UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
(Mark One)
Hanmi Financial Corporation (Exact name of registrant as specified in its charter)
(213) 382-2200 (Registrant's telephone number, including area code)
Not Applicable (Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes /x/ No / /
As of September 30, 2001, there were approximately 12,548,016 outstanding shares of the issuer's Common Stock, with par value at $.001.
FORM 10-Q INDEX HANMI FINANCIAL CORPORATION
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HANMI FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
See accompanying notes to unaudited consolidate financial statements.
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HANMI FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Unaudited)
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HANMI FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Unaudited)
(Amounts in thousands)
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Notes to Consolidated Financial Statements
Note 1. Hanmi Financial Corporation
Hanmi Financial Corporation (the "Hanmi Financial" or the "Company") is a Delaware corporation incorporated on March 14, 2000 pursuant to a Plan of Reorganization and Agreement of Merger to be the holding company for Hanmi Bank (the "Hanmi Bank"). The Company became the holding company for Hanmi Bank in September 2000, and is subject to the Bank Holding Company Act of 1956, as amended.
Hanmi Bank, the sole subsidiary of the Company, was incorporated under the laws of the State of California on August 24, 1984, and was licensed by the California Department of Financial Institutions on December 15, 1982. The Federal Deposit Insurance Corporation insures Hanmi Bank's deposit accounts. Hanmi Bank's headquarter office is located at 3660 Wilshire Boulevard, Penthouse suite "A", Los Angeles, California 90010.
Hanmi Bank is a community bank conducting general business banking with its primary market encompassing the multi-ethnic population of the Los Angeles, Orange and San Diego counties. Hanmi Bank's full-service branch 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. Hanmi Bank currently has twelve full-service branch offices located in Los Angeles, Orange and San Diego counties. Of the twelve offices, Hanmi Bank opened nine as de novo branches and acquired the other three through acquisition.
Note 2. Basis of Presentation
In the opinion of management, the consolidated financial statements of Hanmi Financial Corporation and its subsidiary (the "Company") reflect all the material adjustments necessary for a fair presentation of the results for the nine month period ended September 30, 2001. The results of the interim period are not necessarily indicative of the results which 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.
Note 3. Accounting Matters
The Company adopted the provision of Statement of financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instrument and Hedging Activities", as amended by SFAS Nos. 137 and 138, as of January 1, 2001. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities.
No transition adjustment was required at January 1, 2001. The swaps existing at January 1, 2001 were terminated during the first quarter of 2001 with an insignificant effect on earnings. No derivatives were outstanding at September 30, 2001.
Notes 4. Other Information
On September 14, 2001, the Hanmi Bank, a sole subsidiary of the Company, opened a de novo branch in Irvine, CA. It is the twelfth branch opened, and is strategically located between Garden Grove and San Diego Branch.
On August 16, 2001, the Company announced a three-for-two stock split. The split is to be effected in the form of a common stock dividend, payable to the corporation's stockholders of record as of August 31, 2001. Hanmi Financial stockholders of record at the close of business on August 31, 2001 have received stock certificates representing one additional share of Hanmi Financial common stock for every two shares of common stock then held. Distribution of additional shares issued as a result of the split occurred on September 21, 2001.
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The split is designed to improve trading liquidity and broaden ownership of Hanmi Financial's common shares. After the split, there are 12,548,016 shares outstanding.
Note 5. Recent Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", it retains many of the fundamental provisions of that Statement. The statement is effective for fiscal years beginning after December 15, 2001 and must be adopted as of the beginning of the fiscal year. Management does not expect the implementation of SFAS No. 144 to have a material impact on the Company's consolidated financial statements.
