysis of customer performance or portfolio evaluation, certain inherent but undetected losses are probable within the lease and loan portfolios. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or change in business conditions; the judgmental nature of individual credit evaluations and classification, and the interpretation of economic trends; volatility of economic or customer-specific conditions affecting the identification and estimation of losses and the sensitivity of assumptions utilized to establish allowances for losses, among other factors. Therefore, an estimated inherent loss not based directly on the specific problem assets is recorded as an unallocated allowance. The level of such unallocated allowance is determined based on a review of prior years’ loss experience, and may vary depending on general market conditions. The aggregate allowance in any one period is apportioned between allowance for lease and loan losses and allowance for valuation of residual value.

 

Banking Operations

 

The Bank is focused on gathering deposits from depositors nationwide for the primary purpose of funding its investment in leases and loans. The Bank’s strategy is to be a low cost producer through marketing its products and services directly to end-users. The Bank believes that its operating costs generally will be lower than those of traditional "bricks and mortar" banks because it does not have the expense of a traditional branch network to generate deposits and conduct operations.

 

Deposit Products

 

At June 30, 2017, the Bank had $468.6 million in deposits, down from $633.2 million at June 30, 2016, and composed of $90.9 million in demand, savings or money market accounts and $377.8 million, or 81%, time certificates of deposits (“CD”s). In light of the change in the loan origination effort, in March 2017 the Company took action to reduce deposits, particularly CDs, by drastically cutting rates offered on CDs. As a result, deposits during the last six months of fiscal 2017 declined by 26%.

 

The Bank’s deposits have been gathered primarily through the Internet. The Bank offers interest-bearing checking accounts, money market accounts, savings accounts and three (3) month to three (3) year certificates of deposit (“CDs”) to taxable and IRA depositors. CDs are offered with varying maturities in order to achieve a fair approximation or match of the average life of the Bank’s lease and loan portfolio. With leases generally providing for fixed rental rates, a matching fixed rate CD book is intended to allow the Bank to minimize interest rate fluctuation risk. Most of the Bank’s commercial loans are floating rate.

 

To open a new account, a customer can complete an on-line enrollment form on the Bank’s web site, or can call the Bank’s toll-free customer service number and open an account telephonically. Signature cards and deposits are then mailed to the Bank. Customers can make deposits by wire transfer, via direct deposit programs, or by mail. No teller line is maintained. The Bank’s customers have 24-hour access to account information. Customers can view their banking records and current balances, and transfer funds between accounts through the use of personal computers. They can also pay bills on-line. Customers can receive a free ATM card upon opening a demand deposit or savings account. In order to obtain cash, the Bank’s customers use other banks’ automated teller machines that are affiliated with the Plusä system. The Bank generally will reimburse customers for some portion of any ATM fees charged by other financial institutions.

 

 

Operations

 

The Bank’s operations have been developed by outsourcing certain principal functions to leading bank industry service providers and by sharing established systems utilized by CalFirst Leasing or the Company. Outsourced systems include the Bank’s core processing and electronic banking system, electronic bill payment systems and depository services, including item processing. The Bank believes it benefits from the service provider's expertise and investments in developing technology. A critical element to the Bank’s success is the ability to provide secure transmission of confidential information over the Internet. The Bank’s service providers utilize sophisticated technology to provide maximum security. All banking transactions are encrypted and all transactions are routed from the Internet server through a "firewall" that limits access to the Bank’s and service provider’s systems. Systems are in place to detect attempts by third parties to access other users' accounts and feature a high degree of physical security, secure modem access, service continuity and transaction monitoring. The Bank has implemented the two-factor authentication security to its Internet banking procedures and platform.

 

Investments

 

In addition to leases and loans, the Company had total cash and cash equivalents and investment securities of $195.8 million at June 30, 2017 compared to $204.9 million at June 30, 2016 and $144.8 million at June 30, 2015. Cash and cash equivalents of $96.1 million consists of interest-earning deposits with the FRB, other banks and short-term money market securities. The investment portfolio of $99.8 million includes U.S. government agency (“Agency”) mortgage-backed securities (“MBS”), U.S. Treasury Notes, corporate bonds and common stocks, Federal Reserve Bank and Federal Home Loan Bank stock and other investments. The Company is authorized to invest in high-quality United States agency obligations, mortgage-backed securities, investment grade corporate bonds and municipal securities and selected preferred and equity securities. The investment portfolio may increase or decrease depending upon the comparative returns on investments in relation to leases and loans.

 

Customers

 

Leasing and loan customers include major corporations and middle-market companies, subsidiaries and divisions of Fortune 1000 companies, private and state-related educational institutions, municipalities and other not-for-profit organizations and institutions located throughout the United States. The Company does not believe the loss of any one customer would have a material adverse effect on its operations taken as a whole.

 

The Bank’s deposit customers are primarily individuals from across the nation who place a substantial portion of their savings in safe, government-insured deposits and businesses that spread their liquid investments among a breadth of banks in order to ensure that they are government insured. Such depositors are seeking to maximize their interest income and, therefore, are more inclined to move their investments to a bank that offers the highest yield regardless of the geographic location of the depository.

 

Competition

 

The Company competes for the lease and loan financing of capital assets with other banks, commercial finance companies, and other financial institutions, independent leasing companies, credit companies affiliated with equipment manufacturers, and equipment brokers and dealers. Many of the Company's competitors have substantially greater resources, capital, and more extensive and diversified operations than the Company. The Company believes that the principal competitive factors are rate, responsiveness to customer needs, flexibility in structuring lease financing and loans, financial technical proficiency and the offering of a broad range of financing options. The level of competition varies depending upon market and economic conditions, the interest rate environment, and availability of capital.

 

The Bank competes with other banks and financial institutions to attract deposits. The Bank faces competition from established local and regional banks and savings and loan institutions. Many of them have larger customer bases, greater name recognition and brand awareness, greater financial and other resources, broader product offerings and longer operating histories. The market for Internet banking has seen increased competition over the past several years as large banks and other financial institutions have deployed and aggressively promoted their own on-line banking platforms and aggressively sought deposits over the internet. Additionally, new competitors and competitive factors are likely to emerge with the continued development of Internet banking.

 

Supervision and Regulation

 

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is registered with, regulated and examined by the Board of Governors of the Federal Reserve System (the “FRB”). In addition to the regulation of the Company by the FRB, the Bank is subject to extensive regulation and periodic examination, principally by the Office of the Comptroller of the Currency (“OCC”). The Federal Deposit Insurance Corporation (“FDIC”) insures the Bank’s deposits up to certain prescribed limits. The Bank is a member bank within the San Francisco Federal Reserve district. The Company is also subject to jurisdiction of the Securities and Exchange Commission ("SEC") and to the disclosure and regulatory requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934, and through the listing of the common stock on the NASDAQ Global Select Market is subject to the rules of NASDAQ.

 

 

The Bank Holding Company Act, the Federal Reserve Act, and the Federal Deposit Insurance Act subject the Company and the Bank to a number of laws and regulations. In addition, substantial changes to the regulation of banks and bank holding companies have occurred as a result of the enactment in 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The primary concern of banking regulation is “Safety and Soundness” with an emphasis on asset quality and capital adequacy. These laws and regulations also encompass a broad range of other regulatory concerns including insider transactions, the adequacy of the allowance for credit losses, intercompany transactions, regulatory reporting, adequacy of systems of internal controls and limitations on permissible activities. The federal banking agencies possess broad powers to take corrective action as deemed appropriate for an insured depository institution and its holding company. The FRB examines the Company, which exam includes CalFirst Leasing. The OCC, which has primary supervisory authority over the Bank, regularly examines banks in such areas as asset quality, reserves, investments, risk management practices, interest rate exposure, vendor management and other aspects of operations. These examinations are designed for the protection of the Bank’s depositors rather than the Company’s shareholders. The Bank must furnish annual and quarterly reports to the OCC, which has the authority under the Financial Institutions Supervisory Act to prevent a national bank from engaging in an unsafe or unsound practice in conducting its business. The OCC may impose restrictions or new requirements on the Bank, including, but not limited to, growth limitations, dividend restrictions, individual increased regulatory capital requirements, lease and loan loss reserve requirements, increased supervisory assessments, activity limitations or other restrictions that could have an adverse effect on the Bank, the Company or holders of our common stock. Many banking laws and regulations have undergone significant change in recent years and, given the recent financial crisis in the United States, regulators have increased their oversight of financial institutions and taken a more active role in imposing restrictions on bank operations, the classification of assets and determination of the allowance for credit losses. Future changes to these laws and regulations, and other new financial services laws and regulations are likely, and cannot be predicted with certainty.

 

Under FRB policy, the Company is expected to serve as a source of financial and managerial strength to the Bank and, under appropriate circumstances, to commit resources to support the Bank. Pursuant to a binding written agreement between the Bank and the Company required at the time of the Company’s purchase of the stock of the Bank in 2001, the Company is obligated to provide capital maintenance and liquidity support to the Bank, if and when necessary. Certain loans by the Company to the Bank would be subordinate in right of payment to deposits in, and certain other indebtedness of, the Bank.

 

Among the regulations that affect the Company and the Bank are provisions of Section 23A of the Federal Reserve Act that places limits on the amount of loans or extensions of credit the Bank may make to affiliates and the amount of assets purchased from affiliates, except for transactions exempted by the FRB. The aggregate of all of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank's capital and surplus. Regulation W (“Reg. W”) provides a framework under Section 23A by which the Bank does not have to comply with the quantitative limits of Section 23A when making a loan or extension of credit to an affiliate, but also contains certain provisions designed to prohibit the Bank from buying low-quality assets from an affiliate. The Company and the Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits an institution from engaging in transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. All transactions between the Company or CalFirst Leasing and the Bank are in accordance with these provisions.

 

In connection with the approval of the Company’s purchase of the stock of the Bank in 2001, the FRB and the OCC required the Company and the Bank to make certain commitments with respect to the operation of the Bank. In September 2006, the OCC approved a change in the Bank’s original operating plan that provided for the Bank to originate commercial loans. In June 2012, the OCC provided a written determination of no objection to a revised business plan to continue development of the commercial loan portfolio, but with certain conditions that were removed in January 2015 when the OCC terminated the 2001 operating agreement between the OCC and the Bank and eliminated restrictions imposed in 2012. During the third quarter of fiscal 2017, CalFirst Bank was advised by the OCC to cease originating new leveraged or non-leveraged syndicated commercial loans and to take action to substantially reduce its concentration of leveraged loans. The Bank is working to have the restrictions on its loan activities removed, but it cannot predict if it will be successful, or what the conditions of any relief might be.

 

Bank holding companies are subject to risk-based capital guidelines adopted by the FRB. The Company currently is required to maintain (i) Tier 1 capital equal to at least six percent of its risk-weighted assets and (ii) total capital (the sum of Tier 1 and Tier 2 capital) equal to ten percent of risk-weighted assets. The FRB also requires the Company to maintain a minimum Tier 1 "leverage ratio" (measuring Tier 1 capital as a percentage of adjusted total assets) of at least five percent. At June 30, 2017 and 2016, the Company exceeded all these requirements.

 

 

The Bank is also subject to risk-based and leverage capital requirements. In July 2013, federal bank regulatory agencies jointly issued final rules that revise the general risk-based capital requirements to incorporate certain revisions by the Basel Committee on Banking Supervision to the Basel capital framework (“Basel III”). Under the final rule, minimum requirements increase both the quantity and quality of capital held by banking organizations. Consistent with Basel III, the rule includes a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5 percent and a common equity tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets. The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4 percent to 6 percent and includes a minimum leverage ratio of 4 percent for all banking organizations. The final rule minimizes the burden on smaller, less complex financial institutions such as the Company and the Bank, with a phase-in period that began in January 2015 while the phase-in period for larger institutions began in January 2014. At June 30, 2017, the Bank had capital in excess of all current minimum risk-based and leverage capital requirements as well as the new guidelines.

 

Under the Community Reinvestment Act (“CRA”), the Bank has a continuing and affirmative obligation, consistent with safe and sound operation, to help meet the credit needs of its entire communities, including low- and moderate-income neighborhoods. CalFirst Bank is designated as a wholesale institution for CRA purposes. To evaluate the CRA performance of banks with this designation, regulatory agencies use the community development test. This includes an assessment of the level and nature of the Bank’s community development lending, investments and services. The CRA requires the OCC, in connection with its examination of the Bank, to assess and assign one of four ratings to the Bank’s record of meeting the credit needs of its community. The CRA also requires that the Bank publicly disclose its CRA rating. In December 2016, CalFirst Bank was subjected to a CRA examination and received a “satisfactory” rating on the CRA performance evaluation.

 

The Bank is a member of the Deposit Insurance Fund (“DIF”) maintained by the FDIC. Through the DIF, the FDIC insures the deposits of the Bank up to prescribed limits for each depositor. As a result of the Dodd-Frank Act, the maximum deposit insurance amount has been increased permanently from $100,000 to $250,000. In February 2011, the FDIC adopted a final rule implementing the Dodd-Frank Act provisions which provides for use of a risk scorecard to determine deposit premiums. For FDIC assessment purposes, the bank’s assessment base is its average consolidated total assets minus its average tangible equity. The assessment rate is determined by the FDIC using a risk-based calculation. The Bank's assessment base and assessment rate are calculated and billed each quarter. As of June 30, 2016, the DIF surpassed a target of 1.15 percent to trigger important changes in the FDIC assessments for all banks. The changes took effect for premiums billed after December 2016. Banks with less than $10 billion in assets will see their overall schedule decline by two basis points for banks paying the lowest premiums and up to five points for those at the top end of the assessment scale. The Bank’s overall assessment declined by over two basis points. In addition, a new formula for calculating risk-based assessment rates is now in effect. The FDIC may increase or decrease the assessment rate in the future, and any such increase could have an adverse impact on the earnings of insured institutions, including the Bank.

 

The Bank also is required to make payments for the servicing of obligations of the Financing Corporation (“FICO”) issued in connection with the resolution of savings and loan associations, so long as such obligations remain outstanding. The FICO annual assessment rate as of June 30, 2017 is $0.54 cents per $100 of deposits compared to $0.56 cents per $100 of deposits as of June 30, 2016.

