Hanmi Financial - 10-Q quarterly report FY

 

 

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ   No o

     Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Exchange Act Rule 12b-2.

Large Accelerated Filer þ   Accelerated Filer o    Non-Accelerated Filer o

     Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o   No þ

     As of May 1, 2007, there were 48,825,537 outstanding shares of the Registrant’s Common Stock.

 

 

See Accompanying Notes to Consolidated Financial Statements.

See Accompanying Notes to Consolidated Financial Statements.

     

See Accompanying Notes to Consolidated Financial Statements

See Accompanying Notes to Consolidated Financial Statements

     Basis of Presentation

     Hanmi Financial Corporation (“Hanmi Financial,” “we” or “us”) is a Delaware corporation and is subject to the Bank Holding Company Act of 1956, as amended. Our primary subsidiary is Hanmi Bank (the “Bank”). Our other subsidiaries are Chun-Ha Insurance Services, Inc. (“Chun-Ha”) and All World Insurance Services, Inc. (“All World”), which were acquired on January 2, 2007.

     The Bank is a commercial bank licensed by the California Department of Financial Institutions. The Bank’s deposit accounts are insured under the Federal Deposit Insurance Act up to applicable limits thereof. The Bank is a member of the Federal Reserve System. Chun-Ha and All World are insurance brokerages founded in 1989 and offer a complete line of insurance products, including life, commercial, auto, health, and property and casualty.

     Our primary operations are related to traditional banking activities, including the acceptance of deposits and the lending and investing of money through operation of the Bank. The Bank is a community bank conducting general business banking with its primary market encompassing the multi-ethnic populations of Los Angeles, Orange, San Diego, San Francisco and Santa Clara counties of the State of California. The Bank’s full-service offices are located in business areas where many of the businesses are run by immigrants and other minority groups. The Bank’s client base reflects the multi-ethnic composition of these communities. As of March 31, 2007, the Bank maintained a branch network of 23 locations, serving individuals and small- to medium-sized businesses in its primary market. The Bank also had eight loan production offices in California, Colorado, Georgia, Illinois, Texas, Virginia and Washington. Chun-Ha is headquartered in Garden Grove, California and has an office in Los Angeles.

     In the opinion of management, the consolidated financial statements of Hanmi Financial Corporation and Subsidiaries reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim period ended March 31, 2007, but are not necessarily indicative of the results that will be reported for the entire year. In the opinion of management, the aforementioned consolidated financial statements are in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The interim information should be read in conjunction with our 2006 Annual Report on Form 10-K.

     Descriptions of our significant accounting policies are included in “Note 1 — Summary of Significant Accounting Policies” in our 2006 Annual Report on Form 10-K.

     Certain reclassifications were made to the prior period’s presentation to conform to the current period’s presentation.

     For the three months ended March 31, 2007 and 2006, we recorded share-based compensation expense of $480,000 and $101,000, respectively, resulting in the recognition of $0 and $329,000, respectively, in related tax benefits.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006 (Continued)

     Unrecognized Compensation Expense

     At March 31, 2007, unrecognized share-based compensation expense was as follows:

     Share-Based Payment Award Activity

     The table below provides stock option information related to the Year 2000 Stock Option Plan for the three months ended March 31, 2007:

     The total intrinsic value of options exercised during the three months ended March 31, 2007 and 2006 was $503,000 and $1,063,000, respectively.

THREE MONTHS ENDED MARCH 31, 2007 AND 2006 (Continued)

     The table below provides stock option information related to the 2004 CEO Stock Option Plan for the three months ended March 31, 2007:

     The table below provides information for restricted stock awards for the three months ended March 31, 2007:

     Earnings per share (“EPS”) is calculated on both a basic and a diluted basis. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted from the issuance of common stock that then shared in earnings, excluding common shares in treasury.

     Unvested restricted stock is excluded from the calculation of weighted-average common shares for basic EPS. For diluted EPS, weighted-average common shares include the impact of restricted stock under the treasury method.

THREE MONTHS ENDED MARCH 31, 2007 AND 2006 (Continued)

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

     For the three months ended March 31, 2007 and 2006, there were 926,554 and 49,554 options outstanding, respectively, that were not included in the computation of diluted EPS because their effect would be anti-dilutive.