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement No. 143, "Accounting for Asset Retirement Obligations," ("SFAS No. 143"), which requires that the fair value of a liability for an asset retirement obligation must be recognized in the period in which it is incurred or reasonable estimate of fair value can be made. The associated asset retirement cost would be capitalized as part of the carrying amount of the long-lived asset and depreciated over the life of the asset. The liability is recorded at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement. The provisions of SFAS No. 143 are effective for fiscal years beginning after June 15, 2002. Management does not yet determined the impact, if any, of adoption of SFAS No. 143.
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement No. 141, "Business Combinations" ("SFAS 141") and Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after September 30, 2001 as well as all purchase method business combinations completed after September 30, 2001. SFAS 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted separately. SFAS 141 will require, upon adoption of Statement 142, that the Company evaluate its existing goodwill that was acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform with the new criteria in SFAS 141 for recognition apart from goodwill.
SFAS 142 requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. The amortization of goodwill ceases upon adoption of SFAS 142, which for the Company, will be January 1, 2002. Upon adoption of SFAS 142, the Company will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of SFAS 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. Management does not expect that the adoption of SFAS 142 will have a material impact on the Company's results of operations or financial position, however management expects to complete its analysis of the impact of adopting SFAS 142 by the 4th quarter 2001. As of September 30, 2001, the Company had $1.9 million of goodwill and approximately $364,000 of core deposit intangibles.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140"), which the Company fully adopted by April 1, 2001. Adoption of SFAS 140 did not have a material impact to the Company's consolidated financial statements.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following is management's discussion and analysis of the major factors that influenced the Company's results of operations and financial condition for the three and nine months ended September 30, 2001. This analysis should be read in conjunction with the Company's Annual Report included in Form 10-K for the year ended December 31, 2000 and with the unaudited financial statements and notes as set forth in this report.
The following table sets forth certain selected financial data concerning the Company for the nine month periods indicated (dollars in thousands):
Forward-Looking Information
Certain matters discussed under this caption may constitute forward-looking statements under Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934. There can be no assurance that the results described or implied in such forward-looking statements will, in fact, be achieved and actual results, performance, and achievements could differ materially because the business of the Company involves inherent risks and uncertainties. Risks and uncertainties include
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possible future deteriorating economic conditions in the Company's areas of operation; interest rate risk associated with volatile interest rates and related asset-liability matching risk; liquidity risks; risk of significant non-earning assets, and net credit losses that could occur, particularly in times of weak economic conditions or times of rising interest rates; risks of available for sale securities declining significantly in value as if interest rates rise; and regulatory risks associated with the variety of current and future regulations to which the Company is subject. For additional information concerning these factors, see "Interest Rate Risk Management", and "Liquidity and Capital Resources" contained in the Company's annual 10-K.
Results of Operations
For the third quarter of 2001, the Company reported net income of $4.4 million or $0.35 per diluted share compared to $3.8 million or $0.31 per diluted share for the same quarter of 2000, representing an increase of approximately $600,000 or 15.79%. The increase in net income was primarily attributable to a $1.3 million increase in net interest income due to balanced growth in both loans and deposits, and $1.0 million increase in gain on sale of available-for-sale securities, which was off set by a $1.2 million increase in non-interest expense due to expanding of branch net working.
The annualized return on average assets was 1.55% for the third quarter of 2001 compared to a return on average assets of 1.80% for the same quarter of 2000, a decrease of 25 basis points. The annualized return on average equity was 17.97% for the third quarter of 2001, compared to a return on average equity of 19.62% for the same quarter in 2000, a decrease of 165 basis points. The decrease was mainly due to growth in assets.
For the nine months ended September 30, 2001, the Company reported net income of $12.6 million or $1.00 per basic and $.99 per diluted common share, compared with $11.3 million or $.90 per basic and diluted common share for the same period of 2000. This represented an increase of approximately $1.3 million or 11.7%.
Net Interest Income
The principal component of the Company's earnings is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and other borrowed funds. When net interest income is expressed as a percentage of average interest-earning assets, the result is the net interest margin. The net interest spread is the yield on average interest-earning assets less the average cost of interest-bearing deposits and borrowed funds.
