Graham Holdings Co 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2011
For the transition period from to
Commission File Number: 001-33803
WESTERN LIBERTY BANCORP
(Exact name of registrant as specified in its charter)
8363 W. Sunset Road, Suite 350, Las Vegas, Nevada 89113
(Address, including zip code, and telephone number, including area code, of registrants principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant 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 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 a 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 þ
As of August 4, 2011, the registrant had 15,088,023 shares of its common stock, par value $0.0001 per share, outstanding.
WESTERN LIBERTY BANCORP
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
WESTERN LIBERTY BANCORP
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
($ in 000s)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
WESTERN LIBERTY BANCORP
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
($ in 000s except per share data)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
WESTERN LIBERTY BANCORP CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
($ in 000s)
The accompany notes are an integral part of these unaudited condensed consolidated financial statements.
Western Liberty Bancorp
Notes to Unaudited Condensed Consolidated Financial Statements
Note 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of business
Western Liberty Bancorp (WLBC) became a bank holding company on October 28, 2010 with consummation of the acquisition of Service1st Bank of Nevada. We were formerly known as Global Consumer Acquisition Corp., a special purpose acquisition company formed under the laws of Delaware on June 28, 2007, to consummate an acquisition, capital stock exchange, acquisition, stock purchase, reorganization or similar business combination with one or more businesses. Our stockholders approved certain amendments to our Amended and Restated Certificate of Incorporation removing certain provisions specific to special purpose acquisition companies, changing our name to Western Liberty Bancorp and authorizing the distribution and termination of our trust account. Effective October 7, 2009, the Company began its business operations and exited its development stage. Our sole subsidiary is Service1st Bank of Nevada. We currently conduct no business activities other than acting as the holding company of Service1st Bank.
Service1st Bank of Nevada (Service1st) is a community bank which commenced operations as a financial institution on January 16, 2007. Service1st provides a full range of banking and related services to locally owned businesses, professional firms, real estate developers and investors, local non-profit organizations, high net worth individuals, and other customers in and around the greater Las Vegas area. Banking services provided include basic commercial and consumer depository services, commercial working capital and equipment loans, commercial real estate (both owner occupied and non-owner occupied) loans, construction loans, and unsecured personal and business loans. Service1st relies primarily on locally generated deposits to fund its lending activities. Service1st has two branches located in Las Vegas, Nevada, which accept deposits and grant loans to customers. Substantially all of our business is generated in the Nevada market. Service1st is under the supervision of and subject to regulation and examination by the Nevada FID and the FDIC.
Basis of presentation
The accounting and reporting policies of the Company conform to generally accepted accounting principles in the United States of America. All significant intercompany balances and transactions have been eliminated in consolidation. Our financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. We have evaluated all subsequent events through the date the financial statements were issued.
Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The interim operating results are not necessarily indicative, of operating results for the year. For further information, refer to the consolidated financial statements and notes included in the Companys annual report on Form 10-K for the year ended December 31, 2010.
Since the Companys operations prior to the acquisition of Service1st were insignificant relative to that of Service1st, management believes that Service1st is the Companys predecessor. Management has determined this based on an evaluation of the various facts and circumstances, including, but not limited to the life of Service1st, the operations of Service1st, the purchase price paid, and the fact that the operations on a prospective basis will be most similar to Service1st. Accordingly, the historical statement of operations for the six months ended June 30, 2010 and statement of cash flows for the six months ended June 30, 2010 of Service1st Bank have been presented.
Use of estimates in the preparation of financial statements
To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The purchase accounting adjustments, allowance for loan loss, fair value of financial instruments, and deferred tax assets are particularly subject to change.
Certain amounts in the financial statements and related disclosures as of December 31, 2010 have been reclassified to conform to the current condensed presentation. These reclassification adjustments have no effect on net loss or stockholders equity as previously reported.
Loans are stated at the amount of unpaid principal, reduced or increased by unearned net loan fees or deferred costs, a credit and yield mark, and allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.
The allowance is an amount that management believes will be adequate to absorb probable incurred losses on existing loans that may become uncollectible, based on evaluation of the collectability of loans and prior credit loss experience of the Company and peer bank historical loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, specific problem credits, peer bank information, and current economic conditions that may affect the borrowers ability to pay. Due to the credit concentration of the Companys loan portfolio in real estate-secured loans, the value of collateral is heavily dependent on real estate values in Southern Nevada. This evaluation is inherently subjective and future adjustments to the allowance may be necessary if there are significant changes in economic or other conditions. In addition, the FDIC and state banking regulatory agencies, as an integral part of their examination processes, periodically review the Companys allowance for loan losses, and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations.
For the period ended June 30, 2011, Service1st has implemented a new program to assist in determining estimated credit losses. During the later part of 2010, management began researching for ALLL models that would provide a better estimate for the ALLL but was consistent with all accounting and regulatory guidance. By the end of 2010 a new ALLL model was purchased, data was loaded and initial tests were made comparing the results to the existing methodology. The old and new models were run in parallel at March 31, 2011. It was determined the existing model would be used at March 31, 2011 due to verification and documentation of certain data assumptions. Both models were also run for the period ended June 30, 2011. The new program utilizes a dual factor approach. The ALLL methodology incorporates both a payment default rate (PD) and a loss given default (LGD) rate in lieu of evaluating loss primarily based on charge-offs to total loans. Service1st uses a historical look-back period of three years to compute the payment default rate and loss given default rate. When not statistically meaningful, Service1st will utilize peer institution data to determine an appropriate PD and LGD by that specific loan type. Pursuant to the Joint Policy Statement issued in 2006, the model provides for a variety of qualitative factors to adjust for specific conditions associated with the institution. The new method did not produce materially different results from the previous ALLL model.
The allowance consists of general and specific components. The general component covers non-impaired loans and is based on the methodology described above. The specific component relates to loans that are classified as impaired. For such loans, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Commercial and commercial real estate loans that are graded substandard are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loans existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loans effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
Risk factors impacting loans in each of the portfolio segments include broad deterioration of property values, reduced consumer and business spending as a result of continued high unemployment in our market and a lack of confidence in a sustainable recovery. The Las Vegas market has begun to see an increase in visitor traffic and slight upticks in gaming. However, the oversupply of real estate will continue to suppress pricing power for the foreseeable future. Consequently we believe real estate appraisals will continue to reduce these asset valuations and further stress individuals and businesses that rely on real estate to generate cash flows. The general component covers non-impaired loans and is based on methodology described above. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent three years. The dual factors of payment default rate and a loss given default rate are supplemented with other economic factors based on the risks present for each portfolio segment. These factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified:
These are generally the segments identified in regulatory reporting. Service 1st Bank primarily focuses on the small business market and, therefore, generates most of its loans in the area of commercial real estate and commercial and industrial loans. By segmenting into these categories, the bank is able to monitor the exposure to the related risks and observe compliance with regulatory guidance and limitations.
