UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended March 31, 2003 or
For the transition period from to
Commission File Number: 000-50245
NARA BANCORP, INC.
(213) 639-1700
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of April 30, 2003, there were 10,764,690 outstanding shares of the issuer’s Common Stock, $0.001 par value.
TABLE OF CONTENTS
Table of Contents
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PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
NARA BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION(Unaudited)
(Continued)
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CONSOLIDATED STATEMENTS OF INCOMEFor the three months ended March 31, 2003 and 2002(Unaudited)
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See accompanying notes to consolidated financial statements
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYTHREE MONTHS ENDED MARCH 31, 2003 and 2002(Unaudited)
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DISCLOSURE OF RECLASSIFICATION AMOUNT FOR MARCH 31:
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CONSOLIDATED STATEMENTS OF CASH FLOWSTHREE MONTHS ENDED MARCH 31, 2003 AND 2002(Unaudited)
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Notes to unaudited Consolidated Financial Statements
Nara Bancorp, Inc. (“Nara Bancorp”, on a parent-only basis, and “we” or “our” on a consolidated basis), incorporated under the laws of the State of Delaware in 2000, is a bank holding company, headquartered in Los Angeles, California, offering a full range of commercial banking and consumer financial services through its wholly owned subsidiary, Nara Bank, N.A., a national bank (“Nara Bank”) with branches in California and New York as well as Loan Production Offices in Seattle, Chicago, New Jersey and Atlanta.
Our consolidated financial statements included herein have been prepared without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures, normally included in consolidated 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.
The consolidated financial statements include the accounts of Nara Bancorp and its wholly owned subsidiaries, Nara Bank, Nara Bancorp Capital Trust I and Nara Statutory Trust II. All intercompany transactions and balances have been eliminated in consolidation.
We also believe that we have made all adjustments necessary to fairly present our financial position and the results of our operations for the interim period ended March 31, 2003. Certain reclassifications have been made to prior period figures in order to conform to the March 31, 2003 presentation. The results of operations for the interim period are not necessarily indicative of results for the full year.
These consolidated financial statements should be read along with the audited consolidated financial statements and accompanying notes included in our 2002 Annual Report on Form 10-K.
On February 18, 2003, we declared a $0.05 per share cash dividend payable on April 11, 2003 to stockholders of record at the close of business on March 31, 2003.
On February 14, 2003, Nara Bancorp announced that its Board of Directors approved a two-for-one stock split of its common stock, effected in the form of a 100% stock dividend, which was payable on March 17, 2003 to stockholders of record on close of business on March 3, 2003. The effect of this dividend is that Stockholders received one additional share of Nara Bancorp common stock for each share owned. All per share amounts and number of shares outstanding in this report have been retroactively restated for this stock split.
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Basic earnings-per-share excludes the number of shares of common stock that could be purchased from those who hold exercisable stock options or warrants and is computed by dividing our earnings for the period by the weighted-average number of common shares outstanding for the period. Diluted earnings-per-share includes the weighted-average number of common shares outstanding, plus the number of shares that could be issued upon the exercise of stock options and/or warrants that are currently exercisable and where the exercise price is more than the current market value of our common stock.
The following table shows how we computed basic and diluted earnings per share (“EPS”) at March 31, 2003 and 2002.
Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employees compensation plans at fair value. We have elected to continue to account for stock-based
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compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair value of our stock at the date of grant over the grant price.
We have adopted the disclosure only provisions of SFAS No. 123. Had compensation cost for our stock-based compensation plans been determined base on the fair value at the grant date for awards consistent with the provisions of SFAS No. 123, our net income would have been reduced to the pro forma amounts as follows:
We did not grant any options for the quarters ended March 31, 2003 and March 31, 2002, respectively.
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Certain Small Business Administration (“SBA”) loans that we have the intent to sell prior to maturity have been designated as held for sale at origination and are recorded at the lower of cost or market value, on an aggregate basis. A valuation allowance is established if the aggregate market value of such loans is lower than their cost, and operations are charged or credited for valuation adjustments. A portion of the premium on sale of SBA loans is recognized as gain on sale of loans at the time of the sale. The remaining portion of the premium (relating to the portion of the loan retained) is deferred and amortized over the remaining life of the loan as an adjustment to yield. Servicing assets are recognized when loans are sold with servicing retained. Servicing assets are recorded based on the present value of the contractually specified servicing fee, net of servicing costs, over the estimated life of the loan, using a discounted rate based on the related note rate, plus 1 to 2%. Servicing assets are amortized in proportion to and over the period of estimated future net servicing income.
We periodically evaluate servicing assets for impairment. At March 31, 2003, the fair value of servicing assets was determined using a weighted-average discount rate of 10.9% and a prepayment speed of 10.5%. At March 31, 2002, the fair value of servicing assets was determined using a weighted-average discount rate of 10.9% and a prepayment speed of 11.0%. For purposes of measuring impairment, servicing assets are stratified by loan type. An impairment is recognized if the carrying value of servicing assets exceeds the fair value of the stratum. The fair values of servicing assets were approximately $2,869,000 and $2,433,000 at March 31, 2003 and December 31, 2002, respectively.
