e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2007
OR
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o |
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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 0-25135
Bank of Commerce Holdings
(Exact name of Registrant as specified in its charter)
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California
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94-2823865 |
(State or other jurisdiction of incorporation or organization)
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(I.R.S. Employer Identification No.) |
1951 Churn Creek Road Redding, California |
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96002 |
(Address of principal executive offices)
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(Zip code) |
Registrants telephone number, including area code: (530) 224-3333
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See
the definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check One)
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No þ
Outstanding shares of Common Stock, no par value, as of March 31, 2007: 8,907,680
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Index to Form 10-Q
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2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
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Dollars in thousands |
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March 31, 2007 |
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Dec. 31,2006 |
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March 31,2006 |
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ASSETS |
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Cash and due from banks |
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$ |
12,597 |
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$ |
14,661 |
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$ |
11,819 |
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Federal funds sold and securities purchased under agreements to
resell |
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21,195 |
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24,605 |
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9,835 |
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Cash and cash equivalents |
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33,792 |
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39,266 |
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21,654 |
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Securities available-for-sale (including pledged collateral of
$68,261 at March 31, 2007, $71,686 at December 31, 2006 and $54,514
at March 31, 2006) |
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93,769 |
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95,601 |
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93,645 |
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Securities held-to-maturity, at cost (estimated fair value of $10,693
at March 31, 2007, $10,792 at Dec. 31, 2006
and $7,533 at March 31, 2006) |
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10,673 |
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10,810 |
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7,620 |
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Loans, net of the allowance for loan losses of $4,933 at March 31,
2007, $4,904 at Dec. 31, 2006 and $4,295 at March 31,
2006 |
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411,357 |
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408,990 |
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374,983 |
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Bank premises and equipment, net |
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9,992 |
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8,595 |
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6,261 |
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Other assets |
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18,513 |
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20,180 |
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18,733 |
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TOTAL ASSETS |
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$ |
578,096 |
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$ |
583,442 |
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$ |
522,896 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Demand - noninterest bearing |
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$ |
70,035 |
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$ |
84,779 |
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$ |
74,519 |
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Demand - interest bearing |
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112,550 |
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119,437 |
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102,003 |
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Savings accounts |
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41,537 |
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22,749 |
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28,477 |
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Certificates of deposit |
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211,422 |
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212,442 |
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173,106 |
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Total deposits |
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435,544 |
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439,407 |
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378,105 |
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Securities sold under agreements to repurchase |
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35,053 |
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37,117 |
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25,117 |
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Federal Home Loan Bank borrowings |
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40,000 |
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40,000 |
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55,000 |
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Other liabilities |
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6,646 |
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7,537 |
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8,864 |
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Junior subordinated debt payable to unconsolidated
subsidiary grantor trust |
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15,465 |
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15,465 |
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15,465 |
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Total Liabilities |
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532,708 |
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539,526 |
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482,551 |
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Commitments and contingencies |
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Stockholders Equity: |
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Preferred stock, no par value, 2,000,000 authorized
no shares issued and outstanding in 2007 and 2006 |
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Common stock , no par value, 50,000,000 shares
authorized; 8,907,680 shares issued and outstanding
at March 31, 2007, 8,847,042 at Dec. 31, 2006
and 8,716,872 at March 31, 2006 |
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11,940 |
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11,517 |
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11,198 |
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Retained earnings |
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34,110 |
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33,336 |
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30,535 |
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Accumulated other comprehensive (loss), net of tax |
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(662 |
) |
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(937 |
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(1,388 |
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Total stockholders equity |
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45,388 |
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43,916 |
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40,345 |
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TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
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$ |
578,096 |
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$ |
583,442 |
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$ |
522,896 |
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See accompanying notes to condensed consolidated financial statements.
4
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Condensed Consolidated Statements of Income (Unaudited)
Three months ended March 31, 2007 and 2006
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Three Months Ended |
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Dollars in thousands, except for per share data |
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March 31, 2007 |
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March 31, 2006 |
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Interest income: |
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Interest and fees on loans |
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$ |
8,464 |
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$ |
7,230 |
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Interest on tax exempt securities |
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278 |
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123 |
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Interest on U.S. government securities |
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832 |
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862 |
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Interest on federal funds sold and
securities purchased under agreements to resell |
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200 |
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130 |
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Interest on other securities |
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36 |
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44 |
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Total interest income |
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9,810 |
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8,389 |
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Interest expense: |
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Interest on demand deposits |
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557 |
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233 |
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Interest on savings deposits |
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171 |
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65 |
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Interest on time deposits |
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2,605 |
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1,549 |
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Securities sold under agreements to repurchase |
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342 |
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199 |
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Interest on FHLB and other borrowings |
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539 |
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672 |
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Interest on junior subordinated debt payable to unconsolidated
subsidiary grantor trust |
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269 |
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258 |
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Total interest expense |
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4,483 |
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2,976 |
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Net interest income |
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5,327 |
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5,413 |
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Provision for loan and lease losses |
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6 |
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11 |
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Net interest income after provision for loan and lease losses |
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5,321 |
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5,402 |
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Noninterest income: |
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Service charges on deposit accounts |
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69 |
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88 |
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Payroll and benefit processing fees |
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108 |
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109 |
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Earnings on cash surrender value -
Bank owned life insurance |
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95 |
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53 |
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Net loss on sale of securities available-for-sale |
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46 |
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0 |
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Net gain on sale of loans |
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0 |
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1 |
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Merchant credit card service income, net |
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92 |
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77 |
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Mortgage brokerage fee income |
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6 |
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17 |
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Other income |
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82 |
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103 |
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Total noninterest income |
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498 |
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448 |
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Noninterest expense: |
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Salaries and related benefits |
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2,097 |
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1,878 |
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Occupancy and equipment expense |
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458 |
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435 |
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FDIC insurance premium |
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13 |
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12 |
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Data processing fees |
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55 |
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58 |
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Professional service fees |
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195 |
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204 |
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Payroll processing fees |
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31 |
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29 |
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Deferred compensation expense |
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97 |
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88 |
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Stationery and supplies |
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61 |
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60 |
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Postage |
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33 |
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31 |
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Directors expense |
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45 |
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60 |
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Other expenses |
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403 |
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383 |
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Total noninterest expense |
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3,488 |
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3,238 |
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Income before provision for income taxes |
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2,331 |
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2,612 |
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Provision for income taxes |
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|
844 |
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1,020 |
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Net income |
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$ |
1,487 |
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$ |
1,592 |
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Basic earnings per share |
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$ |
0.17 |
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$ |
0.18 |
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Weighted
average shares - basic |
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8,864 |
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|
8,680 |
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Diluted earnings per share |
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$ |
0.17 |
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$ |
0.17 |
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Weighted
average shares - diluted |
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8,976 |
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8,880 |
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Cash dividends per share |
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$ |
0.08 |
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$ |
0.07 |
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See accompanying notes to condensed consolidated financial statements.
5
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
Three months ended March 31, 2007 and 2006
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Dollars in thousands |
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March 31, 2007 |
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March 31, 2006 |
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Cash flows from operating activities: |
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Net income |
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$ |
1,487 |
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$ |
1,592 |
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Adjustments
to reconcile net income to net cash provided by operating activities: |
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Provision for loan and lease losses |
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6 |
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11 |
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Provision for depreciation and amortization |
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207 |
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|
147 |
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Compensation expense associated with stock options |
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4 |
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|
1 |
|
Tax benefits from the exercise of stock options |
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(118 |
) |
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(134 |
) |
Loss (Gain) on sale of securities available-for-sale |
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46 |
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0 |
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Amortization of investment premiums and accretion of
discounts, net |
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8 |
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|
8 |
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Gain on sale of loans |
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0 |
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|
0 |
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Gain on sale of fixed assets |
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(2 |
) |
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0 |
|
Deferred income taxes |
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|
349 |
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|
69 |
|
Increase in cash surrender value of bank owned life policies |
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(95 |
) |
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(3,042 |
) |
Effect of changes in: |
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Other assets |
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680 |
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(264 |
) |
Deferred loan fees |
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(31 |
) |
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|
(22 |
) |
Other liabilities |
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(883 |
) |
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|
1,669 |
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Net cash from operating activities |
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|
1,658 |
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|
35 |
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Cash flows from investing activities: |
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Proceeds from maturities of available-for-sale securities |
|
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1,627 |
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|
|
1,232 |
|
Proceeds from sales of available-for-sale securities |
|
|
20,372 |
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|
0 |
|
Proceeds from maturities of held-to-maturity securities |
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|
136 |
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|
|
186 |
|
Purchases of available-for-sale securities |
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(19,102 |
) |
|
|
(974 |
) |
Purchases of held-to-maturity securities |
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0 |
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|
|
(869 |
) |
Loan origination, net of principal repayments |
|
|
(2,342 |
) |
|
|
(11,666 |
) |
Purchases of Bank premises and equipment, net |
|
|
(1,601 |
) |
|
|
(777 |
) |
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|
|
|
|
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Net cash from investing activities |
|
|
(910 |
) |
|
|
(12,868 |
) |
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|
|
|
|
|
|
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Cash flows from financing activities: |
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|
|
|
|
|
|
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Net (decrease) in deposit and savings accounts |
|
|
(2,843 |
) |
|
|
(17,861 |
) |
Net (decrease) increase in certificates of deposit |
|
|
(1,020 |
) |
|
|
23,850 |
|
Net (decrease) increase in securities sold under agreement
to repurchase |
|
|
(2,064 |
) |
|
|
2,231 |
|
Proceeds from Federal Home Loan Bank advances |
|
|
0 |
|
|
|
20,000 |
|
Repayments of Federal Home Loan Bank advances |
|
|
(0 |
) |
|
|
(20,000 |
) |
Cash dividends paid on common stock |
|
|
(713 |
) |
|
|
(610 |
) |
Proceeds from stock options exercised |
|
|
284 |
|
|
|
175 |
|
Stock option expense |
|
|
16 |
|
|
|
12 |
|
Tax benefits from the exercise of stock options |
|
|
118 |
|
|
|
134 |
|
|
|
|
|
|
|
|
Net cash from financing activities |
|
|
(6,222 |
) |
|
|
7,931 |
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents |
|
|
(5,474 |
) |
|
|
(4,902 |
) |
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, beginning of period |
|
|
39,266 |
|
|
|
26,556 |
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period |
|
$ |
33,792 |
|
|
$ |
21,654 |
|
|
|
|
|
|
|
|
Supplemental disclosures: |
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|
|
|
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|
Cash paid during the period for: |
|
|
|
|
|
|
|
|
Income taxes |
|
$ |
0 |
|
|
$ |
0 |
|
Interest |
|
|
4,639 |
|
|
|
2,933 |
|
See accompanying notes to condensed consolidated financial statements.
6
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Consolidation and Basis of Presentation
The unaudited condensed consolidated financial statements include the accounts of Bank of Commerce
Holdings (the Holding Company) and its subsidiaries Redding Bank of Commerce, Roseville Bank of
Commerce and Sutter Bank of Commerce (RBC or the Bank) and Bank of Commerce Mortgage
(collectively the Company). All significant inter-company balances and transactions have been
eliminated. The financial information contained in this report reflects all adjustments that in the
opinion of management are necessary for a fair presentation of the results of the interim periods.
All such adjustments are of a normal recurring nature. Certain reclassifications have been made to
the prior period condensed consolidated financial statements to conform to the current financial
statement presentation.
The accounting and reporting policies of the Company conform to accounting principles generally
accepted in the United States of America and general practices within the banking industry. In
preparing the consolidated financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the consolidated financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual results could differ from
those estimates. Certain amounts for prior periods have been reclassified to conform to the current
financial statement presentation.
The accompanying unaudited condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes contained in Bank of
Commerce Holdings 2006 Annual Report on Form 10-K. The results of operations and cash flows for the
2007 interim periods shown in this report are not necessarily indicative of the results for any
future interim period or the entire fiscal year.
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due
from banks, federal funds sold and repurchase agreements. Generally, federal funds are sold for a
one-day period and securities purchased under agreements to resell are for no more than a 90-day
period.
2. Recent Accounting pronouncements
On July 13, 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation
No. 48, Accounting for Income Tax Uncertainties (FIN 48). FIN 48 supplements Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes (FAS 109), by defining the threshold for
recognizing tax benefits in the financial statements as more-likely-than-not to be sustained by
the applicable taxing authority. The benefit recognized for a tax position that meets the
more-likely-than-not criterion is measured based on the largest benefit that is more than 50%
likely to be realized, taking into consideration the amounts and probabilities of the outcomes upon
settlement. The Company adopted FIN 48 on January 1, 2007, as required. FIN 48 had no material
effect on the consolidated financial statements upon adoption.
On September 15, 2006, the FASB issued FAS 157, Fair Value Measurements, which defines fair value,
establishes a framework for measuring fair value in generally accepted accounting principles
(GAAP), and expands disclosures about fair value measurements. FAS 157 applies under other
accounting pronouncements that require or permit fair value measurements, the FASB having
previously concluded in those accounting pronouncements that fair value is the relevant measurement
attribute. FAS 157 is effective for the year beginning January 1, 2008, with early adoption
permitted on January 1, 2007. We do not expect that the adoption of FAS 157 will have a material
effect on our consolidated financial statements.
On September 29, 2006, the FASB issued FAS 158, Employers Accounting for Defined Benefit Pension
and Other Postretirement Plans An Amendment of FASB Statements No. 87, 88, 106, and 132R,
requiring an employer to recognize on its balance sheet the funded status of pension and other
postretirement plans, measure a plans assets and its obligations that determine its funded status
as of the end of the employers fiscal year and recognize changes in a plans funded status in the
year in which the changes occur in comprehensive income. The requirement to recognize the funded
status of our plans is effective December 31, 2006.
