Pacific Premier Bancorp - 10-Q quarterly report FY

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

For the quarterly period ended June 30, 2003

OR

For the transition period from          to         

Commission File Number 0-22193

PACIFIC PREMIER BANCORP, INC.

(Exact name of registrant as specified in its charter)

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.

ý Yes    o No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes o No ý

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 1,333,572 shares of common stock, par value $0.01 per share, were outstanding as of August 8, 2003.

PACIFIC PREMIER BANCORP, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
FOR THE QUARTER ENDED JUNE 30, 2003

Item 1.  Financial Statements.

PACIFIC PREMIER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands)

Accompanying notes are an integral part of these consolidated financial statements.

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PACIFIC PREMIER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(UNAUDITED)

Accompanying notes are an integral part of these consolidated financial statements.

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PACIFIC PREMIER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

(Dollars in thousands)

(UNAUDITED) 

Accompanying notes are an integral part of these consolidated financial statements

(1) See Footnote 4. “Capital Contributions through the Issuance of Warrants”

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PACIFIC PREMIER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(UNAUDITED) 

Accompanying notes are an integral part of these consolidated financial statements.

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PACIFIC PREMIER BANCOROP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2003

(UNAUDITED)

Note 1 - Basis of Presentation

The consolidated financial statements include the accounts of Pacific Premier Bancorp, Inc., (the “Corporation”) and its wholly owned subsidiaries, Pacific Premier Bank, F.S.B. (the “Bank”) and Pacific Premier Insurance Services, doing business as Pacific Premier Investment Services, (the “Insurance Subsidiary”), (collectively, the “Company”).  All significant intercompany accounts and transactions have been eliminated in consolidation.

In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the Company’s financial position as of June 30, 2003 and December 31, 2002, and the results of its operations and its cash flows for the three and six months ended June 30, 2003 and 2002.  Operating results for the three and six months ended June 30, 2003, are not necessarily indicative of the  results that may be expected for any other interim period or the full year ending December 31, 2003.

Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of  America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

Certain amounts reflected in the 2002 consolidated financial statements have been reclassified where practicable, to conform to the presentation for 2003.

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires that a liability for the cost associated with an exit or disposal activity be recognized when the liability is incurred and nullifies the guidance of Emerging Issues Task Force (“EITF”) No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in Restructuring),” which recognized a liability for an exit cost at the date of an entity’s commitment to an exit plan. SFAS No. 146 requires that the initial measurement of a liability be at fair value. SFAS No. 146 is effective for exit and disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 did not have an impact on our financial condition or operating results.

In October 2002, the FASB issued SFAS No. 147, “Acquisitions of Certain Financial Institutions,” which requires that most financial services companies subject their intangible assets to an annual impairment test instead of being amortized. SFAS No. 147 applies to all new and past financial institution acquisitions, including branch acquisitions that qualify as acquisitions of a business, but excluding acquisitions between mutual institutions. All acquisitions within the scope of the new statement will now be governed by the requirements of SFAS Nos. 141 and 142. Certain provisions of SFAS No. 147 were effective on October 1, 2002, while other provisions are effective for acquisitions on or after October 1, 2002. The adoption of SFAS No. 147 had no impact on our financial condition or operating results.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” an amendment of FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and Accounting Pronouncement Board

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(“APB”) Opinion No. 28, “Interim Financial Reporting,” to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements.  While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25. The provisions of SFAS No. 148 are effective for annual financial statements for years ending after December 15, 2002, and for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. The company accounts for the compensation cost associated with its stock option plans under the intrinsic value method, the alternative methods of transition will not apply to the Company. The additional disclosure requirements of the statement are included in these financial statements. In Management’s opinion, the adoption of this Statement did not have a material impact on the Company’s consolidated financial position or results of operations.  The pro forma effects of applying SFAS No. 123 are disclosed below (dollars in thousands, except per share data):

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and loan commitments that relate to the origination of mortgage loans held for sale, and for hedging activities under SFAS No. 133. SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 will not have a material impact on the financial condition or operating results.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires an issuer to classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 is generally effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 had no impact on our financial condition or operating results.