An interest-only strip is recorded based on the present value of the excess of the total future income from serviced loans over the contractually specified servicing fee, calculated using the same assumptions as used to value the related servicing assets. Such interest-only strip is accounted for at the estimated fair value, with unrealized gain or loss, net of tax, recorded as a component of accumulated other comprehensive income (loss).
We offer direct financing leases to customers whereby the assets leased are acquired without additional financing from other sources. Direct financing leases are carried net of unearned income, unamortized nonrefundable fees and related direct costs associated with the origination or purchase of leases.
In July 2001, the Financial Accounting Standards Board (“FASB”) 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 requires that goodwill no longer be amortized, but instead be tested for impairment at least annually. Additionally, SFAS No. 142 requires recognized intangible assets to be amortized over their respective estimated useful lives and reviewed for impairment. Any recognized intangible asset determined to have an
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indefinite useful life will not be amortized, but instead it must be tested for impairment until its life is determined to no longer be indefinite. We adopted SFAS No. 142 on January 1, 2002.
In connection with the transitional impairment evaluation required by SFAS No. 142, we performed an assessment of whether there was an indication that goodwill was impaired as of January 1, 2002. We completed our evaluation of any transitional impairment of goodwill and determined that there was no impairment as of January 1, 2002. We also tested goodwill for impairment as of December 31, 2002, noting no impairment in recorded goodwill of $874,968. No conditions indicated any further impairment as of March 31, 2003.
At December 31, 2001, we had negative goodwill (the amount by which the fair value of assets acquired and liabilities assumed exceeds the cost of an acquired company) of $4,192,334. In accordance with SFAS No. 142, such amount was recognized in the consolidated statement of income as the cumulative effect of a change in accounting principle on January 1, 2002. The recognition of negative goodwill is not tax effected, as no deferred taxes were allocated to it in the initial purchase accounting. We will continue to amortize its other intangible assets, representing core deposit intangibles, over the original estimated useful life of seven years.
As of March 31, 2003, intangible assets that continue to be subject to amortization include core deposits of $1,455,479 (net of $621,010 accumulated amortization) and servicing assets of $2,350,511 (net of $648,104 accumulated amortization). Amortization expense for such intangible asset was $167,591 for the three months ended March 31, 2003. Estimated amortization expense for intangible assets for the remainder of 2003 and the five succeeding fiscal years follows:
SFAS No. 148, Accounting for Stock-based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123, amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provisions of SFAS No. 148 are effective for annual financial statements for fiscal years ending after December 15, 2002, and for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. We have not determined whether we will adopt the fair value based method of accounting for stock-based employee compensation.
The Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others, an interpretation of SFAS Nos. 5, 57 and 107, and rescission of FIN No. 34,Disclosure of Indirect Guarantees of Indebtedness of Others, in November 2002.FIN No. 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a
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guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of the interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, while the provisions of the disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of such interpretation did not have a material impact on our results of operations, financial position or cash flows.
We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Our exposure to credit loss in the event of nonperformance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for extending loan facilities to customers. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; and income-producing properties.
Commitments at March 31, 2003 are summarized as follows:
In the normal course of business, we are involved in various legal claims. We have reviewed all legal claims against us with counsel and have taken into consideration the views of such counsel as to the outcome of the claims. In our opinion, the final disposition of all such claims will not have a material adverse effect on our financial position and results of operations.
As part of our asset and liability management strategy, we may engage in derivative financial instruments, such as interest rate swaps, with the overall goal of minimizing the impact of interest rate fluctuations on our net interest margin. During the second and fourth quarters of 2002, we entered into various interest rate swap agreements as summarized in the table below. Our objective for the interest rate swaps is to manage asset and liability positions in connection with our overall strategy of minimizing the interest rate fluctuations on our interest rate margin and equity. As part of our overall risk management, the Asset Liability Committee, which meets monthly, monitors and measures the interest rate risk, the sensitivity of our assets and liabilities to the interest rate changes, including the impact of the interest rate swaps.
Under the swap agreements, we receive a fixed rate and pay a variable rate based on H.15 Prime. The swaps qualify as cash flow hedges under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended, and are designated as hedges of the variability of cash flows we receive from certain of our Prime-indexed loans. In accordance with SFAS No. 133, these swap agreements are measured at fair value and reported as assets or liabilities on the consolidated statement of financial condition. The portion of the change in the fair value of the swaps that is deemed effective in hedging the cash flows of the designated assets are recorded in accumulated other comprehensive income (“OCI”) and reclassified into
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interest income when such cash flows occur in the future. Any ineffectiveness resulting from the hedges is recorded as a gain or loss in the consolidated statement of income as a part of non-interest income. As of March 31, 2003, the amounts in accumulated OCI associated with these cash flows totaled $2,217,391 (net of tax of $1,478,260), of which $1,053,336 is expected to be reclassified into interest income within the next 12 months. As of March 31, 2003, the maximum length of time over which we are hedging our exposure to the variability of future cash flow is approximately 10 years.
Interest rate swap information at March 31, 2003 is summarized as follows:
1. Gain included in the consolidated statement of earnings for the three months ended March 31, 2003, representing hedge ineffectiveness
2. Prime rate is based on Federal Reserve statistical release H.15
During the 1st quarter of 2003, interest income was increased by $833,000 received from swap counterparties. No such swap contracts were held during the 1st quarter of 2002. At March 31, 2003, we pledged to the interest rate swap counterparty as collateral agency securities with a book value of $2.0 million and real estate loans of $2.1 million.