7
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued) (Unaudited)
The funded status will be determined by comparing the fair value of plan assets and the
projected benefit obligation or accumulated postretirement benefit obligation, as applicable,
including actuarial gains and losses, prior service cost, and any remaining transition amounts. To
the extent the fair value of plan assets is larger, the plan is considered over funded and an asset
is recorded. Any previously recorded prepaid pension asset would be adjusted to reflect the funded
status of the plan with the offset to accumulated other comprehensive income. Conversely, if a plan
is under funded, a liability would be reported. The requirement to measure plan assets and benefit
obligations as of the date of the employers fiscal year-end statement of financial position is
effective for fiscal years ending after December 15, 2008. We do not expect adoption of FAS 158 to
have a material impact on our consolidated financial statements.
On February 15, 2007 the FASB issued FAS 159, The Fair Value Option for Financial Assets and
Financial Liabilities, Including an amendment of FASB Statement 115. FAS 159 provides an
alternative measurement treatment for certain financial assets and financial liabilities, under an
instrument-by-instrument election, that permits fair value to be used for both initial and
subsequent measurement, with changes in fair values recognized in earnings. While FAS 159 is
effective beginning January 1, 2008, earlier adoption is permitted as of January 1, 2007, provided
that the entity also adopts all of the requirements of FAS 157. We do not expect adoption of FAS
159 to have a material impact on our consolidated financial statements.
3. Earnings per Share
Basic earnings per share (EPS) excludes dilution and is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common stock that then
shared in the earnings of the entity. Stock options are considered to be common stock equivalents.
The following table displays the computation of earnings per share for the three months ended March
31, 2007 and 2006.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
(Dollars in thousands, except per share data) |
|
March 31, 2007 |
|
|
March 31, 2006 |
|
|
Basic EPS calculation: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator (net income) |
|
$ |
1,487 |
|
|
$ |
1,592 |
|
|
|
|
|
|
|
|
|
|
Denominator
(average common shares outstanding) |
|
|
8,864 |
|
|
|
8,680 |
|
|
|
|
|
|
|
|
|
|
Basic EPS |
|
$ |
0.17 |
|
|
$ |
0.18 |
|
|
|
|
|
|
|
|
|
|
Diluted EPS calculation: |
|
|
|
|
|
|
|
|
Numerator (net income) |
|
$ |
1,487 |
|
|
$ |
1,592 |
|
Denominator: |
|
|
|
|
|
|
|
|
Average common shares outstanding |
|
|
8,864 |
|
|
|
8,680 |
|
Dilutive effect of stock options |
|
|
112 |
|
|
|
200 |
|
|
|
|
|
|
|
|
Adjusted weighted average common shares outstanding |
|
|
8,976 |
|
|
|
8,880 |
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
$ |
0.17 |
|
|
$ |
0.17 |
|
|
8
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)
4. Stock Option Plans
The Company adopted Statement of Financial Accounting Standards No. 123R, Share-Based Payment, on
January 1, 2006. The scope of FAS 123R includes a wide range of stock-based compensation
arrangements including stock options, restricted stock plans, performance-based awards, stock
appreciation rights, and employee stock purchase plans. FAS 123R requires that the Company measure
the cost of employee services received in exchange for an award of equity instruments based on the
fair value of the award on the grant date. That cost must be recognized in the income statement
over the vesting period of the award. Under the modified prospective transition method, awards
that are granted, modified or settled beginning at the date of adoption will be measured and
accounted for in accordance with FAS 123R. In addition, expense must be recognized in the income
statement for unvested awards that were granted prior to the date of adoption. Prior to the
adoption of FAS 123R and as permitted by FAS 123 and FAS 148, Accounting for Stock-Based
Compensation Transition and Disclosure, the Company elected to follow APB 25 and related
interpretations in accounting for our employee stock options.
The Company adopted FAS 123R using the modified prospective method. Under this transition method,
stock option expense for the first quarter of 2006 included the cost for all share-based payments
granted prior to, but not yet vested, as of January 1, 2006, as well as any share-based payments
granted subsequent to December 31, 2005. This compensation expense is measured on the date of grant
using an option-pricing model. The option-pricing model is based on certain assumptions and changes
to those assumptions may result in different fair value estimates. Under APB25, the Company
accounted for stock options using the intrinsic value method and no compensation expense was
recognized, as the grant price was equal to the strike price. In accordance with SFAS 123R the
Company provides disclosures as if it had adopted the fair value-based method of measuring all
outstanding employee stock options during 2005.
For the first quarter of 2007, stock option compensation expense charged against income was $20,763
At March 31, 2007, there was $180,776 of total unrecognized compensation costs related to
non-vested share based payments which is expected to be recognized over a period of five years. No
options were granted during the first quarter of 2007.
During the three months ended March 31, 2007 and 2006 the Company realized income tax benefits of
$117,925 and $133,984 respectively, related to the exercise of nonqualified stock options. The
income tax benefit is reflected in net cash provided by financing activities in the consolidated
statements of cash flow for the same period.
During the three months ended March 31, 2007 and 2006 the Company received cash of $284,354 and
$175,112 respectively, upon exercise of stock-based compensation arrangements.
9
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)
5. Comprehensive Income
The Companys total comprehensive income was as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
(Dollars in thousands) |
|
March 31, 2007 |
|
|
March 31, 2006 |
|
|
Net income as reported |
|
$ |
1,487 |
|
|
$ |
1,592 |
|
Other
comprehensive income, net of tax: |
|
|
|
|
|
|
|
|
Unrealized holding (loss) gain
on
securities available for
sale |
|
|
164 |
|
|
|
(98 |
) |
Reclassification adjustment for
gain on available for sale
securities, net of tax |
|
|
(46 |
) |
|
|
0 |
|
Unrealized gains arising during
the period on
derivative transactions, net |
|
|
157 |
|
|
|
0 |
|
|
|
|
|
|
|
|
Total other comprehensive (loss) income |
|
|
275 |
|
|
|
(98 |
) |
|
|
|
|
|
|
|
Total comprehensive income |
|
$ |
1,762 |
|
|
$ |
1,494 |
|
|
The ALCO Roundtable initiated a forward starting swap transaction with Morgan Keegan as the
counterparty. Two transactions, $60 million and $40 million, aggregating $100 million were
executed, both commencing on December 1, 2006 and maturing on June 1, 2009. Under the $60 million
swap transaction, the Company will receive, on a monthly basis, a fixed rate of 7.90% and pay
Morgan Keegan a floating rate payment tied to the Wall Street Prime Index commencing on January 1,
2007. Under the $40 million swap transaction the Company will receive, on a monthly basis, a fixed
rate of 7.95% and pay Morgan Keegan a floating rate payment tied to the Wall Street Prime Index
commencing on January 1, 2007. The $40 million swap has a Prime Indexed embedded floor of 6.5%. The
purpose of this strategy is to protect or hedge net interest income in a declining rate
environment.
6. Junior Subordinated Debt Payable to Unconsolidated Subsidiary Grantor Trust
During 2003, Bank of Commerce Holdings formed a wholly-owned Delaware statutory business trust,
Bank of Commerce Holdings Trust I (the grantor trust), which issued $5.0 million of guaranteed
preferred beneficial interests in Bank of Commerce Holdings junior subordinated debentures (the
trust notes) to the public and $155,000 common securities to the Company. These debentures
qualify as Tier 1 capital under Federal Reserve Board guidelines. The proceeds from the issuance of
the trust notes were transferred from the grantor trust to the Holding Company and from the Holding
Company to the Bank as surplus capital. The trust notes accrue and pay distributions on a quarterly
basis at 3 month London Interbank Offered Rate (LIBOR) plus 3.30%. The rate at March 31, 2007 was
8.66%. The rate increase is capped at 2.75% annually and the lifetime cap is 12.5%. The final
maturity on the trust notes is March 18, 2033, and the debt allows for prepayment after five years
on the quarterly payment date.
During 2005, Bank of Commerce Holdings (the Company) participated in a private placement to an
institutional investor of $10 million of fixed rate trust preferred securities (the Trust
Preferred Securities); through a newly formed Delaware trust affiliate, Bank of Commerce Holdings
Trust II (the Trust). The Trust Preferred Securities mature on September 15, 2035, and are
redeemable at the Companys option on any March 15, June 15, September 15 or December 15 on or
after September 15, 2010. In addition, the Trust Preferred Securities require quarterly
distributions by the Trust to the holder of the Trust Preferred Securities at a rate of 6.115%,
until September 10, 2010 after which the rate will reset quarterly to equal LIBOR plus 1.58%. The
Trust simultaneously issued $310,000 of the Trusts common securities of beneficial interest to
the Company.
10
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)
The proceeds from the sale of the Trust Preferred Securities were used by the Trust to purchase
from the Company the aggregate principal amount of $10,310,000 of the Companys floating rate
junior subordinate notes (the Notes). The net proceeds to the Company from the sale of the
Notes to the Trust will be used by the Company for general corporate purposes, including funding
the growth of the Companys various financial services.
The Notes were issued pursuant to a Junior Subordinated Indenture (the Indenture), dated July
29, 2005, by and between the Company and J.P. Morgan Chase Bank, National Association, as trustee.
Like the Trust Preferred Securities, the Notes bear interest at a floating rate, at 6.115% until
September 10, 2010, after which the rate will reset on a quarterly basis to equal LIBOR plus
1.58%. The interest payments by the Company will be used to pay the quarterly distributions
payable by the Trust to the holder of the Trust Preferred Securities.
However, so long as no event of default, as described below, has occurred under the Notes, the
Company may, at any time and from time to time, defer interest payments on the Notes (in which
case the Trust will be entitled to defer distributions otherwise due on the Trust Preferred
Securities) for up to twenty (20) consecutive quarters.
The Notes are subordinated to the prior payment of other indebtedness of the Company that, by its
terms, is not similarly subordinated. Although the Notes will be recorded as a long term
liability on the Companys balance sheet, for regulatory purposes, the Notes are expected to be
treated as Tier 1 or Tier 2 capital under rulings of the Federal Reserve Board, the Companys
primary federal regulatory agency.
The Notes mature on September 15, 2035, but may be redeemed at the Companys option at any time on
or after September 15, 2010, or at any time upon certain events, such as a change in the
regulatory capital treatment of the Notes, the Trust being deemed to be an investment company or
the occurrence of certain adverse tax events. In each case, the Company may redeem the Notes for
their aggregate principal amount, plus accrued interest, if any.
7. Commitments and Contingent Liabilities
Lease Commitments The Company leases certain facilities at which it conducts its
operations. Future minimum lease commitments under all non-cancelable operating leases as of
March 31, 2007 are below:
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
2007 |
|
$ |
365 |
|
2008 |
|
$ |
500 |
|
2009 |
|
$ |
444 |
|
2010 |
|
$ |
400 |
|
2011 |
|
$ |
308 |
|
Thereafter |
|
$ |
128 |
|
|
|
|
|
Total |
|
$ |
2,145 |
|
| |
|
|
|
|
|
|
|
Minimum rental due in the future
Under noncancellable subleases |
|
$ |
4 |
|
|
Legal Proceedings The Company is involved in various pending and threatened legal actions
arising in the ordinary course of business. The Company maintains reserves for losses from
legal actions, which are both probable and estimable. In the opinion of management, the
disposition of claims, currently pending will not have a material adverse affect on the
Companys financial position or results of operations.
FHLB Advances Included in other borrowings are advances from the Federal Home Loan Bank of
San Francisco (FHLB) totaling $40,000,000 as March 31, 2007 and $55,000,000 as of March 31,
2006. The
FHLB advances bear fixed and floating rates of interest ranging from 5.23% to 5.47%. Interest
is payable either monthly or quarterly.
11
BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)
The following table illustrates borrowings outstanding at the end of the period:
|
|
|
|
|
|
|
|
|
|
|
|
|
Advance # |
|
Amount |
|
|
Interest Rate |
|
Maturity |
|
|
#059277 |
|
$ |
10,000,000 |
|
|
|
5.43% |
|
|
|
01/24/2008 |
|
#080890 |
|
$ |
10,000,000 |
|
|
|
5.47% |
|
|
|
11/24/2011 |
|
#087416 |
|
$ |
5,000,000 |
|
|
|
5.23% |
|
|
|
04/28/2008 |
|
#077383 |
|
$ |
15,000,000 |
|
|
|
5.39% |
|
|
|
11/30/2007 |
|
|
|
|
$ |
40,000,000 |
|
|
|
|
|
|
|
|
|
|
|
|
These borrowings are secured by an investment in FHLB stock and certain real estate mortgage
loans which have been specifically pledged to the FHLB pursuant to their collateral
requirements. Based upon the level of FHLB advances, the Company was required to hold a
minimum investment of $2,470,700 in FHLB stock and pledge collateral of $52,274,812 in real
estate mortgage loans as of March 31, 2007. At March 31, 2007, the Bank had available
borrowing lines at the FHLB of $104,912,000 and additional federal fund borrowing lines at
two correspondent banks totaling $25,000,000. |
|
|
|
Off-Balance Sheet Financial Instruments - In the ordinary course of
business, the Company enters various types of transactions, which involve financial
instruments with off-balance sheet risk. These instruments include commitments to extend
credit and standby letter of credits, which are not reflected in the accompanying
consolidated balance sheets. These transactions may involve, to varying degrees, credit
and interest rate risk more than the amount, if any recognized in the consolidated
balance sheets. Commitments to extend credit are agreements to lend to customers. |
|
|
|
These commitments have specified interest rates and generally have fixed expiration
dates but may be terminated by the Company if certain conditions of the contract are
violated. Although currently subject to draw down, many of the commitments do not
necessarily represent future cash requirements. Collateral held relating to these
commitments varies, but generally includes real estate, securities and cash. Standby letters
of credit are conditional commitments issued by the Bank to guarantee the performance of a
customer to a third party. Credit risk arises in these transactions from the possibility that
a customer may not be able to repay the Bank upon default of performance. Collateral held
for standby letters of credit is based on an individual evaluation of each customers
creditworthiness, but may include cash and securities. Commitments to extend credit and
standby letters of credit bear similar credit risk characteristics as outstanding loans. |
|
8. |
|
Accounting for Income Tax Uncertainties (FIN 48) |
|
|
|
In June 2006, the FASB issued Interpretation 48, Accounting for Uncertainty in Income
Taxes (FIN 48), an interpretation of FASB Statement No. 109, Accounting for Income
Taxes. FIN 48 clarifies the accounting and reporting for income taxes where interpretation
of the law is uncertain. FIN 48 prescribes a comprehensive model for the financial statement
recognition, measurement, presentation and disclosure of income tax uncertainties with
respect to positions taken or expected to be taken in income tax returns. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The Company adopted this
Statement on January 1, 2007. As a result of the implementation of Interpretation 48, it
was not necessary for the Company to recognize any increase in the liability for
unrecognized tax benefits. |
|
|
|
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction
and California state jurisdiction |
|
|
|
The Company recognizes interest and penalties accrued related to unrecognized tax benefits
in income tax expense. |
12
|
|
|
ITEM 2. |
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS |
Forward Looking Statements and Risk Factors
An investment in the Company has risk. The discussion below and elsewhere in this Report and in
other documents the Company files with the SEC incorporates various risk factors that could cause
the Companys financial results and condition to vary significantly from period to period.
