UNITED STATESSECURITIES AND EXCHANGE COMMSSION
Washington, D.C. 20549
(Mark One)
Hanmi Financial Corporation
(213) 382-2200
Not Applicable
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 March 31, 2003, there were approximately 14,007,839 outstanding shares of the issuer’s Common Stock, with par value of $0.001.
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TABLE OF CONTENTS
FORM 10-Q
INDEX
HANMI FINANCIAL CORPORATION
HANMI FINANCIAL CORPORATIONCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION(dollars in thousands)
See accompanying notes to consolidated financial statements.
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HANMI FINANCIAL CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOMEFOR THE QUARTER ENDED MARCH 31, 2003 AND 2002 (dollars in thousands)
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HANMI FINANCIAL CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE QUARTER ENDED MARCH 31, 2003 AND 2002(dollars in thousands)
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Notes to Consolidated Financial Statements
Note 1. Hanmi Financial Corporation
Hanmi Financial Corporation (“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 June 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, 1981, and was licensed by the California Department of Financial Institutions on December 15, 1982. Hanmi Bank’s deposit accounts are insured under the Federal Deposit Insurance Act up to applicable limits thereof, and the Bank is a member of the Federal Reserve System. Hanmi Bank’s headquarters 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, San Diego 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 Hanmi Bank currently has fourteen full-service branch offices located in Los Angeles, Orange, San Diego and Santa Clara counties. Of the fourteen offices, Hanmi Bank opened eleven 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 interim period ended March 31, 2003, but 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.
Certain reclassifications were made to the prior period presentation to conform to the current period’s presentation.
Note 3. Employee Stock based Compensation
The Company measures its employee stock-based compensation arrangements under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). 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 Company’s stock option plan been determined based on the fair value estimated using the Black-Scholes model at the grant date for previous awards, the Company’s net income and income per share would have been reduced to the pro forma amounts indicated for the quarters as follows:
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Note 4. Earnings Per Share
Earnings per share is calculated on both a basic and diluted basis. Basic earnings per share 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 earnings per share 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.
The following table presents a reconciliation of the components used to derive basic and diluted earnings per share for the quarters indicated.
Note 5. Derivative Financial instruments
The Company has entered interest rate swaps to hedge the interest rate risk associated with the cash flows of specifically identified variable-rate loans. As of March 31, 2003, the Company had two interest rate swap agreements with a total notional amount of $40 million, wherein the Company receives a fixed rate of 5.77% and 6.37% at quarterly intervals, for each $20 million notional amount, respectively. The Company pays a floating rate at quarterly intervals based on the Wall Street Journal published Prime Rate.
At March 31, 2003, the fair value of the interest rate swaps was in a favorable position of approximately $215,000. A total of $140,000, net of tax, is included in other comprehensive income. The fair value of the interest rate swap is included in other assets in the accompanying consolidated statements of financial condition.
Note 6. Current Accounting Matters
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, and an interpretation of ARB No. 51(FIN 46). This Interpretation, provides guidance to improve financial reporting for Special Purpose Entities, Off-Balance Sheet Structures and Similar Entities. FIN 46 requires a variable interest entity to be consolidated by a
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company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. Prior to FIN 46, a company included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 also requires disclosures about variable interest entities that the company is not required to consolidate but in which it has a significant variable interest. The consolidated requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidated requirements apply to older entities in the first fiscal year or interim period after June 15, 2003. Certain disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company does not believe it has any variable interest entities.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 to require prominent disclosure about the effects on reported net income of the Company’s accounting policy decisions with respect to stock-based employee compensation. Finally, SFAS 148 amends APB Opinion No. 28, “Interim Financial Reporting,” to require disclosure about those effects in interim financial information. Presently, the Company does not intend to adopt the fair value method.
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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 months ended March 31, 2003. This analysis should be read in conjunction with the Company’s Annual Report included in Form 10-K for the year ended December 31, 2002 and with the unaudited financial statements and notes as set forth in this report.
Critical Accounting Policies
We have established various accounting policies which 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. Certain accounting policies require us to make significant estimates and assumptions which 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 which 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 is the critical accounting policies that require the most significant estimates and assumptions, which are particularly susceptible to significant change in the preparation of our financial statements.