The Company, as a result of its purchase of Service1st Bank of Nevada on October 28, 2010, acquired a portfolio of loans, some of which have shown evidence of credit deterioration since origination. These purchased loans are recorded at fair value and there is no carryover of the sellers allowance for loan losses. After acquisition, losses will be recognized by an increase in the allowance for loan losses. It is important that consideration to loss experience be blended with the significant discounts to properly reflect the carrying value of the legacy loan portfolio. In the current process, a general component of the allowance for loan losses is being recorded for new loan originations that were determined based on historical experience and managements judgment.
Purchased loans with credit impairment are accounted for individually. The Company estimates the amount and timing of expected cash flows for each purchased loan, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan (accretable yield). The excess of the loans contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).
Over the life of the loan, expected future cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded. If the present value of expected cash flows is greater than the carrying amount, it is recognized respectively as interest income.
Interest and fees on loans
Interest on loans is recognized over the terms of the loans and is calculated using the effective interest method. The accrual of interest on impaired loans is discontinued when, in managements opinion, the borrower may be unable to make payments as they become due.
The Company determines a loan to be delinquent when payments have not been made according to contractual terms, typically evidenced by nonpayment of a monthly installment by the due date. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection.
All interest accrued but not collected for loans that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Loan origination fees, fair value adjustments on purchased non-impaired loans, commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment to the related loans yield. The Company is generally amortizing these amounts over the contractual life of the loan. Commitment fees, based upon a percentage of a customers unused line of credit, and fees related to standby letters of credit are recognized over the commitment period.
Other real estate acquired through foreclosure
Assets acquired through or in-lieu-of foreclosures are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.
Goodwill and other intangible assets
Goodwill resulting from a business combination after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any non-controlling interests in the acquired company, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selected October 31st as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet. WLBC acquired Service1st Bank of Nevada on October 28, 2010 which resulted in goodwill of $5.6 million being recorded.
Other intangible assets consist of a core deposit intangible which is amortized on an accelerated method over the estimated useful life of 10 years.
Stock compensation plans
The Company has the Service1st Bank of Nevada 2007 Stock Option Plan. Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Companys common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. The Company records the fair value of stock compensation granted to employees and directors as expense over the vesting period. The cost of the award is based on the grant-date fair value.
Fair value measurement
For assets and liabilities recorded at fair value, it is the Companys policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Fair value measurements for assets and liabilities, where
there exists limited or no observable market data and, therefore, are based primarily upon estimates, are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. The Company utilizes fair value measurements to determine fair value disclosures and certain assets recorded at fair value on a recurring and nonrecurring basis. See note 3.
Fair values of financial instruments
The Company discloses fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value.
Management uses its best judgment in estimating the fair value of the Companys financial instruments. However, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates presented herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction as of June 30, 2011. The estimated fair value amounts as of June 30, 2011 have been measured as of that date and have been updated for purposes of these financial statements. As such, the estimated fair values of these financial statements subsequent to the reporting date may be different than the amounts reported as of June 30, 2011.
Certificates of deposit
The carrying amounts reported in the balance sheet for certificates of deposit approximate their fair value as the terms on the certificates of deposits do not exceed one year.
Fair values for securities are based on quoted market prices where available or on quoted market prices for similar securities in the absence of quoted prices on the specific security.
For variable rate loans that re-price frequently and that have experienced no significant change in credit risk, fair values are based on carrying values. Variable rate loans comprise approximately 59% of the loan portfolio as of June 30, 2011. Fair value for all other loans is estimated based on discounted cash flows using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. Prepayments prior to the re-pricing date are not expected to be significant. Loans are expected to be held to maturity and any unrealized gains or losses are not expected to be realized.
The fair value of an impaired loan is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value, and discounted cash flows. Those impaired loans not requiring an allowance for probable losses represent loans for which the fair value of the expected repayments or collateral exceeds the recorded investment in such loans.
Accrued interest receivable and payable
The carrying amounts reported in the balance sheet for accrued interest receivable and payable approximate their fair value.
The Company is a member of the FHLB system and maintains an investment in capital stock of the FHLB of San Francisco in an amount pursuant to the agreement with the FHLB. This investment is carried at cost since no ready market exists, and there is no quoted market value.
The fair value disclosed for demand and savings deposits is by definition equal to the amount payable on demand at their reporting date (carrying amount). The carrying amount for variable-rate deposit accounts approximates their fair value. Due to the short-term maturities of fixed-rate certificates of deposit, their carrying amount approximates their fair value. Early withdrawals of fixed-rate certificates of deposit are not expected to be significant.
Off-balance sheet instruments
Fair values for the Companys off-balance sheet instruments, lending commitments and standby letters of credit, are based on quoted fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties credit standing.
Loss per share
Diluted earnings per share is based on the weighted average outstanding common shares (excluding treasury shares, if any) during each year, including common stock equivalents. Basic earnings per share is based on the weighted average outstanding common shares during the year.
Due to the Companys historical net losses, all of the Companys stock-based awards are considered anti-dilutive, and accordingly, basic and diluted loss per share is the same. As of June 30, 2011, approximately 490,000 stock based instruments were issued and outstanding. For further information, refer to the consolidated financial statements and notes included in the Companys annual report on Form 10-K for the year ended December 31, 2010.
Recent accounting pronouncements
In January 2010, the FASB issued ASU 2010-06, Improving Disclosure about Fair Value Measurements. This standard requires new disclosures on the amount and reason for transfers in and out of Level 1 and Level 2 recurring fair value measurements. The standard also requires disclosure of activities (i.e., on a gross basis), including purchases, sales, issuances, and settlements, in the reconciliation of Level 3 fair value recurring measurements. The standard regarding Level 1 and Level 2 fair value measurements and clarification of existing disclosures are effective for periods beginning after December 15, 2009. The disclosures about the reconciliation of information in Level 3 recurring fair value measurements are required for periods beginning after December 15, 2010. Adoption of the applicable portions of this standard on January 1, 2011 did not have a significant impact on our quarterly disclosures.
Newly Issued But Not Yet Effective Accounting Standards:
In April 2011, the FASB issued an accounting standard updated to amend previous guidance with respect to troubled debt restructurings. This updated guidance is designed to assist creditors with determining whether or not a restructuring constitutes a troubled debt restructuring. In particular, additional guidance has been added to help creditors determine whether a concession has been granted and whether a debtor is experiencing financial difficulties. Both of these conditions are required to be met for a restructuring to constitute a troubled debt restructuring. The amendments in the update are effective for the first interim period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. Also of note is that the update deferred the additional required disclosures surrounding trouble debt restructurings to interim and annual periods beginning after June 15, 2011. The additional trouble debt restructuring disclosures which will be required in the third quarter 2011 include the amount and type of trouble debt restructurings which occurred during the period in addition to the amount and type of defaults of troubled debt restructurings that had been restructured in the preceding 12 months. The provisions of this update are not expected to have a material impact on the Companys financial position, results or operations or cash flows.
