UNITED STATESSECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
FORM 10-Q
For the transition period from to
NARA BANCORP, INC. (Exact name of registrant as specified in its charter)
(213) 639-1700 (Registrant's telephone number, including area code)
Nara Bank, N.A. (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 5,557,520 outstanding shares of the issuer's Common Stock, $0.001 par value.
Table of Contents
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PART I FINANCIAL INFORMATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
See notes to financial statements
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CONSOLIDATED STATEMENTS OF INCOME For the three months and nine months ended September 30, 2001 and 2000 (Unaudited)
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Unaudited)
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CONSOLIDATED STATEMENT OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Unaudited)
See accompanying notes to financial statements
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Notes to Financial Statements
1. Basis of Presentation
The consolidated financial statements included herein have been prepared by Nara Bancorp, Inc., without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Nara Bancorp, Inc., ("Bancorp" or the "Parent"), together with its wholly owned subsidiaries, Nara Bank, N.A. (the "Bank"), and Nara Bancorp Capital Trust I ("Nara Capital"), and the Bank's wholly owned subsidiary, Nara Loan Center Corporation ("Loan Corporation"), is collectively referred to as the "Company". Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such SEC rules and regulations; nevertheless, the Company believes that the disclosures are adequate to make the information presented not misleading.
In the opinion of management, all adjustments have been included, including normal recurring adjustments necessary to present fairly the financial position of the Company and the results of its operations for the interim period ended September 30, 2001. Certain reclassifications have been made to prior year amounts to conform to the 2001 presentation. The results of operations for interim periods are not necessarily indicative of results for the full year.
These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto, which are included in the Company's 2000 Annual Report on Form 10-K.
During the first quarter of 2001, Bancorp became a bank holding company regulated by the Board of Governors of the Federal Reserve System (the "Federal Reserve") as part of the reorganization of the Bank into a holding company formation. Bancorp succeeded to the business and operations of the Bank upon consummation of the reorganization of the Bank into the holding company structure, effective as of February 2, 2001. Prior to the completion of the reorganization, Bancorp had no material operations or assets. The Company's principal business is to serve as a holding company for the Bank and other banks or bank related subsidiaries, which the Company may establish or acquire.
2. Interest-only Strips
Certain Small Business Administration (SBA) loans that may be sold prior to maturity have been designated as held for sale and are recorded at the lower of cost of market value on an aggregate basis. The servicing fees on SBA loans sold are divided into two separate categories called "Servicing Assets" and "Interest-only Strip Receivable". The interest-only strip receivable is the interest income retained by the Bank that exceeds the contractually specified servicing fees (100 basis points). This receivable is a financial asset and is subsequently measured like investments in debt securities classified as available-for-sale. The Company adopted SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125" on April 1, 2001, and the adoption did not have a material impact on the Company's results of operations, financial position, or cash flows.
3. Dividends
In May of 2000, the Bank paid 9.0% stock dividend to its shareholders of record at the close of business on April 14, 2000. On March 21, 2001, the Company declared a $0.15 per share cash dividend payable on May 1, 2001 to shareholders of record at the close of business on April 24, 2001.
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4. Earnings Per Share
Basic earnings-per-share excludes dilution and is computed by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings-per-share reflects the potential dilution of securities that could share in the earnings.
The weighted average number of shares outstanding for basic earnings per share was 5,531,565 and 5,007,470 for the three months ended September 30, 2001 and 2000, respectively. The calculation of fully diluted earnings per share assumes the issuance of 331,582 and 264,405 shares of common stock for the three months ended September 30, 2001 and 2000, respectively, upon conversion of the Company's potentially dilutive instruments. The weighted average number of shares outstanding for fully diluted earnings per share was 5,863,147 and 5,280,268 for the three months ended September 30, 2001 and 2000, respectively.
The weighted average number of shares outstanding for basic earnings per share was 5,496,113 and 5,007,470 for the nine months ended September 30, 2001 and 2000, respectively. The calculation of fully diluted earnings per share assumes the issuance of 309,772 and 264,405 shares of common stock for the nine months ended September 30, 2001 and 2000, respectively, upon conversion of the Company's potentially dilutive instruments. The weighted average number of shares outstanding for fully diluted earnings per share was 5,805,885 and 5,050,139 for the nine months ended September 30, 2001 and 2000, respectively.