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Selected Financial Data
The following table sets forth-certain selected financial data concerning the Company for the periods indicated:
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 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 interest rates rise; and regulatory risks associated with the variety of current and future regulations to which the
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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.
Dividends
On February 20, 2003, the Company declared a quarterly common stock cash dividend of $0.10 per share for the first quarter of 2003. The dividend was paid on April 15, 2003 to shareholders of record on April 1, 2003. The company anticipates declaring a similar or equivalent cash dividend for the rest of the quarters of 2003. The future dividend payout is subject to the Company’s future earnings and legal requirements.
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Results of Operation
The Company’s net income for the quarter ended March 31, 2003 was $4.2 million or $0.30 per diluted share compared to $4.1 million or $0.29 per diluted share for the quarter ended March 31, 2002. The increase in net income for 2003 as compared to 2002 was primarily due to the increase in loan volume and reduction in the effective tax rate, which was offset by the lower interest margin. The annualized return on average assets was 1.14% for the first quarter of 2003 compared to a return on average assets of 1.41% for the first quarter of 2002, a decrease of 27 basis points. The annualized return on average equity was 13.55% for the first quarter of 2003, compared to a return on average equity of 15.77% for the same period in 2002, a decrease of 222 basis points.
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 first three months ended March 31, 2003, the Company’s net interest income before provision for loan losses was $12.1 million. This represented an increase of $945,000 or 8.44% over net interest income of $11.2 million for the three months ended March 31, 2002. The interest rate spread decreased to 2.80% for the three months ended March 31, 2003, from 3.37% for the same period in 2002. The change was primarily due to decrease on interest received on loans and investments. The net interest margin also decreased to 3.47% for the three months ended March 31, 2003, from 4.11% for the same period in 2002 due to an increase in the volume of interest earning assets with lower interest rates.
Total interest income increased $1.3 million or 8.24% to $17.5 million for the three months ended March 31, 2003 from $16.1 million for the three months ended March 31, 2002. The increase was primarily the result of an increase in volume of interest earning assets. The interest-earning assets increased by $310.2 million or 28.48% to $1.4 billion compared to $1.1 billion a year ago.
The Company’s interest expense on deposits for the quarter ended March 31, 2003 increased by approximately $384,000 or 7.79% to $5.3 million from $4.9 million for the quarter ended March 31, 2002. The increase reflected an increase in the volume of interest-bearing deposits and borrowings, which was offset by the decrease in interest paid to depositors. Average interest-bearing liabilities were $971.8 million for the first quarter of 2003, which represented an increase of $199.8 million or 25.88% from average interest-bearing liabilities of $772.0 million for the first quarter of 2002.
The cost of average interest-bearing liabilities decreased to 2.19% for the first quarter ended March 31, 2003, compared to a cost of 2.55% for the same period of 2002. Overall interest on deposits decreased mainly due to repricing of interest rates on long-term certificates of deposit to the current low interest rates as the deposits matured.
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The table below represents 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 periods indicated. All average balances are daily average balances.
[Additional columns below]
[Continued from above table, first column(s) repeated]
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The table below 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 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 three months ended March 31, 2003, the Company made an additional provision of $1.2 million. The Company’s management believes that the allowances are sufficient for the inherent losses at March 31, 2003. (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, fees charged on trade finance, and gain on sale of loans and investment securities. Non-interest income increased approximately $175,000 or 4.04% to $4.5 million for the quarter ended March 31, 2003 from $4.3 million for the same period in 2002.
Service charges on deposit accounts increased approximately $278,000 or 12.72% during the first three months ended March 31, 2003 to $2.5 million compared to $2.2 million during the same period in 2002. The increase was primarily due to expansion of branch network and increase in accounts within existing branches as the bank grows.
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Gain on sale of loans increased approximately $44,000 or 11% during three months ended March 31, 2003 to $444,000, compared to $400,000 during the same period in 2002. The company sells the guaranteed portion of the SBA loans in the government securities secondary markets, while the Company retains servicing rights. During the first quarter of 2003, the secondary market for these loans provided a favorable premium compared to the prior period and, therefore, the Company sold SBA loans in its portfolio. The Company currently plans to keep selling a significant number of its SBA loans in coming quarters as long as the secondary market is favorable.