In May 2011, the FASB issued an accounting standards update to improve the comparability between US GAAP fair value accounting and reporting requirements and International Financial Reporting Standards (IFRS) fair value accounting and reporting requirements. Additional disclosures required by the update include: (i) Disclosure of quantitative information regarding the unobservable inputs used in any fair value measurement classified as Level 3 in the fair value hierarchy in addition to an explanation of the valuation techniques used in valuing Level 3 items and information regarding the sensitivity in the valuation of Level 3 items to changes in the values assigned to unobservable inputs. (ii) Categorization by level within the fair value hierarchy of items not recognized on the Statement of Financial Position at fair value but for which fair values are required to be disclosed. (iii) Instances
where the fair values disclosed for non-financial assets were based on a highest and best use assumption when in fact the assets are not being utilized in that capacity. The amendments in the update are effective for interim and annual periods beginning on or after December 15, 2011. The provisions of this update are not expected to have a material impact on the Companys financial position, results or operations or cash flows.
In June 2011, the FASB issued an accounting standards update to increase the prominence of items included in Other Comprehensive Income and facilitate the convergence of US GAAP with IFRS. The update prohibits continued presentation of Other Comprehensive Income in the statement of Shareholders Equity. The update requires that all non-owner changes in shareholders equity be presented in either a single continuous statement of comprehensive income or in two separate but continuous statements. The amendments in the update are effective for interim and annual periods beginning on or after December 15, 2011. The provisions of this update are only expected to change the manner in which our other comprehensive income is disclosed.
Note 2. BUSINESS COMBINATION
On October 28, 2010, the Company acquired 100% of the outstanding common shares of Service1st Bank of Nevada in exchange for approximately 2.4 million shares of common stock. Under the terms of the acquisition, Service1st Bank common shareholders received 47.5975 shares of the Companys common stock in exchange for each share of Service1st Bank common stock. In addition, the Service1st Bank shareholders are eligible to receive additional common shares equal to twenty percent of Service1st Banks tangible capital at August 31, 2010, if the price of the Companys common stock exceeds $12.75 per share for 30 days during the subsequent two year period. The Company also injected $25 million of cash into its subsidiary bank. With the acquisition, the Company became a bank holding company with its sole operating bank located in Southern Nevada.
The transaction was recorded as an acquisition under the current accounting rules and as a result the balance sheet of Service1st was revalued to fair value as of the acquisition date. Any purchase price in excess of net assets acquired is recorded as goodwill. Based on a purchase price of $17.1 million and the $16.4 million fair value of net assets acquired, the transaction resulted in $5.6 million of goodwill.
The most significant fair value adjustment resulting from the application of purchase accounting adjustment for this acquisition was made to loans. As of the acquisition date, the gross loan portfolio at Service1st Bank was approximately $125.4 million with a related Allowance for Loan and Lease Losses (ALLL) of approximately $9.4 million. The valuation of the loan portfolio resulted in a discount of approximately $15.8 million at October 28, 2010 which was subsequently adjusted to approximately $15.1 million based on additional information after the measurement date, but before the adjustments were considered final. This discount consists of two components; credit discount and yield discount. Loans purchased with credit impairments are loans with credit deterioration since origination and it is probable that not all contractually required principal and interest payments would be collected. The performing loan portfolio was approximately $89.9 million and was discounted by $49,000 for yield and $3.6 million for credit discounts. The remaining $35.6 million of loans were identified as loans with purchased credit impairment (PCI) and those loans had a discount of $576,000 for yield and $10.9 million for credit discounts. The discounts on performing loans are recognized by a level yield method over the remaining life of the loans or loan pools. The loans identified as containing purchase credit impairment are treated somewhat differently. The discount associated with yield is accreted as yield discount and the credit discount is not accreted but is left on the books to reduce the current carrying value of the applicable loans.
In order to assist WLBC in gaining the requisite approval of certain bank regulatory authorities in connection with the Acquisition, on September 23, 2010, WLBC entered into a Letter Agreement (the Warrant Restructuring Letter Agreement) with certain warrant holders who represented to WLBC that they collectively hold at least a majority of its outstanding warrants (the Consenting Warrant Holders) confirming the basis and terms upon which the parties have agreed to amend the Amended and Restated Warrant Agreement, dated as of July 20, 2009, as amended by the Amendment No. 1, dated as of October 9, 2009, each between WLBC and Continental Stock Transfer & Trust Company, as warrant agent (the Warrant Agent) (as amended, the Warrant Agreement), previously filed with the SEC. The Warrant Restructuring Letter Agreement served as the consent and approval of each of the Consenting Warrant Holders to amend and restate the Warrant Agreement. Pursuant to the Warrant Restructuring Letter Agreement, the Warrant Agreement amended where applicable to provide for the automatic exercise of all of the outstanding warrants of WLBC (the Warrants) into one thirty-second (1/32) of one share of WLBCs common stock, par value $0.0001 (Common Stock), which shall occur concurrently with the consummation of the Acquisition (the Automatic Exercise Date). Any Warrants that would entitle a holder of such Warrants to a fractional share of Common Stock after taking into account the automatic exercise of the remainder of such holders Warrants into full shares of Common Stock were cancelled on the Automatic Exercise Date. As of September 23, 2010, there were 48,067,758 Warrants outstanding, each exercisable for one share of Common Stock, which were converted into approximately 1,502,088 shares of Common Stock on the Automatic Exercise Date. As a result of the foregoing, there were no
Warrants outstanding after the Automatic Exercise Date. WLBC also paid a consent fee to the holders of Warrants in an amount equal to $0.06 per Warrant on the Automatic Exercise Date, regardless of whether such holders were party to the Warrant Restructuring Letter Agreement for an aggregate payment of $2.9 million.
On October 28, 2010, the 900 Bank Stock Warrants were converted to 42,834 WLBC stock warrants with an exercise price of $21.01 per stock warrant and all were exercisable at that time. The exercise price was determined in accordance with the Merger Agreement, dated November 6, 2009. The exercise price is calculated by the common stock exchange ratio of 47.5975. Each Service1st stock warrant had an exercise price of $1,000.00. The $1,000.00 is divided by the exchange ratio to create the equivalent exercise price for the Companys stock warrant ($1,000.00 divided by 47.5975 equals $21.01). As of June 30, 2011, the aggregate intrinsic value of outstanding and vested stock warrants is $0.
Note 3. FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy that prioritizes inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, or model-based valuation techniques where all significant assumptions are observable, either directly or indirectly, in the market;
Level 3 Valuation is generated from model-based techniques where all significant assumptions are not observable, either directly or indirectly, in the market. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques may include use of matrix pricing, discounted cash flow models and similar techniques.
Fair value on a recurring basis
Financial assets measured at fair value on a recurring basis include the following:
Securities available for sale
Securities reported as available for sale are reported at fair value utilizing Level 2 inputs. For these securities the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bonds terms and conditions, among other things.
There were no transfers between Levels during 2011.
Fair value on a nonrecurring basis
Certain assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents such assets carried on the balance sheet by caption and by level within the fair value hierarchy.