Our management utilizes an internal reporting system to measure the performance of our various operating segments. We have identified three principal operating segments for purposes of management reporting: banking operation, trade finance (“TFS”), and small business administration (“SBA”). Information related to our remaining centralized functions and eliminations of intersegment amounts have been aggregated and included in banking operation. Although all three operating segments offer financial products and services, they are managed separately based on each segment’s strategic focus. The banking operation segment focuses primarily on commercial and consumer lending and deposit operations throughout our branch network. The TFS segment allows our import/export customers to handle their international transactions. Trade finance products include the issuance and collection of letters of credit, international collection, and import/export financing. The SBA segment provides our customers with the U.S. SBA guaranteed lending program.
Operating segment results are based on our internal management reporting process, which reflects assignments and allocations of capital, certain operating and administrative costs and the provision for loan
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losses. Noninterest income and noninterest expense, including depreciation and amortization, directly attributable to a segment are assigned to that business. We allocate indirect costs, including overhead expense, to the various segments based on several factors, including, but not limited to, full-time equivalent employees, loan volume and deposit volume. We allocate the provision for loan losses based on new loan originations for the period. We evaluate overall performance based on profit or loss from operations before income taxes not including nonrecurring gains and losses. Future changes in our management structure or reporting methodologies may result in changes in the measurement of operating segment results.
The following tables present the operating results and other key financial measures for the individual operating segments for the three months ended March 31, 2003 and 2002.
On April 7, 2003, we formed Nara Real Estate Trust, a Maryland real estate investment trust, as an indirect wholly owned subsidiary of Nara Bank. Nara Bank intends to transfer certain qualifying mortgage assets to Nara Real Estate Trust in order to improve access to capital markets and to further enhance Nara Bank’s cash flow position.
On April 25, 2003, we announced that we signed a non-binding letter of agreement to acquire Asiana Bank, a full service commercial bank headquartered in Sunnyvale, California. Under the terms of the proposed merger, Asiana Bank would be merged into Nara Bank and Asiana Bank’s shareholders would
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receive shares of Nara Bancorp valued at approximately $8.0 million. The parties have agreed to negotiate a mutually acceptable definitive agreement. Once a definitive agreement is reached, the acquisition will be subject to a number of conditions, including the approval of the shareholders of Asiana Bank and receipt of regulatory approvals, and will likely close in the third quarter of 2003.
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 our consolidated results of operations and financial condition for the quarter ended March 31, 2003. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2002 and with the unaudited consolidated financial statements and notes as set forth in this report.
GENERAL
Selected Financial Data
The following table sets forth certain selected financial data concerning the periods indicated:
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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 our business involves inherent risks and uncertainties. Risks and uncertainties include possible future deteriorating economic conditions in our 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 which we are subject to. For additional information concerning these factors, see “Item 1. Business - Factors That May Affect Business or the Value of Our Stock” contained in our Form 10-K for the year ended December 31, 2002.
RESULTS OF OPERATIONS
Net Income
Our net income, before cumulative effect of change in accounting principle for the three months ended March 31, 2003 was $3.2 million or $0.29 per diluted share compared to $2.2 million or $0.19 per diluted share for the same quarter of 2002, which represented an increase of approximately $1.0 million or 45.5%. The increase resulted primarily from an increase in net interest income and noninterest income, resulting primarily from a growth in loans and investments as well as the sale of loans we originated, which was partially offset by higher noninterest expense. During the first quarter of 2002, we recognized $4.2 million as the cumulative effect of a change in accounting principle. The cumulative effect of a change in accounting principle was related to the one-time recognition of all negative goodwill in the consolidated statement of income at January 1, 2002 in accordance with SFAS No. 142, Goodwill and Other Intangible Assets, which resulted in total net income for the quarter of $6.4 million or $0.54 per diluted share.
The annualized return on average assets was 1.32 % for the first quarter of 2003 compared to 1.29% for the same period of 2002. The annualized return on average equity was 19.32% for the first quarter of 2003 compared to 14.58% for the same period of 2002. The resulting efficiency ratios were 56.19% for the three months ended March 31, 2003 compared with 65.52% for the corresponding period of the preceding year. This improvement was primarily due to the increase in net revenue. All 2002 ratios in this section exclude the cumulative effect of a change in accounting principle.
Net Interest Income and Net Interest Margin
Net Interest Income
The principal component of our 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 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 cost of average interest-bearing deposits and borrowed funds. The net interest income is affected by changes in the volume of interest-earning assets and interest-bearing liabilities as well as by changes in yield earned on interest-earning assets and rates paid on interest-bearing liabilities.
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Net interest income before provision for loan losses was $9.9 million for the first quarter of 2003, which represented an increase of $2.5 million, or 33.8% from net interest income of $7.4 million for the same quarter of 2002. This increase was primarily due to an increase in average earning assets. Average earning assets increased $282.5 million or 45.8% to $910.1 million for the first quarter of 2003, from $627.6 million for the same quarter of 2002.