During the first quarter of 2003, the Company sold a part of Worldcom (“Worldcom”) corporate bond, which had defaulted in January 2002. The Company sold the bond at a gain of $151,000, because an impairment charge was taken in the prior year.
Trade finance fees increased by $191,000 or 34.41% to $746,000 compared to $555,000 during the same period in 2002. The increase was primarily due to growing activity in international trade as countries in the Asian-Pacific region are recovering from the economic crisis.
At December 31, 2001, the Company invested $10 million in bank owned life insurance (“BOLI”). BOLI involves the purchasing of life insurance by the Company on a chosen group of employees. The Company is the owner and beneficiary of the policies. During the first quarter of 2003, cash surrender value on life insurance purchased increased by $127,000.
Other income increased approximately $16,000 or 18.82% during three months ended March 31, 2003, to $101,000 from $85,000 thousand during the same period in 2002. As a part of the Company’s continuing effort to expand non-interest income, the Company introduced non-depository products, such as mutual funds and annuities, and credit cards to customers, and generated income of $53,000 from such activity during the first quarter of 2003, representing increase of 6% compared to $50,000 during the same period in 2002.
The breakdown of non-interest income by category is reflected below:
Non-interest Expenses
Non-interest expenses for the first quarter of 2003 increased approximately $1.2 million or 15.94% to $8.9 million from $7.7 million for the same period in 2002. This increase was primarily due to expanding branch network and internal growth.
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Salaries and employee benefits expenses for the first quarter of 2003 increased approximately $461,000 or 10.92% to $4.7 million from $4.2 million for the same period in 2002. This increase was primarily due to addition of new employees at the new branches in Torrance and Santa Clara.
The occupancy and equipment expenses for the first quarter of 2003 increased approximately $122,000 or 11.48% to $1.2 million from $1.1 million for the same period in 2002. This increase is also a result of the Company’s recent expansion of new branches as well as annual adjustment of existing leases for other branch premises.
Data processing fees for the first quarter of 2003 increased by approximately $105,000 or 16.03% to $760,000 from $655,000 during the same period in 2002. Additional expense was incurred primarily due to increase in Company’s recent expansion of new branches and internal growth.
Other operating expenses increased by approximately $219,000 or 29.16% to $970,000 from $751,000 during the same period in 2002. The increase was mainly due to expansion of branch network and internal growth. Among other expenses, correspondent bank charges, corporate administration expense, transportation expense, and credit card related expenses increased over the same period in 2002.
The breakdown of non-interest expense by category is reflected below:
Provision for Income Taxes
For the quarter ended March 31, 2003, the Company recognized a provision for income taxes of $2.3 million on net income before tax of $6.5 million, representing an effective tax rate of 35%, compared to a provision of $2.6 million on pretax net income of $6.8 million, representing an effective tax rate of 39%, for the same quarter of 2002. The lower tax rate in 2002 compared to 2001 was primarily due to an income tax benefit generated from a Real Estate Investment Trust, a special purpose subsidiary of the Bank, which provides flexibility to raise additional capital in a tax efficient manner.
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Financial Condition
Summary of Changes in Balance Sheets March 31, 2003 compared to December 31, 2002
At March 31, 2003, the Company’s total assets increased by $95.5 million or 6.56% to $1,551.8 million from $1,456.3 million at December 31, 2002. Loans, net of unearned loan fees, allowance for loan losses and loans held for sale, totaled $1,019.2 million at March 31, 2003, which represents an increase of $57.6 million or 5.99% from $961.6 million at December 31, 2002. Total deposits also increased by $56.2 million or 4.38% to $1,340.2 million at March 31, 2003 from $1,284.0 million at December 31, 2002.
Investment Security Portfolio
The Company classified its securities as held-to-maturity or available-for-sale in accordance with Statement of Financial Accounting Standards (SFAS) No. 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 March 31, 2003. Securities classified as held-to-maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts, and available-for-sale securities are stated at fair value. The securities currently held by the Company are U.S. agencies, municipal bonds, mortgage-backed securities, collateralized mortgage obligation and asset-backed securities and others.
As of March 31, 2003, held-to-maturity securities totaled $1.9 million and available-for-sale securities totaled $377.6 million, compared to $7.5 million and $272.0 million at December 31, 2002, respectively.