Information in the accompanying financial statements contains certain forward-looking statements,
which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform
Act of 1995. We caution the investor that such statements are subject to risks and uncertainties
that could cause actual results to differ materially from those stated. These risks and
uncertainties include the Companys ability to maintain or expand its market share and net interest
margins, or to implement its marketing and growth strategies. Further, actual results may be
affected by the Companys ability to compete on price and other factors with other financial
institutions; customer acceptance of new products and services; and general trends in the banking
and the regulatory environment, as they relate to the Companys cost of funds and return on assets.
The reader is advised that this list of risks is not exhaustive and should not be construed as any
prediction by the Company as to which risks would cause actual results to differ materially from
those indicated by the forward-looking statements. Readers are cautioned not to place undue
reliance on these forward-looking statements.
For additional information concerning risks and uncertainties related to the Company and its
operations please refer to the Companys Annual Report on Form 10-K for the year ended December 31,
2006 under the heading Risk factors that may affect results. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the date hereof. The
Company undertakes no obligation to revise or publicly release the results of any revision to these
forward-looking statements to reflect events or circumstances after the date hereof or to reflect
the occurrence of unanticipated events.
The following sections discuss significant changes and trends in the financial condition, capital
resources and liquidity of the Company from December 31, 2006 to March 31, 2007. Also discussed are
significant trends and changes in the Companys results of operations for the three months ended
March 31, 2007, compared to the same period in 2006. The consolidated financial statements and
related notes appearing elsewhere in this report are condensed and unaudited. The following
discussion and analysis is intended to provide greater detail of the Companys financial condition
and results.
Company Overview
Bank of Commerce Holdings (the Holding Company) is a financial holding company (FHC) registered
under the Bank Holding Company Act of 1956, as amended, and was incorporated in California on
January 21, 1982 for the purpose of organizing, as a wholly owned subsidiary, Redding Bank of
Commerce (the Bank). The Company celebrates its 25th anniversary during 2007. As a
financial holding company, the Holding Company is subject to the Financial Holding Company Act and
to supervision by the Board of Governors of the Federal Reserve System (FRB). The Holding
Companys principal business is to serve as a holding company for Redding Bank of Commerce,
Roseville Bank of Commerce, Sutter Bank of Commerce and Bank of Commerce Mortgage, a California
corporation and for other banking or banking-related subsidiaries which the Holding Company may
establish or acquire (collectively the Company).
The Holding Company also has two unconsolidated subsidiaries, Bank of Commerce Holdings Trust I and
II. During 2003, Bank of Commerce Holdings formed a wholly-owned Delaware statutory business trust,
Bank of Commerce Holdings Trust I (the grantor trust), which issued $5.0 million of guaranteed
preferred beneficial interests in Bank of Commerce Holdings junior subordinated debentures (the
Trust Notes). These debentures qualify as Tier 1 capital under Federal Reserve Board guidelines.
The proceeds from the issuance of the Trust Notes were transferred from the grantor trust to the
Holding Company and from the Holding Company to the Bank as surplus capital. The Trust Notes accrue
and pay distributions on a quarterly basis at 3 month London Interbank Offered Rate (LIBOR) plus
3.30%. The rate at March 31, 2007 was 8.66%. The rate increase is capped at 2.75% annually and the
lifetime cap is 12.5%. The final maturity on the Trust Notes is March 18, 2033, and the debt allows
for prepayment after five years on the quarterly payment date.
13
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
During 2005, Bank of Commerce Holdings formed a wholly-owned Delaware statutory business trust,
Bank of Commerce Holdings Trust II (the grantor trust), which issued $10.0 million of guaranteed
preferred beneficial interests in Bank of Commerce Holdings junior subordinated debentures (the
Trust Notes). $5 million of the issuance will qualify as Tier 1 capital under Federal Reserve
Board guidelines. $5 million of the proceeds from the issuance of the Trust Notes were transferred
from the grantor trust to the Holding Company and from the Holding Company to the Bank as surplus
capital and $5 million of the issuance is retained at the Holding Company for investment purposes.
The issuance is priced at a fixed rate for the first five years at 6.115%.
The Company will provide free of charge upon request, or through links to publicly available
filings accessed through its Internet website, the Companys annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, if any, as soon
as reasonably practical after such reports have been filed with the Securities and Exchange
Commission. The Internet addresses of the Company are www.bankofcommerceholdings.com,
www.reddingbankofcommerce.com, www.rosevillebankofcommerce.com,
www.sutterbankofcommerce.com and www.bankofcommercemortgage.com. Reports may also be
obtained through the Securities and Exchange Commissions website at www.sec.gov.
The Bank was incorporated as a California banking corporation on November 25, 1981, and received
its certificate of authority to begin banking operations on October 22, 1982. The Bank operates
five full service branch facilities. Two are operated under Redding Bank of Commerce, located in
Redding, California. Two are operated under Roseville Bank of Commerce, one located in Roseville,
California and the second location in Citrus Heights, California. One office is operated under
Sutter Bank of Commerce and is located in Yuba City, California.
The Company also operates Bank of Commerce Mortgage, an affiliate of Bank of Commerce. The
principal business of the subsidiary is mortgage brokerage services. The subsidiary has an
affiliated business arrangement with BWC Mortgage Services. Under the terms of the agreement, BWC
Mortgage Services underwrites or brokers mortgage products, and manages the independent
contractors, supporting staff and broker relationships with various secondary market lenders. Bank
of Commerce Mortgage in turn provides office space, equipment and marketing support for the
mortgage brokerage services. Bank of Commerce Mortgage, through this agreement, offers a full
array of single-family and multi-family residential real estate mortgages including equity lines.
Bank of Commerce Mortgage pays ten percent of gross premiums earned to BWC Mortgage Services.
On June 15, 2004, the Company was listed on the NASDAQ National Market under the trading symbol
BOCH (Bank of Commerce Holdings).
During April 2007, the Bank filed an application with the FDIC and DFI for authority to open an
additional branch in the Redding market, located in the Placer Heights Plaza shopping center. The
new office will have a focus on consumer applications and convenience hours and is planned to open
in the fourth quarter of 2007.
The Holding Companys principal source of income is dividends from its subsidiaries. The Holding
Company conducts its corporate business operations at the administrative office of the Bank located
at 1901 Churn Creek Road, Redding, California. The Company conducts its business operations in two
geographic market areas, Redding and Roseville, California. The Company considers Upstate
California to be the major market area of the Bank. The four Internet addresses of the Company are
reddingbankofcommerce.com, rosevillebankofcommerce.com,
sutterbankofcommerce.com and bankofcommercemortgage.com.
The Bank is principally supervised and regulated by the California Department of Financial
Institutions (DFI) and the Federal Deposit Insurance Corporation (FDIC), and conducts a general
commercial banking business in the counties of El Dorado, Placer, Shasta, Sacramento, Sutter and
Yuba, California. Through the Bank and mortgage subsidiaries, the Company provides a wide range of
financial services and products. The services offered by the Bank include those traditionally
offered by commercial banks of similar size and character in California. Products such as lock-box
servicing, courier services, checking accounts, interest-bearing checking and savings accounts,
money market deposit accounts, merchant bankcard, commercial, construction, agricultural, term
loans, and equity lines of credit, travelers checks, safe deposit boxes, collection services,
payroll services and electronic banking activities.
14
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
The focus of the Bank is to provide financial services to the communities in its major market
areas, including, but not limited to, specialty financing, lock-box accounting, courier services,
payroll accounting packages, benefit administration and billing services, merchant credit card
processing, and health savings accounts. The Bank currently does not offer trust services or
international banking services. The services offered by the Mortgage Company include single and
multi-family residential residence new financing, refinancing and equity lines of credit.
The Companys vision is to embrace changes in the industry and develop profitable business
strategies that allow us to maintain our customer relationships and build new ones. Our competitors
are no longer just banks. We must compete with financial powerhouses that want our core business.
The flexibility provided by the Financial Holding Company Act will become increasingly important.
We have developed strategic plans that evaluate additional financial services and products that can
be delivered to our customers efficiently and profitably. Producing quality returns is, as always,
a top priority.
Many of the Banks customers are small to medium sized businesses, professionals and other
individuals with medium to high net worth. The Bank emphasizes servicing the needs of local
businesses and professionals and individuals requiring specialized services. The business strategy
of the Bank is to focus on its lending activities and core deposit generation, developing products
and services to meet the needs of its clients. The Banks principal lines of lending are (i)
commercial, (ii) real estate construction, (iii) commercial and residential real estate, (iv)
agricultural, and (v) home equity lines of credit. The majority of the loans of the Bank are
direct loans made to individuals and small businesses in the major market areas of the Bank and are
secured by real estate. See Risk Factors That May Affect Results-Dependence on Real Estate in
the Companys 2006 Annual Report on Form 10-K.
The Companys credit risk management processes include comprehensive credit policies, judgmental
or statistical credit underwriting, frequent and detailed risk measurement and modeling, and a
continual loan review and audit process. In addition, regulatory examiners review and perform
detailed testing of our credit underwriting, loan administration and allowance processes. The
Company uses detailed tracking and analysis to measure concentrations, credit performance and
exception rates. Credit Administration strives to identify problem loans early. The Chief Credit
Officer, who reports to the Chief Executive Officer, provides Company wide credit oversight. Each
branch or market has a lending group manager with the responsibility for managing their own credit
risks. The Chief Executive Officer delegates authority, limits and other requirements to the
Lending Group Managers. These delegations are routinely reviewed and amended if there are changes
in personnel, credit performance or business requirements.
15
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Risk Factors
Economic Conditions and Geographic Concentration
An economic slowdown could reduce demand for the Companys products and services and lead to lower
revenues and lower earnings. A change in Californias economic and business conditions may
adversely affect the ability of our borrowers to repay their loans, causing us to incur higher
credit losses. The Company earns revenue from interest and fees charged on loans and financial
services. When the economy slows, the demand for these products and services may fall, reducing our
interest and fee income, and our earnings. In addition, during periods of economic slowdown or
recession, the Bank may experience a decline in collateral values and an increase in delinquencies
and defaults due to the borrowers ability to repay their loans. Several factors could cause the
economy to slow down or even recede, including higher energy costs, higher interest rates, reduced
consumer or corporate spending, a slowdown in housing, natural disasters, terrorist activities,
military conflicts, and the normal cyclical nature of the economy.
The Companys primary lending focus has historically been commercial real estate, commercial
lending and, to a lesser extent, construction lending. At March 31, 2007, all of the Companys
real estate mortgage, real estate construction loans, and commercial real estate loans, were
secured fully or in part by deeds of trust on underlying real estate. The Companys dependence on
real estate increases the risk of loss in the loan portfolio of the Company and its holdings of
other real estate owned if economic conditions in California deteriorate in the future.
Deterioration of the real estate market in California could have a material adverse effect on the
Companys business, financial condition and results of operations.
Changes in Interest Rates could reduce the Companys Net Interest Income and Earnings
The Companys net interest income is the interest earned on loans, debt securities and other assets
minus the interest paid on deposits, long-term and short-term debt and other liabilities. Net
interest income reflects both our net interest margin the difference between the yield on earning
assets and the interest paid on deposits and other sources of funding and the amount (volume) of
earning assets we hold. As a result, changes in either the net interest margin or the volume of
earning assets could adversely affect our net interest income and earnings.
Changes in interest rates, up or down, could adversely affect the net interest margin. The yield we
earn on our deposits and our funding costs tend to move in the same direction in response to
changes in interest rates, one can rise or fall faster than the other (timing differences). A
significant portion of the Companys assets are tied to variable rate pricing and the Company is
considered to be asset sensitive. As a result, the Company is generally adversely affected by
declining interest rates. In addition, changes in monetary policy, including changes in interest
rates, influence the origination of loans, the purchase of investments and the generation of
deposits and affect the rates received on loans and securities and paid on deposits, which could
have a material adverse effect on the Companys business, financial condition and results of
operations. See Quantitative and Qualitative Disclosure about Market Risk.
Changes in the slope of the yield-curve, or the spread between short-term and long-term interest
rates could also reduce our net interest margin. Normally, the yield curve is upward sloping,
meaning that short-term rates are lower than long-term rates. Because our liabilities tend to be
shorter in duration than our assets, when the yield curve flattens or even inverts, the Company
will experience pressure on the net interest margin as the cost of funds increases relative to the
yield that can be earned on assets.