For the third quarter of 2001, net interest income before provision for loan losses totaled $11.6 million, compared with $10.3 million for the corresponding quarter of 2000. This represented an increase of $1.3 million or 12.2%.
For the nine months ended September 30, 2001, net interest income before provision for loan losses amounted to $32.9 million, compared with $ 30.1 million for the corresponding period of 2000. This represented an increase of $2.8 million or 9.3%. The increase in net interest income before provision for loan losses was substantially attributable to an increase of $237.3 million or 31.3% in average interest-earning assets, from $757.3 million to $994.6 million. Even though the Prime rate was cut by 350 basis points, the volume increase has mitigated the negative impact.
For the third quarter of 2001, interest income increased by approximately $595,000 or 3.2% to $19.4 million from $18.8 million for the corresponding quarter of 2000. The Company's interest income on interest-earning assets for the nine months ended September 30, 2001 increased by $8.3 million or 16.2% to $59.6 million from $51.3 million for the nine months ended September 30, 2000. The increase was the net result of a $13.9 million increase due to an increase in interest-earning assets and a $5.6 million decrease due to a decrease in yield.
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The yield on average interest-earning assets decreased to 7.99% for the nine months ended September 30, 2001, from a yield of 9.04% for the nine months ended September 30, 2000. This decrease is mainly due to a decrease of 350 basis points in Prime interest rate during the first three quarters of 2001.
For the third quarter of 2001, interest expense actually decreased by approximately $668,000 or 7.93% to $7.8 million from $8.4 million for the corresponding quarter of 2000. The Company's interest expense on deposits for the nine months ended September 30, 2001 increased by $5.5 million or 26.0% to $26.7 million from $21.2 million for the nine months ended September 30, 2000. This increase was the net result of $8.2 million increase due to an increase in interest bearing liabilities and $2.7 million decrease due to a decrese in the cost of interest-bearing liabilities.
Average interest-bearing liabilities were $731.2 million for the nine months ended September 30, 2001, which represented an increase of $209.7 million or 40.2% from average interest-bearing liabilities of $521.5 million for the nine months ended September 30, 2000.
The cost of average interest-bearing liabilities decreased to 4.87% for the nine months ended September 30, 2001, compared to a cost of 5.42% for the same period of 2000. Until the second quarter of 2001, the cost of average interest-bearing liabilities was higher than the corresponding periods. The reason was the re-pricing interest gap of time certificates of deposits, which consisted of more than 75% of total interest-bearing liabilities. This type of deposit tends to have a longer maturity, usually from three months to a year. Therefore, the higher rate given to these deposits in prior periods had not yet been affected by the recent interest decreases. However, these deposits have been maturing and re-priced at current lower interest rates.
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The table below presents the average yield on each category of interest-earning assets, average rate paid on each category of interest-bearing liabilities, and the resulting interest rate spread and net yield on interest-earning assets for the periods indicated. All average balances are daily average balances.
The following table shows changes in interest income and interest expense and the amounts attributable to variations in interest rates and volumes for the periods indicated. The variances attributable to simultaneous volume and rate changes have been allocated to the change due to volume
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and the change due to rate categories in proportion to the relationship of the absolute dollar amount attributable solely to the change in volume and to the change in rate.
Provision for loan losses
For the quarter ended September 30, 2001, the Company made an additional provision for loan losses of $700,000. The Company's management believes that the allowance is sufficient for the known and inherent losses at September 30, 2001. (See Allowance and Provision for Loan Losses)
Non-interest Income
Non-interest income includes revenues earned from sources other than interest income. It is primarily comprised of service charges and fees on deposit accounts, gain on sale of loans and securities, and trade finance and remittance service fees charged for international trade.
