Hanmi Financial - 10-Q quarterly report FY

 

     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 an accelerated filer (as defined in Rule 12b-2 of the Act).                             Yes þ No o

     As of August 1, 2005, there were 49,702,443 outstanding shares of the issuer’s Common Stock.

See Accompanying Notes to Consolidated Financial Statements

See Accompanying Notes to Consolidated Financial Statements

See Accompanying Notes to Consolidated Financial Statements

     Hanmi Financial Corporation (“Hanmi Financial”, “we” or “our”) is a Delaware corporation that is the holding company for Hanmi Bank (the “Bank”) and is subject to the Bank Holding Company Act of 1956, as amended.

     Hanmi Bank, our primary subsidiary, is a commercial bank licensed by the California Department of Financial Institutions. The Bank’s deposit accounts are insured under the Federal Deposit Insurance Act, up to the applicable limits thereof. The Bank is a member of the Federal Reserve System.

     Our primary operations are related to traditional banking activities, including the acceptance of deposits and the lending and investing of money through operation of the Bank. Hanmi Bank is a community bank conducting general business banking with its primary market encompassing the multi-ethnic population of Los Angeles, Orange, San Diego, San Francisco and Santa Clara counties. Hanmi Bank’s full-service offices are located in business areas where many of the businesses are run by immigrants and other minority groups. Hanmi Bank’s client base reflects the multi-ethnic composition of these communities. The Bank is a California state-chartered, FDIC-insured financial institution.

     On April 30, 2004, we completed the acquisition of Pacific Union Bank (“PUB”), a $1.2 billion (assets) commercial bank headquartered in Los Angeles that also served primarily the Korean-American community. As of June 30, 2005, the Bank maintained a branch network of 22 locations, serving individuals and small- to medium-sized businesses in Los Angeles and surrounding areas.

     In the opinion of management, the consolidated financial statements of Hanmi Financial Corporation and subsidiary reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods ended June 30, 2005, but are not necessarily indicative of the results that will be reported for the entire year. In the opinion of management, the aforementioned consolidated financial statements are in conformity with accounting principles generally accepted in the United States of America. The interim information should be read in conjunction with our 2004 Annual Report on Form 10-K.

     Descriptions of our significant accounting policies are included in “Note 1 — Summary of Significant Accounting Policies” in our 2004 Annual Report on Form 10-K. Certain reclassifications were made to the prior periods’ presentation to conform to the current period’s presentation.

     On January 20, 2005, our Board of Directors declared a two-for-one stock split, to be effected in the form of a 100 percent common stock dividend. The new shares were distributed on February 15, 2005 to shareholders of record on the close of business on January 31, 2005. All share and per share amounts for the prior periods have been restated to reflect the stock dividend.

THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004 (Continued)

     Our employee stock-based compensation arrangements are measured under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”Accordingly, no compensation expense has been recognized for the stock option plan, as stock options were granted at fair value at the date of grant. Had compensation expense for the stock option plan been determined based on the fair values estimated using the Black-Scholes model at the grant dates for previous awards, our net income and earnings per share would have been reduced to the pro forma amounts indicated below:

     In February 2005, 100,000 shares of restricted stock were granted to Dr. Sung Won Sohn, our Chief Executive Officer. 20,000 of these shares vested immediately, and an additional 20,000 shares will vest each year over the next four years on the anniversary date of the grant. The market value of the shares awarded totaled $1,815,000. The 20,000 shares that vested immediately were recorded as compensation expense and the remaining 80,000 shares were recorded as unearned compensation, a separate component of shareholders’ equity. Unearned compensation is being amortized against income over the four-year vesting period. For the three and six months ended June 30, 2005, compensation expense of $91,000 and $484,000, respectively, was recognized in the consolidated statements of income.

     Earnings per share (“EPS”) is calculated on both a basic and a diluted basis. Basic EPS excludes dilution and is computed by dividing income available to common stockholders 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 from the issuance of common stock that then shared in earnings, excluding common shares in treasury.

THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004 (Continued)

     The following table presents a reconciliation of the components used to derive basic and diluted EPS for the periods indicated.

     For the three and six months ended June 30, 2005, there were 430,554 and 395,554 options outstanding, respectively, that were not included in the computation of diluted EPS because their exercise price was greater than the average market price of the common shares and, therefore, the effect would be anti-dilutive. For the three and six months ended June 30, 2004, there were 386,500 and 382,500 options outstanding, respectively, that were not included in the computation of diluted EPS.

     During 2004, the Bank entered into one interest rate swap agreement, wherein the Bank received a fixed rate of 7.29 percent at quarterly intervals, and paid Prime-based floating rates, at quarterly intervals, on a total notional amount of $10.0 million. This swap agreement matures in 2009 and was designated as a cash flow hedge for accounting purposes. During 2003, the Bank entered into four interest rate swap agreements, wherein the Bank received fixed rates of 5.77 percent, 6.37 percent, 6.51 percent and 6.76 percent, at quarterly intervals, and paid Prime-based floating rates, at quarterly intervals, on a total notional amount of $60.0 million. All four of the swap agreements mature in 2008. These swaps were designated as hedges for accounting purposes. As of June 30, 2005, the total notional amount of interest rate swaps was $70.0 million.

     As of June 30, 2005, the fair value of the interest rate swaps was in an unfavorable position of $859,000. A total of ($532,000), net of tax, was included in Other Comprehensive Income. No income related to hedge ineffectiveness was recognized for the six months ended June 30, 2005.

THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004 (Continued)

     In 2004, the Bank offered a certificate of deposit (“CD”) product that pays interest tied to the movement in the Standard & Poor’s 500 Index. The economic characteristics and risks of the embedded option are not clearly and closely related to the CD. Therefore, the embedded option is separated from the CD and accounted for separately in liabilities. As of June 30, 2005, the fair value of the embedded option was $990,000 and the change in the liability during the six months ended June 30, 2005 was $406,000. The change was recognized in earnings.

     To economically hedge the interest risk, the Bank entered into an agreement to purchase an equity swap. As of June 30, 2005, the fair value of the equity swap was $4,000, which was also equal to the change during the year. The change was recognized in earnings.

     As part of the Bank’s services to small- and medium-sized business customers, the Bank issues formal loan commitments and letters of credit. These commitments can be either secured or unsecured. They may be in the form of revolving lines of credit for seasonal working capital needs or may take the form of commercial letters of credit or standby letters of credit. Commercial letters of credit facilitate import trade. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.

     The following table shows the distribution of the Hanmi Bank’s undisbursed loan commitments and letters of credit as of the dates indicated.

     In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using the intrinsic method that is currently used and requires that such transactions be accounted for using a fair value-based method and recognized as expense in the Consolidated Statements of Income. SFAS No. 123R was to be effective as of the beginning of the third quarter of 2005; however, on April 14, 2005, the Securities and Exchange Commission adopted a new rule that deferred the required adoption date to the beginning of the first quarter of 2006. We have provided pro forma disclosures under SFAS No. 123 in “Note 3 — Employee Stock-Based Compensation.”

THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004 (Continued)

     In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 is a replacement of Accounting Principles Board (“APB”) Opinion No. 20, “Accounting Changes,” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements (an Amendment of APB Opinion No. 28).” SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application as the required method for reporting a change in accounting principle. SFAS No. 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS No. 154. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 31, 2005. We will adopt this pronouncement beginning in fiscal year 2006.