     Interest Rate Swap

     During 2004, to hedge interest rate risk, the Bank entered into an interest rate swap agreement maturing in 2009, wherein the Bank received a fixed rate of 7.29 percent at quarterly intervals, and paid Prime-based floating rates at quarterly intervals on a total notional amount of $10.0 million. During 2003, to hedge interest rate risk, the Bank entered into four interest rate swap agreements maturing in 2008, wherein the Bank received fixed rates of 5.77 percent, 6.37 percent, 6.51 percent and 6.76 percent, at quarterly intervals, and paid Prime-based floating rates, at quarterly intervals, on a total notional amount of $60.0 million. These swaps were designated as cash flow hedges for accounting purposes.

     In 2005, the Bank terminated these swaps. At such time, the swaps were in an unfavorable position of $2,139,000. Such amount is being amortized in amounts proportional to the interest income associated with the hedged loan pools over the remaining terms of the swaps or the lives of the hedged loans, whichever is shorter. As of March 31, 2007 and December 31, 2006, the remaining balance was $1,037,000 and $1,260,000, respectively. For the three months ended March 31, 2007 and 2006, amortization expense of $223,000 and $243,000, respectively, was recognized in Other Operating Expenses in the Consolidated Statements of Income.

     Equity Swap

     In 2004, the Bank offered a certificate of deposit (“CD”) product that paid interest tied to the movement in the Standard & Poor’s 500 Index plus 1.00 percent annual interest. Such CD’s will mature in November 2009. The economic characteristics and risks of the embedded option were not clearly and closely related to the CD. Therefore, the embedded option was separated from the CD and accounted for separately in liabilities. As of March 31, 2007 and December 31, 2006, the fair value of the embedded option was $1,622,000 and $1,641,000, respectively, and the change in the liability during the three months ended March 31, 2007 and 2006 was ($19,000) and $102,000, respectively. Such changes were recognized in earnings.

HANMI FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006 (Continued)

     To place an economic hedge for the market risk described above, the Bank purchased an equity swap with a notional amount of $9,340,000. As of March 31, 2007 and December 31, 2006, the fair value of the equity swap was $946,000 and $872,000, respectively, and the change in the asset during the three months ended March 31, 2007 and 2006 was $73,000 and $157,000, respectively. The changes were recognized in earnings.

     Currency Swap

     In 2005, the Bank offered a CD product that paid interest based on the increase in the weighted-average value of five Asian currencies (Korean Won, Singapore Dollar, Taiwan Dollar, Thai Baht and Chinese Yuan) against the U.S. Dollar plus 0.25 percent annual interest. The economic characteristics and risks of the embedded option were not clearly and closely related to the CD. Therefore, the embedded option was separated from the CD and accounted for separately in liabilities. The CD’s matured in February 2006. As of March 31, 2007 and December 31, 2006, the fair value of the embedded option was $0 and the change in the liability during the three months ended March 31, 2007 and 2006 was $0 and ($5,000), respectively. Such change was recognized in earnings.

     To place an economic hedge for the market risk described above, the Bank purchased a currency swap with a notional amount of $14,274,000. The swap terminated in February 2006. As of March 31, 2007 and December 31, 2006, the fair value of the currency swap was $0 and the change in the asset during the three months ended March 31, 2007 and 2006 was $0 and ($105,000), respectively. Such change was recognized in earnings.

     In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109” (“FIN No. 48”). This Statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN No. 48 prescribes a recognition threshold of more-likely–than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements.

     We adopted the provisions of FIN No. 48 effective as of January 1, 2007. We reallocated our existing tax liabilities to provide for a liability of $790,000 (net of federal tax benefit) for uncertain tax positions, related to: (1) the measurement of a position we had taken with respect to certain tax deductions allowed in our state income tax filing with the State of California; (2) the federal deduction related to share-based compensation; and (3) a Section 195 election related to the acquisition of Pacific Union Bank. Such amounts are included within Other Liabilities in the Consolidated Statements of Financial Condition. We do not expect that the amounts of unrecognized tax benefits will change significantly within the next 12 months.