The Company assesses interest rate risk by estimating the effect on earnings in various scenarios
that differ based on assumptions about the direction, magnitude and speed of interest rate changes
and the slope of the yield curve. The Company may hedge some interest rate risk with interest rate
derivatives. The Company does not hedge all of its interest rate risk. There is risk that changes
in interest rates could reduce our net interest income and earnings in material amounts, especially
if actual conditions turn out to be materially different that the assumptions used in the model.
One example: If interest rates rise or fall faster than assumed or the slope of the yield curve
changes, the Company may incur losses on debt securities held as investments. To reduce the
interest
rate risk, the Company may choose to rebalance the investment and loan portfolio, refinance debt
outstanding or take other strategic actions. The
16
Company may incur losses or expenses when taking
such actions.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Lending Risks Associated with Commercial Real Estate and Construction Activities
The business strategy of the Company is to focus on commercial, single family and multi-family real
estate loans, construction loans, equity lines and commercial business loans. Loans secured by
commercial real estate are generally larger and involve a greater degree of credit and transaction
risk than residential mortgage (one-to-four family) loans. Because payments on loans secured by
commercial and multi-family real estate properties are often dependent on successful operation or
management of the underlying properties, repayment of such loans may be subject to a greater extent
to the then prevailing conditions in the real estate market or the economy. Moreover, real estate
construction financing is generally considered to involve a higher degree of credit risk than
long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan
is dependent largely upon the accuracy of the initial estimate of the propertys value at
completion of construction or development compared to the estimated cost (including interest) of
construction. If the estimate of value proves to be inaccurate, the Company may be confronted with
a project which, when completed, has a value which is insufficient to assure full repayment of the
construction loan. Although the Company manages lending risks through its underwriting and credit
administration policies, no assurance can be given that such risks would not materialize, in which
event the Companys financial condition, results of operations, cash flows and business prospects
could be materially adversely affected.
Adequacy of Allowance for Loan and Lease Losses (ALLL)
Higher credit losses could require the Company to increase the allowance for loan and lease losses
through a charge to earnings. When the Company loans money or commits to loan money it incurs
credit risk or the risk of losses if our borrowers do not repay their loans. The Company provides a
reserve for credit risk by establishing an allowance through a charge to earnings. The amount of
the allowance is based on an assessment of credit losses inherent in the loan portfolio (including
unfunded credit commitments). The process for determining the amount of the allowance is critical
to our financial results and condition. It requires difficult, subjective and complex judgments
about the future, including forecasts of economic or market conditions that might impair our
borrowers ability to repay their loans.
The Company might increase the allowance because of changing economic conditions or unexpected
events. The Companys allowance for loan and lease losses was approximately $4.9 million, or 1.18%
of total loans at March 31, 2007.
Potential Volatility of Deposits
The Banks depositors could choose to take their money out of the bank and put it into alternative
investments, causing an increase in funding costs and reducing net interest income. Checking,
savings and money market account balances can decrease when customers perceive that alternative
investments, such as the stock market, as providing a better risk/return tradeoff. When customers
move funds out of bank deposits into other investments, the Bank will lose a relatively low cost
source of funds, increasing funding costs.
At March 31, 2007, time certificates of deposit in excess of $100,000 represented approximately 36%
of the dollar value of the total deposits of the Company. As such, these deposits are considered
volatile and could be subject to withdrawal. Withdrawal of a material amount of such deposits
could adversely affect the liquidity of the Company, profitability, business prospects, results of
operations and cash flows. The Company monitors activity of volatile liability deposits on a
quarterly basis.
Dividends
Bank of Commerce Holdings, the parent holding company, is a separate and distinct legal entity from
its subsidiaries.
The Company conducts no other significant activity than the management of its investment in the
Bank and Mortgage Company and as such, the Company is dependent on these subsidiaries for income.
The ability of the Bank and Mortgage Company to pay cash dividends in the future depends on the
profitability, growth and capital needs of the Bank and Mortgage Company. These dividends are used
to pay dividends on common stock and interest and
17
principal on debt. In addition, the California
Financial Code restricts the ability of the Bank to pay dividends. No assurance can be given that
the Company or the Bank will pay any dividends in the future or, if paid, such dividends will not
be discontinued.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Changes in Accounting Policies or Accounting Standards, and Changes in How Accounting Standards are
interpreted or applied, Could Materially Affect How the Company Reports its Financial Results and
Condition
The Companys accounting policies are fundamental to understanding our financial results and
condition. Some of these policies require use of estimates and assumptions that may affect the
value of our assets or liabilities and financial results. Three of our accounting policies are
critical because they require management to make difficult, subjective and complex judgments about
matters that are inherently uncertain and because it is likely that materially different amount
would be reported under different conditions or using different assumptions (refer to Critical
Accounting Policies).
From time to time the Financial Accounting Standards Board (FASB) and the SEC change the
financial accounting and reporting standards that govern the preparation of financial statements.
In addition, accounting standard setters and those who interpret the accounting standards (such as
the FASB, SEC, banking regulators and outside auditors) may change or even reverse their previous
interpretations or positions on how these standards should be applied. Changes in financial
accounting and reporting standards and changes in current interpretations may be beyond the
Companys control, can be hard to predict and could materially impact how we report our financial
results and condition. The Company could be required to apply a new or revised standard
retroactively or apply an existing standard differently, also retroactively, in each case resulting
in restating prior period financial statements.
Government Regulation and Legislation
The Company and the Bank are subject to extensive state and federal regulation, supervision and
legislation, which govern almost all aspects of the operations of the Company and the Bank. The
business of the Company is particularly susceptible to being affected by the enactment of federal
and state legislation which may have the effect of increasing or decreasing the cost of doing
business, modifying permissible activities or enhancing the competitive position of other financial
institutions. Such laws are subject to change from time to time and are primarily intended for the
protection of consumers, depositors and the deposit insurance funds and not for the protection of
shareholders of the Company. The Company cannot predict what effect any presently contemplated or
future changes in the laws or regulations or their interpretations would have on the business and
prospects of the Company, but it could be material and adverse.
Recent high-profile events have resulted in additional regulations. For example, Sarbanes-Oxley
limits the types of non-audit services our outside auditors may provide to the company in order to
preserve the independence of our auditors. If our auditors were found not to be independent under
SEC rules, we could be required to engage new auditors and file new financial statements and audit
reports with the SEC.
The Patriot Act which was enacted in the wake of the September 2001 terrorist attacks, requires the
Company to implement new or revised policies and procedures related to anti-money laundering,
compliance, suspicious activities, currency transaction reports and due diligence on customers. The
Patriot Act also requires federal bank regulators to evaluate the effectiveness of an applicant in
combating money laundering in determining whether to approve a proposed bank acquisition.
From time to time, Congress considers legislation that could significantly change our regulatory
environment, potentially increasing the cost of doing business, limiting activities or affecting
the competitive balance among banks, savings associations, credit unions and other financial
institutions.
Certain Ownership Restrictions under California and Federal Law
Federal law prohibits a person or group of persons acting in concert from acquiring control of
a bank holding company unless the FRB has been given 60 days prior written notice of such proposed
acquisition and within that time period the FRB has not issued a notice disapproving the proposed
acquisition or extending for up to another 30
days, the period during which such a disapproval may
be issued. An acquisition may be made before the expiration of the disapproval period if the FRB
issues written notice of its intent not to disapprove the action.
18
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Under a rebuttal presumption established by the FRB, the acquisition of more than 10% of a class of
voting stock of a bank with a class of securities registered under Section 12 of the Exchange Act
(such as the common stock), would, under the circumstances set forth in the presumption, constitute
the acquisition of control. In addition, any company would be required to obtain the approval of
the FRB under the BHCA, before acquiring 25% (5% in the case of an acquirer that is, or is deemed
to be, a bank holding company) or more of the outstanding shares of the Companys common stock, or
such lesser number of shares as constitute control. See Supervision and Regulation and Regulation
and Supervision of Bank Holding Companies in the Companys 2006 Annual Report on Form 10-K.
Under the California Financial Code, no person shall, directly or indirectly, acquire control of a
California licensed bank or a bank holding company unless the Commissioner has approved such
acquisition of control. A person would be deemed to have acquired control of the Company and the
Bank under this state law if such person, directly or indirectly, has the power (i) to vote 25% or
more of the voting power of the Company or (ii) to direct or cause the direction of the management
and policies of the Company. For purposes of this law, a person who directly or indirectly owns or
controls 10% or more of the common stock would be presumed to direct or cause the direction of the
management and policies of the Company and thereby control the Company.
Negative Publicity could Damage our Reputation
Reputation risk, or the risk to the Companys earnings and capital from negative public opinion, is
inherent in the financial services business. Negative public opinion could adversely affect our
ability to keep and attract customers and expose us to adverse legal and regulatory consequences.
Negative public opinion could result from actual or alleged conduct in any number of activities,
including lending practices, corporate governance, acquisitions, and from actions taken by
government regulators and community organizations in response to that conduct.
Environmental Risks
The Company, in its ordinary course of business, acquires real property securing loans that are in
default, and there is a risk that hazardous substance or waste, contaminants or pollutants could
exist on such properties. The Company may be required to remove or remediate such substances from
the affected properties at its expense, and the cost of such removal or remediation may
substantially exceed the value of the affected properties or the loans secured by such properties.
Furthermore, the Company may not have adequate remedies against the prior owners or other
responsible parties to recover its costs. Finally, the Company may find it difficult or impossible
to sell the affected properties either before or following any such removal. In addition, the
Company may be considered liable for environmental liabilities concerning its borrowers
properties, if, among other things, it participates in the management of its borrowers operations.
The occurrence of such an event could have a material adverse effect on the Companys business,
financial condition, results of operations and cash flows.
Shares Eligible for Future Sale
As of March 31, 2007, the Company had 8,907,680 shares of Common Stock outstanding, of which
6,088,905 shares are eligible for sale in the public market without restriction and 2,818,775
shares are eligible for sale in the public market pursuant to Rule 144 under the Securities Act of
1933, as amended (the Securities Act). Future sales of substantial amounts of the Companys
common stock, or the perception that such sales could occur, could have a material adverse effect
on the market price of the common stock. In addition, options to acquire 317,107 shares of the
issued and outstanding shares of common stock at exercise prices ranging from $2.75 to $10.76 have
been issued to directors and certain employees of the Company under the Companys 1998 Stock Option
Plan. No prediction can be made as to the effect, if any, that future sales of shares, or the
availability of shares for future sale, will have on the market price of the Companys common
stock.
19
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Technology and Computer Systems
Advances and changes in technology can significantly affect the business and operations of the
Company. The Company faces many challenges including the increased demand for providing computer
access to bank accounts and the systems to perform banking transactions electronically. The
Companys ability to compete depends on its ability to continue to adapt its technology on a timely
and cost-effective basis to meet these requirements. In addition, the Companys business and
operations are susceptible to negative impacts from computer system failures, communication and
energy disruption and unethical individuals with the technological ability to cause disruptions or
failures of the Companys data processing systems. During 2006 the Company built an Administrative
and Information Technology center on property already owned adjacent to the Churn Creek office.
Company Stock Price may be volatile due to Other Factors
The Companys stock price can fluctuate widely in response to a variety of factors, in addition to
those described above, including:
|
|
|
General business and economic conditions; |
|
|
|
|
Recommendations by securities analysts; |
|
|
|
|
New technologies introduced or services offered by our competitors; |
|
|
|
|
News reports relating to trends, concerns and other issues in the financial services industry; |
|
|
|
|
Natural disasters; and |
|
|
|
|
Geopolitical conditions, such as acts or threats of terrorism or military conflicts. |
UNRESOLVED STAFF COMMENTS
No comments to report.
20
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Executive Overview
Our Company was established to make a profitable return while serving the financial needs of the
communities of our markets. We are in the financial services business, and no line of financial
services is beyond our charter as long as it serves the needs of businesses and professionals in
our communities. The mission of our Company is to provide its stockholders with a safe, profitable
return on their investment, over the long term. Management will attempt to minimize risk to our
stockholders by making prudent business decisions, will maintain adequate levels of capital and
reserves, and will maintain effective communications with stockholders. Our Companys most valuable
asset is its customers. We will consider their needs first when we design our products and
services. The high-quality customer experience is an important mission of our Company, and how well
we accomplish this mission will have a direct influence on our profitability.
Our vision is to embrace changes in the industry and develop profitable business strategies that
allow us to maintain our customer relationships and build new ones. Our competitors are no longer
just banks. We must compete with financial powerhouses that want our core business. The flexibility
provided by the Financial Holding Company Act will become increasingly important. We have
developed strategic plans that evaluate additional financial services and products that can be
delivered to our customers efficiently and profitably. Producing quality returns is, as always, a
top priority.
The Companys long term success rests on the shoulders of the leadership team to effectively work
to enhance the performance of the Company. As a financial services company, we are in the business
of taking risk. Whether we are successful depends largely upon whether we take the right risks and
get paid appropriately for the risks we take. Our governance structure enables us to manage all
major aspects of the Companys business effectively through an integrated process that includes
financial, strategic, risk and leadership planning.
We define risks to include not only credit, market and liquidity risk the traditional concerns
for financial institutions but also operational risks, including risks related to systems,
processes or external events, as well as legal, regulatory and reputation risks.
Our management processes, structures and policies help to ensure compliance with laws and
regulations and provide clear lines for decision-making and accountability. Results are important,
but equally important is how we achieve those results. Our core values and commitment to high
ethical standards is material to sustaining public trust and confidence in our Company. For
additional information concerning risks and uncertainties related to the Company and its operations
please refer to the Companys Annual Report on Form 10-K for the year ended December 31, 2006,
under the heading Risk Management.
Sources of Income
The Company derives its income from two principal sources: (i) net interest income, which is the
difference between the interest income it receives on debt securities, loans (including
yield-related loan fees) and other interest-earning assets minus the interest expense it pays for
deposits and long-term and short-term debt, and (ii) fee income, which includes fees earned on
deposit services, electronic-based cash management services, mortgage brokerage fee income and
merchant credit card processing services. The net interest margin is the average yield on earning
assets minus the average interest rate paid for deposits and other sources of funding.