5. Trust Preferred
On March 28, 2001, Nara Capital Trust I (the "Trust"), a statutory business trust and wholly owned subsidiary of the Company, issued in a private placement transaction $10.0 million of 10.18% capital securities (the "Capital Securities"), which represent undivided preferred beneficial interests in the assets of the Trust. The Company is the owner of all the beneficial interests represented by the common securities of the Trust (the "Common Securities") together with the Capital Securities (the "Trust Securities"). The Trust exists for the sole purpose of issuing the Trust Securities and investing the proceeds thereof in 10.18% junior subordinated deferrable interest debentures (the "Junior Subordinated Debentures") issued by the Company and engaging in certain other limited activities. The Junior Subordinated Debentures held by the Trust will mature on June 8, 2031, at which time the Company is obligated to redeem the Capital Securities.
Holders of the Capital Securities are entitled to receive cumulative cash distributions, accumulating from March 28, 2001, the date of original issuance, and payable semi-annually in arrears on June 8 and December 8 of each year, commencing June 8, 2001, at an annual rate of 10.18% of the liquidation amount of $1,000 per Trust Security. The Company has the right under certain circumstances to defer payments of interest on the Junior Subordinated Debentures at any time and from time to time for a period not exceeding 10 consecutive semi-annual periods with respect to each deferral period, provided that no deferral period may end on a day other than an interest payment date or extend beyond the stated maturity date of the Junior Subordinated Debentures. If and for so long as interest payments on the Junior Subordinated Debentures are so deferred, cash distributions on the Trust Securities will also be deferred and the Company will not be permitted, subject to certain exceptions, to declare or pay any cash distributions with respect to the Company's capital stock (which includes common and preferred stock) or to make any payment with respect to debt securities of the Company that rank equal with or junior to the Junior Subordinated Debentures.
Upon the repayment on June 8, 2031, the stated maturity date, or prepayment prior to this date of the Junior Subordinated Debentures, the proceeds from such repayment or prepayment shall be applied to redeem the Trust Securities upon not less than 30 nor more than 60 days notice of a date of redemption at the applicable redemption price. At maturity, the redemption price shall equal the
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principal of and accrued and unpaid interest on the Junior Subordinated Debentures. The Junior Subordinated Debentures will be prepayable prior to the maturity date either through special event or at the option of the Company. Special event, as defined in the indenture, redemption price is 106.09% of the principal payable in whole. Optional prepayment on or after June 8, 2011, in whole or in part, price is equal to 105.09% of the principal amount thereof on the prepayment date, declining ratably on each June 8 thereafter to 100% on or after June 8, 2021, plus accrued and unpaid interest thereon to the date of prepayment.
The Company intends to use the proceeds for possible acquisitions of complementary lines of business and to invest in the Bank to support future growth and expansion. Prior to such usage, the proceeds have been invested in short term investments and used by the Bank to fund loans.
6. Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations completed after June 30, 2001 and also specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill and those acquired intangible assets that are required to be included in goodwill. SFAS No. 142 will require that goodwill no longer be amortized, but instead tested for impairment at least annually. Additionally, SFAS No. 142 will require recognized intangible assets be amortized over their respective estimated useful lives and reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Any recognized intangible asset determined to have an indefinite useful life will not be amortized, but instead tested for impairment until its life is determined to no longer be indefinite.
The Company will adopt the provisions of SFAS No. 141 and SFAS No. 142 on January 1, 2002, with the exception of the immediate requirement to use the purchase method of accounting for all future business combinations completed after June 30, 2001. Early adoption and retroactive application of these Standards are not permitted. However, any goodwill and any intangible asset determined to have an indefinite useful life that is acquired in a business combination completed after June 30, 2001 will not be amortized. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized until December 31, 2001.
At the date of adoption, the Company will evaluate its existing intangible assets and goodwill and to make any necessary reclassifications in order to conform with the new separation requirements in accordance with SFAS No. 141. Upon the adoption of SFAS No. 142, the Company will be required to reassess the useful lives and residual values of all intangible assets and make any necessary amortization period adjustments by March 31, 2002.
Furthermore, in connection with the transitional impairment evaluation, SFAS No. 142 will require the Company to perform an assessment of whether there is an indication that goodwill is impaired as of January 1, 2002. The transitional assessment, which is required to be completed by June 30, 2002, will consist of (1) identifying the Company's reporting units, (2) determining the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units, and (3) determining the fair value of each reporting unit. If the carrying value of any reporting unit exceeds its fair value, then detailed fair values for each of the assigned assets (excluding goodwill) and liabilities will be determined to calculate the amount of goodwill impairment, if any. Such impairment evaluation is to be completed as soon as possible, but no later than December 31, 2002. Any transitional impairment loss resulting from the adoption will be recognized as the effect of a change in accounting principle in the Company's statement of operations.
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The Company is currently evaluating the impact of the adoption of SFAS No. 142 on its goodwill and intangible assets and has not yet determined the full effect of adoption on its financial position and results of operations.