 

The FDIC can terminate insurance of the Bank’s deposits upon a finding that the Bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the OCC. The termination of deposit insurance could have a material adverse effect on the Company’s results of operations, business and financial condition.

 

The principal source of cash flow to the Company, including cash flow to pay dividends on its common shares, is dividends from its subsidiaries and fees for services rendered to its subsidiaries. Various statutory and regulatory provisions limit the amount of dividends or fees that may be paid to the Company by the Bank. In general, the Bank may not declare or pay a dividend to the Company in excess of 100% of its net retained earnings for the current calendar year combined with its net retained earnings for the preceding two calendar years without prior approval of the OCC. The Company has not received any dividends from the Bank to date, and believes CalFirst Leasing and CalFirst Bank have sufficient resources to meet the Company’s requirements.

 

There are numerous laws, regulations and policies affecting financial services businesses currently in effect and they are continually under review by Congress and state legislatures and federal and state regulatory agencies. The Gramm-Leach-Bliley Act established requirements for financial institutions to provide privacy protections to consumers and notices to customers about its privacy policies and practices. The Bank Secrecy Act and USA Patriot Act impose obligations to maintain appropriate policies, procedures and controls to detect, prevent and report suspicious activities, money laundering and terrorist financing as well as maintain compliance programs to verify the identity of customers. The Dodd-Frank Act provides for sweeping financial regulatory reform and may have the effect of increasing the cost of doing business, limiting or expanding permissible activities and affect the competitive balance between banks and other financial intermediaries. Under the Dodd-Frank Act, the Consumer Financial Protection Bureau (the “CFPB”) has assumed all authority to prescribe rules or issue orders or guidelines pursuant to any federal consumer financial laws. While many of the provisions of the Dodd-Frank Act do not impact the existing business of the Bank, the repeal of prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts, could increase deposit rates to be paid by the Bank in order to retain or grow deposits. In addition, the provisions of the Dodd-Frank Act known as the Volcker Rule prohibit proprietary trading of securities and other financial instruments that do not currently impact the Company but could limit future activities. Changes in the laws, regulations or policies that impact the Company cannot necessarily be predicted, and they may have a material effect on the business and earnings of the Company.

 

 

The commercial banking business is also influenced by the monetary and fiscal policies of the federal government and the policies of the FRB. The FRB implements national monetary policies through its management of the discount rate, the money supply, and reserve requirements on bank deposits. Indirectly, such policies and actions may impact the ability of non-bank financial institutions to compete with the Bank. Monetary policies of the FRB have had, and will continue to have, a significant effect on the operating results of financial institutions. The nature and impact of any future changes in monetary or other policies of the FRB cannot be predicted.

 

Employees

 

At June 30, 2017, the Company and its subsidiaries had 98 employees, none of whom are represented by a labor union. The Company believes that its relations with its employees are satisfactory.

 

Available Information

 

Our Internet address is www.calfirstbancorp.com. There we make available, by link to the SEC, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practical after we electronically file such material with, or furnish it to, the SEC. Our SEC reports can be accessed through the Investor Relations section of our Internet site. Our Corporate Governance Guidelines and our Code of Ethics for Senior Financial Management are available for viewing and printing under the Corporate Governance section of our Internet site. The information found on our Internet site is not part of this or any other report we file with or furnish to the SEC and is not incorporated herein by reference.

 

ITEM 1A. RISK FACTORS

 

Forward-Looking Statements

 

This Form 10-K contains forward-looking statements. Forward-looking statements include, among other things, information concerning our possible future consolidated results of operations, business and growth strategies, financing plans, our competitive position and the effects of competition, regulatory actions and economic conditions. Forward-looking statements include all statements that are not historical facts and can be identified by forward-looking words such as “anticipate”, “believe”, “could”, “estimate”, “expect”, “intend”, “plan”, “may”, “should”, “will”, “would”, “project” and similar expressions. These forward-looking statements are based on information currently available to us and are subject to inherent risks and uncertainties, and certain factors could cause actual results to differ materially from those anticipated. Some of the risks and uncertainties that may cause our actual results or performance to differ materially from such forward-looking statements are included in “Item 1A. Risk Factors” of this report. All forward-looking statements are qualified in their entirety by this cautionary statement and the Company undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances arising after the date on which they were made.

 

There are a number of factors, including those specified below, that may adversely affect the Company’s business, financial results or stock price. Additional risks that the Company currently does not know about or currently views as immaterial may also affect the Company’s business or adversely impact its financial results or stock price.

 

Industry Risk Factors

 

The Company’s business and financial results are subject to general business and economic conditions. The economic downturn and slow recovery reduced demand for financing capital assets. Continued or renewed weakness in the economy or in certain sectors could impact the financial performance and condition of customers and negatively affect the repayment of their obligations. In addition, changes in securities markets and monetary fluctuations adversely affect the availability and terms of funding necessary to meet the Company’s liquidity needs.

 

Changes in the domestic interest rate environment could reduce the Company’s net finance and interest income. The Company’s net finance and interest income, which is the difference between income earned on leases, loans and investments and interest expense paid on deposits, is affected by market rates of interest, which in turn are affected by prevailing economic conditions, by the fiscal and monetary policies of the federal government and by the policies of various regulatory agencies. Since December 2016, the Federal Open Market Committee (“FOMC) of the FRB has increased short term interest rates three times from the near zero level maintained for several years, but the timing and amount of any further increases is unclear. Increases in interest rates will increase the income earned on the Company’s available cash balances, but will also increase the Bank’s cost of funds over time. If the interest rates on deposits and other borrowings increase at a faster rate than the interest rates received on leases, loans, securities and other interest-earning investments, net interest income and therefore earnings, could be adversely affected.

 

 

Uncertain worldwide economic conditions and volatility in the currency and credit markets may negatively impact the Company and its customers. The Company’s net interest income is impacted by changes in market rates of interest, changes in credit spreads, changes in the shape of the yield curve, and the interest rate sensitivity of our assets and liabilities. Interest earning assets and interest bearing liabilities may react in different degrees to changes in market interest rates. Interest rates on some types of assets and liabilities may fluctuate prior to changes in broader market interest rates, while rates on other types may lag behind. The result of these changes to rates may cause differing spreads on interest earning assets and interest bearing liabilities, and a narrowing of the spread between longer and shorter term rates tends to negatively impact net interest margins. Although the Bank employs a funding strategy designed to correlate the repricing characteristics of assets with liabilities, the impact of interest rate movements and customer demand is not always consistent during different market cycles, and changes in the costs for deposits and yields on assets may not coincide. Foreign currency fluctuations have hurt the results of many businesses, including certain leveraged loan customers, and may impact their ability to meet their obligations. These circumstances could not only result in increased loan defaults, and charge-offs, but require increases to the allowance for credit losses which may materially and adversely affect our results of operations, business, and financial condition. 

 

Changes in the laws, regulations and policies governing financial services companies could alter the Company’s business environment and adversely affect operations. The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its fiscal and monetary policies determine in a large part the Company’s cost of funds and the return that can be earned on leases, loans and investments, which affect the Company’s net finance, loan and interest income.

 

The Company and the Bank are subject to a wide range of complex laws and regulations established by government entities. Most regulation is intended to protect depositors, federal deposit insurance funds and the banking system as a whole. Bank regulators can impose restrictions on the ability of the Company to undertake certain business and growth initiatives. Following the 2008 financial crisis, regulators increased their oversight of banks and have taken a more active role in imposing restrictions on bank loan operations, the classification of assets and determination of the allowance for credit losses. Changes in laws or governmental regulations, or changes in the interpretation of existing laws or regulations by a regulatory authority, have impacted the Company in substantial and unpredictable ways. The Company cannot predict whether any additional legislation will be enacted, and if enacted, the effect that it or any regulations would have on the Company’s financial condition or results of operations.

 

Cyber security and privacy breaches may hurt our business, damage our reputation, increase our costs, and cause losses. Our systems and networks store all the Company’s business records as well as personal information about our customers and employees. We have security systems and information technology infrastructure in place designed to protect against unauthorized access to such information. However, there is still a risk that the security systems and infrastructure that we maintain may not be successful in protecting against all security breaches, employee error, malfeasance, and cyber-attacks. Efforts have accelerated in recent months by parties seeking to obtain unauthorized access, disable or degrade service or sabotage systems. Techniques change frequently and often are not recognized until launched and we may be unable to anticipate these techniques or to implement adequate preventative measures. Third parties, including vendors that provide services for our operations, could also be a source of security risk to us in the event of a failure of their own security systems and infrastructure or outside parties may attempt to fraudulently induce employees or customers to disclose sensitive information in order to gain access to our data or our customers' data. Any significant violations of data privacy could result in a loss of confidence in the security of our products and services, the loss of business, litigation, regulatory investigations, and penalties that could damage our reputation and adversely affect the growth of our business.

 

The financial services industry is highly competitive, and competitive pressures could intensify and adversely affect the Company’s financial results. The Company operates in a highly competitive industry that could become even more competitive as a result of legislative, regulatory and technological changes. The Company competes with other commercial banks, savings and loan associations, mutual savings banks, finance companies, credit unions and investment companies, many of which have greater resources than the Company.

 

Acts or threats of terrorism and political or military actions taken by the United States or other governments could adversely affect general economic or industry conditions.

 

 

Company Risk Factors

 

Regulatory restrictions on the Bank’s ability to originate syndicated commercial loans may not be rescinded which could have a long term negative impact on the Company. During the third quarter of fiscal 2017, the OCC directed the Bank to cease originating new syndicated commercial loans and to take action to substantially reduce its concentration of leveraged loans. At March 31, 2017, $366.9 million, or 97% of the commercial loan portfolio consisted of participations in syndicated transactions, with approximately $248.1 million, or 65%, characterized as “leveraged loans” under guidance promulgated by federal bank regulators. Consequently, in order to comply with the OCC directive, the net commercial loan portfolio declined by 18% during the 2017 fourth quarter to $306 million at June 30, 2017, and is down 24% from $404 million at June 30, 2016. Syndicated loans have accounted for a substantial portion of the Company’s growth over the past few years. If regulatory restrictions on the Bank’s ability to originate syndicated commercial loans are not lifted, it is expected that this will require further significant reductions in the Bank’s loan portfolio over the next twelve months, and this will have a material adverse effect on the ability of the Company to grow its business and net interest income. See “Recent Events”.

 

The Bank is subject to increased liquidity and interest rate risk as it is forced to reduce its loan portfolio. While the Bank believes it can reduce the loan portfolio in an orderly way so as to coordinate the decline with a reduction in deposits and other funding liabilities, consistent with a prudent asset and liability management strategy, this process is complicated and management is not able to perfectly balance loan repayments with deposit withdrawals. As a result, higher yielding loans have paid off before higher cost deposits used to fund those loans have matured.

 

The Bank’s steps to reduce deposits by drastically cutting rates offered on CDs may have a long term negative effect on the Bank’s ability to raise deposits in the future. CalFirst Bank represents 94% of the Company’s assets and bank deposits exceeded $468 million, or 239% of stockholders’ equity at June 30, 2017. After the Bank eliminates the excess deposits, it will need to retain some portion of its deposit base to fund the remaining portfolio. If the remaining deposits do not roll over, or previous customers do not return, CalFirst Bank may be required to seek other sources of funds, including more expensive time deposits and borrowings, or sell more assets. Depending on market conditions, rates paid on deposits and borrowings may be higher than currently paid or no longer available.

 

The Bank and Company continue to be subject to periodic examination by the FRB and the OCC and if the Bank were found to be operating in an unsound or unsafe manner, or in violation of any OCC directive, they could impose new or additional restrictions or requirements, including, but not limited to activity or growth limitations, dividend restrictions, increased loan and lease loss reserve requirements, or other restrictions that could have an adverse effect on the Bank or the Company.

 

Market for capital asset lease financing continues to show weak demand with competitive pricing. The Company’s volume of new lease originations in fiscal 2017 was down for the third year in a row, and the Company does not see signs of significant improvement in lease origination in the near future.

 

The Company’s allowance for credit losses may not be adequate to cover actual losses. The Company’s subsidiaries retain approximately 90% of lease transactions and all loans in their own portfolios, which expose the Company to credit risk. The Company maintains an allowance for credit losses to provide for probable and estimable losses in the portfolio. The Company’s allowance for credit losses is based on its historical experience as well as industry data, an evaluation of the risks associated with its portfolios, including the size and composition of the lease and loan portfolios, current economic conditions and concentrations within the portfolio. The allowance for credit losses may not be adequate to cover losses resulting from unanticipated adverse changes in the economy or the financial markets. If the credit quality of the customer base materially decreases, or if the reserve for credit losses is not adequate, future provisions for credit losses could materially and adversely affect financial results.

 

The Company may suffer losses in its lease and loan portfolio despite its underwriting practices. The Company seeks to mitigate the risks inherent in its lease and loan portfolio by adhering to specific credit practices. Although the Company believes that its criteria are appropriate for the various kinds of leases and loans it makes, the Company may incur losses on leases and loans that meet these criteria.

 

Larger transactions and customer concentration may increase the risk of loss in the event of the deterioration of one of these customers or industries. At June 30, 2017, leases aggregating to $17.6 million to one customer accounted for 3.5% of the Company’s net investment in leases and loans, with the ten largest customers representing 22% of the portfolio. Only one industry classification represented over 5% of the Company’s total investment in leases and loans, as public and private colleges and universities aggregated to 6.1%.

 

 

The Bank’s commercial loan initiative may increase the Company’s risk of losses. The commercial loan portfolio contains a number of commercial loans with relatively larger balances than the average lease. About 62% of the portfolio consists of “leveraged loans” as characterized by federal regulatory guidelines, with 15% of the commercial loan portfolio considered to be higher risk leveraged loans by the Company. Based on the OCC directive to not extend the term of loans and reduce the concentration of leveraged loans, the Bank’s loans are steadily being paid off, which in some cases might be for an amount less than the Bank’s carrying cost. No loan credit is rated substandard, but the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in an increase in the provision for credit losses and an increase in charge-offs, all of which could have a material adverse effect on the Company’s results of operations.