Interest income for the first quarter of 2003 was $13.9 million, which represented an increase of $3.5 million or 33.7% over interest income of $10.4 million for the same quarter of 2002. The increase was the net result of a $4.4 million increase in average interest-earning assets (volume change) off-set by a $815,000 decrease in the yield earned on those average interest-earning assets (rate change).
Net Interest Margin
The yield on average interest-earning assets decreased to 6.13% for the three months ended March 31, 2003, from a yield of 6.63% for the three months ended March 31, 2002. This decrease is mainly due to an additional 50 basis point decrease in prime rate by the Federal Reserve Board (“FRB”) between these periods.
Interest expense for the first quarter of 2003 was $4.1 million, which represented an increase of $1.1 million or 36.7% over interest expense of $3.0 million for the same quarter of 2002. The increase was the net result of a $1.6 million increase in average interest-bearing liabilities (volume change) off-set by a $504,000 decrease in the cost of those interest-bearing liabilities (rate change).
The average cost of interest-bearing liabilities decreased to 2.44% for the three months ended March 31, 2003 from 2.83% for the three months ended March 31, 2002. This decrease is mainly due to decreases in market rates.
The net interest margin was 4.34% for the three months ended March 31, 2003, down from 4.74% for the same quarter of 2002. The decrease in the net interest margin resulted primarily from a decrease in interest rates. Due to a continued effort to maintain well-balanced assets and liabilities, the interest margin only decreased a 40 basis point despite a 50 basis point rate cut by FRB in November of 2002.
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The following table presents our condensed average balance sheet information, together with interest rates earned and paid on the various sources and uses of funds for the three-month periods indicated:
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The following table illustrates the changes in our 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 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 our judgment of the current period cost associated with credit risk inherent in our loan portfolio. The loan loss provision for each period is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, assessments by management, third parties and regulators of the quality of the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in our market area. Specifically, the provision for loan losses represents the amount charged against current period earnings to achieve an allowance for loan losses that, in our judgment, is adequate to absorb losses inherent in our loan portfolio. Periodic fluctuations in the provision for loan losses result from management’s assessment of the adequacy of the allowance for loan losses; however, actual loan losses may vary from current estimates.
We recorded a $1.3 million in provision for loan losses in the first quarter of 2003 compared to $350,000 in the same quarter of 2002. The increase in the provision for loan losses for the quarter ended March 31, 2003, as compared to the same period ended March 31, 2002 was due to several factors including the growth experienced in our loan portfolio and our levels of non performing assets. We believe that the allowance is sufficient for the known and inherent losses at March 31, 2003. Refer to Allowance and Provision for Loan Losses section for further discussion.
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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 deposits accounts, fees received from letter of credit operations, and gains on sale of SBA loans and investment securities.
Non-interest income for the first quarter of 2003 was $4.9 million compared to $3.7 million for the same quarter of 2002, which represented an increase of $1.2 million, or 32.4%, primarily as a result of increase in service charges on deposits, gains on sale of SBA loans and gain on interest rate swaps. Service charges on deposits increased $282,000 or 19.6% to $1.7 million for the first quarter of 2003, from $1.4 million for the same quarter of 2002. This increase is mainly due to increase in average demand deposits. Average demand deposits increased $36.2 million or 18.4% to $232.7 million for the first quarter of 2003, from $196.5 million for the same quarter of 2002. Gain on sale of SBA loans for the first quarter of 2003 was $1.2 million, increase of $843,000 or 236.1% from $357,000 for the first quarter of 2002. We originated $20.2 million of SBA loans and sold $18.5 million during the first quarter of 2003. During the same quarter of 2002, we originated $7.9 million and sold $6.7 million. Gain on sale of securities was $159,000 during the first quarter of 2003 compared with $572,000 during the first quarter of 2002. We also recognized a gain of $148,000 from the interest rate swap transactions, which was the ineffective portion of a swap that related to cash flow hedge.
The summary of our non-interest income by category is illustrated below:
Non-interest Expense
Non-interest expense for the first quarter of 2003 was $8.3 million compared to $7.3 million for the corresponding quarter of 2002, which represented an increase of $1.0 million or 13.7%, primarily due to increase in salaries and employee benefit expenses.
Salaries and employee benefits expenses for the first quarter of 2003, increased $491,000 or 12.1% to $ 4.6 million from $ 4.1 million for the corresponding quarter of 2002. This increase is primarily due to an
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additional staffing to support the growth, salary adjustments, and significant increase in health insurance premium.
The summary of our non-interest expenses is illustrated below:
Provision for Income Taxes
The provision for income taxes was $1.9 million and $1.3 million on income before taxes and cumulative effect of a change in accounting principle of $5.2 million and $3.5 million for the three months ended March 31, 2003 and 2002, respectively. The effective tax rate for the quarter ended March 31, 2003 was 37.2%, compared with 36.6% for the quarter ended March 31, 2002.
Financial Condition
At March 31, 2003, our total assets were $1,015 million, an increase of $35.8 million or 3.7%, from $979.2 million at December 31, 2002. The growth resulted primarily from increases in our loans and investment securities funded by growth in deposits and other borrowings.