The Company also carries negative goodwill, the amount of the fair values of assets acquired and liabilities assumed exceeds the cost of an acquired company. Upon the adoption, any unamortized deferred credit related to an excess over cost will be recognized as a change in accounting principle and treated as an extraordinary gain. Management expects the remaining balance of negative goodwill of approximately $4.2 million at December 31, 2001 to be written off and recognized as the effect of a change in accounting principle on January 1, 2002 as a consequence of adopting SFAS No. 142.
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, Accounting for Asset Retirement Obligations, which is effective for fiscal years beginning after June 15, 2002. SFAS No. 143 requires, among other things, that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are then capitalized as part of the carrying amount of the long-lived asset. The Company does not believe that the adoption of SFAS No. 143 will have a material impact on its financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which is effective for fiscal years beginning after December 15, 2001. This pronouncement supercedes SFAS No. 121 and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 for the disposal of a segment of a business. The Company is currently evaluating the impact that the adoption of SFAS No. 144 may have on its financial position and results of operations.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Bancorp is a bank holding company offering a full range of commercial banking and consumer financial services through the Bank. During the first quarter of 2001, Bancorp became a bank holding company regulated by the Board of Governors of the Federal Reserve System (the "Federal Reserve") as part of the reorganization of the Bank into a holding company formation.
The following is management's discussion and analysis of the major factors that influenced the Company's consolidated results of operations and financial condition for the nine months ended September 30, 2001. This analysis should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2000 and with the unaudited financial statements and notes as set forth in this report.
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GENERAL
Selected Financial Data
The following table sets forth certain selected financial data concerning the Company for the periods indicated (dollars in thousands):
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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 Company is subject. For additional information concerning these factors, see "Item 1. Business—Business Considerations and Certain Factors That May Affect Our Results of Operation and Stock Price" contained in the Company's Form 10-K for the year ended December 31, 2000.
RESULTS OF OPERATIONS
Overview
Net Income. The Company's net income for the three months ended September 30, 2001 decreased by $247,000, or 8.8%, to $2.5 million, compared to $2.8 million for the corresponding period of the preceding year. The decrease resulted primarily from an increase in income tax provision. During the third quarter of 2001, the Company's provision for taxes increased $436,000 to $1.5 million compared to $1.1 million for the same period in 2000. The increase relates to higher taxes assessed from the State of New York due to an increase in income generated from it relative to the entire Company's operation. The annualized return on average equity ("ROE") and average assets ("ROA") ratios for the three months ended September 30, 2001 were 19.54% and 1.58%, respectively. This compares with annualized ROE and ROA ratios of 32.39% and 2.21%, respectively, for the three months ended September 30, 2000. The resulting efficiency ratios were 61.56% for the three months ended September 30, 2001 compared with 59.46% for the corresponding period of the preceding year. Diluted earnings per common share were $0.43 for the three months ended September 30, 2001 compared with $0.56 for the comparable period of the preceding year.
The Company's net income for the nine months ended September 30, 2001 increased by $518,000, or 6.4%, to $8.6 million, compared to $8.1 million for the corresponding period of the preceding year. The increase resulted primarily from an increase in interest income on the growth of the loan portfolio. The annualized returns on average equity and average assets ratios for the nine months ended September 30, 2001 were 23.59% and 1.84%, respectively. This compares with annualized ROE and ROA ratios of 34.22% and 2.39%, respectively, for the nine months ended September 30, 2000. The resulting efficiency ratios were 58.46% for the nine months ended September 30, 2001 compared with 56.48% for the corresponding period of the prior year. Diluted earnings per common share were $1.49 for the nine months ended September 30, 2001 compared with $1.57 for the comparable period of the preceding year.
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.
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Net interest income before provision for loan losses of $7.6 million for the three months ended September 30, 2001 represented a $323,000, or 4.4%, increase over net interest income of $7.3 million for the three months ended September 30, 2000. This increase was primarily due to the increase in the loan portfolio and was partially offset by the growth in core deposits. The average cost of deposits and other borrowings decreased to 4.11% for the three months ended September 30, 2001 from 5.21% for the three months ended September 30, 2000, primarily due to decreases in interest rates. The Federal Reserve Bank decreased the Fed funds rate by 75 bps during the third quarter of 2001. The increase in loans contributed to an increase of $565,000 in interest on earning assets to $11.7 million for the three months ended September 30, 2001, from $11.1 million for the three months ended September 30, 2000. This compares with an increase of $241,000 in interest expense to $4.0 million for the three months ended September 30, 2001 from $3.8 million for the three months ended September 30, 2000.