For the third quarter of 2001, non-interest income increased approximately $967,000 or 26.1% to $4.7 million from $3.7 million for the corresponding period in 2000. The increase was the net result of the increase of the gain on sale of loans of approximately $131,000 and the gain on sale of investment securities of $1.0 million, and the decrease of approximately $137,000 in other income.
For the nine months ended September 30,2001, non-interest income increased $1.7 million or 15.6% to $12.3 million from $10.7 million for the same period a year ago. This increase was attributable to a combination of an approximately $330,000 increase in service charges and fees on deposit accounts plus an approximately $1.8 million increase in gain on sale of investment securities. The increase was mitigated by a decrease in gain on sale of loans of $274,000, and in other income of $236,000 due to the sale of rental income producing property in the fourth quarter of 2000. Trade
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finance and remittance service fees charged for international trade stayed at the about same amount for the same period in 2000. The breakdown of non-interest income by category is as below:
Non-interest Expenses
Non-interest expenses for the third quarter of 2001 increased approximately $1.2 or 17.88% to $8.2 million from $6.9 million for the corresponding quarter of 2000. For the nine months ended September 30, 2001, non-interest expenses increased $3.2 million or 16.1% to $23.1 million from $19.9 million for the same period a year ago. The increase was attributable to a combination of internal growth and an expanding branch network.
Salaries and employee benefits expenses for the nine months ended September 30, 2001, increased $1.8 million or 17.5% to $11.9 million from $10.1 million for the same period in 2000. This increase was primarily due to expenses associated with annual salary adjustments, addition of new employees to the two new branches opened in 2000 and one in September 2001, and an increase in employee medical insurance cost.
The occupancy and equipment expenses for the nine months ended September 30, 2001 increased by $455,000 or 19.2% to $2.8 million from $2.4 million for the same period in 2000. This increase was also a result of the Company's recent internal growth and expansion of three new branches as well as an annual adjustment of existing leases on the branch premises.
Data processing fees for the nine months ended September 30, 2001 increased by $156,000 or 10.0% to $1.7 million from $1.6 million for the same period in 2000. This increase was also a result of the Company's recent internal growth and expansion of three new branches.
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Professional fees for the nine months ended September 30, 2001 increased by $352,000 or 52.86% to $1.1 million from approximately $666,000 for the same period in 2000. The increase was due to legal and accounting expenses associated with attempted merger of California Central Bank and consulting fees associated with holding company.
Advertising and promotional expenses for the nine months increased by $132,000 or 11.3% to $1.3 million from $1.2 million for the same period in 2000. The increase was due to the introduction of non-depository products to the market, new branch in Irvine in September 2001, and utilization of television media for broad exposure to the target market started during the second quarter of 2001.
Other expenses consist of various operating expenses other than the above mentioned major expenditures. For the nine months ended September 30, 2001, other expenses increased by $351,000 or 14% to $2.9 million from $2.5 million for the same period in 2000. Most of the increase was due to the expansion of the branch network and associated expenses, including, but not limited to, security guards expense, armored expenses, insurance and operating losses. For the nine months ended September 30, 2001, approximately $227,000 was expensed for Hanmi Financing Holding Company in connection with NASDAQ registration fee, state franchise tax of Delaware, and SEC filing and printing cost. The breakdowns on non-interest expenses are summarized as follows:
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Financial Condition
Summary of Changes in Consolidated Statements of Financial Condition as of September 30, 2001 compared to December 31, 2000
At September 30, 2001, the Company's total assets increased by $105 million or 10.2% to $1,139 million from $1,035 million at December 31, 2000. Loans receivable, net of unearned loan fees and the allowance for loan loss, increased by $118 million or 19.4% to $755.6 million at September 30, 2001, from 607.7 million at December 31, 2000. Total deposits also increased by $87.2 million or 9.3% to $1,021.8 million at September 30, 2001 from $934.6 million at December 31, 2000.
