First Regional Bancorp 10-Q 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
Quarter Ended September 30, 2009
Commission File Number 0-10232
FIRST REGIONAL BANCORP
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code
Former name, former address, and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act). (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding in each of the issuers classes of common stock, as of the latest practicable date.
FIRST REGIONAL BANCORP
FIRST REGIONAL BANCORP AND SUBSIDIARIES
(In Thousands Except Share Data)
The accompanying notes are an integral part of these condensed consolidated financial statements.
FIRST REGIONAL BANCORP AND SUBSIDIARIES
(In Thousands Except Per Share Data)
The accompanying notes are an integral part of these condensed consolidated financial statements.
FIRST REGIONAL BANCORP AND SUBSIDIARIES
The accompanying notes are an integral part of these condensed consolidated financial statements.
FIRST REGIONAL BANCORP AND SUBSIDIARIES
September 30, 2009
NOTE 1: Basis of Presentation
First Regional Bancorp, a bank holding company (the Company), and one of its wholly-owned subsidiaries, First Regional Bank, a California state-chartered bank (the Bank), primarily serve Southern California through their branches. The Companys primary source of revenue is providing loans to customers, which are predominantly small and midsize businesses.
In the opinion of the Company, the interim condensed consolidated financial statements contain all adjustments of a normal recurring nature necessary to present fairly the financial position and the results of operations for the interim periods. Interim results may not be indicative of annual operations.
The accompanying financial information has been prepared assuming that First Regional Bancorp will continue as a going concern. The ability of the Company to continue as a going concern is dependent on many factors. The Company has suffered recurring operating losses from operations, and at September 30, 2009 its capital ratios had declined below the level considered adequately capitalized by its regulators. Continued operating losses or further declines in capital levels could raise uncertainty about the ability of the Company to continue as a going concern. The financial information does not include any adjustments that might result from the eventual outcome of this uncertainty.
While the Company believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the financial statements and the notes included in the Companys 2008 annual report on Form 10-K.
NOTE 2: Regulatory Capital
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatoryand possibly additional discretionaryactions by the regulators that, if undertaken, could have a direct, material effect on the Companys consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations), and of Tier I capital to average assets (as defined in the regulations). Management believes, as of December 31, 2008, that the Company and the Bank met all capital adequacy requirements to which they are subject. Management believes that based on their respective capital ratios as of September 30, 2009, and currently, the Company is considered significantly undercapitalized while the Bank is considered undercapitalized.
The Bank is also subject to a regulatory order with the FDIC and the DFI that calls for the Bank to increase its Tier 1 leverage ratio to 10% by September 30, 2009 and maintain at least that level thereafter. For the quarter ended September 30, 2009 the Banks Tier 1 leverage ratio was 5.35%, so the Bank is not in compliance with this requirement of the regulatory order. A Capital Restoration Plan has been developed to address this deficiency, which contemplates several approaches to increasing capital to acceptable levels, including the possibilities of a rights offering to existing Company shareholders or the issuance of new Company shares to interested investors. There can be no assurance that these approaches will be successful. Should the Company or the Bank be unable to increase capital to acceptable levels, or
should capital levels deteriorate further, the Company and/or the Bank could be subject to additional regulatory action.
To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below.
A table showing the minimum capital ratios required for the Company and the Bank and the Companys and the Banks actual capital ratios and actual capital amounts at September 30, 2009 and December 31, 2008, is as follows (in thousands):
The Federal Reserve Board adopted a final rule that allows the continued inclusion of trust-preferred securities in the Tier I capital of bank holding companies until March 31, 2011. However, under the final rule, the aggregate amount of trust-preferred securities and certain other capital elements would be limited to 25% of Tier I capital elements, net of goodwill.
At the conclusion of an examination by the FDIC and DFI of the Bank in 2007, the FDIC expressed concern regarding a previously unidentified Bank Secrecy Act (BSA) concern relating to the Banks program of providing custodial services to individual retirement accounts (IRAs) administered by non-bank third parties.