The specific reserves for collateral dependent impaired loans are based on the fair value of the collateral less estimated costs to sell. The fair value of collateral is determined based on third-party appraisals. In some cases, adjustments are made to the appraised values due to various factors, including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. Accordingly, the resulting fair value measurement has been categorized as a Level 3 measurement. Impaired loans measured for impairment using the fair value of collateral, had a carrying amount of $4.9 million at June 30, 2011 (after netting $2.7 million specific valuation allowance included in the allowance for loan losses). The $4.9 million of impaired loans carried at fair value were the result of certain credit and yield discounts and the aforementioned specific valuation allowance. There have been discounts applied in the amount of $1.1 million on these impaired loans carried at fair value.
Other real estate owned
Other real estate owned consists of properties acquired as a result of, or in-lieu-of, foreclosure. Properties classified as other real estate owned are initially reported at the fair value determined by independent appraisals using appraised value, less cost to sell. Such properties are generally re-appraised every six months. There is risk for subsequent volatility. Costs relating to the development or improvement of the assets are capitalized and costs relating to holding the assets are charged to expense. When significant adjustments
were based on unobservable inputs, such as when a current appraised value is not available or management determines the fair value of the collateral is further impaired below appraised value and there is no observable market price, the resulting fair value measurement has been categorized as a Level 3 measurement. As of June 30, 2011, there was no valuation allowance for the above reported assets.
Fair value of financial instruments
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Companys various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The estimated fair values, and related carrying amounts, of the Companys financial instruments are as follows:
The estimated fair value of the standby letters of credit at June 30, 2011 and December 31, 2010 is insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at June 30, 2011 and December 31, 2010.
Note 4. SECURITIES
Carrying amounts and fair values of investment securities at June 30, 2011 and December 31, 2010 are summarized as follows:
There have been no sales of securities or gross realized gains or losses in any of the periods presented.
As of June 30, 2011 and December 31, 2010, securities of $3.1 and $4.7 million, respectively were pledged for various purposes as required or permitted by law.
Information pertaining to securities with gross losses at June 30, 2011 and December 31, 2010, aggregated by investment category and length of time that individual securities have been in continuous loss position follows:
As of June 30, 2011 and December 31, 2010, six and three debt securities, respectively, have unrealized losses with aggregate degradation less than one percent for both periods from the Companys carrying value. These unrealized losses, totaling $5,000 and $27,000, respectively, relate primarily to fluctuations in the current interest rate environment and other factors, but do not presently represent realized losses. As of June 30, 2011 and December 31, 2010 there are no securities that have been determined to be other-than-temporarily-impaired (OTTI).
The amortized cost and fair value of securities as of June 30, 2011 by contractual maturities are shown below. The maturities of small business administration loan pools differ from their contractual maturities because the loans underlying the securities may be repaid without penalties; therefore, these securities are listed separately in the maturity summary.
Note 5. LOANS
Loans at June 30, 2011 and December 31, 2010 were as follows:
Activity in the allowance for loan losses was as follows:
The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2011 and December 31, 2010:
The impaired balance is the recorded investment, which represents customer balances net of any partial charge-offs recognized on the loans, net of any deferred fees and costs. As nearly all of our impaired loans at June 30, 2011 and December 31, 2010 are on nonaccrual status, recorded investment excludes any insignificant amount of accrued interest receivable on loans 90 days or more past due and still accruing.
Impaired loan details as of June 30, 2011 and December 31, 2010 are as follows:
The following table is a summary of interest recognized and cash-basis interest earned on impaired loans:
The gross year-to-date interest income that would have been recorded in the current period had the nonaccrual loans had been current in accordance with their original terms was $221,000 for the six months ending June 30, 2011 and $0 for the six months ending June 30, 2010.
The following tables present the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of June 30, 2011 and December 31, 2010, respectively:
The following tables present the aging of the recorded investment in past due loans as of June 30, 2011 and December 31, 2010, respectively:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. Generally, performing loans are not subjected to grade reviews unless the loan matures or some event or information occurs that causes the servicing loan officer to re-evaluate the loan grade. Loans that are adversely classified are considered for grade changes in conjunction with preparation of the monthly problem loan reports. The Company uses the following definitions for risk ratings:
Loans in this classification exhibit trends or have weaknesses or potential weaknesses that deserve more than normal management attention. If left uncorrected, these weaknesses may result in the deterioration of the repayment prospects for the asset or in Service1sts credit position at some future date. Special Mention assets pose an elevated level of concern, but their weakness does not yet justify a Substandard classification. Loans in this category are usually performing as agreed, although there may be minor non-compliance with financial or technical covenants.
Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
An asset classified loss is considered uncollectable and of such little value that continuance as bankable assets is not warranted.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans.
As of June 30, 2011 and December 31, 2010, respectively, the risk category, which relate to credit quality indicators, of loans by class of loans, including accrual and non-accrual loans, (net of deferred fees and costs) is as follows:
The Company has purchased loans, for which there was, at acquisition, evidence of credit quality deterioration since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans (including the SBA guaranteed portions) is as follows:
As previously discussed, the October 28, 2010 transaction to acquire Service1st Bank was accounted for as a business combination which resulted in application of fair value accounting to the subsidiarys balance sheet. The total discount to the loan portfolio was approximately $15.1 million at the acquisition date. The loan portfolio was segregated into performing loans and non-performing loans or purchased loans with credit impairment.
The performing loans totaled approximately $89.9 million and were marked with a credit discount of $3.6 million and approximately $49,000 of yield discount. In accordance with current accounting pronouncements, the discounts on performing loans are being recognized on a method that approximates a level yield over the expected life of the loan. During the first half of 2011 approximately $1.0 million of discount was accreted on these loans.
The loans identified as purchased with credit impairments were approximately $35.6 million as of the acquisition date. A credit discount of approximately $10.9 million was recorded and an additional $576,000 of yield discount was also recorded. The yield discount is being recognized on a method that approximates a level yield over the expected life of the loan. The Company does not accrete the credit discount into income until such time as the loan is removed from the bank. The only exception would be on a case-by-case basis when a material event that significantly improves the quality of the loan and reduces the risk to the bank such that management believes it would be prudent to start recognizing some of the discount is documented. The credit discount represents
approximately 30% of the transaction date value of the credit impaired loans. During the first half of 2011, as a result of various loan payoffs, and loan activities, a portion of the credit discount was recognized in earnings.
The following table reflects the discount changes in the purchased credit impaired loan portfolio for the period indicated:
Management does not establish general reserves against purchased credit impaired loans. In the event that deterioration in the credit is identified subsequent to the date of the discount, additional specific reserves will be created. As of June 30, 2011, reserves in the amount of $1.1 million were added relating to the October 28, 2010 purchased credit impaired loan portfolio.
Note 6. GOODWILL AND INTANGIBLES
The excess of the cost of an acquisition over the fair value of the net assets acquired consists of goodwill, and core deposit intangibles. Under ASC Topic 350, goodwill is subject to at least annual assessments for impairment by applying a fair value-based test. The Company reviews goodwill and other intangible assets to determine potential impairment annually, or more frequently if events and circumstances indicate that the asset might be impaired, by comparing the carrying value of the asset with the anticipated future cash flows.