Investment Security Portfolio
The Company classifies its securities as held-to-maturity or available-for-sale in accordance with Statement of Financial Accounting Standards (SFAS) 115. Those securities that the Company has the ability and intent to hold to maturity are classified as "held-to-maturity securities". All other securities are classified as "available-for-sale". The Company owned no trading securities at September 30, 2001. Securities classified as held-to-maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts, and securities as available-for-sale are stated at fair value. The securities currently held by the Company are U.S. agencies, municipal bonds, mortgage-backed and asset-backed securities and corporate bonds.
As of September 30, 2001, the Company owned $19.4 million of held-to-maturity securities and $228.0 million of available-for-sale securities, including unrealized gains of $2.2 million, net of taxes, compared to $22.3 million and $183.7 million at December 31, 2000, respectively.
Loan Portfolio
The Company carries all loans at face amount, less payments collected, net of deferred loan origination fees and costs and the allowance for possible loan losses. Interest on all loans is accrued daily on a simple interest basis. Once a loan is placed on non-accrual status, the accrual of interest is discontinued and previously accrued interest is reversed. Loans are placed on a non-accrual status when principal and interest on a loan is past due 90 days or more, unless a loan is both well-secured and in the process of collection.
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The Company's gross loans were $784.7 million at September 30, 2001. This represented an increase of $120.6 million or 19.0% over gross loans of $634.1 million at December 31, 2000.
Total commercial loans, comprised of domestic commercial, trade-financing loans, and SBA commercial loans, at September 30, 2001, were approximately $447.4 million, which represented an increase of $56.3 million or 14.4% from $391.1 million at December 31, 2000.
Real estate loans increased by $60.6 million or 29.6% to $265.1 million from $204.5 million at December 31, 2000. This increase was mainly due to an increase in construction loans of $20.4 million and commercial property loans of $41.0 million.
The following table shows the Company's loan composition by type:
At September 30, 2001, the Company's nonperforming assets (nonaccrual loans, loans 90 days or more past due and still accruing interest, restructured loans, and other real estate owned) totaled $5.0 million. This represented an increase of $2.5 million or 96.0% from non-performing assets of $2.6 million at December 31, 2000. As a percentage of gross loans, nonperforming assets increased to 0.66% at September 30, 2001, from 0.4% at December 31, 2000. The following table shows the composition of the Company's nonperforming assets as of the dates indicated.
The Company evaluates impairment of loans according to the provision of SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended. Under SFAS No. 114, Loans are considered impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. Imparied loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as an expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent, less costs to sell.
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At September 30, 2001 the Company had classified $5.9 million of its loans as impaired, compared with $5.8 million at December 31, 2000. Specific reserve on impaired loans totaled $3.2 million at September 30, 2001 and $1.6 million at December 31, 2000.
Allowance and Provision for Loan Losses
The allowance for loan losses represents the amounts that the Company has set aside for the specific purpose of absorbing losses that may occur in the Company's loan portfolio. The provision for loan losses is an expense charged against operating income and added to the allowance for loan losses. Management of the Company continues to carefully monitor the allowance for loan losses in relation to the size of the Company's loan portfolio and known risks or problem loans.
In determining the allowance for loan losses, management continues to assess the risk inherent in the loan portfolio, the possible impact of known and potential problem loans, and other factors such as collateral value, portfolio composition, loan concentration, financial strength of borrower, and trends in local economic conditions.
The Company's allowance for loan losses is calculated by applying loss factors to the outstanding loan portfolio. Problem loans which are considered impaired have a specific allowance applied based on the underlying collateral or the present value of the estimated cash flows. Loans, which are not impaired, are grouped into pools based upon loan type and the loan grade. Loss factors are applied to each pool based on the Company's expectation of probable loss.
The allowance for loan losses was $11.3 million at September 30, 2001, compared to $12.0 million at December 31, 2000. The allowance for loan losses was 1.50% of gross loans at September 30, 2001 compared to 1.89% at December 31, 2000. The Company provided an additional provision of $1.0 million for the nine months ended September 30, 2001.