In 2008, the FDIC requested that the Bank enter into a cease and desist order, principally addressing the Banks BSA duties in connection with such third party administered retirement accounts. While the Bank has questioned the need for such a cease and desist order, the Bank concluded that it was advisable for the Bank to enter into, rather than undertake a formal challenge to, the requested cease and desist order. The Bank believes it fully complied with the BSA related components of this Cease and Desist Order. The order also contains standard provisions regarding the prevention of violations of all laws and regulations. While subsequent examinations have found no further BSA violations, some violations of appraisal rules and other regulations have been noted. For this reason, the Bank has not yet achieved full compliance with all terms of this order. No assurance can be given that the FDIC will not require further action if the Bank fails to comply with the terms of the cease and desist order or otherwise fails to correct the deficiencies identified.
During February 2009, the Bank signed an order to cease and desist with the FDIC and the DFI to further strengthen the Banks operations. Under the agreement, First Regional Bank will:
· Retain qualified management, and continue the active involvement of its board of directors in managing the Banks activities
· Increase its capital ratios based on a pre-determined schedule that calls for the Bank to increase its Tier 1 leverage ratio to 9.5% immediately, and to further increase it to 10% by September 30,2009, and develop a comprehensive capital plan to assure compliance with that schedule. No dividends may be declared without prior regulatory approval.
· Eliminate from its books any assets classified loss and a portion of any assets classified doubtful that have not already been charged-off or collected, and develop a comprehensive plan to reduce classified assets based on a pre-determined schedule
· Create and implement a plan to increase the diversification of the Banks lending activities
· Create and implement a comprehensive profit plan to improve the Banks earnings performance
· Update or revise the Banks written policies in the areas of credit administration and liquidity management
As part of the Banks 2009 regulatory examination by the FDIC and the DFI, there were certain loan grading changes and changes in the qualitative reserves resulting from declining trends noted in the delinquent, classified and non-performing loans. As a result of these findings, we concluded that the allowance for loan losses as of June 30, 2009 should be and was increased by $69.9 million to reflect these matters, an additional $50.6 million in loan charge-offs, $1.3 million in interest reversal on impaired loans, $1.2 million in losses on foreclosed properties that were deemed to have existed as of June 30, 2009 and a $20.7 million cost of establishing a valuation allowance for deferred tax assets.
The Company utilizes a variety of funding sources in conducting its operations, including the use of brokered deposits as defined by banking regulators. Such brokered deposits totaled $760,000,000 at December 31, 2008. As a result of First Regional Banks regulatory agreement with the FDIC and the DFI, the bank is prohibited from accepting or renewing any brokered deposit, as defined, unless it receives a waiver from the FDIC. The bank has not received a brokered deposit waiver, and has no plans to seek such a waiver at this time. Instead, existing brokered deposits are being allowed to leave the bank as they mature. As of September 30, 2009 the balance of the brokered deposits had been reduced to $411,479,000; of these, $162,177,000 mature in 2009, of which $74,000,000 was paid out in October, leaving a total of $88,177,000 maturing in November and December,2009, $157,928,000 mature in 2010, and $91,374,000 mature in 2011. The bank anticipates that future brokered deposit outflows, as well as normal deposit activity by customers, will be accommodated using the proceeds of loan repayments, and other lines of credit.
In the interest of preserving its remaining cash reserves, First Regional Bancorp intends to defer interest payments on its trust preferred securities. First Regional has the right to defer interest payments for up to five years under the indentures governing its various trust preferred securities.
In September 2009, the Bank received a Prompt Corrective Action Notification of Capital letter from the FDIC. The letter indicated that the banks capital category was considered undercapitalized as of June 30, 2009. The letter reminded the Bank of the requirement for undercapitalized institutions to develop a Capital Restoration Plan, and of restrictions on growth, branching, and new lines of business imposed pursuant to section 38 of the Federal Deposit Insurance Act. The Bank has developed a Capital Restoration Plan to address this deficiency, which contemplates several approaches to increasing the Banks capital to acceptable levels, including the possibilities of a rights offering to existing Company shareholders or the issuance of new Company shares to interested investors. There can be no assurance that these approaches will be successful.
NOTE 3: Recent Accounting Pronouncements
In April 2009, the FASB issued ASC 820-10-65-4 (formerly FSP SFAS No.157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, to provide additional guidance for estimating fair value in accordance with ASC 820, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. As some constituents indicated that SFAS No. 157 and FSP SFAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, did not provide sufficient guidance on how to determine whether a market for a financial asset that historically was active is no longer active and whether a transaction is not orderly. Therefore, this ASC 820-10-65-4 includes guidance on identifying circumstances that indicate a transaction is not orderly. We adopted ASC 820-10-65-4 in the second quarter of 2009 and the adoption did not have a material impact on our consolidated financial statements.
