Pacific Premier Bancorp - 10-Q quarterly report FY

PACIFIC PREMIER BANCORP, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

FOR THE QUARTER ENDED SEPTEMBER 30, 2004

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 INCOME

(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.

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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 BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2004

(UNAUDITED)

Note 1 - Basis of Presentation

The consolidated financial statements include the accounts of Pacific Premier Bancorp, Inc. (the “Corporation”) and its wholly owned subsidiary, Pacific Premier Bank, F.S.B. (the “Bank”) (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 September 30, 2004 and the results of its operations and its cash flows for the three and nine months ended September 30, 2004 and 2003.  Operating results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for any other interim period or the full year ending December 31, 2004.

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, 2003.

The Company accounts for its investments in its wholly owned special purpose entity, PPBI Trust I, using the equity method under which the subsidiary’s net earnings are recognized in the Company’s statement of income.

Certain amounts reflected in the 2003 consolidated financial statements have been reclassified where practicable, to conform to the presentation for 2004.  These classifications are of a normal recurring nature.  The following table reflects the reclassification of workers compensation expense from other expense to compensation and benefits.

The following table reflects the reclassification on the statement of cash flows of gain on sale of loans held for investment and net accretion on Participation Contract from net cash used in investing activities to net cash provided by operating activities.

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In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (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 Principles Board (“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):

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In January 2003, FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB NO. 51” (“FIN 46”) and in December 2003, FASB issued a revision (“FIN 46R”).  FIN 46 and FIN 46R address the requirements for consolidation by business enterprises of variable interest entities.  Subsidiary business trusts formed by bank holding companies to issue trust preferred securities and lend the proceeds to the parent holding company have been determined to not meet the definition of a variable interest entity and therefore must be deconsolidated for financial reporting purposes.  Bank holding companies have previously consolidated these entities and reported the trust preferred securities as liabilities in the consolidated financial statements.  The Company adopted this statement at the time of the issuance of the junior subordinated debentures in March 2004, which did not have a material impact on the Company’s financial statements as subordinated debentures are reported as a component of liabilities.  See Note 4 – Subordinated Debentures.

Note 2 – Regulatory Matters

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

Note 3 – Borrowings

At September 30, 2004, the Bank had one advance on its $100 million credit facility with Salomon Brothers due March 2005, at a rate of 1.42%, in the amount of $8.4 million, which is secured by $9.3 million in mortgage-backed securities.  Additionally, the Company had $143.5 million in Federal Home Loan Bank (FHLB) advances with a weighted average interest rate of 2.00% and a weighted average maturity of 0.63 years, as of September 30, 2004.  Advances from the FHLB are collateralized by pledges of certain real estate loans with an aggregate principal balance of $239.6 million.  As of September 30, 2004, the Bank was able to borrow up to 35% of its prior quarter’s reported total assets under the line, which amounted to $146.7 million, an increase of $54.6 million from the prior quarter.  FHLB advances consisted of the following as of September 30, 2004:

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Note 4 – Subordinated Debentures

In March 2004, the Corporation issued $10.3 million of Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Subordinated Debentures”) to PPBI Trust I, which fund the payment of $10.0 million of Floating Rate Trust Preferred Securities which were issued by PPBI Trust I in March 2004. The net proceeds from the offering of Trust Preferred Securities were contributed as Capital to the Bank to support further growth.  Interest is payable quarterly on the Subordinated Debentures at three-month LIBOR plus 2.75% for an effective rate of 4.35% as of September 30, 2004.

Under FIN No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51,” the Corporation is not allowed to consolidate PPBI Trust I into the Company’s financial statements.  The resulting effect on the Company’s consolidated financial statements is to report the Subordinated Debentures as a component of liabilities.  Prior to the issuance of FIN No. 46, bank holding companies typically consolidated these entities and reported the Trust Preferred Securities as a component of liabilities.

Note 5 – Earnings Per Share

The tables below set forth the Company’s unaudited earnings per share calculations for the three and nine months ended September 30, 2004 and 2003.

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 and common stock equivalents outstanding for the period.

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

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Note 6 – Sale of portions of the Participation Contract

In March 2004, the Company sold its share of the residual interest in the 1998-1 component of the Participation Contract for $6.3 million.  The gain on sale was $1.6 million.  In August 2004, the 1997-2 component of the Participation Contract was terminated early and the performing assets sold. The gain on the sale was $387,000. The remaining balance of the Participation Contract on the Company’s balance sheet is $1.1 million as of September 30, 2004 and the final residual is expected to be terminated by the end of the fourth quarter of 2004.  See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Participation Contract” for a description of the Participation Contract.