Investment Securities Portfolio
We classify our securities as held-to-maturity or available-for-sale under SFAS No.115. Those securities that we have the ability and intent to hold to maturity are classified as “held-to-maturity securities”. All other securities are classified as “available-for-sale”. We did not own any trading securities at March 31, 2003. Securities that are held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts. Securities that are available for sale are stated at fair value. The securities we
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currently hold are government-sponsored agency bonds, corporate bonds, collateralized mortgage obligations, U.S. government agency preferred stocks, and municipal bonds.
As of March 31, 2003, we had $2.8 million of held-to-maturity securities and $128.4 million of available-for-sale securities, compared to $2.8 million and $101.6 million at December 31, 2002, respectively. The total net unrealized gain on the available-for sale securities at March 31, 2003 was $1.2 million, compared to net unrealized gain of $1.1 million at December 31, 2002. During the first quarter of 2003, we purchased a total of $41.4 million in available-for-sale securities and sold $3.2 million and recognized total gross gains of $159,000.
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 March 31, 2003. Securities with an amortized cost of $23.6 million and $43.7 million were pledged to FHLB of San Francisco and State of California Treasurer’s Office, respectively, at March 31, 2003.
The following table summarizes the book value, market value and distribution of our investment securities portfolio as of dates indicated:
Investment Portfolio
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The carrying value and the yield of investment securities as of March 31, 2003, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Investment Maturities and Repricing Schedule
Loan Portfolio
We carry all loans (except for certain SBA loans held-for-sale) at face amount, less payments collected, net of deferred loan origination fees and the allowance for loan losses. SBA loans held-for-sale are carried at the lower of cost or market. Interest on all loans is accrued daily. 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.
As of March 31, 2003, our gross loans (net of unearned fees), including loans held for sale, increased by $29.5 million or 4.0% to $759.3 million from $ 729.8 million at December 31, 2002. The commercial loans, which include domestic commercial, international trade finance, SBA loans, and equipment leasing, at March 31, 2003 increased by $13.4 million or 4.5 % to $312.3 million from $298.9 million at December 31, 2002. Real estate and construction loans increased by $12.9 million or 3.4% to $388.6 million from $375.7 million at December 31, 2002. There has been a continued high demand for real estate loans during the past months.
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The following table illustrates our loan portfolio by amount and percentage of gross loans in each major loan category at the dates indicated:
We do not normally extend lines of credit and make loan commitments to business customers for periods in excess of one year. We use the same credit policies in making commitments and conditional obligations as we do for extending loan facilities to our customers. We perform annual reviews of such commitments prior to the renewal. The following table shows our loan commitments and letters of credit outstanding at the dates indicated:
At March 31, 2003, our nonperforming assets (nonaccrual loans, loans 90 days or more past due and still accruing interest, restructured loans, and other real estate owned) were $2.1 million, which represented a slight decrease of $100,000 or 4.5% from $2.2 million at December 31, 2002. As of March 31, 2003, a total of $445,000 loans were restructured and are current. At March 31, 2003, nonperforming assets to total assets was 0.21%, compared to 0.22% at December 31, 2002. The nonperforming loans were $1.6 million, which represented an increase of approximately $500,000 or 45.5% from $1.1 million at December 31, 2002. The increase was mainly due to $603,000 in restructured loans, which became nonaccrual as of March 31, 2003. At March 31, 2003, nonperforming loans to total gross loans was 0.22%, compared to 0.15% at December 31, 2002.
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The following table illustrates the composition of our nonperforming assets as of the dates indicated.
Allowance for Loan Losses
The allowance for loan losses represents the amounts that we have set aside for the specific purpose of absorbing losses that may occur in our loan portfolio. The provision for 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.
We continue to carefully monitor the allowance of loan losses in relation to the size of our loan portfolio and known risks or problem loans. Central to our credit risk management is our credit risk rating system. Both internal, contracted external, and regulatory credit reviews are used to determine and validate loan risk grades. Our credit review system takes into consideration factors such as: borrower’s 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 our lien position; and the financial strength of guarantors.
We use three different methodologies to determine the adequacy of the Allowance: (1) the Migration Analysis; (2) the Reasonableness Test; and (3) the Specific Allocation method.
The Migration Analysis is a formula method based on our actual historical net charge-off experience for each loan type pools and undisbursed commitments graded Pass (less cash secured loans), Special Mention, Substandard, and Doubtful.
We use an eight-quarter rolling average of historical losses detailing charge-offs, recoveries, and loan type pool balances to determine the estimated credit losses for non-classified and classified loans. Also, in order to reflect the impact of recent events, the eight-quarter rolling average has been weighted. The most recent four quarters have been assigned a 60% weighted average and the older four quarters have been assigned a 40% weighted average.
The resulting migration risk factors, or our established minimum risk factor for loan type pools that have no historical loss, whichever is greater, for each loan type pool is used to calculate our General Reserve. For loan type pools that have no historical loss, we have established a minimum risk factor for each loan grade Pass (0.40% - 2.47%), Special Mention (3.0% - 5.62%), Substandard (10.0% - 73.88%), Doubtful (50.0%-100%), and Loss (100.0%).
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For identified impaired loans, if the calculated impairment is less than the migration risk factor, the migration risk factor is used. If the calculated impairment is greater than the migration risk factor, the General Reserve is increased by the amount of the difference.