 

The Company’s diversification into broader investment alternatives may increase the Company’s risk of losses. The Company’s investment portfolio includes U.S. Treasury and Agency Securities, corporate and municipal bonds and closed-end mutual funds, equity securities, in addition to interest-earning deposits, short-term money market securities and federal funds. These securities subject the Company to increased risk of volatility in the valuation of the investment, as well as greater interest and market risks. The deterioration of one or a few of these investments on a permanent basis could result in an determination that the investment has been permanently impaired and require a write-down of such investment, all of which could have a material adverse effect on the Company’s results of operations.

 

The change in residual value of leased assets may have an adverse impact on the Company’s financial results. A portion of the Company’s leases is subject to the risk that the residual value of the property under lease will be less than the Company’s recorded value. Adverse changes in the residual value of leased assets can have a negative impact on the Company’s financial results. The risk of changes in the realized value of the leased assets compared to recorded residual values depends on many factors outside of the Company’s control.

 

The financial services business involves significant operational risks. Operational risk is the risk of loss resulting from the Company’s operations, including, but not limited to, the risk of fraud by employees or persons outside of the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements, and failure of business continuation and disaster recovery plans. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, the Company could suffer financial loss, face regulatory action and suffer damage to its reputation.

 

Quarterly operating results may fluctuate significantly.  Operating results may differ from quarter to quarter due to a variety of factors, including the volume and profitability of leased property being remarketed, the size and credit quality of the lease and loan portfolio, the interest rate environment, the volume of new lease and loan originations, including variations in the property mix and funding of such originations and economic conditions in general. The results of any quarter may not be indicative of results in the future.

 

Negative publicity could damage the Company’s reputation and adversely impact its business and financial results. Reputation risk, or the risk to the Company’s business from negative publicity, including recent disclosure related to the OCC’s directive to the Bank, is inherent in the Company’s business. Negative publicity can result from the Company’s actual or alleged conduct in any number of activities, including leasing practices, compliance with bank regulations, corporate governance, and actions taken by government regulators in response to those activities. Negative publicity can adversely affect the Company’s ability to keep and attract customers and deposits and can expose the Company to litigation and regulatory action.

 

The Company’s reported financial results are subject to certain assumptions and estimates and management’s selection of accounting method. The Company’s management must exercise judgment in selecting and applying many accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report the Company’s financial condition and results. In some cases, management may select an accounting policy which might be reasonable under the circumstances yet might result in the Company’s reporting different results than would have been reported under a different alternative.

 

Certain accounting policies are critical to presenting the Company’s financial condition and results. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These critical accounting policies include the estimate of residual values, the allowance for credit losses, and income taxes. For more information, refer to “Critical Accounting Policies and Estimates.”

 

 

Changes in accounting standards could materially impact the Company’s financial statements. The Financial Accounting Standards Board (FASB) may change the financial accounting and reporting standards that govern the preparation of the Company’s financial statements. These changes can be hard to predict and can materially impact how the Company records and reports its financial condition and results of operations. Recently, FASB approved new accounting standards related to the accounting for leases and allowance for credit losses that could change the Company’s financial statements when implemented. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the Company’s restating prior period financial statements.

 

Loss of certain key officers would adversely affect the Company’s business. The Company‘s business and operating results are substantially dependent on certain key employees, including the Chief Executive Officer, Chief Operating Officer, Chief Financial Officer and Chief Credit Officer of the Bank and certain key sales managers. The loss of the services of these individuals, particularly the Chief Executive Officer, would have a negative impact on the business because of their expertise and years of industry experience.

 

The Company’s business could suffer if the Company fails to attract and retain qualified people. The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for personnel in most activities the Company engages in can be intense. The Company may not be able to hire the best people or to keep them.

 

The Company relies on other companies to provide components of the Company’s business infrastructure. Third party vendors provide certain components of the Company’s business infrastructure, such as the Bank’s core processing and electronic banking systems, item processing, and Internet connections. While the Company has selected these third party vendors carefully, it does not control their actions. Any problems caused by these third parties not providing the Company their services for any reason or their performing their services poorly, could adversely affect the Company’s ability to deliver products and services to the Company’s customers and otherwise to conduct its business. Replacing these third party vendors could also entail significant delay and expense.

 

A natural disaster could harm the Company’s business. Natural disasters could harm the Company’s operations directly through interference with communications, including the interruption or loss of the Company’s websites, which would prevent the Company from gathering deposits, originating leases and loans and processing and controlling its flow of business, as well as through the destruction of facilities and the Company’s operational, financial and management information systems.

 

The Company faces systems failure risks as well as security risks, including “hacking” and “identity theft.” The computer systems and network infrastructure the Company and others use could be vulnerable to unforeseen problems. These problems may arise in both our internally developed systems and the systems of our third-party service providers. Our operations are dependent upon our ability to protect computer equipment against damage from fire, power loss or telecommunication failure. Any damage or failure that causes an interruption in our operations could adversely affect our business and financial results. In addition, our computer systems and network infrastructure present security risks, and could be susceptible to hacking or identity theft.

 

The Company relies on dividends from its subsidiaries for its liquidity needs. The Company is a separate and distinct legal entity from CalFirst Leasing and the Bank. The principal source of funds to pay dividends on the Company’s stock is from distributions from the subsidiaries. Various regulations limit the amount of dividends that the Bank may pay to the Company.

 

The Company’s stock price can be volatile. The Company’s common stock is not widely held and the limited trading market for the stock can result in fluctuations in prices between trades and make it difficult for stockholders to dispose of their shares. The Company’s stock price can fluctuate widely in response to a variety of factors, including: actual or anticipated variations in the Company’s quarterly operating results and dividend policy; operating and stock price performance of other companies that investors deem comparable to the Company; news reports relating to trends, concerns and other issues in the financial services industry, and changes in government regulations. General market fluctuations, industry factors and general economic and political conditions and events, including terrorist attacks, economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations, could also cause the Company’s stock price to decrease regardless of the Company’s operating results.

 

The Company is a “controlled company” as defined by NASDAQ, with 63% of the stock held by the Chief Executive Officer, 76% held by two senior executives and fewer than 100 shareholders of record. As a result, senior management has the ability to exercise significant influence over the Company’s policies and business, and determine the outcome of corporate actions requiring stockholder approval. These actions may include, for example, the election of directors, the adoption of amendments to corporate documents, the approval of mergers, sales of assets and the continuation of the Company as a registered company with obligations to file periodic reports and other filings with the SEC.

 

The Company is eligible to delist its common stock from NASDAQ and deregister its common stock under the Exchange Act. As a public company listed on the NASDAQ Global Market, the Company is subject to the reporting requirements of the Exchange Act and the listing standards of NASDAQ. The Company incurs costs and time to comply with these requirements and given the limited public float and trading volume in the Company’s stock, the benefits from continuing as a SEC reporting company may not be supported. The Company is eligible to voluntarily delist its common stock from trading on NASDAQ and, as a bank holding company with fewer than 1,200 stockholders of record, the Company is also eligible to deregister its common stock under Section 12(g) of the Exchange Act. If the Company takes such actions and the Company’s reporting obligations under Section 15(d) of the Exchange Act are also suspended, the Company’s common stock would not continue to be traded on NASDAQ and the Company’s reporting obligations with the SEC would cease. While the Company’s common stock could continue to be traded over-the-counter, including through an over-the-counter market such as the OTCQB or OTCQX if elected by the Company, there can be no assurance that this won’t have an adverse effect on the price of the common stock or that an active trading market will continue to exist. If an active trading market is not maintained, the price and liquidity of the Company’s common stock may be adversely affected. Further, upon suspension of the Company’s reporting obligations under the Exchange Act, significantly less information about the Company may be publicly available, which could also have an adverse effect on the price and liquidity of the Company’s common stock.

 

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

At June 30, 2017 the Company and its subsidiaries occupied approximately 36,000 square feet of office space in Irvine, California leased from an unaffiliated party. The lease provides for monthly rental payments that average $60,100 from July 2017 through August 2018.

 

ITEM 3. LEGAL PROCEEDINGS

 

The Company is sometimes named as a defendant in litigation relating to its business operations. Management does not expect the outcome of any existing suit to have a material adverse effect on the Company's financial condition or results of operations.

 

Item 4. Mine Safety Disclosures

 

Not applicable

 

 

PART II

 

ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The common stock of California First National Bancorp trades on the NASDAQ Global Market System under the symbol CFNB. The following high and low closing sale prices for the periods shown reflect inter-dealer prices without retail markup, markdown or commissions and may not necessarily reflect actual transactions.

 

		For the years ended
		June 30, 2017								June 30, 2016
		High				Low				High				Low
First Quarter		$	15.44			$	13.96			$	13.60			$	13.06
Second Quarter			16.15				13.87				13.70				13.11
Third Quarter			16.45				15.47				13.97				12.85
Fourth Quarter		$	19.30			$	15.85			$	15.00			$	13.45

 

The Company had approximately 14 stockholders of record and in excess of 350 beneficial owners as of September 1, 2017.

 

Beginning in October 2009, the Board of Directors’ dividend policy provided for one annual dividend payment each year. The Company paid an annual dividend in the amount of $0.42 on December 13, 2014, $0.44 on December 15, 2015 and $0.46 on December 15, 2016. The Board of Directors will continue to review the dividend policy on an ongoing basis, taking into consideration a variety of factors including the business, economic and tax environment. No decision to pay dividends in fiscal 2017 and beyond has been made.

 

In April 2001, the Board of Directors authorized management, at its discretion, to repurchase up to 1,000,000 shares of common stock. This authorization has no termination date, but the Board of Directors reviews the authorization to repurchase common stock from time to time. No shares were repurchased during the years ended June 30, 2017 and 2015. The Company repurchased 180,117 shares of common stock under this authorization during the year ended June 30, 2016. As of September 10, 2017, 188,237 shares remain available under this authorization.

 

 

Common Stock Performance Graph

 

The following graph shows a comparison of the five-year cumulative return among the Company, the NASDAQ Composite Index and the Russell 2000. The graph assumes an investment of $100 on June 30, 2012 in our common stock and in each of the indices listed on the graph and reflects the change in the market price of our common stock relative to the changes in the noted indices at June 30, 2013, 2014, 2015, 2016 and 2017. The performance shown below is based on historical data and is not indicative of, nor intended to forecast, future price performance of our common stock. As required by Securities and Exchange Commission rules, total return in each case assumes the reinvestment of dividends paid.

 

 

Equity Compensation Plan Information

 

The following table provides information about shares of the Company’s Common Stock that may be issued upon the exercise of options under our existing equity compensation plans as of June 30, 2017.

 

Plan category		Number of shares of common stock to be issued upon exercise of outstanding options				Weighted average exercise price of outstanding options				Number of shares of common stock available for future issuance under equity compensation plans (excluding shares in first column)(1)
Equity compensation plans approved by shareholders			6,000			$	16.00				2,322,643
Equity compensation plans not approved by shareholders			None				N/A				N/A
Total			6,000			$	16.00				2,322,643	(1)

 

(1)

The maximum number of shares that may be issued under the equity compensation plan increases each year by an amount equal to 1% of the total number of issued and outstanding shares of Common Stock as of June 30 of the fiscal year immediately preceding such fiscal year.

 

 

ITEM 6. SELECTED FINANCIAL DATA

 

The following table sets forth selected financial data and operating information of the Company and its subsidiaries. The selected financial data should be read in conjunction with the Financial Statements and notes thereto and Management's Discussion and Analysis of Results of Operations and Financial Condition contained herein.

 

INCOME STATEMENT FINANCIAL DATA		YEARS ENDED JUNE 30,
(in thousands, except per share amounts)		2017				2016				2015				2014				2013
Finance and loan income		$	26,234			$	25,471			$	21,489			$	18,370			$	18,995
Investment and interest income			3,014				2,230				1,516				1,371				2,408
Total interest income			29,248				27,701				23,005				19,741				21,403
Interest expense on deposits and borrowings			7,229				6,210				3,945				3,037				2,664
Net interest income			22,019				21,491				19,060				16,704				18,739
Provision for credit losses			250				1,475				1,175				200				275
Net interest income after provision for credit losses			21,769				20,016				17,885				16,504				18,464
Operating and sales-type lease income			2,716				1,146				305				2,152				1,711
Gain on sale of leases and leased property			4,336				3,497				4,791				2,980				2,278
Other income			387				220				3,132				432				526
Realized gain on sale of investment securities			-				23				481				-				316
Total non-interest income			7,439				4,886				8,709				5,564				4,831
Non-interest expenses			10,484				10,834				11,779				10,995				11,610
Earnings before income taxes			18,724				14,068				14,815				11,073				11,685
Income taxes			7,601				5,420				5,760				4,022				4,331
Net earnings		$	11,123			$	8,648			$	9,055			$	7,051			$	7,354
Diluted earnings per share		$	1.08			$	0.83			$	0.87			$	0.67			$	0.70
Diluted common shares outstanding			10,280				10,399				10,460				10,456				10,453
Cash dividends per share		$	0.46			$	0.44			$	0.42			$	0.40			$	2.20
Dividend payout ratio			42.5	%			53.2	%			48.5	%			59.3	%			312.6	%
Net interest margin			2.71	%			2.78	%			3.15	%			3.22	%			3.77	%
Net interest spread			2.47	%			2.54	%			2.88	%			2.92	%			3.41	%
Return on average assets			1.30	%			1.06	%			1.39	%			1.30	%			1.40	%
Return on average equity			5.78	%			4.59	%			4.87	%			3.90	%			4.00	%

 

BALANCE SHEET DATA		AS OF JUNE 30,
(in thousands, except per share amounts)		2017				2016				2015				2014				2013
Cash and cash equivalents		$	96,055			$	105,094			$	60,240			$	40,122			$	75,469
Investment securities			99,790				99,801				84,546				29,316				48,162
Net investment in leases and loans			496,807				641,410				541,786				455,805				416,569
Total assets			715,585				888,176				731,074				579,550				558,903
Deposits			468,634				633,147				471,906				355,810				346,028
Borrowings			40,000				40,000				42,000				6,858				-
Non-recourse debt			279				4,449				10,193				8,640				768
Stockholders’ equity		$	196,134			$	191,022			$	188,218			$	183,745			$	180,879
Equity to total assets ratio			27.41	%			21.51	%			25.75	%			31.70	%			32.36	%
Book value per common share		$	19.07			$	18.58			$	17.99			$	17.57			$	17.31

 

 

 

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

General

 

The Company’s results include the operations of CalFirst Bank and CalFirst Leasing. The Company’s finance, loan and interest income includes interest income earned on the Company’s investment in lease receivables and residuals, commercial loans and investment securities. Non-interest income primarily includes gains realized on the sale of leased property, income from sales-type and operating leases, gains realized on the sale of leases, gains or losses recorded on investment securities and other income. Income from sales-type leases relates to the re-lease of off-lease property (“lease extensions”) while operating lease income generally involves lease extensions that do not meet the accounting requirements for sales-type leases.