Note 2 – Regulatory Matters

The Bank’s capital amounts and ratios are presented in the following table:

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Note 3 – Issuance of Senior Secured Note

On January 17, 2002 the Corporation closed a transaction with New Life Holdings, LLC, an unrelated third party, (the “Investor”) to issue $12,000,000 in notes and warrants to purchase 1,116,400 shares of the Company’s Common Stock.  In the transaction, the Investor obtained the right to designate three directors to the Boards of the Company and the Bank for certain time periods, as described below.  The Investor appointed Mr. Ezri Namvar as one of the directors of the Company.  Mr. Namvar owns a controlling interest in the Investor as described below.  In addition to Mr. Namvar, the Investor has appointed Messrs. Marr and Palmer to fill the un-expired terms of their predecessors.  Mr. Namvar and his related entities own a 75% interest in U.S. Properties Group LLC in which Mr. Marr’s firm, Charter Holdings LLC serves as the managing member.  Additionally, Mr. Marr serves as development manager, on a fee basis, for several properties that are owned by entities in which Mr. Namvar and his related entities have an equity interest.

Ownership interests in the Investor are held entirely by family members of Mr. Namvar.  Mr. Namvar directly holds a 50 percent ownership share and a 75 percent controlling and voting interest in the Investor.  Mousa Namvar, a brother of Mr. Namvar, holds an 18 percent interest in the Investor.

The sale of the note and warrant was made pursuant to a Note and Warrant Purchase Agreement (the “Agreement”) entered into by the Corporation and the Investor. The Corporation issued to the Investor a Senior Secured Note Due 2007 (the “Note”) in the initial principal amount of $12,000,000, and bearing interest at an initial rate of 12% (increasing over time to 16%) and a warrant (the “Warrant”) to purchase up to 1,166,400 shares of the Company’s Common Stock at an exercise price of $.75 per share.  There are currently 233,280 shares of the Warrant which are exercisable with the remaining shares vesting on or before January 17, 2005.  The Corporation pledged the stock in its subsidiaries and its Participation Contract, which is substantially all of its assets, as collateral to secure the Note.  The Participation Contract is a contractual right from the sale of certain residual mortgage-backed securities to receive 50% of any cash realized, as defined, from the residual mortgage-backed securities.  During 2002, the Corporation paid the Investor $1.4 million of interest on the Note.  The Corporation has paid $768 thousand of interest on the note to the Investor in the first half of 2003.

Note 4 - Capital Contributions through the Issuance of Warrants

In addition to the $12,000,000 Senior Secured Note, the Corporation issued warrants to purchase 1,166,400 shares of stock at an exercise price of $0.75 per share.  The closing price of the Company’s stock on November 19, 2001, the day before execution of the financing agreement, was $1.35 per share.  The intrinsic value of the warrants at the time of the transaction was $700 thousand, which was accounted for as an original issue discount.  The discount is amortized over the

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term of the Senior Secured Note, which is due in 2007. The unamortized balance of the discount as of June 30, 2003, is $490 thousand.  Interest expense of $955 thousand related to the Senior Secured Note, including $70 thousand of discount amortization and $52 thousand of issuance cost amortization, was charged to operations for the six months ended June 30, 2003.

Note 5 – Earnings (Loss) Per Share

The tables below set forth the Company’s earnings per share calculations for the three and six months ended June 30, 2003 and 2002.

Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period.  Diluted earnings per share is computed by dividing income available to common stockholders including common stock equivalents, such as outstanding stock options and warrants by the weighted average number of common shares outstanding for the period.

Earnings per share reconciliation is as follows (dollars in thousands, except per share data):

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

The following presents management’s discussion and analysis of the consolidated financial condition and operating results of the Company for the three and six months ended June 30, 2003 and 2002.  The discussion should be read in

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conjunction with the Company’s Management Discussion and Analysis included in the 2002 Annual Report on Form 10-K, plus the unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report.