The income of the Company depends to a great extent on net interest income. These interest rate
factors are highly sensitive to many factors, which are beyond the Companys control, including
general economic conditions, inflation, recession, and the policies of various governmental and
regulatory agencies, in particular, the Federal Reserve Board. Because of the Companys
predisposition to variable rate pricing and non-interest bearing demand deposit accounts, the
Company is considered asset sensitive. As a result, the Company is adversely affected by declining
interest rates.
21
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
|
|
|
|
|
|
|
|
|
|
|
March 31, 2007 |
|
March 31, 2006 |
|
Profitability Ratios |
|
|
|
|
|
|
|
|
Net Income to Average Assets |
|
|
3.77 |
% |
|
|
4.22 |
% |
Net Income to Average Equity |
|
|
11.98 |
% |
|
|
14.65 |
% |
|
|
|
|
|
|
|
|
|
Efficiency Ratio 1 |
|
|
59.88 |
% |
|
|
55.25 |
% |
|
|
|
|
|
|
|
|
|
Capital Ratios |
|
|
|
|
|
|
|
|
Leverage Ratio |
|
|
9.75 |
% |
|
|
10.05 |
% |
Risk Based Capital |
|
$ |
56,050,000 |
|
|
$ |
51,733,000 |
|
Tier 1 Capital |
|
|
11.23 |
% |
|
|
12.00 |
% |
Total Capital |
|
|
12.29 |
% |
|
|
13.09 |
% |
|
|
|
|
|
|
|
|
|
Per Common Share Data |
|
|
|
|
|
|
|
|
Dividend Payout Ratio |
|
|
47.94 |
% |
|
|
38.32 |
% |
Book Value |
|
$ |
5.10 |
|
|
$ |
4.63 |
|
Market Price |
|
$ |
11.75 |
|
|
$ |
10.23 |
|
High |
|
$ |
12.29 |
|
|
$ |
10.64 |
|
Low |
|
$ |
10.98 |
|
|
$ |
9.14 |
|
|
Financial Highlights Results of Operations
Net income for the first quarter of 2007 totaled $1,487,000 a decrease of 6.6% from the $1,592,000
reported for the same quarterly period of 2006. On the same basis, diluted earnings per common
share for the first quarter of 2007 were $0.17, compared to $0.17 for
the same period of 2006. Return on average assets (ROA) and return on average equity (ROE) for the first
quarter of 2007 were 1.05% and 13.37%, respectively, compared with 1.24% and 15.18%, respectively,
for the first quarter of 2006.
Net Interest Income and Net Interest Margin
Net interest income is the primary source of the Companys income. Net interest income represents
the excess of interest and fees earned on interest-earning assets (loans, securities and federal
funds sold) over the interest paid on deposits and borrowed funds. Net interest margin is net
interest income expressed as a percentage of average earning assets. Net interest income for the
quarter ended March 31, 2007 was $5,327,000 compared with $5,413,000 for the same period in 2006, a
decrease of 1.6%.
Average earning assets for the three-months ended March 31, 2007 increased $46.7 million or 9.6%
compared with the same period in the prior year. Average net loans, the largest component of
earning assets, increased $38.2 million or 10.3% compared with the prior year period. Average
securities increased $4.5 million or 4.4% over the prior year period. Overall, the yield on earning
assets increased to 7.39% for the three-month period ended March 31, 2007 compared to 6.93% for the
same three-month period in the prior year, partially due to volume increases coupled with rising
interest rates between the two periods.
The overall cost of interest-bearing liabilities (funding costs) for the first three months of 2007
was $4,483,000 compared with $2,976,000 for the first three months of 2006, a 50.69% increase. The
rise in cost of funds is representative of the competitive market for deposit accounts, and the
launch of a high performance savings
product with an introductory rate of 5.00%. The introductory rate will remain in effect for the
first sixty days at which time the product will be variable pricing.
|
|
|
1 |
|
The efficiency ratio is noninterest expense
divided by total revenue (net interest income and noninterest income) |
22
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
The increase in funding costs was primarily a result of increases rates paid on core deposit
accounts. The net effect of the changes discussed above resulted in a decrease of $87,000 or 1.6%
in net interest income for the three-month period ended March 31, 2007 from the same period in
2006. Net interest margin decreased 46 basis points to 4.01% from 4.47% for the same period a year
ago.
Liquidity
The objective of liquidity management is to ensure that the Company can efficiently meet the
borrowing needs of its customers, withdrawals of its depositors and other cash commitments under
both normal operating conditions and under unforeseen and unpredictable circumstances of industry
or market stress.
The Asset Liability Management Committee (ALCO) establishes and monitors liquidity guidelines
that require sufficient asset-based liquidity to cover potential funding requirements and to avoid
over-dependence on volatile, less reliable funding markets. In addition to the immediately liquid
resources of cash and due from banks, federal funds sold and securities purchased under agreements
to resell, asset liquidity is supported by debt securities in the available-for-sale securities
portfolio and wholesale lines of credit with the Federal Home Loan Bank and other financial
institutions. Customer core deposits have historically provided the Company with a source of
relatively stable and low-cost funds. Management monitors the sources and uses of funds on a daily
basis to maintain an acceptable liquidity position. In addition to liquidity from core deposits and
repayments and maturities of loans and securities, the Company has the ability to sell securities
under agreements to repurchase, obtain Federal Home Loan Bank advances or purchase overnight
Federal Funds.
The Companys consolidated liquidity position remains adequate to meet short-term and long-term
future contingencies. At March 31, 2007, the Company had overnight cash in investments of $33.8
million and available lines of credit of at the Federal Home Loan bank of approximately $104
million, and a Federal Funds borrowing line with two correspondent financial institutions of $25.0
million.
To accommodate future growth and business needs, the Company develops an annual capital expenditure
budget during strategic planning sessions. The Company expects that the earnings of the Bank,
acquisition of core deposits and wholesale borrowing arrangements are sufficient to support
liquidity needs in 2007.
Capital Management
The Company has an active program for managing stockholder capital. Capital is used to fund organic
growth, acquisitions, pay dividends and repurchase shares. The objective of effective capital
management is to produce above market long-term returns by using capital when returns are perceived
to be high and issuing capital when costs are perceived to be low.
Periodically, the Board of Directors authorizes the Company to repurchase shares. Share repurchase
announcements are published in press releases and SEC 8-K filings. Typically we do not give any
public notice before repurchasing shares. Various factors determine the amount and timing of our
share repurchases, including our capital requirements, market conditions and legal considerations.
These factors can change at any time and there can be no assurance as to the number of shares
repurchased or the timing of the repurchases.
Our policy has been to repurchase shares under the safe harbor conditions of Rule 10b-18 of the
Exchange Act including a limitation on the daily volume of repurchases. The Companys potential
sources of capital include retained earnings, common and preferred stock issuance and issuance of
subordinated debt and trust notes.
The Company and bank are subject to various regulatory capital adequacy requirements as prescribed
by the Federal Reserve Bank. Risk-based capital guidelines establish a risk-adjusted ratio relating
capital to difference categories of assets and off-balance sheet exposures. At March 31, 2007, the
Company and Bank were well capitalized under applicable regulatory capital adequacy guidelines.
23
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Well |
|
|
Minimum |
|
|
|
|
|
|
|
Actual |
|
|
Capitalized |
|
|
Capital |
|
As of March 31, 2007 |
|
Capital |
|
|
Ratio |
|
|
Requirement |
|
|
Requirement |
|
|
The Company |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Leverage |
|
$ |
56,050,000 |
|
|
|
9.75 |
% |
|
|
n/a |
|
|
|
4.0 |
% |
Tier 1 Risk-Based |
|
|
56,050,000 |
|
|
|
11.23 |
% |
|
|
n/a |
|
|
|
4.0 |
% |
Total Risk-Based |
|
|
61,373,917 |
|
|
|
12.29 |
% |
|
|
n/a |
|
|
|
8.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redding Bank of
Commerce |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Leverage |
|
$ |
55,612,000 |
|
|
|
9.81 |
% |
|
|
5.0 |
% |
|
|
4.0 |
% |
Tier 1 Risk-Based |
|
|
55,612,000 |
|
|
|
11.14 |
% |
|
|
6.0 |
% |
|
|
4.0 |
% |
Total Risk-Based |
|
|
60,936,129 |
|
|
|
12.21 |
% |
|
|
10.00 |
% |
|
|
8.0 |
% |
|
Short and Long Term Borrowings
The Company actively uses Federal Home Loan Bank (FHLB) advances as a source of wholesale funding
to support growth strategies as well as to provide liquidity. At March 31, 2007, all of the
Companys FHLB advances were a combination of fixed term and variable borrowings without call or
put option features.
During the three months ended March 31, 2007, the average balance of FHLB advances was $40.0
million and the average interest rates during the period was 5.40%. The maximum outstanding at any
month-end during the three months ended March 31, 2007 was $40.0 million. The FHLB advances are
collateralized by loans and securities pledged to the FHLB.
Allowance for Loan and Lease Losses
The Allowance for Loan and Lease Losses, which consists of the allowance for loan losses is
managements estimate of credit losses inherent in the loan portfolio at the balance sheet date.
The Company has established a process using several analytical tools and benchmarks, to calculate a
range of possible outcomes and determine the adequacy of the allowance. No single statistic or
measurement determines the adequacy of the allowance. Loan recoveries and the provision for credit
losses increase the allowance, while loan charge-offs decrease the allowance.
The allowance for loan and lease losses is the Companys most significant management accounting
estimate. The Company follows a methodology for calculating the appropriate level for the
allowance for loan and lease losses as discussed under Asset Quality and Allowance for Loan and
Lease Losses (ALLL) in this document. The entire allowance is used to absorb credit losses
inherent in the loan portfolio. The allowance includes an amount for imprecision or uncertainty to
incorporate a range of probable outcomes inherent in estimates used for the allowance, which may
change from period to period. This portion of the total allowance is the results of the Companys
judgment of risks inherent in the portfolio, economic uncertainties, historical loss experience and
other subjective factors, including industry trends. The methodology used is refined to calculate a
portion of the allowance for each portfolio type to reflect our view of the risk in these
portfolios.
Changes in the estimate of the allowance for loan and lease losses and the related provision
expense can materially affect net income. Determining the allowance for loan and lease losses
requires management to make forecasts of losses that are highly uncertain and require a high degree
of judgment.
Provision for loan and lease losses of $6,000 were provided for the three-months ended March 31,
2007 compared with $11,000 for the same period of 2006. The Companys allowance for loan and lease
losses was 1.18% of total loans at March 31, 2007 and 1.13% at March 31, 2006, while its ratio of
non-performing assets to total assets was 0.00% at March 31, 2007, compared to 0.02% at March 31,
2006.
24
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Factors that may affect future results
As a financial services company, our earnings are significantly affected by general business and
economic conditions. These conditions include short-term and long-term interest rates, inflation,
monetary supply, fluctuations in both debt and equity capital markets, and the strength of the
United States economy and local economies in which we operate. For example, an economic downturn,
increase in unemployment, or other events that negatively impact household and/or corporate incomes
could decrease the demand for the Companys loan and non-loan products and services and increase
the number of customers who fail to pay interest or principal on their loans. Geopolitical
conditions can also affect our earnings. Acts or threats of terrorism, actions taken by the United
States or other governments in response to acts or threats of terrorism and our military conflicts
including the aftermath of the war with Iraq, could impact business conditions in the United
States.
The Board of Governors of the Federal Reserve System regulates the supply of money and credit in
the United States. Its policies determine in large part our cost of funds for lending and investing
and the return we earn on those loans and investments, both of which impact our net interest
margin, and can materially affect the value of financial instruments we hold. Its policies can also
affect our borrowers, potentially increasing the risk of failure to repay their loans. Changes in
Federal Reserve Board policies are beyond our control and hard to predict or anticipate.
We operate in a highly competitive industry that could become even more competitive because of
legislative, regulatory and technological changes and continued consolidation. Banks, securities
firms and insurance companies can now merge creating a financial holding company that can offer
virtually any type of financial service, including banking, securities underwriting, insurance
(agency and underwriting) and merchant banking. Technology has lowered barriers to entry and made
it possible for non-banks to offer products and services traditionally provided by banks, such as
automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory
constraints and some have lower cost structures.
The holding company, subsidiary bank and non-bank subsidiary are heavily regulated at the federal
and state levels. This regulation is to protect depositors, federal deposit insurance funds and the
banking system as a whole, not investors. Congress and state legislatures and federal and state
regulatory agencies continually review banking laws, regulations and policies for possible changes.
Changes to statutes, regulations or regulatory policies including changes in interpretation and
implementation could affect us in substantial and unpredictable ways including limiting the types
of financial services and products we may offer. Our failure to comply with the laws, regulations
or policies could result in sanctions by regulatory agencies and damage our reputation. For more
information, refer to the Supervision and Regulation section in the Companys 2006 Annual Report
on Form 10-K.
Our success depends, in part, on our ability to adapt our products and services to evolving
industry standards. There is increasing pressure on financial services companies to provide
products and services at lower prices. This can reduce our net interest margin and revenues from
fee-based products and services. In addition, the widespread adoption of new technologies,
including internet-based services, could require us to make substantial expenditures to modify or
adapt our existing products and services. Our success depends, in large part, on our ability to
attract and retain key people. Competition for the best people can be intense.
The holding company is a separate and distinct legal entity from its subsidiaries. It receives
substantially all of its revenues from dividends from its subsidiaries. These dividends are the
principal source of funds to pay dividends on the holding companys common stock and interest and
principal on its debt. Various federal and state laws and regulations limit the amount of
dividends that our bank may pay to the holding company. For more information, refer to Dividends
and Other Distributions in the Companys 2006 Annual Report on Form 10-K.