 

The Company's operating results are subject to quarterly fluctuations resulting from a variety of factors, including the size and credit quality of the lease and loan portfolios, the interest rate environment, the volume and profitability of leased property being re-marketed through re-lease or sale, the market for investment securities, the volume of new lease or loan originations, including variations in the mix and funding of such originations, and economic conditions in general. The Company’s principal market risk exposure currently is related to interest rates and the differences in the repricing characteristics of interest-earning assets and interest-bearing liabilities. The FRB maintained historically low market interest rates from 2009 to 2016 that’s contributed to lower net interest margins. The Company’s current balance sheet structure is short-term in nature, with over 70% of interest-earning assets and 90% of interest-bearing liabilities that mature or reprice within one year. The Company’s interest margin is susceptible to timing lags related to varying movements in market interest rates. Many of the Company’s leases, loans and liquid investments are tied to U.S. treasury rates and Libor that often do not move in step with bank deposit rates. As a result, this can result in a greater change in net interest income than indicated by the repricing asset and liability comparison.

 

The Company conducts its business in a manner designed to mitigate risks. However, the assumption of risk is a key source of earnings in the leasing and banking industries and the Company is subject to risks through its investment in leases and loans held in its own portfolio, securities, lease transactions-in-process, and residual investments. The Company takes steps to manage risks through the implementation of strict credit and risk management processes and on-going risk management review procedures.

 

Critical Accounting Policies and Estimates

 

The preparation of the Company’s financial statements requires management to make certain critical accounting estimates that impact the stated amount of assets and liabilities at a financial statement date and the reported amount of income and expenses during a reporting period. These accounting estimates are based on management’s judgment and are considered to be critical because of their significance to the financial statements and the possibility that future events may differ from current judgments, or that the use of different assumptions could result in materially different estimates. The following is a description of the most critical accounting policies management applies, all of which require the use of accounting estimates and management’s judgment, based on the relevant information available at the end of each period.

 

Allowance for Credit Losses – The allowance for credit losses provides coverage for probable and estimable losses in the Company’s lease and commercial loan portfolios. The allowance recorded is based on a quarterly review of all leases and loans outstanding, loan commitments and transactions-in-process. The determination of the appropriate amount of any provision is highly dependent on management’s judgment at that time and takes into consideration all known relevant internal and external factors that may affect the lease and loan portfolio, including levels of non-performing leases and loans, customers financial condition, leased property values and collateral appraisals as well as general economic conditions and credit quality indicators. The Company’s allowance includes an estimate of reserves needed to cover specifically identified lease and loan losses and certain unidentified but inherent risks in the portfolio.

 

Fair Value of Investments – Investment securities are characterized as held-to-maturity (Investments) or as available-for-sale (Securities Available-for-Sale) based on management’s ability and intent regarding such investment at acquisition. On an ongoing basis, management must estimate the fair value of its investment securities based on information and assumptions it deems reliable and reasonable, which may be quoted market prices or if quoted market prices are not available, fair values extrapolated from the quoted prices of similar instruments. Based on this information, an assessment must be made as to whether any decline in the fair value of an investment security should be considered an other-than-temporary impairment and recorded in non-interest income as a loss on investments. The determination of such impairment is subject to a variety of factors, including management’s judgment and experience.

 

 

Residual Values – For capital leases that qualify as direct financing leases, the aggregate lease payments receivable and estimated residual value, if any, are recorded on the balance sheet, net of unearned income and allowances, as net investment in leases. Of the volume of leases booked during the fiscal years ended June 30, 2017, 2016 and 2015, approximately 6.7%, 6.8% and 15.9%, respectively, were structured such that the Company owns the leased asset at the end of the term and recorded a residual value. The residual value is an estimate for accounting purposes of the fair value of the leased property at lease termination and is determined at the inception of the lease based on the property leased and the terms and conditions of the underlying lease contract. The realizability of any estimated residual value depends on future collateral values, contractual options available to the lessee, the credit of the lessee, market conditions and other subjective and qualitative factors. The estimated residual values established at lease inception are periodically reviewed to determine if values are realizable and any identified losses are recognized at such time.

 

Initial Direct Costs Deferred – A portion of the Company’s non-interest expenses that management estimates is directly related to originating lease and loan transactions is deferred through a reduction to non-interest expenses recognized in a period. The amount deferred reflects management’s estimate of the expenses applicable to the origination process, taking into account a variety of factors including sales productivity, credit and documentation efficiency and estimates of completion percentages.

 

Deferred Income Taxes and Valuation Allowance – Deferred tax assets and liabilities result from temporary differences between the time income or expense items are recognized for financial statement purposes and for tax reporting. Such amounts are calculated using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The determination of current and deferred income taxes is based on complex analyses of many factors including interpretation of federal and state income tax laws, the difference between tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts due or owed such as the timing of reversals of temporary differences and current financial accounting standards. A valuation allowance is established if, based upon the relevant facts and circumstances, management believes that some or all of certain tax assets will not be realized. The Company has open tax years that may in the future be subject to examination by federal and state taxing authorities. Management periodically evaluates the adequacy of related valuation allowances, taking into account open tax return positions, tax assessments received and tax law changes. The process of evaluating allowance accounts involves the use of estimates and a high degree of management judgment. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities and reserves.

 

Loans Held for Sale Loans that were originated with the intent to hold but subsequently designated as being held for sale are recorded at the lower of cost or fair value at the time of transfer to held for sale. Fair value is determined by firm purchase commitments or quoted prices and if cost exceeds fair value at the transfer date, the difference is taken as a charge against the allowance for loan losses. Loans held for sale continue to be carried at the lower of cost or fair value until sold, with any subsequent decline in fair value recorded as a valuation allowance for held for sale loans and then reflected in the gain or loss on sale when sold.

 

The Company's estimates are reviewed continuously to ensure reasonableness. However, the amounts the Company may ultimately realize could differ from such estimated amounts.

 

Overview of Results, Trends and Outlook

 

Net earnings for the year ended June 30, 2017 of $11.12 million increased $2.5 million, or 28.6%, from $8.65 million reported in fiscal 2016. Fiscal 2017 pre-tax income of $18.7 million was up 33.1%, benefitting from a $1.8 million increase in net interest income after provision for credit losses and a $2.6 million increase in non-interest income.

 

For the year ended June 30, 2017, total leases and loans booked of $231.2 million were 33.7% below fiscal 2016 bookings of $348.5 million. Commercial loans boarded of $123.5 million were down 48% from the $238.1 million boarded in fiscal 2016, and new lease bookings of $107.6 million decreased 2.5% from the $110.4 million booked in the prior fiscal year. The Company’s net investment in leases and loans of $496.8 million at June 30, 2017 decreased 23% from $641.4 million at June 30, 2016, which included a 24% decrease in commercial loans and a 19.7% decline in the investment in leases. See “Recent Events”.

 

New lease and loan transactions approved (“lease and loan originations”) of $213.7 million during fiscal 2017 were 42% below the level of the prior year. Fiscal 2017 loan originations of $116.9 million were down $102.6 million or 47% from $219.5 million in fiscal 2016. Lease originations during fiscal 2017 of $96.7 million were down 34% from $146.7 million the prior year. As a result, the estimated backlog of approved lease and loan commitments of $59.7 million at June 30, 2017 is down 33% from $89.4 million at June 30, 2016, with 95% of the backlog related to leases.

 

 

Consolidated Statement of Earnings Analysis

 

Summary – For the fiscal year ended June 30, 2017, net earnings of $11.12 million increased by 29% or $2.5 million from $8.65 million for fiscal 2016. Diluted earnings per share increased 30.1% to $1.08 in fiscal 2017 from $0.83 fiscal 2016. Net interest income after provision for credit losses increased $1.8 million and non-interest income increased $2.6 million while non-interest expenses decreased 3.2%.

 

Net Interest Income – Net interest income is the difference between interest earned on the investment in leases, loans, securities and other interest earning assets and interest paid on deposits or other borrowings. Net interest income is affected by changes in the volume and mix of interest earning assets and liabilities, the movement of interest rates, and funding and pricing strategies.

 

The following table presents the components of the increases (decreases) in net interest income by volume and rate:

 

		2017 compared to 2016												2016 compared to 2015
		Volume				Rate				Total				Volume				Rate				Total
		(in thousands)
Interest income
Net investment in leases		$	(3,193	)		$	970			$	(2,223	)		$	(1,786	)		$	412			$	(1,374	)
Commercial loans			2,505				482				2,987				5,302				54				5,356
Investment securities			80				126				206				932				(380	)			552
Interest-earning deposits with banks			111				466				577				44				118				162
Total interest income			(497	)			2,044				1,547				4,492				204				4,696
Interest expense
Demand and savings deposits			112				202				314				27				84				111
Time deposits			418				252				670				1,427				582				2,009
Short-term borrowings			(39	)			74				35				96				49				145
Total interest expense			491				528				1,019				1,550				715				2,265
Net interest income		$	(988	)		$	1,516			$	528			$	2,972			$	(511	)		$	2,431

 

Net interest income increased 2.5% to $22.0 million for the fiscal year ended June 30, 2017 compared to $21.5 million for fiscal 2016. Total interest income increased 5.6% to $29.2 million compared to $27.7 million in fiscal 2016. This increase was due to a $3.0 million, or 24.6%, increase in commercial loan income resulting from a 20.6% increase in average loan balances to $400.2 million from $331.8 million for fiscal 2016, and a 12 basis point increase in average yields earned to 3.78%. The increase in loan yields reflects some benefit from higher Libor rates, but was offset by narrower pricing spreads. Direct finance income declined 16.7% for the year to $11.1 million, reflecting a 24.0% decrease in average investment in leases to $204.8 million which offset a 47 basis point increase in average lease yield to 5.42%. The 2017 lease yield benefitted from the recognition of $1.4 million of finance income related to a transaction in process that was unwound in bankruptcy and from accelerated finance income from other early lease terminations. This boosted the yield by 70 basis points while fiscal 2016 benefitted from accelerated finance income for early terminations of 23 basis points. Without these benefits, the average lease yield for fiscal 2017 remained flat. Investment interest income in fiscal 2017 was up 35.1% to $3.0 million, reflecting a 41% increase in average cash balances to $110.7 million and 42 basis point improvement in average yield to 0.76% due to higher rates earned on Fed Funds. In addition, yields on investments increased 13 basis points on a 4% increase in average balances. Interest expense on deposits and borrowings increased 16.4% to $7.2 million, reflecting a 7.5% increase in average balances to $640.8 million and a 9 basis point increase in average cost to 1.13%. The rise in interest cost for fiscal 2017 includes a 6 basis point increase in average cost of deposits to 1.16% and a $54.2 million increase in average deposits, tempered by a $9.3 million decrease in average borrowings at an average rate of 0.61%.

 

The average yield on all interest-earning assets in fiscal 2017 of 3.60% was up by 1 basis point from the prior year while the average rate paid on all interest-bearing liabilities increased by 9 basis points. The small increase in average yield, despite the benefit of accelerated finance income discussed above, reflects the increase of lower yielding commercial loans to 49% of average interest earning assets from 43% in fiscal 2016. As a result, the net interest margin and spread for fiscal 2017 were down slightly from the prior year.

 

 

Net interest income increased 12.8% to $21.5 million for the fiscal year ended June 30, 2016 compared to $19.1 million for fiscal 2015. Total interest income increased 20.4% to $27.7 million compared to $23.0 million in fiscal 2015. This increase was due to a $5.4 million, or 79%, increase in commercial loan income resulting from a 78% increase in average loan balances to $331.8 million from $186.4 million for fiscal 2015, and a 2 basis point increase in average yields earned to 3.66%. The minor increase in loan yields reflects some benefit from an increase in Libor rates, but was offset by narrower pricing spreads. Direct finance income declined 9% for the year to $13.3 million, reflecting a 12% decrease in average investment in leases to $269.4 million which offset a 15 basis point increase in average lease yield to 4.95%. The yield on leases benefitted from the early termination of leases that accelerated interest income recognition. Investment interest income in fiscal 2016 was up 47% to $2.2 million, reflecting a 54% increase in average cash and investment balances to $171.4 million and 6 basis point drop in average yields to 1.30%. While average yields on interest-earning deposits with banks increased 15 basis points, average yields on investment balances declined by 41 basis points as lower yielding treasury and mortgage securities replaced maturing corporate securities. Interest expense on deposits and borrowings increased 57% to $6.2 million, reflecting a 40% increase in average balances to $595.8 million and an 11 basis point increase in average cost to 1.04%. The rise in interest cost for fiscal 2016 includes a 14 basis point increase in average cost of deposits to 1.10% and a $141 million increase in average deposits, tempered by a $30 million increase in average borrowings at an average rate of 0.42%.