The Company has established October 31 as the date it will use for the annual assessment. The first annual testing for goodwill impairment will occur at October 31, 2011. The carrying value of goodwill at June 30, 2011 is $5,633. No impairment losses were recognized as of June 30, 2011.
The Company has other intangible assets which consist of a core deposit intangible that had, as of June 30, 2011, a remaining average amortization period of approximately nine years.
The following table presents the changes in the carrying amount of the core deposit intangible, gross carrying amount, accumulated amortization, and net book value as of June 30, 2011:
Note 7. OTHER REAL ESTATE ACQUIRED THROUGH FORECLOSURE
The following table presents the changes in other real estate acquired through foreclosure:
During the period, Service1st Bank transferred two properties into other real estate owned and sold one property for a $33,000 gain on the sale of the property. As of June 30, 2011, Service1st Bank had four parcels of property in other real estate acquired through foreclosure.
Note 8. DEPOSITS
The composition of deposits is as follows:
Note 9. STOCK-BASED COMPENSATION
The Company has two share-based compensation programs. A restricted stock program granted to the Companys Chief Executive Officer and Chief Financial Officer and the related stock options associated with Service1st Banks 2007 Stock Option Plan have been fully discussed in the Companys 2010 Form 10-K. No grants were made during the first half of 2011. Total compensation cost that has been charged against income for those programs was approximately $280,000 for the period ended June 30, 2011. There has been no income tax benefit recorded because of the offset in the deferred tax asset valuation allowance. As of June 30, 2011 the aggregate intrinsic value of outstanding and vested stock options is $0.
Note 10. REGULATORY MATTERS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believes as of June 30, 2011, the Company and Bank met all capital adequacy requirements to which they are subject.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If the Bank is only adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At June 30, 2011, the most recent regulatory notifications categorized the Bank as adequately capitalized under the regulatory framework for prompt corrective action. This determination is mandated when an institution becomes party to a formal regulatory action. The Bank cannot be considered well capitalized until the Consent Order is removed. There are no conditions or events since that notification that management believes have changed the institutions category.
Actual capital levels and minimum required levels from June 30, 2011 and December 31, 2010 were as follows:
On September 1, 2010, Service1st, without admitting or denying any possible charges relating to the conduct of its banking operations, agreed with the FDIC and the Nevada FID to the issuance of a Consent Order. The Consent Order supersedes a Memorandum of Understanding entered into by Service1st with the FDIC and Nevada FID in May of 2009. Under the Consent Order, Service1st has agreed, among other things, to: (i) assess the qualification of, and have retained qualified, senior management commensurate with the size and risk profile of Service1st; (ii) maintain a Tier I leverage ratio at or above 8.5% and a total risk-based capital ratio at or above 12%; (iii) continue to maintain an adequate allowance for loan and lease losses; (iv) not pay any dividends without prior bank regulatory approval; (v) formulate and implement a plan to reduce Service1sts risk exposure to adversely classified assets; (vi) not extend any additional credit to any borrower whose loan has been classified as loss; (vii) not extend any additional credit to any borrower whose loan has been classified as Substandard or Doubtful without prior approval from Service1sts board of directors or loan committee; (viii) formulate and implement a plan to reduce risk exposure to its concentration in commercial real estate loans in conformance with Appendix A of Part 365 of the FDICs Rules and Regulations; (ix) formulate and implement a plan to address profitability; and (x) not accept brokered deposits (which includes deposits paying interest rates significantly higher than prevailing rates in Service1sts market area) and reduce its reliance on existing brokered deposits, if any.
During the application process for acquisition of Service1st by WLBC, we made a commitment to the FDIC to maintain the Tier 1 leverage capital ratio of Service1st at 10% or greater until October 28, 2013 or, if later, when the September 1, 2010 Consent Order agreed to by Service1st with the FDIC and the Nevada FID terminates.
Note 11. LEGAL CONTINGENCIES
In the ordinary course of our business, we are party to various legal actions, which we believe are incidental to the operation of our business. Although the ultimate outcome and amount of liability, if any, with respect to these legal actions to which we are currently a party, cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to use, any resulting liability is not likely to have a material adverse effect on the Companys consolidated financial position, results of operations or cash flows.
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q and our combined and consolidated financial statements and related notes thereto included in or incorporated into Part II, Item 8 of our Annual Report on Form 10-K and the Risk Factors included in Part I, Item 1A of our Annual Report on Form 10-K , as well as other cautionary statements and risks described elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K .
References to us, we, our or WLBC refer to Western Liberty Bancorp. The following discussion and analysis of WLBCs financial condition and results of operations should be read in conjunction with the condensed financial statements and the notes thereto contained elsewhere in this report. Certain information contained in the discussion and analysis set forth below includes forward-looking statements that involve risks and uncertainties.
All statements other than statements of historical fact included in this Quarterly Report on Form 10-Q including, without limitation, statements under Managements Discussion and Analysis of Financial Condition and Results of Operations regarding our financial position, business strategy and the plans and objectives of management for future operations, are forward-looking statements. When used in this Quarterly Report on Form 10-Q, words such as anticipate, believe, estimate, expect, intend and similar expressions, as they relate to us or our management, identify forward-looking statements. Such forward-looking statements are based on the beliefs of management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors detailed in our filings with the Securities and Exchange Commission. We wish to caution you not to place undue reliance on these forward-looking statements, which speak only as of the date made. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are qualified in their entirety by this paragraph.
Business of WLBC: WLBC became a bank holding company on October 28, 2010 with consummation of the acquisition of Service1st Bank. Our sole subsidiary is Service1st. We currently conduct no business activities other than acting as the holding company of Service1st.
As a bank holding company, operating from its headquarters and two retail banking locations in the greater Las Vegas area, WLBC provides a variety of loans to its customers, including commercial real estate loans, construction and land development loans, commercial and industrial loans, Small Business Administration (SBA) loans, and to a lesser extent consumer loans. As of June 30, 2011, loans secured by real estate constituted 62.19% of WLBCs loan portfolio. This ratio is calculated by adding together loans secured by real estate at June 30, 2011 (construction, land development and other land loans of $4.1 million, commercial real estate loans of $54.3 million and residential real estate loans of $4.7 million, which total $63.1 million of loans secured by real estate) and dividing this balance by gross loans of $101.5 million at June 30, 2011. WLBC relies on locally-generated deposits to provide WLBC with funds for making loans. The majority of its business is generated in the Nevada market.
WLBC generates substantially all of its revenue from interest on loans and investment securities and service fees and other charges on customer accounts. This revenue is offset by interest expense paid on deposits and other borrowings and non-interest expense such as professional, administrative, and occupancy expenses. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as customer deposits and other borrowings used to fund those assets. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities and the level of nonperforming assets combine to affect net interest income.
WLBC receives fees from its deposit customers in the form of service fees, checking fees and other fees. Other services such as safe deposit and wire transfers provide additional fee income. WLBC may also generate income from time to time from the sale of investment securities. The fees collected by WLBC are found in non-interest income.