The statements contained herein that are not historical facts are forward-looking statements based on management’s current expectations and beliefs concerning future developments and their potential effects on the Company.  There can be no assurance that future developments affecting the Company will be the same as those anticipated by management.  Actual results may differ from those projected in the forward-looking statements.  These forward-looking statements involve risks and uncertainties.  These include, but are not limited to, the following risks:   (1) Changes in the performance of the financial markets,  (2) Changes in the demand for and market acceptance of the Company’s products and services,  (3) Changes in general economic conditions including interest rates, presence of competitors with greater financial resources, and the impact of competitive projects and pricing,  (4) The effect of the Company’s policies,  (5) The continued availability of adequate funding sources,  (6) Differences in actual prepayment rates and loan losses as compared to prepayment rates and loan losses assumed by the Company for purposes of its valuation of mortgage derivative securities (the “Participation Contract”), (7) The effect of changes in market interest rates on the spread between the coupon rate and the pass through rate and on the discount rate assumed by the Company in its valuation of its Participation Contract, and  (8) Various legal, regulatory and litigation risks.

GENERAL

The Corporation, a Delaware corporation organized in 1997, is a unitary savings and loan holding company that owns 100% of the capital stock of the Bank, the Corporation’s principal operating subsidiary.  Additionally the Corporation owns 100% of the capital stock of the Insurance Subsidiary. The primary business of the Company is community banking.

The Bank was founded in 1983 as a state chartered savings and loan and became a federally chartered stock savings bank in 1991.  The Bank is a member of the Federal Home Loan Bank of San Francisco (“FHLB”), which is a member bank of the Federal Home Loan Bank System. The Bank’s deposit accounts are insured up to the $100 thousand maximum amount currently allowable under federal laws by the Savings Association Insurance Fund (“SAIF”), which is a separate insurance fund administered by the Federal Deposit Insurance Corporation (“FDIC”).  The Bank is subject to examination and regulation by the Office of Thrift Supervision (“OTS”) its primary federal regulator, and by the FDIC.  The Insurance Subsidiary was organized in 1999 and offers non-deposit and non-FDIC insured investment products such as mutual funds, annuities and insurance.  These products are offered to both Bank and non-Bank customers.  The Insurance Subsidiary has minimal operations.

The Company is a financial services organization committed to serving consumers and small businesses in Southern California. The Bank operates three full-service branches located in its market area of San Bernardino and Orange Counties, California.  The Bank offers a variety of products and services for consumers and small businesses, which include checking, savings, money market accounts and certificates of deposit.  Additionally, the Bank’s lending activities are focused on generating loans secured by multi-family and commercial real estate properties as well as the financing of residential construction loans throughout Southern California. The Bank funds its lending and investment activities primarily with retail deposits obtained through its branches and advances from the FHLB of San Francisco.

The Company’s principal sources of income are the net spread between interest earned on loans and investments and the interest costs associated with deposits and other borrowings used to finance its loan and investment portfolio.  Additionally, the Bank generates fee income from various products and services offered to both depository and loan customers.

CRITICAL ACCOUNTING POLICIES

Management has established various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of the Company’s financial statements. The Company’s significant accounting policies are described in the Notes to the Consolidated Financial Statements. Certain accounting policies require management to make estimates and assumptions which have a material impact on the carrying value of certain assets and liabilities; management considers these to be critical accounting policies. The estimates and assumptions management uses are based on historical experience and other factors, which management believes to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material

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impact on the carrying value of assets and liabilities at balance sheet dates and the Company’s results of operations for future reporting periods.

Management believes that the allowance for loan losses, the method for recognition of income on the Participation Contract, and the valuation allowance on deferred taxes are the critical accounting policies that require estimates and assumptions in the preparation of the Company’s financial statements that are most susceptible to significant change. For further information, see “Allowances for Loan Losses”.

FINANCIAL CONDITION

Total assets of the Company were $250.4 million as of June 30, 2003 compared to $238.3 million as of December 31, 2002. The $12.1 million or 5.1% increase in total assets is primarily the result of a $22.8 million increase in loans held for investment, which was partially offset by an $11.4 million decrease in investment securities classified as available for sale.

Investment Securities

A summary of the Company’s securities as of June 30, 2003 and December 31, 2002 is as follows (dollars in thousands):

(1)                                  Mortgage-backed securities consists of two instruments:  A collateralized mortgage obligation (CMO) secured by the Federal Home Loan Mortgage Corporation (FHLMC) with a carrying value of $9.4 million and a CMO secured by the Veteran’s Administration with a carrying value of $3.8 million.