Net interest income before provision for loan losses of $23.0 million for the nine months ended September 30, 2001 represented a $3.8 million, or 19.6%, increase over net interest income of $19.3 million for the nine months ended September 30, 2000. This increase was primarily due to the increase in loan portfolio and partially offset by the growth in core deposits. The yield on interest-earning assets decreased to 8.7% for the nine months ended September 30, 2001 from 9.9% for the corresponding period of 2000, due to the decrease in interest rates. The average cost of deposits and other borrowings decreased to 4.7% for the nine months ended September 30, 2001 from 5.0% for the nine months ended September 30, 2000, primarily due to decreases in interest rates. The Federal Reserve Bank decreased the Fed funds rate by 350 bps during the nine months ended September 30, 2001. The increase in loans contributed to an increase of $7.5 million in interest on earning assets to $36.6 million for the nine months ended September 30, 2001, from $29.0 million for the nine months ended September 30, 2000. This compares with an increase of $3.8 million in interest expense to $23.0 million for the nine months ended September 30, 2001 from $19.3 million for the nine months ended September 30, 2000.
Average outstanding loans increased to $439.0 million for the nine months ended September 30, 2001 from $300.4 million for the corresponding period of 2000, an increase of $138.6 million, or 46.1%. Average securities increased to $70.0 million for the nine months ended September 30, 2001 from $45.7 million for the same period of 2000, an increase of $24.3 million, or 53.3%. Average interest-bearing deposits increased to $367.7 million for the nine months ended September 30, 2001 from $257.3 million in the corresponding period of the prior year, representing an increase of $110.4 million, or 42.9%.
Net Interest Margin. The net interest margin was 5.45% for the nine months ended September 30, 2001, down from 6.58% for the corresponding period of 2000. The decrease in the net interest margin resulted primarily from a decrease in interest rates and the Company's asset and liability position being asset sensitive to the declining interest rate environment. Due to the further rate reductions from the Federal Reserve Bank, the Company does not expect to see an improvement in net interest margin during the fourth quarter of 2001.
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The following table presents condensed average balance sheet information for the Company, together with interest rates earned and paid on the various sources and uses of funds for each of the year-to-date periods indicated:
The following table illustrates the changes in interest income, interest expense, amount 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 changes due to volume and the
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changes 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. The provision for loan losses reflects management's judgment of the current period cost associated with credit risk inherent in the Company's loan portfolio. Specifically, the provision for loan losses represents the amount charged against current period earnings to achieve an allowance for loan losses that, in management's judgment, is adequate to absorb losses inherent in the Company's loan portfolio.
The provision for loan losses of $300,000 for the nine months ended September 30, 2001 represented a decrease of $100,000 as compared to a provision of $400,000 for the corresponding period of the preceding year. During the first half of the year 2001, the Bank recorded no provision for loan losses due to the high level of loan recoveries during this period. During this period, $1.2 million was recovered, of which $1.1 million, related to Korea First Bank of New York loans that were charged off as a result of its acquisition by the Bank. During the third quarter of 2001, the Bank recorded $300,000 in provision for loan losses partially to reflect the growth of $34.7 million in gross loans less term fed funds ($481.5 at September 30, 2001, compared to $446.8 million at June 30, 2001) as well as a $157,000 increase in non-performing loans for the same period ($959,000 at September 30, 2001, compared to $802,000 at June 30, 2001). At September 30, 2001, the allowance for loan losses was $7.3 million. Net loan charge-offs were $923,000 for the nine months ended September 30, 2001, compared with net loan charge-offs of $1.7 million for the corresponding period of 2000.
Other Operating Income
Other operating income includes revenues earned from sources other than interest income. It is primarily comprised of service charges and fees on deposits accounts, fees received from letter of credit operations, and gains on sale of SBA loans and investment securities.
Noninterest Income. Noninterest income for the three months ended September 30, 2001 was $3.7 million compared to $3.2 million for the corresponding quarter of 2000, an increase of $482,000, or 15.2%, primarily as a result of amortization of negative goodwill and gain from sale of SBA loans.
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Negative goodwill amounted to $331,000 for the third quarter of 2001 compared with none during the same period in 2000. Gain on sale of SBA loans increased $278,000 to $400,000 for the three months ended September 30, 2001 as compared to $122,000 for the corresponding period of 2000.
Noninterest income for the nine months ended September 30, 2001 was $11.6 million compared to $9.7 million for the corresponding period of 2000, an increase of $1.9 million, or 19.0%, primarily as a result of gain on sale of available-for-sale securities and of SBA loans and amortization of negative goodwill. For the nine months ended September 30, 2001, gain on sale of available-for-sale securities, gain on sale of SBA loans, and amortization of negative goodwill was $708,000, $1.1 million, and $993,000, respectively. The gain on sale of SBA loans was $683,000 for the nine months ended September 30, 2000.