In April 2009, the FASB issued ASC 320-10 (Formerly FSP SFAS No.115-2 and SFAS No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments), which amends the other-than-temporary impairment (OTTI) guidance in the U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of OTTI on debt and equity securities in the financial statements. This ASC 320-10 does not amend existing recognition and measurement guidance related to OTTI of equity securities. This issuance also requires increased and more timely disclosures sought by investors regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. ASC 320-10 is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of ASC 320-10 did not have a material impact on our consolidated financial statements.
In April 2009, the FASB issued ASC Topic 825 (formerly FSP SFAS No. 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments), which amends SFAS No. 107, Disclosure about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This ASC 825 also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. ASC Topic 825 is effective for interim and annual reporting periods ending after June 15, 2009. If a reporting entity elects to adopt early either FSP SFAS No. 157-4 or FSP SFAS No. 115-2 and SFAS No. 124-2, the reporting entity also is required to adopt early this ASC Topic 825. However, this does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, Topic 825 requires comparative disclosures only for periods ending after initial adoption. The adoption of ASC Topic 825 did not have a material impact on our consolidated financial statements.
In May 2009, the FASB issued new authoritative guidance under ASC Topic 855 (formerly Statement No. 165) Subsequent Events, to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC Topic 855 is to be applied to the accounting for and disclosure of subsequent events, and is applied to both interim and annual financial statements. This statement does not apply to subsequent events or transactions that are within the scope of other applicable GAAP that provide different guidance on the accounting treatment for subsequent events or transactions. ASC Topic 855 is effective for interim or annual financial periods ending after June 15, 2009. Events that occurred subsequent to September 30, 2009 have been evaluated by the Companys management in accordance with ASC 855 through the time of filing this report on November 23, 2009. The adoption of ASC Topic 855 did not have a material impact on our consolidated financial statements.
In June 2009, the FASB issued new authoritative guidance under ASC Topic 860 (formerly Statement No. 166) Transfers and Servicing. This statement is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance and cash flows; and a transferors continuing involvement, if any, in transferred financial assets. ASC Topic 860 addresses (1) practices that have developed since the issuance of SFAS No. 140 that are not consistent with the original intent and key requirements of that statement, and (2) concerns of financial statement users that many of the financial assets (and related
obligations) that have been derecognized should continue to be reported in the financial statements of transferors. ASC Topic 860 is effective at the beginning of each reporting entitys first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual periods thereafter. Early adoption is prohibited. This statement must be applied to transfers occurring on or after the effective date. However, the disclosure provisions of this statement should be applied to transfers that occurred both before and after the effective date. Additionally, on and after the effective date, the concept of qualifying special-purpose entity (SPE) is no longer relevant for accounting purposes. Therefore, formerly qualifying SPEs, as defined under previous accounting standards, should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance. We are in the process of evaluating the impact that the adoption of ASC Topic 860 will have on our consolidated financial statements.
In June 2009, the FASB issued new authoritative guidance under SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167). Under FASBs Codification at ASC 105-10-65-1d, SFAS 167 will remain authoritative until integrated into the FASB Codification. SFAS 167 amends FIN 46 (Revised December 2003), Consolidation of Variable Interest Entities, to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entitys purpose and design and a companys ability to direct the activities of the entity that most significantly impact the entitys economic performance. SFAS 167 requires additional disclosures about the reporting entitys involvement with variable-interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entitys financial statements. SFAS 167 will be effective January 1, 2010 and we are in the process of evaluating the impact that the adoption of SFAS No. 166 will have on our consolidated financial statements.
In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of SFAS No. 162, which is now codified in FASB ASC 105, The Hierarchy of Generally Accepted Accounting Principles. The FASB Accounting Standards Codification (Codification) will become the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this statement, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative. ASC 105 was effective for interim and annual financial statements issued after September 15, 2009. The adoption of ASC 105 did not have a material impact on our consolidated financial statements.