Summary of Results of Operations and Financial Condition
This section of Managements Discussion and Analysis does not contain a comparative format for the respective reporting periods of 2011 and 2010. As discussed in Note 1 in the Notes to Unaudited Condensed Consolidated Financial Statements, herein the Company deemed its prior operations as insignificant relative to those of Service 1st. Therefore, we believe such information is not meaningful by way of comparison, and as such it is omitted.
Results of Operations for the Three Months Ended June 30, 2011
For the three months ended June 30, 2011, we had a net loss of $4.6 million or $(0.30) per common share. Our revenue was derived from interest income of $2.1 million and non-interest income of $192,000. Our expenses for the three months ended June 30, 2011 are comprised of $2.4 million in non-interest expense, $4.3 million of loan loss provision expense and $127,000 of interest expense. Non-interest expense is primarily comprised of $765,000 in salaries and employee benefits $520,000 in legal and accounting fees, and $374,000 in occupancy expense as the companys locations are leased. Provision expense totaled $4.3 million for the quarter due to deterioration of the loan portfolio. Interest expense of $127,000 is attributed to interest paid to customers on interest-bearing deposits.
Results of Operations for the Six Months Ended June 30, 2011
For the six months ended June 30, 2011, we had a net loss of $5.0 million or $(0.33) per common share. Our revenue was derived from interest income of $5.9 million and non-interest income of $313,000. Our expenses for the six months ended June 30, 2011 are comprised of $5.3 million in non-interest expense, $5.7 million of loan loss provision expense and $239,000 of interest expense. Non-interest expense is primarily comprised of $1.5 million in legal and accounting fees significantly impacted by SEC filings during the period, $1.6 million in salaries and employee benefits, and $748,000 in occupancy expense as the companys locations are leased. Provision expense totaled $5.7 million for the first half of the year due to further deterioration of the loan portfolio, mostly reported during the second quarter. Interest expense of $239,000 is primarily attributed to interest paid to customers on interest-bearing deposits.
Net Interest Income
The following tables set forth WLBCs average balance sheet, average yields on earning assets, average rates paid on interest-bearing liabilities, net interest margins and net interest income/spread for the periods ended June 30, 2011.
For the Three Months Ended
Net interest income was $2.0 million which included approximately $552,000 of loan discount accretion. The interest rate spread was 3.46% and net interest margin was 3.90% in the second quarter of 2011. During the second quarter of 2011, WLBC sought to closely manage the rates on its deposit base in order to grow deposit balances. Average deposit balances increased $2.5 million as of June 30, 2011 from $76.6 million as of March 31, 2011 to $79.1 million as of June 30, 2011. Overall rates on interest bearing deposit accounts approximated 0.65% for the three months ended June 30, 2011 which resulted in interest expense totaling $127,000. WLBC decreased cash and cash equivalents during the second quarter of 2011 by $1.9 million and certificates of deposit held at other banks by $10.0 million and investment securities portfolio decreased by $2.1 million. (Cash and cash equivalents consist of cash and amounts due from banks, federal funds sold and certificates of deposits with original maturities of three months or less.)
Net interest income continued to be positively impacted in the second quarter of 2011 by accretion of the purchase accounting marks. In addition, WLBC continues to maintain a ratio of average non-interest bearing deposit levels to total deposits of 40%; as of June 30, 2011 the ratio of average non-interest bearing to total deposits was 40.19%.
For the Six Months Ended
Net interest income was $5.7 million which included approximately $2.8 million of loan discount accretion. The interest rate spread was 5.29% and net interest margin was 5.67% during the first six months of 2011. During the first six months of 2011, WLBC sought to closely manage the rates on its deposit base in order to increase its average outstanding deposits. Average deposits decreased $30.4 million as of June 30, 2011 from $161.9 million as of March 31, 2010 to $131.5 million as of June 30, 2011. Overall rates on interest bearing deposit accounts approximated 0.62% for the six months ended June 30, 2011 which resulted in interest expense totaling $239,000. WLBC decreased average cash and cash equivalents during the first six months of 2011 by $4.1 million and certificates of deposit held at other banks by $10.5 million and investment securities portfolio decreased by $2.6 million. (Cash and cash equivalents consist of cash and amounts due from banks, federal funds sold and certificates of deposits with original maturities of three months or less.)
Net interest income continued to be positively impacted in the first six months of 2011. Interest bearing transactional deposits decreased by $12.2 million from the $39.3 million as of December 31, 2010 to $27.1 million as of June 30, 2011 primarily due to $23.5 million of interest bearing deposits that the FDIC deemed to be brokered deposits were eliminated on January 4, 2011. The overall yield on interest bearing deposits was 0.62% as of June 30, 2011. In addition, WLBC continues to maintain a ratio of non-interest bearing deposit levels to total deposits of 40%; as of June 30, 2011 the ratio of average non-interest bearing to total deposits was 40.79%.
Provision for Loan Losses
The provision for loan losses was $4.3 million for the quarter ending June 30, 2011, and $5.7 million for the first six months of 2011. During the second quarter, two previously performing loans became impaired which resulted in a provision of $1.9 million. Two relationships previously identified as impaired required additional reserves in the amount of $800,000. Three loans were charged off requiring additional reserves of approximately $1.2 million. The balance of the provision primarily relates to new loans and certain performing loans that were downgraded.
Non-interest income primarily consists of loan documentation and late fees, service charges on deposits, other fees such as wire, ATM fees, and gains on loans.
Three Months Ended
Non-interest income increased to $192,000 for the three months ended June 30, 2011. This revenue is primarily attributable to $78,000 in service charge income due to a continuing effort by WLBCs management to adhere to fee income policies, including limiting waivers of such fees. Other non-interest income of $106,000 consisted of $40,000 in income from an OREO property, and $33,000 from the sale of an OREO property.
Six Months Ended
Non-interest income was $313,000 for the first six months of 2011. Service charge revenue was $156,000 due to a continuing effort by WLBCs management to adhere to fee income policies, including limiting waiver of fees. Other non interest income was $141,000 for the first six months of 2011 which included $40,000 from income on OREO property, $33,000 from gain on sale of OREO property, plus a $16,000 gain on recovery of purchased loans (which are payments on loans that were charged-off prior to WLBC acquiring Service1st).
The following table sets forth the principal elements of non-interest expenses for the periods ending June 30, 2011 and 2010.
Three Months Ended
Non-interest expense totaled $2.4 million for the three months ended June 30, 2011 compared to $1.7 million for the three months ended June 30, 2010. Salaries and employee benefits grew from $63,000 for the three months ended June 30, 2010, to $765,000 for the three months ended June 30, 2011. In comparing the three months ended June 30, 2011 to June 30, 2010 occupancy grew $374,000, other expenses increased $160,000 primarily from a $109,000 in OREO property expenses, FDIC insurance expense grew $129,000 while computer service charges increased $74,000. These increases were all attributed to WLBCs acquisition of Service1st. Professional fees decreased $351,000 from $871,000 for the three months ended June 30, 2010 to $520,000 for the three months ended June 30, 2011. This decrease is attributed to WLBCs management attempting to reduce legal, accounting and consulting expenses as acquisition activity subsides in 2011. In addition, stock based compensation expense decreased $493,000 between the periods. In 2010, the Company was accruing for the previously approved stock grant awards.