 

The following table presents the Company’s average balance sheets, finance and loan income and interest earned or interest paid, the related yields and rates on major categories of the Company’s interest-earning assets and interest-bearing liabilities:

 

(dollars in thousands)		Year ended June 30, 2017												Year ended June 30, 2016												Year ended June 30, 2015
		Average								Yield/				Average								Yield/				Average								Yield/
Assets		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
Interest-earning assets
Interest-earning deposits with banks		$	110,660			$	846				0.76	%		$	78,251			$	269				0.34	%		$	55,374			$	107				0.19	%
Investment securities			96,949				2,168				2.24	%			93,170				1,961				2.10	%			56,082				1,409				2.51	%
Commercial loans			400,222				15,134				3.78	%			331,818				12,148				3.66	%			186,357				6,792				3.64	%
Net investment in leases (1)			204,847				11,100				5.42	%			269,419				13,323				4.95	%			306,697				14,697				4.79	%
Total interest-earning assets			812,678				29,248				3.60	%			772,658				27,701				3.59	%			604,510				23,005				3.81	%
Other assets			40,204												40,402												45,625
		$	852,882											$	813,060											$	650,135
Liabilities and Shareholders' Equity
Interest-bearing liabilities
Demand and savings deposits		$	91,374				756				0.83	%		$	72,829				441				0.61	%		$	67,338				330				0.49	%
Time deposits			509,378				6,231				1.22	%			473,751				5,562				1.17	%			338,080				3,553				1.05	%
FHLB borrowings			40,000				242				0.61	%			49,254				207				0.42	%			19,334				62				0.32	%
Total interest bearing liabilities			640,752				7,229				1.13	%			595,834				6,210				1.04	%			424,752				3,945				0.93	%
Non-interest bearing demand deposits			2,908												2,134												2,024
Other liabilities			16,880												26,743												37,278
Shareholders' equity			192,342												188,349												186,081
		$	852,882											$	813,060											$	650,135
Net interest income						$	22,019											$	21,491											$	19,060
Net interest spread (2)											2.47	%											2.55	%											2.88	%
Net interest margin (3)											2.71	%											2.78	%											3.15	%
Average interest earning assets over average interest bearing liabilities											126.8	%											129.7	%											142.3	%

 

(1)	Average balance is based on month-end balances, includes non-accrual leases, and is presented net of unearned income.
(2)	Net interest spread is equal to the difference between the average yield on interest earning assets and the average rate paid on interest-bearing liabilities.
(3)	Net interest margin represents net finance and interest income as a percent of average interest earning assets.

 

Provision for Credit Losses – The Company recorded a provision for credit losses in fiscal 2017 of $250,000, compared to a provision of $1.48 million recorded in fiscal 2016 and a provision of $1.18 million in fiscal 2015. The provision in fiscal 2017 included a release of $650,000 of reserves during the fourth quarter following the 32% decline in the commercial loan portfolio between December 31, 2016 and June 30, 2017, and a $200,000 recovery recognized in the quarter. The provision in fiscal 2016 covered the $1.0 million write-down during the second quarter of a lease in bankruptcy as well as 66% growth in the loan portfolio. The fiscal 2015 provision related to the 88% growth in the commercial loan portfolio and some increased credit risk in the lease portfolio. At June 30, 2017, the allowance for credit losses of $7.15 million, 1.4% of total leases and loans, is considered to be appropriate for the credit profile of the consolidated portfolio.

 

 

Total Non-interest Income – Total non-interest income for fiscal 2017 of $7.4 million was up 52.3% from $4.9 million in fiscal 2016. The increase reflects gains on the sale of leases and loans of $2.5 million in fiscal 2017 compared to $1.0 million in fiscal 2016. Income from leases reaching their end-of-term increased 24% to $4.6 million in fiscal 2017 from $3.7 million in fiscal 2016.

 

Total non-interest income for fiscal 2016 of $4.9 million was down 43.9% from $8.7 million in fiscal 2015. Non-interest income for the prior year included the pre-tax recovery of $2,743,920 from the settlement of claims filed in a TFT-LCD (thin-film transistor liquid display) products antitrust case. Excluding that income from the prior year, non-interest income for fiscal 2016 was still down by $1.08 million or 18% due to a $1.3 million decrease in gains from the sale of leases and $458,600 decline in securities gains, offset in part by a $706,000 increase in income from the release of property on leases reaching the end of term during the year.

 

Non-interest Expenses – The Company’s non-interest expenses decreased $350,000, or 3.2%, to $10.5 million recognized for the year ended June 30, 2017. This compared to non-interest expenses in fiscal 2016 of $10.8 million, which had decreased by $945,000, or 8.0%, from $11.8 million in fiscal 2015. The decrease in expenses in fiscal 2017 compared to fiscal 2016 was due primarily to the sale of the repossessed asset offset in part by higher compensation and benefits cost recognized.

 

The Company’s non-interest expenses decreased $945,000, or 8.0%, to $10.8 million recognized for the year ended June 30, 2016. This compared to non-interest expenses in fiscal 2015 of $11.8 million, which had increased by $784,000, or 7.1%, from $11.0 million in fiscal 2014. The decrease in expenses in fiscal 2016 compared to fiscal 2015 was due primarily to a decrease in sales compensation and benefits cost recognized, offset in part by charges taken to write-down the value of a repossessed asset.

 

Income Taxes – Income taxes were accrued at a tax rate of 40.6% for the fiscal year ended June 30, 2017, 38.5% for fiscal year ended June 30, 2016 and 38.9% for fiscal year ended June 30, 2015, representing the Company’s estimated effective tax rate for each respective year. The effective tax rate increased in fiscal 2017 compared to 2016 due to the increase in the effective federal tax rate and the estimated state tax rate resulting from apportionment changes. The effective tax rate decreased slightly in fiscal 2016 compared to 2015 due to the decrease in the effective state tax rate.

 

Financial Condition Analysis

 

Lease and Loan Portfolio

 

The following table summarizes the Company’s consolidated lease and loan portfolio by category:

 

		June 30,
		2017				2016				2015				2014				2013
		(in thousands)
Net investment in leases		$	192,741			$	239,964			$	301,733			$	329,935			$	345,753
Commercial loans			306,826				401,629				238,978				123,238				66,541
Commercial real estate loans			4,387				6,679				7,531				7,920				9,411
Total leases and loans			503,954				648,272				548,242				461,093				421,705
Less allowance for credit losses			(7,147	)			(6,862	)			(6,456	)			(5,288	)			(5,136	)
Net leases and loans		$	496,807			$	641,410			$	541,786			$	455,805			$	416,569

 

Lease Portfolio

 

During the fiscal year ended June 30, 2017, 80% of the property value of new leases booked by the Company was held in its own portfolio, compared to 89% during fiscal 2016 and 88% during fiscal 2015. For the fiscal year ended June 30, 2017, the Company’s net investment in lease receivables decreased by $42.7 million and the investment in estimated residual values decreased by $4.2 million. The decrease in the investment in lease receivables reflects the low volume of new lease bookings that didn’t offset payments received and includes the sale or assignment of $43.1 million of lease receivables. The decrease in investment in residual values is due to a lower volume of new leases on which the Company records a residual compared to the volume of residual values recognized during the year.

 

The Company often makes payments to purchase leased property prior to the commencement of the lease. The disbursements for these lease transactions-in-process are made to facilitate the lessees’ property implementation schedule. The lessee generally is contractually obligated by the lease to make rental payments directly to the Company during the period that the transaction is in process, and obligated to reimburse the Company for all disbursements under certain circumstances. Income is not recognized while a transaction is in process and prior to the commencement of the lease. At June 30, 2017, the Company’s investment in property acquired for transactions-in-process was $17.1 million, down from $30.9 million at June 30, 2016, and $31.3 million at June 30, 2015.

 

 

The Company leases capital assets to businesses and other commercial or non-profit organizations. All leases are secured by the underlying property being leased. The Company’s strategy is to develop lease portfolios with risk/reward profiles that meet its objectives and avoid risks that do not meet these requirements through the use of non-recourse financing. The strategy emphasizes diversification on both a geographic and customer level, and spreading the Company’s risk across a breadth of leases. The average size of lease transactions over the past three years has fluctuated from $751,000 to $1.1 million. During the year ended June 30, 2017, three commercial credits accounted for 12.8%, 9.9% and 9.3% of the property cost of leases booked during the fiscal year, respectively, with the five largest commercial accounts aggregating to 44% of leases booked. During the year ended June 30, 2016, two commercial credits accounted for 18.1% and 13.2% of the property cost of leases booked during the fiscal year, respectively, with the five largest commercial accounts aggregating to 47% of leases booked. During the year ended June 30, 2015, two commercial credits accounted for 14.1% and 12%, respectively, of the property cost of leases booked during the fiscal year, with the five largest commercial accounts aggregating to 41% of leases booked. At June 30, 2017, one customer accounted for 3.5% of the Company’s net investment in leases, compared to one customer accounting for 9.8% of the Company’s net investment in leases at June 30, 2016 and two customers accounting for 4.8 and 4.2% of the Company’s net investment at June 30, 2015.

 

Commercial Loan Portfolio

 

The Company’s commercial loan portfolio was $306.0 million at June 30, 2017, a 24.2% decrease from $403.7 million at June 30, 2016. The commercial loan portfolio is comprised primarily of participations in commercial loan syndications where the loans are secured by the borrowers’ and any subsidiary guarantors’ assets. Commercial loan participations represent 96.5% of the commercial loan portfolio with the remainder of the portfolio comprised of two commercial real estate loans and one unsecured loan originated directly. The loan portfolio at June 30, 2017 is distributed among 61 credits with an average balance of $5.1 million and the largest outstanding at $10.4 million. Syndicated loans the Company characterizes as higher risk leveraged loans account for approximately 14.8% of the commercial loan portfolio.

 

The estimated repayment of principal on the commercial loan portfolio as of June 30, 2017 is as follows:

 

						Principal Balance Due in
		Principal				One Year				One to				Due After
Loan Type		Balance				Or less				Five Years				Five Years
		(in thousands)
Commercial term loans		$	304,045			$	7,583			$	238,646			$	57,816
Commercial real estate loans			4,387				247				1,406				2,734
Revolving lines of credit			3,248				-				3,248				-
Principal balance outstanding		$	311,680			$	7,830			$	243,300			$	60,550
Loans with predetermined interest rates														$	10,787
Loans with floating or adjustable interest rates														$	300,893

 

The lease and loan portfolio is diversified geographically with the investment spread across all fifty states. The following table shows the geographic distribution of the Company’s net investment in leases and loans (before valuation allowances and initial direct costs) at June 30, 2017 and 2016.

 

(dollars in thousands)		Net Investment in Leases & Loans
		June 30, 2017								June 30, 2016
State		Balance				Percent				Balance				Percent
California		$	57,702				11.5	%		$	77,868				12.0	%
Texas			51,451				10.3	%			61,040				9.4	%
Ohio			26,946				5.4	%			30,853				4.8	%
Colorado			26,892				5.4	%			37,012				5.7	%
Georgia, Virginia, Tennessee, North Carolina, Florida			107,077				21.3	%			132,488				20.5	%
New York, Massachusetts, Connecticut			53,831				10.7	%			68,940				10.7	%
Indiana, Wisconsin, Michigan, Minnesota, Illinois, Missouri			61,261				12.2	%			72,945				11.3	%
Utah, Idaho, Washington, Nebraska			40,849				8.1	%			63,302				9.8	%
Pennsylvania, New Jersey, Maryland			38,484				7.7	%			65,168				10.1	%
All other states (no state greater than 1.0%)			37,041				7.4	%			36,772				5.7	%
		$	501,534				100.0	%		$	646,389				100.0	%

 

 

 

The lease and loan portfolio is also distributed across a wide spectrum of industry groups as shown below:

 

(dollars in thousands)		Net Investment in Leases & Loans
		June 30, 2017								June 30, 2016
Industry		Balance				Percent				Balance				Percent
Scientific, professional, other business services		$	68,610				13.7	%		$	58,038				9.0	%
Manufacturing - industrial			66,442				13.2	%			82,363				12.7	%
Retail Trade			56,437				11.3	%			58,350				9.0	%
Healthcare and social services			54,237				10.8	%			67,544				10.4	%
Manufacturing - chemicals and materials			45,524				9.1	%			63,940				9.9	%
Wholesale distribution			40,873				8.1	%			57,710				8.9	%
Educational services			34,658				6.9	%			40,115				6.2	%
Arts, entertainment and recreation			34,209				6.8	%			64,634				10.0	%
Agriculture and food products			28,196				5.6	%			34,851				5.4	%
Commercial airlines and aviation services			19,357				3.9	%			22,705				3.5	%
Manufacturing - automotive, truck, aerospace			12,031				2.4	%			22,581				3.5	%
Mining and oil & gas services			9,953				2.0	%			18,264				2.8	%
Transportation			9,125				1.8	%			17,432				2.7	%
Financial services			7,622				1.5	%			8,931				1.4	%
Public administration			6,218				1.2	%			8,556				1.3	%
Utilities			4,957				1.0	%			14,658				2.3	%
Building and construction			3,086				0.6	%			5,718				0.9	%
		$	501,534				100	%		$	646,389				100	%

 

Most of the industry groups identified above include customers captured by different industry codes and may not be directly comparable or considered a concentration. However, at June 30, 2017, approximately 6.1% of the portfolio is with public and private colleges and universities, up from to 5.3% at June 30, 2016, and approximately 4.8% of the portfolio consists of hospitals and medical centers, down from 5.2% at June 30, 2016. The universities and colleges are located throughout the United States and spread over 168 leases with 68 different institutions and no university representing more than 1% of the portfolio. The hospital portfolio involves 15 different credits and includes 24 lease schedules and 1 loan.

 

Securities Available-for-Sale

 

The Company maintains a portfolio of securities to generate interest and investment income from the investment of excess funds and to provide liquidity. Total securities available-for-sale of $95.5 million as of June 30, 2017 compared to $95.8 million at June 30, 2016. The carrying cost and fair value of the Company’s securities portfolio at June 30, 2017 and 2016 is as follows:

 

		As of June 30, 2017								As of June 30, 2016
(in thousands)		Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value
Available-for-sale
U.S. Treasury notes		$	47,426			$	47,721			$	47,355			$	48,774
Corporate debt securities			13,140				13,171				13,291				13,385
Agency MBS			25,803				25,577				31,782				32,223
Equity securities			7,934				7,709				-				-
Mutual fund investments			1,215				1,331				1,215				1,462
Total securities available-for-sale		$	95,518			$	95,509			$	93,643			$	95,844

 

During the fiscal year ended June 30, 2017, the Company’s portfolio of securities available-for-sale decreased $335,000 to $95.5 million. The decrease during the year included the acquisition of $7.9 million in equity securities that was offset by pay downs, net of accretion, of $6.1 million and a $2.2 million decrease in the fair value of securities. The rise in interest rates since June 2016 swung an unrecognized net gain of $2.2 million at June 30, 2016 to an unrealized net loss of $9,000 at June 30, 2017.