In August 2009, the FASB issued Accounting Standards Update (ASU) 2009-05 Fair Value Measurements and Disclosures (Topic 820): Measuring Liabilities at Fair Value (ASU 2009-05) which provides guidance on measuring the fair value of liabilities under FASB ASC 820, Fair Value Measurements and Disclosures (ASC 820). ASU 2009-05 clarifies that the unadjusted quoted price for an identical liability, when traded as an asset in an active market is a Level 1 measurement for the liability and provides guidance on the valuation techniques to estimate fair value of a liability in the absence of a Level 1 measurement. ASU 2009-05 is effective for the first interim or annual reporting period beginning after its issuance. The adoption of ASU 2009-05 did not have a material effect on our consolidated financial statements.
In September 2009, ASU 2009-12, Fair Value Measurements and Disclosures (Topic 820) - Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent),was issued. The issuance allows a company to measure the fair value of an investment that has no readily determinable fair market value on the basis of the investees net asset value per share as provided by the investee. This allowance assumes that the investee has calculated net asset value in accordance with the GAAP measurement principles of Topic 946 as of the reporting entitys measurement date. Examples of such investments include investments in hedge funds, private equity funds, real estate funds and venture capital funds. The update also provides guidance on how the investment should be classified within the fair value hierarchy based on the value for which the investment can be redeemed. The amendment is effective for interim and annual periods ending after December 15, 2009 with early adoption permitted. The Company does not have investments in such entities and, consequently, there will be no impact to our financial statements.
NOTE 4: Allowance for Loan Losses and Unfunded Loan Commitments
An analysis of the activity in the allowance for loan losses for the three and nine months ended September 30, 2009 and 2008 is as follows (in thousands):
Management believes the allowance for loan losses as of September 30, 2009, is adequate to absorb losses inherent in the loan portfolio. While the Company is responsible for determining the adequacy of the allowance, Managements estimates of the allowance are subject to review by the Federal Deposit Insurance Corporation (the FDIC) and the California Department of Financial Institutions (the CDFI) upon examination of the Bank by such authorities.
Loans are determined to be impaired when it is determined probable that the bank will be unable to collect all the contractual interest and principal payments as scheduled in the loan agreement. Impaired loans include both non-performing and performing assets. Per banking industry convention, non-performing assets consist of loans past due 90 or more days and still accruing interest, loans on non-accrual status, and other real estate owned (OREO).
The increase in the provision for loan losses, loans charged off and the allowance for loan losses for the three and nine months ended September 30, 2009 reflect an adjustment to the factors utilized in calculating the allowance for loan losses. These include recent trends in delinquent, classified and non-performing loans in the Banks loan portfolio, as well as changes in property values in the market areas served by the Bank. The increase in the recorded investment in non-performing and performing impaired loans is a result of continued deterioration in the real estate market during the year. All impaired loans are evaluated for specific reserves and charge-offs as appropriate. Due to these deterioration factors, the Company has also increased the general reserve for non-impaired loans.
At September 30, 2009 and December 31, 2008, the recorded investment in non-performing and performing impaired loans net of charge-offs was $416,267,000 and $215,190,000, with specific reserves of $37,813,000 and $32,264,000, respectively. All loans for which impairment had been recognized had a related specific reserve or had been partially charged off at September 30, 2009 and December 31, 2008.
The average recorded investment in impaired loans during the third quarter ended September 30, 2009 and 2008 was $272,032,000, and $103,116,000, respectively. Interest income of $ 40,000 and $0 on impaired loans was recognized for cash payments received in the first nine months of 2009 and 2008, respectively. Foregone interest on impaired loans during the first nine months of 2009 and 2008 was $6,953,000 and $2,494,000, respectively.
NOTE 5: Fair Value Disclosures
FASB ASC 820 Fair Value Measurements and Disclosures (Formerly SFAS No. 157) provides a framework for measuring fair value under GAAP. This standard applies to all financial assets and liabilities, and certain non-financial assets and liabilities, that are being measured and reported at fair value on a recurring or non-recurring basis. For the Company, this includes the investment securities available-for-sale (AFS) portfolio, impaired loans, and other real estate owned (OREO).
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market and income approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability. These inputs can be readily observable, market corroborated, or generally unobservable firm inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the following information according to the fair value hierarchy. The hierarchy ranks the quality and reliability of the information used to determine fair values. The hierarchy gives the highest priority to quoted prices available in active markets and the lowest priority to data lacking transparency. Assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.