Six Months Ended
Non-interest expense totaled $5.3 million for the six months ended June 30, 2011 compared to $3.4 million for the six months ended June 30, 2010. Salaries and employee benefits grew from $138,000 for the six months ended June 30, 2010, to $1.6 million for the six months ended June 30, 2011. In comparing the six months ended June 30, 2011 to June 30, 2010 occupancy grew $748,000, other
expense increased $323,000 primarily from $111,000 in OREO property expense, FDIC Insurance grew $281,000, and computer charges increased $151,000 while telephone expense grew $43,000. These increases were all attributed to WLBCs acquisition of Service1st. Professional fees decreased $271,000 from $1.7 million for the six months ended June 30, 2010 to $1.5 million for six months ended June 30, 2011. This decrease is attributed to WLBCs management attempting to reduce legal, accounting and consulting expenses. In addition, stock based compensation expense decreased $982,000 from the six month period in 2010. As previously reported, the company was accruing $1,850,000 of stock compensation expense over an estimated vesting period of 266 days.
Due to WLBC incurring operating losses from inception, no provision for income taxes has been recorded since the inception of WLBC.
Supplemental Results of Operation Information for Predecessors
The following information represents a discussion and analysis of the results of operations of the Companys predecessor for the six months ended June 30, 2010.
Service1st Bank of Nevada
Results of Operations
For the six months ended June 30, 2010 Service1st reported a net loss was $4.0 million.
Net interest income was $3.4 million for the six months ended June 30, 2010. This resulted in a net interest margin of 3.4%.
For the six months ended June 30, 2010, Service1st recorded $3.2 million provision for loan losses.
For the six months ended June 30, 2010, non-interest income was $306,000. Service charges on deposit accounts represented 79% of total non-interest income.
For the six months ended June 30, 2010, non-interest expenses were $4.5 million. Salaries and employee benefits were $1.9 million. Other overhead costs during the first half of 2010 included professional fees of $993,000, occupancy expense of $844,000, data processing expenses of $145,000, FDIC insurance expense of $248,000, and other expenses of $305,000.
No income tax expense was recorded for six months ended June 30, 2010.
Total assets were at $223.3 million as of June 30, 2011, a decrease of $34.2 million, from $257.5 million as of December 31, 2010. The decrease was principally attributable to a $28.7 million decrease in deposits. WLBC eliminated $23.5 million in deposits on January 4, 2011 so that the Company would be in compliance with its September 1, 2010 Consent Order in which the FDIC deemed a certain deposit to be brokered. As a result of deposits dropping $23.5 million, cash and cash equivalents (consisting of cash and due from banks, federal funds sold and certificates of deposits with original maturities of three months or less), decreased slightly while certificate of deposits held at other banks decreased $22.7 million as the Company decided to allow maturing certificates of deposits held at other institutions for investment purposes, not to be reinvested.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and due from banks, federal funds sold and certificates of deposits with original maturities of three months or less. Cash and cash equivalents totaled $103.4 million at June 30, 2011 and $103.2 million at December 31, 2010. Cash and cash equivalents are managed based upon liquidity needs, investment opportunities and risk adjusted
returns on any investments. The current low yield on investment securities coupled with the market risk warrants keeping funds in the most secure opportunities in managements view. Immediate liquidity allows funding of high quality loans when available.
Investment Securities and Certificates of Deposits held at other Banks
WLBC invests in investment grade securities and certificates of deposits at other banks with original maturities exceeding three months for the following reasons: (i) such investments can be readily reduced in size to provide liquidity for loan fundings or deposit withdrawals; (ii) investment securities provide a source of assets to pledge to secure lines of credit (and, potentially, deposits from governmental entities), as may be required by law or by specific agreement with a depositor or lender; (iii) they can be used as an interest rate risk management tool, since they provide a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of WLBC; and (iv) they represent an alternative interest-earning use of funds when loan demand is weak or when deposits grow more rapidly than loans.
Certificates of deposits consist of investments of $250,000 or less, in bank CDs throughout the United States of America. Certificates of deposit totaled $4.2 million at June 30, 2011 and $26.9 million at December 31, 2010. Certificates of deposits are managed based on liquidity needs. The $22.7 million decrease in certificates of deposits since year end is directly related to the $23.5 million in interest-bearing checking which was wired out of the bank on January 4, 2011 so that the Company would be in compliance with its September 1, 2010 Consent Order in which the FDIC deemed a certain depository account relationship to be brokered. As a result of the $23.5 million leaving, bank management decided not to reinvest these funds.
WLBC uses two portfolio classifications for its investment securities: Held to Maturity, and Available for Sale. The Held to Maturity portfolio consists only of securities that WLBC has both the intent and ability to hold until maturity, to be sold only in the event of concerns with an issuers credit worthiness, a change in tax law that eliminates their tax exempt status, or other infrequent situations as permitted by generally accepted accounting principles. Accounting guidance requires Available for Sale securities to be marked to estimated fair value with an offset, net of taxes, to accumulated other comprehensive income, a component of stockholders equity.
WLBCs investment portfolio is currently composed primarily of: (i) U.S. Government Agency securities; (ii) investment grade corporate debt securities; and (iii) collateralized mortgage obligations. At June 30, 2011, investment securities totaled $4.5 million, a decrease of 36.69% or $2.6 million, compared with $7.1 million at December 31, 2010.
WLBC has not used interest rate swaps or other derivative instruments to hedge fixed rate loans or to otherwise mitigate interest rate risk.
Gross loans, net of deferred fees and the allowance for loan losses, decreased $9.1 million from $106.2 million as of December 31, 2010 to $97.1 million as of June 30, 2011, primarily as a result of $8.3 million in new loans less $9.7 million in payoffs and paydowns, $1.3 million in charged off loans, $2.0 million in loans being reclassified to other real estate owned (OREO), and an increase in the allowance for loan losses of $4.4 million.
Residential real estate decreased $4.5 million, from $9.2 million as of December 31, 2010 to $4.7 million as of June 30, 2011 primarily due to the payoff of two large residential real estate loans, the first loan for $2.3 million, the second for $2.9 million.
Commercial real estate decreased $669,000, from $55.0 million as of December 31, 2010 to $54.3 million as of June 30, 2011 primarily due to the paydowns being mostly offset by new loan originations.
Construction, land development and other land loans decreased $1.8 million, from $5.9 million as of December 31, 2010 to $4.1 million as of June 30, 2011 primarily due to $2.0 million in loans being reclassified to OREO and $114,000 loan balance being charged off.
Commercial and industrial loans increased $2.4 million primarily due to the origination of forty-one new loans totaling $6.4 million in the first quarter 2011 less charge-offs of $1.2 million and payoffs and paydowns of $2.8 million.
The following table summarizes nonperforming assets by category including loans purchased with credit impairment with no contractual interest being reported.