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(2)                                  The Company’s mutual fund investments are with Shay Assets Management Inc, within their AMF Adjustable Rate Mortgage fund and their AMF Intermediate Mortgage fund.  Both of these funds qualified for inclusion in the 20 percent risk-weighting capital category for the quarter ended June 30, 2003.

(3)                                  Effective January 17, 2002, the Corporation purchased the Participation Contract from the Bank for $4.4 million.  The Participation Contract represents the right to receive 50% of any cash realized from three residual mortgage-backed securities.  The Corporation  does not believe there is an active market for this type of asset and has determined the estimated fair value utilizing a cash flow model which determines the present value of the estimated expected cash flows from this contract using a discount rate the Corporation believes is commensurate with the risks involved.   A discount rate of 40 percent has been continuously utilized since December 31, 2000 in estimating the Participation Contract’s fair value. See “Participation Contract” for further details.

Investment Securities by Contractual Maturity
As of 06/30/03

Emerging Issues Task Force 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets”  (“EITF 99-20”) provides guidance on how transferors that retain an interest in a securitization transaction, and companies that purchase a beneficial interest in such a transaction, should account for interest income and impairment. The EITF concluded that the holder of a beneficial interest should recognize interest income over the life of the investment based on an anticipated yield determined by periodically estimating cash flows. Interest income would be revised prospectively for changes in cash flows. If the fair value of the beneficial interest has declined below its amortized cost and the decline is other-than-temporary, an entity should apply impairment of securities guidance using the fair value method. This method differs significantly from the previously acceptable accounting method whereby impairment was measured using a risk-free rate of return.

Effective January of 2001, the Company adopted the provisions of EITF 99-20 on a prospective basis based on the actual cash flows of the securitization trusts underlying the Participation Contract.  At that time the Company had decided that due to the uncertainty and inadequate cash flow history from the securitizations to the holders of the asset, that it was prudent to leave the Participation Contract on a non-accrual basis until there was a sufficient cash flow history.  Based on the cash flows and other events affecting the expected yield of the Participation Contract, the adoption of EITF 99-20 did not have a material impact on the Company’s financial statements for the year ended December 31, 2001.  The Corporation commenced accreting the discount and the expected yield differential (the difference between the fair market value and the book value) on the Participation Contract during 2002 over the expected remaining life of the contract using a level yield methodology. The accretion will be adjusted for any changes in the expected performance of the contract.  The Corporation recorded discount accretion, which is included in interest income, for the quarters ended June 30, 2003 and June 30, 2002 of $826 thousand and $1.2 million, respectively, and received cash proceeds for the quarters ended June 30, 2003 and June 30, 2002 of $803 thousand and $643 thousand, respectively.  See “Participation Contract” for further details.

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Loans

Gross loans outstanding totaled $185.3 million at June 30, 2003 compared to $163.1 million at December 31, 2002.  Included in the Bank’s loan portfolio as of June 30, 2003 are $52.1 million of one-to-four family loans of which $9.6 million of such loans are secured by first liens or second liens on real estate to sub-prime credit borrowers and $7.3 million of such loans are secured by junior liens on real estate and are considered high loan-to-value loans. The Bank ceased originating sub-prime loans and high loan-to-value loans in the years 2000 and 1998, respectively. Currently, the Bank is originating multi-family, commercial real estate and residential construction loans.

The Bank originated and purchased $64.2 million of loans for the six months ending June 30, 2003.  There were loan sales totaling $8.9 million in the first six months of 2003.  The $8.9 million loan sale was comprised entirely of commercial real estate secured loans which were 100% risk-weighted pursuant to applicable capital requirements and were sold as part of Managements’ strategy to actively monitor and manage the Bank’s capital ratios.  Principal repayments totaled $31.0 million during this period.

For the six months ending June 30, 2002, the Bank originated and purchased $21.3 million of loans.  Loan production was held to modest levels during the first quarter of 2002 while the Bank continued to staff its Income Property Lending group. There were loan sales of $33.8 million for the six months ending June 30, 2002 compared to $8.9 million in the six months ended June 30, 2003.  The loan sales in 2002 were comprised of one-to-four family loans which had been originated by the Bank in prior periods.  Principal repayments totaled $44.0 million during this period.