Level 3: Significant unobservable inputs that reflect the reporting entitys own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The following is a description of the Companys valuation methodologies used to measure and disclose the fair values of its assets and liabilities on a recurring or nonrecurring basis:
Investment securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, when available, or the prices of other securities with similar characteristics. Level 1 securities include both U.S. Treasury and actively traded U.S. government sponsored enterprise debt securities, and Level 2 securities are comprised of U.S. government sponsored enterprise debt securities in accordance with GAAP.
Impaired Loans In accordance with GAAP, the Companys impaired loans are generally measured using the fair value of the underlying collateral, which is determined based on the most recent appraisal information received. Appraised values may be adjusted based on factors such as the Companys historical knowledge and changes in market conditions from the time of valuation. As of September 30, 2009, collateral dependent impaired loans totaled $314,729,000 net of the specific reserves. Collateral dependent impaired loans fall within Level 3 of the fair value hierarchy since they were measured at fair value based on appraisals of the underlying collateral.
OREO In accordance with GAAP, at the acquisition date, the Companys OREO assets are recorded at fair value, which is determined based on the most recent appraisal information received. Subsequent to the acquisition date, the Companys OREO assets are reported at the lower of carrying amount or fair value, which is determined based on the most recent appraisal information received. Appraised values may be adjusted based on factors such as the Companys historical knowledge and changes in market conditions from the time of valuation. As of September 30, 2009, OREO assets totaled $73,156,000, net of valuation allowance. OREO assets fall
within Level 3 of the fair value hierarchy since they were measured at fair value based on appraisals.
The balances of assets measured at fair value on a recurring basis as of September 30, 2009 were as follows (in $1,000s):
The amortized cost and estimated fair values of securities available for sale as of September 30, 2009 and December 31, 2008 were as follows (dollars in thousands):
At September 30, 2009 and December 31, 2008, no securities have been in a continuous unrealized loss position for greater than 12 months.
The balances of assets measured at fair value on a non-recurring basis as of September 30, 2009 and the total losses resulting from the fair value adjustments as of September 30, 2009 were as follows (in $1,000s):
(1) Represents carrying value and related reserve remeasurements on collateral dependent loans for which adjustments are based upon the appraised value of the collateral. The fair value measurements of the impaired loans are presented before deducting the estimated costs to sell.
(2) The loss on OREO represents fair value adjustments. The fair value measurements of the OREO are presented before deducting the estimated costs to sell.
There were no material liabilities carried at fair value, measured on a recurring or non-recurring basis at September 30, 2009.
Fair Value of Financial Instruments
The following estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts (in thousands).
Fair values of commitments to extend credit and standby letters of credit are immaterial as of September 30, 2009 and December 31, 2008.
The fair values of cash and due from banks, federal funds sold, non-interest- bearing deposits, money market and other deposits, note payable, Federal funds purchased, FHLB advances, accrued interest receivable and payable, generally approximate their book value due to the short maturities.
The carrying value Federal Home Loan Bank stock approximates fair value, as the stock may be sold back to the Federal Home Loan Bank at carrying value.
The fair value of investment securities available for sale is based on quoted market prices, dealer quotes, and prices obtained from independent pricing services. The fair value of loans and interest-bearing deposits is estimated based on present values using applicable risk-adjusted spreads to the U.S. Treasury curve to approximate current entry-value interest rates applicable to each category of such financial instruments. In obtaining such valuation from third parties, the Company has reviewed the methodologies used to develop their results.
No adjustment was made to the entry-value interest rates for changes in credit of performing loans for which there are no known credit concerns. Management segregates loans in appropriate risk categories. Management believes that the risk factor embedded in the entry-value interest rates, along with the general reserves applicable to the performing loan portfolio for which there are no known credit concerns, results in a fair valuation of such loans on an entry-value basis. The recorded book value of $311,168,000 in 2009 and $111,057,000 in 2008 on non-performing and performing loans were not included in the fair value amounts because it is not practicable to reasonably assess the credit adjustment that would be applied in the marketplace for such loans.
The fair value of the junior subordinated deferrable debentures is estimated by discounting the cash flows through maturity based on prevailing market rates at each reporting date.