Additionally, in order to systematically quantify the credit risk impact of trends and changes within the loan portfolio, we subjectively, within established parameters, make adjustments to the Migration Analysis for:
Our parameters for making adjustments are established under a Credit Risk Matrix that provides seven possible scenarios for each of the above factors. The matrix allows for three positive/decrease (Major, Moderate, and Minor), three negative/increase (Major, Moderate, and Minor), and one neutral credit risk scenarios within each factor for each loan type pool. Generally, the factors are considered to have no impact (neutral) to our migration ratios. However, if information exists to warrant adjustment to the Migration Analysis, we make the changes in accordance with the established parameters supported by narrative and/or statistical analysis. Our Credit Risk Matrix and the seven possible scenarios enable us to adjust the Migration Analysis as much as 50 basis points in either direction (positive or negative) for each loan type pool.
The Reasonableness Test is based on a national historical loss experience for each loan graded Special Mention, Substandard, Doubtful, and Loss; and an established minimum for loans graded Pass. The reserve factors applied under this method are: 1.0% for loans graded Pass; 5.0% for loans graded Special Mention; 15.0% for loans graded Substandard; 50.0% for loans graded Doubtful; and 100.0% for loans graded Loss. This method is not intended to substitute or override the Bank’s other methodologies, but rather is used for comparative purposes.
Under the Specific Allocation method, management establishes specific allowances for loans where management has identified significant conditions or circumstances related to a credit that are believed to indicate the probability that a loss may be incurred. The specific allowance amount is determined by a method prescribed by the Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan. Our actual historical repayment experience and the borrower’s cash
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flow, together with an individual analysis of the collateral held on a loan, is taken into account in determining the allocated portion of the required Allowance under this method. As estimations and assumptions change, based on the most recent information available for a credit, the amount of the required specific allowance for a credit will increase or decrease. The Migration Analysis risk factor is used to determine the unallocated portion of the required Allowance under this method. By analyzing the identified credits on a quarterly basis, we are able to adjust a specific allowance based upon the most recent information that has become available.
The allowance for loan losses was $9.4 million at March 31, 2003, compared to $6.7 million at March 31, 2002. We recorded a provision of $ 1.3 million during the first quarter of 2003, mainly due to an increase in our loan portfolio and classified loans. Average gross loans (net of unearned) increased $225.9 million or 44.0% to $739.8 million for the first quarter of 2003, compared to $513.9 million for the same quarter of 2002. During the first quarter of 2003, we charged off $426,000 and recovered $75,000. The allowance for loan losses was 1.24% of gross loans at March 31, 2003 compared to 1.29% at March 31, 2002. The total classified loans at March 31, 2003 was $6.2 million, compared to $3.4 million at March 31, 2002.
We believe the level of allowance as of March 31, 2003 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 our service areas or other circumstances will not be reflected in increased provisions or loan losses in the future.
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The following table shows the provisions made for loan losses, the amount of loans charged off, the recoveries on loans previously charged off together with the balance in the allowance for possible loan losses at the beginning and end of each period, the amount of average and total loans outstanding, and other pertinent ratios as of the dates and for the periods indicated:
* Total loans are net of unearned
Deposits and Other Borrowings
Deposits. Deposits are our primary source of funds to use in lending and investment activities. At March 31, 2003, our deposits increased by $13.5 million or 1.6% to $830.4 million from $816.9 million at December 31, 2002. Demand deposits totaled $241.8 million, which represented an increase of $4.9 million or 2.1% from $236.9 million at December 31, 2001. Time deposits over $100,000 totaled $282.2 million, which represented an increase of $14.0 million or 5.2% from $268.2 million at December 31, 2002. Other
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interest-bearing demand deposits, including money market and super now accounts, totaled $306.4 million, which represented a decrease of $5.4 million or 1.7% from $311.8 million at December 31, 2001.
At March 31, 2003, 29.1% of the total deposits were non-interest bearing demand deposits, 44.4% were time deposits, 17.1% were savings accounts, and 9.4% were interest bearing demand deposits. By comparison, at December 31, 2002, 29.0% of the total deposits were non-interest bearing demand deposits, 43.4% were time deposits, 17.3% were savings accounts, and 10.3% were interest bearing demand deposits.
At March 31, 2003, we had a total of $38.1 million in time deposits brought in through brokers and $40.0 million in time deposits from the State of California Treasurer’s Office. The deposits from the Sate of California Treasurer’s Office were collateralized with our securities with an amortized cost of $43.7 million. The detail of those deposits is shown on the table below.
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In October of 2000, we 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. The following table shows our outstanding borrowings from FHLB at March 31, 2003. All FHLB advances were fixed rates.
Nara Bancorp established special purpose trusts in 2001 and 2002 for the purpose of issuing Preferred Trust Securities (the “Trust Securities”). The trusts exist for the sole purpose of issuing Trust Securities and investing the proceeds thereof in Junior Subordinated Debentures issued by Nara Bancorp. Payment of distributions out of the monies held by the trusts and payments on liquidation of the trusts or the redemption of the Junior Subordinated Debentures are guaranteed by Nara Bancorp to the extent the trusts have funds available thereof. The obligation of Nara Bancorp under the guarantees and the Junior Subordinated Debentures are subordinate and junior in right of payment to all indebtedness of Nara Bancorp and are structurally subordinated to all liabilities and obligations of Nara Bancorp’s subsidiaries. The table below summarizes the outstanding Junior Subordinated Debentures issued by each special purpose trust and the debentures issued by Nara Bancorp to each trust as of March 31, 2003.