25
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Critical Accounting Policies
The Securities and Exchange Commission (SEC) issued disclosure guidance for critical accounting
policies. The SEC defines critical accounting policies as those that require application of
managements most difficult, subjective or complex judgments, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain and may change in future
periods.
Our accounting policies are integral to understanding the results reported. Accounting policies are
described in detail in Note 2 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS in the Companys
2006 Annual Report on Form 10-K. Not all of the significant accounting policies presented in Note 2
to the Consolidated Financial Statements contained in the Companys 2006 Annual Report on Form 10-K
require management to make difficult, subjective or complex judgments or estimates.
Preparation of financial statements
The preparation of these financial statements requires management to make estimates and judgments
that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis,
management evaluates the estimates used. Estimates are based upon historical experience, current
economic conditions and other factors that management considers reasonable under the circumstances.
Use of estimates
These estimates result in judgments regarding the carrying values of assets and liabilities when
these values are not readily available from other sources, as well as assessing and identifying the
accounting treatments of contingencies and commitments. Actual results may differ from these
estimates under different assumptions or conditions.
Accounting Principles Generally Accepted in the United States of America
The Companys financial statements are prepared in accordance with accounting principles generally
accepted in the United States of America (GAAP). The Companys significant accounting policies
are presented in Note 2 to the Consolidated Financial Statements contained in the Companys 2006
Annual Report on Form 10-K.
The Company follows accounting policies typical to the commercial banking industry and in
compliance with various regulations and guidelines as established by the Financial Accounting
Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA) and the
Banks primary federal regulator, the Federal Deposit Insurance Corporation (FDIC). The following
is a brief description of the Companys current accounting policies involving significant
management judgments.
Allowance for Loan and Lease Losses (ALLL)
The allowance for loan and lease losses is the Companys most significant management accounting
estimate. The allowance for loan and lease losses is managements best estimate of the probable
losses that may be sustained in our loan portfolio. The allowance is based on two basic principles
of accounting. (1) SFAS No.5 which requires that losses be accrued when they are probable of
occurring and estimable and (2) SFAS No. 114, which requires that losses be accrued based on the
differences between that value of collateral, present value of future cash flows or values that are
observable in the secondary market and the loan balance.
The Companys allowance for loan and lease losses is the accumulation of various components that
are calculated based upon independent methodologies. All components of the allowance for loan
losses represent an estimation performed pursuant to Statement of Financial Accounting Standards
(SFAS) Statement No. 5, Accounting for Contingencies or SFAS No. 114, Accounting by Creditors for
Impairment of a Loan. Managements estimate of each SFAS No. 5 component is based on certain
observable data that management believes is the most reflective of the underlying credit losses
being estimated. Changes in the amount of each component of the allowance for
loan losses are directionally consistent with changes in the observable data, taking into account
the interaction of the SFAS No. 5 components over time.
26
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
An essential element of the methodology for determining the allowance for loan and lease losses is
the Companys credit risk evaluation process, which includes credit risk grading individual,
commercial, construction, commercial real estate, and consumer loans. Loans are assigned credit
risk grades based on the Companys assessment of conditions that affect the borrowers ability to
meet its contractual obligations under the loan agreement. That process includes reviewing
borrowers current financial information, historical payment experience, credit documentation,
public information, and other information specific to each individual borrower. Loans are reviewed
on an annual or rotational basis or as management become aware of information affecting the
borrowers ability to fulfill its obligations. Credit risk grades carry a dollar weighted risk
percentage.
For individually impaired loans, SFAS No. 114 provides guidance on the acceptable methods to
measure impairment. Specifically, SFAS No. 114 states that when a loan is impaired, we measure
impairment based on the present value of expected future principal and interest cash flows
discounted at the loans effective interest rate, except that as a practical expedient, a creditor
may measure impairment based on a loans observable market price or the fair value of collateral,
if the loan is collateral dependent. When developing the estimate of future cash flows for a loan,
we consider all available information reflecting past events and current conditions, including the
effect of existing environmental factors. In addition to the ALLL, an allowance for unfunded loan
commitments and letters of credit is determined using estimates of the probability of funding. This
reserve is carried as a liability on the consolidated balance sheet.
Revenue recognition
The Companys primary source of revenue is interest income. Interest income is recorded on an
accrual basis. Note 2 to the Consolidated Financial Statements contained in the Companys 2006
Annual Report on Form 10-K offers an explanation of the process for determining when the accrual of
interest income is discontinued on an impaired loan.
Stock-based Compensation
Statement of Financial Accounting Standards No. 123 (revised 2004); Accounting for Stock Based
Compensation was adopted by the Company as of January 1, 2006, using the modified prospective
transition method. Under the modified prospective transition method, compensation cost is
recognized on or after the required effective date for the portion of outstanding awards, for which
the requisite service has not yet been rendered, based on the grant-date fair value of those awards
calculated under Statement No. 123 for either recognition or pro forma disclosures.
The amount of the reduction for the fiscal years 2004 through 2006 is disclosed in Note 13 to the
Consolidated Financial Statements contained in the Companys 2006 Annual Report on Form 10-K, based
upon the assumptions listed therein. Accounting principles generally accepted in the United States
of America (GAAP), itself may change over time, having impact over the reporting of the Companys
financial activity. Although the economic substance of the Companys transactions would not
change, alterations in GAAP could affect the timing or manner of accounting or reporting.
Income Taxes
The Company files a consolidated federal and state income tax return. The Company accounts for
income taxes under the asset and liability method. Under the asset and liability method, deferred
tax assets and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured using currently
enacted tax rates applied to such taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the enactment date. If
future income should prove non-existent or less than the amount of deferred tax assets within the
tax years to which they may be applied, the asset may not be realized and our net income will be
reduced. The Companys deferred tax assets are described
further in Note 12 of the Notes to Consolidated Financial Statements in the Companys 2006 Annual
Report on Form 10-K.
27
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
The following table presents the Companys daily average balance sheet information together with
interest income and yields earned on average earning assets and interest expense and rates paid on
average interest-bearing liabilities. Average balances are average daily balances.
|
|
|
Table 1. |
|
Average Balances, Interest Income/Expense and Yields/Rates Paid
(Unaudited, Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Three Months Ended |
|
|
|
March 31, 2007 |
|
|
March 31, 2006 |
|
|
|
Average |
|
|
|
|
|
|
Yield/ |
|
|
Average |
|
|
|
|
|
|
Yield/ |
|
|
|
Balance |
|
|
Interest |
|
|
Rate |
|
|
Balance |
|
|
Interest |
|
|
Rate |
|
Earning Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Portfolio Loans |
|
$ |
407,758 |
|
|
$ |
8,464 |
|
|
|
8.30 |
% |
|
$ |
369,589 |
|
|
$ |
7,230 |
|
|
|
7.82 |
% |
Tax-exempt Securities |
|
|
29,712 |
|
|
|
278 |
|
|
|
3.74 |
% |
|
|
14,099 |
|
|
|
123 |
|
|
|
3.49 |
% |
US Government Securities |
|
|
33,722 |
|
|
|
356 |
|
|
|
4.22 |
% |
|
|
43,052 |
|
|
|
423 |
|
|
|
3.93 |
% |
Mortgage backed Securities |
|
|
41,919 |
|
|
|
476 |
|
|
|
4.54 |
% |
|
|
41,910 |
|
|
|
439 |
|
|
|
4.19 |
% |
Federal Funds Sold |
|
|
15,540 |
|
|
|
200 |
|
|
|
5.15 |
% |
|
|
11,587 |
|
|
|
130 |
|
|
|
4.49 |
% |
Other Securities |
|
|
2,302 |
|
|
|
36 |
|
|
|
6.26 |
% |
|
|
4,049 |
|
|
|
44 |
|
|
|
4.35 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Earning Assets |
|
$ |
530,953 |
|
|
$ |
9,810 |
|
|
|
7.39 |
% |
|
$ |
484,286 |
|
|
$ |
8,389 |
|
|
|
6.93 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash & Due From Banks |
|
$ |
12,939 |
|
|
|
|
|
|
|
|
|
|
$ |
13,937 |
|
|
|
|
|
|
|
|
|
Bank Premises |
|
|
9,288 |
|
|
|
|
|
|
|
|
|
|
|
5,943 |
|
|
|
|
|
|
|
|
|
Allowance for Loan Losses |
|
|
( 4,892 |
) |
|
|
|
|
|
|
|
|
|
|
( 4,364 |
) |
|
|
|
|
|
|
|
|
Other Assets |
|
|
17,226 |
|
|
|
|
|
|
|
|
|
|
|
12,877 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Total Assets |
|
$ |
565,514 |
|
|
|
|
|
|
|
|
|
|
$ |
512,679 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand Interest Bearing |
|
$ |
112,910 |
|
|
$ |
557 |
|
|
|
1.97 |
% |
|
$ |
103,500 |
|
|
$ |
233 |
|
|
|
0.90 |
% |
Savings Deposits |
|
|
28,864 |
|
|
|
171 |
|
|
|
2.37 |
% |
|
|
28,093 |
|
|
|
65 |
|
|
|
0.93 |
% |
Certificates of Deposit |
|
|
214,094 |
|
|
|
2,605 |
|
|
|
4.87 |
% |
|
|
164,752 |
|
|
|
1,549 |
|
|
|
3.76 |
% |
Repurchase Agreements |
|
|
34,860 |
|
|
|
342 |
|
|
|
3.92 |
% |
|
|
24,057 |
|
|
|
199 |
|
|
|
3.31 |
% |
FHLB Borrowings |
|
|
40,000 |
|
|
|
539 |
|
|
|
5.39 |
% |
|
|
57,611 |
|
|
|
672 |
|
|
|
4.67 |
% |
Trust Preferred Borrowings |
|
|
15,000 |
|
|
|
269 |
|
|
|
7.17 |
% |
|
|
15,000 |
|
|
|
258 |
|
|
|
6.88 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
445,728 |
|
|
$ |
4,483 |
|
|
|
4.02 |
% |
|
|
393,013 |
|
|
$ |
2,976 |
|
|
|
3.03 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest bearing demand |
|
|
73,977 |
|
|
|
|
|
|
|
|
|
|
|
78,339 |
|
|
|
|
|
|
|
|
|
Other Liabilities |
|
|
1,333 |
|
|
|
|
|
|
|
|
|
|
|
4,376 |
|
|
|
|
|
|
|
|
|
Stockholders Equity |
|
|
44,476 |
|
|
|
|
|
|
|
|
|
|
|
36,951 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Liabilities and
Stockholders Equity |
|
$ |
565,514 |
|
|
|
|
|
|
|
|
|
|
$ |
512,679 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Income and Net
Interest Margin |
|
|
|
|
|
$ |
5,327 |
|
|
|
4.01 |
% |
|
$ |
5,413 |
|
|
|
4.47 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
The following tables set forth changes in interest income and interest expense for each major
category of earning assets and interest-bearing liabilities, and the amount of change attributable
to volume and rate changes for the periods indicated. Changes attributable to rate/volume have
been allocated to volume changes.
Table 2. Analysis of Changes in Net Interest Income and Interest Expense
March 31, 2007 over March 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
Volume |
|
|
Rate |
|
|
Total |
|
Increase (Decrease) In
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Income |
|
|
|
|
|
|
|
|
|
|
|
|
Portfolio Loans |
|
$ |
792 |
|
|
$ |
442 |
|
|
$ |
1,234 |
|
Tax-exempt Securities |
|
|
146 |
|
|
|
9 |
|
|
|
155 |
|
US Government Securities |
|
|
(98 |
) |
|
|
31 |
|
|
|
(67 |
) |
Mortgage back Securities |
|
|
0 |
|
|
|
37 |
|
|
|
37 |
|
Federal Funds Sold |
|
|
51 |
|
|
|
19 |
|
|
|
70 |
|
Other Securities |
|
|
(27 |
) |
|
|
19 |
|
|
|
(8 |
) |
|
|
|
|
|
|
|
|
|
|
Total Increase (Decrease) |
|
$ |
864 |
|
|
$ |
557 |
|
|
$ |
1,421 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase (Decrease) In
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense |
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Demand |
|
$ |
46 |
|
|
$ |
278 |
|
|
$ |
324 |
|
Savings Deposits |
|
|
5 |
|
|
|
101 |
|
|
|
106 |
|
Certificates of Deposit |
|
|
600 |
|
|
|
456 |
|
|
|
1,056 |
|
Repurchase Agreements |
|
|
106 |
|
|
|
37 |
|
|
|
143 |
|
FHLB Borrowings |
|
|
(237 |
) |
|
|
104 |
|
|
|
(133 |
) |
Trust Preferred Borrowings |
|
|
0 |
|
|
|
11 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
Total Increase (Decrease) |
|
$ |
520 |
|
|
$ |
987 |
|
|
$ |
1,507 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Increase |
|
$ |
344 |
|
|
$ |
(430 |
) |
|
$ |
(86 |
) |
|
|
|
|
|
|
|
|
|
|
Net interest income was $5.3 million for the first three-months of 2007 compared with $5.4 million
for the same period in 2006, a 1.6% decrease (Tables 1 and 2). The decrease is attributed to an
increase in the volume of certificates of deposit coupled with increases in interest rates during
the period. Average earning assets for the first three-months of 2007 were $530.9 million compared
with $484.3 million for the same period in 2006, an increase of $46.7 million or 9.6%. The single
largest component of increased earning assets was in the loan portfolio. Average loans increased
$38.2 million or 10.3% over the same three-month period in 2006. Coupled with the asset growth,
yields on earning assets increased to 7.39% compared with 6.93 over the same three-month period in
2006, a gain of 46 basis points.
Average interest bearing liabilities also increased by $52.7 million or 13.4% for the first
three-months of 2007 to $445.7 million in 2007 compared with $393.0 million for the same period in
2006. The cost of interest bearing liabilities or funding increased to 4.02% in 2007 compared to
3.03% in 2006, an increase in interest expense of $1.5 million or 50.6%. The increase in interest
expense is primarily due to increased volume in time accounts.