The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2009 and December 31, 2008. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly from the amounts presented herein.
NOTE 6: Other Real Estate Owned
Other real estate owned includes properties acquired through foreclosure. The Company had five (5) OREO properties December 31, 2008. During the nine months of 2009, the Company acquired fourteen (14) OREO properties and sold four (4) OREO properties for a total of fifteen (15) OREO properties at September 30, 2009. The balance of other real estate owned is as follows (in thousands):
NOTE 7: Earnings per Share and Stock Based Compensation
Basic earnings per share are computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during each period. The computation of diluted earnings per share also considers the number of shares issuable upon the assumed exercise of outstanding common stock options. Due to the net loss recorded during the three and nine months ended September 30, 2009 and during the nine months ended September 30, 2008, incremental shares resulting from the assumed conversion, exercise or contingent issuance of securities is not included as their effect on earnings or loss per share would be anti-dilutive. A reconciliation of the numerator and the denominator used in the computation of basic and diluted earnings (loss) per share is:
As discussed above, anti-dilutive shares from stock options are excluded from the computation of loss per share. The anti-dilutive stock options totaled 2,360,000 for the three and nine months ended September 30, 2009. There were 711,000 and 2,330,000 anti-dilutive stock options for the three and nine months ended September 30, 2008, respectively.
Stock Compensation Plans
In May 2005, the Companys Board of Directors adopted a non-qualified employee stock option plan that expires in 2015 and authorizes the issuance of up to 600,000 (amended to 800,000 in July 2008)shares of its common stock upon the exercise of options granted. The plan is intended to allow the Company the ability to grant stock options to persons who had not previously been awarded option grants commensurate with their positions, primarily persons hired since the exhaustion of options available for grant under the Companys previous stock option plans. The Companys Board of Directors believes that the Plan will assist the Company in attracting and retaining high quality officers and staff, and will provide grantees under the Plan with added incentive for high levels of performance and to assist in the effort to increase the Companys earnings. During 2005, 2007, 2008 and April 2009, the Company granted options to buy up to 177,000, 45,000, 506,000 and 50,000 shares of the Companys common stock to certain officers of the Company and its subsidiaries. All such granted options will vest over seven years and expire in 2015, 2017, 2018 and 2019, respectively.
In 1999, the Company adopted a nonqualified employee stock option plan that authorizes the issuance of up to 1,800,000 shares of its common stock and expires in 2009.
Under all plans, options may be granted at a price not less than the fair market value of the stock at the date of the grant.
A summary of the award activity under the stock option plans as of September 30, 2009 and changes during the nine-month period is presented below:
The total intrinsic value of options exercised during the three and nine month periods ended September 30, 2009 was $-0- and $1,000, respectively. The total intrinsic value of options exercised during the three and nine month periods ended September 30, 2008 was $45,000 and $106,000 respectively. The total fair value of shares vested during the three and nine month periods ended September 30, 2009 was $298,000 and $605,000, respectively. The total fair value of shares vested during the three and nine month periods ended September 30, 2008 was $132,000 and $411,000, respectively.
As of September 30, 2009, there was $1,960,000 of total unrecognized compensation cost related to non-vested share-based compensation awards granted under the stock option plans. That cost is expected to be recognized over a weighted-average period of 2.87 years. The Company received $7,000 and $67,000 cash from the exercise of stock options during the nine month periods ended September 30, 2009 and 2008, respectively.
For the three and nine month periods ended September 30, 2009, stock based compensation expense reduced income before taxes by $151,000 and $454,000 and reduced net income by $87,000 and $263,000. This additional expense reduced both basic and diluted earnings per share by $0.01 for the three months ended September 30, 2009, and reduced both basic and diluted earnings per share by $0.02 for the nine months ended September 30, 2009 Cash provided by operating activities and cash provided by financing activities were not impacted during the nine months of 2009 as there were no excess tax benefits from the exercise of stock options.
For the three and nine month periods ended September 30, 2008, stock based compensation expense reduced income before taxes by $142,000 and $379,000 and reduced net income by $82,000 and $220,000. This additional expense reduced both basic and diluted earnings per share by $0.01 for the three months ended September 30, 2008, and reduced both basic and diluted earnings per share by $0.02 for the nine months ended September 30, 2008. Cash provided by operating activities decreased by $44,000 and cash provided by financing activities increased by an identical amount for the first nine months of 2008 related to excess tax benefits from the exercise of stock options.