During the fourth quarter of 2002 and the first quarter of 2003 the Bank initiated a project involving the re-evaluation of all of its loans 90 days or more past due, which are concentrated in the Banks’ one-to-four family loan portfolio.  The project resulted in the Bank writing down or charging-off various loans during the fourth quarter of 2002 and first quarter of 2003.  The project was completed in April of 2003.  See “Provision for Loan Losses.”

A summary of the Company’s loan originations and principal repayments for the six months ended June 30, 2003 and 2002 are as follows (dollars in thousands):

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The following table sets forth the composition of our loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated (dollars in thousands):

(1) Includes second trust deeds.

Allowance for Loan Losses

For the six months ended June 30, 2003, the Company recognized a $681 thousand provision for loan losses compared to a $191 thousand provision during the six months ended June 30, 2002.  The increase in provision is primarily due to  net charge-offs in the amount of $727 thousand in the first quarter of 2003 and $133 thousand in the second quarter of 2003. Net charge-offs totaled $860 thousand for the six months ended June 30, 2003 with $561 thousand of this amount attributable to a project initiated in the fourth quarter of 2002 to re-evaluate all loans 90 days or more past due and to write-

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down or charge-off the loans based on the findings of this analysis, if so warranted.  The Bank’s Loss Mitigation Department continues collection efforts on loans written-down and/or charged-off to maximize potential recoveries.  See “Provision for Loan Losses.”

The allowance for loan losses totaled $2.7 million as of June 30, 2003 and $2.8 million as of December 31, 2002. The allowance for loan losses as a percent of impaired loans was 70.7% and 48.1% as of June 30, 2003 and December 31, 2002, respectively.  Impaired loans totaled $3.3 million at June 30, 2003 and $5.2 million as of December 31, 2002.   As of June 30, 2003, $536 thousand of the total allowance was deemed as unallocated.

The Company’s determination of the level of the allowance for loan losses and correspondingly, the provision for loan losses, rests upon various judgments and assumptions, including prior loan loss experience, current economic conditions and loan portfolio composition.  Given the composition of the Company’s loan portfolio, the $2.7 million allowance for loan losses was considered adequate to cover losses inherent in the Company’s loan portfolio at June 30, 2003. However, no assurance can be given that the Company will not, in any particular period, sustain loan losses that exceed the amount reserved, or that subsequent evaluation of the loan portfolio, in light of the prevailing factors, including economic conditions which may adversely affect the Company’s or the Bank’s service area or other circumstances, will not require significant increases in the loan loss allowance.  In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses.  Such agencies may require the Bank to recognize additional provisions to increase the allowance or take charge-offs in anticipation of future losses.

The table below summarizes the activity of the Company’s allowance for loan losses for the three and six months ended June 30, 2003 and 2002 (in thousands):

Composition of Impaired Assets

The table below summarizes the Company’s composition of impaired assets as of the dates indicated:

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(1)          Impaired loans are defined as:

•                  90+ Days delinquent

•                  Bankruptcy filing within last 6 months and still accruing interest

•                  Delinquent tax status where tax sale is imminent within 12 months and account still accruing interest

(2)          Gross loans include loans receivable held for investment and held for sale.

(3)          Impaired assets consist of impaired loans and REO.

Participation Contract

The Participation Contract is a contractual right of the Corporation to receive from the purchasers of the Banks’ residual mortgage-backed securities 50% of any cash realized, as defined, in the Participation Contract.  The carrying value of the Participation Contract was $5.4 million at June 30, 2003 compared to $4.9 million at December 31, 2002.  The increase of $510 thousand is due to the net of the discount accretion of $1.6 million, which is included in interest income, and cash flows received of $1.0 million. The accretion is based on the Corporation’s projections of the expected performance of the residual assets underlying the contract.  The Corporation began accreting the discount effective January 1, 2002.  The Corporation does not believe there is an active market for this type of asset and has determined the estimated fair value utilizing a cash flow model which determines the present value of the estimated expected cash flows from this contract using a 40% discount rate which was established by the Bank in December 2000.  The cash flow model estimated the fair value of the Participation Contract to be $7.4 million at June 30, 2003.