As a result of these changes, the interest spread (the difference between the yield on earning
assets and the cost of interest bearing liabilities) decreased 46 basis points to 4.01% for the
three-months ended March 31, 2007 compared with 4.47% for the same three-month period in the prior
year.
29
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Noninterest Income
The Companys noninterest income consists of service charges on deposit accounts, other fee income,
processing fees for credit card payments and gains or losses on security sales. The following table
sets forth a summary of noninterest income for the periods indicated.
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
Three Months Ended |
|
|
|
March 31, 2007 |
|
|
March 31, 2006 |
|
Noninterest income |
|
|
|
|
|
|
|
|
Service charges on deposit accounts |
|
$ |
69 |
|
|
$ |
88 |
|
Payroll and benefit processing fees |
|
|
108 |
|
|
|
109 |
|
Earnings on cash surrender value - |
|
|
|
|
|
|
|
|
Bank owned life insurance |
|
|
95 |
|
|
|
53 |
|
Net gain on sale of securities available-for-sale |
|
|
46 |
|
|
|
0 |
|
Net gain on sale of loans |
|
|
0 |
|
|
|
1 |
|
Merchant credit card service income, net |
|
|
92 |
|
|
|
77 |
|
Mortgage brokerage fee income |
|
|
6 |
|
|
|
17 |
|
Other income |
|
|
82 |
|
|
|
103 |
|
|
|
|
|
|
|
|
Total noninterest income |
|
$ |
498 |
|
|
$ |
448 |
|
|
Noninterest income increased $50,000 or 11.2% for the quarter ended March 31, 2007 over March 31,
2006. During the first quarter, net gains on sale of securities totaled $46,000. The securities
available-for-sale portfolio was repositioned to take advantage of higher yielding investments in
the municipal sector. Mortgage brokerage fee income decreased by $11,000 for the first quarter 2007
over the same period in 2006, due to decreases in mortgage brokerage volume.
|
|
|
|
|
|
|
|
|
Noninterest Expense |
|
Three Months Ended |
|
(Dollars in thousands) |
|
March 31, 2007 |
|
|
March 31, 2006 |
|
|
Noninterest expense |
|
|
|
|
|
|
|
|
|
Salaries and related benefits |
|
$ |
2,097 |
|
|
$ |
1,878 |
|
Occupancy and equipment expense |
|
|
458 |
|
|
|
435 |
|
FDIC insurance premium |
|
|
13 |
|
|
|
12 |
|
Data processing fees |
|
|
55 |
|
|
|
58 |
|
Professional service fees |
|
|
195 |
|
|
|
204 |
|
Payroll processing fees |
|
|
31 |
|
|
|
29 |
|
Deferred compensation expense |
|
|
97 |
|
|
|
88 |
|
Stationery and supplies |
|
|
61 |
|
|
|
60 |
|
Postage |
|
|
33 |
|
|
|
31 |
|
Directors expense |
|
|
45 |
|
|
|
60 |
|
Other expenses |
|
|
403 |
|
|
|
383 |
|
|
|
|
|
|
|
|
Total noninterest expense |
|
$ |
3,488 |
|
|
$ |
3,238 |
|
|
Noninterest expense for the quarter ended March 31, 2007 was $3.5 million, an increase of $250,000
or 7.7% over the same period a year ago. Salaries and employee benefits represent most of the
increase of $219,000 or 11.7% over the same period a year ago and are attributed to the increases
in production at each location.
30
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Income Taxes
The Company accounts for income taxes under the asset and liability method. Under the asset and
liability method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using currently enacted tax rates applied to such taxable income in the
years in which those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date.
The Companys effective tax rate varies with changes in the relative amounts of its non-taxable
income and non-deductible expenses. The increase in the Companys tax provision is attributable to
decreases in non-taxable income related to a reduction in the municipal security portfolio and
reclassification of enterprise zone qualified credits.
The following table reflects the Companys tax provision and the related effective tax rate for the
periods indicated.
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
Three Months Ended |
|
Income Taxes |
|
March 31, 2007 |
|
|
March 31, 2006 |
|
|
Tax provision |
|
$ |
844 |
|
|
$ |
1,020 |
|
Effective tax rate |
|
|
36.2 |
% |
|
|
39.1 |
% |
|
The Companys provision for income taxes includes both federal and state income taxes and reflects
the application of federal and state statutory rates to the Companys net income before taxes. The
principal difference between statutory tax rates and the Companys effective tax rate is the
benefit derived from investing in tax-exempt securities and enterprise zone qualifying loans.
Increases and decreases in the provision for taxes reflect changes in the Companys net income
before tax, and takes into consideration strategies to increase tax exempt income and tax credits.
On January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48
Accounting for Uncertainty in Income Taxes (FIN 48). Fin 48 prescribes a recognition threshold
that a tax position is required to meet before being recognized in the financial statements and
provides guidance on derecognition, measurement, classification, interest and penalties, accounting
in interim periods and disclosure and transition issues. The Company has analyzed filing positions
of federal and state jurisdictions, as well as all open tax years in these jurisdictions. The
Company believes that its income tax filing positions and deductions will be sustained on audit and
does not anticipate any adjustments that will results in a material change to its financial
position. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to
FIN 48. In addition, the Company did not record a cumulative effect adjustment related to the
adoption of FIN 48.
The Company has an unrealized tax benefit of $3.7 million which did not change significantly during
the three months ended March 31, 2007. The Company does not reasonably estimate that the
unrecognized tax benefit will change significantly within the next twelve months. Deferred tax
assets are recognized subject to management judgment that realization is more likely than not. The
Company recognizes accrued interest and penalties related to unrecognized tax benefits in income
tax expense.
The Company files a consolidated federal and state income tax return. The Company determines
deferred income tax assets and liabilities using the balance sheet method. Under this method, the
net deferred tax asset or liability is based on the tax effects of the differences between book and
tax basis of assets and liabilities, and recognizes enacted changes in tax rates and laws.
31
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
The tax effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities at March 31, 2007 consist of the following:
|
|
|
|
|
|
|
March 31, 2007 |
|
|
Deferred Tax Assets |
|
|
|
|
State Franchise taxes |
|
|
276,048 |
|
Deferred compensation |
|
|
1,735,541 |
|
Loan loss reserves |
|
|
1,926,296 |
|
Net unrealized losses on securities available-for-sale |
|
|
554,133 |
|
Other |
|
|
367,151 |
|
|
|
|
|
Total Deferred Tax Assets |
|
|
4,859,169 |
|
|
|
|
|
|
Deferred Tax Liabilities |
|
|
|
|
Depreciation |
|
|
(229,998 |
) |
Deferred loan origination costs |
|
|
(413,431 |
) |
Deferred state taxes |
|
|
(245,348 |
) |
Other |
|
|
(248,809 |
) |
|
|
|
|
Total Deferred Tax Liabilities |
|
|
(1,137,586 |
) |
|
|
|
|
|
|
|
|
|
Total Net Deferred Tax Asset |
|
$ |
3,721,583 |
|
|
Asset Quality
The Company concentrates its lending activities primarily within El Dorado, Placer, Sacramento,
Shasta, Tehama, Sutter and Yuba counties, California, and the location of the Banks five full
services branches, specifically identified as Upstate California. The Company manages its credit
risk through diversification of its loan portfolio and the application of underwriting policies and
procedures and credit monitoring practices. Although The Company has a diversified loan portfolio,
a significant portion of its borrowers ability to repay the loans is dependent upon the
professional services, commercial real estate market and the residential real estate development
industry sectors. Generally, the loans are secured by real estate or other assets located in
California and are expected to be repaid from cash flows of the borrower or proceeds from the sale
of collateral.
The following table sets forth the amounts of loans outstanding by category as of the dates
indicated:
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
Portfolio Loans |
|
March 31, 2007 |
|
|
December 31, 2006 |
|
|
Commercial and financial loans |
|
$ |
120,801 |
|
|
$ |
121,754 |
|
Real estate-construction loans |
|
|
114,658 |
|
|
|
110,693 |
|
Real estate-commercial |
|
|
155,830 |
|
|
|
159,370 |
|
Real estate- other |
|
|
16,848 |
|
|
|
12,986 |
|
Real estate-mortgage |
|
|
1,372 |
|
|
|
4,278 |
|
Installment |
|
|
179 |
|
|
|
203 |
|
Agricultural |
|
|
5,719 |
|
|
|
3,971 |
|
Other loans |
|
|
1,150 |
|
|
|
937 |
|
Less: |
|
|
|
|
|
|
|
|
Net deferred loan fees |
|
|
(267 |
) |
|
|
(298 |
) |
Allowance for loan losses |
|
|
(4,933 |
) |
|
|
(4,904 |
) |
|
|
|
|
|
|
|
Total net loans |
|
$ |
411,357 |
|
|
$ |
408,990 |
|
|
The Companys practice is to place an asset on nonaccrual status when one of the following events
occur: (i) any installment of principal or interest is 90 days or more past due (unless in
managements opinion the loan is well secured and in the process of collection). (ii) Management
determines the ultimate collection of principal or interest to be unlikely or (iii) the terms of
the loan have been renegotiated due to a serious weakening of the borrowers financial condition.
Nonperforming loans are loans that are on nonaccrual, are 90 days past due and still accruing or
have been restructured.
32
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Net portfolio loans increased $2.4 million or 0.58% at March 31, 2007 over December 31, 2006.
The portfolio mix remains consistent with the mix at December 31, 2006. The balance of the
portfolio remains relatively consistent with the mix at December 31, 2006, with commercial and
financial loans of approximately 31%, real estate construction of approximately 29% and commercial
real estate of approximately 39%. Impaired loans are loans for which it is probable that the
Company will not be able to collect all amounts due and payable. The Company had outstanding
balances of $0 and $0 in impaired loans as of March 31, 2007 and December 31, 2006, respectively.
The following table sets forth a summary of the Companys nonperforming assets as of the dates
indicated:
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
Non performing assets |
|
March 31, 2007 |
|
|
December 31, 2006 |
|
|
Nonaccrual loans |
|
$ |
0 |
|
|
$ |
0 |
|
90 days past due and still accruing
interest |
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
Total nonaccrual loans |
|
|
0 |
|
|
|
0 |
|
Other Real Estate Owned |
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
Total non performing assets |
|
$ |
0 |
|
|
$ |
0 |
|
|
Allowance for Loan and Lease Losses (ALLL)
The allowance for loan and lease losses is managements estimate of the amount of probable loan
losses in the loan portfolio. The Company determines the allowance for loan losses based on an
ongoing evaluation. The evaluation is inherently subjective because it requires material estimates,
including the amounts and timing of cash flows expected to be received on impaired loans. Those
estimates may be susceptible to significant change. The Company makes provisions to the ALLL on a
regular basis through charges to operations that are reflected in the Companys statements of
income as a provision for loan losses. When a loan is deemed uncollectible, it is charged against
the allowance. Any recoveries of previously charged-off loans are credited back to the allowance.
There is no precise method of predicting specific losses or amounts that ultimately may be
charged-off on particular categories of the loan portfolio.
The Companys allowance for loan losses is the accumulation of various components that are
calculated based upon independent methodologies. All components of the allowance for loan losses
represent an estimation performed pursuant to SFAS No. 5, Accounting for Contingencies or SFAS No.
114, Accounting by Creditors for Impairment of a Loan. Managements estimate of each SFAS No. 5
Accounting for Contingencies component is based on certain observable data that management believes
is the most reflective of the underlying loan losses being estimated. Changes in the amount of each
component of the allowance for loan losses are directionally consistent with changes in the
observable data, taking into account the interaction of the SFAS No. 5 components over time.
An essential element of the methodology for determining the allowance for loan losses is the
Companys loan risk evaluation process, which includes loan risk grading individual commercial,
construction, commercial real estate and most consumer loans. Loans are assigned loan risk grades
based on the Companys assessment of conditions that affect the borrowers ability to meet its
contractual obligations under the loan agreement. That process includes reviewing borrowers
current financial information, historical payment experience, loan documentation, public
information, and other information specific to each individual borrower. Loans are reviewed on an
annual or rotational basis or as management become aware of information affecting the borrowers
ability to fulfill its obligations. Loan risk grades carry a dollar weighted risk percentage.
The ALLL is a general reserve available against the total loan portfolio. It is maintained without
any inter-allocation to the categories of the loan portfolio, and the entire allowance is available
to cover loan losses. While management uses available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in economic conditions. In
addition, various regulatory agencies, as an integral part of the examination process, periodically
review the Companys ALLL. Such agencies may require the Company to provide additions to the
allowance based on their judgment of information available to them at the time of
their examination. Accordingly, it is not possible to predict the effect future economic trends may
have on the level of the provision for loan losses in future periods. In addition to the ALLL, an
allowance for unfunded loan commitments and letters of loan is determined using estimates of the
probability of funding. This reserve is carried as a liability on the condensed consolidated
balance sheet.
33
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
The ALLL should not be interpreted as an indication that charge-offs in future periods will
occur in the stated amounts or proportions.