     As of January 1, 2007, we reclassified our existing reserves to provide for a liability of $790,000 (net of federal tax benefit) of uncertain tax positions, related to: (1) the measurement of a position we had taken with respect to certain tax deductions allowed in our state income tax filing with the State of California; (2) the federal deduction related to share-based compensation; and (3) a Section 195 election related to the acquisition of Pacific Union Bank. We do not expect that the amounts of unrecognized tax benefits will change significantly within the next 12 months.

     We are currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2003 through 2006. Hanmi Financial and its subsidiaries’ state income tax returns are open to audit under the statute of limitations for the years ended December 31, 2002 through 2006.

     As of March 31, 2007, the total amount of accrued interest related to uncertain tax positions, net of federal tax benefit, is $42,000. We account for interest and penalties related to uncertain tax positions as part of the provision for federal and state income taxes.

     As of March 31, 2007, there have been no material changes to the liability for uncertain tax positions.

     At March 31, 2007 and December 31, 2006, net current taxes payable of $6.6 million and $1.0 million, respectively, were included in Other Liabilities in the Consolidated Statements of Financial Condition.

HANMI FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006 (Continued)

     Stock Warrants

     In 2004, we issued stock warrants to affiliates of Castle Creek Financial LLC for services rendered in connection with the placement of our equity securities. Under the terms of the warrants, the warrant holders can purchase a total of 508,558 shares of common stock at an exercise price of $9.50 per share. The warrants were immediately exercisable and expire after five years. During the three months ended March 31, 2007 and 2006, 0 and 115,392 shares of common stock, respectively, were issued in connection with the exercise of stock warrants. As of March 31, 2007, there were 328,502 warrants outstanding.

     Repurchase of Common Stock

     In April 2006, our Board of Directors authorized the repurchase of up to $50.0 million of our common stock as part of our ongoing capital management program. During the three months ended March 31, 2007, 397,200 shares of our common stock were repurchased on the open market for an aggregate purchase price of $8.1 million. Repurchased shares are held in treasury pending use for general corporate purposes, including issuances under our stock option plans.

     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 and standby 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. The Bank’s exposure to credit losses in the event of non-performance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for extending loan facilities to customers. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty.

     Collateral held varies but may include accounts receivable; inventory; property, plant and equipment; and income-producing or borrower-occupied properties. The following table shows the distribution of undisbursed loan commitments as of the dates indicated:

     Through our branch network and lending units, we provide a broad range of financial services to individuals and companies located primarily in Southern California. These services include demand, time and savings deposits; and commercial and industrial, real estate and consumer lending. While our chief decision makers monitor the revenue streams of our various products and services, operations are managed and financial performance is evaluated on a company-wide basis. Accordingly, we consider all of our operations to be aggregated in one reportable operating segment.

     In connection with the departure of William J. Ruh from Hanmi Financial’s Board of Directors, on April 17, 2007, we entered into a Put Option Agreement with Mr. Ruh and John M. Eggemeyer (the “Warrant Holders”) to provide that Hanmi Financial will, at the request of the Warrant Holders, between the period of May 6, 2007 and June 15, 2007, repurchase common stock purchase warrants (each, a “Warrant”) held by the Warrant Holders at a purchase price equal to the product of (i) the average of the closing price per share of Hanmi Financial’s common stock as reported on the Nasdaq Global Select Market over the five (5) trading days prior to the date of notice of exercise of the right to have the Warrant repurchased, and (ii) the number of shares of Hanmi Financial common stock which can be purchased upon exercise of the Warrant, minus the aggregate exercise price of the Warrant if the Warrant were exercised in full. If the Warrant Holders do not exercise their right to have the Warrants repurchased by Hanmi Financial between May 6, 2007 and June 15, 2007, all rights and obligations under the Warrant shall remain in full force and effect under the original terms of the Warrant. The Warrant Holders currently hold Warrants to purchase 250,724 shares of Hanmi Financial’s common stock at a purchase price of $9.50 per share of common stock. The Warrants were originally issued to affiliates of Castle Creek Financial, LLC for services rendered in connection with the placement of Hanmi Financial equity securities.

     Some of the statements under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-Q constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms and other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ from those expressed or implied by the forward-looking statement. For a discussion of some of the factors that might cause such a difference, see “Item 1A. Risk Factors,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Interest Rate Risk Management” and “— Liquidity and Capital Resources.” We undertake no obligation to update these forward-looking statements to reflect events or circumstances that occur after the date on which such statements were made, except as required by law.