The summary of other operating income by category is illustrated below:
Noninterest Expense. Noninterest expense of $6.9 million for the three months ended September 30, 2001 increased $715,000, or 11.5%, compared with $6.2 million for the corresponding quarter of 2000. Personnel expenses increased to $3.9 million for the three months ended September 30, 2001, from $3.3 million for the corresponding period of 2000, an increase of $542,000, or 16.3%, primarily due to the additional staffing required to support the internal growth of the Bank, and the opening of a new Cerritos branch in La Palma, California.
Noninterest expense of $20.2 million for the nine months ended September 30, 2001 increased $3.9 million, or 23.6%, compared with $16.4 million for the corresponding period of 2000. Personnel expenses increased to $11.0 million for the nine months ended September 30, 2001, from $8.5 million for the corresponding period of 2000, an increase of $2.5 million, or 29.3%, primarily due to the additional staffing required to support the internal growth of the Bank and the opening of two new branches, the Aroma Center in Los Angeles and the Cerritos branch in La Palma, California.
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The summary of other operating expenses is illustrated below:
Provision for Income Taxes. The provision for income taxes was $1.5 million and $1.1 million on the income before taxes of $4.0 million and $3.8 million for the three months ended September 30, 2001 and 2000, respectively. The effective tax rate for the quarter ended September 30, 2001 was 36.9%, compared with 27.4% for the quarter ended September 30, 2000.
The provision for income taxes of $5.4 million and $4.1 million on the income before taxes of $14.1 million and $12.2 million for the nine months ended September 30, 2001 and 2000, respectively, represents effective tax rates of 38.6% and 33.4%, respectively.
Financial Condition
Total assets at September 30, 2001 were $640.0 million, an increase of $38.3 million, or 6.4%, from $601.7 million at December 31, 2000. The growth resulted primarily from increases in the loan portfolio.
Loan Portfolio
The Company carries all loans other than certain SBA loans held-for-sale at face amount, less payments collected, net of deferred loan origination fees and the allowance for possible loan losses. SBA loans held-for-sale are carried at the lower of cost or market. 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.
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During the nine months ended September 30, 2001, total loans increased by $142.2 million, or 39.2%, to $505.1 million, from $362.9 million at December 31, 2000. This growth was led by an increase in commercial loans and real estate and construction loans. Total loans includes $23 million in term federal funds and $3.3 million loans held for sale. Total commercial loans comprised of domestic commercial, international loans, SBA commercial loans, equipment financing, and term fed funds grew to $224.5 million at September 30, 2001, from $139.5 million at December 31, 2000. Real estate and construction loans comprised of commercial and SBA real estate loans increased to $236.8 million at September 30, 2001 from $177.8 million at December 31, 2000.
The following table illustrates the composition of the Bank's loan portfolio by amount and percentage of gross loans in each major loan category at the dates indicated:
Total past due loans were 0.18% of total net loans at September 30, 2001, compared with 0.57% at December 31, 2000. Nonperforming assets (nonaccrual loans, loans 90 days or more past due and still accruing interest, restructured loans, and other real estate owned) were $959,000, or 0.15%, of total assets at September 30, 2001, compared with nonperforming assets of $2.3 million, or 0.38%, of total assets at December 31, 2000. The allowance for loan losses was $7.3 million at September 30, 2001, a decrease of $622,000 from $7.9 million at December 31, 2000. The decrease in the allowance for loan losses reflected management's charge-off of the non-performing loans transferred from the acquisition of the Korea First Bank of New York.
The following table illustrates the composition of the Bank's nonperforming assets as of the dates indicated.
Allowance 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
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loan losses is an expense charged against operating income and added to the allowance for loan losses. Actual loan losses or recoveries are charged or credited, respectively, directly to the allowance for loan losses.
Management of the Company continues to carefully monitor the allowance of loan losses in relation to the size of the Company's loan portfolio and known risks or problem loans. Central to the Company's credit risk management is its credit risk rating system. Both internal, contracted external, and regulatory credit reviews are used to determine and validate loan risk grades. The Company's credit review system takes into consideration such borrower factors as: background and experience; historical and current financial condition; credit history and payment performance; industry and the economy; type, market value, and volatility of market value of collateral, and the Company's lien position; and the financial strength of guarantors.
Analysis of the adequacy of the allowance is conducted by the Company, and reported to the Board on a quarterly basis. The Company utilizes two methodologies to analyze the adequacy of the allowance: the Loss Migration Analysis methodology; and the Specific Allocation methodology.