Based on the Company's evaluation process and the methodology to determine the level of the allowance for loan losses, management believes the allowance level as of September 30, 2001 to adequate to absorb the estimated known and inherent risks identified through its analysis.
The following table shows the provisions made for loan losses, the amount of loans charged off, the recoveries on loans previously charged off together with the balance in the allowance for possible loan losses at the beginning and end of each period, the amount of average and total loans outstanding, and other pertinent ratios as of the dates and for the periods indicated:
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Deposits and Other Borrowings
At September 30, 2001, the Company's total deposits were $1,021.8 million. This represented an increase of $87.2 million or 8.53%, from total deposits of $934.6 million at December 31, 2000. Demand deposits totaled $272.1 million, representing an increase of approximately $32.3 million or 13.5% from total demand deposits of$239.8 million at December 31, 2000.
Time deposits over $100,000 totaled $287.1 million at September 30, 2001. This represented an increase of approximately $39.5 million or 16.0%, compared to $247.6 million at December 31, 2000.
Shareholders' Equity and Regulatory Capital
In order to ensure adequate levels of capital, the Company conducts an ongoing assessment of projected sources and uses of capital in conjunction with projected increases in assets and levels of risk. Management considers, among other things, on an ongoing basis, cash generated from operations, access to capital from financial markets or the issuance of additional securities, including common stock or notes, to meet the Company's capital needs. Total shareholders' equity was $101.8 million at September 30, 2001. This represented an increase of $15.4 million or 17.8% over total shareholders' equity of $86.4 million at December 31, 2000.
The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier I capital to risk-adjusted assets of 4%. In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier I capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier I capital to total assets must be 3%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.
At September 30, 2001, Tier I capital, shareholders' equity less intangible assets was $97.0 million. This represented an increase of $13.5 million or 16.1% over total Tier I capital of $84.1 million at December 31, 2000. At September 30, 2001, the Company had a ratio of total capital to total risk-weighted assets of 13.26% and a ratio of Tier I capital to total risk weighted assets of 12.01%. The Tier I leverage ratio was 8.71% at September 30, 2001.
The following table presents the amounts of regulatory capital and the capital ratio for the Company, compared to regulatory capital requirements for adequacy purposes as of September 30, 2001.
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Item 3. Quantitative and qualitative disclosures about market risk
General
Market risk is the risk of loss to future earnings, to fair values, or to future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, foreign currency exchange rates, commodity prices, equity prices, and other market changes that affect market risk sensitive instruments. Market risk is attributed to all market risk sensitive financial instruments, including securities, loans, deposits, and borrowings, as well as derivative instruments. Our exposure to market risk is a function of our asset and liability management activities and other roles as a financial intermediary in customer-related transactions. The objective of market risk management is to avoid excessive exposure of our earnings and equity to loss and to reduce the volatility inherent in certain financial instruments.
The management of market risk is governed by policies reviewed and approved annually by the Board of Directors ("Board"). The Board delegates responsibility for market risk management to the Asset and Liability Management Committee (ALCO), which is composed of the Company's senior executives and other designated officers. ALCO makes changes in the mix of assets and liabilities. ALCO also reviews and approves market risk management programs and market risk limits.
The Company uses various tools to measure existing and potential interest rate risk exposures. Deposit trend analysis, gap analysis, and shock test is the representative examples of the tools used in risk management.
The following is the most recent status of gap position.
The repricing gap analysis measures the static timing of repricing risk of assets and liabilities. In the third quarter, there was a slight shift towards the liability side as cumulative repricing as a percentage of earning assets fell to 33.86% in the less than three month period. This was an improvement away from the policy guideline of 35%. In the three to twelve month period, the percentage increased to 4.23% from the previous quarter. This asset side shift was mainly caused by the drop in CD's greater than $100M in the three to twelve month period.