(Dollars in Thousand)
The Junior Subordinate Debentures are not redeemable prior to June 8, 2011 with respect to Nara Bancorp Capital Trust I and March 26, 2007 with respect to Nara Statutory Trust II unless certain events have occurred. The proceeds from the issuance of the Trust Securities were used primarily for corporate purposes.
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The following table shows our contractual obligation as of March 31, 2003.
Stockholders’ Equity and Regulatory Capital
In order to ensure adequate levels of capital, we conduct an ongoing assessment of projected sources and uses of capital in conjunction with projected increases in assets and levels of risk. We consider on an ongoing basis, among other things, cash generated from operations, access to capital from financial markets or the issuance of additional securities, including common stock or notes, to meet our capital needs. Total stockholders’ equity was $68.8 million at March 31, 2003. This represented an increase of $3.4 million or 5.2% over total stockholders’ equity of $65.4 million at December 31, 2002.
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 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, stockholders’ equity less intangible assets, plus proceeds from the Trust Securities, was $80.9 million. This represented an increase of $3.0 million or 3.4% over total Tier 1 capital of $77.9 million at December 31, 2002. This increase was due to a net income of $3.2 million off-set by cash dividends of $537,000, which was declared during the first quarter of 2003 to be paid in April of 2003. At March 31, 2003, we had a ratio of total capital to total risk-weighted assets of 10.5% and a ratio of Tier 1 capital to total risk weighted assets of 9.4%. The Tier 1 leverage ratio was 8.3% at March 31, 2003.
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As of March 31, 2003, Management believed that the Bank has met the criteria as a “well capitalized institution” under the regulatory framework for prompt corrective action. The following table presents the amounts of our regulatory capital and capital ratios, compared to regulatory capital requirements for adequacy purposes as of March 31, 2003 and December 31, 2002.
Liquidity Management
Liquidity risk is the risk to earnings or capital resulting from our inability to fund assets when needed and liability 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 our 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 of our assets, maturity and availability of pledgeable investments, and customer demand for credits.
In general, our sources of liquidity are derived from financing activities, which include the acceptance of customer and broker deposits, federal funds facilities, and advances from the Federal Home Loan Bank of San Francisco. These funding sources are augmented by payments of principal and interest on loans and the routine liquidation of securities from principal paydown, maturity and sales. Our primary uses of funds include withdrawal of and interest payments on deposits, originations of loans, purchases of investment securities, and payment of operating expenses.
We manage liquidity risk by controlling the level of federal funds and by maintaining lines with correspondent banks, the Federal Reserve Bank, and Federal Home Loan Bank of San Francisco. The sale of investment securities available-for-sale 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.
As a means of augmenting our liquidity, we have established federal funds lines with corresponding banks and Federal Home Loan Bank of San Francisco. At March 31, 2003, our borrowing capacity included $28.0 million in federal funds line facility from correspondent banks and $37.4 million in unused FHLB advances. In addition to the lines, our liquid assets include cash and cash equivalents, interest bearing deposits in other banks, federal funds sold and securities available for sale that are not pledged. The book value of the aggregate of these assets totaled $132.4 million at March 31, 2003, compared to $138.1 million at December 31, 2002. We believe our liquidity sources to be stable and adequate.
Because our primary sources and uses of funds are loans and deposits, the relationship between gross loans and total deposits provides a useful measure of our liquidity. Typically, higher the ratio of loans to deposits is to 100%, the more we rely on our loan portfolio to provide for short-term liquidity needs.
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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 our assets. At March 31, 2003, our gross loan to deposit ratio was 90.5%.
Item 3. Quantitative and qualitative disclosures about market risk
The objective of our asset and liability management activities is to improve our earnings by adjusting the type and mix of assets and liabilities to effectively address changing condition and risks. Through overall management of our balance sheet and by controlling various risks, we seek to optimize our financial returns within safe and sound parameters. Our operating strategies for attaining this objective include managing net interest margin through appropriate risk/return pricing of asset and liabilities and emphasizing growth in retail deposits, as a percentage of interest-bearing liabilities, to reduce our cost of funds. We also seek to improve earnings by controlling noninterest expense, and enhancing noninterest income. We also use risk management instruments to modify interest rate characteristic of certain assets and liabilities to hedge against our exposure to interest rate fluctuations, reducing the effects these fluctuations might have on associated cash flows or values. Finally, we perform internal analyses to measure, evaluate and monitor risk.
Interest Rate Risk
Interest rate risk is the most significant market risk impacting us. 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. Interest rate risk occurs when interest rate sensitive assets and liabilities do not reprice simultaneously and in equal volume. A key objective of asset and liability management is to manage interest rate risk associated with changing asset and liability cash flows and values and market interest rate movements. The management of interest risk is governed by policies reviewed and approved annually by the Board of Directors. Our Board delegates responsibility for interest risk management to the Asset and Liability Management Committee (“ALCO”), which is composed of Nara Bank’s senior executives and other designated officers.