 

During the twelve months ended June 30, 2016, the Company realized a gain of $23,000 from an early call of a corporate debt security for proceeds of $4.8 million. The net gain is recognized using the specific identification method and is included in non-interest income.

 

 

Management evaluates investment securities for other-than-temporary impairment on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The weighted-average maturity of debt securities at June 30, 2017 was 4.2 years and the corresponding weighted-average yield was 2.06 percent.

 

Asset Quality

 

The Company monitors the performance of all leases and loans held in its own portfolio, transactions-in-process and loan commitments as well as lease transactions assigned to lenders, if the Company retains a residual investment in the leased property subject to those leases. An ongoing review of all leases and loans ten or more days delinquent is conducted. Customers who are delinquent with the Company or an assignee are coded in the Company’s accounting and tracking systems in order to provide management visibility, periodic reporting, and appropriate reserves. The accrual of interest income on leases and loans will be discontinued when the customer becomes ninety days or more past due on its lease or loan payments with the Company, unless the Company believes the investment is otherwise recoverable. Leases and loans may be placed on non-accrual earlier if the Company has significant doubt about the ability of the customer to meet its lease or loan obligations, as evidenced by consistent delinquency, deterioration in the customer’s financial condition or other relevant factors.

 

The following table summarizes the Company’s non-performing leases and loans.

 

		June 30,
Non-performing Leases and Loans		2017				2016				2015				2014				2013
		(dollars in thousands)
Non-accrual leases and loans		$	3			$	12			$	41			$	47			$	1,614
Restructured leases			-				-				-				-				-
Leases past due 90 days (other than above)			-				-				-				-				-
Total non-performing leases and loans		$	3			$	12			$	41			$	47			$	1,614
Repossessed equipment			-				1,300				-				-				-
Total non-performing assets		$	-			$	1,312			$	41			$	47			$	1,614
Non-performing leases as % of net investment in leases and loans before allowances			0.00	%			0.00	%			0.01	%			0.01	%			0.38	%
Non-performing assets as % of total assets			0.00	%			0.15	%			0.01	%			0.01	%			0.29	%

 

Non-performing assets consists of non-performing leases as well as any repossessed assets. In the third quarter of fiscal 2016, the Company transferred $1.7 million of property related to a lease rejected in bankruptcy to repossessed equipment. The repossessed asset had carrying value of $1.3 million at June 30, 2016 and was subsequently sold in May 2017 for $121,000 in excess of the carrying value. The decline in non-accrual leases at June 30, 2017 is due to payments received or write-offs taken with no new leases added. No direct finance income would have been recorded had non-accrual leases at each respective fiscal year end been current in accordance with their original terms during fiscal 2017, 2016 and 2015. There was no direct finance income actually recorded on non-performing leases during fiscal 2017, 2016 and 2015.

 

In addition to the non-performing leases identified above, there was $7.4 million of investment in leases at June 30, 2017 classified as substandard or with credits that currently are experiencing financial difficulties or that management believes may experience financial difficulties in the future. This amount compared to $4.0 million at June 30, 2016. Although these credits have been identified as potential problems, they may never become non-performing. These potential problem leases are considered in the determination of the allowance for credit losses.

 

 

Allowance for Credit Losses

 

The allowance for credit losses and the residual valuation allowance provide coverage for probable and estimable losses in the Company’s lease and loan portfolios. The allowance recorded is based on a quarterly review of all leases and loans outstanding, loan commitments and transactions-in-process to determine that it is adequate to cover these inherent losses. The evaluation of each element and the overall allowance is based on a continuing assessment of problem credits, recent loss experience and other factors, including regulatory guidance and economic conditions. The Company utilizes similar processes to estimate its liability for unfunded loan commitments, which is included in other liabilities in the Consolidated Balance Sheets. Both the allowance for credit losses and the liability for unfunded loan commitments are included in the Company’s analysis of credit losses. Lease receivables, loans or residuals are charged off when they are deemed completely uncollectible. The determination of the appropriate amount of any provision is based on management’s judgment at that time and takes into consideration all known relevant internal and external factors that may affect the lease and loan portfolio. The following table summarizes the activity in the allowance for loan and lease losses for the five years ended June 30, 2017.

 

		Years Ended June 30,
		2017				2016				2015				2014				2013
		(dollars in thousands)
Property acquired for transactions-in-process before allowance		$	17,101			$	30,932			$	31,340			$	40,578			$	11,938
Net investment in leases before allowance			192,741				239,964				301,733				329,935				345,753
Commercial loans, before allowance			311,213				408,308				246,509				131,158				75,952
Leases and loans, before allowances		$	521,055			$	679,204			$	579,582			$	501,671			$	433,643
Average leases and loans		$	605,069			$	601,237			$	493,054			$	422,788			$	382,343
Allowance for credit losses at beginning of year		$	6,862			$	6,456			$	5,299			$	5,147			$	5,216
Charge-off of lease receivables, loans and transactions-in-process			(168	)			(1,120	)			(19	)			(62	)			(350	)
Recovery of lease amounts previously written off			203				51				1				14				6
Provision for credit losses			250				1,475				1,175				200				275
Allowance for credit losses at end of year (“Allowance”)		$	7,147			$	6,862			$	6,456			$	5,299			$	5,147
Components of allowance for credit losses:
Allowance for lease losses		$	1,943			$	2,290			$	3,409			$	3,327			$	3,175
Allowance for loan losses			5,204				4,572				3,047				1,972				1,972
		$	7,147			$	6,862			$	6,456			$	5,299			$	5,147
Allowance as percent of leases and loans before allowances			1.42	%			1.06	%			1.18	%			1.15	%			1.22	%
Net (charge-offs) recoveries as percent of average leases and loans			0.0	%			(0.2	)%			(0.00	)%			(0.01	)%			(0.09	)%

 

The allowance for credit losses increased to $7.15 million (1.42% of net investment in leases and loans) at June 30, 2017 from $6.86 million (1.06% of net investment in leases and loans) at June 30, 2016. The allowance at June 30, 2017 consisted of $373,300 allocated to specific accounts that were identified as problems and $6.8 million that was available to cover losses inherent in the portfolio. This compared to $48,000 allocated to specific accounts at June 30, 2016 and $6.8 million that was available to cover losses inherent in the portfolio at such date. The increase in the specific allowance at June 30, 2017 primarily relates to new specific problems identified. Based on the above factors, the Company considers the allowance for credit losses of $7.15 million at June 30, 2017 adequate to cover losses specifically identified as well as inherent in the lease and loan portfolios. However, no assurance can be given that the Company will not, in any particular period, sustain lease and loan losses that are sizeable in relation to the amount reserved, or that subsequent evaluations of the lease portfolio, in light of factors then prevailing, including economic conditions and the on-going credit review process, will not require significant increases in the allowance for credit losses. Among other factors, a renewed economic slowdown may have an adverse impact on the adequacy of the allowance for credit losses by increasing credit risk and the risk of potential loss even further. As the Company has retained a significantly greater percentage of leases and loans in its own portfolio, this creates increased exposure to delinquencies, repossessions, foreclosures and losses than the Company has historically experienced.

 

Based on management’s evaluation of the lease and loan portfolio at each period end, management has allocated the allowance for loan and lease losses for the past five years as shown in the table below:

 

		2017								2016								2015								2014								2013
						% of								% of								% of								% of								% of
		Allowance				Leases				Allowance				Leases				Allowance				Leases				Allowance				Leases				Allowance				Leases
		Amount				and				Amount				and				Amount				and				Amount				and				Amount				and
		Allocated				Loans				Allocated				Loans				Allocated				Loans				Allocated				Loans				Allocated				Loans
		(dollars in thousands)
Net Investment in Leases			1,943				27.1	%		$	2,290				37.0	%		$	3,409				55.0	%		$	3,327				71.6	%		$	3,175				82.0	%
Commercial Loans			5,143				72.0	%			4,511				62.0	%			2,936				43.6	%			1,761				26.7	%			1,561				15.8	%
Commercial Real Estate Loans			61				0.9	%			61				1.0	%			111				1.4	%			211				1.7	%			411				2.2	%
			7,147				100.0	%		$	6,862				100.0	%		$	6,456				100.0	%		$	5,299				100.0	%		$	5,147				100.0	%

 

While the allowance is allocated by category above, the allowance is general in nature and is available for the portfolio in its entirety.

 

 

Liquidity and Capital Resources

 

The Company funds its operating activities through internally generated funds, bank deposits, borrowings and non-recourse debt. At June 30, 2017 and 2016, the Company’s cash and cash equivalents were $96.1 million and $105.1 million, respectively.

 

Deposits at CalFirst Bank totaled $468.6 million at June 30, 2017, down 26.0% from $633.1 million at June 30, 2016 and 0.7% below $471.9 million at June 30, 2015. Since March 2017, the Bank has worked to manage the reduction in the loan portfolio to a comparable decline in deposits. The Bank historically offered interest rates on deposit accounts that were higher than the national average, but since March 2017 the Bank’s rates have been targeted at the bottom of the market. Average rates paid by the Bank on deposits in fiscal 2017 still increased due to activity during the first seven months of the year and to a deposit mix concentrated in one-year CDs that have not matured or repriced yet. For fiscal 2016 and 2015, average rates increased due to market conditions and the Bank’s need to increase deposits to fund the growth in its loan portfolio at that time. The following table presents average balances and average rates paid on deposits for years ended June 30, 2017, 2016 and 2015:

 

		Years ended June 30,
		2017												2016												2015
		(dollars in thousands)
										Average												Average												Average
		Ending				Average				Rate				Ending				Average				Rate				Ending				Average				Rate
		Balance				Balance				Paid				Balance				Balance				Paid				Balance				Balance				Paid
Non-interest bearing demand deposits		$	4,855			$	2,908				n/a			$	2,181			$	2,134				n/a			$	2,193			$	2,024				n/a
Interest-bearing demand deposits			1,356				1,206				0.20	%			1,298				2,125				0.20	%			2,715				2,023				0.20	%
Savings deposits			84,656				90,168				0.84	%			78,510				70,704				0.62	%			65,539				65,315				0.50	%
Time deposits less than $100,000			74,947				94,717				1.21	%			98,604				83,191				1.17	%			69,226				60,176				1.05	%
Time deposits, $100,000 or more		$	302,820			$	414,661				1.23	%		$	452,554				390,560				1.17	%		$	332,233			$	277,904				1.05	%

 

The following table shows the maturities of certificates of deposits at the dates indicated:

 

		June 30, 2017
		$250,000				More than
		Or less				$250,000
		(in thousands)
Under 3 months		$	68,875			$	23,550
3 – 6 months			65,038				21,535
7 – 12 months			108,686				40,645
13 – 24 months			33,555				9,686
25 – 36 months			5,156				1,041
		$	281,310			$	96,457

 

The Bank has a borrowing agreement with the Federal Home Loan Bank of San Francisco (“FHLB”) and as such, can take advantage of FHLB programs for overnight and term advances at published daily rates. The Bank has short-term borrowings outstanding of $40.0 million at June 30, 2017 at an average rate of 1.12%, and $40.0 million outstanding at an average rate of 0.42% at June 30, 2016. Under terms of the blanket collateral agreement, advances from the FHLB are collateralized by qualifying securities and real estate loans, with $31.1 million available under the agreement as of June 30, 2017. The Bank also has the authority to borrow from the Federal Reserve Bank (“FRB”) discount window amounts secured by certain lease receivables with unused borrowing availability at June 30, 2017 of approximately $73.3 million.

 

An additional source of liquidity for financing and managing the lease portfolio comes from selling, participating or assigning certain lease term payments to banks or other financial institutions. If the transaction is characterized as a sale of the financial asset or meets the parameters of a participating interest, the lease is removed from the balance sheet and a resulting gain or loss recognized. If the Company retains a controlling interest in the lease, the assignment is considered a secured borrowing with the associated financing characterized as non-recourse debt. The assigned lease payments are discounted at fixed rates such that the lease payments are sufficient to fully amortize the aggregate outstanding debt. During fiscal 2017, the Company sold or assigned net lease receivables aggregating to $40.8 million, all of which were characterized as sales by the Bank. This compared to leases sold or assigned of $26.8 million and $73.8 million for fiscal 2016 and 2015, respectively. At June 30, 2017, the Company had outstanding non-recourse debt aggregating $279,000 relating to property under leases assigned to unaffiliated parties. In the past, the Company has been able to obtain adequate non-recourse funding commitments, and the Company believes it will be able to do so in the future.

 

 

The following table presents capital and capital ratio information for the Company and CalFirst Bank as of June 30, 2017 and June 30, 2016 and reflects the transition to the Basel III capital standard from previous regulatory capital adequacy guidelines under the Basel I framework. The Basel III capital standard phases in through 2019 and revises the definition of capital, increases minimum capital ratios, introduces regulatory capital buffers above those minimums, introduces a common equity Tier 1 capital ratio and revises the rules for calculating risk-weighted assets. Under Basel III, the Bank made a one-time election to opt out of the requirement to include components of accumulated other comprehensive income (loss) in common equity Tier 1 capital. The adoption of the new capital standard had an immaterial impact on capital levels and related ratios and the Company and Bank continue to exceed regulatory capital requirements and are considered “well-capitalized” under guidelines established by the FRB and OCC.