The next tabulation is a result of simulations performed by Management to forecast the interest rate impact on the Company's net income and economic value of portfolio equity.
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CURRENT EXPOSURE OF THE BANK TO HYPOTHETICAL CHANGES IN INTEREST RATES As of September 30, 2001 (Dollars in thousands)
Compared to the second quarter, there was little change from the results of the Rate Shock Report. The projected change in net income ranged between 9.18% and -10.28% given a change in interest rate of ±200BPS. The projected change in the economic value of equity ranged between - -17.03% and 20.21% for the same parameters. By comparison, results in the second quarter ranged between 8.18% and -9.17% for net income and -18.13% and 21.44% for economic value of equity. All figures in the third quarter were well within policy guidelines.
The Company's analysis on Interest Rate and Economic Outlook suggested that the Bank operate under a lower interest rate environment for the next two quarters. Economic data in the third quarter did not report a revival of the economy. The unemployment rate fell to 4.9% in August with job loss affecting not only the manufacturing sector but the service sector as well. At 47.0% the NAPM Index continued to remain below the important 50 level. Since June 30th, including the regularly scheduled meeting on October 2nd, the FOMC cut the interest rate by a total of 125BPS to 2.50%. The Economic Outlook noted that the key to a recovery was consumer consumption.
Liquidity and Interest Rate Sensitivity
Liquidity risk is the risk to earnings or capital resulting from the Company's inability to meet its obligations when they come due without incurring unacceptable losses. Liquidity risk includes the ability to manage unplanned decreases or changes in funding sources and to recognize or address changes in market conditions that affect the Company's ability to liquidate assets quickly and with a minimum loss of value. Factors considered in liquidity risk management are stability of the deposit base, marketability, maturity, and pledging of investments, and demand for credit.
The maintenance of a proper level of liquid assets is critical for both the liquidity and the profitability of the Bank. Since the primary objective of the investment portfolio is to maintain proper liquidity of the Bank, it is recommended for Management to keep enough liquid assets to avoid exposure to higher than feasible liquidity risk.
The Company's liquid assets include cash and cash equivalents, term federal funds sold and securities available-for-sale. The aggregate of these assets totaled $344.8 million at September 30, 2001 compared to $359.8 million at December 31, 2000.
The Measuring of Liquidity Ratios is composed of liquid assets as a percentage of total liabilities, liquid assets as a percentage of volatile liabilities, and liquid assets plus available credit Line as a percentage of total liabilities plus Off-Balance amount. The results of the report are as follows:
Compared to the second quarter, all percentages were lower but remained above policy required minimum levels. Liquid Assets as a percentage of Total Liabilities decreased by 1.59%. During the third quarter, total liabilities rose while total liquid assets fell with the biggest drop in Fed Funds sold. Liquid
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Assets as a percentage of Volatile Liabilities also decreased by 1.88%. Volatile Liabilities increased by $6.3 million from the previous quarter. The ratio of Liquid Assets plus Available Credit Line to Total Liabilities plus Off-Balance Amount declined by 1.63%.
In general, the Company manages liquidity risk daily by controlling the level of federal funds and the use of funds provided by the cash flow from the investment portfolio and scheduled loan repayment. To meet unexpected demands, lines of credit are maintained with correspondent banks, and the Federal Reserve Bank. The sale of securities available-for-sale also can also serve as a contingent source of funds. Increases in deposit rates are considered a last resort as a means of raising funds to increase liquidity.
The Company currently uses the interest rate gap to measure interest rate risk. It is the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within specified periods. The gap analysis presented next indicates that assets that are rate sensitive within one year exceeded liabilities within that same period by $43.1 million at September 30, 2001.
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PART II
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a vote of Security Holders
Item 5. Other information
See "Notes to Consolidated Financial Statements-Note 4. Other information."
Item 6. Exhibits and Reports on Form 8-K
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SIGNATURES
Pursuant to 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.
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