     The following is management’s discussion and analysis of the major factors that influenced our results of operations and financial condition for the three months ended March 31, 2007. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2006 and with the unaudited consolidated financial statements and notes thereto set forth in this Report.

     We have established various accounting policies that govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in the “Notes to Consolidated Financial Statements” in our Annual Report on Form 10-K for the year ended December 31, 2006. Certain accounting policies require us to make significant estimates and assumptions that have a material impact on the carrying value of certain assets and liabilities, and we consider these critical accounting policies. For a description of these critical accounting policies, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2006. We use estimates and assumptions based on historical experience and other factors that we believe to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods. Management has discussed the development and selection of these critical accounting policies with the Audit Committee of Hanmi Financial’s Board of Directors.

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

     Return on Average Tangible Equity

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

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

     Tangible Book Value Per Share

     Tangible book value per share is supplemental financial information determined by a method other than in accordance with GAAP. This non-GAAP measure is used by management in the analysis of Hanmi Financial’s performance. Tangible book value per share is calculated by subtracting goodwill and other intangible assets from total shareholders’ equity and dividing the difference by the number of shares of common stock outstanding. Management believes the presentation of this financial measure excluding the impact of these items provides useful supplemental information that is essential to a proper understanding of the financial results of Hanmi Financial, as it provides a method to assess management’s success in utilizing tangible capital. This disclosure should not be viewed as a substitute for results determined in accordance with GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.

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

     For the three months ended March 31, 2007, net income was $13.1 million, or $0.26 per diluted share, compared to $14.8 million, or $0.30 per diluted share, for the three months ended March 31, 2006. The 11.8 percent decrease in net income for 2007 as compared to 2006 was attributable to an increase in the provision for credit losses, offset by increases in net interest income and non-interest income, while non-interest expenses and the efficiency ratio were higher in 2007.

     Effective January 2, 2007, we completed the acquisitions of Chun-Ha Insurance Services, Inc. (“Chun-Ha”) and All World Insurance Services, Inc. (“All World”). The acquisitions were accounted for as purchases, so the operating results of Chun-Ha and All World are included from the acquisition date.

     Net interest income increased primarily because average interest-earning assets increased $313.9 million, or 10.3 percent, due to ongoing growth in the loan portfolio. The effect of the growth in average interest-earning assets was partially offset by a decline in the net interest margin due primarily to a more competitive loan pricing environment and a higher cost of funds as customers placed their funds in certificates of deposit instead of core deposits, and certificates of deposit continued to reprice throughout 2006. Therefore, the cost of funds increased more than the increase in the yield on interest-earning assets. The net interest margin was 4.61 percent for the three months ended March 31, 2007, compared to 4.92 percent for the same period in 2006.

     Our results of operations are significantly affected by the provision for credit losses. The provision for credit losses was $6.1 million and $3.0 million for the three months ended March 31, 2007 and 2006, respectively. The increase in the provision for credit losses is attributable to the migration of loans among risk rating categories and increases in non-performing and delinquent loans.

     For the three months ended March 31, 2007, non-interest income increased by $2.0 million, or 24.1 percent, primarily due to the acquisitions of Chun-Ha and All World, which increased insurance commissions by $984,000, and a higher gain on sales of loans.

     Non-interest expenses increased by $3.2 million or 18.2 percent, due to increases in salaries and employee benefits and other operating expenses, including $848,000 attributable to Chun-Ha and All World. The efficiency ratio (non-interest expenses divided by the sum of net interest income before provision for credit losses and non-interest income) was 43.64 percent for the three months ended March 31, 2007, compared to 39.51 percent for the same quarter in 2006. Of the 4.13 percent increase, 0.89 percent was attributable to the acquisitions of Chun-Ha and All World.

     The annualized return on average assets was 1.42 percent for the three months ended March 31, 2007, compared to 1.75 percent for the same period in 2006. The annualized return on average shareholders’ equity was 10.68 percent for the three months ended March 31, 2007, and the annualized return on average tangible equity was 19.12 percent, compared to 13.83 percent and 27.70 percent, respectively, for the same period in 2006.

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

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