     On July 20, 2005, following a joint regular examination by the Federal Reserve Bank (“FRB”) and the California Department of Financial Institutions, the Bank’s Board of Directors, approved and signed an informal memorandum of understanding (“Memorandum”) in connection with certain deficiencies identified by the regulators relating to the Bank’s compliance with certain provisions of the Bank Secrecy Act (the “BSA”) and anti-money laundering regulations. Under the terms of the Memorandum, the Bank must comply in all material respects with the BSA and take certain actions within various timeframes. The Memorandum requires in part that the Bank enhance its written programs designed to ensure and maintain compliance with the BSA and anti-money laundering regulations, improve documentation of its compliance with suspicious activity reporting provisions of applicable regulations and provide regular compliance reports to the regulators. The implementation of these programs will include revisions of the Bank’s policies, processes and procedures, enhancements of the Bank’s system of internal controls for BSA compliance, retention of and support from an increased compliance staff and improved ongoing employee training.

     Management expects additional BSA compliance expenses for the Bank resulting from the Memorandum, although these expenses are not anticipated to have a material financial impact on our financial position or results of operations. The Memorandum may also affect the timing or ability of the Bank or Hanmi Financial to engage in or obtain regulatory approval for certain expansionary activities.

     The following is management’s discussion and analysis of the major factors that influenced our results of operations and financial condition for the three and six months ended June 30, 2005. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2004 and with the unaudited consolidated financial statements and notes thereto set forth in this Report.

     We have established various accounting policies that govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in our Annual Report on Form 10-K for the year ended December 31, 2004. Certain accounting policies require us to make significant estimates and assumptions that have a material impact on the carrying value of certain assets and liabilities, and we consider these to be critical accounting policies. The estimates and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions that could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods. Management has discussed the development and selection of these critical accounting policies with the Audit Committee of our Board of Directors.

     We believe the allowance for loan losses and allowance for off-balance sheet items, such as unfunded loan commitments and letters of credit, are critical accounting policies that require significant estimates and assumptions that are particularly susceptible to significant change in the preparation of our financial statements. See “Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition — Financial Condition — Allowance for Loan Losses and Allowance for Off-Balance Sheet Items” for a description of the methodology used to determine the allowance for loan losses and allowance for off-balance sheet items.

     During the year ended December 31, 2004, the application of SFAS No. 141, “Business Combinations,” to the purchase of Pacific Union Bank (“PUB”) required significant estimates and assumptions. We engaged outside experts including appraisers to assist in estimating the fair values of certain assets acquired, particularly the loan portfolio, core deposit intangible asset and fixed assets. The fair values of financial assets, including the investments portfolio, deposits and borrowings, were estimated by the Bank, using market data regarding securities market prices and interest rates. We also evaluated long-lived assets for impairment and recorded any necessary adjustments. In accordance with Emerging Issues Task Force Issue No. 95-3, “Recognition of Liabilities in Connection With a Purchase Business Combination,” we recognized liabilities assumed for costs to involuntarily terminate employees of PUB and costs to exit activities of PUB under an exit plan approved by Hanmi Bank’s board of directors.

     The following tables sets forth certain selected financial data for the periods indicated.

     Some of the statements under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-Q constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms and other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ from those expressed or implied by the forward-looking statement. For additional information concerning these factors, see our Form 10-K filed with the Securities and Exchange Commission on March 16, 2005 under the headings “Factors That May Affect Future Results of Operations,” “Interest Rate Risk Management” and “Liquidity and Capital Resources.” We undertake no obligation to update these forward-looking statements to reflect events or circumstances that occur after the date on which such statements were made.

     On April 30, 2004, we completed the merger with Pacific Union Bank (“PUB”). As a result, operating results for the three and six months ended June 30, 2004 include only two months of results following the merger with PUB. Operating results reflect the resulting increase in average total assets from $2.67 billion and $2.22 billion in the three and six month periods ended June 30, 2004, respectively, to $3.17 billion and $3.14 billion in the three and six month periods ended June 30, 2005, respectively.