The fundamental objective of the ALCO is to manage our exposure to interest rate fluctuations while maintaining adequate levels of liquidity and capital. The ALCO meets regularly to monitor the interest rate risk, the sensitivity of our assets and liabilities to interest rate changes, the book and market values of assets and liabilities, investment activities and directs changes in the composition of the balance sheet. Our strategy has been to reduce the sensitivity of our earnings to interest rate fluctuations by more closely matching the effective maturities or repricing characteristics of our assets and liabilities. Certain assets and liabilities, however, may react in different degrees to changes in market interest rates. Further, interest rates on certain types of assets and liabilities may fluctuate prior to changes in market interest rates, while rate on other types may lag behind. We consider the anticipated effects of these factors when implementing our interest rate risk management objectives.
Swaps
As part of our asset and liability management strategy, we may engage in derivative financial instruments, such as interest rate swaps, with the overall goal of minimizing the impact of interest rate fluctuations on our net interest margin. Interest rate swaps involve the exchange of fixed-rate and variable-rate interest payment obligations without the exchange of the underlying notional amounts. During 2002, we entered into eight different interest rate swap agreements as summarized in the table below.
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Under the swap agreements, we receive a fixed rate and pay a variable rate based on H.15 Prime. The swaps qualify as cash flow hedges under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended, and are designated as hedges of the variability of cash flows we receive from certain of our Prime-indexed loans. In accordance with SFAS No. 133, these swap agreements are measured at fair value and reported as assets or liabilities on the consolidated statement of financial condition. The portion of the change in the fair value of the swaps that is deemed effective in hedging the cash flows of the designated assets are recorded in accumulated other comprehensive income (“OCI”) and reclassified into interest income when such cash flows occur in the future. Any ineffectiveness resulting from the hedges is recorded as a gain or loss in the consolidated statement of income as a part of non-interest income. As of March 31, 2003, the amounts in accumulated OCI associated with these cash flows totaled $2,217,391 (net of tax of $1,478,261), of which $1,053,336 is expected to be reclassified into interest income within the next 12 months.
Interest rate swaps information at March 31, 2003 is summarized as follows:
For the first quarter of 2003, interest income was increased by $833,000 received from swap counterparties. No such swap contracts were held during the same quarter of 2002. At March 31, 2003, we pledged to the interest rate swap counterparty as collateral agency securities with a book value of $2.0 million and real estate loans of $2.1 million.
Interest Rate Sensitivity
Our monitoring activities related to managing interest rate risk include both interest rate sensitivity “gap” analysis and the use of a simulation model. While traditional gap analysis provides a simple picture of the interest rate risk embedded in the balance sheet, it provides only a static view of interest rate sensitivity at a specific point in time and does not measure the potential volatility in forecasted results relating to changes in market interest rates over time. Accordingly, we combine the use of gap analysis with the use of a simulation model, which provides a dynamic assessment of interest rate sensitivity.
The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated to reprice within a specific time period and the amount of interest-bearing liabilities anticipated to reprice within that same time period. A gap is considered positive when the amount of interest rate sensitive assets repricing within a specific time period exceeds the amount of interest-bearing liabilities repricing within that same time period. Positive cumulative gaps suggest that earnings will increase when interest rates rise. Negative cumulative gap suggest that earnings will increase when interest rates fall.
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The following table shows our gap position as of March 31, 2003
The simulation model discussed above also provides our ALCO with the ability to simulate our net interest income. In order to measure, at March 31, 2003, the sensitivity of our forecasted net interest income to changing interest rates, both a rising and falling interest scenario were projected and compared to a base market interest rate forecasts. One application of our simulation model measures the impact of market interest rate changes on the net present value of estimated cash flows from our assets and liabilities, defined as our market value of equity. This analysis assesses the changes in market values of interest rate sensitive financial instruments that would occur in response to an instantaneous and sustained increase in market interest rates.
At March 31, 2003, our net interest income and market value of equity expose related to these hypothetical changes in market interest rates are illustrated in the following table.
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Item 4. Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are sufficiently effective to ensure that the information we are required to be disclosed in the reports we file under the Exchange Act is gathered, analyzed and disclosed with adequate timeliness, accuracy and completeness, based on an evaluation of such controls and procedures conducted within 90 days prior to the date thereof.
There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above.
Our management, including the chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
We are a party to routine litigation incidental to our business, none of which is considered likely to have a material adverse effect on us.
Item 2. Changes in Securities and Use of Proceeds
(a) None.
(b) None.
(c) None.
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a vote of Security Holders
Item 5. Other information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The exhibits listed on the accompanying index to exhibits are filed or incorporated by reference (as stated herein) as part of this Quarterly Report on Form 10-Q.
(b) Reports on Form 8-K
During the quarter ended March 31, 2003, Nara Bancorp filed the following Current Reports on Form 8-K: (1) January 28, 2003 (containing a press release regarding the termination of a consent order between Nara Bank and the Office of the Comptroller of the Currency); and (2) February 19, 2003 (containing press release announcing a two for one stock split in the form of a 100% stock dividend).
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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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CERTIFICATION
I, Benjamin Hong, certify that:
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I, Bon T. Goo, certify that:
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INDEX TO EXHIBITS
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