The following table summarizes the activity in the ALLL reserves for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
March 31, 2007 |
|
|
March 31, 2006 |
|
|
Allowance for Loan and Lease Losses |
|
|
|
|
|
|
|
|
Beginning balance for Loan and Lease Losses |
|
$ |
4,904 |
|
|
$ |
4,316 |
|
Provision for Loan and Lease Losses |
|
|
6 |
|
|
|
11 |
|
Charge offs: |
|
|
|
|
|
|
|
|
Commercial |
|
|
(0 |
) |
|
|
(149 |
) |
Real Estate |
|
|
(0 |
) |
|
|
(0 |
) |
Other |
|
|
(0 |
) |
|
|
(0 |
) |
|
|
|
|
|
|
|
Total Charge offs |
|
|
(0 |
) |
|
|
(149 |
) |
|
|
|
|
|
|
|
|
|
Recoveries: |
|
|
|
|
|
|
|
|
Commercial |
|
|
19 |
|
|
|
116 |
|
Real Estate |
|
|
0 |
|
|
|
0 |
|
Other |
|
|
4 |
|
|
|
1 |
|
|
|
|
|
|
|
|
Total Recoveries |
|
|
23 |
|
|
|
117 |
|
|
|
|
|
|
|
|
|
|
Ending Balance |
|
$ |
4,933 |
|
|
$ |
4,295 |
|
ALLL to total loans |
|
|
1.18 |
% |
|
|
1.13 |
% |
Net Charge offs to average loans |
|
|
0.00 |
% |
|
|
0.01 |
% |
|
34
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Securities Portfolio
The Companys available-for-sale securities consists of both debt and marketable equity securities.
The portfolio is comprised of U.S. Treasury securities, U.S. Agency securities, mortgage-backed
securities, and obligations of states and political subdivisions. Securities classified as
available-for-sale are recorded at fair value. Unrealized gains and losses, after applicable income
taxes, are reported in cumulative other comprehensive income. The Company uses the most current
quotations to estimate the fair value of these securities.
Securities classified as held-to-maturity are recorded at cost. Unrealized gains or losses on
available for sale securities, net of the deferred tax effect, are reported as increases or
decreases in stockholders equity. Portions of the securities portfolio are used for pledging
requirements for deposits of state and local subdivisions, securities sold under repurchase
agreements, and FHLB advances.
The Company does not include federal funds sold as securities. These investments are included in
cash and cash equivalents.
Debt securities in the securities available-for-sale portfolio provide asset liquidity, in addition
to the immediately liquid resources of cash and due from banks and federal funds sold.
Total available-for-sale securities increased $124,000 or 0.2% at March 31, 2007 compared to March
31, 2006.
As of March 31, 2007, the Company has pledged $1.0 million of securities for treasury, tax and loan
accounts, $17.2 million for deposits of public funds, approximately $35.1 million for
collateralized repurchase agreements and $15.0 million towards Federal Home Loan Bank borrowings.
The following table summarizes the amortized cost of the Companys available-for-sale securities
held on the dates indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
as of March 31, 2007 |
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
|
|
Costs |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
|
U.S. government & agencies |
|
$ |
26,988 |
|
|
$ |
0 |
|
|
$ |
(473 |
) |
|
$ |
26,515 |
|
Obligations of state and
political subdivisions |
|
|
20,539 |
|
|
|
85 |
|
|
|
(102 |
) |
|
|
20,522 |
|
Mortgage backed securities |
|
|
45,588 |
|
|
|
0 |
|
|
|
(837 |
) |
|
|
44,751 |
|
Corporate Bonds |
|
|
2,000 |
|
|
|
0 |
|
|
|
(19 |
) |
|
|
1,981 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
95,115 |
|
|
$ |
85 |
|
|
$ |
(1,431 |
) |
|
$ |
93,769 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
as of March 31, 2006 |
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
|
|
Costs |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
|
U.S. government & agencies |
|
$ |
42,316 |
|
|
$ |
0 |
|
|
$ |
(957 |
) |
|
$ |
41,359 |
|
Obligations of state and
political subdivisions |
|
|
7,316 |
|
|
|
29 |
|
|
|
(171 |
) |
|
|
7,174 |
|
Mortgage backed securities |
|
|
42,318 |
|
|
|
0 |
|
|
|
(1,220 |
) |
|
|
41,098 |
|
Corporate Bonds |
|
|
4,054 |
|
|
|
0 |
|
|
|
(40 |
) |
|
|
4,014 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
96,004 |
|
|
$ |
29 |
|
|
$ |
(2,388 |
) |
|
$ |
93,645 |
|
|
35
|
|
|
ITEM 3. |
|
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
Market risk is the risk that values of assets and liabilities or revenues will be adversely
affected by changes in market conditions such as market movements. The risk is inherent in the
financial instruments associated with our operations and activities including loans, deposits,
securities, short-term borrowings, long-term debt and derivatives. Market-sensitive assets and
liabilities are generated through loans and deposits associated with our banking business, our
Asset Liability Management (ALM) process, and credit risk mitigation activities. Traditional loan
and deposit products are reported at amortized cost for assets or the amount owed for liabilities.
These positions are subject to changes in economic value based on varying market conditions.
Interest rate risk is the effect of changes in economic value of our loans and deposits, as well as
our other interest rate sensitive instruments and is reflected in the levels of future income and
expense produced by these positions versus levels that would be generated by current levels of
interest rates. We seek to mitigate interest rate risk as part of the ALM process.
Interest rate risk, which potentially can have a significant earnings impact, is an integral part
of financial services. The Company is subject to interest rate risk for the following reasons:
|
|
|
Assets and liabilities may mature or reprice at different times (for example, if assets
reprice faster than liabilities and interest rates fall, earnings will initially decline); |
|
|
|
|
Assets and liabilities may reprice at the same time but by different amounts (for
example, the level of interest rates in the market is falling and the Company may reduce
rates paid on checking and savings deposit accounts by an amount that is less than the
general decline in market rates); |
|
|
|
|
Short-term and long-term market interest rates may change by different amounts (for
example, the shape of the yield curve may affect new loan yields and funding costs
differently); or |
|
|
|
|
The remaining maturities of various assets and liabilities may shorten or lengthen as
interest rates change (for example, if long-term mortgage rates decline sharply,
mortgage-backed securities held in the securities available-for-sale may prepay
significantly earlier than anticipated, which could reduce portfolio income.) |
Our overall goal is to manage interest rate sensitivity so that movements in interest rates do not
adversely affect net interest income. Interest rates risk is measured as the potential volatility
in our net interest income caused by changes in market interest rates. Lending and deposit taking
create interest rate sensitive positions on our balance sheet. Interest rate risk from these
activities as well as the impact of ever changing market conditions is mitigated using the ALM
process. The Company does not operate a trading account and does not hold a position with exposure
to foreign currency exchange or commodities. The Company faces market risk through interest rate
volatility.
The Board of Directors has overall responsibility for the Companys interest rate risk management
policies. The Company has an Asset/Liability Management Committee (ALCO) which establishes and
monitors guidelines to control the sensitivity of earnings to changes in interest rates. The
internal ALCO Roundtable group maintains a net interest income forecast using different rate
scenarios utilizing a simulation model. This group updates the net interest income forecast for
changing assumptions and differing outlooks based on economic and market conditions.
The simulation model used includes measures of the expected repricing characteristics of
administered rate (NOW, savings and money market accounts) and non-related products (demand deposit
accounts, other assets and other liabilities). These measures recognize the relative sensitivity of
these accounts to changes in market interest rates, as demonstrated through current and historical
experience, recognizing the timing differences of rate changes. In the simulation of net interest
margin and net income the forecast balance sheet is processed against five rate scenarios. These
five rate scenarios include a flat rate environment, which assumes interest rates are unchanged in
the future and four additional rate ramp scenarios ranging for + 200 to 200 basis points in 100
basis point increments, unless the rate environment cannot move in these basis point increments
before reaching zero.
The formal policies and practices adopted by the Company to monitor and manage interest rate risk
exposure
measure risk in two ways: (i) repricing opportunities for earning assets and interest-bearing
liabilities and (ii) changes in net interest income for declining interest rate shocks of 100 to
200 basis points. Because of the Companys predisposition to variable rate, pricing and noninterest
bearing demand deposit accounts the Company is asset sensitive.
36
As a result, management anticipates that, in a declining interest rate environment, the Companys
net interest income and margin would be expected to decline, and, in an increasing interest rate
environment, the Companys net interest income and margin would be expected to increase. However,
no assurance can be given that under such circumstances the Company would experience the described
relationships to declining or increasing interest rates. Because the Company is asset sensitive,
the Company is adversely affected by declining rates rather than rising rates.
To estimate the effect of interest rate shocks on the Companys net interest income,
management uses a model to prepare an analysis of interest rate risk exposure. Such analysis
calculates the change in net interest income given a change in the federal funds rate of 100 or 200
basis points up or down. All changes are measured in dollars and are compared to projected net
interest income. At March 31, 2006, the estimated annualized reduction in net interest income
attributable to a 50 and 100 basis point decline in the federal funds rate was $1,025,066 and
$2,858,261, respectively. At March 31, 2007, the estimated annual increase in net interest income
attributable to a 100 and 200 basis point increase in the federal funds rate was $262,294 and
$431,384. At December 31, 2006, the estimated annualized reduction in net interest income
attributable to a 100 and 200 basis point decline in the federal funds rate was $1,197,142 and
$2,093,350, respectively, with a similar and opposite result attributable to a 100 and 200 basis
point increase in the federal funds rate.
The ALCO has established a policy limitation to interest rate risk of -14% of net interest margin
and -12% of the present value of equity.
The securities portfolio is integral to our asset liability management process. The decision to
purchase or sell securities is based upon the current assessment of economic and financial
conditions, including the interest rate environment, liquidity, regulatory requirements and the
relative mix of our cash positions.
The Companys approach to managing interest rate risk may include the use of derivatives. This
helps to minimize significant, unplanned fluctuations in earnings, fair values of assets and
liabilities and cash flows caused by interest rate volatility. This approach involves modifying the
repricing characteristics of certain assets and liabilities so that changes in interest rates do
not have a significant adverse effect on the net interest margin and cash flows. As a result of
interest rate fluctuations, hedged assets and liabilities will gain or lose market value. In a fair
value hedging strategy, the effect of this unrealized gain or loss will generally be offset by
income or loss on the derivatives linked to the hedged assets and liabilities. For a cash flow
hedge, the change in the fair value of the derivative to the extent that it is effective is
recorded through other comprehensive income.
We may use derivatives as part of our interest rate risk management, including interest rate swaps,
caps and floors. At inception, the relationship between hedging instruments and hedged items is
formally documented with our risk management objective, strategy and our evaluation of
effectiveness of the hedge transactions. This includes linking all derivatives designated as fair
value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific
transactions. Periodically, as required, we formally assess whether the derivative we designated
in the hedging relationship is expected to be and has been highly effective in offsetting changes
in fair values or cash flows of the hedged item.
The Companys use of derivatives is monitored by the Directors ALCO committee. During 2006 the
Board of Directors approved a cash flow hedge up to a notional amount of $100 million. The ALCO
Roundtable initiated a forward starting swap transaction with Morgan Keegan as the counterparty.
Two transactions, $60 million and $40 million, aggregating $100 million were executed, both
commencing on December 1, 2006 and maturing on June 1, 2009. Under the $60 million swap
transaction, the Company will receive, on a monthly basis, a fixed rate of 7.90% and pay Morgan
Keegan a floating rate payment tied to the Wall Street Prime Index commencing on January 1, 2007.
Under the $40 million swap transaction the Company will receive, on a monthly basis, a fixed rate
of 7.95% and pay Morgan Keegan a floating rate payment tied to the Wall Street Prime Index
commencing on January 1, 2007. The $40 million swap has a Prime Indexed embedded floor of 6.5%. The
purpose of this strategy is to protect or hedge net interest income in a declining rate
environment.
37
ITEM 4. CONTROLS AND PROCEDURES
As required by SEC rules the Company carried out an evaluation, under the supervision and with the
participation of the Companys management, including the Companys President and Chief Executive
Officer and with the Companys Chief Financial Officer, of the effectiveness of the design and
operation of the Companys disclosure controls and procedures, pursuant to Exchange Act Rule
13a-14.
As part of the disclosure controls and procedures, management has formed the SEC Disclosure
Committee. This committee reviews the quarterly filing to a disclosure checklist to ensure that all
functional areas of the Company have participated in the disclosure review. In addition,
operational and accounting audits are performed ongoing throughout the year by the Companys
internal auditors to support the control structure.
Based upon that evaluation, the Companys President and Chief Executive Officer along with the
Companys Chief Financial Officer concluded that the Companys disclosure controls and procedures
are effective in timely alerting them to material information relating to the Company (including
its consolidated subsidiaries) required to be included in this Form 10-Q.
There have been no significant changes in the Companys internal controls, or in other factors,
which would significantly affect internal controls subsequent to the date the Company carried out
its evaluation.
38
PART II. Other Information
Item 1. Legal proceedings
The Company is involved in various pending and threatened legal actions arising in the ordinary
course of business. The Company maintains reserves for losses from legal actions, which are both
probable and estimable. In the opinion of management, the disposition of claims, currently pending
will not have a material adverse affect on the Companys financial position or results of
operations.
Item 1a. Risk Factors
There have been no material changes from the risk factors previously disclosed in the registrants
Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
N/A
Item 3. Defaults upon Senior Securities
N/A.
Item 4. Submission of Matters to a vote of Security Holders
N/A
Item 5. Other Information
N/A
Item 6A. Exhibits
(31.1) Certification of Chief Executive Officer pursuant to Sarbanes-Oxley Act of 2002
(31.2) Certification of Chief Financial Officer pursuant to Sarbanes-Oxley Act of 2002
(32) Certification of Chief Executive Officer and Chief Financial Officer pursuant to
Sarbanes-Oxley Act of 2002
Item 6B. Reports on Form 8-K
Form 8-K dated 5/2/07 1st Quarter Earnings Release
Form 8-K dated 4/20/07 Lease Agreement Placer Heights Plaza
Form 8-K dated 4/12/07 Cardinal Software license agreement
Form 8-K dated 3/29/07 1st Quarter Dividend
SIGNATURES
Following the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BANK OF COMMERCE HOLDINGS
(Registrant)
Date: May 04, 2007
|
|
|
|
|
|
|
|
|
/s/ Linda J. Miles
|
|
|
Linda J. Miles |
|
|
Executive Vice President &
Chief Financial Officer |
|
|
39