     For the three months ended June 30, 2005, net income was $15.0 million, or $0.30 per diluted share, compared to $7.5 million, or $0.18 per diluted share, for the three months ended June 30, 2004. The 99.3 percent increase in net income for 2005 as compared to 2004 was primarily due to an increase of 85 basis points in the net interest margin, the acquisition of PUB and asset growth subsequent to the acquisition of PUB. Net interest income before provision for credit losses increased $10.1 million, or 42.0 percent, due to ongoing growth in the loan portfolio as well as the newly acquired interest-earning assets from PUB. Non-interest income increased by $440,000, or 6.3 percent, due to a 12.5 percent increase in services charges and fees and an increase in the fair value of derivatives, partially offset by a 93.3 percent decrease in gain on sales of loans. Non-interest expenses decreased by $1.6 million, or 8.7 percent, due to one-time merger-related expenses in the prior year. The annualized return on average assets was 1.90 percent for the three months ended June 30, 2005, compared to an annualized return on average assets of 1.14 percent for the same period of 2004, an increase of 76 basis points. The annualized return on average shareholders’ equity was 14.48 percent for the three months ended June 30, 2005, and the annualized return on average tangible equity was 30.61 percent, compared to 10.02 percent and 19.83 percent, respectively, for the same period in 2004.

     For the six months ended June 30, 2005, net income was $28.4 million, or $0.56 per diluted share, compared to $13.9 million, or $0.39 per diluted share, for the six months ended June 30, 2004. The 103.6 percent increase in net income for 2005 as compared to 2004 was primarily due to an increase of 77 basis points in the net interest margin, the acquisition of PUB and asset growth subsequent to the acquisition of PUB. Net interest income before provision for credit losses increased $25.0 million, or 61.2 percent, due to ongoing growth in the loan portfolio as well as the newly acquired interest-earning assets from PUB. Non-interest income increased by $3.0 million, or 25.5 percent, mainly due to an increase in service charges on deposit accounts. Non-interest expenses increased by $5.5 million, or 19.5 percent, due to the additional salaries and employee benefits, occupancy, professional fees, data processing and core deposit intangible amortization expenses incurred following the merger, offset by decreased merger-related expenses. The annualized return on average assets was 1.82 percent for the six months ended June 30, 2005, compared to an annualized return on average assets of 1.26 percent for the same period of 2004, an increase of 56 basis points. The annualized return on average shareholders’ equity was 13.91 percent for the six months ended June 30, 2005, and the annualized return on average tangible equity was 29.93 percent, compared to 12.48 percent and 18.85 percent, respectively, for the same period in 2004.

     Return on average tangible equity is supplemental financial information determined by a method other than in accordance with accounting principles generally accepted in the United States of America (“GAAP”). This non-GAAP measure is used by management in the analysis of Hanmi Financial’s performance. Average tangible equity is calculated by subtracting average goodwill and average core deposit intangible assets from average shareholders’ equity. Banking and financial institution regulators also exclude goodwill and intangibles from shareholders’ equity when assessing the capital adequacy of a financial institution. Management believes the presentation of this financial measure excluding the impact of these items provides useful supplemental information that is essential to a proper understanding of the financial results of Hanmi Financial, as it provides a method to assess management’s success in utilizing tangible capital. This disclosure should not be viewed as a substitution for results determined in accordance with GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.

     The following table reconciles this non-GAAP performance measure to the GAAP performance measure for the periods indicated:

     Our earnings depend largely upon the difference between the interest income received from the loan portfolio and other interest-earning assets and the interest paid on deposits and borrowings. The difference is “net interest income.” Net interest income, when expressed as a percentage of average total interest-earning assets, is referred to as the net interest margin. Net interest income is affected by the change in the level and mix of interest-earning assets and interest-bearing liabilities, referred to as volume changes. Net interest income is also affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes. Interest rates charged on loans are affected principally by the demand for such loans, the supply of money available for lending purposes and competitive factors. Those factors are, in turn, affected by general economic conditions and other factors beyond our control, such as Federal economic policies, the general supply of money in the economy, income tax policies, governmental budgetary matters and the actions of the Federal Reserve Bank.