NOTE 8: Income Taxes
The Company accounts for income taxes by recognizing deferred tax assets and liabilities based upon temporary differences between the financial reporting and tax basis of its assets and liabilities. Valuation allowances are established when necessary to reduce deferred tax assets when it is more-likely-than-not that a portion or all of the deferred tax assets will not be realized.
During the third quarter of 2009, the Company reviewed its analysis of whether a valuation allowance should be recorded against its deferred tax assets. Accounting literature states that a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. In making such judgments, significant weight is given to evidence that can be objectively verified. During the third quarter of 2009, the estimated realization period for the deferred tax asset based on forecasts of future earnings extended further into the 20-year carryforward period compared to the realization period forecasted in the first quarter of 2009. This extended realization period, combined with the objective evidence of a two-year cumulative loss position and continued near-term losses represent significant negative evidence that caused the Company to conclude that a $57,344,000 deferred tax valuation allowance was required at September 30, 2009. Of this amount, $20,670,000 represents previously recognized deferred tax benefits where the Company has determined they can no longer meet the more likely than not threshold for recognizing this asset. To the extent that the Company generates taxable income in a given quarter, the valuation allowance may be reduced to fully or partially offset the corresponding income tax expense. Any remaining deferred tax asset valuation allowance will ultimately reverse through income tax expense when the Company can demonstrate a sustainable return to profitability that would lead management to conclude that it is more likely than not that the deferred tax asset will be utilized during the 20-year carryforward period.
The Companys effective tax rate for the three and nine months ended September 30, 2009 was 0% and 3.7%, respectively. The Companys effective tax rate for the three and nine months ended September 30, 2008 was 33.3% and (45.2)%, respectively. The change in the effective tax rate is primarily due to the increase in the valuation allowance associated with the net operating losses incurred during the three and nine months ended September 30, 2009.
NOTE 9: Commitments and Contingencies
As of September 30, 2009, the Bank had a total of $13,838,000 in financial and performance standby letters of credit outstanding. No significant losses are anticipated as a result of these transactions.
NOTE 10: Comprehensive Income
The Companys comprehensive income includes all items which comprise net income plus the unrealized holding (losses) gains on available-for-sale securities. For the three and nine month periods ended September 30, 2009 and 2008, the Companys comprehensive income (loss), net of taxes, was as follows:
NOTE 11: Operating Segment Reports
Management has evaluated the Companys overall operation and determined that its business consists of certain reportable business segments as of September 30, 2009 and 2008: core banking operations, the administrative services in relation to TAS (as defined below), and Trust Services. The following describes these three business segments:
Core Bank Operations - The principal business activities of this segment are attracting funds from the general public and originating commercial and real estate loans for small and midsize businesses in Southern California. This segments primary sources of revenue are interest income from loans and investment securities
and fees earned in connection with loans and deposits. This segments principal expenses consist of interest paid on deposits, personnel, and other general and administrative expenses. Core banking services also include the Banks merchant services operations, which provide credit card deposits and clearing services to retailers and other credit card accepting businesses and which generates fee income.
Trust Administrative Services - The principal business activity of the Banks division, Trust Administration Services (referred to as Administrative Services or TAS) is providing administrative services for self-directed retirement plans. The primary source of revenue for this segment is fee income from self-directed accounts. The segments principal expenses consist of personnel, rent, data processing and other general and administrative expenses.
Trust Services - The principal business activity of this segment is providing trust services for living trusts, investment agency accounts, IRA rollovers, and all forms of court-related matters. The primary source of revenue for this segment is fee income. The segments principal expenses consist of personnel, data processing, professional service expenses, and other general and administrative expenses.
Total assets of TAS at September 30, 2009 and December 31, 2008 were $1,188,000 and $951,000, respectively and total assets of Trust Services at September 30, 2009 and December 31, 2008 were $71,000 and $72,000, respectively. The remaining assets reflected on the condensed consolidated balance Sheets of the Company are associated with core banking operations.
A table showing the net income (loss) for the core banking operations, administrative services, and trust services for the three and nine-month periods ended September 30, 2009 and 2008 (in thousands).