The first methodology, Loss Migration Analysis, establishes reserve factors based on the Company's actual historical net charge-off experience for pools of loans graded Pass, Special Mention, Substandard, Doubtful, and Loss. A historical 12-quarter credit grading and loss experience is used. A 50.0% weight is applied to the established reserve factor for off balance sheet transactions (such as undisbursed lines of credit and contingent liabilities) that are graded Pass. The Company applies these reserve factors to the pools of loans graded Pass, Special Mention, Substandard, Doubtful, and Loss to determine the required allowance amount.
Additionally, positive and negative adjustments are made to the resultant Loss Migration Analysis required allowance for changes in judgmental factors such as: the Company's aggregate historical loss experience trends; underwriting criteria and practices; economic conditions; the nature and volume of the loan portfolio; the ability of lending management and staff; the trend of the volume and severity of past due, non-performing, and classified loans; the quality of the credit review system; concentrations of credit; and competition and legal and regulatory requirements.
The second methodology, Specific Allocation Analysis, includes a detailed analysis of specific loans in accordance with SFAS No. 114, "Accounting by Creditors for the Impairment of a Loan" as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures." Individual loans are reviewed to identify loans for impairment. A loan is considered impaired when principal and interest are deemed uncollectable in accordance with the original contractual terms of the loan. Impairment is measured as either the expected future cash flows discounted at each loan's effective interest rate, the fair value of the loan's collateral if the loan is collateral dependent, or an observable market price of the loan (if one exists). Upon measuring the impairment, the Company will insure an appropriate level of allowance is present or established. Based on the risk rating system, specific allowance allocations are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicates the probability that a loss may be incurred in excess of the amount determined by the Loss Migration Analysis formula allowance.
Additionally, even if a loan is not impaired by definition, Management performs a detailed analysis of other loans graded Substandard. This analysis includes but is not limited to: appraisals of the collateral; conditions of the marketplace for liquidating the collateral; and an assessment of guarantors. Management then reviews these conditions in discussion with the Company's senior credit officers, determines the inherent loss, and may make an appropriate specific allocation for the credit.
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Furthermore, under the second methodology, the Loss Migration Analysis reserve factors are applied to the remainder of the loan portfolio, which is grouped in pools by credit risk grade, Pass, Special Mention, Substandard, Doubtful, or Loss, as the unallocated allowance.
The Company also performs a reasonableness test to assist in determining if the allowance is sufficient to absorb the perceived risk in the loan portfolio. This test is not intended to substitute or override the Company's own internal methodology, but rather is used for comparative purposes. The assumptions used for the reasonableness test are:
The allowance for loan losses is increased by the provision for loan losses which is charged against current period operating results. The allowance for loan losses is also increased by recoveries on loan previously charged off and reduced by the actual loan losses charged to the allowance.
The allowance for loan losses was $7.3 million at September 30, 2001, compared to $7.9 million at December 31, 2000. The allowance for loan losses was 1.51% of gross loans, excluding $23 million of term fed fund sold, at September 30, 2001 compared to 2.17% at December 31, 2000. The Company charged off $2.6 million and recovered $1.6 million during the first nine months of 2001. The quality of the loan portfolio continued to be strong evidenced by low nonperforming loan balance and decreased classified loans. At September 30, 2001, the Company had classified $580,000 as loans impaired. This represents a decrease of $1.6 million or 73%, compared to $2.2 million classified as impaired at December 31, 2000. The Company applies the methods prescribed by Statement of Financial Accounting Standards No. 114 for determining the fair value of specific loans for which the eventual collection of all principal and interest is considered impaired.
The Company recorded $300,000 in reserves for the first nine months of 2001. Based on the calculation and continued loan recoveries, especially from the charged-off KFBNY loans, management believes the level of allowance as of September 30, 2001 is adequate to absorb the estimated losses from any known or inherent risks in the loan portfolio and the loan growth for the quarter. However, no assurance can be given that economic conditions which adversely affect the Company's service areas or other circumstances will not be reflected in increased provisions or loan losses in the future.
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
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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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Investment Security Portfolio
At September 30, 2001, the Company classified its securities as held-to-maturity or available-for-sale under FASB 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; nor did the Company hold any derivative financial instruments. Securities that are held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts. The securities currently held by the Company are government-sponsored agency bonds, corporate bonds, and collateralized mortgage obligations.
Securities (including available-for-sale and held-to-maturity) decreased during the nine months of 2001 by $566,000, or 0.8%, to $70.1 million at September 30, 2001 from $70.7 million at December 31, 2000. During the nine month period ended Setpember 30, 2001, $11.5 million in securities held to maturity were called and the proceeds were reinvested in securities available for sale. Securities with an amortized cost of $2.5 million were pledged to secure public deposits and for other purposes as required or permitted by law at September 30, 2001.