The Participation Contract was recorded on the Bank’s financial statements at December 31, 2001 at $4.4 million

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after permanent write downs totaling $4.9 million. Most of the $4.9 million write-down of the Participation Contract resulted from an increase in the discount rate from 15% to 40% and a change in the composite prepayment speeds from 21.6% in 1999 to 24.6% in 2000 in the Bank’s valuation model.  Beginning in June 2001, the residual assets underlying the Participation Contract began to generate cash flow to the lead participants in the contract. In January 2002, the Corporation purchased the Participation Contract from the Bank at the Bank’s carrying value. The Corporation began to receive cash payments from the Participation Contract during the second quarter of 2002.  The Corporation received $3.4 million in 2002, $243 thousand in the first quarter of 2003 and $803 thousand in the second quarter of 2003.  The Corporation expects to receive future cash flows, based on the model projections, of $11 to $13 million over the next five years.  Due to changing market conditions and other unforeseen events beyond the Company’s control, the actual default and prepayment speeds may vary considerably, thus changing the amount of cash proceeds received from the underlying loans.

In January 2002, the Corporation commenced accreting the discount and the expected yield differential (the difference between the estimated fair market value and the book value) on the Participation Contract over the expected remaining life of the contract using a level yield methodology. The accretion is adjusted for any changes in the expected performance of the asset.  The Participation Contract has been pledged as collateral for the Senior Secured Note issued in January 2002.

The table below summarizes the cash flows and discount accretion, of the Participation Contract, by quarter:

The decrease in the cashflow during the quarter ended March 31, 2003 is due to changes made by the Loan Servicer in the timing of charging-off delinquent loans within the 1997-2 and 1997-3 Life Financial Home Loan Owner Trust Securitizations (“Securitization”), which comprise two of the three residual assets of the Participation Contract.  These changes in the timing of loan charge-offs were implemented in the first quarter of 2003 to comply with the requirements of the Securitization documents.  As a result of these changes, cashflows for two of the three residuals were higher in the quarter ended June 30, 2003 than the quarters ended March 31, 2003 and June 30, 2002.

Liabilities and Stockholders’ Equity

Total liabilities of the Company increased from $226.7 million at December 31, 2002 to $238.6 million at June 30, 2003.  The increase is primarily due to increases in deposits and FHLB borrowings of $11.3 million and $800 thousand, respectively.

There were $20.8 million in FHLB advances as of June 30, 2003 compared to $20.0 million in such borrowings at December 31, 2002.  Advances from the FHLB are collateralized by pledges of certain real estate loans and investment securities with an aggregate principal balance of $59.6 million.  The Bank may borrow up to 15% of its assets under the line, which amounted to $36.3 million as of June 30, 2003.

In addition, there were $11.5 million in notes payable as of June 30, 2003 compared to $11.4 million in notes payable at December 31, 2002.  The $11.5 million in notes payable consists of the Senior Secured Note of $12,000,000, net of $490 thousand discount, issued to New Life Holdings, LLC, on January 17, 2002.  The Senior Secured Note is due in 2007 with an initial principal amount of $12,000,000 and bearing interest at an initial rate of 12% (increasing over time to 16%).  The interest is payable on a quarterly basis beginning on March 31, 2003, with an interest rate of 13% per annum for 2003,

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14% in 2004, 15% in 2005 and 16% in 2006.  The current quarterly interest payment is $390 thousand.  All principal is due January 17, 2007, but principal may be prepaid at the option of the Company in whole or in part.

Deposits increased by $11.3 million to $202.5 million at June 30, 2003, compared to $191.2 million of deposits at December 31, 2002.  In the second quarter of 2003, the Bank continued to realize improved core deposit growth, begun in the first quarter of 2003, due primarily to its strategy of emphasizing the development of relationships with both small business owners and consumers to increase checking and money market accounts. During the six months ended June 30, 2003, core deposits increased by $11.3 million and cost of deposits decreased by 54 basis points to 2.58%.  The significant decline in market rates brought about by the decrease in short term rates set by the Federal Reserve Board caused the average rates paid on deposits to decline.

Total stockholder’s equity increased $245 thousand to $11.9 million at June 30, 2003, compared to $11.6 million at December 31, 2002.

RESULTS OF OPERATIONS

Results for the quarter and year-to-date ended June 30, 2003 are compared to the quarter and year-to-date ended June 30, 2002 below.