     For the three months ended June 30, 2005, net interest income before provision for credit losses was $34.0 million. This represented an increase of $10.1 million, or 42.0 percent, over net interest income before provision for credit losses of $24.0 million for the three months ended June 30, 2004. The interest rate spread increased to 4.07 percent for the three months ended June 30, 2005, from 3.50 percent for the same period in 2004. The change was mainly due to an increase in rates received on loans and investments as our prime rate and the Wall Street Journal prime rate both increased by a total of 50 basis points during the second quarter. Approximately 86.0 percent of our loan portfolio is tied to the Wall Street Journal prime rate or our prime rate. We also emphasized spread income and disposed of certain low yielding assets in the first and second quarters of 2004 and reinvested the proceeds from the amortization of our investment portfolio into loan production. Average loans outstanding increased from 80.1 percent of average interest-earning assets in the second quarter of 2004 to 83.6 percent of average interest-earning assets in the second quarter of 2005. The net interest margin also increased by 85 basis points to 4.89 percent for the three months ended June 30, 2005, from 4.04 percent for the same period in 2004, due to an increase in the volume of interest-earning assets with higher interest rates.

     For the six months ended June 30, 2005, net interest income before provision for credit losses was $65.8 million. This represented an increase of $25.0 million, or 61.2 percent, over net interest income before provision for credit losses of $40.8 million for the six months ended June 30, 2004. The interest rate spread increased to 4.03 percent for the six months ended June 30, 2005, from 3.49 percent for the same period in 2004. The change was mainly due to an increase in rates received on loans and investments as we increased our prime rate by a total of 100 basis points during the first half of 2005. We also emphasized spread income and disposed of certain low yielding assets in the first and second quarters of 2004 and reinvested the proceeds from the amortization of our investment portfolio into loan production. Average loans outstanding increased from 78.3 percent of average interest-earning assets in the first half of 2004 to 82.7 percent of average interest-earning assets in the first half of 2005. The net interest margin also increased by 77 basis points to 4.80 percent for the six months ended June 30, 2005, from 4.03 percent for the same period in 2004, due to an increase in the volume of interest-earning assets with higher interest rates.

     Total interest income increased $16.0 million, or 51.0 percent, to $47.5 million for the three months ended June 30, 2005, from $31.5 million for the three months ended June 30, 2004. The increase was the result of a yield increase of 152 basis points on average interest-earning assets and an increase in average interest-earning assets of $408.0 million, or 17.1 percent, to $2.79 billion, compared to $2.39 billion a year ago. Total interest income increased $37.1 million, or 69.4 percent, to $90.6 million for the six months ended June 30, 2005, from $53.5 million for the six months ended June 30, 2004. The increase was the result of a yield increase of 132 basis points on average interest-earning assets and an increase in average interest-earning assets of $730.7 million, or 35.9 percent, to $2.77 billion, compared to $2.03 billion a year ago.

     Total interest expense increased $6.0 million, or 79.9 percent, to $13.5 million for the three months ended June 30, 2005, from $7.5 million for the three months ended June 30, 2004. The increase reflects an increase in average interest-bearing liabilities and higher interest rates paid to depositors. Average interest-bearing liabilities increased by $288.6 million, or 17.3 percent, to $1.96 billion, compared to $1.67 billion a year ago. The cost of average interest-bearing liabilities increased to 2.75 percent for the three months ended June 30, 2005, compared to 1.80 percent for the same period in 2004. Total interest expense increased $12.2 million, or 96.1 percent, to $24.8 million for the six months ended June 30, 2005, from $12.7 million for the six months ended June 30, 2004. The increase reflects an increase in interest-bearing liabilities and higher interest rates paid to depositors. Average interest-bearing liabilities increased by $519.3 million, or 36.5 percent, to $1.94 billion, compared to $1.42 billion a year ago. The cost of average interest-bearing liabilities increased to 2.57 percent for the six months ended June 30, 2005, compared to 1.79 percent for the same period in 2004.

     The following tables present the average balances of assets, liabilities and shareholders’ equity; the amount of interest income or interest expense; the average yield or rate for each category of interest-earning assets and interest-bearing liabilities; and the net interest spread and the net interest margin for the periods indicated. All average balances are daily average balances.