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Loan Portfolio
The Company carries all loans at face amount, less payment collected, net of deferred loan origination fees and costs, and the allowance for loan losses. Interest on all loans is accrued daily on a simple interest basis. Once a loan is placed on non-accrual status, 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 process of collection.
The Company’s net loans, including loans held for sale, were $1,034.0 million at March 31, 2003. This represented an increase of $59.9 million or 6.15% over net loans of $974.1 million at December 31, 2002.
Total commercial loans, comprised of domestic commercial, trade-financing loans, and SBA commercial loans, were approximately $592.3 million at March 31, 2003, which represented an increase of $19.4 million or 3.39% from $572.9 million at December 31, 2002.
Real estate loans increased by $40.6 million or 10.93% to $412.2 million at March 31, 2003 from $371.6 million at December 31, 2002. This increase was due to increase in residential mortgage loans and commercial property loans to take advantage of the decreasing interest rate environment.
The following table shows the Company’s loan composition by type including loans held for sale:
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At March 31, 2003, accruing loans 90 days past due or more were $2.0 million, and increased by $1.4 million from $617,000 at December 31, 2002. This increase was mainly due to a $1.3 million loan to a low-income housing project, which should have been paid off through the city’s subsidy fund. The management anticipated this matter will be resolved in the second quarter of 2003, since it related to a procedural delay.
Non-accrual loans were $7.4 million at March 31, 2003, increased by $1.5 million from $5.9 million at December 31, 2002. Increase was due to two real estate secured loans that were newly placed into non-accrual loan pool, and the Company provided specific reserves for these loans as of March 31, 2003.
The table below shows the composition of the Company’s nonperforming assets as of the dates indicated.
Allowance and Provision for Loan Losses
The allowance for loan losses is maintained at a level that is believed to be adequate by Management to absorb estimated probable loan losses inherent in various financial instruments. The adequacy of the allowance is determined through periodic evaluations of the Company’s portfolio and other pertinent factors, which are inherently subjective as the process calls for various significant estimates and assumptions. Among others, the estimates involve the amounts and timing of expected future cash flows and fair value of collateral on impaired loans, estimated losses on loans based on historical loss experience, various qualitative factors, and uncertainties in estimating losses and inherent risks in the various credit portfolios, which may be subject to substantial change.
On a quarterly basis, the Company utilizes a classification migration model and individual loan review analysis tools, as a starting point for determining the allowance for loan loss adequacy. The Company’s loss migration analysis tracks twelve quarters of loan losses to determine historical loss experience in every classification category (i.e. pass, special mention, substandard, and doubtful) for each loan type, except consumer loans (auto, mortgage and credit cards) which are analyzed as homogeneous loan pools. These calculated loss factors are then applied to outstanding loan balances, unused commitments, and off-balance sheet exposures, such as letters of credit. The individual loan review analysis is the other axis of the allowance allocation process, applying specific monitoring policies and procedures in analyzing the existing loan portfolios.
The results from the above two analyses are thereafter compared to independently generated information such as peer group comparisons and the federal regulatory interagency policy for loan and lease losses. Further assignments are made based on general and specific economic conditions, as well as performance trends within specific portfolio segments and individual concentrations of credit.
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As of March 31, 2003, the allowance for loan losses was $13.1 million or 1.25% of gross loans. This represents an increase of 1 basis point compared to 1.24% at December 31, 2002. The increase of the allowance was primarily due to the increase of Substandard and Doubtful grade loans from $16.9 million and $2.5 million to $19.0 million and $2.9 million respectively, and the increase of specific allocation from $2.0 million to $2.5 million, which was mitigated by the fact that certain loan loss factors on non-classified loans decreased.
The loan loss estimation based on historical losses and specific allocations of the allowance are performed on a quarterly basis. Adjustments to allowance allocations for specific segments of the loan and lease portfolio may be made as a result thereof, based on the accuracy of forecasted loss amounts and other loan- or policy-related issues.
The Company determines the appropriate overall allowance for loan losses based on the foregoing analysis, taking into account management’s judgment. Allowance methodology is reviewed on a periodic basis and modified as appropriate. Based on this analysis, including the aforementioned factors, the Company believes that the allowance for loan losses is adequate as of March 31, 2003.