As of September 30, 2001, the carrying value of the securities was $68.8 million and the market value was $69.8 million. The total net unrealized gain on these securities was $1.0 million. Of this total, $1.3 million relates to securities which are available for sale on which the unrealized gain, net of tax, is included as a reduction of stockholders' equity. The unrealized gains are primarily the result of movements in market interest rates. In compliance to regulatory policy, during September 2001, the Company recorded a provision for an allowance of $138,000 in recognition of a security available for sale which had a book value in excess of market value.
The following table presents the Bank's securities portfolio on the dates indicated:
The amortized cost and estimated fair value of investment securities September 30, 2001 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities
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because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Deposits and Other Borrowings
Deposits. Deposits are the Bank's primary source of funds to use in lending and investment activities. Deposit balances were $547.2 million at September 30, 2001, which represented an increase of $19.5 million, or 3.7%, from $527.7 million at December 31, 2000. Core deposit balances increased by $10.0 million, or 3.1%, and time deposits increased by $9.5 million, or 4.7%, during this period. Core deposits include NOW, demand deposit, money market and savings accounts. The growth in core
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deposits resulted primarily from the Bank's continued focus on developing new and expanding existing commercial and consumer relationships in the ethnic Korean community, its retail niche market. At September 30, 2001, 38.8% of the deposits were time deposits, 13.7% were savings accounts, and 47.5% were NOW, demand deposit and money market accounts. By comparison, at December 31, 2000, 38.5% of the deposits were time deposits, 9.4% were savings accounts, and 52.1% were NOW, demand deposit and money market accounts.
Time deposits over $100,000 totaled $141.9 million at September 30, 2001. This represented an increase of approximately $16.2 million or 12.9%, compared to $125.7 million at December 31, 2000. In February of 2001, the Company brought in $5.0 million brokered deposits: $2.0 million with five year maturity at 5.65%, $2.0 million with two year maturity at 5.30% and $0.9 million with one year maturity at 5.15%. Other time deposits decreased approximately $6.7 million or 8.7% to $70.6 million at September 30, 2001, compared to $77.3 million at December 31, 2000. In September of 2001, the Company obtained $5.0 million time deposit with 3 months maturity at 2.27% from the State of California Office of the Treasurer, collaterized with securities pledged by the Company, with amortized cost of $6.3 million.
On September 31, 1999, the Company issued five-year subordinated capital notes in the aggregate amount of $4.3 million with a stated interest rate of 9.0%, maturing on September 31, 2004. Interest on the notes is payable quarterly and no scheduled payments of principal are due prior to maturity. At September 30, 2001, $2.6 million, which represents 60% of the total outstanding amount of the notes, qualified as risk-based Tier 2 capital.
In October of 2000, the Company established a borrowing line with the FHLB of San Francisco. Advances may be obtained from the FHLB of San Francisco to supplement our supply of lendable funds. Advances from the FHLB of San Francisco are typically secured by a pledge of mortgage loan and/or securities, with a market value at least equal to outstanding advances plus investment in FHLB stocks. At September 30, 2001, the Bank had $5.0 million advances outstanding, all collaterized with securities pledged by the Company, with amortized cost of $8.1 million. The borrowing has a seven-year, fixed rate term.
On March 28, 2001, the Company completed a private offering of $10 million of trust preferred securities, issued by Nara Capital as part of a pooled offering with several other financial institutions. The trust preferred securities bear a 10.18% fixed rate of interest payable semi-annually. Nara Capital used the proceeds from the sale of the trust preferred securities to purchase junior subordinated deferrable interest debentures of the Company. The Company intends to invest a portion of the net proceeds in the Bank to increase the Bank's regulatory guidelines and the Company included the trust preferred securities in Tier I Capital for the regulatory calculation purposes.
Stockholders' 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 Bank's capital needs. Total stockholders' equity was $53.8 million at September 30, 2001. This represented an increase of $9.3 million or 20.8% over total stockholders' equity of $44.5 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 1 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 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
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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 September 30, 2001, Tier 1 capital, shareholders' equity less intangible assets, plus proceeds from the trust preferred securities, was $61.1 million. This represented an increase of $18.4 million or 43.2% over total Tier 1 capital of $42.7 million at December 31, 2000. At September 30, 2001, the Company had a ratio of total capital to total risk-weighted assets of 12.53% and a ratio of Tier 1 capital to total risk weighted assets of 10.82%. The Tier 1 leverage ratio was 9.49% at September 30, 2001.
The following table presents the amounts of regulatory capital and the capital ratios for the Company and the Bank, compared to its minimum regulatory capital requirements as of September 30, 2001.
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 flow 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 our role 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 Bank'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.