Note 7 – Valuation Allowance for Deferred Income Taxes

The Company benefited from a reduction in its valuation allowance for deferred taxes in the three and nine months ended September 30, 2004 and for the three and nine months ended September 30, 2003 of $61,000, $1.7 million, $200,000 and $600,000, respectively.  The Company’s valuation allowance for deferred taxes was $3.7 million at September 30, 2004. The decrease in the deferred tax valuation allowance is due to management’s forecast of taxable earnings, based on assumptions regarding the Company’s growth, in the near future. As the Company achieves continuous taxable income and if the earning projections show that the Company will have the ability to use its net operating loss carry-forwards, then all or part of the remaining valuation allowance for deferred taxes of $3.7 million will be eliminated.

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 nine months ended September 30, 2004 and 2003.  The discussion should be read in conjunction with the Company’s Management Discussion and Analysis included in the 2003 Annual Report on Form 10-K, plus the unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report.  The results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results expected for the year ending December 31, 2004.

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,  and (6)  various legal, regulatory and litigation risks.

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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.  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 FHLB of San Francisco, which is a member bank of the Federal Home Loan Bank System. The Bank’s deposit accounts are insured up to the $100,000 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 Company is a financial services organization committed to serving consumers and small businesses in Southern California. The Bank currently operates three full-service branches in Southern California located in the cities of San Bernardino, Seal Beach and Huntington Beach.   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 throughout Southern California. The Bank funds its lending and investment activities primarily with retail deposits obtained through its branches, advances from the FHLB of San Francisco, lines of credit, and wholesale and brokered certificates of deposits.

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 in our 2003 Annual Report on Form 10-K. 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 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”, “Participation Contract” and “Provision (Benefit) for Income Taxes” discussed later in this document and in our 2003 Annual Report on Form 10-K.

FINANCIAL CONDITION

Total assets of the Company were $488.2 million as of September 30, 2004 compared to $309.4 million as of December 31, 2003.  The $178.8 million or 57.8% increase in total assets is primarily the result of a $158.4 million increase in loans held for investment and an increase in cash of $23.9 million.

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Investment Securities by Contractual Maturity

As of September 30, 2004

(dollars in thousands)

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 September 30, 2004 and September 30, 2003 of $371,000 and $846,000, respectively, and received cash proceeds for the quarters ended September 30, 2004 and September 30, 2003 of $1.3 million and $763,000, respectively.  See “Participation Contract” for further details.

Loans

Gross loans outstanding totaled $407.1 million at September 30, 2004 compared to $250.1 million at December 31, 2003.  Included in the Bank’s loan portfolio as of September 30, 2004 are $25.3 million of one-to-four family loans of which $5.1 million of such loans are secured by first liens or second liens on real estate to sub-prime credit borrowers. Additionally, $4.2 million of the one-to-four family 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.

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Allowance for Loan Losses

For the nine months ended September 30, 2004, the Company provisioned $460,000 for loan losses compared to a $680,000 provision during the nine months ended September 30, 2003.  The decrease in the provision for the nine months ended September 30, 2004 is primarily due to a reduction in net charge-offs from $1.4 million for the nine months ended September 30, 2003 to $41,000 for the same period in 2004. The Bank’s Loss Mitigation Department continues collection efforts on loans previously written-down and/or charged-off to maximize potential recoveries.  See “Provision for Loan Losses.”

The allowance for loan losses totaled $2.4 million as of September 30, 2004 and $2.0 million as of December 31, 2003. The allowance for loan losses as a percent of nonperforming loans was 94.4% and 71.5% as of September 30, 2004 and December 31, 2003, respectively.  Net nonperforming loans totaled $2.2 million at September 30, 2004 and $2.5 million as of December 31, 2003, or .52% and 1.12% of total assets, respectively.

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.  The allowance for the one-to-four residential loan portfolio is primarily based upon the Bank’s historical loss experience from charge-offs and real estate owned for the last 29 quarters, and a historical delinquency migration analysis.   For the multi-family and commercial real estate loan portfolio, the Bank analyzes and uses the 10 year historical loan loss experience for multi-family and commercial real estate secured loans compiled by the OTS to determine its loss factors, since the Bank has not experienced any losses or delinquency on its own within the income property portfolio. Given the composition of the Company’s loan portfolio, the $2.4 million allowance for loan losses was considered adequate to cover losses inherent in the Company’s loan portfolio at September 30, 2004. 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 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.

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The table below summarizes the activity of the Company’s allowance for loan losses for the three and nine months ended September 30, 2004 and 2003 (in thousands):