The Company concentrates the majority of its earning assets in loans. In all forms of lending, there are inherent risks. The Company concentrates the preponderance of its loan portfolio in either commercial loans or real estate loans. A small part of the portfolio is represented by installment loans primarily for the purchase of automobiles.
While the Company believes that its underwriting criteria are prudent, outside factors can adversely impact credit quality. During the early 1990’s the severe recession impacted the Company’s ability to collect loans.
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Having experienced the problems mentioned above in the past, the Company has attempted to mitigate collection problems by supporting its loans by fungible collateral. Additionally, a portion of the portfolio is represented by loans guaranteed by the SBA, which further reduces the Company’s potential for loss. The Company also utilizes credit review in an effort to maintain loan quality. Loans are reviewed throughout the year with new loans and those that are delinquent receiving special attention. In addition to the Company’s internal grading system, loans criticized by this credit review are downgraded with appropriate allowance added if required.
As indicated above, the Company formally assesses the adequacy of the allowance on a quarterly basis by:
Although Management believes the allowance is adequate to absorb losses as they arise, no assurance can be given that the Company will not sustain losses in any given period, which could be substantial in relation to the size of the allowance.
Deposits
At March 31, 2003, the Company’s total deposits were $1,340.2 million. This represented an increase of $56.2 million or 4.38%, from total deposits of $1,284.0 million at December 31, 2002. Demand deposits totaled $402.3 million, representing a decrease of approximately $9.7 million or 2.36% from total demand deposits of $412.0 million at December 31, 2002.
Time certificates of deposit of $100,000 or more totaled $336.6 million at March 31, 2003. This represented an increase of approximately $13.1 million or 4.04%, compared to $323.5 million at December 31, 2002. Other time deposits also increased by $55.9 million or 21.51% to $315.8 million from $259.9 million at December 31, 2002. Overall increase was primarily due to expansion of branch network and the result of special deposit campaign on time deposit during the first quarter of 2003.
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Item 3. Quantitative and qualitative disclosures about market risk
General
Market Risk, called interest rate risk in the banking industry, indicates how much market interest rate fluctuations the Company is exposed to. The movement of interest rates directly and inversely affects the economic value of a fixed income asset. This occurs because the economic value of a fixed income asset is the present value of future cash flow discounted by the current interest rate; the higher the current interest rate, the higher the denominator of discounting. Market risks include basis risk, which stems from the different indexes used for asset/liability, yield curve risk caused by different maturities of financial instruments, and embedded options risk.
The Company uses various tools to measure existing and potential interest rate risk exposures. Deposit trend analysis, gap analysis, and shock test are the representative examples of the tools used in risk management.
The following table is the most recent status of gap position.
The repricing gap analysis measures the static timing of repricing risk of assets and liabilities. The cumulative repricing as a percentage of earning assets decreased significantly in both the less than 3 month and the 3 to 12 month periods. When compared to the previous quarter, the percentage of earning assets in the less than 3-month period dropped to 27.37%. The percentage in the 3 to 12-month period also significantly lowered to 1.65% from 11.93%. Although floating rate loans increased, short-term investments and Fed funds sold were significantly decreased. In addition, $40 million interest rate swaps and CDs under $100K improved the gap position in less than three-month. Floating rate loans increased by $49 million in the less than one-year period during the first quarter while CDs under $100K jumped by $55 million.
In terms of fixed and floating gap positions, the accumulative fixed gap position between assets and liabilities as a percentage of total earning assets was –5.17%. It significantly improved from –14.67% for the previous quarter. The floating gap position in the less than one-year period was 2.02%, which much narrowed from 12.38% in the previous quarter. Both the fixed and floating gap positions were maintained within the company guideline of 15%. They showed significant improvements over the last quarter.
The following table 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 COMPANY TOHYPOTHETICAL CHANGES IN INTEREST RATES(As of March 31, 2003)(Dollars in thousand)
The results of the rate shock test above were mixed when compared to 2002 year-end results. The projected changes in net income were narrower spread than the projections reported in December. The figures were well within policy guidelines of ±25%. Given a 200 basis point shift in interest rates, the net income would rise or fall between 10.94% and –16.56%. This compared to a range of 15.56% to –16.78% as of December 31,2002. The decreased volatility in interest income can be attributed to decreased overnight Fed funds sold and the interest rate swaps, which transferred the short-term cash flow from floating rate loans to fixed cash flow in five years. The results for the economic value of equity became widened from the previous quarter. Given the same rate change parameters, the percentage change stayed between –15.25% and 16.47%. This was a slight deterioration over the previous quarter.