Highlights for the three and six months ended June 30, 2003 and 2002:

The Company reported net income of $864 thousand for the quarter ended June 30, 2003, or $0.65 per basic and $0.34 per diluted share, compared with net income of $253 thousand, or $0.19 per basic and $0.10 diluted share for the quarter ended June 30, 2002.  For the six months ended June 30, 2003, the Company reported net income of $606 thousand compared to $641 thousand for the six months ended June 30, 2002, or net income of $0.24 per diluted share for the six months ended June 30, 2003 compared to $0.27 per diluted share for the six months ended June 30, 2002.  Return on average assets for the six months ended June 30, 2003 was .51% compared to .52% for the same period last year.  The Company’s return on average equity for the six months ended June 30, 2003 was 10.77% compared to 15.26% for the same period last year.

Net income for the three and six months ended June 30, 2003 included the discount accretion on the Participation Contract of $826 thousand and $1.6 million, respectively.    Provision for loan losses was $42 thousand for the three months ended June 30, 2003 compared with a benefit of $142 thousand for the same period a year ago.  For the six months ended June 30, 2003 the provision for loan losses was $681 thousand compared to $191 thousand for the same period last year.

The Company sold $8.9 million of commercial real estate secured loans for a net gain of $207 thousand in the quarter ended June 30, 2003.

Net Interest Income

The Company’s net interest income before provision for loan losses decreased 20.2% to $2.3 million for the three months ended June 30, 2003 compared with $2.8 million for the same period a year earlier. Net interest margin for the three months ended June 30, 2003 was 4.15% compared with 4.85% for the same period a year earlier. The decrease is primarily due to a 19.4% reduction in other interest-earning assets which is primarily the result of a 45.8% reduction in the average balance of investment securities held by the Company.  Average loan yield declined by 130 basis points while the average loan balance increased by $20.0 million from the same prior year period. The decrease in loan yield is in part the result of the Company’s origination of higher credit quality loan products, which carry an overall lower interest rate than the Bank’s one-to-four family loan portfolio as well as the prepayments within the one-to-four family loan portfolio since June 30, 2002.  In addition, the cost of funds decreased 50 basis points and average interest-bearing liabilities decreased $15.5 million from the same prior year period.  The discount accretion included in interest income for the second quarter ended June 30, 2003 and June 30, 2002 was $826 thousand and $1.2 million, respectively.  The discount accretion is based on the Company’s projections of the expected performance of the residual assets underlying the Participation Contract.

For the six months ended June 30, 2003, net interest income before provision for loan losses decreased 23.4% to $4.3 million compared with $5.6 million for the same period a year earlier.  Net interest margin for the six months ended

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June 30, 2003 was 3.91% compared with 4.82% for the same period a year earlier.  The decrease is primarily due to a 20.1% reduction in other interest-earning assets which is primarily the result of a 16.9% reduction and 86.5% reduction in the average balance of investment securities and cash held by the Company.  Average loan yield declined by 113 basis points while the average loan balance increased by $915 thousand from the same prior year period.  In addition, the cost of funds decreased 48 basis points and average interest-bearing liabilities decreased $10.4 million from the same prior year period.  The discount accretion included in interest income for the six months ended June 30, 2003 and June 30, 2002 was $1.6 million and $2.1 million, respectively.  The discount accretion is based on the Company’s projections of the expected performance of the residual assets underlying the Participation Contract. However, the actual performance of the residual assets and cash realized by the Company could vary significantly from the Company’s projections. The assumptions utilized in the projections that could cause a substantial change in the cash realized from the Participation Contract are the estimated levels of future loan losses and the rate of prepayment speeds estimated for the loans underlying the residual assets. The reduction in the cost of interest-bearing liabilities is due to the Bank’s continued focus on increasing lower cost core deposit accounts, namely consumer and small business transaction accounts as well as the overall lower interest rate environment.

The following table sets forth the Company’s average balance sheets (unaudited), and the related weighted average yields and costs on average interest-earning assets and interest-bearing liabilities, for the three and six months ended June 30, 2003 and 2002.

The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown.  Average balances are measured on a daily basis.  The yields and costs include fees that are considered adjustments to yields.

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