 

		June 30,
		2017								2016
		(dollars in thousands)
California First National Bancorp		Amount				Ratio				Amount				Ratio
Common equity Tier 1 capital		$	196,140				33.09	%		$	189,677				25.12	%
Tier 1 risk-based capital		$	196,140				33.09	%		$	189,677				25.12	%
Total risk-based capital		$	203,338				34.30	%		$	196,589				26.04	%
Tier 1 leverage capital		$	196,140				26.01	%		$	189,677				21.67	%
California First National Bank
Common equity Tier 1 capital		$	126,424				22.22	%		$	116,379				15.88	%
Tier 1 risk-based capital		$	126,424				22.22	%		$	116,379				15.88	%
Total risk-based capital		$	133,419				23.45	%		$	123,091				16.79	%
Tier 1 leverage capital		$	126,424				17.23	%		$	116,379				13.94	%

 

 

Contractual Obligations and Commitments

 

The following table summarizes various contractual obligations at June 30, 2017. Commitments to purchase property for unfunded leases are binding but generally have fixed expiration dates and other termination clauses. Commercial loan commitments are agreements to purchase a participation or lend to a customer provided there is no violation of any condition in the contract.   Since the Company expects some of the commitments to expire without being funded, the total commitment amounts do not necessarily represent the Company’s future liquidity requirements.

 

		Due by Period
						Less Than								After
Contractual Obligations		Total				1 Year				1-5 Years				5 Years
		(in thousands)
Lease property purchases (1)		$	38,637			$	38,637			$	-			$	-
Commercial loan and lease purchase commitments			3,181				3,181				-				-
FHLB Borrowings			40,000				40,000				-				-
Operating lease rental payments			841				720				121				-
Total contractual commitments		$	82,659			$	82,538			$	121			$	-

________________

(1)

Disbursements to purchase property on approved lease or loan commitments are estimated to be completed within one year, but it is likely that some portion could be deferred or never funded.

 

The need for cash for operating activities will fluctuate as the Company expands or contracts. The Company believes that existing cash balances, cash flow from operations, cash flows from its financing and investing activities, and sales or assignments of lease receivables will be sufficient to meet its foreseeable financing needs.

 

Inflation has not had a significant impact upon the operations of the Company.

 

Recent Accounting Pronouncements

 

See Note 1, “Summary of Significant Accounting Policies,” of the Company’s consolidated financial statements for disclosure of recent accounting pronouncements.

 

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk is the risk of loss in a financial instrument arising from changes in market indices such as interest rates and equity prices. The Company’s principal market risk exposure is interest rate risk, which is the exposure due to differences in the repricing characteristics of interest-earning assets and interest-bearing liabilities. Market risk also arises from the impact that fluctuations in interest rates may have on security prices that may result in changes in the values of financial instruments, such as available-for-sale securities that are accounted for at fair value. As the banking operations of the Company grew to represent a greater portion of the Company’s assets and liabilities, the Company is subject to increased market risk. The Bank has an Asset/Liability Management Committee and policies established to manage its interest rate and market risk.

 

At June 30, 2017, the Company had $105.1 million of cash or invested in securities of very short duration. The Company’s gross investment in lease payments receivable and loan principal of $518.4 million consists of leases with fixed rates and loans with fixed and variable rates, however, $392.2 million of such investment is due or will reprice within one year of June 30, 2017. This compares to the Company’s interest bearing deposit and borrowing liabilities of $503.8 million, of which 90.2%, or $454.3 million, mature within one year. Non-recourse debt does not represent an interest rate risk to the Company because it is fully amortized through direct payments from lessees to the purchaser of the lease receivable. Based on the foregoing, at June 30, 2017 the Company had assets of $505.4 million subject to changes in interest rates over the next twelve months, compared to repricing liabilities of $454.3 million.

 

The consolidated gap analysis below sets forth the maturity and repricing characteristics of interest-earning assets and interest-bearing liabilities for selected time bands. The mismatch between repricings or maturities within a time band is commonly referred to as the “gap” for that period. A positive gap (asset sensitive) where interest rate sensitive assets exceed interest rate sensitive liabilities generally will result in the net interest margin increasing in a rising rate environment and decreasing in a falling rate environment. A negative gap (liability sensitive) will generally have the opposite result on the net interest margin. However, the traditional gap analysis does not assess the relative sensitivity of assets and liabilities to changes in interest rates and other factors that could have an impact on interest rate sensitivity or net interest income. Sudden and substantial increase or decrease in interest rates may adversely impact our income to the extent that the interest rates associated with the assets and liabilities do not change at the same speed, to the same extent, or on the same basis.

 

Consolidated Interest Rate Sensitivity

 

										Over 1
		3 Months				Over 3 to				Through				Over				Non-rate
(in thousands)		or Less				12 Months				5 years				5 years				Sensitive				Total
Rate Sensitive Assets (RSA):
Cash due from banks		$	96,055			$	-			$	-			$	-			$	-			$	96,055
Investment securities			9,040				8,139				52,754				29,857				-				99,790
Net investment in leases			24,934				63,290				116,544				1,974				(15,944	)			190,798
Commercial loans			301,249				2,691				4,705				3,035				(5,671	)			306,009
Non-interest earning assets			-				-				-				-				22,933				22,933
Totals			431,278				74,120				174,003				34,866				1,318			$	715,585
Cumulative total for RSA		$	431,278			$	505,398			$	679,401			$	714,267
Rate Sensitive Liabilities (RSL):
Demand and savings deposits		$	86,012			$	-			$	-			$	-			$	4,855			$	90,867
Time deposits			92,426				235,903				49,438				-				-				377,767
Borrowings			40,000				-				-				-				-				40,000
Non-interest bearing liabilities			-				-				-				-				10,817				10,817
Stockholders' equity			-				-				-				-				196,134				196,134
Totals		$	218,438			$	235,903			$	49,438			$	-			$	211,806			$	715,585
Cumulative total for RSL		$	218,438			$	454,341			$	503,779			$	503,779
Interest rate sensitivity gap		$	212,840			$	(161,783	)		$	124,565			$	34,866
Cumulative GAP		$	212,840			$	51,057			$	175,622			$	210,488
RSA divided by RSL (cumulative)			197.44	%			111.24	%			134.86	%			141.78	%
Cumulative GAP / total assets			29.74	%			7.14	%			24.54	%			29.41	%

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The following financial statements and supplementary financial information are included herein at the pages indicated below:

 

	Page
Report of Independent Registered Public Accounting Firm	30
Consolidated Balance Sheets at June 30, 2017 and 2016	31
Consolidated Statements of Earnings for the years ended June 30, 2017, 2016 and 2015	32
Consolidated Statements of Comprehensive Income for the years ended June 30, 2017, 2016 and 2015	33
Consolidated Statements of Stockholders' Equity for the years ended June 30, 2017, 2016 and 2015	34
Consolidated Statements of Cash Flows for the years ended June 30, 2017, 2016 and 2015	35
Notes to Consolidated Financial Statements	36-54

 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

To the Board of Directors and Stockholders of California First National Bancorp

 

We have audited the accompanying consolidated balance sheets of California First National Bancorp and Subsidiaries as of June 30, 2017 and 2016 and the related consolidated statements of earnings, comprehensive income, stockholders' equity, and cash flows for each of the years in the three year period ended June 30, 2017. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of California First National Bancorp and Subsidiaries as of June 30, 2017 and 2016, and the results of their operations and their cash flows for each of the years in the three year period ended June 30, 2017, in conformity with accounting principles generally accepted in the United States of America.

 

 

 

Laguna Hills, California

September 27, 2017

 

 

 

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

 

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

 

 

CONSOLIDATED STATEMENTS OF EARNINGS

(in thousands, except share and per share amounts)

 

 

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

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

 

 

 

 

 

 

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

 

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(in thousands, except for share amounts)

 

 

 

 

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

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

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

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

 

The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. As of the end of the period covered by this report, the Company's management, including its principal executive officer and its principal financial officer, evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended and have concluded that the Company's disclosure controls and procedures are adequate and effective for the purposes set forth in the definition in Exchange Act rules.

 

Management’s Report on Internal Control Over Financial Reporting

 

The management of California First National Bancorp is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

 

•

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

•

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

•

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2017. In making its assessment, management used the criteria set forth in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The assessment included the documentation and understanding of the Company’s internal control over financial reporting. Management evaluated the design effectiveness and tested the operating effectiveness of internal controls over financial reporting to form its conclusion.

 

Based on this evaluation, management concluded that, as of June 30, 2017, the Company’s internal control over financial reporting is effective to provide reasonable assurance that the Company’s financial statements are fairly presented in conformity with generally accepted accounting principles.

 

Vavrinek, Trine, Day and Co., LLP, independent registered public accounting firm, is not required to nor has it reported on the effectiveness of the Company’s internal control over financial reporting as of June 30, 2017.

 

Changes in Internal Control Over Financial Reporting

 

There were no significant changes made during the most recent fiscal year to the Company's internal controls or other factors that could significantly affect the Company's internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

 

None.

 

 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

Directors

 

Patrick E. Paddon, age 66, founded the Company in 1977, has served as the President and a Director of the Company since its inception and has been Chief Executive Officer since 1990. In October 2013, Mr. Paddon was appointed to the Board of our subsidiary, California First National Bank (“CalFirst Bank”), and in October 2015 assumed the position of Chief Executive Officer of CalFirst Bank. Mr. Paddon is qualified to be a director and Chairman of the Board based upon over forty years of leadership experience with the Company and his extensive knowledge of its business, operations, customers, capabilities and resources. Mr. Paddon is the spouse of Ms. Jewett.

 

Glen T. Tsuma, age 64, joined the Company in May 1981 and has been Chief Operating Officer since August 1989 and Secretary since October 1991. In June 2011, Mr. Tsuma was appointed to the Board and named Vice Chairman of CalFirst Bank. Prior to joining the Company, he was an audit manager with Arthur Young & Company. Mr. Tsuma’s thirty six year involvement with the Company and extensive knowledge of the business, operations, customers, capabilities and resources qualify him to continue as a director.

 

Michael H. Lowry, age 72, was elected to the Board of Directors in August 1992. In May 2011, Mr. Lowry was appointed to the Board of CalFirst Bank. From 1994 until he retired in December 2010, Mr. Lowry was a Managing Director of Nomura Securities North America, LLC, an investment banking firm. Prior to joining Nomura Securities, Mr. Lowry had been employed by the investment banking firm of Bear Stearns & Co., Inc. from 1991 to 1993 and by the investment banking firm of Kidder, Peabody & Co. Incorporated from 1970 to 1990. Mr. Lowry has committed over twenty five years of service to the Board and is qualified to continue based on this and his experience in various aspects of investment banking and finance, including extensive knowledge and expertise related to capital markets, the financial services industry and working with Boards of Directors on transactional and corporate governance matters.

 

Harris Ravine, age 74, was elected to the Board of Directors in February 1994, and has been Chairman of the Board of CalFirst Bank since May 2001. Mr. Ravine was Chief Operating Officer from March 2009 through June 2017 for Rocky Mountain Public Broadcasting, Inc., the holder and operator of five public broadcasting licenses in the State of Colorado. Prior to that, he was Managing Director with The Ravine Group, an advisory services and investment firm. Mr. Ravine has been a director of the Company for over twenty three years and is qualified to continue based on his service to the Company as well as his prior experience as chief executive of a public company and as executive officer for a lessor of midrange computers. Mr. Ravine’s over 40 years with various businesses and legal training adds important experience in terms of enterprise risk management and corporate governance,

 

Danilo Cacciamatta, age 71, was elected to the Board of Directors in June 2001 and has been a member of the Board of CalFirst Bank since May 2001. Mr. Cacciamatta was the Chief Executive Officer of Cacciamatta Accountancy Corporation until May 2010, a position he held for more than ten years. Mr. Cacciamatta’s years of experience in public accounting, which included sixteen years with KPMG Peat Marwick and a focus on the banking industry, brings important technical and financial expertise to the Board, including the ability to understand and explain accounting, regulatory and tax matters. The Board has determined that Mr. Cacciamatta qualifies as an “audit committee financial expert” under SEC rules and regulations.

 

Named Executive Officers

 

S. Leslie Jewett, age 62, joined the Company in September 1991 as Vice President - Finance. In April 1994, Ms. Jewett was named Chief Financial Officer of the Company and has been a member of the Board of CalFirst Bank since May 2001. From October 1, 2011 thru October 2015, Ms. Jewett also served as President of CalFirst Bank. From 1981 to 1990, she held various management positions at Kidder, Peabody & Co. Incorporated, including Senior Vice President, Corporate Finance. Ms. Jewett has a BA from Swarthmore College and an MBA from Stanford University. Ms. Jewett is the spouse of Mr. Paddon.

 

Thomas M. Duggan, age 63, joined the Company in May 1994 as director of management information systems. He became Vice President of Information Technology for the Company in July 2001 and Senior Vice President of Information Technology and Operations in September 2013. Mr. Duggan has a BA from San Diego State University.

 

Corporate Governance Policies and Practices

 

Over 60% of the Company’s Common Stock is owned by Patrick Paddon, Chairman and Chief Executive Officer, and therefore, the Company is a “controlled company” and exempt from complying with certain corporate governance requirements required by The NASDAQ Stock Market, Inc. (“NASDAQ”), such as a majority independent board and compensation and nominating committees comprised solely of independent directors. Notwithstanding such exemption, a majority of the Board of Directors is independent and the Company’s independent directors review and approve compensation matters related to the Named Executive Officers.

 

 

The position of Chairman of the Board of Directors and Chief Executive Officer are both held by Mr. Paddon. As founder of the Company and majority shareholder, the Board of Directors believes this leadership structure is appropriate for the Company. Mr. Paddon has extensive knowledge of the Company’s strategy and challenges, operations and financial condition, and is best situated to set agendas and lead discussions on matters affecting the Company’s business.

 

The Company’s management is responsible for the day-to-day management of the risks that the Company faces, while the Board of Directors has overall responsibility for risk oversight with a focus on the most significant risks related to credit, market, liquidity, operational and regulatory risk as well as overall enterprise risk. The whole Board of Directors reviews and approves the activities of the Audit Committee that regularly evaluates financial statement and accounting risks and internal controls for the Company and CalFirst Bank. At least annually, the Audit Committee reviews the Company’s risk assessment and risk management policies, and approves an annual plan for internal and external audits to be conducted that is derived from such assessment.