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Liquidity and Interest Rate Sensitivity
Liquidity risk is the risk to earnings or capital resulting from the Bank'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 Bank'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.
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. 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's liquid assets include cash and cash equivalents, interest-bearing deposits in corresponding banks, federal funds sold and securities available-for-sale. The aggregate of these assets totaled $98.2 million at September 30, 2001, compared to $193.6 million at December 31, 2000.
Because the primary sources and uses of funds are loans and deposits, the relationship between gross loans and deposits provides a useful measure of the Company's liquidity. Typically, the closer the ratio of loans to deposits is to 100%, the more the Company relies on its loan portfolio to provide for short-term liquidity needs. Because repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan to deposit ratio, the less liquid are the Company's assets. At September 30, 2001, the Company's loan to deposit ratio averaged 89.2% compared to an average ratio of 73.3% at December 31, 2000.
The Company's success is largely dependent upon its ability to manage interest rate risk, which is the impact of adverse fluctuations in interest rates on the Company's net interest income and net portfolio value. Although in the normal course of business the Company manages other risks, such as credit and liquidity risk, management considers interest rate risk to be its most significant market risk and could potentially have the largest material effect on the Company's financial condition and results of operations
The fundamental objective of the asset liability management process is to manage the Company's exposure to interest rate fluctuations while maintaining adequate levels of liquidity and capital. The Asset Liability Committee meets monthly to monitor the interest rate risk, the sensitivity of the Company's assets and liabilities to those interest rate changes, investment activities and directs changes in the composition of the balance sheet. The Company's balance sheet is inherently asset sensitive, which means that assets generally reprice more often than liabilities. Since an asset-sensitive balance sheet tends to reduce net interest income when interest rates decline and to increase net interest income when interest rate rise, careful forecast of interest rate and security portfolio changes are used to manage the interest rate risk.
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 below indicates that assets that are rate sensitive within one year exceeded liabilities within that same period by $109.0 million at September 30, 2001.
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The following table shows the Company's gap position as of September 30, 2001.
The Company also uses a simulation analysis model to predict and monitor net interest income volatility and market value of equity volatility. The market value of equity is defined as the present value of assets minus the present value of liabilities and off balance sheet contracts. The table below shows the estimated impact of changes in interest rates on net interest income and market value of equity as of June 30, 2001.
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PART II OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
(a) On February 2, 2001, Bancorp became the holding company for the Bank pursuant to a reorganization of the Bank into a holding company structure (the "Reorganization"). As a result of the Reorganization, each share of outstanding common stock of the Bank was cancelled and exchanged for a share of Bancorp. The Certificate of Incorporation and Bylaws of Bancorp replaced the Articles of Association and Charter of the Bank and the constituent instruments defining the rights of the holders of Bancorp's common stock. This change in constituent instruments had the following effects:
(b) None.
(c) On March 28, 2001, the Company completed a $10.0 million offering of trust preferred securities, through Nara Capital, issued as part of a private-placement pooled offering with several
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other financial institutions. Sandler O'Neill & Partners, LP acted as placement agent for the pooled offering. The trust preferred securities bear a 10.18% fixed rate of interest payable semi-annually. Nara Capital used the proceeds from the sale of the trust preferred securities to purchase junior subordinated deferrable interest debentures of Company.
The trust preferred offering was made pursuant to Rule 506 of Regulation D under the Securities Act of 1933 and was made to a limited number of accredited investors. The Company incurred $343,500 in underwriting discounts in this offering.
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a vote of Security Holders
On January 17, 2001, the Bank held a special meeting of shareholders for the purpose of approving the reorganization of the Bank into the holding company structure, establishing Bancorp has the new holding company for the Bank. There were 5,461,092 shares entitled to vote at the special meeting. Votes were received for 3,959,665 shares; and of the shares voting, 3,830,113 voted for the reorganization, 44,634 voted against the reorganization, 84,918 abstained from voting on the reorganization, the remaining shares were broker non-votes.
The first Annual Meeting of Shareholders (the "Meeting") of the Bancorp was held on May 16, 2001 for the purpose of considering and voting upon the following matters:
Election of six persons to serve on the Board of Directors was approved with a total of 3,830,113 votes cast for, 44,634 votes against, and 84,918 abstentions.
The ratification of the appointment of Deloitte & Touche LLP as independent auditors for the fiscal year ending December 31, 2001 was approved with a total of 3,032,184 votes cast for, 0 votes against, and 7,965 abstentions.
There were no other matters brought before the Meeting that required a vote by shareholders.
Item 5. Other information
Inapplicable
Item 6. Exhibits and Reports on Form 8-K
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The following exhibits constitute compensation plans or arrangements: 10.1, 10.2, 10.3. and 10.9.
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(b) 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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