Liquidity and Capital Resources
Liquidity of the Company is defined as the ability to supply cash as quickly as needed without severely deteriorating its profitability. The Company’s major liquidity in the asset side stems from available cash positions, federal funds sold and short-term investments categorized as trading and/or available for sale securities, which can be disposed of without significant capital losses at ordinary business cycle. Liquidity source in the liability side comes from borrowing capabilities, which include federal fund lines, repurchase agreements, federal discount window, and Federal Home Loan Bank advances. Thus, maintenance of high quality securities that can be used for collateral in repurchase agreements is another important feature of liquidity management.
Liquidity risk may occur when the Company has few short-duration investment securities available for sale and/or is not capable of raising funds as quickly as possible at acceptable rates in the capital or money market. Also, a heavy and sudden increase of cash demands in loans and deposits can tighten the liquidity position. Several ratios are reviewed on a daily, monthly and quarterly basis for a better understanding of liquidity position and to preempt liquidity crisis. Six sub-sectors, which include Loan to Asset ratio, Off-balance Sheet items, Dependence on non-core deposits over $100M, Foreign deposits, Line of credit, and Liquid Assets were reviewed quarterly for the liquidity management. The heavy loan demand and limited liquid assets have increased pressure to the liquidity, but the Company still has adequate liquid assets to cover the loan demand.
The maintenance of a proper level of liquid assets is critical for both the liquidity and the profitability of the Company. Since the primary objective of the investment portfolio is to maintain proper liquidity of the Company, Management continually endeavors to keep adequate liquid assets to avoid exposure to higher than feasible liquidity risk.
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Liquidity Ratio and Trends
All of the results in the first quarter of 2003, as noted in the above table, met the guidelines for liquidity levels. Short-term investments over total assets fell from the previous quarter. Net loans and leases over total assets increased due to higher loan demand. Core deposits over total assets fell by 2% from the previous quarter because total assets growth outpaced core deposit growth. Short-term non-core funding increased along with total assets slightly bringing down the ratio to 21%. During the quarter, CD’s increased by $69 million while total assets rose by $95 million. Short-term investments over short-term non-core funding fell sharply from the previous quarter, but stayed well above the 20% guideline. Short-term investments, including Fed funds sold, fell by $54 million. However, the increase in short-term non-core funding was only about $14 million and thus, the ratio fell to 40% from 55%.
Liquidity Measures
The Company saw a steady demand for loans during the quarter. However, the loans to assets ratio remained constant at 67% over the quarter as asset growth kept pace with loan growth. It stayed below the 85% guideline. Loan amounts at the end of the quarter were $1.03 billion while total assets were $1.55 billion. Since assets also grew during the quarter, the risk associated with the loan to asset ratio should be considered as minimal.
The quarterly trend of each account with its available credit facilities is reported to the Board of Directors through the Investment Committee.
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 $128.0 million at March 31, 2003. This represented an increase of $3.5 million or 2.81% over total shareholders’ equity of $124.5 million at December 31, 2002.
The regulatory agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In
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addition to the risk-based guidelines, regulators require banking organizations to maintain a minimum amount of Tier 1 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 1 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 March 31, 2003, Tier 1 capital, shareholders’ equity less intangible assets, was $123.4 million. This represented an increase of $3.5 million or 2.92% over total Tier 1 capital of $119.9 million at December 31, 2002. At March 31, 2003, the Company had a ratio of total capital to total risk-weighted assets of 11.9% and a ratio of Tier 1 capital to total risk weighted assets of 10.75%. The Tier 1 leverage ratio was 8.3% at March 31, 2003.
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 March 31, 2003.
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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 Shareholders
Item 5 Other information
Item 6 Exhibits and Reports on Form 8-K
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Certification of periodic report
I, Yong Ku Choe, Chief Financial Officer and Acting President, certify that:
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EXHIBIT INDEX
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