 

It is the intent of the Company to conduct its business operations in accordance with the highest degree of integrity and ethical standards. As a result, the Company holds its employees, officers and directors to an explicit Code of Ethics and requires reporting of conflicts with or breaches of this code. The Company also has adopted a Code of Ethics for Senior Financial Management and has obtained executed agreements related to such policy from its chief executive officer and principal financial and principal accounting officer. A copy of each Code of Ethics is available for review under the Corporate Governance section of the Company’s web site at Calfirstbancorp.com. Any waivers from the Code of Ethics for Senior Financial Management must be reviewed by the Audit Committee and will be disclosed on the website. The information contained on the Company’s website is not part of this or any other report we file with or furnish to the SEC and is not incorporated by reference herein.

 

Director Meetings

The Company’s business is conducted by management under the direction and oversight of the Board of Directors. The Board of Directors holds regularly scheduled quarterly meetings, with Audit Committee meetings generally occurring at the same time, as necessary. In accordance with NASDAQ governance requirements, at each quarterly board meeting time is available for the independent directors to meet without management present. The Board of Directors met four times in person or by telephone during the year ended June 30, 2017, with all directors participating in such board meetings in person or by telephone

 

Audit Committee

The Audit Committee of the Board of Directors is made up of only the independent directors identified above. The Board of Directors has determined that each Audit Committee member has sufficient knowledge in financial and auditing matters to serve on the committee, and further that Mr. Cacciamatta is an “audit committee financial expert” as that term is defined in regulations issued by NASDAQ pursuant to the Sarbanes-Oxley Act of 2002. The Audit Committee has responsibility for oversight of: (a) the financial reports and other financial information provided by the Company to any governmental or regulatory body, the public or other users thereof, (b) the Company's systems of internal accounting and financial controls, and (c) the annual audit of the Company's financial statements. The Audit Committee has the sole authority and responsibility for selecting the firm of independent public accountants to be retained by the Company to perform the audit and meets at least quarterly with the independent public accountants. The Audit Committee must approve, in advance, all non-audit fees paid to the independent accountants and review and approve all related-party transactions. The Audit Committee has authority to engage legal counsel or other experts or consultants, as it deems appropriate to carry out its responsibilities. The Board of Directors adopted an Audit Committee Charter in June 2000, which was amended in August 2002 and subsequently amended and restated on October 22, 2004.

 

In light of the Company’s position as a controlled company, the Company does not have a nominating committee or compensation committee.

 

ITEM 11. EXECUTIVE COMPENSATION

 

Compensation Philosophy

 

The Company's compensation practices for the Named Executive Officers have generally been designed to bind the interests of the Company's key executives to the long-term performance of the Company and its shareholders. The Company tries to achieve overall compensation levels that are sufficiently competitive to retain talented executives and motivate those executives to achieve superior results while protecting the interests of the shareholders. The Company believes that compensation should be set at responsible levels consistent with the Company’s focus on controlling costs.

 

Compensation for all Named Executive Officers is comprised primarily of 1) base salary, 2) equity participation through common stock ownership or common stock options, and 3) certain perquisites. Of the four Named Executive Officers set forth in the tables below, two are the Company’s largest shareholders and together control approximately 76% of the Company’s common stock. Three of the Named Executive Officers are involved in the credit approval and commitment process. With their substantial interest in the Company’s equity, the Company believes the Named Executive Officers will focus on the long-term prudent growth of the Company and its earnings potential.

 

 

The Company believes that there is no aspect of the compensation program that is reasonably likely to lead any officer to take any unnecessary or inappropriate risks that could have a material adverse effect on the Company. The Company does not maintain an incentive plan for any officer with the ability to commit the Company to any investment, lease or loan that promotes the growth of assets, as the Company believes such a program might result in short-term asset growth without consistency in asset and earnings quality. Given the nature of the Company’s accounting model and income recognition, incentive plans based on current period earnings are avoided as a large portion of earnings are related to and impacted by decisions and activities that occurred in prior years. Therefore, compensation assessment is based on more subjective factors related to the quality and development of the Company’s portfolios, management of people and operations. Performance based incentive plans are in place for sales and finance professionals not directly responsible for the credit decision and policy making process.

 

The Company believes that the cash compensation paid to the Company's Named Executive Officers is generally less than that paid to others in comparable positions. The base compensation for Mr. Paddon and Mr. Tsuma reflects their status as significant shareholders of the Company. The equity ownership of the Company's key executive officers is generally greater than other comparable companies, with the key executive officers of the Company beneficially owning approximately 78% of the Company's common stock outstanding. Through having a substantial portion of each executive's long-term compensation derived from participation in the Company's common stock, the Company believes that the financial interests of the executive officers are aligned with those of the Company's other shareholders.

 

The following summary compensation table discloses compensation paid by the Company to the Named Executive Officers for the fiscal years ended June 30, 2017 and 2016, respectively.

 

Name and Principal Position		Year				Salary				Bonus				Option Awards				All Other Compensation (1)					Total
Patrick Paddon			2017			$	180,000				-				-				$	7,337			$	187,337
President. Chief Executive Officer			2016			$	180,000				-				-				$	7,079			$	187,079
Glen T. Tsuma			2017			$	180,000				-				-				$	7,301			$	187,301
Chief Operating Officer			2016			$	180,000				-				-				$	6,989			$	186,989
S. Leslie Jewett			2017			$	275,000				-				-				$	3,908			$	278,908
Chief Financial Officer			2016			$	275,000				-				-				$	3,908			$	278,908
Thomas M. Duggan Senior Vice President Information Technology and Operations			2017 2016			$ $	230,000 230,000				- $22,000				- -				$ $	2,000 2,000			$ $	232,000 254,000

 ________________

(1)	Includes contribution under the Company’s 401(k) Plan, certain professional fees, and club memberships.

 

Stock Options

 

There were no stock option grants issued to or exercised by the Named Executive Officers during fiscal 2017, and there are no unexercised stock options held by a Named Executive Officer at June 30, 2017.

 

Other Benefits

 

The Company’s Named Executive Officers are eligible to receive the same health benefits that are available to other employees and a contribution to their benefit premium that is the same as provided to other employees. The Company maintains a tax-qualified 401(k) Plan, which provides for broad-based employee participation. All employees are eligible to receive non-discretionary matching contributions by the Company in an amount equal to 50% of the employee’s pretax contributions, subject to a maximum of $2,000. The only special benefits provided the Named Executive Officers included the payment of certain tax preparation fees (approved by the audit committee), payment of health club membership fees and the payment of a business club membership which is predominantly used for corporate or other business purposes. All these costs are included in the column labeled "All Other Compensation" in the Summary Compensation Table above.

 

The Company has not entered into any employment agreements with any of the Named Executive Officers and all Named Executive Officers are considered “at will” employees. The Company has no commitments for payments to be made or benefits provided in the event the employment of the Named Executive Officer is terminated.

 

The Company does not maintain or make contributions to a defined benefit plan for any employees. The Company indemnifies each of the executive officers to the fullest extent permitted under California law against expenses and, in certain cases, judgments, settlements or other payments incurred by the officer or director in suits brought by the Company, derivative actions brought by shareholders and suits brought by other third parties related to the officer’s or director’s service to the Company.

 

 

Director Compensation

 

The following table summarizes director compensation during fiscal year 2017. Each non-employee director is paid an annual retainer of $30,000 plus expenses for service on the Company or CalFirst Bank’s Board. Directors who are employees of the Company do not receive any fees for their services as directors and are not listed in the table. Directors are entitled to participate in the Company’s 1995 Stock Option Plan. During fiscal 2017, there were no stock option grants issued to Directors.

 

Name		Fees Earned Or Paid in Cash				Stock Awards				All Other Compensation				Total Compensation
Michael H. Lowry		$	30,000				-				-			$	30,000
Harris Ravine		$	30,000				-				-			$	30,000
Danilo Cacciamatta		$	30,000				-				-			$	30,000

 

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The following table sets forth certain information as to the number of shares of the Company's Common Stock beneficially owned by each person who is known by the Company to beneficially own more than five percent of the outstanding shares of the Company's Common Stock, by each director, by our Chief Executive Officer, Chief Financial Officer and two other highest paid officers of the Company or its subsidiaries with policy making authority (“Named Executive Officers”), and all directors and Named Executive Officers as a group.

 

Name and Address of Beneficial Owners (1)			Amount of Company's Common Stock Beneficially Owned				Percent of Company's Common Stock Beneficially Owned
Principal Shareholders
Patrick E. Paddon			6,471,084				62.9%
Glen T. Tsuma			1,344,422				13.1%
Timothy E Moriarty c/o McGrath, Doyle & Phair 150 Broadway, Suite 1915 New York, NY 10038			521,112				5.1%
Dimensional Fund Advisors, Inc. 6300 Bee Cave Road, Building One Austin, TX 78746			503,677				4.9%
Independent Directors
Michael H. Lowry			21,336				*
Harris Ravine			14,200				*
Danilo Cacciamatta			39,063				*
Named Executive Officers
S. Leslie Jewett			186,082				1.8%
Thomas M. Duggan			-				*
Directors and Named Executive Officers, as group (7 persons)			8,076,187				78.5%

________________

*

Less than one percent

1)

The address of each shareholder is 28 Executive Park, Irvine, California 92614, unless noted above.

 

Section 16(a) of the 34 Act

 

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's Directors, named executive officers and any persons holding 10% or more of the Company's Common Stock to report their ownership of Common Stock and any changes in that ownership to the Securities and Exchange Commission. Based upon a review of information furnished to the Company for the fiscal year ended June 30, 2017, all required forms were filed on a timely basis.

 

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

 

Transactions with Related Persons

 

Apart from service as an executive officer or on the Board of Directors, there are no additional relationships between the Company and any Related Person, nor are there any related party transactions between any Related Persons and the Company. A "Related Person" is any director or executive officer of the Company, any shareholder owning in excess of 5% of the total equity of the Company, and any "immediate family member" of any such person. The Company does not have a written policy regarding Related Person Transactions because the Company has not, and does not expect to, engage in any Related Person Transactions other than in rare circumstances. Any Related Person Transaction would be considered based on facts and circumstances at such time.

 

The Company’s subsidiary, CalFirst Bank, is an FDIC-insured national bank that gathers deposits through the offer of money market, savings and checking accounts, as well as certificates of deposits. Some of our Related Persons maintain deposit accounts with CalFirst Bank. None of these transactions are considered “material Related Person transactions” under Item 404 of Regulation S-K because the transactions involved CalFirst Bank as a depositary of funds.

 

Director Independence

 

The Board of Directors has determined that Messrs. Lowry, Ravine and Cacciamatta are considered to be “independent directors” in accordance with guidelines established by NASDAQ, and it has determined that none of them has a material relationship with the Company that would impair their independence from management or otherwise compromise their ability to act as an independent director.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The Audit Committee engaged Vavrinek, Trine, Day & Co., LLP to serve as the Company's independent registered public accounting firm for the years ended June 30, 2017 and 2016.

 

Fees Billed for Services Rendered by Vavrinek, Trine, Day & Co., LLP

 

Fees paid to VTD for fiscal years ended June 30, 2016 and 2015 are as follows:

 

		2017				2016
Audit Fees (1)		$	122,000			$	107,000
Audit Related Fees (2)			11,250				11,250
		$	133,250			$	118,250

________________

1)	Includes fees for annual audit of Company?s financial statements, quarterly review of interim financial statements and consultations on accounting matters.
2)	Includes fees related to employee benefit plan audits.

 

No amounts were paid to VTD for Tax or Other Fees and Expenses.

 

 

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a)       Financial Statements and Schedules

All financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.

 

(b)        Exhibits:

 

Exhibit #		Description of Exhibit		Page No.
2.1		Agreement of Merger dated as of May 22, 2001 among Amplicon, Inc., California First National Bancorp and CFNB Merger Sub (incorporated by reference to Exhibit 2.1 to Registrant's Statement on Form 8-K dated May 25, 2001)
3.1		Articles of Incorporation of California First National Bancorp (incorporated by reference to Exhibit 3.1 to Registrant's Statement on Form 8-K dated May 25, 2001)
3.2		Bylaws of California First National Bancorp (incorporated by reference to Exhibit 3.2 to Registrant's Statement on Form 8-K dated May 25, 2001)
10.1		1995 Equity Participation Plan, as amended to date (incorporated by reference to Exhibit 10.1 to Registrant’s Statement on Form S-8 File No. 333-15683)
10.2		Capital Assurances and Liquidity Maintenance Agreement between California First National Bancorp and California First National Bank, effective as of May 23, 2001 (incorporated by reference to Exhibit 10.1 to Registrant's Statement on Form 8-K dated May 25, 2001)
10.3		Agreement by and between California First National Bank and the Office of the Comptroller of the Currency dated as of May 23, 2001 (incorporated by reference to Exhibit 10.2 to Registrant's Statement on Form 8-K dated May 25, 2001)
31.1		Rule 13a-14(a)/15d-14(a) Certifications of Principal Executive Officer		63
31.2		Rule 13a-14(a)/15d-14(a) Certifications of Principal Financial Officer		64
32.0		Section 1350 Certifications by Principal Executive Officer and Principal Financial Officer		65

 

 

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

CALIFORNIA FIRST NATIONAL BANCORP

 

 

By:	/s/ S. Leslie Jewett		Date	September 27, 2017
	S. Leslie Jewett Chief Financial Officer (Principal Financial and Accounting Officer)

 

 

POWER OF ATTORNEY

 

Each person whose signature appears below hereby authorizes each of Patrick E. Paddon, S. Leslie Jewett and Glen T. Tsuma as attorney-in-fact to sign on his behalf, individually in each capacity stated below, and to file all amendments and/or supplements to this Annual Report on Form 10-K.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.

 

Signature		Title		Date
/s/ Patrick E. Paddon		President, Chief Executive		September 27, 2017
Patrick E. Paddon		Officer and Director
/s/ Glen T. Tsuma		Vice President, Chief Operating		September 27, 2017
Glen T. Tsuma		Officer and Director
/s/ S. Leslie Jewett		Chief Financial Officer		September 27, 2017
S. Leslie Jewett		(Principal Financial and Accounting Officer)
/s/ Michael H. Lowry		Director		September 26, 2017
Michael H. Lowry
/s/ Harris Ravine		Director		September 25, 2017
Harris Ravine
/s/ Danilo Cacciamatta		Director		September 27, 2017
Danilo Cacciamatta

 

 

 

 

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