Other Real Estate Owned
Other real estate owned (OREO) increased $1.0 million from $3.4 million as of December 31, 2010 to $4.4 million as of June 30, 2011 when a $2.0 million construction, land and other land loan was moved to the classification of OREO as of February 28, 2011. The sale of one parcel of property for $1.0 million was completed during the second quarter of 2011. This sale resulted in a $33,000 gain being recorded.
WLBCs deposit activities are based in Nevada and primarily generated from this local area. Deposits have historically been the primary source for funding asset growth. As of June 30, 2011 the company has no brokered deposits.
During the first quarter of 2011 the company sought to manage rates on its deposit base in order to increase its net interest income, interest rate spread and net interest margin. Deposits decreased $28.7 million or 17.91% as of June 30, 2011 from $160.3 million as of December 31, 2010 to $131.6 million as of June 30, 2011.
Interest-bearing transactional deposits decreased $22.8 million from $57.8 million as of December 31, 2010 to $35.0 million as of June 30, 2011 primarily as a result of the company eliminating $23.5 million on January 4, 2011 in order for WLBC to remain in compliance with the Consent Order issued September 1, 2010 which deemed a certain depository account as a brokered deposit.
Non-interest bearing checking accounts decreased $12.5 million or 18.63% from $67.1 million as of December 31, 2010 to $54.6 million as of June 30, 2011 primarily due to escrowed funds being utilized for major construction projects during the early months of 2011.
The current and projected capital position of WLBC and the impact of capital plans on long term strategies are reviewed regularly by management. WLBCs capital position represents the level of capital available to support continuing operations and expansion.
Service1st is subject to certain regulatory capital requirements mandated by the FDIC and generally applicable to all banks in the United States. Failure to meet minimum capital requirements can result in restrictions on activities (including restrictions on the rates paid on deposits), and otherwise may cause federal or state bank regulators to initiate enforcement and/or other action against WLBC or the subsidiary bank. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, banks 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. Service1sts capital amounts and classifications are also subject to qualitative judgments by the FDIC about components, risk weightings and other factors. In accordance with Service1sts Consent Order dated September 1, 2010, Service1st must maintain its Tier 1 capital in such an amount to ensure that its leverage ratio equals or exceeds 8.5%.
As of June 30, 2011, WLBCs capital was $89.1 million, which WLBC deems adequate to support continuing operations and growth. As a de novo bank, Service1st is required to maintain a Tier 1 capital leverage ratio of not less than 8.0% during Service1sts first seven years of operations. As a commitment made to the FDIC during acquisition application processing, we also agreed to maintain the Tier 1 leverage capital ratio of Service1st at 10% or greater until October 28, 2013 or, if later, when the September 1, 2010 Consent Order agreed to by Service1st with the FDIC and the Nevada Financial Institutions Division terminates.
WLBCs capital ratios at June 30, 2011 and December 31, 2010 respectively, relative to the ratios required of banks under the prompt corrective action regime or other requirements put in place by federal banking regulations, are as follows:
Liquidity and Asset/Liability Management
Liquidity management refers to WLBCs ability to provide funds on an ongoing basis to meet fluctuations in deposit levels as well as the credit needs and requirements of its clients. Both assets and liabilities contribute to WLBCs liquidity position. Lines of credit with the regional Federal Reserve Bank and FHLB, as well as short term investments, increases in deposits and loan repayments all contribute to liquidity while loan funding, investing and deposit withdrawals decrease liquidity. WLBC assesses the likelihood of projected funding requirements by reviewing current and forecasted economic conditions and individual client funding needs.
WLBCs sources of liquidity consist of cash and due from correspondent banks, overnight funds sold to correspondents and the Federal Reserve Bank, certificates of deposits at other financial institution (non-brokered), unpledged security investments and lines of credit with the Pacific Coast Bankers Bank, Federal Reserve Bank of San Francisco and FHLB of San Francisco. For the period ended June 30, 2011, WLBC had approximately $103.4 million in cash and cash equivalents, approximately $4.2 million in certificates of deposits at other financial institutions, with maturities of one year or less. In addition, WLBC had $1.4 million in unpledged security investments, of which $824,000 is classified as available for sale, while the remaining $620,000 is classified as held to maturity. WLBC also has a $2.6 million collateralized line of credit with the Federal Reserve Bank of San Francisco and a $16.5 million collateralized line of credit with the Federal Home Loan Bank of San Francisco. In addition, an unsecured Fed Funds facility with Pacific Coast Bankers Bank in the amount of $5.0 million was established in March 2011. As of June 30, 2011, all of the lines have a zero balance.
Liquidity is also affected by portfolio maturities and the effect of interest rate fluctuations on the marketability of both assets and liabilities. WLBC can sell any of its unpledged securities held in the available for sale category to meet liquidity needs. These securities are also available to pledge as collateral for borrowings, if the need should arise.
WLBCs management believes the level of liquid assets and available credit facilities are sufficient to meet current and anticipated funding needs during the next twelve months. In addition, Service1st Banks Asset/Liability Management Committee oversees Service1st Banks liquidity position by reviewing a monthly liquidity report. While management recognizes that Service1st may use some of its existing liquidity to issue loans during the next twelve months, it is not aware of any trends, demands, commitments, events or uncertainties that are reasonably likely to impair WLBCs liquidity.
Commitments and Contingencies
The Company is a party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, and letters of credit. To varying degrees, these instruments involve elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position.
WLBC maintains an allowance for unfunded commitments, based on the level and quality of WLBCs undisbursed loan funds, which comprises the majority of WLBCs off-balance sheet risk. For the periods ended June 30, 2011 and December 31 2010, respectively, the allowance for unfunded commitments was approximately $35,000, and $372,000 respectively.
Application of Critical Accounting Policies and Estimates
Managements Discussion and Analysis of Financial Condition and Results of Operations discusses the Companys condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, the disclosure of contingent assets and liabilities in the financial statements and the accompanying notes, and the reported amounts of revenue and expenses during the periods presented. On an on-going basis, management evaluates its estimates and judgments, including those related to allowances for loan losses, bad debts, investments, financing operations, contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which have formed the basis for making such judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual amounts and results could differ from the recorded estimates under different assumptions or conditions. A summary of critical accounting policies and estimates are listed in the Managements Discussion and Analysis of Financial Condition and Results of Operations section of the Companys 2010 Annual Report Form 10-K for the fiscal year ended December 31, 2010. There have been no significant changes to the critical accounting policies listed in the Companys 2010 Annual Report Form 10-K during 2011.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. There have been no material changes in market risk as of June 30, 2011 to the disclosures included in the Companys Annual Report on Form 10-K for the year ended December 31, 2010.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Based on an evaluation under the supervision and with the participation of our management (including our Chief Executive Officer and Chief Financial Officer), our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), were effective as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and (ii) accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially effect, our internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 1A. RISK FACTORS
As of August 1, 2011, there have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010 filed with the SEC, except we may disclose changes to such risk factors or disclose additional risk factors from time to time in our future filings with the SEC.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. (REMOVED AND RESERVED)
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
The following exhibits are filed as part of, or incorporated by reference into, this Quarterly Report on Form 10-Q.
Pursuant to the requirements of Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.